Balance Sheet: Warfield Weygandt Kieso

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Warfield

Weygandt
Kieso

CHAPTER 4
BALANCE SHEET

INTERMEDIATE ACCOUNTING
Principles and Analysis
2nd Edition
Chapter
4-1
Chapter
Chapter Opener
Opener
 Hi and Good Day MAPUANS!
 Welcome to my class Intermediate
Accounting 3
 Our topic for today is Statement of Financial
Position
 Let’s begin with a story entitled “ There
ought to be a Law”.

Chapter
4-2
““THERE
THERE OUGHT
OUGHT TO
TO BE
BE A
A LAW”
LAW”
 As one manager noted, “There ought to be a
law in this country that before you are allowed
to buy a stock, you have to be able to read a
balance sheet.” We agree and the same can
be said for a statement of cash flows.
 Krispy Kreme Doughnuts provides a good
example of how stunning earnings growth can
hide real problems. Not long ago the
doughnut maker was a glamour stock, with a
60 percent earnings per share growth rate

Chapter
4-3
 and a price-earnings ratio around 70. Seven
months later its stock price had dropped 72
percent. Krispy Kreme, alleged some of its
stockholders, may have been stuffing its
channels with too many doughnuts (inflating
its revenues) and not taking enough bad
debt expense (which inflated both assets and
income). Krispy Kreme also had weak cash
flow from operating activities. Most
financially sound companies throw off
positive cash flow, but Krispy Kreme's cash
Chapter
4-4
 flow was negative. Thus, the company's
quality of earnings was suspect.
 
 For comparison, here are examples of how
one rating agency rated some other
companies' earnings quality, using some key
balance sheet and cash flow measures.

Chapter
4-5
Company Earnings-Quality Indicators
Earnings-Quality  
Winners
Avon Products Strong cash flow
Capital One Conservatively capitalized
Financial
Ecolab Good management of working capital
Timberland Minimal off–balance sheet commitments
Earnings-Quality  
Losers
Ford Motor High debt and underfunded pension plan
Kroger High goodwill and debt
Ryder System Negative free cash flows
Teco Energy Selling assets to meet liquidity needs
Chapter
4-6
These examples illustrate that earnings
declines (and falling stock prices) can often be
predicted by using the balance sheet and
related cash flow information. And just as
deteriorating balance sheets warn of trouble,
improving balance sheet and cash flow
information is a leading indicator of improved
earnings.
Sources: Adapted from Gretchen Morgenson, “How Did They Value Stocks? Count the Absurd Ways,” New York Times on the
Web (March 18, 2001); and K. Badanhausen, J. Gage, C. Hall, and M. Ozanian, “Beyond Balance Sheet Earnings
Quality,” Forbes (January 29, 2005).

Chapter
4-7
 Readers of the financial statements
sometimes ignore important information in
the balance sheet and related cash flow
information. As our opening story shows,
analyzing the balance sheet helps investors
avoid surprises in earnings. In this chapter we
examine the many different types of assets,
liabilities, and stockholders' equity items that
affect the balance sheet, as follows.

Chapter
4-8
Learning
Learning Objectives
Objectives

1. Explain the uses and limitations of a balance sheet.


2. Identify the major classifications of the balance
sheet.
3. Prepare a classified balance sheet using the report
and account formats.
4. Determine which balance sheet information requires
supplemental disclosure.
5. Describe the major disclosure techniques for the
balance sheet.

Chapter
4-9
Balance
Balance Sheet
Sheet

Use and Additional Techniques of


Classification
Limitations Information Disclosure

Usefulness Current assets Contingencies Parenthetical


Limitations Noncurrent Accounting explanations
assets policies Notes
Liabilities Contractual Cross-
Owners’ equity situations reference and
Post–balance- contra items
Format
sheet events Supporting
Fair values schedules
Terminology
Chapter
4-10
Balance
Balance Sheet
Sheet

Usefulness of the Balance Sheet


Evaluating the capital structure.
Assess risk and future cash flows.
Analyze the company’s:
 Liquidity,
 Solvency, and
 Financial flexibility.

