05 Balance Sheet

Intermediate
Financial Accounting I
Balance Sheet and

Financial Disclosures
Objectives of the Chapter

1. Identify the major classifications of the
balance sheet.
2. Prepare a classified balance sheet
statement.
3. Discuss the disclosures to financial
statements.
The Balance Sheet and Financial Disclosures
Objectives of the Chapter (contd.)

4. Understand the accounting treatment
for subsequent events.
5. Limitations of the balance sheet.
6. Use financial ratios to study financial
performance of corporations.
Balance Sheet Statement

Usefulness of the Balance Sheet:
Providing information about the
financial position and the capital
structure of a business entity.
Providing information about the
liquidity, solvency (risk assessment),
financial flexibility and operating
capability of a business entity.
Classified Balance Sheet (Kieso, etc. 14th e,, illustration

5-16)
Scientific Products, Inc.
BALANCE SHEET
December 31, 2012
Assets
Current assets
Cash
$42,485
Available-for-sale
securities--at fair value
28,250
Accounts receivable
$165,824
Less allow. for
doub. Accts.
1,850 163,974
Notes receivable
23,000
Inventories -at average cost
489,713
Supplies on hand
9,780
Prepaid expenses The Balance Sheet and Financial Disclosures
16,252
Illustration 5-16 (Contd.)

Scientific Products, Inc.
BALANCE SHEET
December 31, 2012
Prepaid expenses
16,252
Total current assets
$773,454
Long-term investments
Investments in Warren Co.
87,500
Property, plant, and equipment
Land--at cost
125,000
Buildings--at cost
975,800
Less accu. Depr.
341,200 634,600
Total PPE
759,600
Intangible assets
Goodwill
100,000
Total assets
$1,720,554
Illustration 5-16 (contd.)

Liabilities and Stockholders Equity
Current liabilities
N/P to banks
$50,000
Accounts payable
197,532
Accrued int. on N/P
500
Income taxes payable
62,520
Accrued salaries, wages,
and other liabilities
9,500
Deposits received
from customers
420
Total current liabilities
$320,472
Long-term debt
20-year 12% debentures,
due January 1, 2008
500,000
Total liabilities
820,472
Illustration 5-16 (contd.)
Stockholders equity
Paid in on capital stock
Preferred, 7%, cumulative
Authorized, issued,
and outstanding,
30,000 shares of
$10 par value
$300,000
Common-Authorized, 500,000
shares of $1 par value;
issued & outstanding,
400,000 shares
400,000
additional paid-in capital 37,500 737,500
Earnings retained
in the business
162,582
Total stockholders equity
900,082
Total liabilities
and stockholders equity
$1,720,554
Definition of Elements of a Balance

Sheet: (SFAC No. 6)
Assets
Liabilities
Stockholders equity
Assets
Resources with future economic

benefit to a business entity as a result
of a past transaction.
10
Assets (contd.)
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
(fair value), short-term investments (fair
value), receivables (estimated amount
collectible), inventory (LCM), prepaid
expenses).
11
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 (investment in Uncon Subsidiary)
12
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.
13
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).
14
Assets (contd.)
Other Assets: Include assets
sufficiently different from assets in
other categories.
Examples: long-term prepayments,

deferred income tax.
15
Liabilities
Legal obligations required future

payments of assets or services as a
result of a business entitys past
transactions or events.
A. Current Liabilities
B. Long-term Liabilities
C. Other Liabilities
16
A. Current Liabilities
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)
17
Contingencies
Contingent Liabilities
Contingent Losses
Contingent Gains
18
Contingent Liabilities
Obligations may arise because of the

occurrence or not occurrence of future
event(s). (i.e., warranty obligations)
19
Contingent Losses
Losses may arise because of the

event(s).
(i.e., the uncollectable accounts, the
pending lawsuit losses, possible
damage of a fire (or flood))
20
Contingent Gains
Gains may arise because of the

events). (i.e., pending lawsuit gains)
21
Accounting Treatments of
Contingencies
The accounting treatments of the

contingencies depend on the
occurrence probability of the related
future event(s).
22
Contingencies (contd.)
Occurrence probabilities of future event(s):

