1. Accounting, Fifth Edition2
A FURTHER LOOK AT FINANCIAL STATEMENTS
Accounting, Fifth Edition

2. Learning Objectives
After studying this chapter, you should be able to:
Identify the sections of a classified balance sheet.
Identify tools for analyzing financial statements and ratios for computing a company’s profitability.
Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.* (slides 19-24)
Explain the importance of accounting and qualities of useful information.* (slides 25-27)
Discuss financial reporting concepts. (slides 28-31)
Accounting for International Companies (slides 32-34)
* Self-study

3. Accounting Equation & Fin’l Stmts
Balance Sheet
Illustration 3-2
Expanded accounting equation
Stmt of Retained Earnings
Net Income/Income Statement
LO 1 Analyze the effect of business transactions on the basic accounting equation.

4. Communicating with Users
Balance Sheet
Reports assets and claims to assets at a specific point in time.
Assets = Liabilities + Stockholders’ Equity.
Lists assets first, followed by liabilities and stockholders’ equity.
Illustration 1-7
Helpful Hint The heading of a balance sheet must identify the company, the statement, and the date.

5. The Classified Balance Sheet - Assets
Illustration 2-2
LO 1

6. Classified Balance Sheet – Current Assets
Illustration 2-3
Assets that a company expects to convert to cash or use up within one year. Companies list current asset accounts in the order they expect to convert them into cash. CASH is always first & I like to see ACCOUNTS RECEIVABLE second.
LO 1 Identify the sections of a classified balance sheet.

7. Classified Balance Sheet – LT Investments
Investments/Long-Term 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.
Long-term notes receivable.
Illustration 2-4
LO 1

8. Classified Balance Sheet – PP&E
Property, Plant, and Equipment/Fixed Assets/Plant Assets (Long-term Asset)
It has a long useful life (>one year).
Currently used in operations.
Includes land, buildings, equipment, delivery vehicles, and furniture.
Depreciation – allocating/expensing the cost of an asset over the number of years it produces revenue.
Accumulated depreciation – cumulative total of depreciation expense recognized thus far in the asset’s life.
LO 1 Identify the sections of a classified balance sheet.

9. Classified Balance Sheet – PP&E
Property, Plant, and Equipment
Illustration 2-5
LO 1 Identify the sections of a classified balance sheet.

10. Classified Balance Sheet – Intangible Assets
Helpful Hint 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 or trade names.
Illustration 2-6
LO 1

11. Classified Balance Sheet - Liabilities
Illustration 2-2
LO 1

12. Classified Balance Sheet – Current Liabs
Current Liabilities
Obligations the company is to pay within the next year or 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.
LO 1 Identify the sections of a classified balance sheet.

13. Classified Balance Sheet – Current Liabs
Current Liabilities
Illustration 2-7
LO 1 Identify the sections of a classified balance sheet.

14. Classified Balance Sheet – LT Liabs
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.
Illustration 2-8
LO 1 Identify the sections of a classified balance sheet.

15. Classified Balance Sheet - Equity
Stockholders’ Equity
Common stock - investments of assets into the business by the stockholders.
Retained earnings – the cumulative total of a company’s income/losses minus dividends since the business started (i.e. cumulative GPA).
Illustration 2-2
LO 1 Identify the sections of a classified balance sheet.

16. Classifed Balance Sheet Practice Problem
Ex 2-8, p. 78
Tips to solve:
Label each account as one of the following:
Current assets (CA)
Long-term investments (LTI)
Property, plant & equipment (PP&E)
Intangible Assets (IA)
Current Liabilities (CL)
Long-term Liabilities (LTL)
Stockholders’ Equity (SE)
Organize & regroup the accounts by account type
Prepare the Classified Balance Sheet

17. Using the Financial Statements
Ratio Analysis – Tells the real story
Ratio analysis expresses the relationship among selected items of financial statement data.
A ratio expresses the mathematical relationship between one quantity and another.
A single ratio by itself is not very meaningful.
LO 2 Identify tools for analyzing financial statements and ratios for computing a company’s profitability.

18. Using the Financial Statements
Illustration 2-9
Financial ratio classifications
LO 2 Identify tools for analyzing financial statements and ratios for computing a company’s profitability.

19. Financial Ratios for Ch 2
Earnings per Share (Profitability ratio)
Net Income – Preferred Dividends
Average Common Shares Outstanding
Working Capital (Liquidity ratio)
Current Assets – Current Liabilities
Debt to Assets (Solvency ratio)
Total Liabilities
Total Assets

20. Using the Income Statement
Profitability Ratio
Using the Income Statement
Illustration: Earnings per share (EPS) measures the net income earned on each share of common stock.
Best Buy
Illustration 2-11
$1,277
- $0
$1,317
- $0 = =
(393
+ 419) 2
(419
+ 414) 2
$3.14
$3.16
LO 2

21. Using the Financial Statements
Using a Classified Balance Sheet
Illustration 2-13

22. Liquidity Ratios – ability to pay obligations due within the next year
*Working capital measures a company’s ability to pay its bills in the immediate future
For every dollar of current liabilities, Best Buy has $1.21 of current assets.
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.

