1. The Balance Sheet and the Statement of Changes in Stockholders’ Equity C hapter 4 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2. Objectives 1.Understand the purposes of the balance sheet. 2.Define the elements of a balance sheet. 3.Explain how to measure (value) the elements of a balance sheet. 4.Classify the assets of a balance sheet. 5.Classify the liabilities of a balance sheet. 2

3. Objectives 6.Report the stockholders’ equity of a balance sheet. 7.Prepare a statement of changes in stockholders’ equity. 8.Understand the other disclosure issues for a balance sheet. 3

4. Interrelationship of Financial Statements 4

5. Basic Accounting Equation 5 Assets = Liabilities + Stockholders’ Equity Economic resources Economic obligations Net assets

6. Liquidity 6 The term liquidity is used to describe how quickly an asset can be converted into cash or a liability paid.

7. Three-Stage Process for Disclosing Information on the Balance Sheet 1.Identification of what items meet the definition of the elements 2.Measurement (valuation) of the elements 3.Reporting (classification) of the elements 7

8. Elements of the Balance Sheet: Assets 8 Assets are probable future economic benefits obtained or controlled by a company as a result of past transactions or events.

9. Elements of the Balance Sheet: Assets 1.The resource must be able to contribute directly or indirectly to the company’s future net cash inflows. 2.The company must be able to obtain the future benefit and control others’ access to it. 3.The transaction or event giving the company the right to or control over the benefit must have occurred. 9

10. 10 Assets may be natural or man-made, tangible or intangible, and either exchangeable or useful only in the company’s activities. Elements of the Balance Sheet: Assets Simply, assets have future value.

11. Elements of the Balance Sheet: Liabilities 11 Liabilities are probable future sacrifices of economic benefits arising from present obligations...

12. Elements of the Balance Sheet: Liabilities 12 …of a company to transfer assets or provide services in the future as a result of past transactions or events.

13. Elements of the Balance Sheet: Stockholders’ Equity 13 Assets = Liabilities + Stockholders’ Equity Equity is the residual interest in the assets of a company that remains after deducting its liabilities.

14. Measurement (Valuation) of the Elements of the Balance Sheet 14 Historical Cost Fair Value Present Value

15. 15 Historical cost is the exchange price in the transaction in which an asset was acquired. Fair value is the price that a company would receive to sell an asset (or transfer a liability) in an orderly transaction between market participants on the date of measurement. Measurement (Valuation) of the Elements of the Balance Sheet The present value of an asset is the net amount of discounted future cash inflows less the discounted future cash outflows relating to the asset.

16. 16 Fair Value Measurement Need Fair Value Select Highest Appropriate Level of Input for Valuation (Hierarchy of Valuation Methods)  Level 1: Quoted Price for Identical Asset (or Liability) in Active Market  Level 2: Adjusted Quoted Price (Exit Value) for Similar Asset (or Liability)  Level 3: Unobservable Inputs (e.g., Present Value of Expected Cash Flows) Select Highest Appropriate Level of Input for Valuation (Hierarchy of Valuation Methods)  Level 1: Quoted Price for Identical Asset (or Liability) in Active Market  Level 2: Adjusted Quoted Price (Exit Value) for Similar Asset (or Liability)  Level 3: Unobservable Inputs (e.g., Present Value of Expected Cash Flows)

17. 17 Fair Value Measurement Measure Best Fair Value Use Valuation Method Consistent with  Market Approach (Identical or Comparable Assets or Liabilities)  Income Approach (Present Value)  Cost Approach (Replacement Cost) Use Valuation Method Consistent with  Market Approach (Identical or Comparable Assets or Liabilities)  Income Approach (Present Value)  Cost Approach (Replacement Cost)

18. Current Assets 18 Current assets are cash and other assets that are expected to be converted into cash, sold, or consumed within one year or the normal operating cycle, whichever is longer.

19. 19 Current Assets 1.Cash (and cash equivalents) 2.Temporary investments in marketable securities 3.Receivables (accounts and notes with short-term maturity dates) 4.Inventories 5.Prepaid items 1.Cash (and cash equivalents) 2.Temporary investments in marketable securities 3.Receivables (accounts and notes with short-term maturity dates) 4.Inventories 5.Prepaid items

20. 20 Current Assets Cash includes cash on hand and readily available in checking and savings accounts.