Chapter
4-11 LO 1 Explain the uses and limitations of a balance sheet.
Balance
Balance Sheet
Sheet

Review:
Financial flexibility measures the ability
of an enterprise to take effective
actions to alter the amounts and timing
of cash flows.

True False

Chapter
4-12 LO 1 Explain the uses and limitations of a balance sheet.
Balance
Balance Sheet
Sheet

Limitations of the Balance Sheet


Use of historical cost.
Use of judgments and estimates.
Many items of financial value are omitted.

Chapter
4-13 LO 1 Explain the uses and limitations of a balance sheet.
Balance
Balance Sheet
Sheet

Classification in the Balance Sheet


Three General Classifications
Assets, Liabilities, and Stockholders’ Equity
Companies further divide these classifications:

Illustration 4-1
Balance Sheet
Classifications

Chapter
4-14 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
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 4-2
Accounts and
basis of valuation

Chapter
4-15 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Review
The correct order to present current assets is
a. Cash, Accounts Receivable, Prepaid Items,
Inventories.
b. Cash, Accounts Receivable, Inventories, Prepaid
Items.
c. Cash, Inventories, Accounts Receivable, Prepaid
Items.
d. Cash, Inventories, Prepaid Items, Accounts
Receivable.

Chapter
4-16 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Review:
An asset which is expected to be converted
into cash, sold, or consumed within one year of
the balance sheet date is always reported as a
current asset.

True False

Chapter
4-17 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Cash
Generally any monies available “on demand.”
Cash equivalents are short-term highly liquid
investments that will mature within three
months or less.
Any restrictions or commitments must be
disclosed. Illustration 4-3

Chapter
4-18 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Short-Term Investments

Portfolios Type Valuation Classification

Held-to- Amortized Current or


Debt
Maturity Cost Noncurrent

Trading Debt or Equity Fair Value Current

Available- Current or
Debt or Equity Fair Value
for-Sale Noncurrent

Chapter
4-19 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Short-Term Investments
Illustration 4-5 Balance
Sheet Presentation

Chapter
4-20 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Receivables
Claims held against customers and others for
money, goods, or services.

Accounts Receivable – oral promises

Notes Receivable – written promises

Major categories of receivables should be shown in


the balance sheet or the related notes.

Chapter
4-21 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”
Accounts Receivable – Presentation Options
Current assets:
11
Cash $ 346
Accounts receivable 500
Less: Allowance for doubtful accounts 25 475
Inventory 812
Total current assets $1,633

Current assets:
22
Cash $ 346
Accounts receivable, net of $25 allowance 475
Inventory 812
Total current assets $1,633

Chapter
4-22 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”
Accounts Receivable
Illustration 4-6
Balance Sheet Presentation

Chapter
4-23 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Inventories
Company discloses:

basis of valuation (e.g., lower-of-cost-or-


market) and

the method of pricing (e.g., FIFO or LIFO).

Chapter
4-24 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Inventories
Illustration 4-7 Balance
Sheet Presentation

Chapter
4-25 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:


insurance rent
supplies maintenance on equipment
advertising
Chapter
4-26 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Current
“Current Assets”
Assets”

Prepaid Expenses
Illustration 4-9
Balance Sheet Presentation

Chapter
4-27 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”

Long-Term Investments
Generally consists of four types:
Securities
Tangible fixed assets
Special funds
Nonconsolidated subsidiaries or
affiliated companies.

