Chapter_2 accounting

Chapter_2 accounting - 9/13/11 A Further Look at Financial...

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Unformatted text preview: 9/13/11 A Further Look at Financial Statements Chapter 2 AIS 100 !" General Framework for Viewing Accounting 1. User`s 2. Recognize When are transactions recorded? 3. Measure 4. Impact on Users How are transactions? Basic Accounting Equation Assets Current assets Long-term investments Property, plant, and equipment Intangible assets Liabilities Equity Current liabilities Long-term liabilities Common stock Retained earnings Stockholders’ equity 1 9/13/11 Current Assets !  Assets that a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer. !  Operating cycle is the average time it takes from the purchase of inventory to the collection of cash from customers. Current Assets !  Current assets are generally listed in the order in which they are expected to be converted to cash 2 9/13/11 Long-term Investments !  Investments in stocks and bonds of other companies that are held for more than one year. !  Investments in long-term assets such as land or buildings not currently being used in operating activities. Property, Plant, and Equipment !  Long useful lives !  Currently used in operations !  Depreciation - allocating the cost of assets to a number of years !  Accumulated depreciation - total amount of depreciation expensed thus far in the asset’s life Intangible Assets !  Assets that do not have physical substance 3 9/13/11 Current Liabilities !  Obligations the company is to pay within the coming year !  Usually list notes payable first, followed by accounts payable !  Other items follow in order of magnitude Long-Term Liabilities !  Obligations a company expects to pay after one year Stockholders’ Equity !  Common Stock - investments of assets into the business by the stockholders !  Retained earnings - income retained for use in the business 4 9/13/11 Ratio Analysis !  Is an analysis of the relationship between elements of financial statement data that helps to better understand the economic condition of a company. !  A single ratio by itself is not very meaningful. Thus, we use three various comparisons to shed light upon company’s performance. !  Intracompany comparisons: two year comparisons of the same company !  Industry-average comparisons: average ratios for particular industries !  Intercompany comparisons: comparison with a competitor in the same industry Three Primary Financial Ratio Classifications Using Income Statements !  An income statement reports how successful a company is at generating profit from its sales !  An income statement reports the amount earned (revenue) and the cost incurred (expenses) !  Net income shows us how much we actually earned after sales and paying off our expenses 5 9/13/11 Using Income Statements !  Earnings Per Share (EPS) – is profitability ratio that measures the net income earned on each share of common stock !  In essence it is the earnings available to common stock holders !  By comparing EPS of a single company over time, one can calculate the relative earnings performance from the perspective of a stockholder EPS Calculation Example Review Question !  For 2010 Stoneland Corporation reported net income $26,000; net sales $400,000; and average shares outstanding 6,000. There were preferred stock dividends of $2,000. What was the 2010 earnings per share? a.  $4.00 b.  $0.06 c.  $16.67 d.  $66.67 6 9/13/11 Review Question !  For 2010 Stoneland Corporation reported net income $26,000; net sales $400,000; and average shares outstanding 6,000. There were preferred stock dividends of $2,000. What was the 2010 earnings per share? a.  $4.00 $26,000 b.  $0.06 - $2,000 = $4.00 6,000 c.  $16.67 d.  $66.67 Using Stockholder’s Equity !  Stockholder’s Equity is compromised of Retained Earnings and Common Stock !  It reports all changes in the stockholders equity accounts !  For example: buyback/issue/sell common stock, dividends paid, !  Closely looking at actions of companies such as issuing dividends or buying back stock really shows the mindset’s of the company’s management and their financial position Using A Classified Balance Sheet !  Evaluating the relationship between various assets and liabilities can help one learn a lot about the company’s financial health especially about the company’s Liquidity and Solvency !  Liquidity: the company’s ability to pay obligations expected to become due within the next year or operating cycle !  Solvency: the company’s ability to pay interest as it comes due and to repay the balance of debt due at its maturity compare it to other companies liquidity- the companys ability to turn an asset into cash to pay an obligation, a company needs cash- if it is more liquid you can turn it into cash easier solvency- a measure that looks at a company going forward, will a company go back on their debt 7 9/13/11 Liquidity Ratios !  