3 The Balance Sheet and Statement of Changes in Stockholders

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• 3 The Balance Sheet and Statement of Changes in
  Stockholders Equity

Accounting School Zhongnan University of
Economics Law
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
1. Interrelationship of financial statements
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
2. Elements of the Balance Sheet

• An item of information to be recognized as an
  element (i.e. formally recorded and reported in
  the body of the financial statements), an item
  must
• (a) meet the definition of an element as
  specified in FASB Statement of Concepts No. 6
• (b) be measurable
• (c) be relevant, and
• (d) be reliable.

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Assets

Assets Probable future economic benefit obtained
or controlled by a particular entity as a result
of past transactions or events
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Assets

The primary purpose of the balance sheet is to
help forecast the future.
Assets Probable future economic benefit obtained
or controlled by a particular entity as a result
of past transactions or events
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Assets

Substance over form.
Assets Probable future economic benefit obtained
or controlled by a particular entity as a result
of past transactions or events
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Assets

Assets may be natural or man-made, tangible or
intangible, and exchangeable or useful only in
the companys activities.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Liabilities

Obligation includes legal, moral, social, and
implied commitments.
Liability Probable future sacrifice of economical
benefit arising from a present obligation of a
particular entity to transfer assets or provide
services to other entities in the future as a
result of past transactions or events.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Liabilities

An obligation to provide services is a liability.
Liability Probable future sacrifice of economical
benefit arising from a present obligation of a
particular entity to transfer assets or provide
services to other entities in the future as a
result of past transactions or events.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Elements of the Balance Sheet Stockholders
Equity

Asset - Liability Equity
Equity is residual interest in the assets of a
company that remain after deducting liabilities.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
3. Measurement of the elements of the balance
sheet

The FASB has identified five alternative
valuation methods

• Historical cost
• Current cost (or current replacement cost)
• Current market value (or current exit value)
•  Net realizable value (or expected exit value)
• Present value

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
valuation methods

The historical cost of an asset is the exchange
price in the transaction in which the asset was
acquired.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
valuation methods

The current cost of an asset is the amount of
cash (or equivalent) that would be required on
the date of the balance sheet to obtain the same
asset.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
valuation methods

The current market value of an asset is the
amount of cash (or equivalent) that could be
obtained on the date of the balance sheet by
selling the asset in an orderly liquidation.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
valuation methods

The net realizable value of an asset is the
amount of cash (or equivalent) into which the
asset is expected to be converted in the ordinary
operations of the company, less any expected
conversion costs.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
valuation methods

The present value of an asset is the net amount
of future cash inflows into which the asset is
expected to be converted less the present value
of future cash outflows necessary to obtain those
inflows.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
4. Reporting classifications on the balance sheet

How to Classify Items on the Balance Sheet?

• Current (one year or less)
• Noncurrent (more than 1 year or 1 operating
  cycle, whichever is longer)

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Operating Cycle
Cash
Collections
Purchases
Inventories
Receivables
Sales
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Assets

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.

• Cash and cash equivalent
• Temporary investments in marketable securities
• Accounts and notes receivable
• Inventories
• Prepaid items

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Assets

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.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Assets

Temporary investments in marketable securities
include debt and equity securities that are
classified as trading securities and
available-for-sale securities.
Receivables include accounts receivable and notes
receivable with short-term maturity dates. They
are listed at their estimated collectible amounts
(net realizable values).
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Assets

Inventories include goods held for resale in the
normal course of business plus, in the case of a
manufacturing company, raw materials and goods in
process inventories.
Prepaid items include insurance, rent, office
supplies and taxes that will not be converted
into cash but will be consumed.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Measurement of Current Assets

• Cash and receivablesnet realizable value
• Investments in debt and equity securitiesin most
  cases, current market value
• Inventoriescost (FIFO, LIFO,etc.) or
  lower-of-cost-or-market
• Prepaid expenseshistorical cost

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Liabilities

Current liabilities are those obligations whose
liquidation is expected to require the use of
existing current assets, or the creation of other
current liabilities.

• Accounts and notes payable
• Accrued expenses
• Current portion of long-term obligations
• Unearned revenues

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Noncurrent Assets

• Long-term Investments
• Property, plant, and equipment
• Intangible Assets
• Deferred income taxes

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Long-Term 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.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Property, Plant, and Equipment

Property, plant, and equipment are properties of
a tangible and relatively permanent nature that
are used in the normal business operations.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Intangible Assets

Intangible assets are long-term rights and
privileges of a nonphysical nature acquired for
use in business operations.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Other Assets

The Other Assets section occasionally is used to
report miscellaneous assets that may not be
readily classified within one of the previous
sections.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Noncurrent Liabilities

• Long-term liabilities
• Deferred income tax liability
• Pension obligations

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Long-Term Liabilities

Long-term liabilities are those obligations that
are 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).
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
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.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Conceptual Guidelines

FASB suggested guidelines for developing
homogeneous classes of assets and liabilities.

• 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
  measurement method used to value the items.

