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Chapter 2

A FURTHER LOOK A FURTHER LOOK AT FINANCIAL AT FINANCIAL STATMENTSSTATMENTS

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Identify the sections of a classified balance sheet.

Identify and compute ratios for analyzing a company's profitability.

Explain the relationship between a retained earnings statement and a statement of stockholders' equity.

Identify and compute ratios for analyzing a company's liquidity and solvency using a balance sheet.

Chapter 2A Further Look at Financial Statements

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Explain the meaning of generally accepted accounting principles.

Discuss financial reporting concepts.

Chapter 2A Further Look at Financial Statements

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Identify the Sections of a Identify the Sections of a Classified Balance SheetClassified Balance Sheet

Helps users see if company Helps users see if company has enough assets to pay has enough assets to pay debtsdebts

Can determine the short-term Can determine the short-term and long-term claims on total and long-term claims on total assetsassets

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Classified Balance SheetClassified Balance Sheet Generally contains the following Generally contains the following

standard classifications:standard classifications: Current Assets Current Assets Long-Term InvestmentsLong-Term Investments Property, Plant, and EquipmentProperty, Plant, and Equipment Intangible AssetsIntangible Assets Current LiabilitiesCurrent Liabilities Long-Term LiabilitiesLong-Term Liabilities Stockholders' EquityStockholders' Equity

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Current Assets

Assets that are expected to be converted to cash or used up within one year.

Current assets are listed in order of liquidity. Examples:

Cash Short-term investments Receivables Inventories Supplies Prepaid expenses

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Long-Term Investments

Investments of stocks and bonds of other corporations which are normally held for many years.

Investments in long-term assets such as land or buildings that are not currently being used in the company’s operations

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Property, Plant, and Equipment

Assets with relatively long useful lives.

Assets used in operating the business.

Examples: land buildings machinery delivery equipment furniture and fixtures

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Depreciation is... Practice of allocating an asset’s full

purchase price to a number of years instead of expensing full cost in year of purchase.

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Accumulated Depreciation...

Shows the total amount of depreciation that the company has expensed thus far in the asset’s life.

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Assets That A Company Depreciates...

Should be shown at cost less accumulated depreciation

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Intangible Assets have value because of the exclusive

rights or privileges they give the company.

Intangible Assets Non-current assets Have no physical substance Examples:

patents copyrights trademarks or trade names franchise

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Current Liabilities

Obligations that are supposed to be paid within the coming year...

accounts payable wages payable bank loans payable interest payable taxes payable current maturities of long-term bank

loans payable

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Long-Term LiabilitiesDebts expected to be paid after one yearExamples… bonds payable mortgages payable long-term notes payable lease liabilities and obligations under employee

pension plans

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Stockholders' Equity

Capital stock - investments of assets in the business by the stockholders

Retained earnings - earnings kept for use in the business

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Ratio AnalysisRatio Analysis Expresses relationship among

selected items of financial statement data

Relationship can be expressed in terms of… Percentage Rate Proportion

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Ratio AnalysisRatio Analysis Profitability RatiosProfitability Ratios - Measures

the income or operating success of a company for a given period of time

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Ratio AnalysisRatio Analysis

Liquidity RatiosLiquidity Ratios - Measures short-term ability of company to pay its maturing obligations and meet unexpected needs for cash

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Ratio AnalysisRatio Analysis

Solvency RatiosSolvency Ratios - Measures the ability of the company to survive over a long period of time

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Ratio Analysis – Ratio Analysis – Use Multiple Measures!Use Multiple Measures!

Intracompany comparisonsIntracompany comparisons - covering two years of the same company

Industry average comparisonsIndustry average comparisons - based on average ratios for a particular industry

Intercompany comparisonsIntercompany comparisons - based on comparisons with a competitor in the same industry

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Earnings Per ShareEarnings Per ShareHow does the company’s earning performance compare with that of previous years (on a per share basis)?

Higher value = improved performance

Net income-Preferred stock dividendsNet income-Preferred stock dividends Average common shares outstandingAverage common shares outstandingEPS=EPS=

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For 2005 Stoneland Corporation reported net For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no shares outstanding 6,000. There were no preferred stock dividends. What was 2005 preferred stock dividends. What was 2005 earnings per share?earnings per share?

a.a. $4.00$4.00

d.d. $66.67$66.67

c.c. $16.67$16.67

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bb. $. $ .06.06

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For 2005 Stoneland Corporation reported net For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no shares outstanding 6,000. There were no preferred stock dividends. What was 2005 preferred stock dividends. What was 2005 earnings per share?earnings per share?

a.a. $4.00$4.00

d.d. $66.67$66.67

c.c. $16.67$16.67

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bb. $. $ .06.06

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Liquidity RatiosLiquidity Ratios

Measure of short-term ability to pay maturing obligations and to meet unexpected needs for cash

•Working capitalWorking capital

•Current ratioCurrent ratio

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Working CapitalWorking Capital

Working Capital = Current Assets - Current Liabilities Working Capital = Current Assets - Current Liabilities

•Measure of short-term ability to pay obligations

•Difference between current assets and current liabilities

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Current RatioCurrent Ratio

CurrentCurrent Ratio =Ratio =Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

•More dependable indicatorMore dependable indicator

•Does not consider composition of current Does not consider composition of current assetsassets

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Measure the ability of a company to survive over a long period of time

Solvency RatiosSolvency Ratios

Total DebtsTotal DebtsTotal AssetsTotal Assets

Debt to Total Asset Ratio Debt to Total Asset Ratio ==

•Measures percentage of assets financed by Measures percentage of assets financed by creditors rather than stockholderscreditors rather than stockholders

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ReviewReviewStatement of Cash FlowsStatement of Cash Flows

Provides information about sources and uses of cash, organized as: Operating Activities Investing Activities Financing Activities

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Primary Accounting Setting Body in the U.S.

