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Chapter 3 Balance Sheet and Owners’ Interests. Chapter 3--Learning Objectives 1.Interpret the conceptual basis for the balance sheet and its components:

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Presentation on theme: "Chapter 3 Balance Sheet and Owners’ Interests. Chapter 3--Learning Objectives 1.Interpret the conceptual basis for the balance sheet and its components:"— Presentation transcript:

1 Chapter 3 Balance Sheet and Owners’ Interests

2 Chapter 3--Learning Objectives 1.Interpret the conceptual basis for the balance sheet and its components: assets, liabilities, and owners’ equity

3 Balance Sheet w Shows financial position w of an enterprise w at a particular point in time A “snapshot”

4 Balance Sheet Elements w Assets w Liabilities w Owners’ Equity Accounting Equation Assets = Liabilities & Owners’ Equity Assets Liabilities & Equity

5 Assets:Definition Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events

6 Assets:Characteristics I Probable Future Benefit /will contribute to future cash flows I Of a Particular Entity /the business that will receive the benefit I Transaction or event giving rise to the benefit has already occurred

7 Liabilities:Definition Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events

8 Liabilities: Characteristics I Present duty or obligation that entails the probable future transfer or use of assets I Of a Particular Entity /the business that has the duty or obligation I Transaction or event giving rise to the obligation has already occurred

9 Equity:Definition The residual interest in the assets of the entity that remains after deducting liabilities Equity = Assets - Liabilities Net Assets

10 Equity:Characteristics I Ownership Interest /stockholder, sole proprietor, or Partner I Residual Interest /increases or decreases by { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/10/2919705/slides/slide_10.jpg", "name": "Equity:Characteristics I Ownership Interest /stockholder, sole proprietor, or Partner I Residual Interest /increases or decreases by

11 Chapter 3--Learning Objectives XYZ Company 2.Recognize the various formats and typical account classifications for the balance sheet

12 Asset Classification w In order of Liquidity Current then Long-Term Most Liquid Least Liquid

13 Assets - Order of Classification w Current Assets w Investments w Property, Plant & Equipment w Intangible Assets w Other Assets

14 Chapter 3--Learning Objectives 3.Understand and identify the elements of current assets and current liabilities that comprise an enterprise’s working capital

15 Working Capital Current assets Less: Current liabilities Equals: Working capital

16 Definition-Current Asset Cash and other assets that can reasonably be expected to be converted into cash or consumed within the current operating cycle or one year whichever is longer

17 Current Operating Cycle w Time between acquisition of inventory and the conversion of the inventory back to cash Cash Receivables Inventory

18 Typical Current Assets w Cash w Short-term investments w Accounts and notes receivables w Inventories w Prepaid expenses 30-Day note receivable IBM

19 Cash w All cash on hand and on deposit w Readily available for current use w Measured in U.S. dollars

20 Short-Term Investments w Equity Securities w Debt Securities w Nonsecuritized Debt Sometimes called “Temporary Investments”

21 SFAS 115 w Applies to Equity securities with readily determinable fair values Debt securities

22 Measurement of Short-term Investments in Equity Securities w Fair value Equity securities with readily determinable fair values w Cost all other equity securities

23 Measurement of Short-Term Investments in Debt w Cost If management plans to hold to maturity If nonsecuritized (e.g., notes receivable from individuals) w Fair value All other debt securities

24 A/R and N/R w Carried at net realizable value The amount of cash expected to be collected Accounts Receivable minus Allowance for Doubtful Accounts Net Realizable Value

25 Inventories w Measured at Lower-of-cost-or market w Examples: Merchandise Inventory Supplies Work-in-Process Raw Materials Finished Goods

26 Prepaid Expenses w Measured at historical cost not consumed w Examples: Prepaid Insurance Prepaid Taxes Prepaid Rent

27 Liability Classifications w Current Liabilities w Long-term Liabilities

28 Current Liabilities w Obligations expected to be eliminated through the use of existing current assets or by the creation of other current liabilities w Typically, those due within one year

29 Typical current liabilities w Notes Payable w Accounts Payable w Accrued Expenses w Deferred Revenues w Current Maturities of Long-term Debt

30 Notes Payable w Trade and nontrade w Report at face value less any discount

31 Accounts Payable w From purchase of merchandise goods services w Typically reported at invoice amount ie, not discounted

32 Accrued Expenses w Typically not discounted w Examples: Salaries Payable Interest Payable Taxes Payable

33 Deferred Revenues w Obligated to perform services or deliver goods for monies already received w Examples: Rent received in advance Magazine subscriptions received Deposits received

34 Chapter 3--Learning Objectives 4.Understand and identify the noncurrent elements of a firm’s balance sheet

35 Noncurrent Assets w Investments w Property, Plant & Equipment w Intangible Assets w Other 5 year Bond IBM Patent

36 Investments w Special purpose funds (Sinking funds) w Long term investments in stock w Long term investments in bonds w Long term interest-bearing receivables w Land held for Speculation

