Further Chapter
2-1
A Look at
Financial Statements
Financial
Chapter
2-2
Accounting, Third Edition
Study Objectives
Study Objectives
1.
Identifythesectionsofaclassifiedbalancesheet.
2.
Identifyandcomputeratiosforanalyzingacompanysprofitability.
3.
Explaintherelationshipbetweenaretainedearningsstatementanda
statementofstockholdersequity.
4.
Identifyandcomputeratiosforanalyzingacompanysliquidityandsolvency
usingabalancesheet.
5.
Usethestatementofcashflowstoevaluatesolvency.
6.
Explainthemeaningofgenerallyacceptedaccountingprinciples.
7.
Discussfinancialreportingconcepts.
Chapter
2-3
A Further Look At Financial Statements
A Further Look At Financial Statements
The
The Classified
Balance Sheet
Balance
Current assets
Long-term
Long-term
investments
investments
Property, plant, and
Property,
equipment
equipment
Intangible assets
Current liabilities
Long-term liabilities
Stockholders equity
Chapter
2-4
Using
Using the Financial
Statements
Statements
Ratio analysis
Using the income
Using
statement
statement
Using the statement of
Using
stockholders equity
stockholders
Using a classified
Using
balance sheet
balance
Using the statement of
Using
cash flows
cash
Financial
Financial Reporting
Concepts
Concepts
The standard-setting
The
environment
environment
Characteristics of
Characteristics
useful information
useful
Assumptions and
Assumptions
principles
principles
Constraints
The Classified Balance Sheet
The Classified Balance Sheet
Presentsasnapshotatapointintime.
Toimproveunderstanding,companiesgroupsimilarassetsand
similarliabilitiestogether.
Standard Classifications
Assets
Liabilities and Owners Equity
Currentassets Currentliabilities
Longterminvestments
Property,plant,andequipment
Intangibleassets
Chapter
2-5
Illustration 2-1
Longtermliabilities
Stockholdersequity
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Illustration 2-2
Chapter
2-6
The Classified Balance Sheet
The Classified Balance Sheet
Illustration 2-2
Chapter
2-7
The Classified Balance Sheet
The Classified Balance Sheet
Current Assets
Assetsthatacompanyexpectstoconverttocashoruseup
within one yearortheoperating cycle,whicheveris
longer.
Operating cycleistheaveragetimeittakesfromthe
purchaseofinventorytothecollectionofcashfromcustomers.
Chapter
2-8
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Current Assets
Illustration 2-3
Companiesusuallylistcurrentassetaccountsintheordertheyexpecttoconvert
themintocash.
Chapter
2-9
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Review Question
Cash,andotherresourcesthatarereasonablyexpectedtoberealizedin
cashorsoldorconsumedinthebusinesswithinoneyearorthe
operatingcycle,arecalled:
a. Currentassets.
b. Intangibleassets.
c. Longterminvestments.
d. Property,plant,andequipment.
Chapter
2-10
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Long-Term Investments
Investmentsinstocksandbondsofothercompanies.
Investmentsinlongtermassetssuchaslandorbuildingsthata
companyisnotcurrentlyusinginitsoperatingactivities.
Illustration 2-4
Chapter
2-11
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Property, Plant, and Equipment
Longusefullives.
Currentlyusedinoperations.
Depreciationallocatingthecostofassetstoanumberofyears.
Accumulated depreciationtotalamountofdepreciation
expensedthusfarintheassetslife.
Chapter
2-12
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Property, Plant, and Equipment
Illustration 2-5
Chapter
2-13
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Intangible Assets
Assetsthatdonothavephysicalsubstance.
Illustration 2-6
Chapter
2-14
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Review Question
Patentsandcopyrightsare
a. Currentassets.
b. Intangibleassets.
c. Longterminvestments.
d. Property,plant,andequipment.
Chapter
2-15
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Current Liabilities
Obligationsthecompanyistopaywithinthecomingyear.
Usuallylistnotespayablefirst,followedbyaccountspayable.
Otheritemsfollowinorderofmagnitude.
Liquidity - abilitytopayobligationsexpectedtobeduewithin
thenextyear.
