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Balance Sheet and Financial Disclosures

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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
4/15/2017 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.)
4/15/2017 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)
4/15/2017 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
4/15/2017 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


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