ch02_Day2_Fall09

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ACCT 252 – Chapter 1 and 2

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Participation 7/9/08 1. E1-3, for each state if O, I, F activity

a. Golf course operations revenue _____ b. Long-term debt ____ c. Property, plant, and equipment ______

2. E1-4 – Net income __________ 3. E1-6 – Retained Earnings, Dec.31

________ 4. E1-10 – Classify as A, L, SE, R, E

a. Income tax expense __________ b. Accounts payable _________ c. Cash _______5. E1-14 – (b) Accounting equation for Nike

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EXERCISE 1-3

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EXERCISE 1-4

CONNOR CO. Income Statement

For the Year Ended December 31, 2007 Revenues Service revenue ...................................................... $58,000 Expenses Salaries expense .................................................... $30,000 Rent expense .......................................................... 10,400 Utilities expense ..................................................... 2,400 Advertising expense .............................................. 1,800 Total expenses ................................................ 44,600 Net income ..................................................................... $13,400

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CONNOR CO. Retained Earnings Statement

For the Year Ended December 31, 2007 Retained earnings, January 1 ......................................................... $64,000 Add: Net income ............................................................................ 13,400 77,400 Less: Dividends .............................................................................. 6,000 Retained earnings, December 31 .................................................... $71,400

Exercise 1-4 contd.

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EXERCISE 1-6

ANNE CHARLOTTE INC. Retained Earnings Statement

For the Year Ended December 31, 2007 Retained earnings, January 1 ................................. $130,000 Add: Net income .................................................... 240,000* 370,000 Less: Dividends ...................................................... 82,000 Retained earnings, December 31 ............................ $288,000 *Revenue from legal services ................................. $410,000 *Total expenses ........................................................ 170,000 *Net income .............................................................. $240,000

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Exercise 1-10 (b) KELLOGG COMPANY Income Statement For the Year Ended December 31, 2004 (in millions) Revenues Net sales .................................................... $9,613.9 Expenses Cost of goods sold ................................... $5,298.7 Selling and administrative expenses ...... 2,634.1 Income tax expense .................................. 475.3 Interest expense ....................................... 308.6 Other expense ........................................... 6.6 Total expenses .................................. 8,723.3 Net income ........................................................ $ 890.6

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EXERCISE 1-14 All dollars are in millions. (a) Assets Cash .......................................................................................... $ 828.0 Accounts receivable................................................................. 2,120.2 Inventories ................................................................................ 1,633.6 Property, plant, and equipment............................................... 1,586.9 Other assets.............................................................................. 1,722.9 Total assets................................................................... $7,891.6 Liabilities Notes payable........................................................................... $ 146.0 Accounts payable..................................................................... 763.8 Income taxes payable .............................................................. 118.2 Other liabilities ......................................................................... 2,081.9 Total liabilities............................................................... $3,109.9 Stockholders’ Equity Common stock ......................................................................... $ 890.6 Retained earnings .................................................................... 3,891.1 Total stockholders’ equity ........................................... $4,781.7

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Exercise 1-14 (b) Assets Liabilities Stockholders’ Equity

$7,891.6 = $3,109.9 + $4,781.7

(c) Nike has relied more heavily on equity than debt to finance its assets.

Debt (liabilities) financed 39% of its assets ($3,109.9 ÷ $7,891.6) compared to equity financing of 61% ($4,781.7 ÷ $7,891.6).

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Chapter 2

A FURTHER LOOK A FURTHER LOOK AT FINANCIAL AT FINANCIAL STATMENTSSTATMENTS

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EXERCISE 2-3

H. J. HEINZ COMPANY Partial Balance Sheet

April 28, 2004 (in thousands)

Assets Current assets Cash and cash equivalents............ $1,180,039 Accounts receivable....................... 1,093,155 Inventories ...................................... 1,156,932 Prepaid expenses........................... 165,177 Other current assets ...................... 15,493 Total current assets................ $3,610,796 Property, plant, and equipment Land ................................................ 65,836 Buildings and equipment............... $3,661,388 Less: Accumulated depreciation.. 1,669,938 1,991,450 2,057,286 Intangible assets.................................... 2,753,735 Other noncurrent assets ....................... 1,455,372 Total assets ............................................ $9,877,189