(SFAS No. 5)
1. Probable: The future event(s) is(are) likely
to occur.
2. Reasonably possible: The chance for the
future event(s) to occur is less than
probable but greater than remote.
3. Remote: The chance of the future event to
occur is unlikely.
23
Contingent Liabilities & Losses
If the future event(s) is(are)

a. probable, and
b. amount of loss (liability) can be
estimated
-- The loss (liability) should be
estimated, and recognized (accrued).
24
Examples
1. B/D Exp.
Allowance for B/D
XXX
XXX
2. Warranty Exp.
XXX
Estimated Warranty Liabilities
XXX
3. Lawsuit Exp.
XXX
Estimated Liability under Litigation

XXX
25
Accounting Treatments of Contingent

Liabilities & Losses (contd.)
If the future event is probable, but the

amount of loss (or liability) CANNOT
be estimated, the contingent loss (or
liability) should only be footnoted (not
accrued).
26
Contingent Gains
If the event is probable and the amount

of contingent gains is determinable,
only footnote the information. NO
unrealized gain can be recognized
under the current accounting standards
(conservatism!).
27
B. Long-Term Liabilities
Obligations are not due in next year or

next operating cycle, whichever is
longer. (i.e., bonds payable, pension
liability)
28
C. Other Liabilities
Long-term advances from customers,

deferred income taxes.
29
Stockholders Equity
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
30
a. Contributed Capital
Par value of common stock
Par value of prefer stock
Paid-in capital in excess of par value

of common stock or preferred stock
31
b. Accumulated Other
Comprehensive Income
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.)
32
c. Retained Earnings
Net income not distributed to

stockholders
appropriated
unappropriated
33
Other Disclosure Issues
APB opinion No. 22 (ASC 235-10-05)

required the disclosure of the following
information as an integral part of the
financial statement (i.e., in the notes):
1. Accounting Policies: All significant
accounting principles and methods such
as :
depreciation method of PPE,
inventory cost flow method and
valuation method (LCM),
revenue recognition principles.
34
Other Disclosure Issues

2. Contingencies.
3. Subsequent Events.
35
Subsequent Event
Significant events occurred after the

fiscal year end but before the issuance
date of the annual report.
36
Subsequent Event - Introduction
Investors should be informed of significant

events such as mergers, acquisitions,
break-ups, spin-offs, issuance of bonds,
issuance of stocks, settlement of litigation,
loss of plant due to flood or fire even if
these events occur after the fiscal year
end. As long as these events occur prior
to the issuance date of the annual reports,
they should be disclosed in the reports.
37
Subsequent Event - Overview
There are two types of subsequent

events:
1. Events require adjustments of
balance sheet statement.
2. Events do not require adjustment of
balance sheet statement but require
disclosure in the footnotes.
38
Events Require Adjustment of B/S
Events with evidence indicates that

conditions existed at or prior to the B/ S date.
Examples: (assume FYE is 12/31/x1 and the
report release date is 3/31/x2)
Bankruptcy
occurred on a major client on

2/1/x2. The bankruptcy condition may exist
for this client prior to 12/31/x1.
Litigation settlement on 2/10/x2. The
condition for this litigation existed prior to
12/31/x1.
39
Events Do Not Require Adjustment

of B/S but Require Disclosure
Examples: (assume FYE is 12/31/x1 and the

report release date is 3/31/x2)
A fire occurred on a major client on 3/1/x2.
Sales of bonds on 2/9/x2.
Loss of inventories due to a fire on

1/20/x2.
Issuance of common stock on 1/30/x2.

