Accounting, Fifth Edition 2 A FURTHER LOOK AT THE FINANCIAL STATEMENTS Spring 2016 Accounting, Fifth Edition

The Classified Balance Sheet The B/S presents a snapshot at a point in time. To improve understanding, companies group similar assets and similar liabilities together in a specific order. Standard Classifications Assets L S/E Common Stock & Retained Earnings

The Classified Balance Sheet These are just the Assets. The Liabilities and Owner’s Equity are on the next slide.

The Classified Balance Sheet Illustration 2-2 These are just the Liabilities and Owner’s Equity. Assets are on the previous slide.

The Classified Balance Sheet Current Assets Assets that a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer (the operating cycle is seldom used). The operating cycle is the average time it takes from the purchase of inventory to the collection of cash from customers. If there’s no inventory (only a service is being provided) then the operating cycle is much shorter. Common types of current assets are (1) cash, (2) short term investments, (3) receivables, (4) inventories, and (5) prepaid expenses.

The Classified Balance Sheet Current Assets $2,601,000,000 Companies list current assets in the order they expect to convert them into cash. Note “in millions” means you have to add 6 zeros! It’s actually over 2 billion! These are all discussed in the NOTES to the F/S

The Classified Balance Sheet Long-Term Investments Long-term investments are often referred to simply as investments. Investments in stocks and bonds of other corporations that are held for more than one year. Long-term assets such as land or buildings that a company is not currently using in its operating activities (you plan to resell them for a profit at a later date). Long-term notes receivable. Note only 3 zeros (in thousands) were added. $90,266,000

The Classified Balance Sheet Property, Plant, and Equipment Property, plant, and equipment is sometimes called Fixed Assets or Plant Assets or PPE Long useful lives of more than 1 year Currently used in operations (not as a long term investment) Includes land, buildings, equipment, vehicles, and furniture. Depreciation - allocating the cost of assets to a number of years (more than 1 year). Accumulated depreciation – the total amount of depreciation expensed thus far in the asset’s life. Land never wears out so we never depreciate land

The Classified Balance Sheet Property, Plant, and Equipment $991,816,000

The Classified Balance Sheet Intangible Assets Sometimes intangible assets are reported under a broader heading called “Other Assets.” Assets that do not have physical substance. Includes goodwill, patents, copyrights, and trademarks (covered more in Chapter 10) $92,806,000,000 LO 1

The Classified Balance Sheet Current Liabilities Obligations the company is to pay within the next year or the operating cycle, whichever is longer. Common examples are accounts payable, salaries and wages payable, notes payable, interest payable, and income taxes payable. Also included as current liabilities are current maturities of long-term obligations (payments to be made within the next year on long-term obligations; like a 30 year mortgage). $127,143,000

The Classified Balance Sheet Long-Term Liabilities Obligations a company expects to pay after one year. Include bonds payable, mortgages payable, long-term notes payable, lease liabilities, and pension liabilities. $40,537,000,000

The Classified Balance Sheet Stockholders’ Equity Common stock - investments of assets into the business in exchange for stock (the investments do not have to be cash). “Retained” earnings - income retained (kept) for use in the business (all the earnings since inception of the business less all the dividends distributed back to shareholders). Dividends are only shown on a Retained Earnings statement!

Using the Financial Statements Ratio Analysis - A ratio expresses the mathematical relationship between two quantities and thus the relationship among selected F/S items

Using the Financial Statements Using the Income Statement We can look at the $ and % changes between years $ % $576 1% Numbers in red and/or (parens) mean a negative number $(616) (1)% $(40) (3)% Profitability ratios measure the operating success of a company for a given period of time. Earnings per share (EPS) measures the NI earned on each share of common stock and is a profitability ratio!

Using a Classified Balance Sheet $17,849,000,000 Note that Total Current Assets exceed Total Current Liabilities in 2011 by $1,810 million! Liquidity is the ability to pay obligations expected within the next year or operating cycle. Best Buy is very liquid in 2011!

Using the Financial Statements Working Capital Using the Financial Statements Using a Classified Balance Sheet One measure of liquidity is Working Capital: the excess of current assets over current liabilities that’s available to work with. When working capital is positive, there is greater likelihood that the company will pay its liabilities. Best Buy had working capital in 2011 of $1,810 million ($10,473 million - $8,663 million).

