Chapter 4 The Balance Sheet and the Statement of Shareholders Equity 2013 Cengage Learning All Rights Reserved May not be scanned copied or duplicated or posted to a publicly accessible website in whole or in part ID: 400500
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Intermediate Accounting
Chapter 4 The Balance Sheet and the Statement of Shareholders’ Equity
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Intermediate
AccountingSlide2
What is the Purpose of the Balance Sheet?
The FASB and the IASB have established the balance sheet as the cornerstone of financial reporting because it reports the accounting equation, representing the financial position of the company:Assets = Liabilities + Shareholders’ EquityThe balance sheet reports the financial position from two perspectives:Specific resources the company controlsClaims on the company by the persons or entities that provided the resources, including the creditors and lenders (liabilities) and investors (shareholders’ equity)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide3
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Articulation of Financial StatementsSlide4
To provide relevant and faithfully represented information about assets, liabilities, and shareholders’ equity, the company must determine what, how, and where to report the elements of the balance sheet. Step 1.
What: Identify the elements that must be recognized.Step 2. How: Measure (value) the elements.Step 3. Where: Report (classify) the elements.Recognition is the process of formally recording and reporting an element in the financial statements. In order to meet the definition of a balance sheet element, an item must be measurable, relevant and faithfully represented.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Recognition on the Balance SheetSlide5
Assets are the economic resources used to carry out a company’s business activities.
An economic resource must possess all of the following characteristics to be considered an asset:Probable Future Economic Benefit: The resource must be expected to contribute future economic benefits either directly or indirectly to the company.Control: The company must be able to obtain the future benefit and control others’ access to it. Control means that the company can deny or regulate the ability of others to use the asset.Acquisition: The transaction or event giving the company the right to or control over the benefit must have occurred.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
AssetsSlide6
Liabilities are the probable future sacrifices of economic benefits arising from a company’s present obligations to transfer assets or provide services in the future to other entities as a result of past transactions or events.
A company’s obligation must have all of the following characteristics to be recognized as a liability:Transfer: It must involve a responsibility that will be settled by a sacrifice involving the transfer of assets, provision of services, or other use of assets at a specified or determinable date, on occurrence of a specified event, or on demand.Obligation: The responsibility must obligate the company so that it has little or no discretion to avoid the future sacrifice.Incurred: The transaction, event, or arrangement obligating the company must have occurred.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
LiabilitiesSlide7
Equity is the residual interest in the assets of a company after deducting its liabilities.
Balance sheets separate total shareholders’ equity into three general categories:Contributed capital accounts—amounts invested by shareholders for an ownership interest in a companyEarned capital accounts—retained earningsNoncontrolling interests—equity capital amounts invested by minority shareholders in consolidated subsidiaries© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Shareholders’ EquitySlide8
Mixed attribute measurement modelMeasurement models that reflect
historical values includeHistorical cost or acquisition cost (assets) and historical proceedsOriginally incurred obligation amounts (liabilities)Allocated historical amounts (for assets and liabilities allocated over time)Initial present value (assets) and adjusted present value (liabilities)Measurement models that reflect current values or a combination of historical and current values includeFair value (assets and liabilities)
Current replacement cost (assets)Net realizable value (assets)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Are Elements of
a Balance Sheet Measured?Slide9
Assets
Current assets, Long-term investments, Property, plant, and equipment, Intangible assets and Other assetsLiabilitiesCurrent liabilities, Long-term liabilities and Other liabilitiesShareholders’ EquityContributed capital, Common stock, Additional paid-in capital, Retained earnings and Accumulated other comprehensive income© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
How Are Items Classified and Reported on the Balance Sheet?Slide10
Current assets are cash and other assets that a company expects to convert into cash, sell, or consume within one year or the normal
operating cycle, whichever is longer. An operating cycle is the average length of time taken by a company to convert operational cash expenditures into operational cash receipts.Presented in order of liquidity.© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Current AssetsSlide11
Types of Current Assets
Cash (cash on hand and readily available in checking and savings accounts) and cash equivalents (highly-liquid, low-risk securities)Short term investments including investments in marketable securities (debt, trading securities, available-for-sale securities, held-to-maturity securities that will mature within a year)Receivables (accounts receivable, notes receivable with short-term maturity dates)
Inventories (goods held for resale, raw materials, work in process inventories)Other Current Assets (prepaid items that will be consumed instead of converted into cash)
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide12
Current liabilities are obligations that the company expects to settle or satisfy within one year or the normal operating cycle, whichever is longer.
Companies commonly report the following types of current liabilities: payable and accrued expenses, deferred revenues (unearned revenues), short-term debt and current maturities of long-term debt
.© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Current LiabilitiesSlide13
Types of Current Liabilities
Payables and accrued expenses obligations for items (goods or services) that have been received but not yet paidDeferred revenues (unearned revenues) obligations from advance payments from customers for the future delivery of goods or services
Short-term debt and Current maturities of long-term debt short-term financing instruments that will be paid within one year or the operating cycle and the portions of long- term financing instruments that mature during the next period
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide14
If a company expects to hold the investment for more than one year or the operating cycle, whichever is longer, it is classified as a long-term investment,
or noncurrent investment. Reasons that companies invest Primary objective is to increase shareholder valueAppreciation of the market value of the investmentIncome from interest or dividendsExercising control over other companiesSaving cash for specific future purposes
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Long-Term InvestmentsSlide15
The property, plant, and equipment section of a company’s balance sheet includes the long-lived tangible assets used in its operations.
