Elements of the balance sheet - PowerPoint - PowerPoint by Hhna5v1

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									The Balance Sheet Statement
Learning Objectives
1.How balance sheet accounts are measured,
classified and presented.
2.How   balance sheet information is used.
3.Balance  sheet terminology and format
outside the U.S.
4.How footnotes aid to the understanding
of the firm’s accounting policies, contingent
liabilities, subsequent events, and related-
party transactions
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The Accounting Equation

 Assets = Liabilities + Equity

     Shareholders’ Equity:
      What’s left of the company’s assets
      after paying off liabilities.
    It also referred to as net assets.


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Balance sheet classification:
Overview

         ASSETS          =   LIABILITIES         +      EQUITY


 • Currentassets
 • Property, plant and        • Current  liabilities
   equipment
                              • Long-term debt
 • Investments
 • Other assets
                              • Other liabilities
                                                • Preferred and        Contributed
                                                  common stock         Capital
                                                • Additional paid-in
                                                   capital
                                                • Retained earnings

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Elements of the balance sheet
      How the money is
         invested                 Where the money came from


          ASSETS           =    LIABILITIES         +     EQUITY


 • Probablefuture economic benefits
 • Obtained from past transactions or events
                   • Probable  future sacrifices of economic benefits
                   • Arising from present obligations
                   • To transfer assets or provide services in the future
                   • As a result of past transactions or events
                                                    • The residual interest in net asset


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     Balance sheet Classification and Account
     Measurement - Current assets




Amortized cost
or current
market value
  Net
  realizable
  value




                 Lower of cost or
                 current market
                 value

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Assets – classification and measurement
n   Resources with future economic benefit to a
    business entity as a result of a past transaction.
n   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, short-
      term investments (reported at the fair value),
      receivables (estimated amount collectible),
      inventory (LCM), prepaid expenses, etc.

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Balance Sheet Classification and Account
Measurement -PPE, Investments and Intangibles




    Historical cost minus
    accumulated
    depreciation except that
    fair market value is used
    when “impaired”


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  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

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 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.
                                                   9
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).
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     Balance Sheet Classification and
     Measurement - Liabilities


  Amount due
  at maturity

  Historical
       cost




Discounted
present
value




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Liabilities

n   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
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A. Current Liabilities

n   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)
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Contingent Liabilities

n   Obligations may arise because of the
    occurrence or not occurrence of
    future event(s). (i.e., warranty
    obligations)




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B. Long-Term Liabilities

n   Obligations are not due in next year
    or next operating cycle, whichever is
    longer. (i.e., bonds payable, pension
    liability)




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C. Other Liabilities

n   Long-term advances from customers,
    deferred income taxes.




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Balance Sheet Classification and Account
Measurement -Stockholders’ equity

Historical
par value


 Historical
 cost




Combination of
different
measurement
bases

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Stockholders’ Equity

n   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

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a. Contributed Capital

n   Par value of common stock
n   Par value of prefer stock
n   Paid-in capital in excess of par value
    of common stock or preferred stock



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b. Accumulated Other Comprehensive
Income
n   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.)

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c. Retained Earnings

 n   Net income not distributed to
     stockholders
     u   appropriated
     u   unappropriated



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Balance sheet information

                          1. Rates of return   ROA and ROCE


                          2. Capital structure Debt vs. Equity
    ASSETS
                 Helps
                 assess
                           3. Liquidity        Cash conversion
   LIABILITIES
        +
     EQUITY
                           4. Solvency         Ability to pay debt


                            5. Flexibility     Operating and financial
 Balance Sheet




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1. Rate of Return Ratios
    ROA (return on assets) and ROCE (return on
    common equity) ratios:
     Evaluate operating efficiency and profitability.
    ROA =
     Net operating profit after taxes (NOPAT) /
      Average assets

    ROCE =
    (Net income – Preferred dividends) / Average
      common shareholders’ equity

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2. Capital Structure

 The balance sheet provides critical
 information for understanding an
 entity’s capital structure.
 Capital structure refers to how much
 of an entity’s assets are financed from
 debt versus equity sources.


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3. Liquidity Ratios

   Liquidity measures how readily assets can
    be converted to cash relative to how soon
    liabilities will have to be paid in cash.
   Current ratio: Indicate the level of current
    resources available to pay current debts.
    Current Ratio = Current Assets / Current
     Liabilities
   Question:
    Does higher ratio always indicate better
    financial status?
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4. Solvency
   Solvency defines the ability of a company
    to generate sufficient cash flows to
    maintain its productive capacity and still
    able to pay off the long-term debt.
   Debt ratios provide information about the
    amount of long-term debt in a company’s
    financial structure.
   Long-term debt to assets =
                   Long term debt/Total assets

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Solvency (contd.)

   A company that can not make timely
    payments in the amount required
    becomes insolvent and may be
    compelled to reorganize or liquidate.




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5. Flexibility

   Flexibility refers to the ability to adapt or
    revise to a new strategy for different
    circumstances.
   The ability to adjust to unexpected
    downturn in the economic environment
    in which it operates or to take
    advantage of profitable investment
    opportunities when they arise.
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                             Which company is:
Analytical insights:          Deere
                              E-Trade
Understanding the business    Potomac Electric Power
                              Wal-Mart




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Balance sheet presentation:
International differences


     U.S. Format:               U.K. Format:
      Current Assets             Fixed Assets
                  +                          +
      Long-lived Assets          Current Assets
                                             -
                  =              Current Liabilities
      Current Liabilities
                                             -
                                 Non-current Liabilities
                  +
      Non-current Liabilities                =
                  +
      Stockholders’ Equity       Capital Employed




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Financial statement footnotes
   Footnotes are an integral part of
    companies’ financial reports.
   These “notes” help users better
    understand and interpret the numbers
    presented in the body of the financial
    statements.
   Three important notes:
    1. Summary of significant accounting
       policies.
    2. Subsequent event disclosures.
    3. Related party transactions            31
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Limitations of the Balance Sheet
n   1. Historical costs reporting for most
    of assets and liabilities.
n   2. Estimations involved in the value of
    some assets and liabilities (i.e., the net
    realizable value of accounts receivable
    and the cost of warranty).
n   3. the omission of some valuable items
    such as goodwill of the company.
n   4. Off-balance sheet liabilities.
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Summary
1.   The balance sheet shows the assets
     owned by a company at a given point in
     time, and how those assets are
     financed (debt vs. equity).
2.   Be alert for differences in balance
     sheet measurement bases, account
     titles, and statement format.
3.   Financial statement footnotes provide
     important information..

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