1. Balance Sheet and Financial Disclosures

2. Objectives of the Chapter
1. Identify the major classifications of the balance sheet.
2. Prepare a classified balance sheet statement.
3. Discuss the disclosures to financial statements.
The Balance Sheet and Financial Disclosures

3. Objectives of the Chapter (contd.)
4. Understand the accounting treatment for subsequent events.
5. Limitations of the balance sheet.
6. Use financial ratios to study financial performance of corporations.
The Balance Sheet and Financial Disclosures

4. Balance Sheet Statement
Usefulness of the Balance Sheet:
Providing information about the financial position and the capital structure of a business entity.
Providing information about the liquidity, solvency (risk assessment), financial flexibility and operating capability of a business entity.
The Balance Sheet and Financial Disclosures

5. Classified Balance Sheet (Kieso, etc. 14th e,, illustration 5-16)
Scientific Products, Inc.
BALANCE SHEET
December 31, 2012
Assets
Current assets
Cash $42,485
Available-for-sale
securities--at fair value 28,250
Accounts receivable $165,824
Less allow. for
doub. Accts , ,974
Notes receivable 23,000
Inventories --
at average cost 489,713
Supplies on hand 9,780
Prepaid expenses ,252
The Balance Sheet and Financial Disclosures 5

6. Illustration 5-16 (Contd.)
Scientific Products, Inc.
BALANCE SHEET
December 31, 2012
Prepaid expenses ,252
Total current assets $773,454
Long-term investments
Investments in Warren Co. 87,500
Property, plant, and equipment
Land--at cost 125,000
Buildings--at cost 975,800
Less accu. Depr. 341, ,600
Total PPE 759,600
Intangible assets
Goodwill ,000
Total assets $1,720,554
The Balance Sheet and Financial Disclosures 6

7. Illustration 5-16 (contd.)
Liabilities and Stockholders’ Equity
Current liabilities
N/P to banks $50,000
Accounts payable 197,532
Accrued int. on N/P 500
Income taxes payable 62,520
Accrued salaries, wages,
and other liabilities 9,500
Deposits received
from customers
Total current liabilities $320,472
Long-term debt
20-year 12% debentures,
due January 1, ,000
Total liabilities 820,472
The Balance Sheet and Financial Disclosures 7

8. Illustration 5-16 (contd.)
Stockholders’ equity
Paid in on capital stock
Preferred, 7%, cumulative
Authorized, issued,
and outstanding,
30,000 shares of
$10 par value $300,000
Common--
Authorized, 500,000
shares of $1 par value;
issued & outstanding,
400,000 shares 400,000
additional paid-in capital 37, ,500
Earnings retained
in the business 162,582
Total stockholders’ equity ,082
Total liabilities
and stockholders’ equity $1,720,554
The Balance Sheet and Financial Disclosures 8

9. Definition of Elements of a Balance Sheet: (SFAC No. 6)
Assets
Liabilities
Stockholders’ equity
The Balance Sheet and Financial Disclosures

10. The Balance Sheet and Financial Disclosures
Assets
Resources with future economic benefit to a business entity as a result of a past transaction.
The Balance Sheet and Financial Disclosures

11. The Balance Sheet and Financial Disclosures
4/15/2017
Assets (contd.)
Current Assets: cash and other assets that are reasonably expected to be realized in cash or sold, or consumed during a normal operating cycle or one year, whichever is longer
Examples: Cash and cash equivalents (fair value), short-term investments (fair value), receivables (estimated amount collectible), inventory (LCM), prepaid expenses…).
The Balance Sheet and Financial Disclosures

12. The Balance Sheet and Financial Disclosures
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Assets (contd.)
Long-term Investments: Comprise of the following
Securities (i.e., bonds, stock, long-term notes)
Fixed assets (i.e., land, building)
Special funds (i.e., pension fund, bond sinking fund)
Nonconsolidated subsidiaries or affiliated companies (investment in Uncon Subsidiary)
The Balance Sheet and Financial Disclosures

