Ch02_A Further Look at Financial Statements-2

8/11/2019 Ch02_A Further Look at Financial Statements-2

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A FURTHER LOOKAT FINANCIALSTATEMENTS

Financial Acc oun t ing, Seventh Edition


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Preview of Chapter 2

Financial Accounting

Seventh Edition

Kimmel Weygandt Kieso


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The Classified Balance Sheet

LO 1 Identi fy the sectio ns of a classif ied balanc e sheet.

Presents a snapshot at a point in time.

To improve understanding, companies group similar

assets and similar liabilities together.

Illustration 2-1Standard Classifications


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Illustration 2-2


LO 1


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Illustration 2-2


LO 1


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Assets that a company expects to convert to cash or use

up within one yearor the operating cycle, whichever is

longer.

Operating cycleis the average time it takes from the

purchase of inventory to the collection of cash from

customers.

Common typesof current assets are (1) cash, (2)

investments, (3) receivables, (4) inventories, and (5)

prepaid expenses.

Current Assets


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Companies list current asset accounts in the order they expect to

convert them into cash.

Current Assets Illustration 2-3


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Cash, and other resources that are reasonably expected to

be realized in cash or sold or consumed in the business

within one year or the operating cycle, are called:

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

Review Question




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LO 1

Investments in stocks and bondsof other corporations that

are held for more than one year.

Long-term assetssuch as land or buildings that a companyis not currentlyusing in its operating activities.

Long-term notes receivable.

Long-Term Investments

Illustration 2-4

Alternative Terminology

Long-term investments are often referredto simply as investments.


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Property, Plant, and Equipment



Long useful lives.

Currently used in operations.

Includes land, buildings, equipment, delivery vehicles, and

furniture.

Depreciation- allocating the cost of assets to a number of

years.

Accumulated depreciation- total amount of depreciation

expensed thus far in the assets life.

Alternative TerminologyProperty, plant, and equipment issometimes called fixed assets orplant assets.


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Illustration 2-5

Property, Plant, and Equipment


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Intangible Assets


LO 1

Assets that do not have physical substance.

Includes goodwill, patents, copyrights, and

trademarks or trade names. Illustration 2-6

Helpful HintSometimes intangibleassets are reportedunder a broaderheading called Other

assets.


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Patents and copyrights are

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.



Review Question


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Obligations the company is to pay within the next year or

operating cycle, whichever is longer.

Common examplesare accounts payable, salaries andwages payable, notes payable, interest payable, and income

taxes payable.

Also included as current liabilities are current maturities

of long-term obligationspayments to be made within thenext year on long-term obligations.

Current Liabilities


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Illustration 2-7Current Liabilities


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Obligations a company expects to pay after one year.

Include bonds payable, mortgages payable, long-term

notes payable, lease liabilities, and pension liabilities.Illustration 2-8

Long-Term Liabilities


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Which of the following is not a long-term liability?

a. Bonds payable.

b. Current maturities of long-term debt.

c. Long-term notes payable.

d. Mortgages payable.



Review Question


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Illustration 2-2

Common stock- investments of assets into the business by

the stockholders.

Retained earnings- income retained for use in the business.

Stockholders Equity


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CL Salaries and wages payable LTI Investment in real estate

NA Service revenue PPE Equipment

CL Interest payable PPE Accumulated depreciation

IA Goodwill CA Debt investments (short-term)

NA Depreciation expense SE Retained earnings

LTL Mortgage payable CL Unearned service revenue

(due in 3 years)

Match each of the items to its proper balance sheet

classification, shown below. If the item would not appear on a balance sheet, use

NA.Current assets (CA) Current liabilities (CL)

Long-term investments (LTI) Long-term liabilities (LTL)

Property, plant, and equipment (PPE) Stockholders equity (SE)

Intangible assets (IA)

Solution

LO 1


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Using the Financial Statements

Ratio Analysis Ratio analysisexpresses the relationship among selected

items of financial statement data.

A ratioexpresses the mathematical relationship betweenone quantity and another.

A single ratio by itself is not very meaningful.

LO 2 Ident i fy tools for analyzing f inancia l statements and

ratios for computing a companys profitability.


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Illustration 2-9Financial ratio classifications


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Using the Income Statement



Illustration 2-10


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Illustration:Earnings per share (EPS)measures the netincome earned on each share of common stock.

$1,277

(393

- $0

+ 419) 2=

$3.14

$1,317

(419

- $0

+ 414) 2=

$3.16

Illustration 2-11

Best Buy

Profitability

Ratio


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For 2014 Stoneland Corporation reported net

income $26,000; net sales $400,000; and average shares

outstanding 6,000. There were preferred stock dividends of

$2,000. What was the 2014 earnings per share?

a. $4.00

b. $0.06

c. $16.67

d. $66.67


$26,000 - $2,000

6,000= $4.00



Review Question


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Using the Statement of Stockholders Equity

LO 3 Expla in the relationsh ip between a reta ined earnings

statement and a statement of stockholders equity.

