the balance sheet and the statement of changes in stockholders’ equity c hapter 4 copyright ©...
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The Balance Sheet and the Statement of Changes
in Stockholders’ Equity
Chapter 4
COPYRIGHT © 2010 South-Western/Cengage Learning
Intermediate AccountingIntermediate Accounting 11th edition 11th edition
Nikolai Bazley JonesNikolai Bazley Jones
An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University
FASB Statement of Concepts No. 5FASB Statement of Concepts No. 5
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FASB Statement of Concepts No. 5 recommends that a full set of financial statements for an accounting period should
show a company’s...
FASB Statement of Concepts No. 5
1. Financial position at the end of the period
2. Net income for the period
3. Comprehensive income for the period
4. Cash flows for the period
5. Investments by and distributions to owners for the period
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Basic Accounting Equation
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Assets = Liabilities + Stockholders’ Equity
Economic resources
Economic obligations
Net assets
Liquidity
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The term liquidity is used to describe how quickly an asset can
be converted into cash or a liability
paid.
Financial Flexibility
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Financial flexibility refers to the ability of a company to use its financial resources to adapt to
change.
Operating Capability
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Operating capability refers to the ability of a
company to maintain a given physical level of
operations.
Three-Stage Process for Disclosing Information on the Balance Sheet
1. Identification of what items meet the definition of the elements
2. Measurement (valuation) of the elements
3. Reporting (classification) of the elements
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Elements of the Balance Sheet: Assets
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Assets are probable future economic benefits obtained or controlled by a
company as a result of past transactions or events.
Assets are probable future economic benefits obtained or controlled by a
company as a result of past transactions or events.
Elements of the Balance Sheet: Assets
1. The resource must be able to contribute directly or indirectly to the company’s future net cash inflows.
2. The company must be able to obtain the future benefit and control others’ access to it.
3. The transaction or event giving the company the right to or control over the benefit must have occurred.
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Elements of the Balance Sheet: Liabilities
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Liabilities are probable future sacrifices of economic benefits
arising from present obligations...
Liabilities are probable future sacrifices of economic benefits
arising from present obligations...
Elements of the Balance Sheet: Liabilities
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…of a company to transfer assets or provide services in the future as a
result of past transactions or events.
…of a company to transfer assets or provide services in the future as a
result of past transactions or events.
Elements of the Balance Sheet: Stockholders’ Equity
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Assets = Liabilities + Stockholders’ Equity
Equity is the residual interest in the assets of a
company that remains after deducting its liabilities.
Equity is the residual interest in the assets of a
company that remains after deducting its liabilities.
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Historical cost is the exchange price in the
transaction in which an asset was acquired.
Historical cost is the exchange price in the
transaction in which an asset was acquired.
Fair value is the price that a company would receive to sell
an asset (or transfer a liability) in an
orderly transaction between market
participants on the date of measurement.
Fair value is the price that a company would receive to sell
an asset (or transfer a liability) in an
orderly transaction between market
participants on the date of measurement.
Measurement (Valuation) of the Elements of the Balance Sheet
The present value of an asset is the net amount of
discounted future cash inflows less the discounted future cash outflows relating to the asset.
The present value of an asset is the net amount of
discounted future cash inflows less the discounted future cash outflows relating to the asset.
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Fair Value Measurement
Need Fair ValueNeed Fair Value
Select Highest Appropriate Level of Input for Valuation (Hierarchy of Valuation Methods)
Level 1: Quoted Price for Identical Asset (or Liability) in Active Market
Level 2: Adjusted Quoted Price (Exit Value) for Similar Asset (or Liability)
Level 3: Unobservable Inputs (e.g., Present Value of Expected Cash Flows)
Select Highest Appropriate Level of Input for Valuation (Hierarchy of Valuation Methods)
Level 1: Quoted Price for Identical Asset (or Liability) in Active Market
Level 2: Adjusted Quoted Price (Exit Value) for Similar Asset (or Liability)
Level 3: Unobservable Inputs (e.g., Present Value of Expected Cash Flows)
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Fair Value Measurement
Measure Best Fair ValueMeasure Best Fair Value
Use Valuation Method Consistent with Market Approach (Identical or Comparable
Assets or Liabilities) Income Approach (Present Value) Cost Approach (Replacement Cost)
Use Valuation Method Consistent with Market Approach (Identical or Comparable
Assets or Liabilities) Income Approach (Present Value) Cost Approach (Replacement Cost)
Limitations of the Balance Sheet
The use of historical cost to value assets and liabilities does not help users assess the likely amounts of future cash flows.
