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ACCT303 Chapter 4A - Balance Sheet, Teaching PP
ACCT303 Chapter 4A - Balance Sheet, Teaching PP
Learning Objectives
1.How balance sheet accounts are measured,
classified and presented.
2.How balance sheet information is used.
3.Balance sheet terminology and format
outside the U.S.
4.How footnotes aid to the understanding
of the firm’s accounting policies, contingent
liabilities, subsequent events, and related-
party transactions
4-1 1
The Accounting Equation
Shareholders’ Equity:
What’s left of the company’s assets
after paying off liabilities.
It also referred to as net assets.
2
Balance sheet
classification:
Overview
ASSETS = LIABILITIES + EQUITY
• Currentassets
• Property, plant and • Current liabilities
equipment • Long-term debt
• Investments
• Other assets
• Other liabilities
• Preferred and Contributed
common stock Capital
• Additional paid-in
capital
• Retained earnings
3
Elements of the balance
sheet
How the money is
invested Where the money came from
4
Balance sheet Classification and
Account Measurement - Current
assets
Amortized cost
or current
market value
Net
realizable
value
Lower of cost or
current market
value
4-5 5
Assets – classification and
measurement
Resources with future economic benefit to a
business entity as a result of a past transaction.
Current Assets: cash and other assets that are
reasonably expected to be realized in cash or
sold, or consumed during a normal operating
cycle or one year, whichever is longer
Examples: Cash and cash equivalents, short-
term investments (reported at the fair value),
receivables (estimated amount collectible),
inventory (LCM), prepaid expenses, etc.
6
Balance Sheet Classification and
Account Measurement -PPE,
Investments and Intangibles
4-7 7
Assets (contd.)
Long-term Investments: Comprise of the
following
Securities (i.e., bonds, stock, long-term notes)
Fixed assets (i.e., land, building)
Special funds (i.e., pension fund, bond sinking
fund)
Nonconsolidated subsidiaries or affiliated
companies
8
Assets (contd.)
Property, Plant, Equipment (i.e., building,
Land, Machinery and equipment, capital
leases): assets used in firms’ operations
and meet the following criteria:
1. Economic life > 1 year;
2. Acquired for use in operation;
3. Not for resale to customers;
4. $ is material. (materiality)
Depreciation will be applied except for land.
9
Assets (contd.)
Intangible Assets: assets with no
physical substance but have value
based on rights or privileges that
belong to the owner (i.e., goodwill,
patents, franchises, trademarks,…).
Amortization for limited life
intangibles (i.e., patents, franchises)
and impairment test for indefinite-life
intangibles (i.e., goodwill).
10
Balance Sheet Classification and
Measurement - Liabilities
Amount due
at maturity
Historical
cost
Discounted
present
value
4-1111
Liabilities
14
B. Long-Term Liabilities
15
C. Other Liabilities
16
Balance Sheet Classification and
Account Measurement
-Stockholders’ equity
Historical
par value
Historical
cost
Combination of
different
measurement
bases
4-1717
Stockholders’ Equity
19
b. Accumulated Other
Comprehensive Income
Increase of assets without outflows of
assets, increase of liabilities, increase
of income or issuance of common stock
(i.e.,(+) increase in market value of
securities-available-for-sale (+ or -),
gains or losses of foreign currency
adjustments, etc.)
20
c. Retained Earnings
21
Balance sheet information
22
1. Rate of Return Ratios
ROA (return on assets) and ROCE (return on
common equity) ratios:
Evaluate operating efficiency and profitability.
ROA =
Net operating profit after taxes (NOPAT) / Average
assets
ROCE =
(Net income – Preferred dividends) / Average
common shareholders’ equity
23
2. Capital Structure
24
3. Liquidity Ratios
Liquidity measures how readily assets can
be converted to cash relative to how soon
liabilities will have to be paid in cash.
Current ratio: Indicate the level of current
resources available to pay current debts.
Current Ratio = Current Assets / Current
Liabilities
Question:
Does higher ratio always indicate better
financial status?
25
4. Solvency
Solvency defines the ability of a company
to generate sufficient cash flows to
maintain its productive capacity and still
able to pay off the long-term debt.
Debt ratios provide information about the
amount of long-term debt in a company’s
financial structure.
Long-term debt to assets =
Long term debt/Total assets
26
Solvency (contd.)
27
5. Flexibility
4-2929
Balance sheet presentation:
International differences
4-3030
Financial statement
Footnotes are an integral part of
footnotes
companies’ financial reports.
These “notes” help users better
understand and interpret the numbers
presented in the body of the financial
statements.
Three important notes:
1. Summary of significant accounting
policies.
2. Subsequent event disclosures.
3. Related party transactions
4-3131
Limitations of the Balance
Sheet
1. Historical costs reporting for most
of assets and liabilities.
2. Estimations involved in the value of
some assets and liabilities (i.e., the net
realizable value of accounts receivable
and the cost of warranty).
3. the omission of some valuable items
such as goodwill of the company.
4. Off-balance sheet liabilities.
32
Summary
1. The balance sheet shows the assets
owned by a company at a given point in
time, and how those assets are
financed (debt vs. equity).
2. Be alert for differences in balance
sheet measurement bases, account
titles, and statement format.
3. Financial statement footnotes provide
important information..
4-3333