2-1 A FURTHER LOOK AT FINANCIAL STATEMENTS Accounting, Fifth Edition 2.
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Transcript of 2-1 A FURTHER LOOK AT FINANCIAL STATEMENTS Accounting, Fifth Edition 2.
2-1
A FURTHER LOOK AT FINANCIAL STATEMENTS
Accounting, Fifth Edition
2
2-2
After studying this chapter, you should be able to:After studying this chapter, you should be able to:
1. Identify the sections of a classified balance sheet.
2. Identify tools for analyzing financial statements and ratios for
computing a company’s profitability.
3. Identify and compute ratios for analyzing a company’s liquidity and
solvency using a balance sheet.
4. Explain the meaning of generally accepted accounting principles.
5. Discuss financial reporting concepts.
Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives
2-3
Communicating with UsersCommunicating with UsersCommunicating with UsersCommunicating with Users
Balance Sheet Reports assets and claims
to assets at a specific
point in time.
Assets = Liabilities +
Stockholders’ Equity.
Lists assets first, followed
by liabilities and
stockholders’ equity.
Illustration 1-7
Helpful Hint The heading of a balance sheet must identify the
company, the statement, and the date.
2-4
The The ClassifiedClassified Balance Sheet Balance SheetThe The ClassifiedClassified Balance Sheet Balance Sheet
LO 1 Identify the sections of a classified balance sheet.
Presents a snapshot at a point in time.
To improve understanding, companies group similar
assets and similar liabilities together.
Illustration 2-1Standard Classifications
2-5
Illustration 2-2
The Classified Balance Sheet - AssetsThe Classified Balance Sheet - AssetsThe Classified Balance Sheet - AssetsThe Classified Balance Sheet - Assets
LO 1
2-6
Classified Balance Sheet – Current AssetsClassified Balance Sheet – Current AssetsClassified Balance Sheet – Current AssetsClassified Balance Sheet – Current Assets
LO 1 Identify the sections of a classified balance sheet.
Assets that a company expects to convert to cash or use
up within one year or the operating cycle, whichever is
longer.
Operating cycle is the average time it takes from the
purchase of inventory to the collection of cash from
customers.
Common types of current assets are (1) cash, (2)
investments, (3) receivables, (4) inventories, and (5)
prepaid expenses.
Current Assets
2-7
Classified Balance Sheet – Current AssetsClassified Balance Sheet – Current AssetsClassified Balance Sheet – Current AssetsClassified Balance Sheet – Current Assets
LO 1 Identify the sections of a classified balance sheet.
Companies list current asset accounts in the order they expect to convert them into cash.
Current AssetsIllustration 2-3
2-8
Classified Balance Sheet – LT InvestmentsClassified Balance Sheet – LT InvestmentsClassified Balance Sheet – LT InvestmentsClassified Balance Sheet – LT Investments
LO 1
Investments in stocks and bonds of other corporations that
are held for more than one year.
Long-term assets such as land or buildings that a company
is not currently using in its operating activities.
Long-term notes receivable.
Long-Term Investments
Illustration 2-4
Alternative TerminologyLong-term investments are often referred to simply as investments.
2-9
Property, Plant, and Equipment
Classified Balance Sheet – PP&EClassified Balance Sheet – PP&EClassified Balance Sheet – PP&EClassified Balance Sheet – PP&E
LO 1 Identify the sections of a classified balance sheet.
Long useful lives.
Currently used in operations.
Includes land, buildings, equipment, delivery vehicles, and
furniture.
Depreciation - allocating the cost of assets to a number of
years.
Accumulated depreciation - total amount of depreciation
expensed thus far in the asset’s life.
Alternative TerminologyProperty, plant, and equipment is sometimes called fixed assets or plant assets.
2-10
Classified Balance Sheet – PP&EClassified Balance Sheet – PP&EClassified Balance Sheet – PP&EClassified Balance Sheet – PP&E
LO 1 Identify the sections of a classified balance sheet.
Illustration 2-5
Property, Plant, and Equipment
2-11
Intangible Assets
Classified Balance Sheet – Intang AssetsClassified Balance Sheet – Intang AssetsClassified Balance Sheet – Intang AssetsClassified Balance Sheet – Intang Assets
LO 1
Assets that do not have physical substance.
Includes goodwill, patents, copyrights, and trademarks or trade names.
Illustration 2-6
Helpful Hint Sometimes intangible assets are reportedunder a broader heading called “Other assets.”
