The Balance Sheet and the Statement of Changes in Stockholders’ Equity An electronic presentation by Norman Sunderman Angelo State University An electronic

The Balance Sheet and the Statement of

Changes in Stockholders’ Equity

An electronic presentation by Norman Sunderman Angelo State University

An electronic presentation by Norman Sunderman Angelo State University

COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.

Chapter4

Intermediate AccountingIntermediate Accounting 10th edition 10th edition

Nikolai Bazley JonesNikolai Bazley Jones

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FASB Statement of FASB Statement of Concepts No. 5Concepts No. 5

FASB Statement of Concepts No. 5

recommends that a full set of financial

statements for an accounting period

should show a company’s...

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1. Financial position at the end of the period.

2. Net income for the period.3. Comprehensive income for the period.4. Cash flows for the period.5. Investments by and distributions to

owners for the period.

FASB Statement of Concepts No. 5

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Interrelationship of Financial Statements

TransactionTransactions and Eventss and Events

ContinuedContinuedContinuedContinued

Beginning Balance Sheet

Assets Liabilities

Stockholders’ Equity

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Income Statement Revenues Expenses

Statement of Cash Flows

Operating Activities Investing Activities Financing Activities


ContinuedContinuedContinuedContinued

TransactionTransactions and Eventss and Events

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EndingBalance Sheet

Assets Liabilities



Income Statement Revenues Expenses

Statement of Cash Flows

Operating Activities Investing Activities Financing Activities

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Basic Accounting Equation

Assets = Liabilities + Stockholders’ Equity

Economic resources

Economic obligations

Net assets

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Liquidity

The term liquidity is used to describe how quickly an asset can

be converted into cash or a liability

paid.

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Financial Flexibility

Financial flexibility refers to the ability of a company to use its financial resources to adapt to

change.

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Operating Capability

Operating capability refers to the ability of a

company to maintain a given physical level of

operations.

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Elements of the Balance Sheet — Assets

Assets are probable future economic benefits obtained or

controlled by a company as a result of past transactions or events.

Assets are probable future economic benefits obtained or

controlled by a company as a result of past transactions or events.

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1. The resource must be able to contribute directly or indirectly to the company’s future net cash inflows.

2. The company must be able to obtain the future benefit and control others’ access to it.

3. The transaction or event giving the company the right to or control over the benefit must have occurred.

Elements of the Balance Sheet -- Assets

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Assets may be natural or man-made, tangible or intangible,

and exchangeable or useful only in the company’s activities.

Assets may be natural or man-made, tangible or intangible,

and exchangeable or useful only in the company’s activities.

Elements of the Balance Sheet -- Assets

Simply, assets have

future value.

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Liabilities are probable future sacrifices of

economic benefits arising from present

obligations...L


economic benefits arising from present

obligations...L

Elements of the Balance Sheet -- Liabilities

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economic benefits arising from present obligations...L


economic benefits arising from present obligations...L

… of a company to transfer assets or provide services to

other entities in the future as a result of past transactions or

events.

… of a company to transfer assets or provide services to

other entities in the future as a result of past transactions or

events.

Elements of the Balance Sheet -- Liabilities

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Assets = Liabilities + Stockholders’ Equity

Equity is residual interest in the assets of a

company that remain after deducting

liabilities.

Equity is residual interest in the assets of a

company that remain after deducting

liabilities.

Elements of the Balance Sheet – Stockholders’ equity

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Measurement of the Elements of the Balance Sheet

Historical CostHistorical Cost

Current CostCurrent Cost

Current Current Market ValueMarket Value

Net Realizable Net Realizable ValueValue

Present ValuePresent Value

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The historical cost of an asset is the exchange price in the transaction in which

the asset was acquired.

The historical cost of an asset is the exchange price in the transaction in which

the asset was acquired.

The current cost of an asset is the amount of

cash (or equivalent) that would be required on the date of the balance sheet to obtain the same asset.

The current cost of an asset is the amount of

cash (or equivalent) that would be required on the date of the balance sheet to obtain the same asset.

The current market value of an asset is the amount of cash (or equivalent)

that could be obtained on the date of the balance

sheet by selling the asset in an orderly liquidation.

The current market value of an asset is the amount of cash (or equivalent)

that could be obtained on the date of the balance

sheet by selling the asset in an orderly liquidation.


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The net realizable value of an asset is the amount of cash (or equivalent) into which the asset is

expected to be converted in the ordinary

operations of the company, less any

expected conversion costs.