Most companies use

a statement of

stockholders

equity, rather than a

retained earnings

statement, so that

they can report all

changes in

stockholders equity

accounts.

Illustration 2-12


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LO 3

Observations from this financial statement of Best Buy:

Common stock increasedin the first year as the result of an

issuance of shares.

Common stock decreasedduring the second year because

the stock issuance was much smaller than the stock

repurchase.

Best Buy paid dividendseach year.

For many years, Best Buy did not pay dividends, even

though it was profitable and could do so.

Using the Statement of Stockholders Equity


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The balance in retained earnings is not affected by:

a. net income

b. net lossc. issuance of common stock

d. dividends

Review Question

LO 3 Expla in the relationsh ip between a reta ined earnings

statement and a statement of stockholders equity.



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Using theFinancial

Statements

Using a

ClassifiedBalance Sheet

Illustration 2-13


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Using a Classified Balance Sheet

LO 4 Identify and compute ratios for analyzing a companys

l iquidi ty and s olvency u sing a balance sheet.

Liquiditythe ability to pay obligations expected to becomedue within the next year or operating cycle.

Illustration 2-14

Working capitalis the difference between the amounts of

current assets and current liabilities.

Best Buy had working capital in 2011 of $1,810 million

($10,473 million - $8,663 million).


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Liquidity ratiosmeasure the short-term ability to pay maturingobligations and to meet unexpected needs for cash.

Illustration 2-15

For every dollar of current liabilities, Best Buy has $1.21 of current assets.



Liquidity

Ratio


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Solvencythe ability to pay interest as it comes due and torepay the balance of a debt due at its maturity.

Solvency ratiosmeasure the ability of the company to

survive over a long period of time.




Helpful Hint Some users evaluate solvencyusing a ratio of liabilities divided by stockholders

equity. The higher this debt to equity ratio, the

lower is a companys solvency.


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The 2011 ratio means that every dollar of assets was financed by 59 cents of debt.


Debt to assets ratiomeasures the percentage of total financingprovided by creditors rather than stockholders.

Illustration 2-16



Solvency

Ratio


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LO 4

Review QuestionThe following ratios are available for Leer Inc. and Stable Inc.

Compared to Stable Inc., Leer Inc. has:

a. higher liquidity, higher solvency, and higher profitability.

b. lower liquidity, higher solvency, and higher profitability.c. higher liquidity, lower solvency, and higher profitability.

d. higher liquidity and lower solvency, but profitability cannot be

compared based on information provided.


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In the Statement of Cash Flows, cashprovided by operating activitiesfails to

take into account that a company must

invest in new PP&E and must maintain dividends at current levels to

satisfy investors.

Free cash flowis a measurement to provide additional insight

regarding a companys cash-generating ability.


LO 5 Use the statement of c ash f lows to evaluate solvency.


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LO 5 Use the statement of c ash f lows to evaluate solvency.

Illustration: MPC produced and sold

10,000 personal computers this year. It

reported $100,000 cash provided by

operating activities. In order to maintain production at 10,000

computers, MPC invested $15,000 in equipment. It chose to pay

$5,000 in dividends. Calculate free cash flow.

Cash provided by operating activities $100,000

Less: Expenditures on property, plant, and equipment -15,000

Dividends paid 5,000

Free cash flow $ 80,000


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Financial Reporting Concepts

The Standard-Setting EnvironmentGenerally Accepted Accounting Principles (GAAP) -A set of

rules and practices, having substantial authoritative support, that

the accounting profession recognizes as a general guide for

financial reporting purposes.

Standard-setting bodiesdetermine these guidelines:

Securities and Exchange Commission (SEC)

Financial Accounting Standards Board (FASB) International Accounting Standards Board (IASB)

Public Company Accounting Oversight Board (PCAOB)

International NoteOver 115 countriesuse internationalstandards (calledIFRS).

LO 6 Expla in the meaning of generally accepted accoun t ing pr inc ip les.


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Generally accepted accounting principles are:

a. a set of standards and rules that are recognized as

a general guide for financial reporting.

b. usually established by the Internal Revenue Service.

c. the guidelines used to resolve ethical dilemmas.

d. fundamental truths that can be derived from the laws

of nature.

Review Question

LO 6 Expla in the meaning of generally accepted accoun t ing pr inc ip les.



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Qualities of Useful Information

LO 7

According to the FASB, useful information should possess two

fundamental qualities, relevanceand faithful representation.

Relevance Accounting information has relevanceif it would

make a difference in a business decision. Information is

considered relevant if it provides information that has

predictive value, that is, helps provide accurate expectations

about the future, and has confirmatory value, that is,

confirms or corrects prior expectations. Materialityis a

company-specific aspect of relevance. An item is material

when its size makes it likely to influence the decision of an

investor or creditor.


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Qualities of Useful InformationAccording to the FASB, useful information should possess two

fundamental qualities, relevanceand faithful representation.

Faithful Representation Faithful representationmeans

that information accurately depicts what really happened. To

provide a faithful representation, information must be

complete (nothing important has been omitted), neutral (is

not biased toward one position or another), and free from

error.

