Prep ch3


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Prep ch3

  1. 1. Chapter 3 Understanding the Balance Sheet and Statement of Owners’ Equity
  2. 2. Learning Objectives <ul><li>Understand the articulation of financial statements </li></ul><ul><li>Understand components of the Balance Sheet </li></ul><ul><li>Evaluate the balance sheet with caution </li></ul>
  3. 3. Assets = Claims The Accounting Equation <ul><li>Assets </li></ul><ul><ul><li>Resources controlled by the entity to provide future benefits </li></ul></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Property </li></ul></ul><ul><ul><li>Other resources </li></ul></ul><ul><li>Claims </li></ul><ul><ul><li>Contractual and other obligations held against assets </li></ul></ul><ul><ul><li>Liabilities: creditors’ claims </li></ul></ul><ul><ul><li>Owners’ equity: residual claim of shareholders </li></ul></ul>
  4. 4. Articulation of Financial Statements Income Statement Revenue -Expenses Net Income Balance Sheet Assets = Liabilities + Equity Cash Flows Beginning cash ± Operating ± Investing ± Financing Ending cash Equity Statement Beginning Equity + Net Income - Dividends Ending Equity Balance Sheet Assets = Liabilities + Equity
  5. 5. Basic Financial Statements <ul><li>Balance sheet </li></ul><ul><ul><li>Assets = Liabilities + Owners’ Equity </li></ul></ul><ul><ul><li>A snapshot at a particular moment of time </li></ul></ul><ul><li>Income statement </li></ul><ul><ul><li>Revenue – Expenses </li></ul></ul><ul><ul><li>Covers a period of time </li></ul></ul><ul><li>Cash flow statement </li></ul><ul><ul><li>Changes in cash during the period </li></ul></ul><ul><li>Equity statement </li></ul><ul><ul><li>Changes in equity during the period </li></ul></ul><ul><ul><li>P3-1; P3-2; P3-3; </li></ul></ul>
  6. 6. Differentiate between current and long-term assets <ul><li>Based on liquidity </li></ul><ul><ul><li>How long, how difficult, and how costly does it take to turn an asset into cash </li></ul></ul><ul><ul><li>One year or the length of operating cycle </li></ul></ul><ul><li>Why need such a differentiation </li></ul><ul><ul><li>Current ratio = Current assets/Current liabilities </li></ul></ul><ul><ul><li>Quick ratio = Quick assets/Current liabilities </li></ul></ul>
  7. 7. Current Assets <ul><li>Cash and cash equivalents </li></ul><ul><li>Marketable securities </li></ul><ul><ul><li>At market value </li></ul></ul><ul><li>Accounts receivable </li></ul><ul><ul><li>Revenue recognition </li></ul></ul><ul><ul><li>Estimation of bad debts </li></ul></ul><ul><li>Inventory </li></ul><ul><ul><li>LIFO, FIFO, Weighted average, Specific identification result in different estimations of inventory </li></ul></ul><ul><ul><li>In hi-tech industry, the price of inventory usually deflates </li></ul></ul><ul><ul><li>Lower cost or market </li></ul></ul><ul><li>Prepaid or deferred expenses </li></ul><ul><ul><li>Future expenses (caution, really future expenses?) </li></ul></ul>
  8. 8. Current Assets: Example
  9. 9. Noncurrent Assets <ul><li>Property, plant and equipment </li></ul><ul><ul><li>Historical cost less accumulated depreciation </li></ul></ul><ul><li>Intangible assets </li></ul><ul><ul><li>Copyrights & trademarks (historical cost less accumulated amortization) </li></ul></ul><ul><ul><li>Goodwill (excess acquisition cost beyond current market value of net assets acquired less impairment) </li></ul></ul><ul><ul><li>Historical cost tends to be much lower than its value </li></ul></ul><ul><ul><li>Many intangible resources are not recorded as assets </li></ul></ul>
  10. 10. Noncurrent Assets: Example <ul><ul><li>P3-4; P3-6; P3-15; </li></ul></ul>
  11. 11. Liabilities <ul><li>Current Liabilities </li></ul><ul><ul><li>Accounts payable to suppliers (Purchase material without paying cash) </li></ul></ul><ul><ul><li>Accrued expenses (Interest, taxes, wages…) </li></ul></ul><ul><ul><li>Current portion of debt (principal to be paid within the next year) </li></ul></ul><ul><li>Non-current Liabilities </li></ul><ul><ul><li>Principal associated with Long-term portion of Loans, Notes, Mortgages, Bonds (due in more than one year) </li></ul></ul><ul><ul><li>Adjust for discount or premium </li></ul></ul>
  12. 12. Liabilities: Example <ul><li>P3-7 </li></ul>
  13. 13. Owners’ Equity <ul><li>Paid-in capital </li></ul><ul><ul><li>Reflects what was paid for stock at original issuance (owners’ original investment) </li></ul></ul><ul><ul><li>Preferred stock and common stock </li></ul></ul><ul><li>Retained earnings </li></ul><ul><ul><li>Cumulative earnings that belongs to owners but has not yet been distributed </li></ul></ul><ul><ul><li>Change of retained earnings = net income - dividends </li></ul></ul><ul><li>Other comprehensive income </li></ul>
  14. 14. Owners’ Equity: Example <ul><li>P3-9; P3-11; & P3-13; </li></ul>
  15. 15. Statement of Shareholders’ Equity <ul><li>Change of paid-in capital </li></ul><ul><ul><li>Issuance, repurchase, conversion, and stock dividend </li></ul></ul><ul><li>Change of retained earnings </li></ul><ul><ul><li>net income, cash dividends, and stock dividend </li></ul></ul><ul><li>Change of other comprehensive income </li></ul>
  16. 16. Statement of Shareholders’ Equity: Example
  17. 17. Summary <ul><li>The articulation of financial statements </li></ul><ul><ul><li>Balance Sheet </li></ul></ul><ul><ul><li>Income Statement, Cash Flow Statement, and Statement of Change of Owners’ Equity </li></ul></ul><ul><li>Components of the Balance Sheet </li></ul><ul><ul><li>Assets </li></ul></ul><ul><ul><li>Liabilities </li></ul></ul><ul><ul><li>Owners’ Equity </li></ul></ul><ul><li>Cautions </li></ul><ul><ul><li>P3-10; P3-12; P3-14; P3-16; </li></ul></ul>
  18. 18. Problems and Cases <ul><li>Financial statements </li></ul><ul><ul><li>P3-1 (C); P3-2 (B); P3-3 (B); </li></ul></ul><ul><li>Balance sheet </li></ul><ul><ul><li>Assets: P3-4 (B); P3-6 (D); P3-15 (B); </li></ul></ul><ul><ul><li>Liabilities: P3-7 (C); </li></ul></ul><ul><ul><li>Owners’ Equity: P3-9 (6,682,000); P3-11 (C); & P3-13 (4,500,000); </li></ul></ul><ul><li>Cautions </li></ul><ul><ul><li>P3-10 (D); P3-12; P3-14 (A); P3-16 (B); </li></ul></ul>
  19. 19. Problems and Cases <ul><li>Case 3-1 </li></ul><ul><ul><li>An asset or an expense? </li></ul></ul><ul><ul><li>The effect of accounting estimates (# of amortization years) on reported numbers </li></ul></ul><ul><ul><li>Exclude one-time charges before we predict future earnings </li></ul></ul>