13. The Balance Sheet and Financial Disclosures
Assets (contd.)
Property, Plant, Equipment (i.e., building, Land, Machinery and equipment, capital leases): assets used in firms’ operations and meet the following criteria:
1. Economic life > 1 year;
2. Acquired for use in operation;
3. Not for resale to customers;
4. $ is material. (materiality)
Depreciation will be applied except for land.
The Balance Sheet and Financial Disclosures

14. The Balance Sheet and Financial Disclosures
Assets (contd.)
Intangible Assets: assets with no physical substance but have value based on rights or privileges that belong to the owner (i.e., goodwill, patents, franchises, trademarks,…).
Amortization for limited life intangibles (i.e., patents, franchises) and impairment test for indefinite-life intangibles (i.e., goodwill).
The Balance Sheet and Financial Disclosures

15. The Balance Sheet and Financial Disclosures
Assets (contd.)
Other Assets: Include assets sufficiently different from assets in other categories.
Examples: long-term prepayments, deferred income tax.
The Balance Sheet and Financial Disclosures

16. The Balance Sheet and Financial Disclosures
Liabilities
Legal obligations required future payments of assets or services as a result of a business entity’s past transactions or events.
A. Current Liabilities
B. Long-term Liabilities
C. Other Liabilities
The Balance Sheet and Financial Disclosures

17. The Balance Sheet and Financial Disclosures
A. Current Liabilities
Obligations must be fulfilled in one year or one operating cycle, whichever is longer. (will require the use of current assets or the creation of current liability) (i.e., A/P, N/P, accrual payable, unearned revenue, income tax payable, current portion of L-T debt)
The Balance Sheet and Financial Disclosures

18. The Balance Sheet and Financial Disclosures
Contingencies
Contingent Liabilities
Contingent Losses
Contingent Gains
The Balance Sheet and Financial Disclosures

19. Contingent Liabilities
Obligations may arise because of the occurrence or not occurrence of future event(s). (i.e., warranty obligations)
The Balance Sheet and Financial Disclosures

20. The Balance Sheet and Financial Disclosures
Contingent Losses
Losses may arise because of the occurrence or not occurrence of future event(s).
(i.e., the uncollectable accounts, the pending lawsuit losses, possible damage of a fire (or flood)…)
The Balance Sheet and Financial Disclosures

21. The Balance Sheet and Financial Disclosures
Contingent Gains
Gains may arise because of the occurrence or not occurrence of future events). (i.e., pending lawsuit gains)
The Balance Sheet and Financial Disclosures

22. Accounting Treatments of Contingencies
The accounting treatments of the contingencies depend on the occurrence probability of the related future event(s).
The Balance Sheet and Financial Disclosures

23. Accounting Treatments of Contingencies (contd.)
Occurrence probabilities of future event(s): (SFAS No. 5)
1. Probable: The future event(s) is(are) likely to occur.
2. Reasonably possible: The chance for the future event(s) to occur is less than probable but greater than remote.
3. Remote: The chance of the future event to occur is unlikely.
The Balance Sheet and Financial Disclosures

24. Accounting Treatments of Contingent Liabilities & Losses
If the future event(s) is(are)
a. probable, and
b. amount of loss (liability) can be estimated
-- The loss (liability) should be estimated, and recognized (accrued).
The Balance Sheet and Financial Disclosures

25. The Balance Sheet and Financial Disclosures
Examples
1. B/D Exp. XXX
Allowance for B/D XXX
2. Warranty Exp. XXX
Estimated Warranty Liabilities XXX
3. Lawsuit Exp. XXX
Estimated Liability under Litigation XXX
The Balance Sheet and Financial Disclosures

26. Accounting Treatments of Contingent Liabilities & Losses (contd.)
If the future event is probable, but the amount of loss (or liability) CANNOT be estimated, the contingent loss (or liability) should only be footnoted (not accrued).
The Balance Sheet and Financial Disclosures