Now let’s work E2-5

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EXERCISE 2-5

TEXAS INSTRUMENTS, INC. Balance Sheet

December 31, 2004 (in millions)

Assets Current assets Cash ......................................................................... $ 2,668 Short-term investments .......................................... 3,690 Accounts receivable................................................ 1,696 Inventories ............................................................... 1,256 Prepaid expenses.................................................... 326 Other current assets ............................................... 554 Total current assets......................................... $10,190 Long-term investments .................................................. 264 Property, plant, and equipment Property, plant, and equipment .............................. 9,573 Less: Accumulated depreciation........................... (5,655) 3,918 Other noncurrent assets ................................................ 1,927 Total assets ..................................................................... $16,299

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Liabilities and Stockholders’ Equity Current liabilities Accounts payable.................................................... $ 1,444 Loans payable in 2005 ............................................ 11 Other current liabilities ........................................... 470 Total current liabilities..................................... $ 1,925 Noncurrent liabilities Long-term debt ........................................................ 368 Other noncurrent liabilities..................................... 943 Total noncurrent liabilities .............................. 1,311 Total liabilities ................................................................. 3,236 Stockholders’ equity Common stock ........................................................ 2,488 Retained earnings ................................................... 10,575 Total stockholders’ equity............................... 13,063 Total liabilities and stockholders’ equity ...................... $16,299

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Ratio AnalysisRatio Analysis Expresses relationship among

selected items of financial statement data

Relationship can be expressed in terms of… Percentage Rate Proportion

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Ratio AnalysisRatio Analysis Profitability RatiosProfitability Ratios - Measures the

income or operating success of a company for a given period of time (Is the owner getting a return on his/her investment?)

Remember: net income = earnings = profit

Use INCOME STATEMENT information

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Ratio AnalysisRatio Analysis Liquidity RatiosLiquidity Ratios - Measures short-term

ability of company to pay its maturing obligations and meet unexpected needs for cash (Can the company pay its debts?)

Use BALANCE SHEET information

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Ratio AnalysisRatio Analysis Solvency RatiosSolvency Ratios - Measures the

ability of the company to survive over a long period of time


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Ratio Analysis – Ratio Analysis – Use Multiple Measures!Use Multiple Measures!

Intracompany comparisonsIntracompany comparisons - covering two years of the same company

Industry average comparisonsIndustry average comparisons - based on average ratios for a particular industry

Intercompany comparisonsIntercompany comparisons - based on comparisons with a competitor in the same industry

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Earnings Per ShareEarnings Per ShareHow does the company’s earning performance compare with that of previous years (on a per share basis)?

Higher value = improved performance

Net income-Preferred stock dividendsNet income-Preferred stock dividends Average common shares outstandingAverage common shares outstandingEPS=EPS=

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Use INCOME STATEMENT information

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For 2007 X Corp reported net income, $24,000; net sales, $400,000; and average shares outstanding, 6,000. There were no preferred stock dividends. What was the 2007 earnings per share? A. $4.00 B. $0.06 C. $16.67 D. $66.67

Net income-Preferred stock dividendsNet income-Preferred stock dividends Average common shares outstandingAverage common shares outstanding

$24,000 - $0$24,000 - $06,000 shares6,000 shares

Now let’s work E2-7

EXERCISE 2-7 (a) Earnings per share = Net income – Preferred stock dividends Average common shares outstanding

2008 : $66,176,000 – 0 (64,507,000 + 66,282,000) / 2 = $1.01

2007 : $54,587,000 – 0 (66,282,000 + 73,139,000) / 2 = $ .78

(b) Using net income (loss) as a basis to evaluate profitability, Callaway Golf’s income improved by 21% between 2007 and 2008. Its earnings per share increased by 29%.

(c) To determine earnings per share, dividends on preferred stock are subtracted from net income, but dividends on common stock are not subtracted.