Chapter
2-16
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Current Liabilities
Illustration 2-7
Chapter
2-17
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Long-Term Liabilities
Obligationsacompanyexpectstopayafter oneyear.
Illustration 2-8
Chapter
2-18
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Review Question
Whichofthefollowingisnotalongtermliability?
a. Bondspayable
b. Currentmaturitiesoflongtermobligations
c. Longtermnotespayable
d. Mortgagespayable
Chapter
2-19
SO 1 Identify the sections of a classified balance sheet.
The Classified Balance Sheet
The Classified Balance Sheet
Stockholders Equity
Illustration 2-2
Common stockinvestmentsofassetsintothebusinessbythestockholders.
Retained earningsincomeretainedforuseinthebusiness.
Chapter
2-20
SO 1 Identify the sections of a classified balance sheet.
Using the Financial Statements
Using the Financial Statements
Ratio Analysis
Expressesrelationshipamongselecteditemsoffinancialstatement
data.
Relationshipexpressedintermsofeitherapercentage,arate,ora
simpleproportion.
Chapter
2-21
Using the Financial Statements
Using the Financial Statements
Illustration:Best Buyhascurrentassetsof$9,081millionandcurrent
liabilitiesof$6,301million.Wecandeterminearelationshipbetweenthese
accountsbydividingcurrentassetsbycurrentliabilities,toget1.44.The
alternativemeansofexpressionare:
Percentage:
Currentassetsare144%ofcurrentliabilities.
Rate:
Currentassetsare1.44timesasgreatascurrentliabilities.
Proportion:
Therelationshipofcurrentassetstocurrentliabilitiesis
1.44:1.
Chapter
2-22
Using the Financial Statements
Using the Financial Statements
Chapter
2-23
Using the Financial Statements
Using the Financial Statements
Using the Income Statement
Illustration 2-10
Circuit City reported a net loss of $10.2 million for the year ended Feb. 28, 2007.
Chapter
2-24
SO 2 Identify and compute ratios for analyzing a companys profitability.
Using the Financial Statements
Using the Financial Statements
Profitability
Ratio
Illustration: Earnings per share (EPS)measuresthenetincome
earnedoneachshareofcommonstock.
BestBuy
Illustration 2-11
$1,377 - $0
=
(481 + 485)
2
Chapter
2-25
$1,140 - $0
=
(485 + 493)
2
$2.85
$2.33
Using the Financial Statements
Using the Financial Statements
Review Question
For2010StonelandCorporationreportednet
income$26,000;netsales$400,000;andaveragesharesoutstanding
6,000.Therewerepreferredstockdividendsof$2,000.Whatwasthe
2010earningspershare?
a. $4.00
b. $0.06
c. $16.67
d. $66.67
Chapter
2-26
$26,000
$2,000
6,000
=$4.00
SO 2 Identify and compute ratios for analyzing a companys profitability.
Using the Financial Statements
Using the Financial Statements
Using the Statement of Stockholders Equity
Illustration 2-12
Mostcompaniesusea
statement of
stockholders
equity,ratherthana
retainedearnings
statement,sothatthey
canreportallchangesin
stockholdersequity
accounts.
Chapter
2-27
SO 3 Explain the relationship between a retained earnings
statement and a statement of stockholders equity.
Using the Financial Statements
Using the Financial Statements
Using the Statement of Stockholders Equity
ObservationsfromthisfinancialstatementofBest Buy:
Commonstockincreasedduringthefirstyearastheresultofissuanceof
commonstock.
Commonstockdeclinedinthesecondandthirdyearsastheresultof
repurchasingsharesofstock.
BestBuypaidanincreasingamountofdividendseachyear.
Priorto2003,BestBuydidnotpaydividends,eventhoughitwas
profitableandcoulddoso.
WhydidntBestBuypaydividendspriorto2003?
Chapter
2-28
SO Explain 3 the relationship between a retained earnings
statement and a statement of stockholders equity.
Using the Financial Statements
Using the Financial Statements
Review Question
Thebalanceinretainedearningsisnotaffectedby:
a. netincome
b. netloss
c. issuanceofcommonstock
d. dividends
Chapter
2-29
SO 3 Explain the relationship between a retained earnings
statement and a statement of stockholders equity.