“Human resources” such as high-quality management or highly creative employees are not included as assets.
Many of the amounts that a company reports are based on estimates.
In periods of inflation, some amounts listed do not show the “purchasing power” of assets and liabilities.
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Current Assets
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Current assets are cash and other assets that are expected to be converted into cash, sold, or
consumed within one year or the normal operating cycle,
whichever is longer.
Current assets are cash and other assets that are expected to be converted into cash, sold, or
consumed within one year or the normal operating cycle,
whichever is longer.
Operating Cycle
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An operating cycle is the average time taken by a company to spend
cash for inventory,...
An operating cycle is the average time taken by a company to spend
cash for inventory,...
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…process and sell the inventory, and collect the receivables,
converting them back into cash.
…process and sell the inventory, and collect the receivables,
converting them back into cash.
Operating Cycle
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Current Assets
Cash includes cash on hand and readily available in checking
and savings accounts.
Cash includes cash on hand and readily available in checking
and savings accounts.
Cash equivalents are risk-free securities, such as money market funds and treasury bills that
will mature in three months or less from the
date acquired by the holder.
Cash equivalents are risk-free securities, such as money market funds and treasury bills that
will mature in three months or less from the
date acquired by the holder.
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Current Assets
Temporary investments in marketable securities include debt and equity
securities that are classified as “trading securities,”
“available-for-sale securities,” and “held-to-
maturity” securities.
Temporary investments in marketable securities include debt and equity
securities that are classified as “trading securities,”
“available-for-sale securities,” and “held-to-
maturity” securities.
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Receivables include accounts receivable and notes receivable with short-term maturity dates.
They are listed at their estimated collectible amounts (net realizable values).
Receivables include accounts receivable and notes receivable with short-term maturity dates.
They are listed at their estimated collectible amounts (net realizable values).
Inventories include goods held for resale in the normal course of business plus, in the case of a
manufacturing company, raw materials and work in process inventories.
Inventories include goods held for resale in the normal course of business plus, in the case of a
manufacturing company, raw materials and work in process inventories.
Prepaid items such as insurance, rent, office supplies, and taxes will not be converted into cash
but will be consumed.
Prepaid items such as insurance, rent, office supplies, and taxes will not be converted into cash
but will be consumed.
Current Assets
Current Liabilities
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1. Obligations for items are in the operating cycle (accounts payable and salaries payable).
2. Advance collections for the future delivery of goods or performances of service (unearned rent and unearned ticket sales).
3. Other obligations that will be paid within one year or the operating cycle (the estimated liability for short-term product warranties).
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Working Capital
Current Assets
– Current Liabilities
= Working Capital
Long-Term Investments
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Investment items that management expects to hold for more than one year or the
operating cycle, whichever is longer, are classified as long-term (noncurrent)
investments.
Investment items that management expects to hold for more than one year or the
operating cycle, whichever is longer, are classified as long-term (noncurrent)
investments.
Property, Plant, and Equipment
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Property, plant, and equipment includes the tangible assets used in the firm’s operations.
Also called Also called fixed fixed assetsassets
Also called Also called fixed fixed assetsassets
Intangible Assets
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Intangible assets are those noncurrent economic resources that a company uses in its operations but
have no physical existence.
Intangible assets are those noncurrent economic resources that a company uses in its operations but
have no physical existence.
Patents Copyrights Franchises
Intangible Assets
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Intangible assets are those noncurrent economic resources that a company uses in its operations but
have no physical existence.
Intangible assets are those noncurrent economic resources that a company uses in its operations but
have no physical existence.
Trademarks
® a registered trademark
Computer software costs Goodwill
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Other AssetsOther Assets
The Other Assets section occasionally is used to report
miscellaneous assets that may not be readily classified
within one of the previous sections.
The Other Assets section occasionally is used to report
miscellaneous assets that may not be readily classified
within one of the previous sections.