27. Accounting Treatments of Contingent Gains
If the event is probable and the amount of contingent gains is determinable, only footnote the information. NO unrealized gain can be recognized under the current accounting standards (conservatism!).
The Balance Sheet and Financial Disclosures

28. B. Long-Term Liabilities
Obligations are not due in next year or next operating cycle, whichever is longer. (i.e., bonds payable, pension liability)
The Balance Sheet and Financial Disclosures

29. The Balance Sheet and Financial Disclosures
C. Other Liabilities
Long-term advances from customers, deferred income taxes.
The Balance Sheet and Financial Disclosures

30. The Balance Sheet and Financial Disclosures
Stockholders’ Equity
Residual claims (assets-liabilities) to the business entity from stockholders including:
a. contributed capital
b. (+ or -)Accumulated Other Comprehensive Income
c. retained earnings (or - deficit)
d. (-)treasury stock
The Balance Sheet and Financial Disclosures

31. The Balance Sheet and Financial Disclosures
a. Contributed Capital
Par value of common stock
Par value of prefer stock
Paid-in capital in excess of par value of common stock or preferred stock
The Balance Sheet and Financial Disclosures

32. b. Accumulated Other Comprehensive Income
Increase of assets without outflows of assets, increase of liabilities, increase of income or issuance of common stock (i.e.,(+) increase in market value of securities-available-for-sale (+ or -), gains or losses of foreign currency adjustments, etc.)
The Balance Sheet and Financial Disclosures

33. The Balance Sheet and Financial Disclosures
c. Retained Earnings
Net income not distributed to stockholders
appropriated
unappropriated
The Balance Sheet and Financial Disclosures

34. Other Disclosure Issues
APB opinion No. 22 (ASC ) required the disclosure of the following information as an integral part of the financial statement (i.e., in the notes):
1. Accounting Policies: All significant accounting principles and methods such as :
depreciation method of PPE,
inventory cost flow method and valuation method (LCM),
revenue recognition principles.
The Balance Sheet and Financial Disclosures

35. Other Disclosure Issues
2. Contingencies.
3. Subsequent Events.
The Balance Sheet and Financial Disclosures

36. The Balance Sheet and Financial Disclosures
Subsequent Event
Significant events occurred after the fiscal year end but before the issuance date of the annual report.
The Balance Sheet and Financial Disclosures

37. Subsequent Event - Introduction
Investors should be informed of significant events such as mergers, acquisitions, break-ups, spin-offs, issuance of bonds, issuance of stocks, settlement of litigation, loss of plant due to flood or fire even if these events occur after the fiscal year end. As long as these events occur prior to the issuance date of the annual reports, they should be disclosed in the reports.
The Balance Sheet and Financial Disclosures

38. Subsequent Event - Overview
There are two types of subsequent events:
1. Events require adjustments of balance sheet statement.
2. Events do not require adjustment of balance sheet statement but require disclosure in the footnotes.
The Balance Sheet and Financial Disclosures

39. Events Require Adjustment of B/S
Events with evidence indicates that conditions existed at or prior to the B/ S date.
Examples: (assume FYE is 12/31/x1 and the report release date is 3/31/x2)
Bankruptcy occurred on a major client on 2/1/x2. The bankruptcy condition may exist for this client prior to 12/31/x1.
Litigation settlement on 2/10/x2. The condition for this litigation existed prior to 12/31/x1.
The Balance Sheet and Financial Disclosures

40. Events Do Not Require Adjustment of B/S but Require Disclosure
Examples: (assume FYE is 12/31/x1 and the report release date is 3/31/x2)
A fire occurred on a major client on 3/1/x2.
Sales of bonds on 2/9/x2.
Loss of inventories due to a fire on 1/20/x2.
Issuance of common stock on 1/30/x2.
The Balance Sheet and Financial Disclosures