Illustration 2-13
Using the
Using the
Using
Using
Financial
Financial
Statements
Statements
Statements
Statements
Using a
Classified
Balance Sheet
Chapter
2-30
Using the Financial Statements
Using the Financial Statements
Using a Classified Balance Sheet
Liquiditytheabilitytopayobligationsexpectedtobecomeduewithin
thenextyearoroperatingcycle.
Illustration 2-14
Whenworking capitalispositive,thereisgreaterlikelihoodthatthe
companywillpayitsliabilities.
BestBuyhadworkingcapitalin2007of$2,780million.
Chapter
2-31
SO 4 Identify and compute ratios for analyzing a companys
liquidity and solvency using a balance sheet.
Using the Financial Statements
Using the Financial Statements
Liquidity
Ratio
Liquidity ratiosmeasuretheshorttermabilityofthecompanytopayits
maturingobligationsandtomeetunexpectedneedsforcash.
Illustration 2-15
$9,081
$6,301
= 1.44:1
$7,985
$6,056
= 1.32:1
1.68:1
1.75:1
1.21:1
NA
Foreverydollarofcurrentliabilities,BestBuyhas$1.44ofcurrentassets
Chapter
2-32
SO 4 Identify and compute ratios for analyzing a companys
liquidity and solvency using a balance sheet.
Chapter
2-33
Using the Financial Statements
Using the Financial Statements
Using a Classified Balance Sheet
Solvencytheabilitytopayinterestasitcomesdueandtorepaythe
balanceofadebtdueatitsmaturity.
Solvency ratiosmeasuretheabilityofthecompanytosurviveoveralong
periodoftime.
Chapter
2-34
SO 4 Identify and compute ratios for analyzing a companys
liquidity and solvency using a balance sheet.
Using the Financial Statements
Using the Financial Statements
Solvency
Ratio
Debt to total assets ratiomeasuresthepercentageoftotalfinancing
providedbycreditorsratherthanstockholders.
Illustration 2-16
$7,369
$13,570
= 54%
$6,607
$11,864
= 56%
55%
52%
21%
NA
The2007ratiomeansthateverydollarofassetswasfinancedby54centsofdebt.
Chapter
2-35
SO 4 Identify and compute ratios for analyzing a companys
liquidity and solvency using a balance sheet.
Using the Financial Statements
Using the Financial Statements
Review Question
ThefollowingratiosareavailableforLeerInc.andStableInc.
ComparedtoStableInc.,LeerInc.has:
a.
higherliquidity,highersolvency,andhigherprofitability.
b.
lowerliquidity,highersolvency,andhigherprofitability.
c.
higherliquidity,lowersolvency,andhigherprofitability.
d.
higherliquidityandlowersolvency,butprofitabilitycannotbecomparedbasedon
informationprovided.
Chapter
2-36
SO 4 Identify and compute ratios for analyzing a companys
liquidity and solvency using a balance sheet.
Chapter
2-37
Using the Financial Statements
Using the Financial Statements
Using the Statement of Cash Flows
Toaidintheanalysisofcash,thestatementofcashflowsreportsthecash
effectsof
1. acompanysoperatingactivities,
2. itsinvestingactivities,and
3. itsfinancing activities.
Chapter
2-38
SO 5 Use the statement of cash flows to evaluate solvency.
Using the Financial Statements
Using the Financial Statements
Illustration 2-17
Using the
Statement
of Cash
Flows
Wouldyoufeelbetterabout
acompanyshealthifyou
knewthatmostofitscash
wasgeneratedbyoperating
itsbusinessratherthanby
borrowingcashfrom
lenders?
Chapter
2-39
(
)
(
)
SO 5 Use the statement of cash flows to evaluate solvency.
Using the Financial Statements
Using the Financial Statements
Cashprovidedbyoperatingactivitiesfailstotakeinto
accountthatacompanymustinvestinnewPP&Eand
mustmaintaindividendsatcurrentlevelstosatisfy
investors.
Chapter
2-40
Answersonnotespage.
SO 5 Use the statement of cash flows to evaluate solvency.