The net realizable value of an asset is the amount of cash (or equivalent) into which the asset is

expected to be converted in the ordinary

operations of the company, less any

expected conversion costs.

The present value of an asset is the net

amount of discounted expected cash inflows

less the discounted expected cash outflows

related to the asset.

The present value of an asset is the net

amount of discounted expected cash inflows

less the discounted expected cash outflows

related to the asset.


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Initially, the amount of cash received when an

obligation was incurred (historical proceeds);

subsequent to incurrence, the historical amount may be adjusted

for amortization.

Initially, the amount of cash received when an

obligation was incurred (historical proceeds);

subsequent to incurrence, the historical amount may be adjusted

for amortization.

The current proceeds is the amount of cash that would be obtained if the

same obligation were incurred.

The current proceeds is the amount of cash that would be obtained if the

same obligation were incurred.

The current market value of a liability is the

amount of cash that would be required

currently to eliminate the liability.

The current market value of a liability is the

amount of cash that would be required

currently to eliminate the liability.

Measurement of the Elements of the Balance Sheet-Liabilities

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The net realizable value of a liability is the amount of cash expected to be paid

to eliminate the liability in due

course of business.

The net realizable value of a liability is the amount of cash expected to be paid

to eliminate the liability in due

course of business.The present value of future cash outflows to eliminate the liability

in due course of business.

The present value of future cash outflows to eliminate the liability

in due course of business.

Measurement of the Elements of the Balance Sheet-Liabilities

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Limitations of the Balance Sheet

Use of historical cost to value assets and liabilities does not help assess the likely amounts of future cash flows.

“Human resources” such as high-quality management or highly motivated workers are not included as assets.

Many of the amounts that a company reports are based on estimates.

In periods of inflation, the amounts listed do not show the “purchasing power” of assets and liabilities.

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Current Assets

Current assets are cash and other assets that are expected to be converted

into cash, sold, or consumed within one year or the normal operating

cycle, whichever is longer.

Current assets are cash and other assets that are expected to be converted

into cash, sold, or consumed within one year or the normal operating

cycle, whichever is longer.

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Operating Cycle

An operating cycle is the average time taken by a

company to spend cash for inventory,...

An operating cycle is the average time taken by a

company to spend cash for inventory,...

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Operating Cycle

…process and sell the inventory, and collect the

receivables, converting them back into cash.

…process and sell the inventory, and collect the

receivables, converting them back into cash.

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Operating Cycle FlowMake Collections of

Accounts Receivable

1. Collect cash1. Collect cash 2. Incur bad debts2. Incur bad debts

Make Sales (Revenues) 1.1. Collect cashCollect cash 2.2. Increase accounts Increase accounts

receivablereceivable 3.3. Reduce deferred revenuesReduce deferred revenuesIncur Cost of Goods Sold

1. Reduce inventory1. Reduce inventory

Acquire Inventory 1. Pay cash1. Pay cash 2. Incur accounts 2. Incur accounts

payablepayable

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1. Cash-Unrestricted

2. Short-term investments

3. Accounts receivable

4. Inventories

5. Prepaid expenses

1. Cash-Unrestricted

2. Short-term investments

3. Accounts receivable

4. Inventories

5. Prepaid expenses

Current Assets

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Current Assets

Cash includes cash on hand and readily available in checking and

savings accounts.

Cash includes cash on hand and readily available in checking and

savings accounts.

Cash equivalents are risk-free

securities, such as money market funds

and treasury bills that will mature in three months or less from the date acquired by

the holder.

Cash equivalents are risk-free

securities, such as money market funds

and treasury bills that will mature in three months or less from the date acquired by

the holder.

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Temporary investments in

marketable securities include debt and equity

securities that are classified as “trading

securities” and “available-for-sale

securities.”

Temporary investments in

marketable securities include debt and equity

securities that are classified as “trading

securities” and “available-for-sale

securities.”

Current Assets

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Receivables include accounts receivable and notes receivable with short-term maturity dates.

They are listed at their estimated collectible amounts (net realizable values).

Receivables include accounts receivable and notes receivable with short-term maturity dates.

They are listed at their estimated collectible amounts (net realizable values).

Inventories include goods held for resale in the normal course of business plus, in the case of a

manufacturing company, raw materials and goods in process.

Inventories include goods held for resale in the normal course of business plus, in the case of a

manufacturing company, raw materials and goods in process.

Prepaid items include insurance, rent, office supplies and taxes that will not be converted into

cash but will be consumed.

