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WILEY

A Further Look at Financial

Statements

Kimmel ● Weygandt
Survey of Accounting, First Edition
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 CHAPTER OUTLINE
LEARNING OBJECTIVES

1 Identify the sections of a classified balance sheet.

Use ratios to evaluate a company’s profitability,

2 liquidity, and solvency.

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 Identify the sections of a classified
LEARNING
OBJECTIVE 1 balance sheet.

 Presents a snapshot at a point in time.

 To improve understanding, companies group similar

assets and similar liabilities together.

Standard Classifications

Assets Liabilities and Stockholders’ Equity

Current assets Current liabilities
Long-term investments Long-term liabilities
Property, plant, and equipment Stockholders’ equity
Intangible assets
ILLUSTRATION 2-1
Standard balance sheet classifications
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 ILLUSTRATION 2-2
Classified balance sheet

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 ILLUSTRATION 2-2
Classified balance sheet

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 THE CLASSIFIED BALANCE SHEET

CURRENT ASSETS
 Assets that a company expects to convert to cash or
use up within one year or the operating cycle,
whichever is longer.

 Operating cycle is the average time it takes from the

purchase of inventory, to the sale of goods, and then
to the collection of cash from customers.

 Common types of current assets are (1) cash, (2)

investments, (3) receivables, (4) inventories, and (5)
prepaid expenses.
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 THE CLASSIFIED BALANCE SHEET

CURRENT ASSETS ILLUSTRATION 2-3

Current assets section

Companies list current asset accounts in the order they expect to

convert them into cash.

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 THE CLASSIFIED BALANCE SHEET

Review Question
Cash, and other resources that are reasonably expected to
be realized in cash or sold or consumed in the business
within one year or the operating cycle, are called:

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

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 THE CLASSIFIED BALANCE SHEET

LONG-TERM INVESTMENTS
 Investments in stocks and bonds of other corporations
that are held for more than one year.
 Long-term assets such as land or buildings that a
company is not currently using in its operating activities.
 Long-term notes receivable.
ILLUSTRATION 2-4
Long-term investments section

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 THE CLASSIFIED BALANCE SHEET

PROPERTY, PLANT, AND EQUIPMENT

 Long useful lives. Alternative Terminology
Property, plant, and equipment is
sometimes called fixed assets or
 Currently used in operations. plant assets.

 Includes land, buildings, equipment, delivery vehicles,

and furniture.

 Depreciation - allocating the cost of assets to a number

of years.

 Accumulated depreciation - total amount of

depreciation expensed thus far in the asset’s life.

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 PROPERTY, PLANT, AND EQUIPMENT

ILLUSTRATION 2-5
Property, plant, and equipment section

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 THE CLASSIFIED BALANCE SHEET

INTANGIBLE ASSETS ▼Helpful Hint

Sometimes intangible
assets are reported
 Assets that do not have physical under a broader
heading called “Other
substance. assets.”

 Includes goodwill, patents, copyrights,

and trademarks or trade names.

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 THE CLASSIFIED BALANCE SHEET

INTANGIBLE ASSETS ILLUSTRATION 2-6

Intangible assets section

Illustration 2-6

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 THE CLASSIFIED BALANCE SHEET

Review Question
Patents and copyrights are

a. Current assets.

b. Intangible assets.

c. Long-term investments.

d. Property, plant, and equipment.

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 Assets Section of Classified Balance
DO IT! 1a Sheet

Baxter Hoffman recently received the following information

related to Hoffman Corporation’s December 31, 2017, balance
sheet.
Prepaid insurance $ 2,300 Inventory $3,400
Cash 800 Accumulated depreciation—
Equipment 10,700 equipment 2,700
Accounts receivable 1,100
Prepare the assets section of Hoffman Corporation’s classified
balance sheet.

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 Prepare the assets section of the classified balance sheet.
Prepaid insurance $ 2,300 Inventory $3,400
Cash 800 Accumulated depreciation—
Equipment 10,700 equipment 2,700
Accounts receivable 1,100

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 THE CLASSIFIED BALANCE SHEET

CURRENT LIABILITIES
 Obligations the company is to pay within the next year
or operating cycle, whichever is longer.