23. Solvency Ratios – ability to pay interest when due & to repay debt balances at maturity.
Solvency ratios measure the ability of the company to survive over a long period of time.
The 2011 ratio means that every $1 of assets was financed by 59 cents of debt.
Helpful Hint Some users evaluate solvency using a ratio of liabilities divided by stockholders’ equity. The higher this “debt to equity” ratio, the lower is a company’s solvency.
LO 4 Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet.

24. Financial Ratios Practice Problem
Do it! Review 2-3 (a & b), p 76

25. to help users make better decisions.
Importance of Accounting
is a
system that
Accounting
Identifies
Records
GAAP
information
that is
Relevant
Communicates
Accounting is the process of identifying, recording and communicating information that is relevant, reliable, and comparable. The goal of the accounting process is to provide helpful information to users of financial information. Quality information may help users reach more informed decisions.
Reliable
to help users make better decisions.
Comparable

26. Qualities of Useful Information
According to the FASB, useful information must have relevance and faithful representation.
Relevance Accounting information is relevant if it impacts a business decision. For example, does the Information have predictive value? Does it give accurate insight to expectations about the future? Does it have confirmatory value, can it confirm or corrects prior expectations? Information is relevant only if it is material. It is material if it is big enough to influence the decision of an investor or creditor. For example, missing $1,000 if you have $2,000 or $500,000.
Faithful Representation Faithful representation means that information accurately depicts what really happened. To provide a faithful representation, information must be complete (nothing important has been omitted), neutral (is not biased toward one position or another), and free from error.
LO 7

27. Qualities of Useful Information
Comparability results when different companies use the same accounting principles.
Information is verifiable if independent
observers, using the same methods, obtain similar results.
Information has the quality of understandability
if it is presented in a clear and concise fashion.
Consistency means that a company uses the same accounting
principles and methods from year to year.
For accounting information to have relevance, it must be timely.
LO 7 Discuss financial reporting concepts.

28. Financial Reporting Concepts
Assumptions in Financial Reporting
Illustration 2-18
Monetary Unit
Business Entity
Requires that only those things that can be expressed in money are included in the accounting records.
States that every economic entity can be separately identified and accounted for.
LO 7 Discuss financial reporting concepts.

29. Financial Reporting Concepts
Assumptions in Financial Reporting
Illustration 2-18
Periodicity
Going Concern
States that the life of a business can be divided into artificial time periods (i.e. month, quarter or year). A company’s FISCAL year can differ from a CALENDAR year.
The business will remain in operation for the foreseeable future.
LO 7 Discuss financial reporting concepts.

30. Financial Reporting Concepts
Principles in Financial Reporting
Measurement Principles
Historical Cost
Fair Value
Full disclosure
Or cost principle, dictates that companies record assets at their cost.
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 financial statement users.
LO 7 Discuss financial reporting concepts.

31. Financial Reporting Concepts
Cost Constraint
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 from having the information available.
LO 7 Discuss financial reporting concepts.

33. IFRS tends to be simpler in its accounting and disclosure requirements; some people say it is more “principles-based.” GAAP is more detailed; some people say it is more “rules-based.”
International standards are referred to as International Financial Reporting Standards (IFRS), developed by the International Accounting Standards Board (IASB). Over 115 countries require or permit use of IFRS.
Recent events in the global capital markets underscore the importance of financial disclosure and transparency not only in the United States but in markets around the world. As a result, many are examining which accounting and financial disclosure rules should be followed.
Over 120 countries use the IFRS & 90 countries have fully adopted ( Jul 2016)
LO 7 Describe the impact of international accounting
standards on U.S. financial reporting.

34. Financial Reporting Concepts
The Standard-Setting Environment
U.S.
Global
Rule Maker
FASB (Fin’l Acctg Stds Board) issues broad & specific US accounting principles.
IASB (Int’l Acctg Stds Board ) issues preferred
accounting practices in other countries.
Rules
GAAP (Generally Accepted Accounting Principles)
IFRS (Int’l Financial Reporting Standards)
Police/Enforcers
SEC (Securities & Exchange Commission)
IFRS not enforceable BUT recommended.
US Reqm’ts
US GAAP req’d for US SEC Registrants
IFRS or GAAP for non-US SEC Registrants
It seems unlikely that IFRS will be mandated soon given the new SEC Chairman’s focus on investor protections & securities law enforcement. However US GAAP & IFRS accounting standards continue to converge SO US companies are being impacted by IFRS. (Apr 2013)
LO 6 Explain the meaning of generally accepted accounting principles.