1 Class today –Quiz –Finish Ch. 4, Levitt, Brennan –Ch. 5 B/S Monday 1/31 –Ch. 5 and Ch. 23 SCF Agenda

2  Financial Position at a particular point in time  IFRS vs. US GAAP  IFRS requires presentation of 2 years of balance sheet data  US GAAP  Public companies, 2 years B/S (SEC)  Private companies, only 1 year B/S required  Generally listed in order of liquidity  Classified as “Current” or “Non-Current”. Chapter 5, 17 Balance Sheet

3 Current Assets Long-term investments Property, plant, and equipment Intangible assets Other assets Total Assets Current liabilities Long-term debt Owners’ equity Capital stock Additional paid-in capital Retained earnings Accum OCI Less: T-stock Total Liab & Equity AssetsLiabilities and Equity Balance Sheet: Classification

The balance sheet provides information:  Evaluating Capital structure – financing by creditors/investors  Analyzing an enterprise’s:  Profitability with rates of return (in combination with the I/S)  ROE  ROA  Liquidity (sufficient resources for day-to-day operations)  Current Ratio/Working Capital  Solvency (ability to pay debts as they mature – more long-run)  Lower solvency = higher debt  Financial flexibility (ability to respond to threats /take advantage of opportunities)  Effectiveness in using assets employed  Inventory and Receivables turnover Balance Sheet: Usefulness

Benchmarks: –Trends –Peers Scaling: –Ratios –Common size financial statements Limitations: Must compare apples to apples –Nature of accounting –Accounting choices –Economic conditions and business model differences Financial Statement Analysis

6 Coverage/ Solvency ratios Degree of protection for long-term creditors and investors Debt to total assets Times interest earned Type What is measuredExamples Liquidity ratios Short-term ability to pay maturing obligations Current ratio Quick assets ratio Profitability ratios Degree of success or failure for a given period Rate of return on assets Earnings per share Activity ratios Effectiveness in using assets employed Receivables turnover Inventory turnover Types of Ratios

7 Is the B/S appropriate for valuing a company? Most assets and liabilities are stated at historical cost. Judgments and estimates are used in determining many of the items. The balance sheet does not report items that can not be objectively determined. It does not report information regarding certain off-balance sheet financing. Balance Sheet: Limitations

8 Balance Sheet – Current Assets Asset CategoryGeneral Valuation Rule Cash & Cash Equivalents Fair Market value Accounts ReceivableNet realizable value InventoryLower of cost or market (cost measured using a variety of methods) Prepaid ExpensesHistorical cost Marketable Securities/Investments Fair Market value

9 Investments of < 20% Held-to-maturity: –Record debt securities at cost and don’t revalue “Fair value” or “Mark to Market” –Trading: Debt & equities intended to sell. Revalue annually to Fair Value in B/S. Unrealized holding gains and losses in income –Available for Sale: All others. Revalue annually to Fair Value in B/S. Unrealized holding gains and losses in OCI and equity (AOCI)

10 Investments of < 20% Issues with Fair Value Method How is “fair value” determined? –Level 1: active market –Level 2: observable market data other than quoted market price –Level 3: determined only through “unobservable inputs” and prices based on internal models or estimates Classification of Trading vs. AFS Dividends received: –DR Cash CR Dividend Income

11 Balance Sheet – Non Current Assets Asset CategoryGeneral Valuation Rule Property, Plant, & Equipment Historical cost less accumulated depreciation LandHistorical cost, no depreciation Long-term InvestmentsHistorical cost, Market value, Equity method Deferred Income Tax Asset Undiscounted sum of expected future tax benefits Intangible AssetsAcquisition cost less amortization if acquired from external parties (usually zero if developed internally)

Liabilities

Short-term obligations: –Accounts payable, accrued liabilities (examples?) –Current portion of long-term debt Long-term obligations: – obligations arising from specific financing situations (issuance of bonds, bank debt) – obligations arising from ordinary business operations (pension obligations) – obligations that are contingent (product warranties for long-term items) Liabilities

14 Book N/I ≠ Tax N/I Deferred Tax Liability and Asset accounts reconcile difference Example: Assume 34% effective tax rate BookTax Revenue$500,000$500,000 Expense(300,000)(350,000) NIBT 200, ,000 Tax exp( 68,000) (51,000) NI$132,000$ 99,000 Deferred Tax Liabilities (and Assets)

15 What is the journal entry to record this? Is a deferred tax liability “good” or “bad”? Deferred Tax Liabilities (and Assets)

16  Measurement of Liabilities uses a variety of techniques:  Amount equal to actual future payment  The present value of expected future payments  Ex: Capital lease obligations  Some future obligations are not reported on the balance sheet, but instead disclosed entirely in the notes to the financial statements.  Ex: Operating lease obligations Balance Sheet - Liabilities

1.Capital Stock Par or stated value of the shares issued 2.Additional paid-in capital The excess of amounts paid in over par value 3.Retained earnings Undistributed earnings 4.Accumulated Other Comprehensive Income Analogous to RE as AOCI is the “bucket” where OCI goes Owners’ Equity

19  Measurement  Amounts reported in these accounts represent the aggregate of transactions that occurred at various points in time  Common Stock & APIC will include proceeds from the sale of stock from inception to present  Retained Earnings will include the sum of Net Income from inception through current year less dividends paid  Note that each year’s net income is expressed in that year’s dollars (i.e., monetary unit assumption) Balance Sheet - Equity

20 Supplemental Information Reported  Contingencies – material events that have an uncertain outcome  Accounting Policies – Explanations of the valuation methods used or the basic assumptions made concerning inventory valuations, depreciation, investment in subsidiaries, etc.  Contractual Situations – Explanations of certain restrictions or covenants attached to specific assets or, more likely, liabilities.  Fair Values – Disclosures of fair values for certain items  Subsequent Events – Disclosure of material events or transactions that occur between the balance sheet date and its issuance date.  Events that relate to conditions that existed as of the balance sheet date are incorporated into the balance sheet as if the subsequent information was known as of the balance sheet date.  Events that relate to conditions that did not exist as of the balance sheet date are typically disclosed in the notes to the financial statements. Balance Sheet