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Intermediate Accounting October 19th, 2010

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1 Intermediate Accounting October 19th, 2010
General Course Questions Questions before Quiz Chapters 4, 17 & 22 Income Statement, Statement of RE and Comprehensive Income (Non-recurring items, Intra period Tax Allocation & EPS) Changes in Accounting Estimates, Error Corrections, Changes in Accounting Principles Review the Balance Sheet using today’s homework 5. Assignments for Thursday, October 21st: A. Chapter 5 Balance Sheet & Statement of Cash Flows B. Chapter 23 Statement of Cash Flows 6. Return Discussion Questions #3 Earnings Management

2 Chapter 5 Balance Sheet Financial Position at a particular point in time IFRS vs. US GAAP IFRS requires presentation of 2 years of balance sheet data US GAAP Public companies, 2 years B/S (SEC) Private companies, only 1 year B/S required Generally listed in order of liquidity Classified as “Current” or “Non-Current”.

3 Balance Sheet: Classification
Assets Liabilities and Equity Current Assets Long-term investments Property, plant, and equipment Intangible assets Other assets Current liabilities Long-term debt Owners’ equity Capital stock Add’l paid-in cap. Retained earnings Accumulated Other Comp. Income (Treasury Stock) Question 6, ex 3, Prob. 1

4 Balance Sheet: Usefulness
The balance sheet provides information: Evaluating Capital structure – financing by creditors/investors Analyzing an enterprise’s: Liquidity (sufficient resources for day-to-day operations) Current Ratio, Quick Ratio, Working Capital Solvency (ability to pay debts as they mature – more long-run) Lower solvency = higher debt Financial flexibility (ability to respond to threats or take advantage of opportunities) Effectiveness in using assets employed Inventory and Receivables turnover Profitability with rates of return (in combination with the I/S) ROE ROA Question 1 & 3

5 Types of Ratios Type What is measured Examples Liquidity ratios
Short-term ability to pay maturing obligations Current ratio Quick assets ratio Coverage/ Capital Structure Solvency ratios Degree of protection for long-term creditors and investors Debt to total assets Times interest earned Activity ratios Effectiveness in using assets employed Receivables turnover Inventory turnover Total Asset Turnover Profitability ratios Degree of success or failure for a given period Rate of return on assets Return on equity Earnings per share

6 Financial Statement Analysis
Benchmarks: Trends Peers Scaling: Ratios Common size financial statements Limitations: Must compare apples to apples Nature of accounting Accounting choices Economic conditions and business model differences

7 Balance Sheet: Limitations
Is the B/S appropriate for valuing a company? Most assets and liabilities are stated at historical cost. Judgments and estimates are used in determining many of the items. The balance sheet does not report items that can not be objectively determined. It does not report information regarding certain off-balance sheet financing. Need to be able to reliably measure and control Human Resources, Litigation exposure, Research and Development, Intellectual capital, Question 7 & 8

8 Balance Sheet – Current Assets
Asset Category General Valuation Rule Cash & Cash Equivalents Fair Market value Marketable Securities or Short term Investments Trading (Gains or Losses in Income) AVS (Gains or Losses in Equity) Accounts Receivable Net realizable value (estimated amount collectible) Inventory Lower of cost or market (cost measured using a variety of methods, LIFO, FIFO) Prepaid Expenses Historical cost Chapter 5 question 11 where should AVS securities be on the B/S

9 Balance Sheet – “Current Assets”
Cash Generally any monies available “on demand.” Cash equivalents - short-term highly liquid investments that mature within three months or less. Restrictions or commitments must be disclosed. Illustration 5-3

10 Investments of < 20% Held-to-maturity: (current or non-current)
Record debt securities at amortized cost, don’t revalue “Fair value” or “Mark to Market” Trading: (current) Debt & equities intended to sell. Revalue annually to Fair Value in B/S. Unrealized holding gains and losses in income Available for Sale: (current or noncurrent) All others (debt or equity) Revalue annually to Fair Value in B/S. Unrealized holding gains and losses in OCI and equity (AOCI) question 11

