1. 1 Financial Accounting: Tools for Business Decision Making, 3rd Ed. Kimmel, Weygandt, Kieso ELS

2. Chapter 2

3. 3 Chapter 2 A Further Look at Financial Statements zExplain the meaning of generally accepted accounting principles and describe the basic objective of financial reporting. zDiscuss the qualitative characteristics of accounting information. zIdentify two constraints in accounting. zIdentify the sections of a classified balance sheet. After studying Chapter 2, you should be able to:

4. 4 zIdentify and compute ratios for analyzing a company's profitability. zExplain the relationship between a retained earnings statement and a statement of stockholders' equity. zIdentify and compute ratios for analyzing a company's liquidity and solvency using a balance sheet. zIdentify and compute ratios for analyzing a company’s liquidity and solvency using a statement of cash flows. Chapter 2 A Further Look at Financial Statements

5. 5 General Guide for Financial Accounting zGenerally zAccepted zAccounting zPrinciples

6. 6 What is financial accounting supposed to accomplish? Provide the the most useful financial information for… Decision Making

7. 7 Primary Accounting Setting Body in the U.S. zFinancial zAccounting zStandards zBoard

8. 8 U.S. Government Agency That Oversees Financial Markets zSecurities zExchange zCommission

9. Remember… GAAP Are the Rules The FASB makes the rules. The SEC enforces the rules.

10. 10 Basic Terms vRelevance - information makes a difference in decisions vReliability - information must be free of error and bias vComparability - ability to compare information of different companies because they use the same accounting principles vConsistency - use of same accounting principles and methods from year to year within the same company

11. 11 Characteristics of Useful Information Relevance 1. Provides a basis for forecasts 2.Confirms/corrects prior expectations 3. Is timely 11 Reliability 1. Is verifiable 2. Is a faithful representation 3. Is neutral Comparability Different companies use similar accounting PRINCIPLES Consistency Company uses same accounting METHODS from year to year

12. 12 Constraints in Accounting Permits companies to apply GAAP without hurting the usefulness of information zMateriality - The constraint of determining whether an item is large enough to likely influence a decision. zConservatism - The approach of choosing an accounting method, when in doubt, that will be least likely to overstate assets and net income.

13. 13 A Classified Balance Sheet... Generally contains the following standard classifications: yCurrent Assets yLong-Term Investments yProperty, Plant, and Equipment yIntangible Assets yCurrent Liabilities yLong-Term Liabilities yStockholders' Equity

14. 14 Current Assets zAssets that are expected to be converted to cash or used in the business within one year. zCurrent assets are listed in order of liquidity. zExamples: yCash yShort-term investments yReceivables yInventories ySupplies yPrepaid expenses

15. 15 Long-Term Investments zAssets that can be converted into cash, but whose conversion is not expected within one year. zAssets not intended for use within the business. zExample: yInvestments of stocks and bonds of other corporations. yInvestments in long-term assets such as land or buildings that are not currently being used in the company’s operating activities.

16. 16 Property, Plant, and Equipment zAssets with relatively long useful lives. zAssets used in operating the business. zExamples: yland ybuildings ymachinery ydelivery equipment yfurniture and fixtures

17. 17 Depreciation is... zPractice of allocating an asset’s full purchase price to a number of years instead of expensing full cost in year of purchase.

18. 18 Accumulated Depreciation... zShows the total amount of depreciation taken over the life of the asset.

19. 19 Assets That A Company Depreciates... Should be shown at cost less accumulated depreciation CSU CORPORATION Balance Sheet December 31, 2004 Assets Cash$ 2,000 Accounts receivable 4,000 Supplies 1,800 Equipment24,000 Less: Accumulated Depreciation 8,000 16,000 Total assets $23,800

20. 20 Intangible Assets have value because of the exclusive rights or privileges they possess. Intangible Assets zNoncurrent assets zHave no physical substance zExamples: ypatents ycopyrights ytrademarks or trade names yfranchise

21. 21 Current Liabilities Obligations that are supposed to be paid within the coming year... zaccounts payable zwages payable zbank loans payable zinterest payable ztaxes payable zcurrent maturities of long-term bank loans payable