41. The Balance Sheet and Financial Disclosures
SEC Regulations
Publicly traded firms need to file the 10-K reports with the SEC. Some of the SEC regulations for the 10-K reports are also followed by the firms in preparing the annual reports.
The Balance Sheet and Financial Disclosures

42. The Balance Sheet and Financial Disclosures
Example A
Comparative financial statements
B/S  2 years
I/S and cash flow statement  3 years
Selected financial data items (i.e., net sales, operating revenue EPS, total assets, cash dividends declared) should have a 5-year data.
The Balance Sheet and Financial Disclosures

43. The Balance Sheet and Financial Disclosures
Example B (MD&A)
Management Discussion and Analysis (including critical accounting estimates):
Any information useful in assessing cash flows but not in the B/S (i.e. inflation impact on sales, liquidity and capital resources of the firm,…) should be included in the management discussion.
The Balance Sheet and Financial Disclosures

44. MD&A: Critical Accounting Estimates
The estimation of possible losses inherent in the financial receivables.
The estimation of profits over the multiple-year terms for revenue recognition on long-term project services agreements .
The estimates and assumptions needed in assessing asset impairment for investments, long-lived assets and goodwill.
Pension assumptions such as discount rate and expected rate of returns on pension assets.
The Balance Sheet and Financial Disclosures

45. MD&A: Contractual Obligations (required by the SEC)
The contractual obligations for future payments as of December 31, 2008 for GE are as follows:
In billions
Total
2009
2014 and thereafter
Borrowings (Note 18)
$523.8
$193.7
$115.6
$79.8
$134.7
Int. on borrowings
142 20 29 18 75
Operating Lease Obli.
6.6
1.3
2.2
1.6
1.5
Purchase Obligations. 63 40 16 6 1
Insurance Liabilities 22 4 5 3 11
Other liabilities 97 33 8 52
Contractual Obl. Of discontinued. operations -
The Balance Sheet and Financial Disclosures

46. The Balance Sheet and Financial Disclosures
Example C
Market Prices and Dividends of Common Stocks:
The high and low prices for each quarter in the last two years.
The dividends paid in the last two years.
The Balance Sheet and Financial Disclosures

47. Other Footnote Disclosures
Earnings Per Share
Inventories
Employee Stock Options
Postretirement Benefit Plans
Leases,
Investment Securities
Purchase Commitment
Bond covenants
Receivables
The Balance Sheet and Financial Disclosures

48. Other Footnote Disclosures (contd.)
Property, Plant and Equipment
Goodwill and other Intangible Assets
Allowance for Losses on Financial Receivables
Borrowing
Financial Instruments
Provisions for income taxes
Off-Balance Sheet Arrangements
The Balance Sheet and Financial Disclosures

49. Other Footnote Disclosures (contd.)
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Other Footnote Disclosures (contd.)
Fair Value Measurements Disclosure (SFAS 157,effective 1/1/2008)
Companies report fair value for assets and liabilities must disclose the fair value hierarchy level of the fair value measurements.
The Balance Sheet and Financial Disclosures

50. Fair Value Hierarchy (SFAS 157)
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Fair Value Hierarchy (SFAS 157)
Level 1 (most reliable) measures are based on quoted prices for identical instruments in active markets.
Level 2 measures are based on quoted prices for similar instruments (assets or liabilities) in active markets.
Level 3 (least reliable) measures are based on unobservable inputs such company’s data or assumptions.
The Balance Sheet and Financial Disclosures

51. The Balance Sheet and Financial Disclosures
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Fair Value Measurements Disclosure : Footnote 28 of GE 2008 Annual Report
Level 1
Level 2
Level 3
Fin. 39 Netting
Net Bal.
Assets
Investment Securities
$1,158
$27,332
$12,956
___
$41,446
Derivatives
18,911
1,142
(7,411)
12,642
Others 1
288
1,105
____
1,394
total
$1,159
$46,531
15,203
$(7,411)
$55,482
Liabilities $
$12,643 $
$(7,575)
$ 5,236
Other
1,031
Total $
$13,674
$ 166
$6,267
The Balance Sheet and Financial Disclosures