40
SEC Regulations
Publicly traded firms need to file the

10-K reports with the SEC. Some of
the SEC regulations for the 10-K
reports are also followed by the firms
in preparing the annual reports.
41
Example A
Comparative financial statements

B/S 2 years
I/S and cash flow statement 3
years
Selected financial data items (i.e., net
sales, operating revenue EPS, total
assets, cash dividends declared)
should have a 5-year data.
42
Example B (MD&A)
Management Discussion and Analysis

(including critical accounting estimates):
Any information useful in assessing cash
flows but not in the B/S (i.e. inflation
impact on sales, liquidity and capital
resources of the firm,) should be
included in the management discussion.
43
MD&A: Critical Accounting Estimates
The estimation of possible losses inherent in

the financial receivables.
The estimation of profits over the multiple-year
terms for revenue recognition on long-term
project services agreements .
The estimates and assumptions needed in
assessing asset impairment for investments,
long-lived assets and goodwill.
Pension assumptions such as discount rate
and expected rate of returns on pension assets.
44
MD&A: Contractual Obligations (required by the

SEC)
The contractual obligations for future payments

as of December 31, 2008 for GE are as follows:
In billions
Total
2009
20102011
2012- 2014 and

2013 thereafter
Borrowings (Note 18)
$523.8
$193.7
$115.6
$79.8 $134.7
Int. on borrowings
142
20
29
18
75
Operating Lease Obli.
6.6
1.3
2.2
1.6
1.5
Purchase Obligations.
63
40
16
Insurance Liabilities
22
11
Other liabilities
97
33
52
Contractual Obl. Of
discontinued. operations
45
Example C
Market Prices and Dividends of

Common Stocks:
The high and low prices for each

quarter in the last two years.
The dividends paid in the last two

years.
46
Other Footnote Disclosures

Earnings
Per Share
Inventories
Employee
Stock Options
Postretirement
Benefit Plans
Leases,
Investment
Purchase
Bond
Securities
Commitment
covenants
Receivables
47
Other Footnote Disclosures (contd.)

Property,
Plant and Equipment
Goodwill
and other Intangible Assets
Allowance
for Losses on Financial

Receivables
Borrowing
Financial
Instruments
Provisions
for income taxes
Off-Balance
Sheet Arrangements
48
Other Footnote Disclosures (contd.)

Fair Value Measurements Disclosure
(SFAS 157,effective 1/1/2008)
Companies report fair value for assets
and liabilities must disclose the fair value
hierarchy level of the fair value
measurements.
49
Fair Value Hierarchy (SFAS 157)

Level 1 (most reliable) measures are based on
quoted prices for identical instruments in
active markets.
Level 2 measures are based on quoted
prices for similar instruments (assets or
liabilities) in active markets.
Level 3 (least reliable) measures are based on
unobservable inputs such companys data or
assumptions.
50
Fair Value Measurements Disclosure :

Footnote 28 of GE 2008 Annual Report
Level 1
Level 2
Level 3
Fin. 39
Netting
Net Bal.
$1,158
$27,332
$12,956
___
$41,446
___
18,911
1,142
(7,411)
12,642
288
1,105
____
1,394
$1,159
$46,531
15,203
$(7,411)
$55,482
$12,643
166
$(7,575)
$ 5,236
____
1,031
____
____
1,031
$13,674
$ 166
Assets
Investment Securities
Derivatives
Others
total
Liabilities
Derivatives
Other
Total
$(7,575)
$6,267
51
Limitations of the Balance Sheet

1. Historical costs reporting for most of
assets and liabilities.
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).
3. the omission of some valuable items
such as goodwill of the company.
4. Off-balance sheet assets and liabilities.
52
Ratio Analysis
Ratio analysis is one of the techniques

that financial analysts use to analyze
the financial statements of firms.
For the purpose of analyzing financial
statements, ratios can be classified into
the following four categories: (see
Exhibit 5-3)
53
Exhibit 5-3
Major Types of Ratios
Liquidity Ratios. Measures of the enterprises shortterm ability to pay its maturing obligations.
Activity Ratios. Measures of how effectively the
enterprise is using the assets employed.
Profitability Ratios. Measures of the degree of
success or failure of a given enterprise or division for
a given period of time.
(Stability Ratios.)
Coverage Ratios. Measures of the degree of
protection for long-term creditors and investors.
54
Exhibit 5-4
Ratio
I. Liquidity
1.Current ratio
2.Quick or acidtest ratio
3.Current cash
debt coverage
ratio
Formula
Current assets
Current liabilities
Cash, marketable
securities, and
receivables (net)
Current liabilities
Net cash provided by
operating activities
Average current
liabilities
Purpose or Use
Measures short-term
debt-paying ability
Measures immediate
short-term liquidity
Measures a companys
ability to pay off its
current liabilities in a
given year from its
operations
55
Exhibit 5-4 (contd.)