2-12
Ex 2-4Ex 2-4Ex 2-4Ex 2-4
2-13
Illustration 2-2
Classified Balance Sheet - LiabilitiesClassified Balance Sheet - LiabilitiesClassified Balance Sheet - LiabilitiesClassified Balance Sheet - Liabilities
LO 1
2-14
Classified Balance Sheet – Current LiabsClassified Balance Sheet – Current LiabsClassified Balance Sheet – Current LiabsClassified Balance Sheet – Current Liabs
LO 1 Identify the sections of a classified balance sheet.
Obligations the company is to pay within the next year or
operating cycle, whichever is longer.
Common examples are accounts payable, salaries and
wages payable, notes payable, interest payable, and income
taxes payable.
Also included as current liabilities are current maturities
of long-term obligations—payments to be made within the
next year on long-term obligations.
Current Liabilities
2-15
Classified Balance Sheet – Current LiabsClassified Balance Sheet – Current LiabsClassified Balance Sheet – Current LiabsClassified Balance Sheet – Current Liabs
LO 1 Identify the sections of a classified balance sheet.
Illustration 2-7
Current Liabilities
2-16
Classified Balance Sheet – LT LiabsClassified Balance Sheet – LT LiabsClassified Balance Sheet – LT LiabsClassified Balance Sheet – LT Liabs
LO 1 Identify the sections of a classified balance sheet.
Obligations a company expects to pay after one year.
Include bonds payable, mortgages payable, long-term
notes payable, lease liabilities, and pension liabilities.Illustration 2-8
Long-Term Liabilities
2-17
Classified Balance Sheet - EquityClassified Balance Sheet - EquityClassified Balance Sheet - EquityClassified Balance Sheet - Equity
LO 1 Identify the sections of a classified balance sheet.
Illustration 2-2
Common stock - investments of assets into the business by
the stockholders.
Retained earnings - income retained for use in the business.
Stockholders’ Equity
2-18
CL Salaries and wages payable LTI Investment in real estate
NA Service revenue PPE Equipment
CL Interest payable PPE Accumulated depreciation
IA Goodwill CA Debt investments (short-term)
NA Depreciation expense SE Retained earnings
LTL Mortgage payable CL Unearned service revenue
(due in 3 years)
Match each of the items to its proper balance sheet classification,
shown below. If the item would not appear on a balance sheet, use “NA.”
Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Long-term liabilities (LTL)
Property, plant, and equipment (PPE) Stockholders’ equity (SE)
Intangible assets (IA)
Solution
LO 1
2-19
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
Ratio Analysis – Tells the real story
Ratio analysis expresses the relationship among selected
items of financial statement data.
A ratio expresses the mathematical relationship between
one quantity and another.
A single ratio by itself is not very meaningful.
LO 2 Identify tools for analyzing financial statements and ratios for computing a company’s profitability.
2-20
Using the Financial StatementsUsing the Financial StatementsUsing the Financial StatementsUsing the Financial Statements
LO 2 Identify tools for analyzing financial statements and ratios for computing a company’s profitability.
Illustration 2-9 Financial ratio classifications
2-21
Financial Ratios for Ch 2Financial Ratios for Ch 2Financial Ratios for Ch 2Financial Ratios for Ch 2
Earnings per Share Earnings per Share (Profitability ratio)(Profitability ratio)
Net Income – Preferred DividendsNet Income – Preferred Dividends
AverageAverage Common Shares Outstanding Common Shares Outstanding
Working Capital Working Capital (Liquidity ratio)(Liquidity ratio)
Current Assets – Current LiabilitiesCurrent Assets – Current Liabilities
Debt to Assets Debt to Assets (Solvency ratio)(Solvency ratio)
Total LiabilitiesTotal Liabilities
Total AssetsTotal Assets
2-22LO 2
Using the Income StatementUsing the Income StatementUsing the Income StatementUsing the Income Statement
Illustration: Earnings per share (EPS) measures the net income earned on each share of common stock.
$1,277
(393
- $0
+ 419) 2=
$3.14
$1,317
(419
- $0
+ 414) 2=
$3.16
Illustration 2-11
Best Buy
Profitability Ratio
2-23
Using the Using the Financial Financial StatementsStatements
Using the Using the Financial Financial StatementsStatements
Using a
Classified
Balance Sheet
Illustration 2-13
2-24
Using a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance Sheet
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.
Liquidity—the ability to pay obligations expected to become
due within the next year or operating cycle.Illustration 2-14
Working capital is the difference between the amounts of current assets and current liabilities.
Best Buy had working capital in 2011 of $1,810 million ($10,473 million - $8,663 million).
2-25
Using a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance Sheet
Liquidity ratios measure the short-term ability to pay maturing
obligations and to meet unexpected needs for cash.Illustration 2-15
For every dollar of current liabilities, Best Buy has $1.21 of current assets.
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.
