ACCY 111 ch 3
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Balance Sheet (statement of financial position):
- Summary of the financial balances of a company. Specific date, snapshot of companies financial condition. Single point in time. describes many of the resources a company has for generating future cash flows. It provides liquidity information useful in assessing a companies 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. DOES NOT portray the market value of the entity as a going concern or liquidation value and resources such as employee skills and reputation are not recorded in the balance sheet. Balance sheet does not reflect Market value (share price x shares)
- whether assets are to be consumed in a year or an operating cycle. We want to know whether the assets are current or long term liability. · In an asset expected to be chased or consumed within a year or an operating cycle· Does a claim need to be settled within a year or an operating cycle· Assets: are probable future economic benefits obtained or controlled by a particular entity as a result of past transaction or events.· Balance sheet is a time shot of financial position. It shows how much is owed and how much is owned. Frozen point of time. Not video camera, but a still camera. A POINT OF TIME!!!!· Operating cycle: for a typical manufacturing company refers to the period of time necessary to convert cash to raw materials, raw materials to a finished product, the finished product to receivables, and then finally receivables back to cash.
- whether assets are to be consumed in a year or an operating cycle. We want to know whether the assets are current or long term liability. · In an asset expected to be chased or consumed within a year or an operating cycle·
- Does a claim need to be settled within a year or an operating cycle·
- Assets: are probable future economic benefits obtained or controlled by a particular entity as a result of past transaction or events.·
- Balance sheet is a time shot of financial position. It shows how much is owed and how much is owned. Frozen point of time. Not video camera, but a still camera. A POINT OF TIME!!!!·
- Operating cycle: for a typical manufacturing company refers to the period of time necessary to convert cash to raw materials, raw materials to a finished product, the finished product to receivables, and then finally receivables back to cash.
- FUTURE BENEFITS (defined by the operating cycle) will be converted to cash or consumed within one year or the operating cycle, whichever is longer. Sometimes an operating cycle is over a year.6 basic elements of current assets section:
- 1. Cash
- 2. Cash equivalents (commercial paper, money market funds, and US treasury bills)
- 3. Short-term investments (can be classified as current or non current)
- 4. Receivables (current year is 1 yr. If owed within 1 yr it is current assets)
- 5. Inventories (can be classified as current or non current) goods waiting for sale (finished goods), goods in the course of production (work in progress), good consumed in the production process (raw materials)
- 6. Prepaid expenses: you paid in advance, deposit, not consumed the asset yet.When it is due, it will be an expense. (can be classified as current or non current)
- Not expected to be converted to cash or consumed within one year or the operating cycle, whichever is longer.4 basic elements of NONcurrent assets section:
- 1. Investments (cash set aside for plant expansion, investments not for the purpose of operations) NOT used for operations. Includes both debt and equity securities or other corps. Land held for speculation, noncurrent a/r, cash set aside for special purposes (can’t use cash within operating cycle).
- 2. Property, plant, & Equipment (PPE) – tangible,, long lived, and used in the operation of the business. Land, buildings equipment, machinery, furniture, natural resources (miners tract, oil wells, mineral mines)
- 3. Intangible Assets: owners exclusive right to a product process or name. Patent copies, copyrights, franchises. Reported on the balance sheet as accumulated amortization.
- 4. Other Assets: catch all phrase. Deferred charges, and any noncurrent not falling in one of the classifications. Long term prepaid expenses, called deferred charges, an any noncurrent assets not falling in one of the other classifications.
FUTURE SACRAFICES!! Liabilities are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities as a result of past transactions or events.
- ***Will be satisfied through the use of current assets. Obligations expected to be satisfied through current assets or creation of other current liabilities within one year or the operation cycle whichever is longer.
- 1. Accounts Payable
- 2. Notes Payable (IOUs)
- 3. Accrued Liabilities: different from payables. Salaries payable. The labor has been done and it has not been paid out. EX: accrued interest payable, accrued taxes payable., accured warranty liablities.Or current maturities of long term debt.