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Statement of Retained Statement of Retained EarningsEarnings

From Chapter 1: From Chapter 1: The Statement of Retained The Statement of Retained Earnings Earnings describes the changes in the retained earnings for the period . . .

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Retained earnings, January 1Retained earnings, January 1 $ 0$ 0Add: Net incomeAdd: Net income 6,8006,800

6,8006,800Less: DividendsLess: Dividends 600600Retained earnings, Dec. 31 Retained earnings, Dec. 31 $ 6,200$ 6,200

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Statement of Retained Statement of Retained EarningsEarnings

From Chapter 1: From Chapter 1: The Statement of Retained The Statement of Retained Earnings Earnings describes the changes in the retained earnings for the period . . .

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Retained earnings, January 1Retained earnings, January 1 $ 0$ 0Add: Net incomeAdd: Net income 6,8006,800

6,8006,800Less: DividendsLess: Dividends 600600Retained earnings, Dec. 31 Retained earnings, Dec. 31 $ 6,200$ 6,200

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Statement of Statement of Stockholders’ EquityStockholders’ Equity

Stockholders’ equity has two parts:Stockholders’ equity has two parts:Common StockCommon Stock andandRetained Earnings,Retained Earnings,

Thus, The Statement of Stockholders’ Equity Thus, The Statement of Stockholders’ Equity reports reports ALL CHANGESALL CHANGES in the common stock in the common stock and retained earnings accounts… and retained earnings accounts…

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Statement of Statement of Stockholders’ EquityStockholders’ Equity

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Liquidity RatiosLiquidity Ratios Measure of short-term ability to

pay maturing obligations and to meet unexpected needs for cash

•Working capitalWorking capital

•Current ratioCurrent ratio


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Working CapitalWorking Capital

Working Capital = Current Assets - Current Liabilities Working Capital = Current Assets - Current Liabilities

•Measure of short-term ability to pay obligations

•Difference between current assets and current liabilities


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Current RatioCurrent Ratio

CurrentCurrent Ratio =Ratio = Current AssetsCurrent AssetsCurrent LiabilitiesCurrent Liabilities

•More dependable indicatorMore dependable indicator

•Does not consider composition of current Does not consider composition of current assetsassets


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Measure the ability of a company to survive over a long period of time

Solvency RatiosSolvency Ratios

Total DebtsTotal DebtsTotal AssetsTotal Assets

Debt to Total Asset Ratio Debt to Total Asset Ratio ==

•Measures percentage of assets financed by Measures percentage of assets financed by creditors rather than stockholderscreditors rather than stockholders


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Selected financial information for Selected financial information for Drummond Company at 12/31/2007:Drummond Company at 12/31/2007:

Cash $60,000Receivables (net) $80,000Inventory $70,000Long-term assets $330,000Total Assets $540,000

Current Liabilities $140,000Long-term debt $130,000Total Liabilities $270,000

Let’s compute current ratio . . .Let’s compute current ratio . . .

ReviewReview

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$210,000$210,000

$140,000$140,000

==1.5 : 11.5 : 1

Review Review Compute Current RatioCompute Current Ratio

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Selected financial information for Selected financial information for Drummond Company at 12/31/2007:Drummond Company at 12/31/2007:



Compute debt to total assets . . .Compute debt to total assets . . .

ReviewReview

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$270,000 $270,000 $540,000 = 50% $540,000 = 50%

ReviewReview

Now let’s work E2-9, 11

EXERCISE 2-9 (a) Beginning of Year End of Year

Working capital $3,361 – $1,635 = $1,726 $$3,217 – $1,601 = $1,616

Current ratio $3,361/$1,635 = 2.06:1 $3,217/$1,601 = 2.01:1

(b) Nordstrom’s liquidity decreased during the year. Its current ratio decreased from 2.06:1 to 2.01:1. Also, Nordstrom’s working capital decreased by $110 million.

(c) Nordstrom’s current ratio at both the beginning and the end of the recent year exceeds Best Buy’s current ratio for 2009 . Nordstrom’s end-of-year current ratio (2.01) exceeds Best Buy’s 2009 current ratio (.97). Nordstrom would be considered more liquid than Best Buy for the recent year.