37 Property, Plant & Equipment w Long-lived tangible assets used in operations w Reported at cost less accumulated depreciation w Examples: Land Buildings Equipment vehicles

38 Intangible Assets w Long-lived intangible operating assets w Reported at cost less accumulated amortization w Examples: Patents Trademarks Organization Costs Goodwill

39 Other Assets w Deferred Tax Assets w Long-term prepaids rent deposits w Idle plant assets

40 Long-Term Liabilites w Reported at present value of future cash payments. w Examples Bonds payable Leasehold obligations Deferred taxes

41 Chapter 3--Learning Objectives 5.Distinguish among the various forms of entities, and interpret the traditional presentation of stockholders’ equity by source: contributes capital and retained earnings

42 Types of business entity w Proprietorships--Enterprises with a single owner w Partnerships--Unincorporated businesses with two or more owners w Corporations--Separate legal entities established by applicable laws of incorporation

43 Types of corporations w Private companies w Stock companies w Publicly held w Listed companies w Unlisted (over-the-counter) w Closely held (nonpublic) w Nonstock companies w Public companies w Mutual companies

44 Advantages of the corporate form of business w Potential to accumulate large amounts of capital w Limited liability of owners w Relative ease of transferability of ownership

45 Disadvantages of the corporate form of business w Double taxation w Limited control by owners w Additional regulatory and reporting requirements

46 Owner’s Equity w Paid-in Capital w Retained Earnings w Accumulated Other Comprehensive Income w Treasury Stock

47 Paid-in Capital w Common Stock w Preferred Stock w Additional Paid-in Capital

48 Common Stock & Preferred Stock w Par value or stated value w Additional paid-in capital Investments by owners in excess of par or stated value

49 Retained Earnings w Accumulated earnings that have not been distributed to owners.

50 Accumulated Other Comprehensive Earnings w Adjustments to assets and liabilities that are not reported in earnings w Examples: Unrealized gains/losses on investments in securities under SFAS 115 Translation Adjustment Unrealized losses from pension plans

51 Treasury Stock (at Cost) w The cost of acquiring stock back from stockholders w This is stock that has been reacquired and not retired w A contra equity

52 Chapter 3--Learning Objectives 6.Identify uses and limitations of traditional balance sheets for financial analysis

53 Analysis of Liquidity w Liquidity Ability to pay debts and continue operations w Liquidity measures Working capital Current ratio

54 Current Ratio Current Assets Current Liabilities The higher the current ratio The greater the company’s liquidity

55 Analysis of Solvency w Solvency Long-term financial status Ability to meet long-term as well as current obligations w Solvency (risk) measures Debt ratio Leverage ratio Debt-to-equity ratio

56 *Debt ratio =Total Liabilities Total Assets Leverage ratio = Total Assets Total Equity *Debt-to-Equity = Total Liabilities Total Equity *Higher ratios indicate more risk

57 Supplemental Disclosures w Segments w Subsequent Events w Contingencies

58 Subsequent events w Occur between the end of the reporting period and the issue date for the financial statements w Are not part of the normal operating activities of the enterprise w Two types 1.Originating prior to subsequent period and resolved during it 2.Originating during subsequent period

59 Subsequent events w Events originating prior to the statement date and resolved during the subsequent period w Requirement: adjust financial statements

60 Subsequent events w Events originating during the subsequent period w Requirement: disclosure in the notes to the statements

61 Contingencies w Gain Contingencies A possible future increase in Cash flows Generally not recognized in financial statements w Loss Contingencies A possible future reduction in Cash flows

62 Accrue Loss Contingency w When both of the following conditions are met ¬Probable ­Can Reasonably Estimate Amount

63 Disclose Loss Contingency in Footnotes w When either of the following conditions is met If remote - Don’t disclose ¬Probable, but cannot reasonably estimate amount ­Reasonably Possible

64 Exercise w Determine accounting treatment for each of the following contingencies

65 Accounting Treatment? w Company is being sued, loss is probable, but cannot estimate amount Accrue Footnotes Nondisclosure

66 Accounting Treatment? w Company has warranty on products. Experience indicates that warranty expenses will probably be 5% of sales Accrue Footnotes Nondisclosure

67 Accounting Treatment? w Company is being sued, loss is considered remote Accrue Footnotes Nondisclosure

68 Accounting Treatment? w Company is suing a competitor for patent infringement. The company president expects to win. Accrue Footnotes Nondisclosure

69 Other disclosures w Significant accounting policies w Specific disclosures required by pronouncements e.g., pension plan details

70 Balance sheet limitations What does not appear ? Human capital

71 Balance sheet limitations What does not appear ? Internally generated goodwill

72 Balance sheet limitations What does not appear ? Benefits from research and development activities


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