22. 22 Long-Term Liabilities Debts expected to be paid after one year Examples… y bonds payable y mortgages payable y long-term notes payable y lease liabilities and yobligations under employee pension plans

23. 23 Stockholders' Equity zCapital stock - investments in the business by the stockholders zRetained earnings - earnings kept for use in the business

24. 24 HUMANA CORPORATION Balance Sheet December 31, 200X (in millions ) Assets Current Assets Cash $ 272 Marketable securities (current) 609 Receivables 74 Other current assets 83 Total current assets 1,038 Property and equipment (net) 317 Marketable securities (long-term) 322 Other long-term assets 280 Total Assets $1,957 Liabilities and Stockholders’ Equity Liabilities Current Liabilities Medical costs payable$527 Accounts payable233 Income taxes payable 56 Total current liabilities816 Long-term debt 83 Total liabilities899 Stockholders’ equity Common stock 830 Retained earnings228 Total Liabilities and stockholders’ equity $1,957 Current

25. 25 Ratio Analysis... êExpresses relationship among selected items of financial statement data êRelationship can be expressed in term of… êpercentage êrate êproportion

26. 26 Ratio Analysis Classifications... zLiquidity Ratios - measures of short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash zProfitability Ratios - Measures of the income or operating success of a company for a given period of time zSolvency Ratios - Measures of the ability of the company to survive over a long period of time

27. 27 Ratio Analysis zIntracompany comparisons - covering two years of the same company zIndustry average comparisons - based on average ratios for a particular industry zIntercompany comparisons - based on comparisons with a competitor in the same industry

28. 28 Profitability Ratios... Measures of the income or operating success of a company for a given period of time Two Examples…  Earnings Per Share  Price-Earnings Ratio

29. 29 Earnings Per Share How does the company’s earning performance compare with that of previous years? Higher value = improved performance Net income-Preferred stock dividends Average common shares outstanding EPS=

30. 30 Price-Earnings Ratio How does the market perceive the company’s prospect for future earnings? High ratio suggests market has favorable expectations Price-Earnings Ratio = Stock price per share Earnings per share

31. 31 Statement of Retained Earnings Describes the events that caused changes in the retained earnings account for the period.

32. 32 CSU CORPORATION Retained Earnings Statement For the Year Ended December 31, 200X Retained earnings, January 1$ 0 Add: Net Income 6,800 6,800 Less: Dividends 0 Retained earnings, December 31$ 6,800

33. 33 Statement of Retained Earnings and Statement of Stockholders Equity Stockholders’ Equity: zRetained Earning zCommon Stock Since both of these parts affect stockholders’ equity… a statement of stockholders’ equity provides better information than a statement of retained earnings.

34. 34 Financial Ratio Classifications zLiquidity Ratios - measures of short- term ability of the company to pay its maturing obligations and to meet unexpected needs for cash zProfitability Ratios -measures of the income or operating success of a company for a given period of time zSolvency Ratios - measures of the ability of a company to survive over a long period of time

35. 35 Liquidity Ratios zWorking capital zCurrent ratio

36. 36 Working Capital Measures short-term ability to pay liabilities Current Assets - Current Liabilities = Working Capital

37. 37 Current Ratio Measure of short - term ability to pay obligations Current Ratio = Current Assets Current Liabilities

38. 38 Solvency Ratio Debt to Total Assets Ratio measures % of assets financed by creditors. Total Debts Total Assets Debt to Total Asset Ratio =

39. 39 Purpose of Statement Of Cash Flows To provide information about zcash receipts zcash payments znet changes in cash

40. 40 Changes Result From zOperating activities zFinancing activities zInvesting activities

41. 41 Operating Activities Cash inflows and cash outflows associated with the primary operations of the business.

42. 42 Financing Activities Cash inflows/ outflows come from sources funding the business… zSale of Stock/ Payment of Dividends zIssuing Debt/Repaying Debt

43. 43 Investing Activities Cash inflows/ outflows result from changes in investments and long- term assets… zpurchasing/disposing of investments and long-lived assets using cash zlending money and collecting the loans

44. 44 Current Cash Debt Coverage Ratio Cash Provided by Operating Activities Average Current Liabilities =

45. 45 Cash Debt Coverage Ratio Cash Provided by Operating Activities Average Total Liabilities =

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