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Balance Sheet and Financial Disclosures

Balance Sheet and Financial Disclosures

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Balance Sheet and Financial Disclosures

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  1. Balance Sheet and Financial Disclosures

  2. Objectives of the Chapter 1. Identify the major classifications of the balance sheet. 2. Prepare a classified balance sheet statement. 3. Discuss the disclosures to financial statements. The Balance Sheet and Financial Disclosures

  3. Objectives of the Chapter (contd.) 4. Understand the accounting treatment for subsequent events. 5. Limitations of the balance sheet. 6. Use financial ratios to study financial performance of corporations. The Balance Sheet and Financial Disclosures

  4. Balance Sheet Statement Usefulness of the Balance Sheet: • Providing information about the financial position and the capital structure of a business entity. • Providing information about the liquidity, solvency (risk assessment), financial flexibility and operating capability of a business entity. The Balance Sheet and Financial Disclosures

  5. Classified Balance Sheet (Kieso, etc. 14th e,, illustration 5-16) Scientific Products, Inc. BALANCE SHEET December 31, 2012 Assets Current assets Cash $42,485 Available-for-sale securities--at fair value 28,250 Accounts receivable $165,824 Less allow. for doub. Accts. 1,850 163,974 Notes receivable 23,000 Inventories -- at average cost 489,713 Supplies on hand 9,780 Prepaid expenses 16,252 The Balance Sheet and Financial Disclosures 5

  6. Illustration 5-16 (Contd.) Scientific Products, Inc. BALANCE SHEET December 31, 2012 Prepaid expenses 16,252 Total current assets $773,454 Long-term investments Investments in Warren Co. 87,500 Property, plant, and equipment Land--at cost 125,000 Buildings--at cost 975,800 Less accu. Depr. 341,200 634,600 Total PPE 759,600 Intangible assets Goodwill 100,000 Total assets $1,720,554 The Balance Sheet and Financial Disclosures 6

  7. Illustration 5-16 (contd.) Liabilities and Stockholders’ Equity Current liabilities N/P to banks $50,000 Accounts payable 197,532 Accrued int. on N/P 500 Income taxes payable 62,520 Accrued salaries, wages, and other liabilities 9,500 Deposits received from customers 420 Total current liabilities $320,472 Long-term debt 20-year 12% debentures, due January 1, 2008 500,000 Total liabilities 820,472 The Balance Sheet and Financial Disclosures 7

  8. Illustration 5-16 (contd.) Stockholders’ equity Paid in on capital stock Preferred, 7%, cumulative Authorized, issued, and outstanding, 30,000 shares of $10 par value $300,000 Common-- Authorized, 500,000 shares of $1 par value; issued & outstanding, 400,000 shares 400,000 additional paid-in capital 37,500 737,500 Earnings retained in the business 162,582 Total stockholders’ equity 900,082 Total liabilities and stockholders’ equity $1,720,554 The Balance Sheet and Financial Disclosures 8

  9. Definition of Elements of a Balance Sheet: (SFAC No. 6) • Assets • Liabilities • Stockholders’ equity The Balance Sheet and Financial Disclosures

  10. Assets • Resources with future economic benefit to a business entity as a result of a past transaction. The Balance Sheet and Financial Disclosures

  11. Assets (contd.) • 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 (fair value), short-term investments (fair value), receivables (estimated amount collectible), inventory (LCM), prepaid expenses…). The Balance Sheet and Financial Disclosures

  12. 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 (investment in Uncon Subsidiary) The Balance Sheet and Financial Disclosures

  13. 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. The Balance Sheet and Financial Disclosures

  14. 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). The Balance Sheet and Financial Disclosures

  15. Assets (contd.) • Other Assets: Include assets sufficiently different from assets in other categories. • Examples: long-term prepayments, deferred income tax. The Balance Sheet and Financial Disclosures

  16. Liabilities • Legal obligations required future payments of assets or services as a result of a business entity’s past transactions or events. A. Current Liabilities B. Long-term Liabilities C. Other Liabilities The Balance Sheet and Financial Disclosures

