Chapter 4 The Balance Sheet and the Statement of Changes in Stockholders’ Equity Intermediate Accounting 11 th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University COPYRIGHT © 2010 South-Western/Cengage Learning
2 FASB Statement of Concepts No. 5 recommends that a full set of financial statements for an accounting period should show a company’s. . .
3 FASB Statement of Concepts No. 5 1. 2. 3. 4. 5. Financial position at the end of the period Net income for the period Comprehensive income for the period Cash flows for the period Investments by and distributions to owners for the period
4 Basic Accounting Equation Assets = Liabilities + Stockholders’ Equity Economic resources obligations Net assets
5 Liquidity The term liquidity is used to describe how quickly an asset can be converted into cash or a liability paid.
6 Financial Flexibility Financial flexibility refers to the ability of a company to use its financial resources to adapt to change.
7 Operating Capability Operating capability refers to the ability of a company to maintain a given physical level of operations.
8 Three-Stage Process for Disclosing Information on the Balance Sheet 1. Identification of what items meet the definition of the elements 2. Measurement (valuation) of the elements 3. Reporting (classification) of the elements
9 Elements of the Balance Sheet: Assets are probable future economic benefits obtained or controlled by a company as a result of past transactions or events.
10 Elements of the Balance Sheet: Assets 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.
11 Elements of the Balance Sheet: Liabilities are probable future sacrifices of economic benefits arising from present obligations. . .
12 Elements of the Balance Sheet: Liabilities …of a company to transfer assets or provide services in the future as a result of past transactions or events.
13 Elements of the Balance Sheet: Stockholders’ Equity Stockholders’ Assets = Liabilities + Equity is the residual interest in the assets of a company that remains after deducting its liabilities.
14 Measurement (Valuation) of the Elements of the Balance Sheet Historical cost is the exchange price in the transaction in which an asset was acquired. The present value of an asset is the net amount of discounted future cash inflows less the discounted future cash outflows relating to the asset. Fair value is the price that a company would receive to sell an asset (or transfer a liability) in an orderly transaction between market participants on the date of measurement.
15 Fair Value Measurement Need Fair Value Select Highest Appropriate Level of Input for Valuation (Hierarchy of Valuation Methods) v. Level 1: Quoted Price for Identical Asset (or Liability) in Active Market v. Level 2: Adjusted Quoted Price (Exit Value) for Similar Asset (or Liability) v. Level 3: Unobservable Inputs (e. g. , Present Value of Expected Cash Flows)
16 Fair Value Measurement Use Valuation Method Consistent with v. Market Approach (Identical or Comparable Assets or Liabilities) v. Income Approach (Present Value) v. Cost Approach (Replacement Cost) Measure Best Fair Value
17 Limitations of the Balance Sheet v The use of historical cost to value assets and liabilities does not help users assess the likely amounts of future cash flows. v “Human resources” such as high-quality management or highly creative employees are not included as assets. v Many of the amounts that a company reports are based on estimates. v In periods of inflation, some amounts listed do not show the “purchasing power” of assets and liabilities.
18 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.
19 Operating Cycle An operating cycle is the average time taken by a company to spend cash for inventory, . . .
20 Operating Cycle …process and sell the inventory, and collect the receivables, converting them back into cash.
21 Current Assets 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 includes cash on hand readily available in checking and savings accounts.
22 Current Assets Temporary investments in marketable securities include debt and equity securities that are classified as “trading securities, ” “available-for-sale securities, ” and “held-tomaturity” securities.
23 Current Assets 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 work in process inventories. Prepaid items such as insurance, rent, office supplies, and taxes will not be converted into cash but will be consumed.
24 Current Liabilities 1. Obligations for items are in 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 (the estimated liability for short-term product warranties).
25 Working Capital Current Assets – Current Liabilities = Working Capital
26 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.
27 Property, Plant, and Equipment Also called fixed assets Property, plant, and equipment includes the tangible assets used in the firm’s operations.
28 Intangible Assets Intangible assets are those noncurrent economic resources that a company uses in its operations but have no physical existence. Patents Copyrights Franchises
29 Intangible Assets Intangible assets are those noncurrent economic resources that a company uses in its operations but have no physical existence. ® a registered trademark Trademarks Computer software costs Goodwill
30 Other Assets 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”
31 Long-Term Liabilities Long-term liabilities are those obligations of a company whose liquidation is not expected to require the use of current assets or not expected to create current liabilities within one year or the normal operating cycle (whichever is longer).
32 Other Liabilities Deferred tax liabilities and obligations of a component of the company that is being discontinued are examples of items that might be included as other liabilities.
33 Conceptual Guidelines FASB suggested guidelines for developing homogeneous classes of assets and liabilities. v Reporting assets according to their type or expected function in the central operations or other activities of the company. v Reporting as separate items assets and liabilities that affect the financial flexibility of the company differently. v Reporting assets and liabilities according to the fair value method used to value the items.
