accounting, fifth edition

2-1

A FURTHER LOOK AT THE FINANCIAL STATEMENTS

Accounting, Fifth Edition

2

Spring 2016

2-2

The The ClassifiedClassified Balance Sheet Balance Sheet The B/S presents a snapshot at a point in time.

To improve understanding, companies group similar assets and similar liabilities together in a specific order.

Standard Classifications

Assets S/EL

Common Stock & Retained Earnings

2-3

The Classified Balance SheetThe Classified Balance SheetThese are just the Assets. The Liabilities and Owner’s Equity are on the next slide.

2-4

Illustration 2-2

The Classified Balance SheetThe Classified Balance Sheet

These are just the Liabilities and Owner’s Equity. Assets are on the previous slide.

2-5

The Classified Balance SheetThe 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 (the operating cycle is seldom used).

The operating cycle is the average time it takes from the purchase of inventory to the collection of cash from customers. If there’s no inventory (only a service is being provided) then the operating cycle is much shorter.

Common types of current assets are (1) cash, (2) short term investments, (3) receivables, (4) inventories, and (5) prepaid expenses.

Current Assets

2-6

The Classified Balance SheetThe Classified Balance Sheet

Companies list current assets in the order they expect to convert them into cash. Note “in millions” means you have to add 6 zeros! It’s actually over 2 billion! These are all discussed in the NOTES to the F/S

Current Assets

$2,601,000,000

2-7

The Classified Balance SheetThe Classified Balance Sheet

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 (you plan to resell them for a profit at a later date).

Long-term notes receivable.

Long-Term Investments Long-term investments are often referred to simply as investments.

$90,266,000

Note only 3 zeros (in thousands) were added.

2-8

Property, Plant, and Equipment

The Classified Balance SheetThe Classified Balance Sheet

Long useful lives of more than 1 year

Currently used in operations (not as a long term investment)

Includes land, buildings, equipment, vehicles, and furniture.

Depreciation - allocating the cost of assets to a number of years (more than 1 year).

Accumulated depreciation – the total amount of depreciation expensed thus far in the asset’s life.

Land never wears out so we never depreciate land

Property, plant, and equipment is sometimes called Fixed Assets or Plant Assets or PPE

2-9

The Classified Balance SheetThe Classified Balance Sheet

Property, Plant, and Equipment

$991,816,000

2-10

Intangible Assets

The Classified Balance SheetThe Classified Balance Sheet

LO 1

Assets that do not have physical substance.

Includes goodwill, patents, copyrights, and trademarks (covered more in Chapter 10)

Sometimes intangible assets are reportedunder a broader heading called “Other Assets.”

$92,806,000,000

2-11

The Classified Balance SheetThe Classified Balance Sheet

Obligations the company is to pay within the next year or the 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; like a 30 year mortgage).

Current Liabilities

$127,143,000

2-12

The Classified Balance SheetThe 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.

Long-Term Liabilities

$40,537,000,000

2-13

The Classified Balance SheetThe Classified Balance Sheet

Stockholders’ Equity Common stock - investments of assets into the business in

exchange for stock (the investments do not have to be cash).

“Retained” earnings - income retained (kept) for use in the business (all the earnings since inception of the business less all the dividends distributed back to shareholders). Dividends are only shown on a Retained Earnings statement!

2-14

Using the Financial StatementsUsing the Financial Statements

Ratio Analysis - A ratio expresses the mathematical relationship between two quantities and thus the relationship among selected F/S items

2-15

Using the Financial StatementsUsing the Financial Statements

Profitability ratios measure the operating success of a company for a given period of time. Earnings per share (EPS) measures the NI earned on each share of common stock and is a profitability ratio!

Using the Income Statement

We can look at

the $ and %

changes between

years

Numbers in red and/or

(parens) mean a negative number

$ %

$576 1%

$(616) (1)%

$(40) (3)%

2-16

Using a Classified

Balance Sheet

Note that Total Current Assets

exceed Total Current Liabilities in 2011 by

$1,810 million!

Liquidity is the ability to pay obligations expected within the next year or operating cycle. Best Buy is very liquid in 2011!

$17,849,000,000

2-17

Using the Financial StatementsUsing the Financial Statements

Using a Classified Balance SheetOne measure of liquidity is Working Capital: the excess of current assets over current liabilities that’s available to work with.

When working capital is positive, there is greater likelihood that the company will pay its liabilities.

Working Capital

Best Buy had working capital in 2011 of $1,810 million ($10,473 million - $8,663 million).

2-18

Using a Classified Balance SheetUsing a Classified Balance SheetLiquidity ratios measure the short-term ability to pay maturing obligations and to meet unexpected needs for cash. The Current Ratio is an example of a liquidity ratio. It’s just like working capital only calculated and expressed as a ratio.

For every dollar of current liabilities, Best Buy has $1.21 of current assets.

Liquidity Ratio

2-19

Using a Classified Balance Sheet

Solvency ratios measure the ability of the company to survive over a long period of time.

Solvency is the ability to pay interest as it comes due and repay the balance of a debt that’s due at its maturity.

For example, total debt to total assets is a solvency ratio that measures the % of total financing provided by creditors rather than stockholders $10,557/$17,849 = 59%!

Using the Financial StatementsUsing the Financial Statements

2-20

Financial Reports ConceptsFinancial Reports Concepts

Qualities of Useful InformationAccording to the FASB, useful information should possess two fundamental qualities, relevance and faithful representation.