  17. A. Current Liabilities • Obligations must be fulfilled in one year or one operating cycle, whichever is longer. (will require the use of current assets or the creation of current liability) (i.e., A/P, N/P, accrual payable, unearned revenue, income tax payable, current portion of L-T debt) The Balance Sheet and Financial Disclosures

  18. Contingencies • Contingent Liabilities • Contingent Losses • Contingent Gains The Balance Sheet and Financial Disclosures

  19. Contingent Liabilities • Obligations may arise because of the occurrence or not occurrence of future event(s). (i.e., warranty obligations) The Balance Sheet and Financial Disclosures

  20. Contingent Losses • Losses may arise because of the occurrence or not occurrence of future event(s). (i.e., the uncollectable accounts, the pending lawsuit losses, possible damage of a fire (or flood)…) The Balance Sheet and Financial Disclosures

  21. Contingent Gains • Gains may arise because of the occurrence or not occurrence of future events). (i.e., pending lawsuit gains) The Balance Sheet and Financial Disclosures

  22. Accounting Treatments of Contingencies • The accounting treatments of the contingencies depend on the occurrence probability of the related future event(s). The Balance Sheet and Financial Disclosures

  23. Accounting Treatments of Contingencies (contd.) • Occurrence probabilities of future event(s): (SFAS No. 5) 1. Probable: The future event(s) is(are) likely to occur. 2. Reasonably possible: The chance for the future event(s) to occur is less than probable but greater than remote. 3. Remote: The chance of the future event to occur is unlikely. The Balance Sheet and Financial Disclosures

  24. Accounting Treatments of Contingent Liabilities & Losses • If the future event(s) is(are) a. probable, and b. amount of loss (liability) can be estimated -- The loss (liability) should be estimated, and recognized (accrued). The Balance Sheet and Financial Disclosures

  25. Examples 1. B/D Exp. XXX Allowance for B/D XXX 2. Warranty Exp. XXX Estimated Warranty Liabilities XXX 3. Lawsuit Exp. XXX Estimated Liability under Litigation XXX The Balance Sheet and Financial Disclosures

  26. Accounting Treatments of Contingent Liabilities & Losses (contd.) • If the future event is probable, but the amount of loss (or liability) CANNOT be estimated, the contingent loss (or liability) should only be footnoted (not accrued). The Balance Sheet and Financial Disclosures

  27. Accounting Treatments of Contingent Gains • If the event is probable and the amount of contingent gains is determinable, only footnote the information. NO unrealized gain can be recognized under the current accounting standards (conservatism!). The Balance Sheet and Financial Disclosures

  28. B. Long-Term Liabilities • Obligations are not due in next year or next operating cycle, whichever is longer. (i.e., bonds payable, pension liability) The Balance Sheet and Financial Disclosures

  29. C. Other Liabilities • Long-term advances from customers, deferred income taxes. The Balance Sheet and Financial Disclosures

  30. Stockholders’ Equity • Residual claims (assets-liabilities) to the business entity from stockholders including: a. contributed capital b. (+ or -)Accumulated Other Comprehensive Income c. retained earnings (or - deficit) d. (-)treasury stock The Balance Sheet and Financial Disclosures

  31. a. Contributed Capital • Par value of common stock • Par value of prefer stock • Paid-in capital in excess of par value of common stock or preferred stock The Balance Sheet and Financial Disclosures

  32. 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.) The Balance Sheet and Financial Disclosures

  33. c. Retained Earnings • Net income not distributed to stockholders • appropriated • unappropriated The Balance Sheet and Financial Disclosures

  34. Other Disclosure Issues • APB opinion No. 22 (ASC 235-10-05) required the disclosure of the following information as an integral part of the financial statement (i.e., in the notes): 1. Accounting Policies: All significant accounting principles and methods such as : • depreciation method of PPE, • inventory cost flow method and valuation method (LCM), • revenue recognition principles. The Balance Sheet and Financial Disclosures

  35. Other Disclosure Issues 2. Contingencies. 3. Subsequent Events. The Balance Sheet and Financial Disclosures

  36. Subsequent Event • Significant events occurred after the fiscal year end but before the issuance date of the annual report. The Balance Sheet and Financial Disclosures

