Wacky Warning Labels (from www.wackywarnings.com)

1. Wacky Warning Labels (from www.wackywarnings.com) • A 12-inch rack for storing compact disks warns: “Do not use as a ladder” • A cartridge for a laser printer warns, “Do not eat toner” • A label on a hair dryer reads, “Never use hair dryer while sleeping” • A 13-inch wheel on a wheelbarrow warns: “Not intended for highway use” • A can of self-defense pepper spray warns users: “May irritate eyes” • A warning on a pair of shin guards manufactured for bicyclists says: “Shin pads cannot protect any part of the body they do not cover” • A popular manufactured fireplace log warns: “Caution - Risk of Fire”

2. Test 1 versus Test 2 • On test 1, some were happy with results and some were not • Test 1 had two primarily conceptual chapters, oneself-study chapter and one financial statement chapter • Test 2 will have one self-study chapter, one financial statement chapter, and two detailed content chapters • Chapter 18 will be the hardest material you have seen thus far in accounting • Last year almost 50% of student had a change in grade of greater then 10% between these two tests • 80% went down and 20% went up • Next exam will be much more computational but still 100% conceptual

3. Chapter 5 The balance sheet and statement of cash flowsSommers – Intermediate I

4. The Balance Sheet • Reports a company’s financial position on a particular date. Limitations: • The balance sheet does not directly measure the market value of the entity nor its liquidation value, but it provides valuable information that can be used to help judge market value. • Resources such as employee skills and reputation are not recorded in the balance sheet. Usefulness: • The balance sheet describes many of the resources a company has for generating future cash flows. • It provides liquidity information useful in assessing a company’s ability to pay its current obligations. • It provides long-term solvency information relating to the riskiness of a company with regard to the amount of liabilities in its capital structure.

5. Discussion Question Q5-2 What is meant by solvency? What information in the balance sheet can be used to assess a company’s solvency? Solvency refers to the ability of an enterprise to pay its debts as they mature. For example, when a company carries a high level of long-term debt relative to assets, it has lower solvency. Information on long-term obligations, such as long-term debt and notes payable, in comparison to total assets can be used to assess resources that will be needed to meet these fixed obligations (such as interest and principal payments).

6. Balance Sheet Classification Classification Illustration 5-1 In practice you usually see little departure from these major subdivisions.

7. Classification in the Balance Sheet Current Assets Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Illustration 5-2

8. Balance Sheet – Current Assets Current Assets - “Summary” Cash and other assets a company expects to • convert into cash, • sell, or • consume either in one yearor in the operating cycle, whichever is longer.

9. Balance Sheet – Current Assets Cash • Generally any monies available “on demand.” • Cash equivalents - short-term highly liquid investments that mature within three months or less. • Restrictions or commitments must be disclosed. Illustration 5-3

10. Balance Sheet – Current Assets Short-Term and Long-Term Investments Portfolios Type Valuation Classification Held-to-Maturity Debt Amortized Cost Current or Noncurrent Trading Debt or Equity Fair Value Current Adj on Inc Stmt Available- for-Sale Debt or Equity Fair Value Current or Noncurrent Adj is OCI

11. Balance Sheet – Current Assets Receivables • Major categories of receivables should be shown in the balance sheet or the related notes.A company should clearly identify • Anticipated loss due to uncollectibles. • Amount and nature of any nontrade receivables. • Receivables used as collateral.

12. Balance Sheet – Current Assets Inventories • Disclose: • Basis of valuation (e.g., lower-of-cost-or-market). • Cost flow assumption (e.g., FIFO or average cost). Illustration 5-6

13. Classification in the Balance Sheet Non-Current Assets • Long-term Investments • Securities (bonds, common stock, or long-term notes). • Tangible fixed assets not currently used in operations (land held for speculation). • Special funds (sinking fund, pension fund, or plant expansion fund). • Non-consolidated subsidiaries or affiliated companies.

14. Balance Sheet – Noncurrent Assets Long-Term Investments Securities • bonds, • stock, and • long-term notes For marketable securities, management’s intent determines current or noncurrent classification.

15. Balance Sheet – Noncurrent Assets Long-Term Investments Fixed Assets • Land held for speculation

16. Balance Sheet – Noncurrent Assets Long-Term Investments Special Funds • Sinking fund • Pensions fund • Cash surrender value of life insurance

17. Balance Sheet – Noncurrent Assets Long-Term Investments Nonconsolidated Subsidiaries or Affiliated Companies

18. Balance Sheet – Noncurrent Assets Long-Term Investments Illustration 5-10 Balance Sheet Presentation of Long-Term Investments

19. Balance Sheet – Noncurrent Assets Property, Plant, and Equipment • Tangible long-lived assets used in the regular operations of the business. • Physical property such as land, buildings, machinery, furniture, tools, and wasting resources (minerals). • With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets.

20. Balance Sheet – Noncurrent Assets Property, Plant, and Equipment Tangible assets used in the regular operations of the business.

21. Balance Sheet – Noncurrent Assets Illustration 5-11 Balance Sheet Presentation of Property, Plant, and Equipment

22. Balance Sheet – Noncurrent Assets Intangibles • Lack physical substance and are not financial instruments. • Limited life intangibles amortized. • Indefinite-life intangibles tested for impairment.

23. Balance Sheet – Noncurrent Assets Other Assets • Items vary in practice. Can include: • Long-term prepaid expenses • Non-current receivables • Assets in special funds • Property held for sale • Restricted cash or securities

24. Balance Sheet – Noncurrent Assets Other Assets This section should include only unusual items sufficiently different from assets in the other categories.