21. 21 Current Assets Temporary investments in marketable securities include debt and equity securities that are classified as “trading securities,” “available-for-sale securities,” and “held-to- maturity” securities.

22. 22 Receivables include accounts receivable and notes receivable with short-term maturity dates. They are listed at their estimated collectible amounts (net realizable values). Inventories include goods held for resale in the normal course of business plus, in the case of a manufacturing company, raw materials and work in process inventories. Prepaid items such as insurance, rent, office supplies, and taxes will not be converted into cash but will be consumed. Current Assets

23. Current Liabilities 23 Current liabilities are obligations of a company that it expects to liquidate by using current assets, or creating other current liabilities within one year or the normal operating cycle, whichever is longer.

24. Current Liabilities Examples 24  Trade payables from the purchase of goods for resale  Short-term notes payable  Current maturities of long-term liabilities  Unearned revenues  Accrued expenses

25. 25 Working Capital Current Assets – Current Liabilities = Working Capital

26. Long-Term Investments The company expects the market value of the investment to increase. The company wishes to receive income from interest or dividends. The company may desire to exercise control over another company or a supplier. The company may acquire property, plant, or equipment for future expansion. 26 A company makes investments for several reasons:

27. Property, Plant, and Equipment 27 Property, plant, and equipment includes the tangible assets used in the firm’s operations. Also called fixed assets

28. Intangible Assets 28 Intangible assets are those noncurrent economic resources that a company uses in its operations but have no physical existence. Patents Copyrights Franchises

29. 29 Intangible Assets A company may have three categories of intangible assets: 1.Intangible assets with finite useful lives 2.Intangible assets with indefinite lives 3.Goodwill

30. Long-Term Liabilities 30 Long-term liabilities are those obligations of a company whose liquidation is not expected to require the use of current assets or not expected to create current liabilities within one year or the normal operating cycle (whichever is longer).

31. Stockholders’ Equity 31 Stockholders’ equity is the residual interest of the stockholders in the assets of the corporation.

32. Stockholders’ Equity 32 Stockholders’ equity is the residual interest of the stockholders in the assets of the corporation. The corporation is a complex business organization. Usually there is absentee ownership.

33. Stockholders’ Equity Contributed capital Retained earnings Accumulated other comprehensive income 33 Components of Stockholders’ Equity

34. 34 Stockholders’ Equity Retained earnings is the total amount of corporate net income that has not been distributed to stockholders as dividends. Uses of net income To use in daily operations To maintain its productive facilities For growth

35. Stockholders’ Equity 1.Unrealized increases (gains) or decreases (losses) in the fair value of investments in available-for-sale securities. 2.Transaction adjustments from converting the financial statements of a company’s foreign operations into U. S. dollars. 3.Certain gains and losses on “derivative” financial instruments. 4.Certain pension plan gains, losses, and prior service cost adjustments. 35 Comprehensive income includes both net income and “other comprehensive income.” Accumulated other comprehensive income might include four items:

36. 36 Statement of Changes in Stockholders’ Equity

37. Summary of Accounting Policies A selection from existing acceptable alternatives Principles and methods peculiar to the industry in which the company operates Unusual or innovative applications of GAAP 37 GAAP requires that a company must include a description of all its significant accounting policies as an integral part of its financial statements. In particular, when these principles and methods involve:

38. 38 IFRS vs. U.S. GAAP  The financial statements required by the International Accounting Standards Board (IASB) are similar to those in the United States.  Unlike U.S. GAAP, in which a company typically presents either a classified or nonclassified balance sheet, International Financial Reporting Standards (IFRS) do not require a particular format; the appropriate format depends on the type of company.

39. 39 IFRS vs. U.S. GAAP  IFRS do require that companies classify assets on the balance sheet as either noncurrent or current.  Noncurrent assets include property, plant, and equipment, as well as other items such as investments, long-term receivables, and intangibles.  Current assets are defined similarly to those under U.S. GAAP.  Typically, noncurrent assets are presented first, followed by current assets.

40. 40 IFRS vs. U.S. GAAP  “Capital and reserves,” which includes issued capital (capital stock and additional paid-in capital), reserves, and accumulated profits or losses (retained earnings), is usually listed first.  Reserves may result from upward revaluations of properties and investments, as well as currency translation differences.  Noncurrent liabilities are usually listed next, followed by current liabilities.

41. 41 C hapter 4 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.