 Common examples are accounts payable, salaries and

wages payable, notes payable, interest payable, and
income taxes payable.

 Also included as current liabilities are current maturities

of long-term obligations—payments to be made within
the next year on long-term obligations.

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 THE CLASSIFIED BALANCE SHEET

CURRENT LIABILITIES

ILLUSTRATION 2-7
Current liabilities section

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 THE CLASSIFIED BALANCE SHEET

LONG-TERM LIABILITIES
 Obligations a company expects to pay after one year.

 Include bonds payable, mortgages payable, long-term

notes payable, lease liabilities, and pension liabilities.

ILLUSTRATION 2-8
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Long-term liabilities section LO 1
 THE CLASSIFIED BALANCE SHEET

Review Question
Which of the following is not a long-term liability?

a. Bonds payable.

b. Current maturities of long-term debt.

c. Long-term notes payable.

d. Mortgages payable.

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 THE CLASSIFIED BALANCE SHEET

STOCKHOLDERS’ EQUITY
 Common stock - investments of assets into the business by the
stockholders.

 Retained earnings - income retained for use in the business.

Stockholders’ Equity section for Franklin Corporation

ILLUSTRATION 2-2

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 DO IT! 1b Balance Sheet Classifications

Match each of the items to its proper balance sheet classification, shown below. If
the item would not appear on a balance sheet, use “NA.”
Current assets (CA) Current liabilities (CL)
Long-term investments (LTI) Long-term liabilities (LTL)
Property, plant, and equipment (PPE) Stockholders’ equity (SE)
Intangible assets (IA)

Solution
CL Salaries and wages payable LTI Investment in real estate
NA Service revenue PPE Equipment
CL Interest payable PPE Accumulated depreciation
IA Goodwill CA Debt investments (short-term)
NA Depreciation expense SE Retained earnings
LTL Mortgage payable CL Unearned service revenue
(due in 3 years)
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 Use ratios to evaluate a company’s
LEARNING
OBJECTIVE 2 profitability, liquidity, and solvency.

RATIO ANALYSIS
 Ratio analysis expresses the relationship among
selected items of financial statement data.

 A ratio expresses the mathematical relationship

between one quantity and another.

 A single ratio by itself is not very meaningful.

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 RATIO ANALYSIS

ILLUSTRATION 2-9
Financial ratio classifications

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 USING THE INCOME STATEMENT

Illustration 2-10

ILLUSTRATION 2-10
Best Buy’s income statement

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 Earnings per Share Profitability
Ratio

Illustration: Earnings per share (EPS) measures the net income

earned on each share of common stock.

2-27 ILLUSTRATION 2-11 LO 2

Best Buy’s earnings per share
 USING THE INCOME STATEMENT

Review Question
For 2017 Stoneland Corporation reported net income
$26,000; net sales $400,000; and average shares
outstanding 6,000. There were preferred stock dividends of
$2,000. What was the 2017 earnings per share?

a. $4.00

b. $0.06 $26,000 - $2,000

= $4.00
c. $16.67 6,000

d. $66.67

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 USING A
CLASSIFIED
BALANCE
SHEET

Illustration 2-12
Best Buy’s
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 USING A CLASSIFIED BALANCE SHEET

Liquidity—the ability to pay obligations expected to become

due within the next year or operating cycle.

Working capital is the difference between the amounts of

current assets and current liabilities.

ILLUSTRATION 2-13
Working capital
Best Buy had working capital in
2014 of $3,049 million ($10,485
million − $7,436 million).

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 USING A CLASSIFIED BALANCE SHEET

Liquidity ratios measure the short-term ability to pay maturing

obligations and to meet unexpected needs for cash.

