5-1 copyright 2004 the mcgraw-hill companies, inc. permission required for reproduction or display....
TRANSCRIPT
5-1
Copyright 2004 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
PowerPoint Presentation Materials
For
Financial Accounting:
A New Perspective
by
Dr. Joseph Otto
CHAPTER 5
Using the Balance Sheet to Make Decisions
5-3
CLASSIFIED BALANCE SHEET
Classifies assets, liabilities into current and noncurrent categoriesCurrent categoriesAccounts expected to be
Turned into cashSoldExchangedDischarged
Within one year
5-4
CMUBalance Sheet
12/31Assets
Current assets
Investments
Property, plant,
Equipment
$56,300
2,000
16,700
Liabilities
Current
Noncurrent
Owner’s Equity
$9,000
4,000
61,900
Total assets $75,000
Total liabilities & Equity $75,000
5-5
WHY DISTINGUISH BETWEEN CURRENT, NONCURRENT?
To allocate resources to meet needs
Timing influences decisions
5-6
HOW TO DISTINGUISH BETWEEN CURRENT, NONCURRENT
Operating cycle
Related to current assets, liabilitiesAverage length of time it takes to move
through 3 phasesPurchasingSellingCollecting
5-7
CURRENT ASSETS
Current assets areCashNoncash assets that will be
Converted into cashSoldConsumed
Within 1 year or operating cycle, whichever is longer
5-8
LIQUIDITY
Measure of availability of cashHow quickly noncash assets can be
turned into cash
Sign of financial health
5-9
CURRENT LIABILITIES
Current liabilities areObligations that will be eliminated
within one year or operating cycle of business
Paid byCurrent assetsCreating other current liabilities
5-10
USING BALANCE SHEET RATIOS
RatiosShow percentage relationship
between 2 numbersSummarize informationEasily understood, interpreted,
compared
Example: Return on equityMeasures performance
5-11
HOW TO USE LIQUIDITY RATIOS
Help determine solvencyAbility to meet obligations that
come due in current period
Working capitalCurrent assets – Current liabilitiesLimitation: measures absolute
ability to meet debts
5-12
LIQUIDITY RATIOS
Current ratio
Acid test (Quick) ratio
Bank ratios
5-13
CURRENT RATIO
Measures relative ability to meet maturing current debts (solvency)
High ratio desirable
Current Asset
Current Liabilities
5-14
ACID TEST RATIO
Measures relative ability to meet maturing current debts (solvency)
High ratio desirable
Current assets – (Inventories + prepaid Assets)
Current Liabilities
5-15
BANK RATIOSApproving Susan’s Loan
Banker’s measure of loan risk
To protect lenderLoan to valueLoan to liquidation value
5-16
LOAN TO VALUE
Lower is better
Maximum Loan Liability
Market value of collateral
5-17
LOAN TO LIQUIDATION VALUE
Lower is better
Maximum Loan Liability
Liquidation Value of Asset
5-18
LEVERAGE RATIOS
Evaluate financial riskDebt to Assets RatioDebt to Equity Ratio
5-19
DEBT TO ASSETS RATIO
Indicates long-run solvency of business
Describes relative amount of financial risk
Total Liabilities
Total Assets
5-20
DEBT TO EQUITY RATIO
Indicates long-run solvency of business
Describes relative amount of financial risk
Total Liabilities
Total Owners’ Equity
5-21
Discussions of Liquidity, Leverage
Contained in Annual ReportManagement’s Discussion &
Analysis (MD&A)Provides liquidity, leverage ratiosProvides discussion/interpretation of
ratios
Example: Merck
5-22
USING INFORMATION TO MAKE DECISIONS: MD&A
Outside balance sheet
Management’s Discussion and Analysis of Operations (MD&A)Relates to balance sheetLiquidity and Capital Resources
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USING INFORMATION TO MAKE DECISIONS:
Information that documents, supports, elaborates on specific items
Summary of significant accounting policiesEssential accounting principles of
business
Other notesDetail for balance sheet accounts
5-24
USING INFORMATION TO MAKE DECISIONS:
CommitmentsExecutory contractExample: noncancelable lease
arrangements
ContingencyMay never materializePotential future obligation
5-25
Executory Contract
Promise to perform duties in future
Commitment
No current liability
Definition: liabilityProbably future sacrifices of economic
benefits arising from present obligations
5-26
HOW ARE ASSETS MEASURED?
Entry prices Historical cost Current cost
Exit prices Fair market value (FMV) Present value of future cash flows
5-27
When are Valuation Methods Equivalent?
At point of exchange when recordedHistorical costs = current cost = fair
market value (FMV) = present value of future cash flows
Valuation methods differ when reported
5-28
ASSET VALUATION
Personal balance sheetEstimated current value or fair market
value (FMV)
Business balance sheetFollows GAAP
5-29
ASSET VALUATION:Current Assets
Asset
Category
Account Measurement
Current Cash
Marketable Sec.
A/R
Inventory
Monetary
FMV or cost
FMV less
allowance
LCM
5-30
ASSET VALUATION:Investments
Asset
Category
Account Measurement
Investments Equity
Bonds
Long term
Notes
Receivables
FMV
Present value of future cash
flows
5-31
ASSET VALUATION:Property, Plant, Equipment
Asset
Category
Account Measurement
Property, Plant, Equipment
Buildings, Equipment, etc.
Cost less Accumulated Depreciation
5-32
ASSET VALUATION:Intangible Assets
Asset
Category
Account Measurement
Intangibles Patents, Goodwill, etc
Cost less Amortization
5-33
KEY QUALITATIVE CHARACTERISTICS
Characteristics of accounting informationRelevance
Makes a difference in a decisionReliability
Degree of confidence in informationVerifiability
Traceable
5-34
Limitations of Balance Sheet
Not all obligations reported in liabilitiesAsset valuation not always current market valueQualitative information incompleteMoney measurement assumes stable dollar; no inflationHuman resources not reported, valued
5-35
Assign #11read chapter 6, pg. 251-252, Questions 2, 8, 11, 15, 16
Assign #12pg. 252-258, Reinforcement Exercises 3, 5, 7, 12, 18, pg. 259-265, Critical Thinking Problems 1, 7, 14, 17, 19
Assign #4CCustom Computer transmittals and SC.