11 Investments of < 20% Issues with Fair Value Method
How is “fair value” determined? Level 1: active market Level 2: observable market data other than quoted market price Level 3: determined only through “unobservable inputs” and prices based on internal models or estimates Classification of Trading vs. AFS Dividends received: DR Cash CR Dividend Income

12 Balance Sheet – Non Current Assets
Asset Category General Valuation Rule Property, Plant, & Equipment Historical cost less accumulated depreciation Land Historical cost, no depreciation Long-term Investments Historical cost, Market value, Equity method Other Assets (Deferred Income Tax Asset Undiscounted sum of expected future tax benefits Intangible Assets BE 5-6 Acquisition cost less amortization if acquired from external parties (usually zero if developed internally)

13 Long – Term Investments
Generally consists of four types: Securities Fixed assets Special funds Nonconsolidated subsidiaries or affiliated companies. e

14 Long – Term Investments
Generally consists of four types: Securities Fixed assets Special funds Nonconsolidated subsidiaries or affiliated companies. e

15 Long – Term Investments
Securities bonds, stock, and long-term notes For marketable securities, management’s intent determines current or noncurrent classification.

16 Property, Plant and Equipment
Assets of a durable nature used in the regular operations of the business.

17 Intangibles Lack physical substance and are not financial instruments.
Limited life intangibles amortized. Indefinite-life intangibles tested for impairment.

18 Other Assets This section should include only unusual items sufficiently different from assets in the other categories.

19 Liabilities Current Liabilities: “Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.” Long-Term Liabilities “Obligations that a company does not reasonably expect to liquidate within the normal operating cycle.” All covenants and restrictions must be disclosed.

20 Liabilities Short-term obligations: Long-term obligations:
Accounts payable, accrued liabilities (examples?) Notes payable, Unearned Revenue Current portion of long-term debt Long-term obligations: obligations arising from specific financing situations (issuance of bonds, bank debt) obligations arising from ordinary business operations (pension obligations, capital leases, deferred income taxes) obligations that are contingent (product warranties for long-term items) Question 13

21 Balance Sheet - Liabilities
Measurement of Liabilities uses a variety of techniques: Amount equal to actual future payment The present value of expected future payments Some future obligations are not reported on the balance sheet, but instead disclosed entirely in the notes to the financial statements.

22 Owners’ Equity Capital Stock Additional paid-in capital
Par or stated value of the shares issued Additional paid-in capital The excess of amounts paid in over par value Retained earnings Undistributed earnings Accumulated Other Comprehensive Income Analogous to RE for Other Comprehensive Income Treasury Stock (contra Stockholders’ Equity)

23 Owners’ Equity

24 Balance Sheet - Equity Measurement
Amounts reported in these accounts represent the aggregate of transactions that occurred at various points in time Common Stock & Additional Paid in Capital will include proceeds from the sale of stock from inception to present Retained Earnings will include the sum of Net Income from inception through current year less dividends paid Note that each year’s net income is expressed in that year’s dollars (i.e., monetary unit assumption) RE may be adjusted when purchase of Treasury Stock exceeds original iss

25 Balance Sheet Supplemental Information Reported
Contingencies – material events that have an uncertain outcome Accounting Policies – Explanations of the valuation methods used or the basic assumptions made concerning inventory valuations, depreciation, investment in subsidiaries, etc. Contractual Situations – Explanations of certain restrictions or covenants attached to specific assets or, more likely, liabilities. Fair Values – Disclosures of fair values for certain items Subsequent Events – Disclosure of material events or transactions that occur between the balance sheet date and its issuance date. Events that relate to conditions that existed as of the balance sheet date are incorporated into the balance sheet as if the subsequent information was known as of the balance sheet date. Events that relate to conditions that did not exist as of the balance sheet date are typically disclosed in the notes to the financial statements. Add some exercises here for balance sheet

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