©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Chapter 17 Understanding Corporate Annual Reports: Basic Financial Statements

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 1 Identify and explain the main types of assets in the balance sheet of a corporation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton The Balance Sheet Assets Liabilities Equity

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Assets Example December Current assets Cash and cash equivalents$ 3,445$ 1,553 Short-term investments Accounts receivable, net 5,125 5,057 Inventories 3,422 3,745 Deferred income taxes 3,162 2,362 Other current assets Total current assets$16,603$13,631 Property, plant, and equipment, net 9,246 10,049 Other assets 11,578 5,148 Total assets$37,427$28,828

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Assets Example December Property, plant, and equipment Land Buildings 5,989 6,288 Machinery 15,608 16,316 $21,848$22,888 Less: Accumulated depreciation 12,602 12,839 Property, plant, and equipment, net$ 9,246$10,049

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Equivalents l Cash equivalents are short-term investments that can easily be converted into cash with little delay. l What are some examples? – money market funds – Treasury bills

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Operating Cycle Cash $100,000 Cash $100,000 Merchandise Inventory $100,000 Merchandise Inventory $100,000 Accounts Receivable $160,000 Accounts Receivable $160,000 BuySell

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Depreciation Cost Expense Acquisition cost – Estimated residual value = Amount to be allocated

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Depreciation Straight line Accelerated Units of production Cost – Accumulated depreciation = Net book value

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Natural Resources l Natural resources such as mineral deposits are typically grouped with plant assets. l Their original cost is written off in the form of depletion as the natural resource is used.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Intangible Assets l Intangible assets are a class of long-lived assets that are not physical in nature. l What are some examples? Trademarks Patents Goodwill Franchises Copyrights

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 2 Identify and explain the main types of liabilities in the balance sheet of a corporation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Liabilities Example December Current liabilities Notes payable and current portion of long-term debt$ 2,604$ 2,909 Accounts payable 3,015 2,405 Accrued liabilities 6,897 6,226 Total current liabilities 12,516 11,540 Long-term debt 3,089 2,633 Deferred income taxes 3,481 1,188 Other liabilities 1,513 1,245 Total liabilities$20,599$16,606

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 3 Identify and explain the main elements of the stockholders’ equity section of the balance sheet of a corporation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Stockholders’ Equity Example December Preferred stock, $100 par value issuable in series, Authorized shares: 0.5 (none issued) – – Common stock, $3 par value Authorized shares: 1,400 Issued and outstanding: 2003, 612.8; 2002, ,838 1,804 Additional paid-in capital 2,772 1,894 Retained earnings 9,064 8,254 Non-owner changes to equity 3, Total stockholders’ equity 16,828 12,222 Total liabilities and stockholders’ equity$37,427$28,828

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Stockholders’ Equity Contributed or paid-in capital Retained income

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Common Stock l Common stock has no predetermined rate of dividends and is the last to obtain a share in the assets when the corporation is dissolved. l Common shares usually have voting power to elect the board of directors of the corporation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Preferred Stock Preferred stock has some priority over other shares regarding dividends or the distribution of assets upon liquidation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Treasury Stock It is a corporation’s own stock that was issued and subsequently repurchased by the company and is being held for a specific purpose.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 4 Identify and explain the principal elements in the income statement of a corporation.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Income Statement Single stepMultiple step An income statement can take one of two major forms:

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Operating Management Operating management focuses on the major day-to-day activities that generate sales revenue.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Financial Management In contrast, financial management focuses on where to get cash and how to use cash for the benefit of the organization.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Net Income Net income is the popular “bottom line” – the residual after deducting all expenses including income taxes.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Earnings Per Share Income statements conclude with disclosure of earnings per share, which is net income divided by the average number of common shares outstanding during the year.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 5 Identify and explain the elements in the statement of retained earnings.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Statement of Retained Earnings l An analysis of the changes in retained earnings is frequently placed in a separate financial statement, the statement of retained earnings (also called statement of retained income). l The major reasons for changes in retained earnings are dividends and net income.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 6 Identify activities that affect cash, and classify them as operating, investing, or financing activities.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Statement of Cash Flows It shows the relationship of net income to changes in cash balances. It reports past cash flows. It reveals commitments to assets that may restrict or expand future courses of action.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Typical Activities Affecting Cash 1 List the activities that increased or decreased cash. 2 Place each cash inflow and outflow into one of three categories. – operating activities – investing activities – financing activities

