Tools for Business Decision Making, 4th Ed.

Kimmel, Weygandt, Kieso

Financial Accounting:

CHAPTER 2
Prepared by

Ellen L. Sweatt Georgia Perimeter College

Chapter 2

A FURTHER LOOK AT FINANCIAL STATMENTS

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A Further Look at Financial Statements

Chapter 2

Identify the sections of a classified balance sheet. Identify and compute ratios for analyzing a company's profitability. Explain the relationship between a retained earnings statement and a statement of stockholders' equity. Identify and compute ratios for analyzing a company's liquidity and solvency using a balance sheet.
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A Further Look at Financial Statements

Chapter 2

Explain the meaning of generally accepted accounting principles. Discuss financial reporting concepts.

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Identify the Sections of a Classified Balance Sheet

Helps users see if company has enough assets to pay debts Can determine the shortterm and long-term claims on total assets

Classified Balance Sheet

Generally contains the following standard classifications:

Current Assets Long-Term Investments Property, Plant, and Equipment Intangible Assets Current Liabilities Long-Term Liabilities Stockholders' Equity

Current Assets

Assets that are expected to be converted to cash or used up within one year. Current assets are listed in order of liquidity. Examples: Cash Short-term investments Receivables Inventories Supplies Prepaid expenses
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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 Equipment

Assets with relatively long useful lives. Assets used in operating the business. Examples: land buildings machinery delivery equipment furniture and fixtures 9

Depreciation is...

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

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Accumulated Depreciation...

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

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Assets That A Company Depreciates...

Should be shown at cost less accumulated depreciation

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Intangible Assets

Non-current assets Have no physical substance Examples: patents copyrights trademarks or trade names franchise

Intangible Assets have value because of the exclusive 13 rights or privileges they give the company.

Current Liabilities
Obligations that are supposed to be paid within the coming year...

accounts payable wages payable bank loans payable interest payable taxes payable current maturities of long-term bank loans payable

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Long-Term Liabilities
Debts expected to be paid after one year
Examples bonds payable mortgages payable long-term notes payable lease liabilities and obligations under employee pension plans
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Stockholders' Equity

Capital stock - investments of assets in the business by the stockholders Retained earnings - earnings kept for use in the business

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Ratio Analysis

Expresses relationship among selected items of financial statement data Relationship can be expressed in terms of Percentage Rate Proportion
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Ratio Analysis

Profitability Ratios - Measures the

income or operating success of a company for a given period of time

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Ratio Analysis

Liquidity Ratios - Measures short-term

ability of company to pay its maturing obligations and meet unexpected needs for cash

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Ratio Analysis

Solvency Ratios - Measures the ability

of the company to survive over a long period of time

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Ratio Analysis Use Multiple Measures!

Intracompany comparisons - covering two years of the same company Industry average comparisons - based on average ratios for a particular industry Intercompany comparisons - based on comparisons with a competitor in the same industry
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Earnings Per Share

How does the companys earning performance compare with that of previous years (on a per share basis)?
EPS=

Net income-Preferred stock dividends Average common shares outstanding

Higher value = improved performance

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Review
For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no preferred stock dividends. What was 2005 earnings per share?
a. $4.00 b. $ .06 c. $16.67 d. $66.67
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Review
For 2005 Stoneland Corporation reported net income $24,000; net sales $400,000; and average shares outstanding 6,000. There were no preferred stock dividends. What was 2005 earnings per share?
a. $4.00 b. $ .06 c. $16.67 d. $66.67
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Statement of Retained Earnings

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

Retained earnings, January 1 Add: Net income Less: Dividends Retained earnings, Dec. 31

0 6,800 6,800 600 $ 6,200

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Statement of Retained Earnings

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

Retained earnings, January 1 Add: Net income Less: Dividends Retained earnings, Dec. 31

0 6,800 6,800 600 $ 6,200

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Statement of Stockholders Equity

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

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Liquidity Ratios

Measure of short-term ability to pay maturing obligations and to meet unexpected needs for cash
Working capital

Current ratio

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

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Current Ratio
Current Ratio =

Current Assets Current Liabilities

More dependable indicator

Does not consider composition of current assets

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Solvency Ratios

Measure the ability of a company to survive over a long period of time

Debt to Total Asset Ratio = Total Debts Total Assets Measures percentage of assets financed by creditors rather than stockholders
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Review Statement of Cash Flows

Provides information about sources and uses of cash, organized as:

Operating Activities Investing Activities Financing Activities

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Free Cash Flow

Free Cash Flow
Cash Provided _ Capital By Operations Expenditures

Cash Dividends

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Primary Accounting Setting Body in the U.S. Financial Accounting Standards Board

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U.S. Government Agency That Oversees Financial Markets Securities Exchange Commission

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

Review
What organization issues United States accounting standards? a. Financial Accounting Standards Board b. Internal Accounting Standards Committee

c. Internal Auditing Standards Committee

d. Securities and Exchange Committee
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Review
What organization issues United States accounting standards? a. Financial Accounting Standards Board b. Internal Accounting Standards Committee

c. Internal Auditing Standards Committee

d. Securities and Exchange Committee
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Basic Terms

Relevance - information makes a difference in decisions Reliability - information must be free of error and bias Comparability - ability to compare information of different companies because they use the same accounting principles Consistency - use of same accounting principles and methods from year to year within the same company

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Characteristics of Useful Information

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Accounting Assumptions

Accounting Principles

Constraints In Accounting

Illustration 23

Review
What is the primary criterion by which accounting information can be judged?
a. Consistency

b. Predictive Value c. Usefulness for decision making

d. Comparability
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Review
What is the primary criterion by which accounting information can be judged?
a. Consistency

b. Predictive Value c. Usefulness for decision making

d. Comparability
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Review
What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and revenues? a. Comparability b. Materiality c. Conservatism d. Consistency
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Review
What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and revenues? a. Comparability b. Materiality c. Conservatism d. Consistency
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Review
Which is not an indicator of profitability? a. Current ratio b. Earnings per share c. Net income

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Review
Which is not an indicator of profitability? a. Current ratio b. Earnings per share c. Net income

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Review
The balance in retained earnings is not affected by: a. Net income.
b.Issuance of common stock. c. Dividends. d.Net Loss.
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Review
The balance in retained earnings is not affected by: a. Net income.
b.Issuance of common stock. c. Dividends. d.Net Loss.
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Review
Selected financial information for Drummond Company at 12/31/2006:
Cash Receivables (net) Inventory Long-term assets Total Assets Current Liabilities Long-term debt Total Liabilities $60,000 $80,000 $70,000 $330,000 $540,000 $140,000 $130,000 $270,000

Lets compute current ratio . . .

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Review Compute Current Ratio

Cash Receivables (net) Inventory Long-term assets Total Assets Current Liabilities Long-term debt Total Liabilities $60,000 $80,000 $70,000 $330,000 $540,000 $140,000 $130,000 $270,000

$210,000

$140,000

=
1.5 : 1
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Review
Selected financial information for Drummond Company at 12/31/2006:
Cash Receivables (net) Inventory Long-term assets Total Assets Current Liabilities Long-term debt Total Liabilities $60,000 $80,000 $70,000 $330,000 $540,000 $140,000 $130,000 $270,000

Compute debt to total assets . . .

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Review
Cash Receivables (net) Inventory Long-term assets Total Assets Current Liabilities Long-term debt Total Liabilities $60,000 $80,000 $70,000 $330,000 $540,000 $140,000 $130,000 $270,000

$270,000 $540,000 = 50%

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