C2 a Futher Look at Financial Statment

8/13/2019 C2 a Futher Look at Financial Statment

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A FURTHER LOOK AT

FINANCIAL STATEMENTS

Accounting, Fourth Edition

2


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1. Identify the sections of a classified balance sheet.2. Identify and compute ratios for analyzing a companys

profitability.

3. Explain the relationship between a retained earnings statement

and a statement of stockholders equity.

4. Identify and compute ratios for analyzing a companys liquidity

and solvency using a balance sheet.

5. Use the statement of cash flows to evaluate solvency.6. Explain the meaning of generally accepted accounting

principles.

7. Discuss financial reporting concepts.

Study Objectives


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Ratio analysis

Using the income

statement

Using the statement of

stockholders equity

Using a classifiedbalance sheet

Using the statement of

cash flows

The ClassifiedBalance Sheet

Current assets

Long-term

investments

Property, plant, and

equipment

Intangible assetsCurrent liabilities

Long-term liabilities

Stockholders equity

The standard-settingenvironment

Qualities of useful

information

Assumptions

PrinciplesConstraints

Using the FinancialStatements

Financial ReportingConcepts

A Further Look At Financial Statements


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The Classified Balance Sheet

SO 1 Identi fy the sectio ns of a classif ied balance sheet.

The difference between traditional and classified BS

Presents a snapshot at a point in time.

To improve understanding, companies group similar

assets and similar liabilities together.Illustration 2-1Standard Classifications


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Illustration 2-2


SO 1


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Illustration 2-2


SO 1


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Assets that a company expects to convert to cash or

use up within one yearor theoperating cycle,

whichever is longer.

Operating cycleis the average time it takes from the

purchase of inventory to the collection of cash from

customers.

Current Assets


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Companies list current asset accounts in the order they expect to

convert them into cash.

Current AssetsIllustration 2-3


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Current assets1. Cash and cash equivalents: the most liquid assets

(marketable securities, commercial paper, short term

government bond,..). # short term investment (within 12

month, risk to convert to cash).

2. Short-term investment: expire within one year (stocks and

bonds,). Ex: Microsoft, which is always in a strong cash

position, had short-term investments totaling approximately

$32 billion at the end of 2005.

3. Account receivables: Money owed by individuals and corp.

(relatively short time period). Ex: salary bi-weekly payment.




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Current assets4. Inventories: A company's merchandise, raw materials,

and finished and unfinished productswhich have not yet

been sold. The cost of inventory should include all costs

necessary to acquire the items and to get them ready forsale

5.Prepaid expenses: as a result of business

making payments for goods and services to be received

in the near future. Ex: a company had a one-year insurance

policy cost of $1200. As each month elapses, $100 of

prepaid insurance would be expensed to the income

statement until the account is empty at the end of the year.


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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




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Investments in stocksand bondsof other companies that

are held for more than one year.

Investments in long-term assetssuch as land or buildingsnot currently being usedin operating activities.

Long-Term Investments

Illustration 2-4


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Property, Plant, and Equipment



Long useful lives.

Currently usedin operations.

Depreciation- allocating the cost of assets to a number

of years.

Accumulated depreciation- total amount of

depreciation expensed thus far in the assets life.


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Illustration 2-5

Property, Plant, and Equipment


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Intangible Assets



Assets that do not have physical substance.

Illustration 2-6


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Intangeble assets



Intellectual property (patents, trademarks, copyr ights,

business methodologies), goodwill and brand

recognition,

Valuable for a firm and can be critical to its long-term

success or failure. Ex: Coca-Cola , its po sit iv e effects on

bottom-l ine prof i ts c an prove extremely valuable to f i rms

suc h as Coca-Cola, whose brand s trength dr ives glo bal

sales year after y ear.


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Patents and copyrights are

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

Review Question




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Obligations the company is to pay within the coming year.

Usually list notes payable first, followed by accounts

payable.

Other items follow in order of magnitude.

Current Liabilities


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Illustration 2-7

Current Liabilities


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Current Liabilities1. Note payables: A written promissory note, in which

a borrower borrows a specific amount of money and

promises to pay it back with interest over a

predetermined time period (shor

term/long term)2. Account payables: represents an entity's obligation

to pay off a short-term debt to its creditors. Ex: the

phone company, the gas company and the cable

company are types of creditors. Each one of these

creditors provide a service first and then bills the

customer after the fact.
http://www.accountingtools.com/definition-interesthttp://www.accountingtools.com/definition-interest


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3. Tax payable4. Wage and salary payable

5. Unearned revenue: Company receives money for a

service or product that has yet to be fulfilled. The early

cash flow to the firm is advantageous for any number ofactivities, such as paying interest on debt to purchasing

more inventory.