25. Classification in the Balance Sheet Current Liabilities “Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.”

26. Classification in the Balance Sheet Current Liabilities Illustration 5-13 Balance Sheet Presentation of Current Liabilities

27. Classification in the Balance Sheet Long-Term Liabilities “Obligations that a company does not reasonably expect to liquidate within the normal operating cycle.” All covenants and restrictions must be disclosed.

28. Balance Sheet – Owners Equity Owners’ Equity Illustration 5-15 Balance Sheet Presentation of Stockholders’ Equity

29. Balance Sheet Format Classified Report Form Illustration 5-16

30. Discussion Question Q5-4 Discuss at least two situations in which estimates could affect the usefulness of information in the balance sheet. • Allowance for doubtful accounts. • Depreciable lives and estimated salvage values for plant and equipment. • Warranty returns. • Determining the amount of revenues that should be recorded as unearned

31. E5-1 Balance Sheet Classification • Investment in Preferred Stock • Treasury Stock • Common Stock • Dividends Payable • Accumulated Depreciation – Equipment • Construction in Process • Petty Cash • Interest Payable • Deficit • Equity Investments (trading) • Income Tax Payable • Unearned Subscription Revenue • Work in Process • Vacation Wages Payable

32. Ratio Analysis Categories • Liquidity – Measures of the company’s short-term ability to pay its maturing obligations. • Activity – Measures of how effectively the company uses its assets. • Profitability – Measures of the degree of success or failure of a given company or division for a given period of time. • Coverage – Measures of the degree of protection for long-term creditors and investors.

33. For Exam (p. 246)

34. Calculating Ratios Current cash debt coverage ratio Inventory turnover Profit margin on sales Debt to total assets

35. Calculating Ratios Big Lots • Current cash debt coverage ratio 318,471 / avg(584,820 and 541,931) = 0.56 • Inventory turnover 3,131,862 / avg(825,195 and 762,146) = 3.95 • Profit margin on sales 207,064 / 5,202,269 = 3.98% • Debt to total assets (1,641,310 – 823,233) / 1,641,310 = 0.50 Family Dollar 0.52 5.05 4.54% 0.64

36. Word(s) of the Day for Cash Flows Journal Entry

37. Statement of Cash Flows Purpose of the Statement of Cash Flows • To provide relevant information about the cash receipts and cash payments of an enterprise during a period. • The statement provides answers to the following questions: • Where did the cash come from? • What was the cash used for? • What was the change in the cash balance?

38. Focus on Perhaps the most noteworthy item reported on an income statement is net income—the amount by which revenues exceed expenses. The most noteworthy item reported on a statement of cash flows is not the amount of net cash flows. The amount of net cash flows may in fact be the least important number on the statement. The increase or decrease in cash can be seen easily on comparative balance sheets. The purpose of the Statement of Cash Flows is not to report that cash increased or decreased by a certain amount, but why cash increased or decreased by that amount. The individual cash inflows and outflows provide that information.

39. Discussion Question Q5-24 Differentiate between operating activities, investing activities, and financing activities. Operating activities involve the cash effects of transactions that enter into the determination of net income. Investing activities include making and collecting loans and acquiring and disposing of debt and equity instruments; property, plant, and equipment and intangibles. Financing activities involve liability and owners’ equity items and include obtaining capital from owners and providing them with a return on (dividends) and a return of their investment and borrowing money from creditors and repaying the amounts borrowed.

40. Classification of Cash Flows Balance Sheet Current Assets Current Liabilities Operating Noncurrent Liabilities Noncurrent Assets Investing Financing Equity

41. Classifying Cash Flows Indicate the reporting classification of each transaction by entering the appropriate classification code. +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity • Sale of land • Issuance of common stock for cash • Purchase of treasury stock • Conversion of bonds payable to common stock • Lease of equipment by capital lease • Sale of patent

42. Classifying Cash Flows +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity • Acquisition of building for cash • Issuance of common stock for land • Collection of note receivable (principal amount) • Issuance of bonds • Payment of cash dividends • Issuance of short-term note payable for cash • Issuance of long-term note payable for cash • Purchase of marketable securities (“available for sale”)

43. Classifying Cash Flows +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity • Payment of note payable • Sale of equipment • Issuance of note payable for equipment • Repayment of long-term debt by issuing common stock • Loan to another firm • Sale of inventory to customers • Purchase of marketable securities (cash equivalents)

44. Direct Method Indirect Method Reports the cash effects of each operating activity Starts with accrualnet income and converts to cash basis Reporting Cash Flows from Operating Activities Two Formats for Reporting Operating Activities Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

45. Direct Method Under the direct method, the cash effect of each operating activity is reported directly in the statement.

46. Indirect Method By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis.

47. Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported (usually in a disclosure note). • Acquiring an asset by incurring a debt payable to the seller. • Acquiring an asset by entering into a capital lease. • Converting debt into common stock or other equity securities. • Exchanging noncash assets or liabilities for other noncash assets or liabilities.

48. Determining Cash Received or Paid • When preparing a SCF using direct method, the numbers needed generally are not kept by the accounting system • There is not an account that is the amount (balance) of cash paid to suppliers for merchandise • Most people get these numbers by backing into them using accounting relations via T-accounts or by using journal entries

49. Determining Cash Received or Paid Given: Beginning End of yearof year Inventory $ 90 $ 93 Accounts payable 14 16 Cost of goods sold 300 Determine cash paid to merchandise suppliers. • Cash paid to suppliers for merchandise Inventory 3 Cost of goods sold 300 Accounts payable 2 Cash 301

50. Cash from Customers Given: Beginning End of yearof year Accounts receivable $ 100 $110 Allowance for bad debts 5 3 Sales revenue 600 Bad debt expense 10 Determine cash received from customers. • Cash received from customers Accounts receivable 10 Allowance for bad debts 2 Bad debt expense 10 Cash 578 Sales 600