1. Financial Accounting: Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm
KIMMEL
Prepared by:
Barbara Trenholm
University of New Brunswick

2. Chapter 2 A Further Look at Financial Statements
After studying Chapter 2, you should be able to:
Describe the basic objective of financial reporting, and explain the meaning of generally accepted accounting principles.
Discuss the qualitative characteristics of accounting information.
Identify two constraints in accounting.
Identify the sections of a classified balance sheet. 1

3. Chapter 2 A Further Look at Financial Statements
After studying Chapter 2, you should be able to:
Identify and compute ratios for analysing a company's profitability.
Explain the relationship between a statement of retained earnings, a statement of earnings, and a balance sheet.
Identify and compute ratios for analysing a company's liquidity and solvency. 2

4. Objective of Financial Reporting
Provide the most useful financial information for decision making 4

5. General Guide for Financial Reporting
Generally
Accepted
Accounting
Principles

6. Characteristics of Useful Information
Understandability
Relevance
Reliability
Comparability and consistency

7. Characteristics of Useful Information
Illustration 2-1
Characteristics of Useful Information

8. Constraints in Accounting
Modify GAAP without hurting the usefulness of information
Cost-benefit
Materiality 10

9. Classified Balance Sheet
Generally contains the following standard classifications:
Assets
Current assets
Long-term investments
Capital assets
Liabilities
Current liabilities
Long-term liabilities
Shareholders’ Equity
Share capital
Retained earnings 21

10. Current Assets
Assets expected to be converted to cash or used in the business within the year
Listed in order of liquidity
Examples
Cash
Short-term investments
Receivables
Inventories
Prepaid expenses 22

11. Long-Term Investments
Assets that can be converted into cash, but whose conversion is not expected within one year
Assets not intended for use within the business
Example
Investments in shares
and bonds of other
corporations 23

12. Capital Assets Assets with relatively long useful lives
Assets used in operating the business
Two categories of capital assets
Tangible (with physical substance)
Intangible (with no physical substance)

13. Tangible Capital Assets
Examples
Property, plant, and equipment
Land
Buildings
Machinery and equipment
Furniture and fixtures
Natural resources
Mineral deposits
Timber 24

14. Intangible Capital Assets
Examples
Patents
Copyrights
Trademarks or trade names
Franchise
Intangible assets have value
because of the exclusive
rights or privileges they possess

15. Amortization
Allocation of an asset’s full purchase price to match cost to revenues over entire estimated useful life instead of expensing full cost in year of purchase
Amortization is allocated for all capital assets except land 24

16. AMORTIZATION
Accumulated amortization account shows the total amount of amortization taken to date
The difference between the cost of the asset and its accumulated amortization is referred to as the net book value of the asset 8

17. CSU CORPORATION Balance Sheet December 31, 2001
Capital assets should be shown at net book value (cost less accumulated amortization)
Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 24,000
Less: Accumulated amortization 8, ,000
Total assets $23,800 24

18. Current Liabilities
Obligations that are supposed to be paid within the coming year
Accounts payable
Wages payable
Notes (bank loans) payable
Interest payable
Taxes payable
Current maturities of long-term liabilities

19. Long-Term Liabilities
Debts expected to be paid after one year
Bonds payable
Mortgages payable
Long-term notes payable
Capital lease liabilities
Obligations under employee pension plans 27

20. Shareholders' Equity Share capital Retained earnings
Investments in the business by the shareholders
Retained earnings
Earnings kept for use in the business 28

21. Current Current Assets Current assets Cash $ 272
ANY CORPORATION Balance Sheet (Sample Presentation) December 31, 2001 (in millions)
Assets
Current assets
Cash $
Short-term investments (current)
Receivables
Other current assets
Total current assets 1,038
Investments (long-term)
Capital assets
Other long-term assets
Total assets $ 1,957
Liabilities and Shareholders’ Equity
Liabilities
Current liabilities
Notes payable $ 527
Accounts payable 233
Income taxes payable Total current liabilities 816
Long-term debt 83
Total liabilities 899
Shareholders’ equity
Share capital 830
Retained earnings 228
Total shareholders’ equity ,058
Total liabilities and shareholders’ equity $ 1,957
Current
Current

22. Ratio Analysis Mathematical relationship
Relationship can be expressed in terms of
Percentage
Rate
Proportion

23. Comparisons Intracompany (prior years of your company)
Intercompany (between companies)
Industry averages

24. Financial Ratio Classifications
Profitability ratios
Measures of the earnings or operating success of a company for a given period of time
Liquidity ratios
Measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash
Solvency ratios
Measures of the ability of a company to survive over a long period of time

25. Using the Statement of Earnings
With profitability ratios
Return on assets
Profit margin

26. Profitability Return On Assets Ratio
Reveals the amount of net earnings generated by each dollar invested
Return on assets =
Net earnings
Average total assets
Higher value suggests favourable efficiency 18

27. Profitability Profit Margin Ratio
Measures the percentage of each dollar of sales that results in net earnings
Profit margin =
Net earnings
Net sales
Higher value suggests favourable return on each dollar of sales 19

28. Using the Statement of Retained Earnings
Describes the events that caused changes in the retained earnings account for the period
Increased by earnings
Decreased by losses and dividends + - 20

29. CSU CORPORATION Statement of Retained Earnings For the Year Ended December 31, 2001
Retained earnings, January 1 $ (1)
Add: Net earnings 6,800 (2)
6,800
Less: Dividends
Retained earnings, December 31 $ 6,800 (3)
Statement interrelationships:
Opening retained earnings comes from, and agrees to, ending retained earnings on prior period balance sheet
Net earnings comes from, and agrees to, net earnings on statement of earnings
Ending retained earnings goes to, and agrees to, ending retained earnings on current period balance sheet

30. Using the Balance Sheet
With liquidity ratios
Working capital
Current ratio
With solvency ratios
Debt to total assets

31. Liquidity Working Capital
Measures short-term ability to pay liabilities
Current assets - current liabilities
= Working capital 31

32. Liquidity Current Ratio
Measure of short term ability to pay obligations
Current ratio =
Current assets
Current liabilities 32

33. Solvency Debt to Total Assets
Measures % of assets financed by creditors
Debt to total assets =
Total liabilities
Total assets 33

34. Using the Statement of Cash Flows
To provide information about
Cash receipts
Cash payments
Changes in cash (and cash equivalents)
From changes in
Operating activities
Financing activities
Investing activities 35

35. Operating Activities
Cash inflows and cash outflows associated with the primary operations of the business 38

36. Financing Activities
Cash inflows / outflows come from sources funding the business
Sale of shares / payment of dividends
Issuing debt / repaying debt 36

37. Investing Activities
Cash inflows/ outflows result from changes in investments and capital assets
Purchasing/disposing of investments and long-lived assets using cash
Lending money and collecting the loans 37

38. Liquidity Cash Current Debt Coverage
Measures ability to generate sufficient cash to satisfy short-term needs
Cash current debt coverage ratio =
Cash provided by operating activities
Average current liabilities 33

39. Solvency Cash Total Debt Coverage
Measures ability to generate sufficient cash to meet long-term needs
Cash total debt coverage ratio =
Cash provided by operating activities
Average total liabilities

40. Decision Checkpoints Return on assets ratio
Is the company using its assets effectively?
Is the company maintaining an adequate margin between sales and expenses?
Can the company meet its short-term obligations?
Can the company meet its long-term obligations?
Return on assets ratio
Profit margin ratio
Working capital, current ratio, cash current debt coverage ratio
Debt to total assets ratio, cash total debt coverage ratio

41. COPYRIGHT
Copyright © 2001 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.