Prepaid items include insurance, rent, office supplies and taxes that will not be converted into

cash but will be consumed.

Current Assets

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Current Liabilities

Current liabilities are those obligations whose liquidation is expected to require the use of existing current assets, or the

creation of other current liabilities.

Current liabilities are those obligations whose liquidation is expected to require the use of existing current assets, or the

creation of other current liabilities.

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1. Obligations for items that have entered into the operating cycle (accounts payable and salaries payable).

2. Advance collections for the future delivery of goods or performances of service (unearned rent and unearned ticket sales).

3. Other obligations that will be paid within one year or the operating cycle (estimated liabilities for short-term product warranties).

Current Liabilities

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Current Assets

Current Liabilities

= Working Capital

Working Capital

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Long-Term Investments

Investment items that management expects to hold for more than one year

or the operating cycle, whichever is longer, are classified as long-term

(noncurrent) investments.

Investment items that management expects to hold for more than one year

or the operating cycle, whichever is longer, are classified as long-term

(noncurrent) investments.

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The company expects the market value of the investment to increase.

The company wishes to receive income from interest or dividends.

The company may desire to exercise control over another company or a supplier.

The company may acquire property, plant, or equipment for future expansion.

A company makes investments for a variety of reasons.

Long-Term Investments

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Property, plant, and equipment includes the tangible assets used in the firm’s operations.

Also called fixed Also called fixed assetsassets

Also called fixed Also called fixed assetsassets

Plant Assets

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Plant Assets

Land

Buildings

Equipment

Furniture

Natural Resources

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Intangible AssetsIntangible assets are those noncurrent economic resources that are used in the operations of the business but have no

physical existence.

Intangible assets are those noncurrent economic resources that are used in the operations of the business but have no

physical existence.

Patents Copyrights Franchises

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Intangible AssetsIntangible assets are those noncurrent economic resources that are used in the operations of the business but have no

physical existence.

Intangible assets are those noncurrent economic resources that are used in the operations of the business but have no

physical existence.

Trademarks® a registered

trademarkComputer

software costs Goodwill

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Other AssetsOther Assets

The Other Assets section occasionally is used to report

miscellaneous assets that may not be readily classified

within one of the previous sections.

The Other Assets section occasionally is used to report

miscellaneous assets that may not be readily classified

within one of the previous sections.

Sometimes referred to as “deferred charges”Sometimes referred to as “deferred charges”

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Long-Term Liabilities

Long-term liabilities are those obligations that are not expected to require the use of current assets or not expected

to create current liabilities within one year or the normal

operating cycle (if longer than a year).

Long-term liabilities are those obligations that are not expected to require the use of current assets or not expected

to create current liabilities within one year or the normal

operating cycle (if longer than a year).

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Stockholders’ equity is the residual interest of the

stockholders in the assets of the corporation.



A sole proprietorship is a single-owner

company.

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A partnership involves two or more persons who have agreed to combine their capital and efforts

in the operations of a company.

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The corporation is a complex business

organization. Usually there is absentee

ownership.

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Contributed capital Retained earnings Accumulated other

comprehensive income

Components of Stockholders’ EquityComponents of Stockholders’ EquityComponents of Stockholders’ EquityComponents of Stockholders’ Equity


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Legal capital is the minimum amount of

stockholders’ equity that the corporation may not distribute as dividends.

Legal capital is the minimum amount of

stockholders’ equity that the corporation may not distribute as dividends.

Preferred stock receives preference

in declared dividends.

Preferred stock receives preference

in declared dividends.

Common stock carries the right to vote

at the annual stockholders’ meeting

and to share in residual profits.

Common stock carries the right to vote

at the annual stockholders’ meeting

and to share in residual profits.

Contributed CapitalContributed CapitalContributed CapitalContributed Capital


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A corporation sells 100 shares of its $5 par common stock for $30 per share.

A corporation sells 100 shares of its $5 par common stock for $30 per share.

Cash 3,000Common Stock, $5 par 500Additional Paid-in Capital on Common Stock 2,500



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A corporation sells 20 shares of its $100 par preferred stock for $110 per share.

A corporation sells 20 shares of its $100 par preferred stock for $110 per share.

Cash 2,200Preferred Stock, $100 par 2,000Additional Paid-in Capital on Preferred Stock 200



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A corporation sells 100 shares of its no-par common stock at $50 per share.

A corporation sells 100 shares of its no-par common stock at $50 per share.

