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The Balance The Balance Sheet and Sheet and
Notes to the Notes to the Financial Financial
StatementsStatements
2
Describe the specific elements of the balance sheet (assets, liabilities, and owners’ equity) and prepare a balance sheet with assets and liabilities properly classified into current and noncurrent categories.
Identify the different formats used to present balance sheet data.
Learning Objectives
3
Learning Objectives
Analyze a company’s performance and financial position through the computation of financial ratios.
Recognize the importance of the notes to the financial statements, and outline the types of disclosures made in the notes.
Understand the major limitations of the balance sheet.
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Usefulness of the Balance Sheet
• Reports the resources (assets), obligations (liabilities), and residual ownership claims (equity) of a company.
• Facilitates analysis of the company’s ability to:– meet short-term obligations (liquidity).
– pay all debts as due (solvency).
• Provides information about the company’s financial flexibility.
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Elements of the Balance Sheet
Assets
Probable future Probable future economic benefit economic benefit
obtained or obtained or controlled by a controlled by a
particular entity as particular entity as a result of past a result of past transactions or transactions or
eventsevents
Assets
Probable future Probable future economic benefit economic benefit
obtained or obtained or controlled by a controlled by a
particular entity as particular entity as a result of past a result of past transactions or transactions or
eventsevents
The inclusion of “probable”
acknowledges that accounting is not an exact
science.
The inclusion of “probable”
acknowledges that accounting is not an exact
science.
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Elements of the Balance Sheet
The primary purpose of the
balance sheet is to help forecast
the future.
The primary purpose of the
balance sheet is to help forecast
the future.
Assets
Probable future Probable future economic benefit economic benefit
obtained or obtained or controlled by a controlled by a
particular entity as particular entity as a result of past a result of past transactions or transactions or
eventsevents
Assets
Probable future Probable future economic benefit economic benefit
obtained or obtained or controlled by a controlled by a
particular entity as particular entity as a result of past a result of past transactions or transactions or
eventsevents
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Elements of the Balance Sheet
Typical assets found on a balance sheet are cash,
supplies, accounts receivable, land, buildings,
and equipment.
Typical assets found on a balance sheet are cash,
supplies, accounts receivable, land, buildings,
and equipment.
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Elements of the Balance Sheet
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligation of a particular obligation of a particular entity to transfer assets or entity to transfer assets or provide services to other provide services to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligation of a particular obligation of a particular entity to transfer assets or entity to transfer assets or provide services to other provide services to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
“Obligation” includes legal, moral, social, and implied
commitments.
“Obligation” includes legal, moral, social, and implied
commitments.
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligationobligation of a particular of a particular entity to transfer assets or entity to transfer assets or provide services to other provide services to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligationobligation of a particular of a particular entity to transfer assets or entity to transfer assets or provide services to other provide services to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
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Elements of the Balance Sheet
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligation of a particular obligation of a particular entity to transfer assets or entity to transfer assets or provide servicesprovide services to other to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
Liability
Probable future sacrifice Probable future sacrifice of economical benefit of economical benefit arising from a present arising from a present
obligation of a particular obligation of a particular entity to transfer assets or entity to transfer assets or provide servicesprovide services to other to other entities in the future as a entities in the future as a result of past transactions result of past transactions
or events.or events.
An obligation to provide services
is a liability.
An obligation to provide services
is a liability.
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Typical liabilities include accounts
payable, notes payable, and advances from
customers.
Typical liabilities include accounts
payable, notes payable, and advances from
customers.
Elements of the Balance Sheet
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Elements of the Balance Sheet
Equity
Residual interest in the assets of an entity that remains after deducting its liabilities.
Equity
Residual interest in the assets of an entity that remains after deducting its liabilities.