34 Stockholders’ Equity Stockholders’ equity is the residual interest of the stockholders in the assets of the corporation. A sole proprietorship is a single-owner company.
35 Stockholders’ Equity Stockholders’ equity is the residual interest of the stockholders in the assets of the corporation. A partnership involves two or more persons who have agreed to combine their capital and efforts in the operations of a company.
36 Stockholders’ Equity Stockholders’ equity is the residual interest of the stockholders in the assets of the corporation. The corporation is a complex business organization. Usually there is absentee ownership.
37 Stockholders’ Equity Contributed Capital Legal capital is the minimum amount of stockholders’ equity that the corporation may not distribute as 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.
38 Stockholders’ Equity Retained earnings is the total amount of corporate net income that has not been distributed to stockholders as dividends. Uses of net income To use in daily operations To maintain its productive facilities For growth
39 Stockholders’ Equity Comprehensive income includes both net income and “other comprehensive income. ” Accumulated other comprehensive income might include four items: 1. Unrealized increases (gains) or decreases (losses) in the fair 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 plan gains, losses, and prior service cost adjustments.
40 Stockholders’ Equity If a corporation has more than one item of other comprehensive income, it may report the amount of accumulated other comprehensive income for each item in stockholders’ equity.
41 Stockholders’ Equity 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.
42 Statement of Changes in Stockholders’ Equity This corporation must disclose the A statement should show, among other information, investments by changes in its stockholders’ equity and distributionsissuing financial account when to owners during the period. statements.
43 Statement of Changes in Stockholders’ Equity FASB Statement of Concepts No. 6 defines investments by owners and distributions to owners as follows: v Investments by owners are increases in the equity of a company resulting from transfers of something valuable to the company from other entities to obtain or increase ownership interests. v Distributions to owners are decreases in the equity of a company caused by transferring assets, rendering services, or incurring liabilities to owners.
44 Summary of Accounting Policies GAAP requires that a company must include a description of all its significant accounting policies as an integral part of its financial statements. In particular, when these principles and methods involve: ü A selection from existing acceptable alternatives ü Principles and methods peculiar to the industry in which the company operates ü Unusual or innovative applications of GAAP
45 Accounting for Loss Contingencies Loss No Probable? or No Disclosure Yes and Reasonably estimated? Reasonably possible Yes Report amount in financial statements Disclose in notes to the financial statements
46 Subsequent Events A subsequent event is one that occurs between a company’s balance sheet date and the date of issuance of the annual report. End of Accounting Period Subsequent Events Annual Report Publication Date
47 SEC Integrated Disclosures The Securities and Exchange Commission has the legal authority to prescribe accounting principles and reporting practices for all regulated companies. A regulated company must file a Form 10 -K annual report with the SEC within 60 days of its fiscal year-end. This report must be filed electronically according to the EDGAR requirements. Continued
48 SEC Integrated Disclosures The SEC requires comparative balance sheets for two years and comparative income statements and statements of cash flows for three years. The SEC requires specific disclosures of important accounting information for a five-year period. These include net sales or operating revenues, income (loss) from continuing operations and related earnings per share, total assets, long-term obligations and redeemable stock, and cash dividends declared per share.
49 SEC Integrated Disclosures Management must include a discussion and analysis of the company’s financial condition, changes in financial condition, and results of operations.
50 SEC Integrated Disclosures Several disclosures must be made about the common stock market prices and dividends: v The principal trading markets for the company’s common stock v The high and low market prices for each quarter in the last two years v The approximate number of shareholders v The dividends paid in the last two years v Any dividend transactions
51 IFRS vs. U. S. GAAP v The financial statements required by the International Accounting Standards Board (IASB) are similar to those in the United States. v Unlike U. S. GAAP, in which a company typically presents either a classified or nonclassified balance sheet, International Financial Reporting Standards (IFRS) do not require a particular format; the appropriate format depends on the type of company.
52 IFRS vs. U. S. GAAP v IFRS do require that companies classify assets on the balance sheet as either noncurrent or current. v Noncurrent assets include property, plant, and equipment, as well as other items such as investments, long-term receivables, and intangibles. v Current assets are defined similarly to those under U. S. GAAP. v Typically, noncurrent assets are presented first, followed by current assets.
53 IFRS vs. U. S. GAAP v “Capital and reserves, ” which includes issued capital (capital stock and additional paid-in capital), reserves, and accumulated profits or losses (retained earnings), is usually listed first. v Reserves may result from upward revaluations of properties and investments, as well as currency translation differences. v Noncurrent liabilities are usually listed next, followed by current liabilities.
54 Balance Sheet Formats Report Form Assets xxxx Total assets $xxx Liabilities and Stockholders’ Equity xxxx $xxx xxx Total liabilities and stockholders’ equity $xxx
55 Balance Sheet Formats Account Form Assets xxxx Total assets $xxx Liabilities and Stockholders’ Equity xxxx $xxx xxx Total liab. & stock. eq. $xxx
56 Chapter 4 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.
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