1. A Further Look at Financial Statements CHAPTER 2

2. To provide the most useful financial information for decision makingTo provide the most useful financial information for decision making Objective of Financial Reporting

3. GenerallyGenerally AcceptedAccepted AccountingAccounting PrinciplesPrinciples General Guide for Financial Reporting

4. UnderstandabilityUnderstandability RelevanceRelevance ReliabilityReliability Comparability and consistencyComparability and consistency Characteristics of Useful Information

5. Constraints in Accounting Cost-benefitCost-benefit MaterialityMateriality

6. Classified Balance Sheet Assets Current assetsCurrent assets Long-term investmentsLong-term investments Property, plant, and equipmentProperty, plant, and equipment Intangible assetsIntangible assets Liabilities Current liabilities Long-term liabilities A classified balance sheet generally contains the following standard classifications: Shareholders’ Equity Share capital Share capital Retained earnings Retained earnings

7. Current Assets Assets expected to be converted to cash or used in the business within the yearAssets expected to be converted to cash or used in the business within the year Listed in order of liquidityListed in order of liquidity ExamplesExamples –Cash –Short-term investments –Accounts receivable –Inventories –Prepaid expenses

8. Long-Term Investments Assets that can be converted into cash, but whose conversion is not expected within one yearAssets that can be converted into cash, but whose conversion is not expected within one year Assets not intended for use within the businessAssets not intended for use within the business ExampleExample – Investments in shares and bonds of other corporations

9. Property, Plant, and Equipment Tangible assets with relatively long useful livesTangible assets with relatively long useful lives Assets used in operating the businessAssets used in operating the business

10. Property, Plant, and Equipment Examples –Land –Land improvements –Buildings –Machinery and equipment –Furniture and fixtures

11. Intangible Assets Intangible assets with relatively long useful livesIntangible assets with relatively long useful lives Future value because of the exclusive rights or privileges they possessFuture value because of the exclusive rights or privileges they possess

12. Intangible Assets Examples –Patents –Copyrights –Trademarks or trade names –Franchises –Goodwill © ® ™

13. Amortization Allocation of an asset’s full purchase price to match cost to revenues over the entire estimated useful life instead of expensing full cost in the year of purchaseAllocation of an asset’s full purchase price to match cost to revenues over the entire estimated useful life instead of expensing full cost in the year of purchase The cost of long-lived assets with indefinite lives (e.g., land) is not amortizedThe cost of long-lived assets with indefinite lives (e.g., land) is not amortized

14. Amortization Accumulated amortization account shows the total amount of amortization taken to dateAccumulated amortization account shows the total amount of amortization taken to date The difference between the cost of the asset and its accumulated amortization is referred to as the net book value of the assetThe difference between the cost of the asset and its accumulated amortization is referred to as the net book value of the asset

15. CSU CORPORATION Balance Sheet December 31, 2004 Amortizable long-lived assets should be shown at net book value (cost less accumulated amortization) Assets Cash Accounts receivable SuppliesEquipment Less: Accumulated amortization Total assets $24,000 8,000 8,000 $ 2,000 4,0001,800 16,000 16,000$23,800

16. –Accounts payable –Wages payable –Notes (bank loans) payable –Interest payable –Income taxes payable –Current maturities of long-term liabilities Current Liabilities Obligations that are supposed to be paid within the coming year

17. Long-Term Liabilities Debts expected to be paid after one yearDebts expected to be paid after one year –Bonds payable –Mortgages payable –Long-term notes payable –Capital lease liabilities –Obligations under employee pension plans

18. Shareholders' Equity Share capitalShare capital –Investments in the business by the shareholders Retained earningsRetained earnings –Earnings kept for use in the business

19. Ratio Analysis Mathematical relationshipMathematical relationship Relationship can be expressed in terms ofRelationship can be expressed in terms of –Percentage –Rate –Proportion

