Financial Accounting: Tools for Business Decision Making, 4th Ed. Kimmel, Weygandt, Kieso CHAPTER 2 Prepared by Ellen L. Sweatt Georgia Perimeter College

A FURTHER LOOK AT FINANCIAL STATMENTS Chapter 2 A FURTHER LOOK AT FINANCIAL STATMENTS

Chapter 2 A Further Look at Financial Statements Identify the sections of a classified balance sheet. Identify and compute ratios for analyzing a company's profitability. Explain the relationship between a retained earnings statement and a statement of stockholders' equity. Identify and compute ratios for analyzing a company's liquidity and solvency using a balance sheet. 2

Chapter 2 A Further Look at Financial Statements Explain the meaning of generally accepted accounting principles. Discuss financial reporting concepts. 2

Identify the Sections of a Classified Balance Sheet 11 1 Identify the Sections of a Classified Balance Sheet Helps users see if company has enough assets to pay debts Can determine the short-term and long-term claims on total assets

Classified Balance Sheet Generally contains the following standard classifications: Current Assets Long-Term Investments Property, Plant, and Equipment Intangible Assets Current Liabilities Long-Term Liabilities Stockholders' Equity 21

Current Assets Assets that are expected to be converted to cash or used up within one year. Current assets are listed in order of liquidity. Examples: Cash Short-term investments Receivables Inventories Supplies Prepaid expenses 22

Long-Term Investments Investments of stocks and bonds of other corporations which are normally held for many years. Investments in long-term assets such as land or buildings that are not currently being used in the company’s operations 23

Property, Plant, and Equipment Assets with relatively long useful lives. Assets used in operating the business. Examples: land buildings machinery delivery equipment furniture and fixtures 24

Depreciation is... Practice of allocating an asset’s full purchase price to a number of years instead of expensing full cost in year of purchase. 24

Accumulated Depreciation... Shows the total amount of depreciation that the company has expensed thus far in the asset’s life. 24

Assets That A Company Depreciates... Should be shown at cost less accumulated depreciation 24

Intangible Assets Non-current assets Have no physical substance Examples: patents copyrights trademarks or trade names franchise Intangible Assets have value because of the exclusive rights or privileges they give the company.

Current Liabilities accounts payable wages payable bank loans payable Obligations that are supposed to be paid within the coming year... accounts payable wages payable bank loans payable interest payable taxes payable current maturities of long-term bank loans payable

Long-Term Liabilities Debts expected to be paid after one year Examples… bonds payable mortgages payable long-term notes payable lease liabilities and obligations under employee pension plans 27

Stockholders' Equity Capital stock - investments of assets in the business by the stockholders Retained earnings - earnings kept for use in the business 28

Ratio Analysis Expresses relationship among selected items of financial statement data Relationship can be expressed in terms of… Percentage Rate Proportion

Ratio Analysis Profitability Ratios - Measures the income or operating success of a company for a given period of time

Ratio Analysis Liquidity Ratios - Measures short-term ability of company to pay its maturing obligations and meet unexpected needs for cash

Ratio Analysis Solvency Ratios - Measures the ability of the company to survive over a long period of time

Ratio Analysis – Use Multiple Measures! Intracompany comparisons - covering two years of the same company Industry average comparisons - based on average ratios for a particular industry Intercompany comparisons - based on comparisons with a competitor in the same industry

11 2 Earnings Per Share How does the company’s earning performance compare with that of previous years (on a per share basis)? Net income-Preferred stock dividends Average common shares outstanding EPS= Higher value = improved performance 18

Review For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no preferred stock dividends. What was 2005 earnings per share? a. $4.00 c. $16.67 d. $66.67 b. $ .06

Review For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no preferred stock dividends. What was 2005 earnings per share? a. $4.00 c. $16.67 d. $66.67 b. $ .06

Statement of Retained Earnings 11 3 Statement of Retained Earnings From Chapter 1: The Statement of Retained Earnings describes the changes in the retained earnings for the period . . . Retained earnings, January 1 $ 0 Add: Net income 6,800 6,800 Less: Dividends 600 Retained earnings, Dec. 31 $ 6,200 20

Statement of Retained Earnings 11 3 Statement of Retained Earnings From Chapter 1: The Statement of Retained Earnings describes the changes in the retained earnings for the period . . . Retained earnings, January 1 $ 0 Add: Net income 6,800 6,800 Less: Dividends 600 Retained earnings, Dec. 31 $ 6,200 20

Statement of Stockholders’ Equity Stockholders’ equity has two parts: Common Stock and Retained Earnings, Thus, The Statement of Stockholders’ Equity reports ALL CHANGES in the common stock and retained earnings accounts… 20

Statement of Stockholders’ Equity 11 4 Statement of Stockholders’ Equity

Liquidity Ratios Measure of short-term ability to pay maturing obligations and to meet unexpected needs for cash Working capital Current ratio

Working Capital = Current Assets - Current Liabilities Measure of short-term ability to pay obligations Difference between current assets and current liabilities Working Capital = Current Assets - Current Liabilities 31

Current Ratio Current Assets Current Ratio = Current Liabilities More dependable indicator Does not consider composition of current assets 32

Solvency Ratios Measure the ability of a company to survive over a long period of time Total Debts Total Assets Debt to Total Asset Ratio = Measures percentage of assets financed by creditors rather than stockholders

Review Statement of Cash Flows 11 5 Review Statement of Cash Flows Provides information about sources and uses of cash, organized as: Operating Activities Investing Activities Financing Activities

Free Cash Flow Free Cash Flow _ _ Cash Provided By Operations Capital Expenditures _ Cash Dividends

Primary Accounting Setting Body in the U.S. 11 6 Primary Accounting Setting Body in the U.S. Financial Accounting Standards Board 4

U.S. Government Agency That Oversees Financial Markets Securities Exchange Commission 4

IASB = International Accounting Standards Board GAAP Are the Rules The FASB makes the rules. The SEC enforces the rules. IASB = International Accounting Standards Board

Review What organization issues United States accounting standards? a. Financial Accounting Standards Board b. Internal Accounting Standards Committee c. Internal Auditing Standards Committee d. Securities and Exchange Committee

Review What organization issues United States accounting standards? a. Financial Accounting Standards Board b. Internal Accounting Standards Committee c. Internal Auditing Standards Committee d. Securities and Exchange Committee

Basic Terms 7 Relevance - information makes a difference in decisions 11 7 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

Characteristics of Useful Information 41

Accounting Assumptions

Accounting Principles Constraints In Accounting Illustration 23 10

Review 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 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 What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and revenues? a. Comparability b. Materiality c. Conservatism d. Consistency

Review What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and revenues? a. Comparability b. Materiality c. Conservatism d. Consistency

Review Which is not an indicator of profitability? a. Current ratio b. Earnings per share c. Net income

Review Which is not an indicator of profitability? a. Current ratio b. Earnings per share c. Net income

Review The balance in retained earnings is not affected by: Net income. Issuance of common stock. Dividends. Net Loss.

Review The balance in retained earnings is not affected by: Net income. Issuance of common stock. Dividends. Net Loss.

Review Let’s compute current ratio . . . Selected financial information for Drummond Company at 12/31/2006: Let’s compute current ratio . . .

Review Compute Current Ratio $210,000  $140,000 = 1.5 : 1

Review Compute debt to total assets . . . Selected financial information for Drummond Company at 12/31/2006: Compute debt to total assets . . .

Review $270,000  $540,000 = 50%

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