FinancialAccountingStandardsBoard

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U.S. Government Agency That Oversees Financial Markets

SecuritiesExchangeCommission

GAAP Are the Rules

The FASB makes the rules.

The SEC enforces the rules.

IASB = International Accounting Standards Board

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ReviewReviewWhat organization issues United States What organization issues United States accounting standards?accounting standards?

a.a. Financial Accounting Standards BoardFinancial Accounting Standards Board

d.d. Securities and Exchange CommitteeSecurities and Exchange Committee

c.c. Internal Auditing Standards CommitteeInternal Auditing Standards Committee

b. b. Internal Accounting Standards CommitteeInternal Accounting Standards Committee

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ReviewReviewWhat organization issues United States What organization issues United States accounting standards?accounting standards?

a.a. Financial Accounting Standards BoardFinancial Accounting Standards Board

d.d. Securities and Exchange CommitteeSecurities and Exchange Committee

c.c. Internal Auditing Standards CommitteeInternal Auditing Standards Committee

b. b. Internal Accounting Standards CommitteeInternal Accounting Standards Committee

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Basic Terms Relevance - information makes a difference in

decisions Reliability - information must be free of error

and bias Comparability - ability to compare

information of different companies because they use the same accounting principles

Consistency - use of same accounting principles and methods from year to year within the same company

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Characteristics of Useful Information

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Accounting Assumptions

Accounting Principles

Constraints In Accounting Illustration 23

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

a.a. ConsistencyConsistency

d.d. ComparabilityComparability

c.c. Usefulness for decision makingUsefulness for decision making

b.b. Predictive ValuePredictive Value

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

a.a. ConsistencyConsistency

d.d. ComparabilityComparability

c.c. Usefulness for decision makingUsefulness for decision making

b.b. Predictive ValuePredictive Value

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What accounting constraint refers to the tendency What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way of accountants to resolve uncertainty in a way least likely to overstate assets and revenues?least likely to overstate assets and revenues?

a.a. ComparabilityComparability

d. d. ConsistencyConsistencyc.c. ConservatismConservatism

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bb. Materiality. Materiality

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What accounting constraint refers to the tendency What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way of accountants to resolve uncertainty in a way least likely to overstate assets and revenues?least likely to overstate assets and revenues?

a.a. ComparabilityComparability

d. d. ConsistencyConsistencyc.c. ConservatismConservatism

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bb. Materiality. Materiality

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Which is Which is notnot an indicator of profitability? an indicator of profitability?

a.a. Current ratioCurrent ratio

c.c. Net incomeNet income

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b. b. Earnings per shareEarnings per share

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Which is Which is notnot an indicator of profitability? an indicator of profitability?

a.a. Current ratioCurrent ratio

c.c. Net incomeNet income

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b. b. Earnings per shareEarnings per share

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The balance in retained earnings is The balance in retained earnings is notnot affected by:affected by:

a.a. Net income.Net income.

b.b. Issuance of common stock.Issuance of common stock.

c.c. Dividends.Dividends.

d.d. Net Loss.Net Loss.

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The balance in retained earnings is The balance in retained earnings is notnot affected by:affected by:

a.a. Net income.Net income.

b.b. Issuance of common stock.Issuance of common stock.

c.c. Dividends.Dividends.

d.d. Net Loss.Net Loss.

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Selected financial information for Selected financial information for Drummond Company at 12/31/2006:Drummond Company at 12/31/2006:

Cash $60,000Receivables (net) $80,000Inventory $70,000Long-term assets $330,000Total Assets $540,000

Current Liabilities $140,000Long-term debt $130,000Total Liabilities $270,000

Let’s compute current ratio . . .Let’s compute current ratio . . .

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Cash $60,000Receivables (net) $80,000Inventory $70,000Long-term assets $330,000Total Assets $540,000

Current Liabilities $140,000Long-term debt $130,000Total Liabilities $270,000

$210,000$210,000

$140,000$140,000

==1.5 : 11.5 : 1

Review Review Compute Current RatioCompute Current Ratio

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Selected financial information for Selected financial information for Drummond Company at 12/31/2006:Drummond Company at 12/31/2006:

Cash $60,000Receivables (net) $80,000Inventory $70,000Long-term assets $330,000Total Assets $540,000

Current Liabilities $140,000Long-term debt $130,000Total Liabilities $270,000

Compute debt to total assets . . .Compute debt to total assets . . .

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Cash $60,000Receivables (net) $80,000Inventory $70,000Long-term assets $330,000Total Assets $540,000

Current Liabilities $140,000Long-term debt $130,000Total Liabilities $270,000

$270,000 $270,000 $540,000 = 50% $540,000 = 50%

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