Liquidity Ratio
2-26
Solvency—the ability to pay interest as it comes due and to
repay the balance of a debt due at its maturity.
Solvency ratios measure the ability of the company to
survive over a long period of time.
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.
Using a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance Sheet
Helpful Hint Some users evaluate solvency using a ratio of liabilities divided by stockholders’ equity. The higher this “debt to equity” ratio, the lower is a company’s solvency.
2-27
The 2011 ratio means that every dollar of assets was financed by 59 cents of debt.
Using a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance SheetUsing a Classified Balance Sheet
Debt to assets ratio measures the percentage of total financing
provided by creditors rather than stockholders.Illustration 2-16
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.
Solvency Ratio
2-28
Do it! Review 2-3 (a-b) page 76Do it! Review 2-3 (a-b) page 76Do it! Review 2-3 (a-b) page 76Do it! Review 2-3 (a-b) page 76
2-29
2-30
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
The Standard-Setting Environment
International Note Over 115 countries use international standards (called IFRS).
LO 6 Explain the meaning of generally
accepted accounting principles.
U.S. Global
Rule Maker FASB (Fin’l Acctg Stds Board) issues broad & specific US accounting principles.
IASB (Int’l Acctg Stds Board ) issues preferred accounting practices in other countries.
Rules GAAP (Generally Accepted Accounting Principles)
IFRS (Int’l Financial Reporting Standards)
Police/Enforcers SEC (Securities & Exchange Commission)
IFRS not enforceable BUT recommended.
US Reqm’ts US GAAP req’d for US SEC Registrants
IFRS or GAAP for non-US SEC Registrants
It seems unlikely that IFRS will be mandated soon given the new SEC Chairman’s focus on investor
protections & securities law enforcement. However US GAAP & IFRS accounting standards continue to converge SO US companies are being impacted by
IFRS. (Apr 2013)
2-31
IdentifiesIdentifies
RecordsRecords
CommunicatesCommunicatesRelevantRelevant
ReliableReliable
ComparableComparable
AccountingAccountingis a
system that
information
that is
to help users make better decisions.
to help users make better decisions.
GAAP
Importance of AccountingImportance of AccountingImportance of AccountingImportance of Accounting
2-32
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Qualities of Useful Information
LO 7
According to the FASB, useful information should possess two
fundamental qualities, relevance and faithful representation.
Relevance Accounting information has relevance if it would
make a difference in a business decision. Information is
considered relevant if it provides information that has
predictive value, that is, helps provide accurate expectations
about the future, and has confirmatory value, that is,
confirms or corrects prior expectations. Materiality is a
company-specific aspect of relevance. An item is material
when its size makes it likely to influence the decision of an
investor or creditor.
2-33
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Qualities of Useful Information
According to the FASB, useful information should possess two
fundamental qualities, relevance and faithful representation.
Faithful Representation Faithful representation means
that information accurately depicts what really happened. To
provide a faithful representation, information must be
complete (nothing important has been omitted), neutral (is
not biased toward one position or another), and free from
error.
LO 7 Discuss financial reporting concepts.
2-34
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Enhancing Qualities
Comparability results when
different companies use the same
accounting principles.
Consistency means that a company uses the same accounting
principles and methods from year to year.
Information is verifiable if independent
observers, using the same methods, obtain
similar results.
For accounting information to have relevance, it must be
timely.
Information has the quality of
understandabilityif it is presented in a clear and concise
fashion.
LO 7 Discuss financial reporting concepts.
Qualities of Useful Information
2-35
2-36
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Assumptions in Financial Reporting
LO 7 Discuss financial reporting concepts.
Monetary Unit Economic Entity
Illustration 2-18
Requires that only those things that can be expressed in money are included in the
accounting records.
States that every economic entity can be separately
identified and accounted for.
2-37
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Assumptions in Financial Reporting
LO 7 Discuss financial reporting concepts.
Illustration 2-18
Going Concern
The business will remain in operation for the
foreseeable future.
Periodicity
States that the life of a business can be divided into
artificial time periods.
2-38
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Principles in Financial Reporting
LO 7 Discuss financial reporting concepts.
Measurement Principles
Historical Cost Fair Value Full disclosure
Or cost principle, dictates that
companies record assets at their
cost.
Indicates that assets and
liabilities should be reported at fair value (the price
received to sell an asset or settle
a liability).
Requires that companies disclose all circumstancesand events that would make a difference to
financial statement users.
2-39
Financial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting ConceptsFinancial Reporting Concepts
Cost Constraint
Cost Constraint
Accounting standard-setters weigh the cost that companies will incur to provide the information against the
benefit that financial statement users will gain from having the
information available.
LO 7 Discuss financial reporting concepts.