Financial Reports Concepts
Financial Reports Concepts
The Standard-Setting Environment
Generally Accepted Accounting Principles (GAAP) - Asetof
rulesandpractices,havingsubstantialauthoritative
support,thattheaccountingprofessionrecognizesasageneralguidefor
financialreportingpurposes.
Various standard-setting bodiesdeterminetheseguidelines:
SecuritiesandExchangeCommission(SEC)
PublicCompanyAccountingOversightBoard(PCAOB)
FinancialAccountingStandardsBoard(FASB)
InternationalAccountingStandardsBoard(IASB)
Chapter
2-41
SO 6 Explain the meaning of generally accepted accounting principles.
Financial Reports Concepts
Financial Reports Concepts
Review Question
Generallyacceptedaccountingprinciplesare:
a. asetofstandardsandrulesthatarerecognizedasageneral
guideforfinancialreporting.
b. usuallyestablishedbytheInternalRevenueService.
c. theguidelinesusedtoresolveethicaldilemmas.
d. fundamentaltruthsthatcanbederivedfromthelawsofnature.
Chapter
2-42
SO 6 Explain the meaning of generally accepted accounting principles.
Chapter
2-43
Financial Reports Concepts
Financial Reports Concepts
Characteristics of Useful Information
Illustration 2-18
Chapter
2-44
SO 7 Discuss financial reporting concepts.
Chapter
2-45
Financial Reports Concepts
Financial Reports Concepts
Assumptions in Financial Reporting
Illustration 2-19
Mo ne ta ry Unit
TimePeriod
Chapter
2-46
EconomicEntity
GoingConcern
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
Principles in Financial Reporting
Illustration 2-20
Cost
Chapter
2-47
FullDisclosure
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
Constraints in Financial Reporting
Illustration 2-20
Materiality
Chapter
2-48
Conservatism
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
1.
Abilitytoeasilyevaluateonecompanysresultsrelativetoanothers.
Comparability
2.
Beliefthatacompanywillcontinuetooperatefortheforeseeable
future.
Going concern
Thejudgmentconcerningwhetheranitemislargeenoughtomatter
todecisionmakers.
Materiality
3.
Chapter
2-49
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
4.
Thereportingofallinformationthatwouldmakeadifferenceto
financialstatementusers.
Full disclosure
5.
Thepracticeofpreparingfinancialstatementsatregularintervals.
Time period
6.
Thequalityofinformationthatindicatestheinformationmakesa
differenceinadecision.
Relevance
Chapter
2-50
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
7.
Abeliefthatitemsshouldbereportedonthebalancesheetatthe
pricethatwaspaidtoacquiretheitem.
8.
Acompanysuseofthesameaccountingprinciplesandmethodsfrom
yeartoyear.
Consistency
Theuseofaccountingmethodsthatdonotoverstateassetsor
income.
Conservatism
9.
Chapter
2-51
Cost
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
10.
Tracingaccountingeventstoparticularcompanies.
Economic entity
11.
Thedesiretominimizeerrorsandbiasinfinancialstatements.
Reliability
12.
Reportingonlythosethingsthatcanbemeasuredindollars.
Chapter
2-52
Monetary unit
SO 7 Discuss financial reporting concepts.
Financial Reports Concepts
Financial Reports Concepts
Review Question
Whatistheprimarycriterionbywhichaccountinginformationcanbe
judged?
a. Consistency.
b. Predictivevalue.
c. Usefulnessfordecisionmaking.
d. Comparability.
Chapter
2-53
SO 7 Discuss financial reporting concepts.
Copyright
Copyright
Copyright2009JohnWiley&Sons,Inc.Allrightsreserved.Reproductionor
translationofthisworkbeyondthatpermittedinSection117ofthe1976United
StatesCopyrightActwithouttheexpresswrittenpermissionofthecopyrightowner
isunlawful.RequestforfurtherinformationshouldbeaddressedtothePermissions
Department,JohnWiley&Sons,Inc.Thepurchasermaymakebackupcopiesfor
his/herownuseonlyandnotfordistributionorresale.ThePublisherassumesno
responsibilityforerrors,omissions,ordamages,causedbytheuseoftheseprograms
orfromtheuseoftheinformationcontainedherein.
Chapter
2-54