Working Capital: the difference between the amounts of current assets and current liabilities !  A positive working capital means there is a greater likelihood the company will bay its liabilities working capital- a greater liklihood that a company will be able to pay their liabilities working capital = current assets current liabilities !  A negative working capital means a company might not be able to pay its short term debt and thus might be forced into bankruptcy Liquidity Ratios !  Current Ratio: Current assets divided by current liabilities !  The higher the current ratio, the more capable the company is of paying its obligations !  The ratio as shown in the illustration means that in 2009 for every $1 of current liabilities, the company has 97¢ of current assets !  However, compared to industry avg. this company’s liquidity is quite low Solvency Ratios !  Debt to total assets ratio: measures the % of total financing provided by creditors rather than stockholders !  Since debt financing is more riskier than equity financing, the higher the % of debt, the riskier the company current assets- higher current ratiohigher company is of paying its future obligations Best Buy's current ratio below oneimplies that they have taken out a lot of loans- current liabilites greater than current assets..will they be able to pay their current liablities? debt to total assets ratio- of your total assets ,how many are financed by your liabilities? Best Buy- debt to total assets ratio is significantly higher meaning that they have more liabilities than they do !  The ratio as show in illustration means that in 2009 every dollar of asset was financed by 71¢ of debt. 8 9/13/11 Review Question correct answer is D- because you cannot compare earnings per share between the two The following ratios are available for Leer Inc. and Stable Inc. Compared to Stable Inc., Leer Inc. has: a.  higher liquidity, higher solvency, and higher profitability. b.  lower liquidity, higher solvency, and higher profitability. c.  higher liquidity, lower solvency, and higher profitability. d.  higher liquidity and lower solvency, but profitability cannot be compared based on information provided. Review Question The following ratios are available for Leer Inc. and Stable Inc. Compared to Stable Inc., Leer Inc. has: a.  higher liquidity, higher solvency, and higher profitability. b.  lower liquidity, higher solvency, and higher profitability. c.  higher liquidity, lower solvency, and higher profitability. d.  higher liquidity and lower solvency, but profitability cannot be compared based on information provided. The Standard Setting Environment !  Generally accepted accounting principles (GAAP) are a set of standards and rules for reporting financial information set by the Accounting Standards Board. !  Securities & Exchange Commission (SEC): The agency of the U.S. government that oversees the financial markets and accounting standard setting bodies. !  Financial Accounting Standards Board (FASB): Primary standard setting bodies in the United States. !  International Accounting Standards Board (IASB): The international equivalent of FASB. !  International Financial Reporting Standard (IFRS): Set of standards and rules adopted by most international countries for reporting financial information by public companies. FASB and IASB have been continuously working together to minimize the differences in their standards. A convergence process is under way. !  Public Company Accounting Oversight Board (PCAOB): Was created as a result of SOX to determine auditing standards and to review the performance of audit firms. FASB- a private body SEC- enforces rules set by FASB IASB- international counterpart to FASB IASB write the IFRS IFRS is similar to GAAP- adopted by most countries across the world PCAOB- created as the result of the SOX- determines auditing standards 9 9/13/11 Review Questions A!!!!!!! Generally accepted accounting principles are: a.  a set of standards and rules that are recognized as a general guide for financial reporting. b.  usually established by the Internal Revenue Service. c.  the guidelines used to resolve ethical dilemmas. d.  fundamental truths that can be derived from the laws of nature. Review Questions Generally accepted accounting principles are: a.  a set of standards and rules that are recognized as a general guide for financial reporting. b.  usually established by the Internal Revenue Service. c.  the guidelines used to resolve ethical dilemmas. d.  fundamental truths that can be derived from the laws of nature. Qualities of Useful Information relevance- looking for information that is relevant to their financial ability faithful representation (reliability)- !  The primary objective of financial reporting is to provide financial information that is useful to investors and creditors for making decisions about providing capital. !  