2014

ILLUSTRATION 2-14
Current ratio
For every dollar of current liabilities, Best
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Buy has $1.41 of current assets. LO 2
 ACCOUNTING ACROSS THE ORGANIZATION
Can a Company Be Too Liquid?
There actually is a point where a company can be too liquid—that is, it can
have too much working capital. While it is important to be liquid enough to be
able to pay short-term bills as they come due, a company does not want to tie
up its cash in extra inventory or receivables that are not earning the company
money. By one estimate from the REL Consultancy Group, the thousand
largest U.S. companies had cumulative excess working capital of $1.017
trillion in a recent year. This was an 18% increase, which REL said
represented a“ deterioration in the management of operations.” Given that
managers throughout a company are interested in improving profitability, it is
clear that they should have an eye toward managing working capital. They
need to aim for a “Goldilocks solution”—not too much, not too little, but just
right.
Source: Maxwell Murphy, “The Big Number,” Wall Street Journal (November
9, 2011).
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 USING A CLASSIFIED BALANCE SHEET

Solvency—the ability to pay interest as it comes due and to

repay the balance of a debt due at its maturity.

Solvency ratios measure the ability of the company to

survive over a long period of time.

▼Helpful Hint Some users evaluate solvency

using a ratio of liabilities divided by stockholders’
equity. The higher this “debt to equity” ratio, the
lower is a company’s solvency.

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 USING A CLASSIFIED BALANCE SHEET

Debt to assets ratio measures the percentage of total

financing provided by creditors rather than stockholders.

ILLUSTRATION 2-15
Debt to assets ratio
The 2014 ratio means that every dollar of
assets was financed by 72 cents of debt.
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 INVESTOR INSIGHT

When Debt Is Good

Debt financing differs greatly across industries and companies.
Here are some debt to assets ratios for selected companies in a
recent year:
Debt to
Assets Ratio
Google 23%
Nike 41%
Microsoft 48%
ExxonMobil 48%
General Motors 74%

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 USING THE STATEMENT OF CASH FLOWS

In the Statement of Cash Flows, cash provided by operating

activities fails to take into account that a company must invest
in new property, plant, and equipment and must maintain
dividends at current levels to satisfy investors.

Free cash flow describes the net cash provided by operating

activities after adjusting for capital expenditures and dividends
paid.

ILLUSTRATION 2-16
Free cash flow

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 USING THE STATEMENT OF CASH FLOWS

Illustration: MPC produced and sold 10,000 personal computers this

year. It reported $100,000 cash provided by operating activities. In
order to maintain production at 10,000 computers, MPC invested
$15,000 in equipment. It chose to pay $5,000 in dividends. Calculate
free cash flow.

Cash provided by operating activities $100,000

Less: Expenditures on property, plant, and equipment -15,000
Dividends paid - 5,000
Free cash flow $ 80,000

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 DO IT! 2 Ratio Analysis
The following information is available for Ozone Inc.
2017 2016
Current assets $ 88,000 $ 60,800
Total assets 400,000 341,000
Current liabilities 40,000 38,000
Total liabilities 120,000 150,000
Net income 100,000 50,000
Net cash provided by operating activities 110,000 70,000
Preferred dividends 10,000 10,000
Common dividends 5,000 2,500
Expenditures on PP&E 45,000 20,000
Shares outstanding at beginning of year 60,000 40,000
Shares outstanding at end of year 120,000 60,000
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 DO IT! 2 Ratio Analysis
(a) Compute earnings per share for 2017 and 2016 for Ozone.
Ozone’s primary competitor, Frost Corporation, had earnings
per share of $2 in 2017.

SOLUTION
Earnings per
share

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 DO IT! 2 Ratio Analysis
(b) Compute the current ratio and debt to assets ratio for 2017.

SOLUTION

Current
Ratio

Debt to Assets
ratio

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 DO IT! 2 Ratio Analysis
(c) Compute free cash flow for each year.

SOLUTION
2017 2016
Net cash provided by
operating activities $110,000 $70,000
Expenditures on PP&E − 45,000 − 20,000
Preferred dividend − 10,000 − 10,000
Common dividends − 5,000 − 2,500
$ 50,000 $ 37,500

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 COPYRIGHT

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