LO 7 Discuss f inancia l report ing concepts.


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Enhancing Qualities

Comparability

results whendifferent companiesuse the same

accountingprinciples.

Consistencymeansthat a company usesthe same accounting

principles and methodsfrom year to year.

Information is

verifiableifindependentobservers, using the

same methods, obtainsimilar results.

For accounting information tohave relevance, it must be

timely.

Information has the

quality ofunderstandabilityif it is presented in aclear and concise

fashion.


Qualities of Useful Information


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Assumptions in Financial Reporting


Monetary Unit Economic Entity

Illustration 2-18

Requires that only those thingsthat can be expressed in

money are included in the

accounting records.

States that every economic

entity can be separately

identified and accounted for.


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Assumptions in Financial Reporting


Illustration 2-18

Going Concern

The business will remain inoperation for the

foreseeable future.

Periodicity

States that the life of abusiness can be divided into

artificial time periods.


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Principles in Financial Reporting


Measurement Principles

Historical Cost Fair Value Full disclosure

Or cost principle,dictates that

companies record

assets at their

cost.

Indicates thatassets and

liabilities should be

reported at fair

value (the price

received to sell an

asset or settle

a liability).

Requires thatcompanies disclose

all circumstances

and events that

would make a

difference to

financial statement

users.


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Cost Constraint

Cost Constraint

Accounting standard-setters weigh

the cost that companies will incur to

provide the information against the

benefit that financial statement

users will gain from having the

information available.



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Comparability

Going concern

Materiality


The following items guide the FASB when it creates accounting

standards.

Relevance Periodicity assumption

Faithful representation Going concern assumption

Comparability Historical cost principle

Consistency Full disclosure principle

Monetary unit assumption Materiality

Economic entity assumption

Match each item above with a description below.

1. Ability to easily evaluate one companys results

relative to anothers.

2. Belief that a company will continue to operate for theforeseeable future.

3. The judgment concerning whether an item is large

enough to matter to decision-makers.


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Full disclosure

Periodicity

Relevance



4. The reporting of all information that would make a

difference to financial statement users.

5. The practice of preparing financial statements atregular intervals.

6. The quality of information that indicates the

information makes a difference in a decision.


standards.








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Historical cost

Consistency

Economic entity



7. Belief that items should be reported on the balance

sheet at the price that was paid to acquire the item.

8. A companys use of the same accounting principlesand methods from year to year.

9. Tracing accounting events to particular companies.


standards.








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Faithfulrepresentation

Monetary unit



10. The desire to minimize errors and bias in financial

statements.

11. Reporting only those things that can be measured indollars.


standards.








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What is the primary criterion by which accounting

information can be judged?

a. Consistency.b. Predictive value.

c. Usefulness for decision making.

d. Comparability.

Review Question




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IFRS recommends but does not require the use of the title

statement of financial position rather than balance sheet.

The format of statement of financial position information is often

presented differently under IFRS. Most companies that follow

IFRS present statement of financial position information in this

order:

1. Noncurrent assets

2. Current assets

3. Equity

4. Noncurrent liabilities

5. Current liabilities

Key Points

LO 8 Compare the classif ied balanc e sheet form at under GAAP and IFRS.


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IFRS requires a classified statement of financial position except

in very limited situations. IFRS follows the same guidelines as

this textbook for distinguishing between current and noncurrent

assets and liabilities.

Under IFRS, current assets are usually listed in the reverse

order of liquidity.

Some companies report the subtotal net assets, which equals

total assets minus total liabilities.

Key Points



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IFRS has many differences in terminology. In the investment

category stock is called shares, and common stock is called

share capitalordinary.

Key Points



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Comparative prior-period information must be presented and

financial statements must be prepared annually.

Both GAAP and IFRS are increasing the use of fair value to

report assets. As examples, under IFRS companies can apply

fair value to property, plant, and equipment; natural resources;

and in some cases intangible assets.

Recently, the IASB and FASB completed the first phase of a

jointly created conceptual framework.

Key Points



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The monetary unit assumption is part of each framework.

However, the unit of measure will vary depending on the

currency used (e.g., Chinese yuan, Japanese yen, and British

pound).

Key Points



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The IASB and the FASB are working on a project to converge their

standards related to financial statement presentation. A key feature of

the proposed framework is that each of the statements will be

organized in the same format, to separate an entitys financing

activities from its operating and investing activities and, further, to

separate financing activities into transactions with owners and

creditors.

Looking to the Future



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IFRS Practice

Which of the following statements is false?

a) The monetary unit assumption is used under IFRS.

b) Under IFRS, companies sometimes net liabilities againstassets to report net assets.

c) The FASB and IASB are working on a joint conceptual

framework project.

d) Under IFRS, the statement of financial position is usually

referred to as the statement of assets and equity.



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Current assets under IFRS are listed generally:

a) by importance.

b) in the reverse order of their expected conversion to cash.

c) by longevity.

d) alphabetically.

IFRS Practice

Ch02_A Further Look at Financial Statements-2

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