Sometimes referred to as “deferred charges”Sometimes referred to as “deferred charges”
Long-Term Liabilities
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Long-term liabilities are those obligations of a company whose
liquidation is not expected to require the use of current assets or
not expected to create current liabilities within one year or the
normal operating cycle (whichever is longer).
Long-term liabilities are those obligations of a company whose
liquidation is not expected to require the use of current assets or
not expected to create current liabilities within one year or the
normal operating cycle (whichever is longer).
Other Liabilities
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Deferred tax liabilities and obligations of a component of the
company that is being discontinued are examples of
items that might be included as other liabilities.
Deferred tax liabilities and obligations of a component of the
company that is being discontinued are examples of
items that might be included as other liabilities.
Conceptual Guidelines
Reporting assets according to their type or expected function in the central operations or other activities of the company.
Reporting as separate items assets and liabilities that affect the financial flexibility of the company differently.
Reporting assets and liabilities according to the fair value method used to value the items.
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FASB suggested guidelines for developing homogeneous classes of assets and liabilities.
Stockholders’ Equity
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Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation.
Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation.
A sole proprietorship is a single-owner
company.
Stockholders’ Equity
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Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation.
Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation.
A partnership involves two or more persons who have
agreed to combine their capital and efforts in the operations of a company.
Stockholders’ Equity
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Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation.
Stockholders’ equity is the residual interest of the stockholders in the
assets of the corporation. The corporation is a
complex business organization. Usually there is
absentee ownership.
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Stockholders’ Equity
Legal capital is the minimum amount of
stockholders’ equity that the corporation may not distribute as dividends.
Legal capital is the minimum amount of
stockholders’ equity that the corporation may not distribute as dividends.
Preferred stock receives preference
in declared dividends.
Preferred stock receives preference
in declared dividends.
Common stock carries the right to vote
at the annual stockholders’ meeting
and to share in residual profits.
Common stock carries the right to vote
at the annual stockholders’ meeting
and to share in residual profits.
Contributed CapitalContributed CapitalContributed CapitalContributed Capital
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Stockholders’ Equity
Retained earnings is the total amount of corporate net income that has not been
distributed to stockholders as dividends.
Retained earnings is the total amount of corporate net income that has not been
distributed to stockholders as dividends.
Uses of net incomeUses of net incomeTo use in daily operationsTo maintain its productive facilities
For growth
Stockholders’ Equity
1. Unrealized increases (gains) or decreases (losses) in the fair value of investments in available-for-sale securities.
2. Transaction adjustments from converting the financial statements of a company’s foreign operations into U. S. dollars.
3. Certain gains and losses on “derivative” financial instruments.
4. Certain pension plan gains, losses, and prior service cost adjustments.
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Comprehensive income includes both net income and “other comprehensive income.” Accumulated other comprehensive income might include four items:
Comprehensive income includes both net income and “other comprehensive income.” Accumulated other comprehensive income might include four items:
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Stockholders’ Equity
If a corporation has more than one item of other comprehensive income, it may report
the amount of accumulated other comprehensive income for each item in
stockholders’ equity.
If a corporation has more than one item of other comprehensive income, it may report
the amount of accumulated other comprehensive income for each item in
stockholders’ equity.
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Stockholders’ Equity
Or, it may report the total amount of accumulated other comprehensive income for
all the items in stockholders’ equity. This approach requires a note to the statements.
Or, it may report the total amount of accumulated other comprehensive income for
all the items in stockholders’ equity. This approach requires a note to the statements.
Statement of Changes in Stockholders’ Equity
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A corporation must disclose the changes in its stockholders’ equity
account when issuing financial statements.
A corporation must disclose the changes in its stockholders’ equity
account when issuing financial statements.
This statement should show, among other information, investments by and distributions to owners during
the period.
This statement should show, among other information, investments by and distributions to owners during
the period.
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Statement of Changes in Stockholders’ Equity
FASB Statement of Concepts No. 6 defines investments by owners and distributions to owners as follows: Investments by owners are increases in the
equity of a company resulting from transfers of something valuable to the company from other entities to obtain or increase ownership interests.
Distributions to owners are decreases in the equity of a company caused by transferring assets, rendering services, or incurring liabilities to owners.
