This week its Accounting and Beyond

Morning Session Afternoon Session

Monday Financial Statements/Expenses/Revenues Accounting Cycle & Accounts / Quiz

Tuesday The Balance Sheet The Income Statement / Quiz

Wednesday The Cash Flow Statement Tools & Techniques / Quiz

Thursday Presentations Career Discussion / Open Questions

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The Balance Sheet

Also called the statement of condition or the statement of financial position

Shows the financial condition of a company on a particular date

Summarizes what the firms owns and what the firm owes to outsiders and to internal owners

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Financial Condition

Assets are what the firm owns. Liabilities are what the firm owes to

outsiders. Stockholders’ equity is what the firm owes to

internal owners.

equity rs'Stockholde sLiabilitie Assets

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Financial Condition

Consolidation

Parent company owns more than 50% of voting stock.

Financial statements are combined.

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Financial Condition

Balance Sheet Date

The date the balance sheet is prepared Could be the end of the calendar year, fiscal

year, quarter, etc.

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Financial Condition

Comparative Data

SEC requires two-year audited balance sheets.

Provides a reference point for determining changes in financial position

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Financial Condition

Common-Size Balance Sheet

Expresses each item on the balance sheet as a percentage of total assets

Reveals the composition of assets Form of vertical ratio analysis Useful for evaluating trends within a firm Allows for making industry comparisons

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Financial Condition

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Assets

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Assets

The allowance account for Sage Inc. represents approximately 5% of accounts receivable:

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Assets

Sage Inc.

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Assets

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Assets

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Assets

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Assets

Example – A new company in its first year of operations purchases five products for sale in the order and at the prices shown. The company sells three of these items at the end of the year.

Item Purchase Price

#1 $5

#2 $7

#3 $8

#4 $9

#5 $11

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Assets

Cost flow assumptions

Resulting effect on the income statement and balance sheet

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Assets

Current Assets – Prepaid Expenses Expenses paid in advance

Insurance Rent Property taxes Utilities

Included in current assets if they expire within one year or one operating cycle

Generally not material to the balance sheet

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Assets

Property, Plant, and Equipment (PP&E)

Encompasses a company’s fixed assets Not used up during annual operations Produce economic benefits for more

than one year Have physical substance Shown at book value on the balance

sheet

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Assets

Property, Plant, and Equipment (PP&E)

The relative proportion of fixed assets in a company’s asset structure will largely be determined by the nature of the business.

Manufacturing firms typically have higher percentages of fixed assets than retailers or wholesalers.

Firms with newly purchased assets will have higher percentages of fixed assets than firms with older fixed assets.

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Assets

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Assets

Example – Assume that Sage Inc. purchases an artificial ski mountain for its Phoenix flagship store in order to demonstrate skis and allow prospective customers to test-run skis on a simulated course. The cost of the mountain is $50,000 and is expected to have a five-year useful life and $0 salvage value at the end of that period.

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Assets

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Assets

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Liabilities

Represent claims against assets Current liabilities

Must be satisfied in one year or one operating cycle

Noncurrent liabilities Obligations with maturities beyond one year

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Liabilities

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Liabilities

Current Liabilities – Accrued LiabilitiesExample – Assume that a company has a $100,000 note outstanding with 12% interest due in semiannual installments on March 31 and September 30. For a balance sheet prepared on December 31, interest will be accrued for three months (October, November, and December). The December 31 balance sheet would include an accrued liability of $3,000:

$100,000 x 0.12 = $12,000 annual interest$12,000/12 = $1,000 monthly interest$1,000 x 3 = $3,000 accrued interest for three months

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Liabilities

Deferred Taxes Result of temporary differences in the

recognition of revenue and expense for taxable income relative to reported income

Depreciation methods are the most common source for temporary differences.

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LiabilitiesExample – Assume that a company has a total annual revenue of $500,000, expenses other than depreciation of $250,000, and a depreciation expense of $100,000 for tax accounting and $50,000 for financial reporting. The income for tax reporting purposes would be computed two ways, assuming a 34% tax rate:

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Liabilities

Taxes actually paid ($51,000) are less than the tax expense ($68,000) reported in the financial statements. To reconcile the $17,000 difference between the expense recorded and the cash outflow, there is a deferred tax liability of $17,000:

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Liabilities

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Stockholders’ Equity

Also called shareholders’ equity Residual interest in assets that remains after

deducting liabilities Owners bear greatest risk and benefit from

greatest rewards.

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Stockholders’ Equity

Common Stock Shareholders

do not ordinarily receive a fixed return have voting privileges in proportion to

ownership interest can benefit through price appreciation can suffer through price depreciation

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Stockholders’ Equity

Common Stock• Dividends are declared at the discretion of a

company’s board of directors• Amount listed on the balance sheet is based on

the par or stated value of the shares issued (which bears no relationship to actual market price).

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Stockholders’ Equity

Retained Earnings Sum of every dollar a company has earned

since inception less any payments made to shareholders

Funds a company has elected to reinvest in the operations of the business rather than pay out in stock

Measurement of all undistributed earnings

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Stockholders’ Equity

Retained Earnings Key link between the income

statement and the balance sheet Unless there are unusual transactions

affecting the retained earnings account,

Beginning retained earnings

Net income (loss)

Ending retained earnings

– Dividends =±

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Stockholders’ Equity

Other Equity Accounts Preferred stock Accumulated other comprehensive income

(expense) Treasury Stock Employee benefit trusts Equity attributable to non-controlling

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Stockholders’ Equity

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Quality of Financial Reporting

Economic recession of 2008 and many market gyrations since can be traced directly to overvaluation of balance sheet assets.

When financial reporting does not reflect economic reality quality and usefulness are significantly impaired.

Type of debt used to finance assets, commitments and contingencies, and the classification of leases relate directly to quality of financial reporting.

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Quality of Financial Reporting

“Commitments and Contingencies” disclosure in the notes to financial statements provide important information about off-balance sheet financing and other complex financing arrangements.

Enron is a prime example of a company with enormous activity reported in the “Commitments and Contingencies” disclosure.

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Other Balance Sheet Items

Corporate balance sheets are not limited to the accounts described in this chapter.

The reader of annual reports will encounter additional accounts and will find many of the same accounts listed under different titles.

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Create a Balance Sheet

Using material from Paul’s Guitar Store, work individually to create a balance sheet for year end

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