1. The Balance Sheet and Notes to the Financial Statements

2. Learning Objectives
Describe the specific elements of the balance sheet (assets, liabilities, and owners’ equity) and prepare a balance sheet with assets and liabilities properly classified into current and noncurrent categories.
Identify the different formats used to present balance sheet data.

3. Learning Objectives
Analyze a company’s performance and financial position through the computation of financial ratios.
Recognize the importance of the notes to the financial statements, and outline the types of disclosures made in the notes.
Understand the major limitations of the balance sheet.

4. Usefulness of the Balance Sheet
Reports the resources (assets), obligations (liabilities), and residual ownership claims (equity) of a company.
Facilitates analysis of the company’s ability to:
meet short-term obligations (liquidity).
pay all debts as due (solvency).
Provides information about the company’s financial flexibility.

5. Elements of the Balance Sheet
The inclusion of “probable” acknowledges that accounting is not an exact science.
Assets
Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events

6. Elements of the Balance Sheet
The primary purpose of the balance sheet is to help forecast the future.
Assets
Probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events

7. Elements of the Balance Sheet
Typical assets found on a balance sheet are cash, supplies, accounts receivable, land, buildings, and equipment.

8. Elements of the Balance Sheet
“Obligation” includes legal, moral, social, and implied commitments.
Liability
Probable future sacrifice of economical benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
Liability
Probable future sacrifice of economical benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.

9. Elements of the Balance Sheet
Liability
Probable future sacrifice of economical benefit arising from a present obligation of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.
An obligation to provide services is a liability.

10. Elements of the Balance Sheet
Typical liabilities include accounts payable, notes payable, and advances from customers.

11. Elements of the Balance Sheet
Asset - Liability = Equity
Equity
Residual interest in the assets of an entity that remains after deducting its liabilities.
Paid-in Capital in Excess of Par
Capital Stock
Retained Earnings

12. How to Classify Items on the Balance Sheet
Current (one year or less)
Noncurrent (more than 1 year) 24

13. Current Assets
Cash and resources expected to be converted to cash during the entity’s normal operating cycle or one year, whichever is longer, are current assets.
Cash
Accounts and notes receivable
Inventories
Prepaid items

14. Operating Cycle Cash Collections Purchases Inventories Receivables
Sales

15. Noncurrent Assets Investments Property, plant, and equipment
Deferred income taxes

16. Property, Plant, and Equipment
Property, plant, and equipment are properties of a tangible and relatively permanent nature that are used in the normal business operations.

17. Intangible Assets
Intangible assets are long-term rights and privileges of a nonphysical nature acquired for use in business operations.

18. Current Liabilities
Current liabilities are obligations expected to be paid within one year or the normal operating cycle.
Accounts and notes payable
Accrued expenses
Current portion of long-term obligations
Unearned revenues

19. Current Liabilities
If the terms of the agreement for a callable obligation is due on demand or will become due on demand within one year from the balance sheet date, the obligation should be classified as current.

20. Noncurrent Liabilities
The current liability classification generally does not include the following items:
Debts to be liquidated from a noncurrent sinking fund.
Short-term obligations to be refinanced.

21. Noncurrent Liabilities
Long-term debt
Long-term lease obligations
Deferred income tax liability
Pension obligations

22. Noncurrent Liabilities
Long-term debt is reported at its discounted present value.

23. Contingent Liabilities
Past activities or circumstances may give rise to possible future liabilities. Potential obligations that do not exist on the balance sheet date are known as contingent liabilities.

24. Contingent Liabilities
An estimated liability is a definite liability, so it is not a contingent liability.

25. Owners’ Equity Contributed Capital: Capital stock
Additional paid-in capital
Capital stock usually is the number of shares issued multiplied by the par or stated value.

26. The two types of capital stock are preferred and common.
Owners’ Equity
Contributed Capital:
Capital stock
Additional paid-in capital
The two types of capital stock are preferred and common.

27. Owners’ Equity Contributed Capital: Capital stock
Additional paid-in capital is the excess invested above par or stated value of the capital stock.
Contributed Capital:
Capital stock
Additional paid-in capital

28. Owners’ Equity
Retained earnings is the amount of undistributed earnings of past periods.

29. Evaluating Liquidity
Current Ratio: current assets divided by current liabilities.
Quick Ratio: quick assets divided by current liabilities (Acid-Test Ratio).

30. Liquidity Ratios Example
Current Ratio
Cash $ 30
Net Accounts Receivable 70
Inventory 100
Current Assets $200
Current Liabilities $100
Current Assets
Current Liabilities
$200
$100
= 2:1

31. Liquidity Ratios Example
Cash $ 30
Net Accounts Receivable 70
Inventory 100
Current Assets $200
Current Liabilities $100
Cash $ 30
Net Accounts Receivable 70
Inventory 100
Current Assets $200
Current Liabilities $100
Quick Ratio
$100
Quick Assets
Current Liabilities
= 1:1

32. Current Ratio McDonald’s 0.5 Microsoft 2.8 Disney 1.2 Coca-Cola 0.7
Yahoo! 5.8
Coke

33. Overall Leverage
Debt Ratio: total liabilities divided by total assets.
Total Assets $400
Total Liabilities 300
$300
$400
Total Liabilities
Total Assets
= 75%

34. Debt Ratio McDonald’s 52.2% Microsoft 25.6% Disney 53.1%
Coca-Cola 56.1%
Yahoo! 13.8%
Coke

35. Asset Mix The proportion of total assets in each asset category.
Property, Plant, and Equipment $ 50
Total Assets 400
$50
$400
Asset Group
Total Assets
= 12.5%

36. Efficiency
“Asset Turnover” is a financial ratio measuring how efficiently a company uses its assets to generate sales.
Sales $200
Total Assets 400
$200
$400
Sales
Total Assets
= 0.50

37. Asset Turnover McDonald’s 0.63 Microsoft 0.65 Disney 0.56
Coca-Cola 0.98
Yahoo! 0.33
Coke

38. Overall Profitability
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”
Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Return on Assets
Net Income
Total Assets
$40
$400
= 10.0%

39. Return on Assets McDonald’s 7.8% Microsoft 20.2% Disney 4.5%
Coca-Cola 18.5%
Yahoo! 4.1%
Coke

40. Overall Profitability
Two ratios that measure overall profitability are “Return on Assets” and “Return on Equity.”
Net Income $ 40
Total Assets 400
Stockholders’ Equity 160
Return on Equity
Net Income
Stockholders’ Equity
$40
$160
= 0.25%

41. Return on Equity McDonald’s 16.4% Microsoft 27.0% Disney 9.5%
Coca-Cola 42.0%
Yahoo! 4.8%
Coke

42. Notes to Financial Statements
Summary of significant accounting policies.
Additional information to support summary totals.
Information about items not included in financial statements.
Supplementary information required by the FASB or the SEC to fulfill the full-disclosure principle.

43. Subsequent Events Financial Statement Subsequent Period Period
Balance Sheet Date
Date Statements Issued
Financial Statement
Period
Subsequent
Period
Events in this period
may affect the reporting
of amounts in the
subsequent periods

44. Date Statements Issued
Subsequent Events
Balance Sheet Date
Date Statements Issued
Financial Statement
Period
Subsequent
Period
Types of Events
Those that materially affect one or more financial
statements.
Those that create a need for a footnote.

45. Limitations of the Balance Sheet
Does not disclose actual value of the entity.
Does not disclose effects of inflation.
Classifications are not uniform among companies.
Does not disclose all assets and liabilities.

46. The End