Chapter 2

A FURTHER LOOK
AT FINANCIAL
STATMENTS
1

1
11

Identify the Sections of a

Classified Balance Sheet

Helps users see if company

has enough assets to pay
debts
Can determine the short-term
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
4

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
5

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
6

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 Assets

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

Intangible Assets have value because of the

exclusive

10

1. Current assets are

listed:

A. by liquidity
B. by importance
C. by longevity
D. alphabetically

11

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
12

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

13

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

14

Ratio Analysis

Expresses relationship among

selected items of financial statement
data
Relationship can be expressed in
terms of
Percentage
Rate
Proportion
15

Ratio Analysis

Profitability 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?)

16

Ratio Analysis

Liquidity Ratios - Measures short-term

ability of company to pay its maturing
obligations and meet unexpected needs
for cash (Can the company pay its debts?)

17

Ratio Analysis

Solvency Ratios - Measures the

ability of the company to survive over

a long period of time

18

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

19

2
11

Earnings Per Share

How does the companys earning
performance compare with that of
previous years (on a per share basis)?
Net income-Preferred stock dividends
EPS=
Average common shares outstanding

Higher value = improved performance

20

2. For 2007 X Corp reported net

income, $24,000; net sales,
$400,000; and average shares
A. $4.00
outstanding, 6,000. There were
B. $0.06
no preferred stock dividends.
C. $16.67
What
was the 2007 earnings per
D. $66.67
share?
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3
11

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
22

3
11

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
23

3. The balance in retained

earnings is not affected
by:

A. net income
B. net loss
C. issuance of common stock
D dividends

24

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

25

4
11

Statement of
Stockholders Equity

26

Liquidity Ratios

Measure of short-term ability to

pay maturing obligations and to
meet unexpected needs for cash
Working capital
Current ratio

27

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

28

Current Ratio
Current Ratio =

Current Assets
Current Liabilities

More dependable indicator

Does not consider composition of current
assets
29

4. Which of these
measures is an evaluation
of a company's ability to
A. Earnings per share
pay
current
liabilities?

B. Current ratio
C. Both a) and b)
D. None of the above

30

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
31

5. Which is an indicator of
profitability?

A. Current ratio
B. Earnings per share
C. Debt to total assets ratio
D. Free cash flow

32

6
11

Primary Accounting
Financial
Setting Body in the
U.S.
Accounting
Standards
Board
33

U.S. Government Agency

That
Oversees Financial
Securities
Markets
Exchange
Commission
34

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
36

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11

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

37

Characteristics of Useful Information

38

Accounting Assumptions

Accounting Principles

Constraints In Accounting

Illustration 23

Generally accepted
accounting principles are

A. a set of standards and rules that

are recognized as a general guide for
financial reporting
B. usually established by the Internal
Revenue Service
C. the guidelines used to resolve
ethical dilemmas
D. fundamental truths derived from
laws of nature

41

Done by
FASB

Standard
Setting

USEFULNESS of
Financial information
Called
GAAP

Relevance

Process overseen
By SEC

Reliability
Comparability
Consistency

Monetary unit
Economic entity
Assumptions made
and principles followed
when setting
accounting standards

Constraints
Time period
Materiality
Going concern

Cost principle

Conservatism
Full disclosure

42

What is the primary criterion by

which accounting information can
be judged?
a. Consistency
b. Predictive Value
c. Usefulness for decision making
d. Comparability
43

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
44

Review

Selected financial information for

Drummond Company at 12/31/2006:
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets

$60,000
$80,000
$70,000
$330,000
$540,000

Current Liabilities
Long-term debt
Total Liabilities

$140,000
$130,000
$270,000

Lets compute current ratio . . .

45

Review
Compute Current Ratio
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets

$60,000
$80,000
$70,000
$330,000
$540,000

Current Liabilities
Long-term debt
Total Liabilities

$140,000
$130,000
$270,000

$210,000

$140,000

=
1.5 : 1
46

Review
Selected financial information for
Drummond Company at 12/31/2006:
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets

$60,000
$80,000
$70,000
$330,000
$540,000

Current Liabilities
Long-term debt
Total Liabilities

$140,000
$130,000
$270,000

Compute debt to total assets . . .

47

Review
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets

$60,000
$80,000
$70,000
$330,000
$540,000

Current Liabilities
Long-term debt
Total Liabilities

$140,000
$130,000
$270,000

$270,000 $540,000 = 50%

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