11 Chapter 5: Balance Sheet and Supplemental Disclosures (omit SCF)

2 The Balance Sheet The balance sheet reports the financial position at a point in time (end of the quarter or year). Also called the Statement of Financial Position. Useful for assessing liquidity, solvency and financial flexibility. Limitations: – Primarily historical cost basis. – Many values include estimation. – Some assets and liabilities not reflected.

3 The Balance Sheet (B/S) Assets – “probable future economic benefit obtained or controlled by a particular entity as a result of past transactions or events” (SFAC 6). Liabilities – “probable future sacrifices of economic benefits arising from present obligations of a particular entity... as a result of past transactions or events” (SFAC 6). Equity – “Residual interest in the assets of an entity that remains after deducting its liabilities” (SFAC 6).

4 Classification Assets – – Current assets – Long-term investments – Property, plant and equipment – Intangible assets – Other assets Liabilities – Current liabilities – Long-term debt Stockholders’ Equity – Capital (Common) stock – Additional paid-in capital – Retained earnings

5 B/S Assets: Current Assets Current assets: expected to be converted into cash, sold, or used up within one year or operating cycle (cash to inventory to receivable to cash), whichever is longer. – Cash: checking and savings accounts; petty cash. – Short-term investments: investments in stocks and bonds of other companies. – Accounts receivable: amounts owed to a company from its customers. – Inventory: products on hand designated for sale to customers. – Prepaid expenses: amounts paid for future expenses.

6 B/S Assets: Long-term Investments Long-term investments are assets acquired by the company to provide long-term benefits to the company. Long-term investments include: – Long-term notes receivable owed to the company (from customers or others). – Investments in stock of other companies: held for expectation of dividends and/or stock price increase. – Investment in bonds of other companies: held for expectation of dividends and/or stock price increase. – Other assets, like land, held for the long term, but not part of operations.

7 B/S Assets: Property, Plant, and Equipment Property and equipment are assets that are used in the production of goods and services. These productive assets are long-term in nature, and include the following: – Land: property upon which the productive facilities are located. – Building: the physical structure of the company’s operations. – Machinery and Equipment: include operating machinery, vehicles, computers, copy machines, etc. – Accumulated Depreciation: contra asset to reduce the cost for the portion used.

8 B/S Assets: Intangible Assets Intangible assets are long-lived assets that have no physical substance, and their useful life is difficult to determine. Examples include: – Patents: legal claim to produce and sell a product. – Copyrights: legal claims to books, art, music and other created works. – Trademarks: company logos and other identification that are owned by the company. – Goodwill: recognized when one company buys another company, and the purchase price is greater than the fair value of the identifiable net assets.

9 B/S Liabilities: Current Liabilities Current liabilities are obligations expected to be paid (or services expected to be performed) within the next year or operating cycle. The elimination of the current liabilities requires the use of current assets (most commonly cash). Examples include: – Accounts payable – Wages payable – Interest payable – Short-term notes payable – Current maturities of long-term debt – Deferred (unearned) revenues

10 B/S Liabilities: Long-term Liabilities Long-term liabilities are obligations expected to require payments beyond the current year or operating cycle. Examples include: – Notes payable: amounts owed to banks and other creditors beyond the current year. – Mortgage payable: amounts owed to mortgage company beyond the current year. – Bonds payable: amounts owed to investors holding bond investments issued by the company, where payments of principal and interest are beyond the current year. – Portions of pension liabilities and deferred tax liabilities that are long-term.

11 B/S: Stockholders’ Equity Stockholders’ equity – Capital (common) stock: shares of stock issued to owners to reflect ownership; recorded at par or stated value, or at issue price if no-par stock. – Additional paid in capital: excess amounts contributed by shareholders for various activities, including amounts over par, if par value stock. – Retained earnings: the cumulative undistributed earnings of a company.

12 Financial Statement Ratios Ratios are used to identify the financial health of a company. The major types of ratios are: – Liquidity ratios: measure company’s short- term ability to meet obligations. – Activity ratios: measure how effectively a company uses its assets. – Profitability ratios: measure the profit- related performance of a company for a period of time – Coverage (solvency) ratios: measure the long term ability of a company to satisfy its creditors and investors.

13 Other Financial Statement Information Supplemental disclosures – notes to the financial statements. – Accounting Policies: explanations of methods for inventory, depreciation, investments, etc. – Contingencies: material events that have uncertain outcome, like lawsuits. – Contractual Situations: debt covenants, borrowing commitments, significant employee contracts. – Fair Values: assumptions for calculating fair values, particularly for financial instruments.

14 Other Financial Statement Information Techniques of Disclosure – Parenthetical Explanations: disclosed in the financial statements – Notes: for the vast majority of disclosures, the financial statement notes are an expansive and integral part of the financial statements. – Supporting Schedules: often included in the notes, or in SEC schedules, to clearly present certain types of financial information. – Cross-Reference and Contra/Adjunct Items: similar to parenthetical explanations.