Capital StockCapital StockCapital StockCapital Stock
Retained EarningsRetained EarningsRetained EarningsRetained EarningsPaid-in Capital in Excess of ParPaid-in Capital in Excess of ParPaid-in Capital in Excess of ParPaid-in Capital in Excess of Par
12How to Classify Items on the Balance Sheet
Current (one year or less)
Noncurrent (more than 1 year)
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Current Assets
Cash and resources expected to be converted to cash during the entity’s normal operating cycle or one year, whichever is longer, are current assets.
Cash and resources expected to be converted to cash during the entity’s normal operating cycle or one year, whichever is longer, are current assets.
• Cash• Accounts and notes receivable• Inventories• Prepaid items
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Operating Cycle
Receivables
Cash
Inventories
PurchasesCollections
Sales
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Noncurrent Assets
• Investments • Property,
plant, and equipment
• Deferred income taxes
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Property, Plant, and Equipment
Property, plant, and equipment are properties of a tangible and
relatively permanent nature that are used in the normal business
operations.
Property, plant, and equipment are properties of a tangible and
relatively permanent nature that are used in the normal business
operations.
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Intangible Assets
Intangible assets are long-term rights and
privileges of a nonphysical nature acquired for use in
business operations.
Intangible assets are long-term rights and
privileges of a nonphysical nature acquired for use in
business operations.
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Current Liabilities
Current liabilities are obligations expected to be paid within one year or the normal operating cycle.
Current liabilities are obligations expected to be paid within one year or the normal operating cycle.
• Accounts and notes payable• Accrued expenses• Current portion of long-term
obligations• Unearned revenues
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Current Liabilities
If the terms of the agreement for a callable
obligation is due on demand or will become due on demand within
one year from the balance sheet date, the obligation should be classified as current.
If the terms of the agreement for a callable
obligation is due on demand or will become due on demand within
one year from the balance sheet date, the obligation should be classified as current.
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Noncurrent Liabilities
The current liability classification generally does not include the following items: Debts to be liquidated from a noncurrent
sinking fund.
Short-term obligations to be refinanced.
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Noncurrent Liabilities
• Long-term debt• Long-term lease
obligations• Deferred income
tax liability• Pension
obligations
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Noncurrent Liabilities
Long-term debt is reported at its discounted
present value.
Long-term debt is reported at its discounted
present value.
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Contingent Liabilities
Past activities or circumstances may give rise to possible
future liabilities. Potential obligations that do not exist on the balance sheet date are known as
contingent liabilities.
Past activities or circumstances may give rise to possible
future liabilities. Potential obligations that do not exist on the balance sheet date are known as
contingent liabilities.
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Contingent Liabilities
An estimated liability is a definite liability, so it is
not a contingent liability.
An estimated liability is a definite liability, so it is
not a contingent liability.
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Owners’ Equity
Contributed Capital: Capital stock Additional paid-in capital
Capital stock usually is the number of shares
issued multiplied by the par or stated value.
Capital stock usually is the number of shares
issued multiplied by the par or stated value.
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Owners’ Equity
Contributed Capital: Capital stock Additional paid-in capital
The two types of capital stock are preferred and
common.
The two types of capital stock are preferred and
common.
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Owners’ Equity
Contributed Capital: Capital stock Additional paid-in capital
Additional paid-in capital is the excess
invested above par or stated value of the
capital stock.
Additional paid-in capital is the excess
invested above par or stated value of the
capital stock.
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Owners’ Equity
Retained earnings is the amount of undistributed earnings of past periods.
Retained earnings is the amount of undistributed earnings of past periods.
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Evaluating Liquidity
Current Ratio: current assets divided by current liabilities.
Quick Ratio: quick assets divided by current liabilities (Acid-Test Ratio).