20. Comparisons Intracompany (between prior years of the company)Intracompany (between prior years of the company) Intercompany (between companies)Intercompany (between companies) Industry averages (based on average ratios for particular industries)Industry averages (based on average ratios for particular industries)

21. Financial Ratio Classifications Profitability ratiosProfitability ratios –Measure the earnings or operating success of a company for a given period of time Liquidity ratiosLiquidity ratios –Measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash Solvency ratiosSolvency ratios –Measure the ability of a company to survive over a long period of time

22. Using the Statement of Earnings Many stakeholders in a company are concerned with profitability. Two ratios can be used to assess profitability.Many stakeholders in a company are concerned with profitability. Two ratios can be used to assess profitability. Earnings per share: measures the net earnings for each common share.Earnings per share: measures the net earnings for each common share. Price-earnings ratio: measures the ratio of the market price of each common share to its earnings per share.Price-earnings ratio: measures the ratio of the market price of each common share to its earnings per share.

23. Profitability Ratios EPS = Net Income - Preferred DividendsEPS = Net Income - Preferred Dividends Number of Shares P-E Ratio = Market Price Per Share Earnings Per Share P-E Ratio = Market Price Per Share Earnings Per Share

24. Using the Classified Balance Sheet The classified balance sheet can be used to evaluate a company’s financial healthThe classified balance sheet can be used to evaluate a company’s financial health Liquidity ratios measure the short term ability of the company to pay its maturing obligations (e.g. working capital, current ratio)Liquidity ratios measure the short term ability of the company to pay its maturing obligations (e.g. working capital, current ratio) Solvency ratios measure the company’s ability to survive over a long period of time (e.g. debt to total assets)Solvency ratios measure the company’s ability to survive over a long period of time (e.g. debt to total assets)

25. Liquidity Ratios Working Capital = Current Assets - Current LiabilitiesWorking Capital = Current Assets - Current Liabilities Current Ratio = Current Assets Current Liabilities Current Ratio = Current Assets Current Liabilities

26. Solvency Ratios Debt to Total Assets = Total LiabilitiesDebt to Total Assets = Total Liabilities Total Assets Total Assets

27. Using the Statement of Retained Earnings Describes the events that caused changes in the retained earnings account for the periodDescribes the events that caused changes in the retained earnings account for the period –Increased by earnings –Decreased by losses and dividends

28. CSU CORPORATION Statement of Retained Earnings Year Ended December 31, 2004 Retained earnings, January 1 Add: Net earnings Less: Dividends Retained earnings, December 31 $ 0 (1) 6,800 (2) 6,800 (2) 6,800 6,800 0 0 $6,800 (3)

29. Using the Statement of Retained Earnings Statement Interrelationships: (1)Opening retained earnings comes from, and agrees to, ending retained earnings on prior period balance sheet (2)Net earnings comes from, and agrees to, net earnings on statement of earnings (3)Ending retained earnings goes to, and agrees to, ending retained earnings on current period balance sheet

30. Using the Cash Flow Statement To provide information aboutTo provide information about –Cash receipts –Cash payments –Changes in cash (and cash equivalents) From changes inFrom changes in –Operating activities –Financing activities –Investing activities

31. Operating Activities Cash inflows and cash outflows associated with the primary operations of the businessCash inflows and cash outflows associated with the primary operations of the business

32. Financing Activities Cash inflows / outflows that come from sources funding the businessCash inflows / outflows that come from sources funding the business –Sale of shares / payment of dividends –Issuing debt / repaying debt

33. Investing Activities Cash inflows / outflows that result from changes in investments, property, plant and equipment and intangible assetsCash inflows / outflows that result from changes in investments, property, plant and equipment and intangible assets –Purchasing / disposing of investments and long-lived assets using cash –Lending money and collecting the loans

34. Using the Cash Flow Statement Cash Current Debt Coverage = Cash Provided by Operating Activities Average Current Liabilities

35. Using the Cash Flow Statement Cash Total Debt Coverage = Cash Provided by Operating Activities Average Total Liabilities