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Stockholders Equity

Components of Stockholders Equity

• Contributed capital
• Retained earnings
• Accumulated other comprehensive income

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Stockholders Equity

• Contributed Capital
• Capital stock
• Additional paid-in capital

The two types of capital stock are preferred and
common.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Stockholders Equity

• Contributed Capital
• Capital stock
• Additional paid-in capital

Additional paid-in capital is the excess
invested above par or stated value of the capital
stock.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Stockholders Equity

Retained earnings is the amount of undistributed
earnings of past periods.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Stockholders Equity

Comprehensive income includes both net income and
other comprehensive income. Accumulated other
comprehensive income might include four items
1. Unrealized increases (gains) or decreases
(losses) in the market value of investments in
available-for-sale securities. 2. Transaction
adjustments from converting the financial
statements of a companys foreign operations into
U. S. dollars. 3. Certain gains and losses on
derivative financial instruments. 4. Certain
pension liability adjustments.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
5. Limitations of the balance sheet

• Use of historical cost to value assets and
  liabilities does not help assess the likely
  amounts of future cash flows.
• Human resources or intellectual capital, 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, the amounts listed do
  not show the purchasing power of its assets and
  liabilities.

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
6. Statement of changes in stockholders' equity

This statement should show investments by and
distributions to owners during the period, among
other items.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Statement of Changes in Stockholders Equity
SCHEDULE A CARON MANUFACTURING COMPANY
Exhibit 3-8
Statement of Changes in Stockholders Equity For
Year Ended December 31, 2004

Accumulated Common Additional
Other Stock
Paid-in Retained Comprehensive 5
par Capital Earnings Income
Total
Balance, Jan. 1, 2004 65,000 143,400 64,900
10,000 283,300 Unrealized increase in value
of available- for-sale securities 2,000 2,00
0 Net income 62,500 62,500 Cash dividends
paid (11,200 ) (11,200 ) Common stock issued
6,500 30,500 37,000 Balance, Dec. 31,
2004 71,500 173,900 116,200 12,000 373,600
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
7. Other disclosure issues

• Summary of accounting policies
• Fair value and risk of financial instruments
• Contingent liabilities and assets
• Subsequent events
• Related party transactions

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Summary of Accounting Policies
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
APB Opinion No. 22 requires that a company
include a description of all significant
accounting policies as an integral part of its
financial statements.
In particular, when these principles and methods
involve--

• 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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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Derivative Financial Instruments
FASB Statement No. 107 requires a company to
disclose the fair value of all its financial
instruments, whether recognized or not on its
balance sheet. The Statement also requires a
company to disclose all significant
concentrations of credit risk due to its
financial instruments. A company typically makes
these disclosures in the notes to its financial
statements.
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Derivative Financial Instruments
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Fair value is the amount at which the instrument
could be purchased or sold in a current
transaction between willing parties.
FASB Statement No. 133 requires a company to
recognize all derivative financial instruments as
either assets or liabilities on the balance sheet.
These instruments should be measured at fair
value.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Derivative Financial Instruments
FASB Statement No. 133 also requires the
following information

• The type of derivative instruments it holds.
• Its objectives in holding the instruments.
• Its strategies for achieving these objectives.

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Contingent Liabilities and Assets
Loss
Disclosure
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Subsequent Events
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Balance Sheet Date
Date Statements Issued
Financial Statement Period
Subsequent Period
A subsequent event is one that occurs between the
balance sheet date and the date of issuance of
the annual report.
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Subsequent Events
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
A subsequent event is one that occurs between the
balance sheet date and the date of issuance of
the annual report.

• Types of Events
• Those that materially affect one or more
  financial
• statements.
• Those that create a need for a footnote.

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SEC Integrated Disclosures
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
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 90 days of its fiscal
year-end. This report must be filed
electronically according to the EDGAR
requirements.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
SEC Integrated Disclosures
The SEC requires comparative balance sheets for
at least 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.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
SEC Integrated Disclosures
Management must include a discussion and analysis
of the companys financial condition, changes in
financial condition, and results of operations.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
8. Reporting Techniques

• Statement Format
• Combined Amounts
• Rounding
• Notes, Supporting Schedules, and Parenthetical
  Notations

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Balance Sheet Formats
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Most companies use the report form or the account
form format in presenting their balance sheets.
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Balance Sheet Formats
Report Form
Assets xxxx xxx xxxx
xxx Total assets xxx Liabilities and
Stockholders Equity xxxx xxx xxxx xxx Total
liabilities and stockholders eq. xxx
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Balance Sheet Formats
Account Form
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
9. Balance Sheet analysis

Evaluating Liquidity

• Current Ratio current assets divided by current
  liabilities.
• Quick Ratio quick assets divided by current
  liabilities (Acid-Test Ratio).

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Liquidity Ratios Example

• Cash 30
• Net Accounts Receivable 70
• Inventory 100
• Current Assets 200
• Current Liabilities 100

Current Ratio
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Liquidity Ratios Example
Cash 30 Net Accounts Receivable
70 Inventory 100 Current Assets 200 Current
Liabilities 100
Quick Ratio
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Current Ratio
McDonalds 0.5 Microsoft 2.8 Disney 1.2
Coca-Cola 0.7 Yahoo! 5.8
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Overall leverage

• Debt Ratio total liabilities divided by total
  assets.
• Total Assets 400
• Total Liabilities 300

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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Debt Ratio
McDonalds 52.2 Microsoft 25.6
Disney 53.1 Coca-Cola 56.1 Yahoo! 13.8
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Assets mix

• The proportion of total assets in each asset
  category.
• Property, Plant, and Equipment 50
• Total Assets 400

12.5
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
Efficiency

• Asset Turnover is a financial ratio measuring
  how efficiently a company uses its assets to
  generate sales.
• Sales 200
• Total Assets 400

0.50
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Intermediate Accounting 3 The Balance Sheet and
Statement of Changes in Stockholders Equity
The End