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

2 Chapter 2 A FURTHER LOOK AT FINANCIAL STATMENTS

3 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. Chapter 2 A Further Look at Financial Statements

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

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

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

7 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

8 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

9 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

10 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.

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

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

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

14 Current Liabilities 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

15 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

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

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

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

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

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

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

22 Earnings Per Share How 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 dividends Average common shares outstanding EPS= 11 2

23 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 d. $66.67 c. $16.67 Review b. $.06

24 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 d. $66.67 c. $16.67 Review b. $.06

25 Statement of Retained Earnings From Chapter 1: The 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 6,800 Less: Dividends 600 Retained earnings, Dec. 31 $ 6,200

26 Statement of Retained Earnings From Chapter 1: The 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 6,800 Less: Dividends 600 Retained earnings, Dec. 31 $ 6,200

27 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…

28 Statement of Stockholders’ Equity 11 4

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

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

31 Current Ratio Current Ratio = Current Assets Current Liabilities More dependable indicatorMore dependable indicator Does not consider composition of current assetsDoes not consider composition of current assets

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

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

34 Free Cash Flow Cash Provided By Operations Capital Expenditures Cash Dividends __

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

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

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

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

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

40 Basic Terms v Relevance - information makes a difference in decisions v Reliability - information must be free of error and bias v Comparability - ability to compare information of different companies because they use the same accounting principles v Consistency - use of same accounting principles and methods from year to year within the same company 11 7

Characteristics of Useful Information 41

Accounting Assumptions

Accounting Principles Constraints In Accounting Illustration 23

44 Review Review What is the primary criterion by which accounting information can be judged? a. Consistency d. Comparability c. Usefulness for decision making b. Predictive Value

45 Review Review What is the primary criterion by which accounting information can be judged? a. Consistency d. Comparability c. Usefulness for decision making b. Predictive Value

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

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

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

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

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

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

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

53 $210,000 $140,000 = 1.5 : 1  Review Compute Current Ratio

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

55 $270,000  $540,000 = 50% Review

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