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 7 Interpret a statement of cash flows that uses the direct method.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Receipts: Collections from customers$180 Payments: To suppliers$72 To employees 15 For interest 4 For taxes 20 Total payments 111 Net cash provided by operating activities$ 69 Cash Flows from Operating Activities The Direct Method

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Collections from Customers Sales$200,000 Decrease (increase) in accounts receivable (20,000) Cash collections from customers$180,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Collections from Customers Cost of goods sold$100,000 Increase (decrease) in inventory 40,000 Decrease (increase) in trade accounts payable (68,000) Payments to suppliers$ 72,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Payments to Suppliers Cost of goods sold$100,000 Increase (decrease) in inventory 40,000 Decrease (increase) in trade accounts payable (68,000) Payments to suppliers$ 72,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Payments to Employees Wages and salaries expense$36,000 Decrease (increase) in wages and salaries payable (21,000) Cash payments to employees$15,000

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash flows from investing activities: Purchases of fixed assets$(287) Proceeds from sale of fixed assets 10 Net cash used in investing activities$(277) Investing Activities

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash flows from financing activities: Proceeds from issue of long-term debt$120 Proceeds from issue of common stock 98 Dividends paid (19) Net cash provided by financing activities$199 Financing Activities

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Net cash provided by operating activities$ 69 Net cash used in investing activities (277) Net cash provided by financing activities 199 Net (decrease in cash)$ (9) Cash, December 31, 2002$25 Cash, December 31, 2003$16 Statement of Cash Flows Statement of Cash Flows (Direct Method) Year Ended December 31, 2003 (Thousands)

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Fixed Assets l Three items usually explain changes in net fixed assets. 1 Asset acquisitions 2 Asset dispositions 3 Depreciation expense for the period

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Stockholders’ Equity l Changes in stockholders’ equity can be explained by three factors: 1 Issuance (or repurchase) of capital stock 2 Net income (or loss) 3 Dividends

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Noncash Investing and Financing Activities Must be reported in a schedule that accompanies the statement of cash flows.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Cash Flow l A focal point of the statement of cash flows is the net cash flow from operating activities, which is frequently referred to as simply cash flow.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 8 Understand the reconciliation of net income to net cash provided by operations.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Reconciliation of Net Income to Net Cash Net income$23 Adjustments to reconcile net income Depreciation$ 17 Net increase in accounts receivable (20) Net increase in inventory (40) Net increase in accounts payable 68 Net increase in wages and salaries payable 21 Total additions and deductions 46 Net cash provided by operating activities$69

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Adjustment for Increases in Noncash Current Assets l Suppose the $20,000 increase in receivables resulted from credit sales made near the end of the year. l The $20,000 sales figure would be included in the computation of net income, but the $20,000 would not have increased cash flow from operations.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Adjustment for Increases in Current Liabilities l Suppose the $21,000 increase in wages payable was attributable to wages earned near the end of the year, but not yet paid in cash. l The $21,000 wages expense would be deducted in computing net income, but the $21,000 would not have decreased cash flow from operations.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 9 Explain the role of depreciation in the statement of cash flows.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Role of Depreciation Depreciation is an allocation of historical cost to expense. Therefore, depreciation expense does not entail a current outflow of cash.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Learning Objective 10 Understand how investors and managers use balance sheets, income statements, and cash flow statements to aid their decision making.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton Financial Statements Aid Managers’ Decision Making Managers and investors use balance sheets to assess a company’s financial position at a point in time. Managers and investors use income statements and statements of cash flows to assess performance over a period of time.

©2002 Prentice Hall Business Publishing, Introduction to Management Accounting 12/e, Horngren/Sundem/Stratton End of Chapter 17