6. Mortgage payable: The long-term financing used to

purchase property. The property itself serves ascollateral for the mortgage until it is paid off. A

mortgage usually requires equal payments, consisting of

principal and interest, throughout its term.


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Obligations a company expects to pay after one year.

Illustration 2-8

Long-Term Liabilities


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

a. Bonds payable

b. Current maturities of long-term obligations

c. Long-term notes payable

d. Mortgages payable

Review Question




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Illustration 2-2

Paid-in capital: is the amount invested in the corporation by its

owners. The basic component of paid-in capital is common

stock.

Common stock - investments of assets into the business by

the stockholders.

Retained earnings- income retained for use in the business.

Stockholders Equity


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Using the Financial Statements

Ratio Analysis

Ratio analysisexpresses the relationship among

selected items of financial statement data.

A ratioexpresses the mathematical relationship

between one quantity and another.


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Profitability ratiosmeasure the operating success of a company for a given period of time.

Using the Income Statement

SO 2 Identify and compute ratios for analyzing a companys profitability.

Illustration 2-10


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Illustration:Earnings per share (EPS)measures the netincome earned on each share of common stock.

Profitability

Ratio

$1,003

(414

- $0

+ 411) 2=

$2.43

$1,407

(411

- $0

+ 481) 2=

$3.15

Illustration 2-11

Best Buy


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For 2010 Stoneland Corporation reported net

income $26,000; net sales $400,000; and average shares

outstanding 6,000. There were preferred stock dividends of$2,000. What was the 2010 earnings per share?

a. $4.00

b. $0.06

c. $16.67

d. $66.67

Review Question


SO 2 Identify and compute ratios for analyzing a companys profitability.

$26,000 - $2,000

6,000= $4.00


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Using theFinancial

Statements

Using a

ClassifiedBalance Sheet

Illustration 2-13


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Using a Classified Balance Sheet

SO 4 Identify and compute ratios for analyzing a companys

l iquid i ty and solvency using a balance sheet.

Liquiditythe ability to pay obligations expected tobecome due within the next year or operating cycle.

Illustration 2-14

When working capitalis positive, there is greater likelihood that

the company will pay its liabilities.Video: h ttp:/ /www.investo pedia.com /video/play/work ing -

capital/


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Liquidity ratiosmeasure the short-term ability to pay maturingobligations and to meet unexpected needs for cash.

Illustration 2-15

Liquidity

Ratio

For every dollar of current liabilities, Best Buy has $.97 of current assets

SO 4 Identify and compute ratios for analyzing a companysl iquid i ty and s olvency u sing a balance sheet.


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Using a Classified Balance Sheet


Solvencythe ability to pay interest as it comes due and to

repay the balance of a debt due at its maturity.

Solvency ratiosmeasure the ability of the company to

survive over a long period of time.



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Debt to total assets ratiomeasures the percentage of totalfinancing provided by creditors rather than stockholders.

Illustration 2-16

Solvency

Ratio

The 2009 ratio means that every dollar of assets was financed by 71 cents of debt.



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SO 4

Review QuestionThe following ratios are available for Leer Inc. and Stable Inc.

Compared to Stable Inc., Leer Inc. has:

a. higher liquidity, higher solvency, and higher profitability.

b. lower liquidity, higher solvency, and higher profitability.c. higher liquidity, lower solvency, and higher profitability.

d. higher liquidity and lower solvency, but profitability cannot be

compared based on information provided.


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SO 5 Use the statemen t of cash flow s to evaluate solv ency.

In the Statement of Cash Flows, cash

provided by operating activitiesfails to

take into account that a company must

invest in new PP&E and must maintain dividends at current levels to

satisfy investors.

Free cash flowis a measurement to provide additional insight

regarding a companys cash-generating ability.


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SO 5 Use the statemen t of cash flow s to evaluate solv ency.

Illustration: MPC produced and sold

10,000 personal computers this year. It

reported $100,000 cash provided by

operating activities. In order to maintain production at 10,000

computers, MPC invested $15,000 in equipment. It chose to pay

$5,000 in dividends. Calculate free cash flow.

Cash provided by operating activities $100,000

Less: Expenditures on property, plant, and equipment -15,000

Dividends paid 5,000

Free cash flow $ 80,000


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Using the Statement of Stockholders Equity

SO 3 Explain the relat ions hip betw een a retained earning sstatement and a statement of stockholders equity.

Most companies use

a statement of

stockholders

equity, rather than aretained earnings

statement, so that

they can report all

changes instockholders equity

accounts.