The depreciable costs of all the fixed assets are allocated to expense over the expected service life of the asset, except for construction in progress (which will become depreciable once it is completed and put into service) and land. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Property, Plant and EquipmentSlide16
Intangible assets are noncurrent economic resources that have no physical or financial nature.
They generally derive their value from the legal, intellectual, and intangible benefits they convey to the company. Intangible resources are normally recognized as assets only when they have been acquired by a company in an external transaction. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Intangible Assets (Slide 1 of 2)Slide17
The following three categories of intangible assets that have been acquired in external market transactions:Intangible assets with finite useful lives
are amortized over their useful lives and reported on the balance sheet at their adjusted historical cost.Intangible assets with indefinite useful lives are not amortized but are reviewed for impairment annually.Goodwill represents the purchase premium paid when one company acquires another company and is reviewed for impairment annually. © 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Intangible Assets (Slide 2 of 2)Slide18
Other assets include miscellaneous assets that do not fit in one of the previous categories
Examples include long-term prepayments (such as for rent, insurance, or licenses), deferred tax assets (net), assets of a component of the company that is being discontinued, advances to officers, security deposits paid by the company, and assets temporarily restricted by foreign countries.© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Other AssetsSlide19
Long-Term LiabilitiesLong-term liabilities
(noncurrent liabilities) obligations that are not expected to settle within one year or the normal operating cycle (whichever is longer)Most are reported at their present value, unless the company elects the fair value option.Interest rates, maturity values, and other provisions are disclosed parenthetically on the balance sheet or in the notes to the financial statements© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide20
Types of Long-Term Liabilities
Long-term accruals include obligations that may be outstanding for many years including obligations for pension and other post-employment benefits, estimated liabilities from long-term warranties, and deferred tax liabilities.Long-term financing instruments formal borrowings to finance the assets and operations of the company including long-term notes payable, capital lease obligations, mortgages payable and bonds payableOther liabilities miscellaneous liabilities that do not fit into one of the previous categories
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide21
Shareholders’ EquityShareholders’ equity
is the residual interest of the shareholders in the assets of the corporation, after deducting the liabilities Shareholders’ rights are defined by the laws of the state granting the corporate charter Consists of two components: contributed capital and earned capitalA third component can arise when equity capital is invested by noncontrolling interests© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide22
Contributed CapitalContributed capital
is recognized when a shareholder acquires shares directly from the corporationCan involve as many as four or more componentsCommon stockAdditional paid-in capitalTreasury stock (debit balance)Preferred stock (different ownership rights from common stock)© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide23
Earned CapitalEarned capital
consists of retained earnings and accumulated other comprehensive incomeRetained earnings is the total amount of corporate net income that has been earned but not been distributed to shareholders as dividendsDeficit arises when cumulative net losses and/or dividends exceed cumulative net incomeAccumulated Other Comprehensive Income (Loss) is the cumulative amount of other comprehensive income (or loss)Noncontrolling
interests arise when a parent company consolidates a less than 100% owned subsidiary company’s financial statements with its own financial statements© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide24
What is the Statement of Shareholders’ Equity?Financial statements must include a disclosure of the ending balances and the changes in its shareholders’ equity accounts
The SEC requires a separate financial statement for publicly traded companies, but smaller companies and private companies may report it in a supporting schedule or a note to the financial statements© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide25
Additional Balance Sheet DisclosuresNot all the relevant financial information about a company’s financial position and activities are in the body of the financial statements
Many issues may instead be disclosed in accompanying notes to the financial statementsSummary of accounting policiesFair value and risk of financial instrumentsLoss and gain contingencies© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide26
Summary of Accounting PoliciesUsually the first financial statement note
Informs external users about the company’s accounting policies, practices, and methodsIncludes principles relating to revenue recognition and asset allocation, particularly when these principles and methods arechoices from existing acceptable alternativespeculiar to the industry in which the company operatesunusual or innovative applications of GAAP© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide27
Fair Value and Risk of Financial InstrumentsFinancial instruments include items such as stocks, bonds, and notes payable and receivable as well as more exotic instruments
U.S. GAAP requires disclosure in the notes the fair values of all financial instruments, whether or not they are measured at fair value on its balance sheet A company is also required to disclose all significant concentrations of credit risk due to its financial instruments.GAAP requires disclosure of the fair value of all derivative financial instruments on its balance sheet A derivative financial instrument derives its value from changes in the price of the underlying resource to which it is linked© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide28
Loss and Gain ContingenciesUncertain situations that exist on the balance sheet date as to contingent losses or gains are known as
loss contingencies or gain contingencies© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide29
Subsequent EventsA
subsequent event is one that occurs between a company’s balance sheet date and the date when it issues its annual reportAn adjustment to the financial statements is required if a subsequent event provides additional evidence about conditions that existed on the balance sheet dateA material subsequent event that does not affect a company’s closed financial statements is instead disclosed in a note, in a pro forma (“as if”) statement, or in an explanatory paragraph in the audit report© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide30
Related Party TransactionsTransactions between related parties may not be conducted at arms length and could be viewed as self-dealing
GAAP requires certain disclosures by the company including the following:Nature of the relationship involvedDescription of the transactionsDollar amounts of the transactionsAny amounts due to or from the related parties on the balance sheet date© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.Slide31
How Do We Analyze Balance Sheet Information?
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.