ACCT303 Chapter 4A - Balance Sheet, Teaching Pp

7/27/2019 ACCT303 Chapter 4A - Balance Sheet, Teaching Pp

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The Balance Sheet Statement

Learning Objectives1.How balance sheet accounts are measured,classified and presented.

2.How balance sheet information is used.3.Balance sheet terminology and formatoutside the U.S.

4.How footnotes aid to the understandingof the firms accounting policies, contingentliabilities, subsequent events, and related-party transactions

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The Accounting Equation

Assets = Liabilities + Equity

Shareholders Equity:Whats left of the companys assets

after paying off liabilities.

It also referred to as net assets.

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Balance sheet classification:Overview

Current assets Property, plant andequipment

Investments Other assets

Current liabilities Long-term debt Otherliabilities

Preferred andcommon stock

Additional paid-incapital

Retained earnings

ASSETS LIABILITIES EQUITY= +

ContributedCapital

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Elements of the balance sheet

Probable future economic benefits Obtained from past transactions or events

Probable future sacrifices of economic benefits

Arising from present obligations To transfer assets or provide services in the future As a result of past transactions or events

The residual interest in net asset

ASSETS LIABILITIES EQUITY= +

How the money isinvested Where the money came from

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Balance sheet Classification and Account

Measurement - Current assets

Amortized costor currentmarket value

Netrealizablevalue

Lower of cost orcurrent marketvalue

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Assetsclassification and measurement

n Resources with future economic benefit to abusiness entity as a result of a past transaction.

n Current Assets: cash and other assets that arereasonably expected to be realized in cash orsold, or consumed during a normal operatingcycle or one year, whichever is longer

Examples: Cash and cash equivalents, short-

term investments (reported at the fair value),receivables (estimated amount collectible),inventory (LCM), prepaid expenses, etc.


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Balance Sheet Classification and Account

Measurement -PPE, Investments and Intangibles

Historical cost minus

accumulateddepreciation except thatfair market value is usedwhen impaired

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Assets (contd.)

Long-term Investments: Comprise of thefollowing

Securities (i.e., bonds, stock, long-term notes)

Fixed assets (i.e., land, building)

Special funds (i.e., pension fund, bond sinking

fund) Nonconsolidated subsidiaries or affiliated

companies


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Assets (contd.)

Property, Plant, Equipment (i.e., building,Land, Machinery and equipment, capitalleases): assets used in firms operationsand meet the following criteria:

1. Economic life > 1 year;

2. Acquired for use in operation;

3. Not for resale to customers;

4. $ is material. (materiality)

Depreciation will be applied except for land.


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Assets (contd.)

Intangible Assets: assets with nophysical substance but have valuebased on rights or privileges thatbelong to the owner (i.e., goodwill,patents, franchises, trademarks,).

Amortization for limited life

intangibles (i.e., patents, franchises)and impairment test for indefinite-lifeintangibles (i.e., goodwill).


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Balance Sheet Classification and

Measurement - Liabilities

Amount dueat maturity

Historicalcost

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Discounted

presentvalue

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Liabilities

n Legal obligations required futurepayments of assets or services as aresult of a business entitys past

transactions or events.

A. Current Liabilities

B. Long-term Liabilities

C. Other Liabilities


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A. Current Liabilities

n Obligations must be fulfilled in oneyear or one operating cycle,

whichever is longer. (will require theuse of current assets or the creationof current liability) (i.e., A/P, N/P,

accrual payable, unearned revenue,income tax payable, current portion ofL-T debt)


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Contingent Liabilities

n Obligations may arise because of theoccurrence or not occurrence of

future event(s). (i.e., warrantyobligations)


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B. Long-Term Liabilities

n Obligations are not due in next year

or next operating cycle, whichever is

longer. (i.e., bonds payable, pensionliability)


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C. Other Liabilities

n Long-term advances from customers,deferred income taxes.