Summary of Accounting Policies
A selection from existing acceptable alternatives
Principles and methods peculiar to the industry in which the company operates
Unusual or innovative applications of GAAP
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GAAP requires that a company must include a description of all its significant accounting policies as an integral part of its financial
statements.
GAAP requires that a company must include a description of all its significant accounting policies as an integral part of its financial
statements.
In particular, when these principles and methods involve:
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Accounting for Loss Contingencies
Loss
Probable?
Reasonably estimated?
No
No
or
Disclosure
and
Yes
YesReport amount
in financial statements
Reasonably possibleDisclose in notes to the financial
statements
Subsequent Events
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A subsequent event is one that occurs between a company’s balance sheet date and
the date of issuance of the annual report.
A subsequent event is one that occurs between a company’s balance sheet date and
the date of issuance of the annual report.
End of Accounting Period
Annual Report Publication Date
Subsequent Events
SEC Integrated Disclosures
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The Securities and Exchange Commission has the legal authority to prescribe accounting principles and reporting practices for all
regulated companies.
The Securities and Exchange Commission has the legal authority to prescribe accounting principles and reporting practices for all
regulated companies.
A regulated company must file a Form 10-K annual report with the SEC within 60 days of its
fiscal year-end. This report must be filed electronically according to the EDGAR
requirements.
A regulated company must file a Form 10-K annual report with the SEC within 60 days of its
fiscal year-end. This report must be filed electronically according to the EDGAR
requirements.
ContinuedContinuedContinuedContinued
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SEC Integrated Disclosures
The SEC requires comparative balance sheets for two years and comparative income
statements and statements of cash flows for three years.
The SEC requires comparative balance sheets for two years and comparative income
statements and statements of cash flows for three years.
The SEC requires specific disclosures of important accounting information for a five-year
period. These include net sales or operating revenues, income (loss) from continuing
operations and related earnings per share, total assets, long-term obligations and redeemable stock, and cash dividends declared per share.
The SEC requires specific disclosures of important accounting information for a five-year
period. These include net sales or operating revenues, income (loss) from continuing
operations and related earnings per share, total assets, long-term obligations and redeemable stock, and cash dividends declared per share.
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SEC Integrated Disclosures
Management must include a discussion and analysis of the
company’s financial condition, changes in financial condition,
and results of operations.
Management must include a discussion and analysis of the
company’s financial condition, changes in financial condition,
and results of operations.
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SEC Integrated DisclosuresSeveral disclosures must be made about the common stock market prices and dividends:
The principal trading markets for the company’s common stock
The high and low market prices for each quarter in the last two years
The approximate number of shareholders The dividends paid in the last two years Any dividend transactions
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IFRS vs. U.S. GAAP
The financial statements required by the International Accounting Standards Board (IASB) are similar to those in the United States.
Unlike U.S. GAAP, in which a company typically presents either a classified or nonclassified balance sheet, International Financial Reporting Standards (IFRS) do not require a particular format; the appropriate format depends on the type of company.
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IFRS vs. U.S. GAAP
IFRS do require that companies classify assets on the balance sheet as either noncurrent or current.
Noncurrent assets include property, plant, and equipment, as well as other items such as investments, long-term receivables, and intangibles.
Current assets are defined similarly to those under U.S. GAAP.
Typically, noncurrent assets are presented first, followed by current assets.
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IFRS vs. U.S. GAAP
“Capital and reserves,” which includes issued capital (capital stock and additional paid-in capital), reserves, and accumulated profits or losses (retained earnings), is usually listed first.
Reserves may result from upward revaluations of properties and investments, as well as currency translation differences.
Noncurrent liabilities are usually listed next, followed by current liabilities.
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Report FormReport FormReport FormReport Form
Assetsxxxx $xxxxxxx xxxTotal assets $xxx
Liabilities and Stockholders’ Equityxxxx $xxxxxxx xxxTotal liabilities and stockholders’ equity $xxx
Balance Sheet Formats
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Liabilities and Stockholders’ Equityxxxx $xxxxxxx xxxTotal liab. & stock. eq. $xxx
Account FormAccount FormAccount FormAccount Form
Assetsxxxx $xxxxxxx xxxTotal assets $xxx
Balance Sheet Formats
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Chapter 4
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