Relevance: Accounting information is considered relevant if it makes a difference in a business decision by: 1. by helping provide accurate expectations about the future 2. by confirming and correcting prior expectations !  Faithful Representation: Means that information accurately depicts what really happened by: 1. Ensuring that nothing important has been omitted 2. Making sure that the information is not biased towards one position or another. 10 9/13/11 Enhancing Qualities !  Apart from relevance and faithful representation FASB and IASB have also described a number of other qualities for enhancing financial reporting information. !  Comparability: Is when different companies use the same accounting principles allowing investors to compare them. !  Consistency: Is when a company uses the same accounting principles and methods from year to year. !  Verifiability: Is when financial information users are able to prove that the information is free from error. !  Timeliness: Is when financial information is available to it’s users before it looses its capacity to influence their decisions. !  aim of financil reporting is to gain comparability verifiability timliness- inverstors want the information as soon as they can get it Understandability: Is when financial information is presented in a clear and concise fashion so that reasonably informed users can interpret and comprehend the meaning of the information provided. Assumptions in Financial Reporting Economic Entity States that every economic entity can be separately identified and accounted for. Monetary Unit Periodicity Requires that only those things that can be expressed in money are included in the accounting records. States that the life of a business can be divided into artificial time periods. Assumptions in Financial Reporting Going Concern The business will remain in operation for the foreseeable future. three main assumptions: monetary unit- can only be in the financial statements if according to the monetary unit economic entity- only reporting your own companies separate entities periodicity- the life of a business can be divided into artifical time periods (quarterly and annual) going concern- if we werent to assume that the business would be around in the future, we would list them at their liquidation value accrual basis- Accrual-Basis Transactions are recorded in the periods in which the events occur. 11 9/13/11 Principles in Financial Reporting Or historical cost principle, dictates that companies record assets at their cost. Indicates that assets and liabilities should be reported at fair value (the price received to sell an asset or settle a liability). Requires that companies disclose all circumstances and events that would make a difference to financial statement users. memorize vocab words and understand concepts cost and fair value dont usually agree with eachother we will be discussing different assests that are listed at cost and at fair value full disclosure- goes along with transperency materiality- so if something is immaterial it is small enough not to effect the creditor cost constraint- Constraints in Financial Reporting !  Materiality Constraint - an item is material when its size makes it likely to influence the decision of an investor or creditor !  Cost Constraint - Accounting standard-setters weigh the cost that companies will incur to provide the information against the benefit that financial statement users will gain Applying Framework to Inventory 1. Users 2. Recognize 3. Measure 4. Impact on Users When is inventory recognized on the balance sheet? How is inventory measured on the balance sheet? Example of alternative ways to recognize inventory: •  When company controls the asset •  Transfer of legal ownership •  When cash is paid Example of alternative ways to measure inventory: •  Historical Cost ! More Faithful representation •  Fair value ! More Relevant More details relating to how the recognition and measurement of inventory meets some of the assumptions, principles and constraints will be discussed in Chapter 6. 12 9/13/11 Applying Framework to Property, Plant, and Equipment 1. Users 2. Recognize 3. Measure 4. Impact on Users When are plant assets recognized on the balance sheet? How are plant assets measured on the balance sheet? Example of alternative ways to recognize plan assets: •  When company controls the asset •  Transfer of legal ownership •  When cash is paid Example of alternative ways to Measure plant assets: •  Historical Cost ! More Faithful Representation •  Acquisition Cost # Cost Principle •  Depreciation # Matching Principle •  Fair value ! More Relevant More details relating to how the recognition and measurement of plant assets meets some of the assumptions, principles and constraints will be discussed in Chapter 9. Use of Framework in Standard Setting Environment Recognize & Measure Assumptions, Principles, and Constraints in Financial Reporting Qualities of Useful Information 13 ...
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