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EXERCISE 2-11 EXERCISE 2-11 (a) Debt to total assets ratio 2009 = $554,645/$1, 963,576 = 28.2% 2008 = $527,216/$1, 867,680 = 28.2%

(b) Free cash flow 2009 = $302,193 – $265,335 – $82,394 = $-45,536 2008 = $464,270 – $250,407 – $80,796= $133,067

(c) Using the debt to total assets ratio and free cash flow as measures of solvency produces mixed results for American Eagle Outfitters. Its debt to total assets ratio remained flat at28.2% from 2008 to 2009 indicating steady and

strong solvency for 2009. In contrast, its free cash flow decreased more than $170 thousand indicating a substantial decrease in

solvency.

(d) In 2008 American Eagle Outfitters’s cash provided by operating activities was greater than the cash used for capital expenditures. It is generating plenty of cash from operations to cover its investing needs. This is not unusual for a company that has been operating successfully for more than ten years, as has been the case with American Eagle Outfitters. In 2009, free cash flow turned negative but this

could easily be resolved by issuing stock or debt.

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Primary Accounting Setting Body in the U.S.

FinancialAccountingStandardsBoard

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U.S. Government Agency That Oversees Financial MarketsSecuritiesExchangeCommission

GAAP Are the RulesThe FASB makes the rules.

The SEC enforces the rules.

IASB = International Accounting Standards Board

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ReviewReviewWhat organization issues United What organization issues United States accounting standards?States accounting standards?

a.a. Financial Accounting Standards Financial Accounting Standards BoardBoard

d.d. Securities and Exchange CommitteeSecurities and Exchange Committeec.c. Internal Auditing Standards Internal Auditing Standards CommitteeCommittee

b. b. Internal Accounting Standards Internal Accounting Standards CommitteeCommittee

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Basic Terms Relevance - information makes a

difference in decisions Reliability - information must be free

of error and bias Comparability - ability to compare

information of different companies because they use the same accounting principles

Consistency - use of same accounting principles and methods from year to year within the same company

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Characteristics of Useful Information43

Accounting Assumptions

Accounting Principles

Constraints In Accounting Illustration 23

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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 derived from laws of nature

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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 derived from laws of nature

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StandardSetting

CalledGAAP

Done byFASB

Process overseen By SEC

USEFULNESS ofFinancial information

Relevance

Reliability

Comparability

Consistency

Assumptions made and principles followed

when setting accounting standards

Monetary unit

Economic entity

Time period

Going concernCost principle

Full disclosure

Constraints

Materiality

Conservatism

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What is the primary criterion by What is the primary criterion by which accounting information can which accounting information can be judged?be judged?

a.a.ConsistencyConsistencyb.b.Predictive ValuePredictive Valuec.c.Usefulness for decision Usefulness for decision

makingmakingd.d.ComparabilityComparability

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What is the primary criterion by What is the primary criterion by which accounting information can which accounting information can be judged?be judged?

a.a.ConsistencyConsistencyb.b.Predictive ValuePredictive Valuec.c.Usefulness for decision Usefulness for decision

makingmakingd.d.ComparabilityComparability

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What accounting constraint refers to What accounting constraint refers to the tendency of accountants to resolve the tendency of accountants to resolve uncertainty in a way least likely to uncertainty in a way least likely to overstate assets and revenues?overstate assets and revenues?

a.a.ComparabilityComparabilityb.b.MaterialityMaterialityc.c.ConservatismConservatismd.d.ConsistencyConsistency

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What accounting constraint refers to What accounting constraint refers to the tendency of accountants to resolve the tendency of accountants to resolve uncertainty in a way least likely to uncertainty in a way least likely to overstate assets and revenues?overstate assets and revenues?

a.a.ComparabilityComparabilityb.b.MaterialityMaterialityc.c.ConservatismConservatismd.d.ConsistencyConsistency

ch02_Day2_Fall09

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