52. Limitations of the Balance Sheet
Historical costs reporting for most of assets and liabilities.
Estimations involved in the value of some assets and liabilities (i.e., the net realizable value of accounts receivable and the cost of warranty).
the omission of some valuable items such as goodwill of the company.
Off-balance sheet assets and liabilities.
The Balance Sheet and Financial Disclosures

53. The Balance Sheet and Financial Disclosures
Ratio Analysis
Ratio analysis is one of the techniques that financial analysts use to analyze the financial statements of firms.
For the purpose of analyzing financial statements, ratios can be classified into the following four categories: (see Exhibit 5-3)
The Balance Sheet and Financial Disclosures

54. The Balance Sheet and Financial Disclosures
Exhibit 5-3
Major Types of Ratios
Liquidity Ratios. Measures of the enterprise’s short-term ability to pay its maturing obligations.
Activity Ratios. Measures of how effectively the enterprise is using the assets employed.
Profitability Ratios. Measures of the degree of success or failure of a given enterprise or division for a given period of time.
(Stability Ratios.)
Coverage Ratios. Measures of the degree of protection for long-term creditors and investors.
The Balance Sheet and Financial Disclosures

55. Exhibit 5-4 Ratio I. Liquidity 1.Current ratio
2.Quick or acid-test ratio
3.Current cash debt coverage ratio
Formula
Current assets
Current liabilities
Cash, marketable securities, and
receivables (net)
Net cash provided by
operating activities
Average current liabilities
Purpose or Use
Measures short-term debt-paying ability
Measures immediate short-term liquidity
Measures a company’s ability to pay off its current liabilities in a given year from its operations
The Balance Sheet and Financial Disclosures

56. The Balance Sheet and Financial Disclosures
Exhibit 5-4 (contd.)
Ratio
II. Activity
4.Receivable turnover
5.Inventory turnover
6.Asset turnover
III. Profitability
7.Profit margin on sales
Formula
Net Credit Sales
Average trade
receivables (net)
Cost of goods sold
Average inventory
Net Sales
Average total assets
Net income
Net sales
Purpose or Use
Measures liquidity of receivables
Measures liquidity of inventory
Measures how efficiently assets are used to generate sales
Measures net income generated by each dollar of sales
The Balance Sheet and Financial Disclosures 56

57. Exhibit 5-4 (contd.) Ratio III. Profitability(contd.)
8.Rate of return on assets
9.Rate of return on common stock equity
10.Earnings per share
11.Price earnings ratio
Formula
Net income
Average total assets
Net income minus
preferred dividends
Average common stockholders’ equity
Weighted shares outstanding
Market price of stock
Earnings per share
Purpose or Use
Measures overall profitability of assets
Measures profitability of owners’ investment
Measures net income earned on each share of common stock
Measures the ratio of the market price per share to earnings per share
The Balance Sheet and Financial Disclosures 57

58. Exhibit 5-4 (contd.) Ratio III. Profitability(contd.) 12.Payout ratio
IV. Coverage
(Stability Ratios)
13.Debt to total assets
14.Time interest earned
Formula
Cash dividends
Net income
Total debt
Total assets or equities
Income before int.
charges & taxes
Interest charges
Purpose or Use
Measures % of earnings distributed in the form of cash dividends
Measures the % of total assets provided by creditors
Measures ability to meet interest payments as they come due
The Balance Sheet and Financial Disclosures 58

59. Exhibit 5-4 (contd.) Ratio IV. Coverage(contd.)
15.Cash debt coverage ratio
16. Book value per share
Formula
Net cash provided by
operating activities
Average total liabilities
Common
Stockholders’ equity
Outstanding shares
Purpose or Use
Measures a company’s ability to repay its total liabilities in a given year from its operations
Measures the amount each share would receive if the company were liquidated at the amounts reported on the balance sheet
The Balance Sheet and Financial Disclosures 59