- 4. Unearned Revenues (mirrored to prepaid expense) Prepayment (holding a deposit)
- 5. Current maturities of Long-Term Debt: whatever payment is going to be paid to you within 12 months like a long-term loan.
- obligations that will not be satisfied within one year or operating cycle, whichever is longer.
- 1. Long-term Notes: portion of the long-term can be classified as current on test
- 2. Mortgages
- 3. Long-term Bonds
- 4. Pension Obligations
- 5. Lease Obligations
- shareholders’ equity is the residual interest in the assets of an entity that remains after deducting liabilities from assets (net assets)
- 1. Shareholders’ Investment: after deducting liabilitiesa. Investment by the shareholders. Earnings from operations
- 2. Amounts earned by the corp
- a. paid in captial:
- b.Retained earnings: rights and claims against asset because of operations. Additional net income. It is the accumulated net income earned since the inception of the corporation and not yet paid to the shareholders as dividends.
US GAAP vs. IFRS:
- There are more similarities than differences in balance sheets prepared according to US GAAP and those prepared applying
- Does not specify a minimum list of items to be presented in the balance sheet·
- Some US companies use the statement of financial position title as well·
- Presents current assets and liabilities before noncurrent assets and liabilities·
- Specifies a min list of items to be presented in the balance sheet·
- Statement title changed to statement of financial position ·
- Does not prescribe the format of the balance sheet, but balance sheets prepared using IFRS often report noncurrent items first
- The full-disclosure principle studied in Chapter One requires: Financial statements provide All material relevant information concerning the reporting entity.2 major categories of disclosures
- 1. Those explain or elaborate upon the data presented in the financial statements themselves: related to a specific item in a statement
- a. Pension plans
- b. Information related to A/R: (who are your major customers holding the A/R like Intel or US Govt. in order to determine if they are good at paying bills)
- c. Investments: what kind of investment, bonds, derivatives (intention of the company of what it going to do with it, sell or long-term)
- d. Income Taxes. PPE (land but can be an investment for speculation purpose) must be categorized as holding it for future operations.
- 2. Those provide information not directly related to any specific item in the statement
- a. Summary of significant accounting policies: what are the company policies you use to calculate with. IE Depreciation methods: straight-line, specific unit, double decline. Perpetually or Periodic. FIFO LIFO. Alternative accounting methods. Must know company policy of the methods used.
- b. Subsequent Events: a significant development that occurs after the company’s fiscal year end but before the financial states are issued or available to be issued. What’s considered a subsequent event (the window time)EX: issuance of debt or equity securities, a business combination or the sale of a business, the sale of assets
- c. Noteworthy Events and Transactions: financial transactions between related parties. What is considered transactions, Irregularities and illegal acts. Distinction between errors: errors are intentional. Irregularities are unintentional and may not be illegal acts (bribes, kickbacks, illegal contributions to political canidates.
Management Discussion and Analysis
Provides a biased but informed perspective of a company’s operations, liquidity and capital resources. Forward looking, discussed what happened recently, and making projections of future… Biased, yet informed discussion. Management view of what may happen based on managements judgment.
- Management’s Responsibility
- 1. Preparing the financial statement and other information in the annual report. Free of material mistake!
- 2. Maintaining and assessing the company’s internal control procedures.
- Auditors’ Report
- 1. Expresses the auditor’s opinion as to the fairness of presentation of the financial statements in conformity with general accepted accounting principles. MUST BE INDEPENDENT ACCOUNTING MANAGER
- 2. Auditors’ reports must comply with specifications of the public companies accounting oversight board
Auditors’ Opinions – 4 types
- 1. Unqualified: issued when the financial statements present fairly the financial position, results of operations, and cash flows are in conformity with GAAP.
