W. F. BentzA&MIS 521 1 Financial Accounting I William F. Bentz Sessions 9 and 10.

W. F. Bentz A&MIS 521 1

Financial Accounting I

William F. Bentz

Sessions 9 and 10


Statement of Financial Position

the statement of financial position, a primary financial statement,

reporting standards and objectives for contingencies, and

the effect of subsequent events on financial reporting.


Statements of Financial Position (SFP)

Amount and composition of assets, liabilities & equities reported» Classification of assets and liabilities as

current or noncurrent

» Information about working capital

» Information about asset liquidity

» Information about the use of leverage

» Equity interests of stockholder groups


Current versus Noncurrent

Current assets are those assets that will be converted into cash, used to reduce current liabilities, or consumed (as expenses) in the operation of the business over one year or the operating cycle, whichever is longer.


Current versus Noncurrent

Current liabilities are obligations that will come due or be satisfied within one year or the operating cycle, whichever is longer.

All other liabilities are long-term liabilities.


Working capital (gross)

Working capital represents the liquid assets available to operate a business. Cash, accounts receivable, and marketable securities are short-term sources of purchasing power. Inventories are available for sale or use in the business. Prepaid expenses represents goods and services that have been paid for in advance.


Working capital

Current liabilities are those obligations that must be repaid with current assets or cash flows from operations. Thus, current liabilities represent a drain on the liquid assets available to operate a business.


Net working capital

Net working capital is equal to total current assets minus total current liabilities. Net working capital is the preferred measure of the liquid resources available to operate a business, because it recognizes the obligations--current liabilities--that will require resources within the next operating cycle.


Net working capital

Net working capital is thus an important measure of the solvency and financial flexibility of an enterprise.


Stockholders’ equity

Stockholders’ equity is the total residual interest of equity investors in the assets of the entity» Contributed capital--Investment from

the owners (par value + paid-in capital)

» Earned capital--Undistributed cumulative earnings of the entity (retained earnings)



Contributed capital» Par value of common and any

preferred stocks

» Paid-in capital in excess of par values Earned capital--The cumulative

undistributed earnings of the entity (retained earnings = cumulative income - cumulative dividends)



Treasury stock consists of the historical cost of common or preferred shares that have been repurchased by the corporation directly from its investors or in the open market.

Reported as a deduction from stockholders’ equity because it represents a reduction in the investment in the firm


Contingencies

A contingency is an issue that is unresolved as of the end of a reporting period, the resolution of which is subject to significant risk and uncertainty.


A contingency

Depends on an external party, event, or conditions for resolution

Is not controllable by the company, i.e. is contingent on conditions of nature or the actions of others

Results from a past transaction, condition, or event


Examples of contingencies

Outcome of a lawsuit regarding patent or copyright dispute

Outcome of a product liability suit Provision for current income taxes Outcome of an income tax

negotiation or court case concerning prior years


More examples

Provision for uncollectible accounts and notes receivable

Provision for product warranty costs Estimated useful lives of assets Estimated value of an acquired

company


Recognition - contingent gains

Contingent gains are not recognized in the financial statements

Contingent gain amounts are rarely mentioned in footnote or parenthetical disclosures

There may be some mention by management of an expected contingent gain in the section called MD&A--Management Discussion & Analysis.


Recognition - contingent gains

Disclosure of prospective contingent gains is apt to be in the form of press releases and presentations to financial analysts.

Consequence: financial reports tend to understate the contingent gains that may be available to an entity. However, most such one-time events are ignored by investors anyway.


Recognition - contingent losses

There are three issues to consider when deciding how to report loss contingencies:

1. Issue one is the probability of loss

2. Issue two is the ability of the company to estimate the loss with acceptable accuracy


Recognition - contingent losses

3. Issue three is the materiality of the expected contingent loss.


Losses that must be accrued in the accounts

1. A loss is more probable than not (Pr > 0.5).

2. The probable loss is material in amount.

3. The magnitude of the loss is “reasonably” estimable.

Note: In the case of estimates and forecasts, some loss (cost) will occur, so the only remaining issues are materiality and estimableness.


Losses that are not accrued, but are footnoted

Losses that are less probable than not (Pr < 0.5) OR are not reasonably estimable

Losses that are more probable than not (Pr > 0.5), BUT are not reasonably estimable


Losses not disclosed in the financial statements

Losses that are only remotely possible.

Losses that are not specific in nature or are part of the normal risk of being in business

Six possible combinations of estimability & probability.

Estimable Not estimable

Probable Pr > 0.5

Accrue & Footnote

Footnote Disclosure

Possible Pr < 0.5

Footnote Disclosure

Footnote Disclosure

Remote No Disclosure No Disclosure

Reporting Contingencies

Reasonably Estimable?

Probability


Contingent losses Current reporting practice is consistent

with the full and prompt disclosure of information that is material to investor decisions. By reporting bad news as soon as it is known, companies hope to earn the confidence of investors and financial analysts. Conservatism argues for the early recognition of losses, while recognizing gains only when realized.


Subsequent events

Sub-se-quent (sub′si kwant), adj.

1. Occurring or coming later or after: subsequent events.

The Random House Dictionary of the English Language (2nd ed.)


Subsequent events These are events that occur after the

end of a fiscal year, but before the audited financial statements for that year have been issued.

Type 1 subsequent events have their origins in the fiscal year just ended and provide confirming or disconfirming information.


Subsequent Events-2 Type one subsequent events may result

in the revision of estimates or other adjustments in light of the information that becomes available after year-end, but before the related statements are issued. When appropriate, the accounts involved are adjusted to reflect the new information.


Subsequent Events-3 Type two subsequent events do not relate

to the year just ended, but they constitute important information that should be disclosed to investors. However, since the information is not based in a prior year, no adjustments are made to the financial statements. Instead, type 2 events are disclosed in the footnotes to the prior year statements.


Statements of Financial Position

Aka balance sheets

W. F. BentzA&MIS 521 1 Financial Accounting I William F. Bentz Sessions 9 and 10.

Documents

Transcript of W. F. BentzA&MIS 521 1 Financial Accounting I William F. Bentz Sessions 9 and 10.