Illustration 2-12


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Observations from this financial statement of Best Buy:

Common stock decreasedduring the first year because the

stock issuance was much smaller than the stock repurchase.

Common stock increasedin the second year as the result of

an issuance of shares..

Best Buy paid dividendseach year.

Prior to 2003, Best Buy did not pay dividends, even though itwas profitable and could do so.

Why didnt Best Buy pay dividends prior to 2003? Read Page 57

Using the Statement of Stockholders Equity


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The balance in retained earnings is not affected by:

a. net income

b. net loss

c. issuance of common stock

d. dividends

Review Question




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Financial Reports Concepts

The Standard-Setting Environment

SO 6 Explain the meaning of generally accepted accoun t ing pr inc ip les.

Generally Accepted Accounting Principles (GAAP) -A set of

rules and practices, having substantial authoritative support, that

the accounting profession recognizes as a general guide for

financial reporting purposes.

Standard-setting bodiesdetermine these guidelines:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB)

International Accounting Standards Board (IASB)

Public Company Accounting Oversight Board (PCAOB)


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Generally accepted accounting principles 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

SO 6 Explain the meaning of generally accepted accoun t ing pr inc ip les.



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Qualities of Useful Information

SO 7

According to the FASB, useful information should possess two

fundamental qualities, relevanceand faithful representation.

Illustration 2-17


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Enhancing Qualities

Comparability

results whendifferent companiesuse the same

accountingprinciples.

Consistencymeansthat a company usesthe same accounting

principles and methodsfrom year to year.

Information isverifiableif we areable to prove that itis free from error.

For accounting information to berelevant, it must be timely.

Information has thequality of

understandabilityif it is presented in aclear and concise

fashion.

SO 7 Discuss f inancia l report ing conc epts.

Qualities of Useful Information


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Assumptions in Financial Reporting


Monetary Unit Periodicity

Economic Entity

Illustration 2-18

Requires that only

those things that canbe expressed in

money are included inthe accounting

records.

States that everyeconomic entity can

be separatelyidentified andaccounted for.

States that the life of a

business can bedivided into artificial

time periods.


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Assumptions in Financial Reporting


Going Concern

Illustration 2-18

Accrual-Basis

Transactions arerecorded in the

periods in which the

events occur.

The business willremain in operation

for the foreseeable

future.


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Principles in Financial Reporting


Measurement Principles

Cost Fair Value Full disclosure

Or historical costprinciple, dictates

that companies

record assets at

their cost.Ex: If land that purc hased

for $30.000 increase in

value to 40.000, it

cont inued to report at

$30.000

Indicates that assetsand liabilities should

be reported at fair

value (the price

received to sell an

asset or settlea liability).

Ex:Investment

securities

Requires thatcompanies disclose

all circumstances

and events that

would make a

difference to

financial statement

users.


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Comparability

Going concern

Match each item above with a description below.

1. Ability to easily evaluate one companys resultsrelative to anothers.

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

3. The judgment concerning whether an item islarge enough to matter to decision makers.

Materiality



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Constraints in Financial Reporting Illustration 2-19

SO 7

Materiality Constraint

An item is material when its size makes it

likely to influence the decision of aninvestor or creditor.

Cost Constraint

Accounting standard-setters weigh the costthat companies will incur to provide the

information against the benefit that

financial statement users will gain.


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Full disclosure

Periodicity

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

5. The practice of preparing financial statementsat regular intervals.

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

Relevance



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Cost

Consistency

7. Belief that items should be reported on thebalance sheet at the price that was paid toacquire the item.

8. A companys use of the same accountingprinciples and methods from year to year.

9. Tracing accounting events to particularcompanies.

Economic entity



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Faithful representation10. The desire to minimize errors and bias infinancial statements.

11. Reporting only those things that can bemeasured in dollars. Monetary unit



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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



Self test


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Notes payable (due in 3 years) 50.5

Cash 141.1

Salaries and wages expense 2,933.6Common stock 454.9

Accounts payable 922.2

Accounts receivable 723.3

Equipment, net 921.0

Cost of goods sold 9,501.4

Income taxes payable 7.2Interest expense 1.5

Mortgage payable 451.5

Retained earnings 1,336.3

Inventory 1,636.5

Sales revenue 12,456.9

Short-term investments 382.6

Income tax expense 30.5

Goodwill 202.7

Notes payable (due in 6 months) 784.6

Self test

Listed here are items

($1000) taken from

Bargain Electronics,

Inc. for the year ended

December 31, 2012.

Instructions

Prepare an incomestatement and a

classified balance sheet

using the items listed.

Do not use any item

more than once.

C2 a Futher Look at Financial Statment

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