- Sometimes circumstances cause the auditors' report to include an explantory paragraph in addition to the standard wording even though it is still unqualified. *****(The statements are presented fairly in conformity with GAAP)
- a. Lack of consistency: due to a change in accounting principle such that comparability is affected
- b. Uncertainity: as to the ultimate resolution of a contingency for which a lost in material amount
- c.Emphasis: of a matter concerning the financial statement that does not affect the existence of an unqualified opinion bur relates to significant event such as a related party transaction.
Some audits result in the need to issue other than an unqualified opinion due to exceptions such as (a) nonconfomity (b) inadequate disclosures (c) a limitation or restriction of the scope of the examination.
- 2. Qualified: issued when there is an exception that is not of sufficient seriousness to invalidate the financial statement as a whole. ***Scope limitation or adeparture from GAAP
- 3. Adverse: issued when the exceptions are so serious that a qualified opinion is not justified
- 4. Disclaimer: issued when insufficient information has been gathered to express an opinion.
Compensation of Directors and Top Executives
Proxy statement Information (mailed annually to shareholders with the annual report)o
- Summary Compensation table
- § Salary
- § Bonus
- § Stock Awards
- § Option Awards
- § Other Compensation
Using Financial Statement Information
- 1. Comparative Financial Statements: Allows financial statement users to compare year to year financial position, results of operations, and cash flows. Operations expand and contract in a cyclical fashion so it may not always compare.
- 2. Horizontal Analysis: Expresses each item in the financial statems as a percentage of that same item in the financial statements of another year (base amount)
- 3. Vertical Analysis: Involves expressing each item in the financial statements as a percentage of an appropriate corresponding total, or base amount, within the same year
- 4. Ratio Analysis: allows analysts to control for size differences over time and among firms
readiness of assets can be converted to cash (use balance sheets)a. Current ratio and Acid-test ratio (or quick ratio
a. current assets/current liabilities. Measures a company’s ability to satisfy its short-term liabilities. (use balance sheet) 2.79 read as more than 2 times the amount of cash to pay liabilities. The higher the ratio the better for the company. Comparing companies like Google vs. Caterpillar the ratios won’t be relevant. Oracle compared with HP would be relevant.
Acid-test ratio (or quick ratio):
a. Quick assets/Current liabilities. Provides a more stringent indication of a company’s ability to pay its current liabilities (use balance sheet) Quick Assets are very covenant to convert to cash. (cash and cash equivalents, short term investments, trading assets, A/R) 2.13 read as more than 2 times the amount of cash to pay liabilities.
Debt to Equity ratio and Time Interest Earnedratio
Debt to Equity ratio
a. total liabilities/shareholders’ equity. Indicates the extent of reliance on creditors, rather than owners, in providing resources. If you finance your own company you will only have owners equity. If you borrow from a bank, you will have a liability. How much you rely on creditors/ financial leverage (favorable leverage or less favorable leverage). Borrow at 10% and Lend at 15% this is a good deal. Sustain during economic times. 40000 borrowed, 60000 owners equity = 2/3 or 66.67% The higher the debt the higher the financial leverage.
Time Interest Earned ratio:
Net Income + Interest Expense + Income taxes/ Interest Expense. Indicates the margin of safety provided to creditors. Do you have enough money to cover interest expense.
Long term solvency
- refers to the riskiness of a company with regard to the amount of liabilities in the capital structure. Risk to the investor or creditor increases as the percentage of liablities, relative to equity increases.
- Solvency offers financial flexibility in order to take care of unexpected investment oppurtunities.
(or net assets) called shareholders equity or stockholders equity for a corporation, is the residual interest in the assets of an entity that remains after deducting liabilities.
An organized array of assets, liabilities, and equity.
Relates to the amount of time before an asset is converted to cash or a liability is paid.
Items expected to be converted to cash or consumed within one year or the operating cycle, whichever is longer.
Cash to cash.
Current assets minus current liabilities.
Recorded when an expense is incurred but not yet paid.
Summary of significant accounting politicies
Important to a user in comparing financial information across companies.
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