2-21

Financial Reports ConceptsFinancial Reports 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 we are able to prove that it is free from error.

For accounting information to be relevant, it must be timely.

Information has the quality of

understandabilityif it is presented in a clear and concise

fashion.

Qualities of Useful Information

2-22

Financial Reports ConceptsFinancial Reports Concepts

Assumptions in Financial Reporting

Monetary UnitPeriodicity

Economic Entity

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 (from personal

transactions) and accounted for.

States that the life of a business can be

divided into artificial time periods.

2-23

Financial Reports ConceptsFinancial Reports Concepts

Two More Assumptions in Financial Reporting

Going Concern Accrual-BasisTransactions are recorded in the

periods in which the events occur.

The business will remain in operation for the foreseeable

future.

2-24

Financial Reports ConceptsFinancial Reports Concepts

Principles in Financial ReportingMeasurement Principles

Cost Fair Value Full disclosureAlso called the historical cost

principle, dictates that companies record assets at

their cost (not what they think it’s

worth)

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 users (provided in the F/S

and the notes).

2-25

Financial Reports ConceptsFinancial Reports Concepts

Constraints in Financial Reporting

Materiality ConstraintAn item is material when its size makes it

likely to influence the decision of an investor or creditor.

Cost ConstraintAccounting standard-setters weigh the cost

that companies will incur to provide the information against the benefit thatfinancial statement users will gain.

2-26

Comparability

Going concern

Materiality

LO 7 Discuss financial reporting concepts.

The following items guide the FASB when it creates accounting standards.

Relevance Periodicity assumptionFaithful representation Going concern assumptionComparability Historical cost principleConsistency Full disclosure principleMonetary unit assumption MaterialityEconomic entity assumption

Match each item above with a description below.

1. Ability to easily evaluate one company’s results relative to another’s.

2. Belief that a company will continue to operate for the foreseeable future.

3. The judgment concerning whether an item is large enough to matter to decision-makers.

2-27

Full disclosure

Periodicity

Relevance

LO 7 Discuss financial reporting concepts.

Match each item above with a description below.

4. The reporting of all information that would make a difference to financial statement users.

5. The practice of preparing financial statements at regular intervals.

6. The quality of information that indicates the information makes a difference in a decision.

The following items guide the FASB when it creates accounting standards.

Relevance Periodicity assumptionFaithful representation Going concern assumptionComparability Historical cost principleConsistency Full disclosure principleMonetary unit assumption MaterialityEconomic entity assumption

2-28

Historical cost

Consistency

Economic entity

LO 7 Discuss financial reporting concepts.

Match each item above with a description below.

7. Belief that items should be reported on the balance sheet at the price that was paid to acquire the item.

8. A company’s use of the same accounting principles and methods from year to year.

9. Tracing accounting events to particular companies.

The following items guide the FASB when it creates accounting standards.

Relevance Periodicity assumptionFaithful representation Going concern assumptionComparability Historical cost principleConsistency Full disclosure principleMonetary unit assumption MaterialityEconomic entity assumption

2-29

Faithful representation

Monetary unit

LO 7 Discuss financial reporting concepts.

Match each item above with a description below.

10. The desire to minimize errors and bias in financial statements.

11. Reporting only those things that can be measured in dollars.

The following items guide the FASB when it creates accounting standards.

Relevance Periodicity assumptionFaithful representation Going concern assumptionComparability Historical cost principleConsistency Full disclosure principleMonetary unit assumption MaterialityEconomic entity assumption

2-30

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

What accounts would you need to calculate the Current Ratio?

2-31

What is the primary criterion by which accounting information can be judged?

a. Consistency.

b. Predictive value.

c. Usefulness for decision making.

d. Comparability.

Review Question

Financial Reporting ConceptsFinancial Reporting Concepts

LO 7 Discuss financial reporting concepts.

2-32

Cash, and other resources that are reasonably expected to be realized in cash or sold or consumed in the business within one year or the operating cycle, are called:

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

Review Question

The Classified Balance SheetThe Classified Balance Sheet

LO 1 Identify the sections of a classified balance sheet.

2-33

Patents and copyrights are

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

The Classified Balance SheetThe Classified Balance Sheet

LO 1 Identify the sections of a classified balance sheet.

Review Question

2-34

Which of the following is not a long-term liability?

a. Bonds payable.

b. Current maturities of long-term debt.

c. Long-term notes payable.

d. Mortgages payable.

The Classified Balance SheetThe Classified Balance Sheet

LO 1 Identify the sections of a classified balance sheet.

Review Question

2-35

The balance in retained earnings is not affected by:

a. net income

b. net loss

c. issuance of common stock

d. dividends

Review Question

LO 3 Explain the relationship between a retained earnings statement and a statement of stockholders’ equity.

Using the Financial StatementsUsing the Financial Statements

2-36

Generally accepted accounting principles (GAAP) are:

a. a set of standards and rules that are recognized as a general guide for financial reporting.

b. usually established by the Internal Revenue Service.

c. the guidelines used to resolve ethical dilemmas.

d. fundamental truths that can be derived from the laws of nature.

Review Question

LO 6 Explain the meaning of generally accepted accounting principles.

Financial Reporting ConceptsFinancial Reporting Concepts