  37. Subsequent Event - Introduction • Investors should be informed of significant events such as mergers, acquisitions, break-ups, spin-offs, issuance of bonds, issuance of stocks, settlement of litigation, loss of plant due to flood or fire even if these events occur after the fiscal year end. As long as these events occur prior to the issuance date of the annual reports, they should be disclosed in the reports. The Balance Sheet and Financial Disclosures

  38. Subsequent Event - Overview • There are two types of subsequent events: 1. Events require adjustments of balance sheet statement. 2. Events do not require adjustment of balance sheet statement but require disclosure in the footnotes. The Balance Sheet and Financial Disclosures

  39. Events Require Adjustment of B/S • Events with evidence indicates that conditions existed at or prior to the B/ S date. • Examples: (assume FYE is 12/31/x1 and the report release date is 3/31/x2) • Bankruptcy occurred on a major client on 2/1/x2. The bankruptcy condition may exist for this client prior to 12/31/x1. • Litigation settlement on 2/10/x2. The condition for this litigation existed prior to 12/31/x1. The Balance Sheet and Financial Disclosures

  40. Events Do Not Require Adjustment of B/S but Require Disclosure • Examples: (assume FYE is 12/31/x1 and the report release date is 3/31/x2) • A fire occurred on a major client on 3/1/x2. • Sales of bonds on 2/9/x2. • Loss of inventories due to a fire on 1/20/x2. • Issuance of common stock on 1/30/x2. The Balance Sheet and Financial Disclosures

  41. SEC Regulations • Publicly traded firms need to file the 10-K reports with the SEC. Some of the SEC regulations for the 10-K reports are also followed by the firms in preparing the annual reports. The Balance Sheet and Financial Disclosures

  42. Example A • Comparative financial statements • B/S  2 years • I/S and cash flow statement  3 years • Selected financial data items (i.e., net sales, operating revenue EPS, total assets, cash dividends declared) should have a 5-year data. The Balance Sheet and Financial Disclosures

  43. Example B (MD&A) • Management Discussion and Analysis (including critical accounting estimates): Any information useful in assessing cash flows but not in the B/S (i.e. inflation impact on sales, liquidity and capital resources of the firm,…) should be included in the management discussion. The Balance Sheet and Financial Disclosures

  44. MD&A: Critical Accounting Estimates • The estimation of possible losses inherent in the financial receivables. • The estimation of profits over the multiple-year terms for revenue recognition on long-term project services agreements . • The estimates and assumptions needed in assessing asset impairment for investments, long-lived assets and goodwill. • Pension assumptions such as discount rate and expected rate of returns on pension assets. The Balance Sheet and Financial Disclosures

  45. MD&A: Contractual Obligations (required by the SEC) • The contractual obligations for future payments as of December 31, 2008 for GE are as follows: The Balance Sheet and Financial Disclosures

  46. Example C • Market Prices and Dividends of Common Stocks: • The high and low prices for each quarter in the last two years. • The dividends paid in the last two years. The Balance Sheet and Financial Disclosures

  47. Other Footnote Disclosures • Earnings Per Share • Inventories • Employee Stock Options • Postretirement Benefit Plans • Leases, • Investment Securities • Purchase Commitment • Bond covenants • Receivables The Balance Sheet and Financial Disclosures

  48. Other Footnote Disclosures (contd.) • Property, Plant and Equipment • Goodwill and other Intangible Assets • Allowance for Losses on Financial Receivables • Borrowing • Financial Instruments • Provisions for income taxes • Off-Balance Sheet Arrangements The Balance Sheet and Financial Disclosures

  49. Other Footnote Disclosures (contd.) • Fair Value Measurements Disclosure (SFAS 157,effective 1/1/2008) • Companies report fair value for assets and liabilities must disclose the fair value hierarchy level of the fair value measurements. The Balance Sheet and Financial Disclosures

  50. Fair Value Hierarchy (SFAS 157) • Level 1 (most reliable) measures are based on quoted prices for identical instruments in active markets. • Level 2 measures are based on quoted prices for similar instruments (assets or liabilities) in active markets. • Level 3 (least reliable) measures are based on unobservable inputs such company’s data or assumptions. The Balance Sheet and Financial Disclosures