Risk Management & Financial Statements

Also called the statement of condition or the statement of financial position

Shows the financial condition of a company on a particular date

Summarizes what the firms owns and what the firm owes to outsiders and to internal owners

Assets are what the firm owns. Liabilities are what the firm owes to

outsiders. Stockholders’ equity is what the firm owes

to internal owners.equity rs'Stockholde sLiabilitie Assets

Balance Sheet Date The date the balance sheet is prepared Could be the end of the calendar year, fiscal

year, quarter, etc.

Segregated according to how they are utilized

Current Assets Property, Plant, and Equipment Other Assets

Current Assets Expected to be converted to cash within

one year or one operating cycle Continually used up and replenished

Current Assets Operating cycle

◦ Time required to purchase or manufacture inventory, sell the product, and collect the cash

Working capital◦ Also called net working capital◦ Current assets less current liabilities

Current Assets Cash and cash equivalents Marketable securities Accounts receivable Inventories Prepaid expenses

Current Assets – Cash and Cash Equivalents

Cash awaiting deposit Cash in a bank account Short-term investments that can be

converted to cash within three months

Current Assets – Marketable Securities

Short-term investments that can be converted to cash within a year

Three categories◦ Held to maturity◦ Trading securities◦ Securities available for sale

Current Assets – Accounts Receivable

Customer balances outstanding on credit sales

Net realizable value – actual amount of account less an allowance for doubtful accounts

Current Assets – Accounts Receivable

Allowance for doubtful accounts◦ Affects balance sheet valuation◦ Important in assessing earnings quality◦ Should reflect volume of credit sales, past

experiences with customers, customer base, credit policies, collections practices, and economic conditions

Current Assets – Inventories Items held for sale Items used in the manufacture of products

that will be sold Major revenue producer for most companies

Current Assets – Inventories Retail companies

◦ Finished goods Manufacturing companies

◦ Raw materials◦ Work-in-process◦ Finished goods

Service –oriented companies◦ Little to no inventory

Current Assets – Inventories Inventory Accounting Methods

◦ First in, first out (FIFO)◦ Last in, first out (LIFO)◦ Average cost

Current Assets – Prepaid Expenses

Expenses paid in advance◦ Insurance◦ Rent◦ Property taxes◦ Utilities

Included in current assets if they expire within one year or one operating cycle

Generally not material to the balance sheet

Property, Plant, and Equipment (PP&E)

Encompasses a company’s fixed assets

Not used up during annual operations Produce economic benefits for more

than one year Have physical substance Shown at book value on the balance

sheet

Property, Plant, and Equipment (PP&E)

The relative proportion of fixed assets in a company’s asset structure will largely be determined by the nature of the business.

Manufacturing firms typically have higher percentages of fixed assets than retailers or wholesalers.

Firms with newly purchased assets will have higher percentages of fixed assets than firms with older fixed assets.

Depreciation Methods Straight-line method allocated an equal

amount of expense to each year of the depreciation period.

Accelerated methods apportions larger amounts of expense to earlier years of the asset’s depreciable life.

Units-of-production method bases depreciation expense on actual use.

Goodwill Arises when one company acquires

another company for a price in excess of the fair market value of the net identifiable assets acquired

Evaluated annually◦ If no loss of value has occurred,

goodwill remains on the balance sheet.◦ If the book value exceeds the fair value,

the excess must be written off as an impairment expense

Other Assets Can include a multitude of other noncurrent

items◦ Property held for sale◦ Start-up costs associated with a new business◦ Cash surrender value of life insurance policies◦ Long-term advance payments◦ Intangible assets (other than goodwill)

Represent claims against assets Current liabilities

◦ Must be satisfied in one year or one operating cycle

Noncurrent liabilities◦ Obligations with maturities beyond one year

Current Liabilities Accounts payable Notes payable Current portion of long-term debt Accrued liabilities Unearned revenue

Current Liabilities – Accounts Payable Short-term obligations that arise from credit

extended by suppliers for the purchase of goods and services

Eliminated when the bill is satisfied Increase and decrease depending on credit

policies, economic conditions, and cyclical nature of operations

Current Liabilities – Notes Payable Also referred to as short-term debt Short-term obligations in the form of

promissory notes Lines of credit to suppliers or financial

institutions

Deferred Taxes Result of temporary differences in the

recognition of revenue and expense for taxable income relative to reported income

Depreciation methods are the most common source for temporary differences.

Deferred Taxes Other temporary differences arise from

methods used to account for◦ Installment sales◦ Long-term contracts and leases◦ Warranties and service contracts◦ Pensions and other employee benefits◦ Subsidiary investment earnings

Noncurrent Liabilities Long-term debt Capital lease obligations Postretirement benefits other than pensions Commitments and contingencies Hybrid securities

Noncurrent Liabilities – Long-term Debt

Bonds Long-term notes payable Mortgages Obligations under leases Pension liabilities Long-term warranties

Noncurrent Liabilities – Pensions and Postretirement Benefits

Pensions are cash compensation paid to retired employees.

Postretirement benefits are benefits other than pensions that employers promise to pay for retired employees.

Can appear under the liability section of the balance sheet

Noncurrent Liabilities – Commitments and Contingencies

Commitments refer to contractual agreements that will have a significant financial impact in the future.

Contingencies refer to potential liabilities (such as possible damage awards assessed in lawsuits).

Intended to draw attention to the fact that required disclosures can be found in the notes to the financial statements.

Also called shareholders’ equity Residual interest in assets that remains

after deducting liabilities Owners bear greatest risk and benefit from

greatest rewards.

Common Stock Shareholders

◦ do not ordinarily receive a fixed return◦ have voting privileges in proportion to ownership

interest◦ can benefit through price appreciation◦ can suffer through price depreciation

Common Stock• Dividends are declared at the discretion of a

company’s board of directors• Amount listed on the balance sheet is based on the

par or stated value of the shares issued (which bears no relationship to actual market price).

Additional Paid-In Capital Reflects the amount by which the original

sales price of the stock shares exceeded par value

Retained Earnings Sum of every dollar a company has earned

since inception less any payments made to shareholders

Funds a company has elected to reinvest in the operations of the business rather than pay out in stock

Measurement of all undistributed earnings

Other Equity Accounts Preferred stock Accumulated other comprehensive income

(expense) Treasury Stock Employee benefit trusts Equity attributable to non controlling

interests

Other Equity Accounts – Preferred Stock

Carries a fixed annual dividend payment Carries no voting rights

Other Equity Accounts – Accumulated Other Comprehensive Income (Expense)

Unrealized gains or losses in the market value of investments in available-for-sale securities

Any change in the excess of additional pension liability over unrecognized prior service cost

Certain gains and losses on derivative financial instruments

Foreign currency translation adjustments resulting from converting financial statements from a foreign currency into U.S. dollars

Other Equity Accounts – Treasury Stock Repurchased shares of stock that are not

retired Shown as an offsetting account

Other Equity Accounts – Equity Attributable to Noncontrolling Interests

Represents the equity interest a firm has in companies whose financial statement have been consolidated with the firm’s statements but that are not 100% owned by the firm