3 Chapter Balance Sheet and Financial Disclosures Preparation: Company's name Balance Sheet At December 31, 2011 Assets Current Assets: Cash AR Less: Allowance for uncollectible Note receivable (>1 year) Inventories Prepaid expenses Total Current Assets Investments PP&E Land Buildings Machinery Less: Accumulated depreciation Net PP&E Intangible assets: Patent Total assets Liabilities and SE Current liabilities: Payables Current maturities of long-term debt Total liabilities Long-term liabilities: Notes payable Bonds payable Total long-term liabilities Shareholders' equity Common stock, no par, # of shares authorized, # of shares issued and outstanding Retained earnings Total Shareholders' equity
Total liabilities and shareholders' equity The Balance sheet Presents assets, liabilities, and shareholder's equity at a point in time. A company's book value is assets minus liabilities. Benefits: o It describes many of the company's resources which are available to generate future cash flows. o It provides information useful for assessing future cash flows, liquidity, and long term solvency. Limitations: o It does not portray the market value of the company. o It does not portray the liquidity value of the company. o Costs of R&D are not presented in the balance sheet. o The balance sheet does not portray the market value of the entity (number of common stock shares outstanding multiplied by price per share) for a number of reasons. Most assets are not reported at fair value, but instead are measured according to historical cost. Also, there are certain resources, such as trained employees, an experienced management team, and a good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in the balance sheet, will not be representative of the company's market value. Classification of elements within the balance sheet Assets Current assets Investments PP&E Intangible assets Liabilities Current liabilities Long-term liabilities Shareholders' Equity Paid-in capital Retained earnings
Current assets & current liabilities Current assets include cash and other assets that are reasonably expected to be converted to cash or consumed during one year, or within the normal operating cycle of the business if the operating cycle is longer than one year. Current assets: Current Liabilities: Cash and cash equivalents Current maturities of long-term debt Short-term investments Short-term notes payable
Accounts receivable Inventories Prepaid expenses
Accrued liabilities Accounts payable
Cash & cash equivalients Cash includes: 1. Cash on hand and in bank available for use in the operations of the business. 2. Bank drafts 3. Cashier's checks 4. Money orders Cash equivalents include: 1. Commercial papers 2. Money market funds 3. U.S. treasury bills 4. Investments of 3 months or less Cash that is restricted for a special purpose and not available for current operations should not be classified as a current asset. For example, if cash is being saved to repay a debt due in five years, the cash is classified as investments, a noncurrent asset. Current liabilities are those obligations that are expected to be satisfied through the use of current assets or the creation of other current liabilities. So, this classification will include all liabilities that are scheduled to be liquidated within one year or the operating cycle, whichever is longer, except those that management intends to refinance on a long-term basis. Investments in equity securities are classified as current if the company's management (1) intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2) has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold, the investment is classified as noncurrent. Noncurrent assets: Investments +1 year Property, plant, and equipment PP&E Intangible assets Property, plant, and equipment These are tangible, long-lived assets used in the operations of the business. They usually are the primary revenue-generating assets of the business. These assets include land, buildings, equipment, machinery, furniture and other assets used in the operations of the business, as well as natural resources, such as mineral mines, timber tracts and oil wells. Intangible assets Property, plant, and equipment and intangible assets each represent assets that are long-lived and are used in the operations of the business. The difference is that property, plant, and equipment
represent physical assets, while intangible assets lack physical substance. Generally, intangible assets represent the ownership of an exclusive right, such as a patent, copyright or franchise. Other assets Long-term prepaid expenses, or deferred charges are classified as other assets, a noncurrent asset. Shareholders' equity Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained earnings equals net income less dividends paid to shareholders from the inception of the corporation. Retained earnings = Net income dividends paid Financial disclosures Disclosure Notes Disclosure notes provide additional detail concerning specific financial items. statement Included are such data as the fair values of financial instruments and off-balance-sheet risk associated with financial instruments and details of pension plans, leases, debt, and assets. Common to all companies' disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, many notes are designed to fit the disclosure needs of the particular reporting company. In fact, any explanation that helps investors and creditors make decisions should be included. Pension plans Lease Contingency information Long-term debt Investments Income taxes PP&E Employee benefit plans
Summary of significant accounting policies The summary of significant accounting policies provides information on why companies choose to use certain accounting methods over others. For example: Straight line or accelerated depreciation FIFO, LIFO, or average cost Completed contract or percentage of completion method Which securities are considered cash equivalents And the timing of recognizing revenues Subsequent event Is a significant event that occurs after a company's fiscal year but before the financial statements are issued or "available to be issued." Examples include:
Issuance of debt or securities Merger or sale of business Sale of assets Information on loss contingency Events having material effect on operations.
Noteworthy events and transactions Related party transactions o Transactions with owners, management, families, affiliated companies. o The potential problem is that the economic substance may differ from their legal form. o When related-party transactions occur, companies must disclose the nature of the relationship, description of the transaction, and dollar amounts. Errors and irregularities o Errors are unintentional o Irregularities are intentional distortions of financial statements Illegal acts Management discussion and analysis The discussion provides management's views on significant events, trends and uncertainties pertaining to the company's (a) operations, (b) liquidity, and (c) capital resources. Certainly the Management Discussion and Analysis section may be slanted to management's biased perspective and therefore can lack objectivity. However, management can offer an informed insight that might not be available elsewhere, so if the reader maintains awareness of the information's source, it can offer a unique view of the situation. Auditors' report Explanatory paragraphs unqualified opinion Lack of consistency o Due to a change in accounting principle Uncertainty o As to the ultimate resolution of a contingency for which a loss is material in amount but not necessarily probable or probable but not estimable. Emphasis o Of a matter concerning the financial statements that does not affect the existence of an unqualified opinion but relates to a significant event such as a related-party transaction. Main types of opinions
1. Unqualified opinion The auditors are satisfied that the financial statements "present
fairly" the financial position, results of operations, and cash flows and are "prepared in accordance with generally accepted accounting principles."
2. Qualified opinion This contains an exception to the standard unqualified opinion, but
not of sufficient seriousness to invalidate the financial statements as a whole. Examples
of exceptions are (a) unconformity with generally accepted accounting principles, (b) inadequate disclosures, and (c) a limitation or restriction of the scope of the examination.
3. Adverse opinion This is necessary when the exceptions (a) and (b) above are so
serious that a qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report.
4. Disclaimer An auditor will disclaim an opinion if item (c) above applies and therefore
insufficient information has been gathered to express an opinion. Operating Segment Characteristics that define an operating segment: 1. Engages in business activities from which it may earn revenues and incur expenses 2. Operating results are regularly reviewed by the enterprise's chief of operating decision maker to make decisions about resources to be allocated to the segment and assess performance. 3. For which discrete financial information is available. The following disclosures are required for an operating segment: 1. General information 2. Profit, loss, revenues and expenses, segment assets, and the basis of measurement 3. Reconciliations of the revenues, profit or loss, assets 4. Interim period information Working capital and ratios Working capital is the difference between current assets and current liabilities. The current ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio) is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts receivable) by current liabilities. Calculations Assets = liabilities + shareholders' equity Assets = liabilities + Paid-in-Capital + Retained earnings
Retained earnings = Net income dividends paid