Chapter
4-28 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Long-Term Current assets

Investments Cash $ 285,000

Investments:
Securities Invesment in ABC bonds 321,657
Investment in UC Inc. 253,980
bonds, Notes receivable 150,000
Land held for speculation 550,000
stock, and Sinking fund 225,000
long-term notes Pension fund 653,798
Cash surrender value 84,321
For marketable securities, Investment in Uncon. Sub. 457,836
management’s intent Total investments 2,696,592
Property, Plant, and Equip.
determines current or
Building 1,375,778
noncurrent classification.
Land 975,000
Chapter
4-29 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Long-Term Current assets

Investments Cash $ 285,000

Investments:
Invesment in ABC bonds 321,657
Fixed
Fixed Assets
Assets Investment in UC Inc. 253,980
Notes receivable 150,000
Land held for Land held for speculation 550,000
Sinking fund 225,000
speculation
Pension fund 653,798
Cash surrender value 84,321
Investment in Uncon. Sub. 457,836
Total investments 2,696,592
Property, Plant, and Equip.
Building 1,375,778
Land 975,000
Chapter
4-30 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Long-Term Current assets

Investments Cash $ 285,000

Investments:
Invesment in ABC bonds 321,657
Special Funds Investment in UC Inc. 253,980
Notes receivable 150,000
Sinking fund Land held for speculation 550,000
Sinking fund 225,000
Pensions fund Pension fund 653,798
Cash surrender value 84,321
Cash surrender
Investment in Uncon. Sub. 457,836
value of life Total investments 2,696,592
insurance Property, Plant, and Equip.
Building 1,375,778
Land 975,000
Chapter
4-31 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Long-Term Current assets

Investments Cash $ 285,000

Investments:
Invesment in ABC bonds 321,657
Investment in UC Inc. 253,980
Notes receivable 150,000
Land held for speculation 550,000
Sinking fund 225,000
Nonconsolidated Pension fund 653,798
Cash surrender value 84,321
Subsidiaries or Investment in Uncon. Sub. 457,836
Affiliated Total investments 2,696,592
Property, Plant, and Equip.
Companies Building 1,375,778
Land 975,000
Chapter
4-32 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Property, Plant, and Current assets
Cash $ 285,000
Equipment
Total investments 2,696,592
Property, Plant, and Equip.
Assets of a durable Building 1,375,778
nature used in the Land 975,000
Machinery and equipment 234,958
regular operations Capital leases 384,650
of the business. Leasehold improvements 175,000
Accumulated depreciation (975,000)
Total PP&E 2,170,386
Intangibles
Goodwill 3,000,000
Patents 177,000
Trademarks 40,000
Chapter
4-33 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Review:
Land held for speculation is reported in the
property, plant, and equipment section of the
balance sheet.

True False

Chapter
4-34 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Intangibles Current assets
Cash $ 285,000
Lack physical Accumulated depreciation (975,000)
substance and are not Total PP&E 2,170,386
financial instruments. Intangibles
Goodwill 2,000,000
Limited life Patents 177,000
intangibles amortized. Trademark 40,000
Franchises 125,000
Indefinite-life Copyright 55,000
Total intangibles 2,397,000
intangibles tested for
Other assets
impairment. Prepaid pension costs 133,000
Deferred income tax 40,000
Total other 173,000
Chapter
4-35 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Exercise”
“Exercise”
Exercise Mickey Snyder Corporation’s adjusted trial balance
contained the following asset accounts at December 31, 2008:
Prepaid Rent $12,000; Goodwill $40,000; Franchise Fees
Receivable $2,000; Franchises $47,000; Patents $33,000;
Trademarks $10,000. Prepare the intangible assets section of the
balance sheet.
Intangibles
Goodwill $ 40,000
Franchises 47,000
Patents 33,000
Trademarks 10,000
Total $130,000

Chapter
4-36 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Noncurrent
“Noncurrent Assets”
Assets”
Balance Sheet (in thousands)
Other Assets Current assets
Cash $ 285,000

This section should Intangibles


Goodwill 2,000,000
include only unusual
Patents 177,000
items sufficiently Trademark 40,000
different from assets Franchises 125,000
Copyright 55,000
in the other Total intangibles 2,397,000
categories. Other assets
Prepaid pension costs 133,000
Deferred income tax 40,000
Total other 173,000
Total Assets $ 9,210,978