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Balance Sheet Classification and Account

Measurement -Stockholders equity

Historicalpar value

Historicalcost

Combination ofdifferentmeasurementbases

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Stockholders Equity

n Residual claims (assets-liabilities) tothe business entity from stockholdersincluding:

a. contributed capital

b. (+ or -)Accumulated OtherComprehensive Income

c. retained earnings (or - deficit)

d. (-)treasury stock


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a. Contributed Capital

n Par value of common stock

n Par value of prefer stock

n Paid-in capital in excess of par valueof common stock or preferred stock


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b. Accumulated Other Comprehensive

Income

n Increase of assets without outflows ofassets, increase of liabilities, increase

of income or issuance of common stock(i.e.,(+) increase in market value ofsecurities-available-for-sale (+ or -),

gains or losses of foreign currencyadjustments, etc.)


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c. Retained Earnings

n Net income not distributed tostockholders

u appropriated

u unappropriated


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Balance sheet information

LIABILITIES

+

EQUITY

ASSETS

1. Rates of return

2. Capital structure

3. Liquidity

4. Solvency

5. Flexibility

ROA and ROCE

Debt vs. Equity

Cash conversion

Ability to pay debt

Operating and financial

Helpsassess

Balance Sheet

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1. Rate of Return Ratios

ROA (return on assets) and ROCE (return oncommon equity) ratios: Evaluate operating efficiency and profitability.

ROA =Net operating profit after taxes (NOPAT) /Average assets

ROCE =(Net income Preferred dividends) / Average

common shareholders equity

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2. Capital Structure

The balance sheet provides criticalinformation for understanding an

entitys capital structure. Capital structure refersto how much

of an entitys assets are financed from

debtversus equitysources.

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3. Liquidity Ratios

Liquidity measures how readily assetscanbe converted to cash relat ive tohow soonliabilities will have to be paid in cash.

Current ratio: Indicate the level of currentresources available to pay current debts.

Current Ratio = Current Assets / CurrentLiabilities

Question:Does higher ratio always indicate betterfinancial status?

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4. Solvency

Solvency defines the ability of a companyto generate sufficient cash flows tomaintain its productive capacity and stillable to pay off the long-term debt.

Debt ratios provide information about theamount of long-term debt in a companysfinancial structure.

Long-term debt to assets =

Long term debt/Total assets

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Solvency (contd.)

A company that can not make timelypayments in the amount required

becomes insolvent and may becompelled to reorganize or liquidate.

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5. Flexibility

Flexibility refers to the ability to adapt orrevise to a new strategy for differentcircumstances.

The ability to adjust to unexpecteddownturn in the economic environmentin which it operates or to takeadvantage of profitable investmentopportunities when they arise.

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Analytical insights:Understanding the business

Which company is:

Deere

E-Trade

Potomac Electric Power

Wal-Mart

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Balance sheet presentation:International differences

Current Assets

Long-lived Assets

Current Liabilities

Non-current Liabilities

Stockholders Equity

Fixed Assets

Current Assets

Current Liabilities

Non-current Liabilities

Capital Employed

U.S. Format: U.K. Format:

+

=

+

+

+

-

-

=

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Financial statement footnotes Footnotes are an integral part of

companies financial reports. These notes help users better

understand and interpret the numbers

presented in the body of the financialstatements.

Three important notes:

1. Summary of significant accountingpolicies.

2.Subsequent event disclosures.

3.Related party transactions 4-3131


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Limitations of the Balance Sheet

n 1. Historical costs reporting for mostof assets and liabilities.

n 2. Estimations involved in the value of

some assets and liabilities (i.e., the netrealizable value of accounts receivableand the cost of warranty).

n 3. the omission of some valuable itemssuch as goodwill of the company.

n 4. Off-balance sheet liabilities.


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Summary

1.

The balance sheet shows the assetsowned by a company at a given point intime, and how those assets arefinanced (debt vs. equity).

2. Be alert for differences in balancesheet measurement bases, accounttitles, and statement format.

3. Financial statement footnotes provideimportant information..

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Documents

ACCT303 Chapter 4A - Balance Sheet, Teaching Pp