Cash 5,000Common Stock--No-Par Value 5,000



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Retained earnings is the total amount of corporate net income that has not been

distributed to stockholders as dividends.

Retained earnings is the total amount of corporate net income that has not been

distributed to stockholders as dividends.

Uses of net incomeUses of net incomeTo use in daily operationsTo maintain its productive facilities

For growth


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1. Unrealized increases (gains) or decreases (losses) in the market value of investments in available-for-sale securities.

2. Transaction adjustments from converting the financial statements of a company’s foreign operations into U. S. dollars.

3. Certain gains and losses on “derivative” financial instruments.

4. Certain pension liability adjustments.

Comprehensive income includes both net income and other comprehensive income. Accumulated other comprehensive income might include four items:

Comprehensive income includes both net income and other comprehensive income. Accumulated other comprehensive income might include four items:


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A company is required to report its total

comprehensive income for the accounting period.

A company is required to report its total

comprehensive income for the accounting period.

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If a corporation has more than one item of other comprehensive income, it may report the amount

of each item in stockholders’ equity.

If a corporation has more than one item of other comprehensive income, it may report the amount

of each item in stockholders’ equity.


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Or, it may report the total amount of accumulated other

comprehensive income for all the items in stockholders’ equity.

This approach requires a note to the statements.

Or, it may report the total amount of accumulated other

comprehensive income for all the items in stockholders’ equity.

This approach requires a note to the statements.


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Statement of Changes in Stockholders’ Equity

A corporation must disclose the changes in its stockholders’

equity account when issuing financial statements.

A corporation must disclose the changes in its stockholders’

equity account when issuing financial statements.

This statement should show investments by and

distributions to owners during the period, among other items.

This statement should show investments by and

distributions to owners during the period, among other items.

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FASB Statement of Concepts No. 6 defined investments by owners and distributions to owners, as follows: Investments by owners are increases in the

equity of a company resulting from transfers of something valuable to the company from other entities in order to obtain or increase ownership interests.

Distributions to owners are decreases in the equity of a company caused by transferring assets, rendering services, or incurring liabilities to owners.

Statement of Changes in Stockholders’ Equity

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Summary of Accounting Policies

A selection from existing acceptable alternatives.

Principles and methods peculiar to the industry in which the company operates.

Unusual or innovative applications of GAAP.

APB Opinion No. 22 requires that a company include a description of all significant accounting

policies as an integral part of its financial statements.

APB Opinion No. 22 requires that a company include a description of all significant accounting

policies as an integral part of its financial statements.

In particular, when these principles and methods involve--

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FASB Statement No. 107 requires a company to disclose the fair value of all its financial instruments, whether recognized or not on its balance sheet. The Statement

also requires a company to disclose all significant concentrations of credit risk

due to its financial instruments. A company typically makes these

disclosures in the notes to its financial statements.

Derivative Financial Instruments

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FASB Statement No. 133 requires a company to recognize all derivative financial instruments as

either assets or liabilities on the balance sheet.

FASB Statement No. 133 requires a company to recognize all derivative financial instruments as

either assets or liabilities on the balance sheet.

These instruments should be These instruments should be measured at fair value.measured at fair value.

These instruments should be These instruments should be measured at fair value.measured at fair value.

Fair value is the Fair value is the amount at which amount at which the instrument the instrument

could be could be purchased or purchased or

sold in a current sold in a current transaction transaction

between willing between willing parties.parties.

Fair value is the Fair value is the amount at which amount at which the instrument the instrument

could be could be purchased or purchased or

sold in a current sold in a current transaction transaction

between willing between willing parties.parties.

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1. The type of derivative instruments it holds.

2. Its objectives in holding the instruments.3. Its strategies for achieving these

objectives.

1. The type of derivative instruments it holds.

2. Its objectives in holding the instruments.3. Its strategies for achieving these

objectives.

FASB Statement No. 133 also requires the following information:


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Loss

Probable (?)

Reasonably estimated (?)

No

No

or

Disclosure

and

Yes

YesReport amount

in financial statements

Reasonably possibleDisclose in notes to the financial

statements

Contingent Liabilities and Assets

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Subsequent Events

A subsequent event is one that occurs between the balance sheet date and the date of issuance of the annual report.

A subsequent event is one that occurs between the balance sheet date and the date of issuance of the annual report.

End of Accounting Period

Annual Report Publication Date

Subsequent Events

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Chapter4

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Documents

The Balance Sheet and the Statement of Changes in Stockholders’ Equity An electronic presentation by Norman Sunderman Angelo State University An electronic