Using a Classified Balance Sheet Liquidity Ratio Using a Classified Balance Sheet Liquidity ratios measure the short-term ability to pay maturing obligations and to meet unexpected needs for cash. The Current Ratio is an example of a liquidity ratio. It’s just like working capital only calculated and expressed as a ratio. For every dollar of current liabilities, Best Buy has $1.21 of current assets.

Using the Financial Statements Using a Classified Balance Sheet Solvency ratios measure the ability of the company to survive over a long period of time. Solvency is the ability to pay interest as it comes due and repay the balance of a debt that’s due at its maturity. For example, total debt to total assets is a solvency ratio that measures the % of total financing provided by creditors rather than stockholders $10,557/$17,849 = 59%!

Financial Reports Concepts Qualities of Useful Information According to the FASB, useful information should possess two fundamental qualities, relevance and faithful representation.

Financial Reports Concepts Qualities of Useful Information Enhancing Qualities Information has the quality of understandability if it is presented in a clear and concise fashion. Comparability results when different companies use the same accounting principles. Information is verifiable if we are able to prove that it is free from error. Consistency means that a company uses the same accounting principles and methods from year to year. For accounting information to be relevant, it must be timely.

Financial Reports Concepts Assumptions in Financial Reporting Economic Entity States that every economic entity can be separately identified (from personal transactions) and accounted for. Monetary Unit Periodicity Requires that only those things that can be expressed in $ money are included in the accounting records. States that the life of a business can be divided into artificial time periods.

Financial Reports Concepts Two More Assumptions in Financial Reporting Going Concern Accrual-Basis The business will remain in operation for the foreseeable future. Transactions are recorded in the periods in which the events occur.

Financial Reports Concepts Principles in Financial Reporting Measurement Principles Cost Fair Value Full disclosure Also called the historical cost principle, dictates that companies record assets at their cost (not what they think it’s worth) Indicates that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability). Requires that companies disclose all circumstances and events that would make a difference to users (provided in the F/S and the notes).

Financial Reports Concepts Constraints in Financial Reporting Materiality Constraint An item is material when its size makes it likely to influence the decision of an investor or creditor. 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.

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. Ability to easily evaluate one company’s results relative to another’s. Belief that a company will continue to operate for the foreseeable future. The judgment concerning whether an item is large enough to matter to decision-makers. Comparability Going concern Materiality LO 7 Discuss financial reporting concepts.

Full disclosure Periodicity Relevance 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. The reporting of all information that would make a difference to financial statement users. The practice of preparing financial statements at regular intervals. The quality of information that indicates the information makes a difference in a decision. Full disclosure Periodicity Relevance LO 7 Discuss financial reporting concepts.

Historical cost Consistency Economic entity 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. Belief that items should be reported on the balance sheet at the price that was paid to acquire the item. A company’s use of the same accounting principles and methods from year to year. Tracing accounting events to particular companies. Historical cost Consistency Economic entity LO 7 Discuss financial reporting concepts.

Faithful representation 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. The desire to minimize errors and bias in financial statements. Reporting only those things that can be measured in dollars. Faithful representation Monetary unit LO 7 Discuss financial reporting concepts.

What accounts would you need to calculate the Current Ratio? 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 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) LO 1

Financial Reporting Concepts Review Question What is the primary criterion by which accounting information can be judged? Consistency. Predictive value. Usefulness for decision making. Comparability. LO 7 Discuss financial reporting concepts.

The Classified Balance Sheet Review Question 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: Current assets. Intangible assets. Long-term investments. Property, plant, and equipment. LO 1 Identify the sections of a classified balance sheet.

The Classified Balance Sheet Review Question Patents and copyrights are Current assets. Intangible assets. Long-term investments. Property, plant, and equipment. LO 1 Identify the sections of a classified balance sheet.

The Classified Balance Sheet Review Question Which of the following is not a long-term liability? Bonds payable. Current maturities of long-term debt. Long-term notes payable. Mortgages payable. LO 1 Identify the sections of a classified balance sheet.

Using the Financial Statements Review Question The balance in retained earnings is not affected by: net income net loss issuance of common stock dividends LO 3 Explain the relationship between a retained earnings statement and a statement of stockholders’ equity.

Financial Reporting Concepts Review Question Generally accepted accounting principles (GAAP) are: a set of standards and rules that are recognized as a general guide for financial reporting. usually established by the Internal Revenue Service. the guidelines used to resolve ethical dilemmas. fundamental truths that can be derived from the laws of nature. LO 6 Explain the meaning of generally accepted accounting principles.