Chapter 2A FURTHER LOOK AT FINANCIAL STATMENTS

Identify the Sections of a Classified Balance SheetHelps users see if company has enough assets to pay debtsCan determine the short-term and long-term claims on total assets

Classified Balance Sheet Generally contains the following standard classifications:Current Assets Long-Term InvestmentsProperty, Plant, and EquipmentIntangible AssetsCurrent LiabilitiesLong-Term LiabilitiesStockholders' Equity

Current AssetsAssets that are expected to be converted to cash or used up within one year. Current assets are listed in order of liquidity.Examples:CashShort-term investmentsReceivablesInventoriesSuppliesPrepaid expenses

Long-Term Investments

Investments of stocks and bonds of other corporations which are normally held for many years.Investments in long-term assets such as land or buildings that are not currently being used in the companys operations

Property, Plant, and EquipmentAssets with relatively long useful lives.Assets used in operating the business.Examples:landbuildingsmachinerydelivery equipmentfurniture and fixtures

Depreciation is...Practice of allocating an assets full purchase price to a number of years instead of expensing full cost in year of purchase.

Accumulated Depreciation...Shows the total amount of depreciation that the company has expensed thus far in the assets life.

Assets That A Company Depreciates...Should be shown at cost less accumulated depreciation

Intangible AssetsNon-current assetsHave no physical substanceExamples:patentscopyrightstrademarks or trade namesfranchiseIntangible Assets have value because of the exclusiverights or privileges they give the company.

1. Current assets are listed:A. by liquidityB. by importanceC. by longevityD. alphabetically

Current LiabilitiesObligations that are supposed to be paid within the coming year...accounts payablewages payablebank loans payableinterest payabletaxes payablecurrent maturities of long-term bank loans payable

Long-Term LiabilitiesDebts expected to be paid after one yearExamples bonds payable mortgages payable long-term notes payable lease liabilities and obligations under employee pension plans

Stockholders' EquityCapital stock - investments of assets in the business by the stockholdersRetained earnings - earnings kept for use in the business

Ratio AnalysisExpresses relationship among selected items of financial statement dataRelationship can be expressed in terms ofPercentageRate Proportion

Ratio AnalysisProfitability Ratios - Measures the income or operating success of a company for a given period of time (Is the owner getting a return on his/her investment?)

Ratio AnalysisLiquidity Ratios - Measures short-term ability of company to pay its maturing obligations and meet unexpected needs for cash (Can the company pay its debts?)

Ratio AnalysisSolvency Ratios - Measures the ability of the company to survive over a long period of time

Ratio Analysis Use Multiple Measures!Intracompany comparisons - covering two years of the same company Industry average comparisons - based on average ratios for a particular industryIntercompany comparisons - based on comparisons with a competitor in the same industry

Earnings Per ShareHow does the companys earning performance compare with that of previous years (on a per share basis)?

2. For 2007 X Corp reported net income, $24,000; net sales, $400,000; and average shares outstanding, 6,000. There were no preferred stock dividends. What was the 2007 earnings per share?A. $4.00B. $0.06C. $16.67D. $66.67

Statement of Retained EarningsFrom Chapter 1: The Statement of Retained Earnings describes the changes in the retained earnings for the period . . .

Retained earnings, January 1$ 0Add: Net income 6,800 6,800Less: Dividends 600Retained earnings, Dec. 31 $ 6,200

Statement of Retained EarningsFrom Chapter 1: The Statement of Retained Earnings describes the changes in the retained earnings for the period . . .