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Liquidity Ratios Example
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Current AssetsCurrent Assets
Current LiabilitiesCurrent Liabilities
Current AssetsCurrent Assets
Current LiabilitiesCurrent Liabilities$200$200
$100$100
$200$200
$100$100= 2:1
Current RatioCurrent RatioCurrent RatioCurrent Ratio
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Liquidity Ratios Example
Quick AssetsQuick Assets
Current LiabilitiesCurrent Liabilities
Quick AssetsQuick Assets
Current LiabilitiesCurrent Liabilities
$100$100
$100$100
$100$100
$100$100= 1:1
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Cash $ 30Net Accounts Receivable 70Inventory 100Current Assets $200Current Liabilities $100
Quick RatioQuick RatioQuick RatioQuick Ratio
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Current Ratio
McDonald’s 0.5
Microsoft 2.8
Disney 1.2
Coca-Cola 0.7
Yahoo! 5.8
Cok
e
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Overall Leverage
Debt Ratio: total liabilities divided by total assets.
Total Assets $400
Total Liabilities 300
Debt Ratio: total liabilities divided by total assets.
Total Assets $400
Total Liabilities 300
Total LiabilitiesTotal Liabilities
Total AssetsTotal Assets
Total LiabilitiesTotal Liabilities
Total AssetsTotal Assets
$300$300
$400$400
$300$300
$400$400= 75%
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Debt Ratio
McDonald’s 52.2%
Microsoft 25.6%
Disney 53.1%
Coca-Cola 56.1%
Yahoo! 13.8%
Cok
e
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Asset Mix
The proportion of total assets in each asset category.Property, Plant, and Equipment $ 50
Total Assets 400
The proportion of total assets in each asset category.Property, Plant, and Equipment $ 50
Total Assets 400
Asset GroupAsset Group
Total AssetsTotal Assets
Asset GroupAsset Group
Total AssetsTotal Assets
$50$50
$400$400
$50$50
$400$400= 12.5%
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Efficiency
“Asset Turnover” is a financial ratio measuring how efficiently a company uses its assets to generate sales.
Sales $200
Total Assets 400
“Asset Turnover” is a financial ratio measuring how efficiently a company uses its assets to generate sales.
Sales $200
Total Assets 400
SalesSales
Total AssetsTotal Assets
SalesSales
Total AssetsTotal Assets$200$200
$400$400
$200$200
$400$400= 0.50
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Asset Turnover
McDonald’s 0.63
Microsoft 0.65
Disney 0.56
Coca-Cola 0.98
Yahoo! 0.33
Cok
e
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Overall Profitability
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Net IncomeNet Income
Total AssetsTotal Assets
Net IncomeNet Income
Total AssetsTotal Assets
$40$40
$400$400
$40$40
$400$400= 10.0%
Return on AssetsReturn on AssetsReturn on AssetsReturn on Assets
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Return on Assets
McDonald’s 7.8%
Microsoft 20.2%
Disney 4.5%
Coca-Cola 18.5%
Yahoo! 4.1%
Cok
e
40
Overall Profitability
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Net IncomeNet Income
Stockholders’ EquityStockholders’ Equity
Net IncomeNet Income
Stockholders’ EquityStockholders’ Equity
$40$40
$160$160
$40$40
$160$160= 0.25%
Return on EquityReturn on EquityReturn on EquityReturn on Equity
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Return on Equity
McDonald’s 16.4%
Microsoft 27.0%
Disney 9.5%
Coca-Cola 42.0%
Yahoo! 4.8%
Cok
e
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Notes to Financial Statements
• Summary of significant accounting policies.
• Additional information to support summary totals.
• Information about items not included in financial statements.
• Supplementary information required by the FASB or the SEC to fulfill the full-disclosure principle.
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Subsequent Events
Financial StatementPeriod
SubsequentPeriod
Balance Sheet Date
Date Statements Issued
Events in this periodmay affect the reporting
of amounts in thesubsequent periods
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•Types of Events•Those that materially affect one or more financial statements.•Those that create a need for a footnote.
Subsequent Events
Balance Sheet Date
Date Statements Issued
Financial StatementPeriod
SubsequentPeriod
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Limitations of the Balance Sheet
Does not disclose actual value of the entity.
Does not disclose effects of inflation. Classifications are not uniform among
companies. Does not disclose all assets and liabilities.
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The EndThe End