Intermediate Accounting Chapter 4 The Balance Sheet and the Statement of Shareholders’ Equity © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What is the Purpose of the Balance Sheet? The FASB and the IASB have established the balance sheet as the cornerstone of financial reporting because it reports the accounting equation, representing the financial position of the company: Assets = Liabilities + Shareholders’ Equity The balance sheet reports the financial position from two perspectives: Specific resources the company controls Claims on the company by the persons or entities that provided the resources, including the creditors and lenders (liabilities) and investors (shareholders’ equity) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Articulation of Financial Statements © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Recognition on the Balance Sheet To provide relevant and faithfully represented information about assets, liabilities, and shareholders’ equity, the company must determine what, how, and where to report the elements of the balance sheet. Step 1. What: Identify the elements that must be recognized. Step 2. How: Measure (value) the elements. Step 3. Where: Report (classify) the elements. Recognition is the process of formally recording and reporting an element in the financial statements. In order to meet the definition of a balance sheet element, an item must be measurable, relevant and faithfully represented. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Assets Assets are the economic resources used to carry out a company’s business activities. An economic resource must possess all of the following characteristics to be considered an asset: Probable Future Economic Benefit: The resource must be expected to contribute future economic benefits either directly or indirectly to the company. Control: The company must be able to obtain the future benefit and control others’ access to it. Control means that the company can deny or regulate the ability of others to use the asset. Acquisition: The transaction or event giving the company the right to or control over the benefit must have occurred. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Liabilities Liabilities are the probable future sacrifices of economic benefits arising from a company’s present obligations to transfer assets or provide services in the future to other entities as a result of past transactions or events. A company’s obligation must have all of the following characteristics to be recognized as a liability: Transfer: It must involve a responsibility that will be settled by a sacrifice involving the transfer of assets, provision of services, or other use of assets at a specified or determinable date, on occurrence of a specified event, or on demand. Obligation: The responsibility must obligate the company so that it has little or no discretion to avoid the future sacrifice. Incurred: The transaction, event, or arrangement obligating the company must have occurred. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Shareholders’ Equity Equity is the residual interest in the assets of a company after deducting its liabilities. Balance sheets separate total shareholders’ equity into three general categories: Contributed capital accounts—amounts invested by shareholders for an ownership interest in a company Earned capital accounts—retained earnings Noncontrolling interests—equity capital amounts invested by minority shareholders in consolidated subsidiaries © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Are Elements of a Balance Sheet Measured? Mixed attribute measurement model Measurement models that reflect historical values include Historical cost or acquisition cost (assets) and historical proceeds Originally incurred obligation amounts (liabilities) Allocated historical amounts (for assets and liabilities allocated over time) Initial present value (assets) and adjusted present value (liabilities) Measurement models that reflect current values or a combination of historical and current values include Fair value (assets and liabilities) Current replacement cost (assets) Net realizable value (assets) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Are Items Classified and Reported on the Balance Sheet? Assets Current assets, Long-term investments, Property, plant, and equipment, Intangible assets and Other assets Liabilities Current liabilities, Long-term liabilities and Other liabilities Shareholders’ Equity Contributed capital, Common stock, Additional paid-in capital, Retained earnings and Accumulated other comprehensive income © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Current Assets Current assets are cash and other assets that a company expects to convert into cash, sell, or consume within one year or the normal operating cycle, whichever is longer. An operating cycle is the average length of time taken by a company to convert operational cash expenditures into operational cash receipts. Presented in order of liquidity. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Types of Current Assets Cash (cash on hand and readily available in checking and savings accounts) and cash equivalents (highly- liquid, low-risk securities) Short term investments including investments in marketable securities (debt, trading securities, available- for-sale securities, held-to- maturity securities that will mature within a year) Receivables (accounts receivable, notes receivable with short-term maturity dates) Inventories (goods held for resale, raw materials, work in process inventories) Other Current Assets (prepaid items that will be consumed instead of converted into cash) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Current Liabilities Current liabilities are obligations that the company expects to settle or satisfy within one year or the normal operating cycle, whichever is longer. Companies commonly report the following types of current liabilities: payable and accrued expenses, deferred revenues (unearned revenues), short- term debt and current maturities of long-term debt. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Types of Current Liabilities Payables and accrued expenses obligations for items (goods or services) that have been received but not yet paid Deferred revenues (unearned revenues) obligations from advance payments from customers for the future delivery of goods or services Short-term debt and Current maturities of long-term debt short-term financing instruments that will be paid within one year or the operating cycle and the portions of long- term financing instruments that mature during the next period © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Long-Term Investments If a company expects to hold the investment for more than one year or the operating cycle, whichever is longer, it is classified as a long-term investment, or noncurrent investment. Reasons that companies invest Primary objective is to increase shareholder value Appreciation of the market value of the investment Income from interest or dividends Exercising control over other companies Saving cash for specific future purposes © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Property, Plant and Equipment The property, plant, and equipment section of a company’s balance sheet includes the long-lived tangible assets used in its operations. The depreciable costs of all the fixed assets are allocated to expense over the expected service life of the asset, except for construction in progress (which will become depreciable once it is completed and put into service) and land. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Intangible Assets (Slide 1 of 2) Intangible assets are noncurrent economic resources that have no physical or financial nature. They generally derive their value from the legal, intellectual, and intangible benefits they convey to the company. Intangible resources are normally recognized as assets only when they have been acquired by a company in an external transaction. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Intangible Assets (Slide 2 of 2) The following three categories of intangible assets that have been acquired in external market transactions: Intangible assets with finite useful lives are amortized over their useful lives and reported on the balance sheet at their adjusted historical cost. Intangible assets with indefinite useful lives are not amortized but are reviewed for impairment annually. Goodwill represents the purchase premium paid when one company acquires another company and is reviewed for impairment annually. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Other Assets Other assets include miscellaneous assets that do not fit in one of the previous categories Examples include long-term prepayments (such as for rent, insurance, or licenses), deferred tax assets (net), assets of a component of the company that is being discontinued, advances to officers, security deposits paid by the company, and assets temporarily restricted by foreign countries. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Long-Term Liabilities Long-term liabilities (noncurrent liabilities) obligations that are not expected to settle within one year or the normal operating cycle (whichever is longer) Most are reported at their present value, unless the company elects the fair value option. Interest rates, maturity values, and other provisions are disclosed parenthetically on the balance sheet or in the notes to the financial statements © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Types of Long-Term Liabilities Long-term accruals include obligations that may be outstanding for many years including obligations for pension and other post- employment benefits, estimated liabilities from long-term warranties, and deferred tax liabilities. Long-term financing instruments formal borrowings to finance the assets and operations of the company including long-term notes payable, capital lease obligations, mortgages payable and bonds payable Other liabilities miscellaneous liabilities that do not fit into one of the previous categories © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Shareholders’ Equity Shareholders’ equity is the residual interest of the shareholders in the assets of the corporation, after deducting the liabilities Shareholders’ rights are defined by the laws of the state granting the corporate charter Consists of two components: contributed capital and earned capital A third component can arise when equity capital is invested by noncontrolling interests © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Contributed Capital Contributed capital is recognized when a shareholder acquires shares directly from the corporation Can involve as many as four or more components Common stock Additional paid-in capital Treasury stock (debit balance) Preferred stock (different ownership rights from common stock) © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Earned Capital Earned capital consists of retained earnings and accumulated other comprehensive income Retained earnings is the total amount of corporate net income that has been earned but not been distributed to shareholders as dividends Deficit arises when cumulative net losses and/or dividends exceed cumulative net income Accumulated Other Comprehensive Income (Loss) is the cumulative amount of other comprehensive income (or loss) Noncontrolling interests arise when a parent company consolidates a less than 100% owned subsidiary company’s financial statements with its own financial statements © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

What is the Statement of Shareholders’ Equity? Financial statements must include a disclosure of the ending balances and the changes in its shareholders’ equity accounts The SEC requires a separate financial statement for publicly traded companies, but smaller companies and private companies may report it in a supporting schedule or a note to the financial statements © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional Balance Sheet Disclosures Not all the relevant financial information about a company’s financial position and activities are in the body of the financial statements Many issues may instead be disclosed in accompanying notes to the financial statements Summary of accounting policies Fair value and risk of financial instruments Loss and gain contingencies © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Summary of Accounting Policies Usually the first financial statement note Informs external users about the company’s accounting policies, practices, and methods Includes principles relating to revenue recognition and asset allocation, particularly when these principles and methods are choices from existing acceptable alternatives peculiar to the industry in which the company operates unusual or innovative applications of GAAP © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Fair Value and Risk of Financial Instruments Financial instruments include items such as stocks, bonds, and notes payable and receivable as well as more exotic instruments U.S. GAAP requires disclosure in the notes the fair values of all financial instruments, whether or not they are measured at fair value on its balance sheet A company is also required to disclose all significant concentrations of credit risk due to its financial instruments. GAAP requires disclosure of the fair value of all derivative financial instruments on its balance sheet A derivative financial instrument derives its value from changes in the price of the underlying resource to which it is linked © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Loss and Gain Contingencies Uncertain situations that exist on the balance sheet date as to contingent losses or gains are known as loss contingencies or gain contingencies © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Subsequent Events A subsequent event is one that occurs between a company’s balance sheet date and the date when it issues its annual report An adjustment to the financial statements is required if a subsequent event provides additional evidence about conditions that existed on the balance sheet date A material subsequent event that does not affect a company’s closed financial statements is instead disclosed in a note, in a pro forma (“as if”) statement, or in an explanatory paragraph in the audit report © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Related Party Transactions Transactions between related parties may not be conducted at arms length and could be viewed as self-dealing GAAP requires certain disclosures by the company including the following: Nature of the relationship involved Description of the transactions Dollar amounts of the transactions Any amounts due to or from the related parties on the balance sheet date © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

How Do We Analyze Balance Sheet Information? © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.