Retained earnings, January 1$ 0Add: Net income 6,800 6,800Less: Dividends 600Retained earnings, Dec. 31 $ 6,200

3. The balance in retained earnings is not affected by:A. net incomeB. net lossC. issuance of common stockD dividends

Statement of Stockholders EquityStockholders equity has two parts:Common Stock andRetained Earnings,Thus, The Statement of Stockholders Equity reports ALL CHANGES in the common stock and retained earnings accounts

Statement of Stockholders Equity

Liquidity RatiosMeasure of short-term ability to pay maturing obligations and to meet unexpected needs for cashWorking capital

Current ratio

Working CapitalWorking Capital = Current Assets - Current Liabilities Measure of short-term ability to pay obligationsDifference between current assets and current liabilities

Current RatioMore dependable indicatorDoes not consider composition of current assets

4. Which of these measures is an evaluation of a company's ability to pay current liabilities?A. Earnings per shareB. Current ratioC. Both a) and b)D. None of the above

Solvency RatiosMeasure the ability of a company to survive over a long period of timeMeasures percentage of assets financed by creditors rather than stockholders

5. Which is an indicator of profitability?A. Current ratioB. Earnings per shareC. Debt to total assets ratioD. Free cash flow

Primary Accounting Setting Body in the U.S.FinancialAccountingStandardsBoard

U.S. Government Agency That Oversees Financial MarketsSecuritiesExchangeCommission

GAAP Are the RulesThe FASB makes the rules. The SEC enforces the rules.IASB = International Accounting Standards Board

ReviewWhat organization issues United States accounting standards?

a. Financial Accounting Standards Boardd. Securities and Exchange Committeec. Internal Auditing Standards Committeeb. Internal Accounting Standards Committee

Basic TermsRelevance - information makes a difference in decisionsReliability - information must be free of error and biasComparability - ability to compare information of different companies because they use the same accounting principlesConsistency - use of same accounting principles and methods from year to year within the same company

Characteristics of Useful Information*

Accounting Assumptions

Accounting PrinciplesConstraints In AccountingIllustration 23

Generally accepted accounting principles areA. a set of standards and rules that are recognized as a general guide for financial reportingB. usually established by the Internal Revenue ServiceC. the guidelines used to resolve ethical dilemmasD. fundamental truths derived from laws of nature

StandardSettingCalledGAAPDone byFASBProcess overseen By SECUSEFULNESS ofFinancial information Relevance ReliabilityComparabilityConsistencyAssumptions made and principles followedwhen setting accounting standards Monetary unitEconomic entityTime periodGoing concernCost principleFull disclosureConstraintsMaterialityConservatism

What is the primary criterion by which accounting information can be judged?a. Consistencyd. Comparabilityc. Usefulness for decision makingb. Predictive Value

What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and revenues?a. Comparabilityd. Consistencyc. Conservatismb. Materiality

ReviewSelected financial information for Drummond Company at 12/31/2006:Lets compute current ratio . . .

Sheet1

Cash$60,000

Receivables (net)$80,000

Inventory$70,000

Long-term assets$330,000

Total Assets$540,000

Current Liabilities$140,000

Long-term debt$130,000

Total Liabilities$270,000

Sheet2

Sheet3

Review Compute Current Ratio$210,000$140,000=1.5 : 1

Sheet1

Cash$60,000

Receivables (net)$80,000

Inventory$70,000

Long-term assets$330,000

Total Assets$540,000

Current Liabilities$140,000

Long-term debt$130,000

Total Liabilities$270,000

Sheet2

Sheet3

ReviewSelected financial information for Drummond Company at 12/31/2006:Compute debt to total assets . . .

Sheet1

Cash$60,000

Receivables (net)$80,000

Inventory$70,000

Long-term assets$330,000

Total Assets$540,000

Current Liabilities$140,000

Long-term debt$130,000

Total Liabilities$270,000

Sheet2

Sheet3

Review$270,000 $540,000 = 50%

Sheet1

Cash$60,000

Receivables (net)$80,000

Inventory$70,000

Long-term assets$330,000

Total Assets$540,000

Current Liabilities$140,000

Long-term debt$130,000

Total Liabilities$270,000

Sheet2

Sheet3

2122232424242427281820202031324410