Chapter
4-37 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Current Liabilities Balance Sheet (in thousands)


Current liabilities
Notes payable $ 233,450
“Obligations that a Accounts payable 131,800
company reasonably Accrued compensation 43,000
Unearned revenue 17,000
expects to liquidate Income tax payable 23,400
either through the use Current maturities LT debt 121,000
Total current liabilities 569,650
of current assets or the Long-term liabilities
creation of other Long-term debt 979,500
current liabilities.” Obligations capital lease 345,800
Deferred income taxes 77,909
Total long-term liabilities 2,093,859
Stockholders' equity

Chapter
4-38 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Long-Term Liabilities Balance Sheet (in thousands)


Current liabilities
Notes payable $ 233,450
“Obligations that a Accounts payable 131,800
company does not Accrued compensation 43,000
Unearned revenue 17,000
reasonably expect to Income tax payable 23,400
liquidate within the Current maturities LT debt 121,000
Total current liabilities 569,650
normal operating cycle.” Long-term liabilities
Long-term debt 979,500
Obligations capital lease 345,800
All covenants and Deferred income taxes 77,909
restrictions must be Total long-term liabilities 2,093,859
disclosed. Stockholders' equity

Chapter
4-39 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet –– “Exercise”
“Exercise”
Exercise Included in Ewing Company’s December 31, 2008, trial
balance are the following accounts: Accounts Payable $240,000;
Pension Liability $375,000; Discount on Bonds Payable $24,000;
Advances from Customers $41,000; Bonds Payable $400,000;
Wages Payable $27,000; Interest Payable $12,000; Income Taxes
Payable $29,000. Prepare the long-term liabilities section of the
balance sheet.
Long-term liabilities
Pension liability $375,000
Bonds payable 400,000
Discount on bonds payable (24,000)
Total 751,000

Chapter
4-40 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet

Owners’ Equity
Companies usually divide equity into three parts,
(1) Capital Stock, (2) Additional Paid-In Capital,
and (3) Retained Earnings.
Illustration 4-15
Balance Sheet Presentation

Chapter
4-41 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet Classification
Classification Exercise
Exercise
Account Classification
(a) Investment in Preferred Stock (a) Current asset/Investment
(b) Treasury Stock (b) Equity
(c) Common Stock (c) Equity
(d) Cash Dividends Payable (d) Current liability
(e) Accumulated Depreciation (e) Contra-asset
(f) Interest Payable (f) Current liability
(g) Deficit (g) Equity
(h) Trading Securities (h) Current asset
(i) Unearned Revenue (i) Current liability

Chapter
4-42 LO 2 Identify the major classifications of the balance sheet.
Balance
Balance Sheet
Sheet -- Format
Format

Classified Balance Sheet


Account form
Report form

Accounting Trends and Techniques—2004 (New York:


AICPA) indicates that all of the 600 companies surveyed
use either the “report form” (506) or the “account
form” (94), sometimes collectively referred to as the
“customary form.”

Chapter
4-43 LO 3 Prepare a classified balance sheet using the report and account formats.
Additional
Additional Information
Information Reported
Reported

There are normally five types of


information that are supplemental to
account titles and amounts presented in
the balance sheet:
Contingencies
Accounting Policies
Contractual Situations
Post-Balance-Sheet Disclosures
Fair Values
Chapter LO 4 Determine which balance sheet information
4-44 requires supplemental disclosure.
Additional
Additional Information
Information Reported
Reported
Post-Balance-Sheet Disclosures

Two Types:
1. Events that provide evidence about conditions that existed at the
balance sheet date.
2. Events that provide evidence about conditions that did not exist at
the balance sheet date.
Chapter LO 4 Determine which balance sheet information
4-45 requires supplemental disclosure.
Techniques
Techniques of
of Disclosure
Disclosure

Parenthetical Explanations

Notes

Cross-Reference and Contra Items

Supporting Schedules

Terminology

Chapter
4-46 LO 5 Describe the major disclosure techniques for the balance sheet.

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