Ratio
II. Activity
4.Receivable
turnover
5.Inventory
turnover
6.Asset
turnover
III. Profitability
7.Profit margin
on sales
Formula
Net Credit Sales
Average trade
receivables (net)
Cost of goods sold
Average inventory
Net Sales
Average total assets
Net income
Net sales
Purpose or Use
Measures liquidity of
receivables
Measures liquidity of
inventory
Measures how
efficiently assets are
used to generate
sales
Measures net income
generated by each
dollar of sales
56

Formula
Ratio
III. Profitability(contd.)
Net income
8.Rate of return
Average total assets
on assets
Net income minus
9.Rate of return
preferred dividends
on common
Average common
stock equity
stockholders equity
Net income minus
10.Earnings per
preferred dividends
share
Weighted shares
outstanding
11.Price earningsMarket price of stock
Earnings per share
ratio
Purpose or Use
Measures overall
profitability of assets
Measures profitability
of owners investment
Measures net income
earned on each share
of common stock
Measures the ratio of
the market price per
share to earnings per
share
57

Ratio
III. Profitability(contd.)
12.Payout ratio
IV. Coverage
(Stability Ratios)
13.Debt to total
assets
Formula
Cash dividends
Net income
Total debt
Total assets or equities
Income before int.
14.Time interest charges & taxes
Interest charges
earned
Purpose or Use
Measures % of
earnings distributed in
the form of cash
dividends
Measures the % of
total assets provided
by creditors
Measures ability to
meet interest
payments as they
come due
58

Formula
Ratio
Purpose or Use
IV. Coverage(contd.)
Net cash provided by Measures a
15.Cash debt
coverage ratio operating activities
companys ability to
Average total liabilities repay its total
liabilities in a given
year from its
Common
operations
Stockholders equity
16. Book value
Outstanding shares Measures the
per share
amount each share
would receive if the
company were
liquidated at the
amounts reported on
the balance sheet
59

05 Balance Sheet

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05 Balance Sheet

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Intermediate

Balance Sheet and

Objectives of the Chapter

The Balance Sheet and Financial Disclosures

Objectives of the Chapter (contd.)

The Balance Sheet and Financial Disclosures

Balance Sheet Statement

Classified Balance Sheet (Kieso, etc. 14th e,, illustration

Illustration 5-16 (Contd.)

Illustration 5-16 (contd.)

Illustration 5-16 (contd.)

Definition of Elements of a Balance

The Balance Sheet and Financial Disclosures

Resources with future economic

The Balance Sheet and Financial Disclosures

Nonconsolidated subsidiaries or affiliated

building, Land, Machinery and equipment, capital

and meet the following criteria:

1. Economic life > 1 year;

The Balance Sheet and Financial Disclosures

Examples: long-term prepayments,

The Balance Sheet and Financial Disclosures

Legal obligations required future

Obligations must be fulfilled in one

The Balance Sheet and Financial Disclosures

Obligations may arise because of the

The Balance Sheet and Financial Disclosures

Losses may arise because of the

The Balance Sheet and Financial Disclosures

Gains may arise because of the

The Balance Sheet and Financial Disclosures

The accounting treatments of the

The Balance Sheet and Financial Disclosures

Occurrence probabilities of future event(s):

If the future event(s) is(are)

Estimated Liability under Litigation

Accounting Treatments of Contingent

If the future event is probable, but the

The Balance Sheet and Financial Disclosures

If the event is probable and the amount

The Balance Sheet and Financial Disclosures

Obligations are not due in next year or

The Balance Sheet and Financial Disclosures

Long-term advances from customers,

The Balance Sheet and Financial Disclosures

Residual claims (assets-liabilities) to

Par value of common stock

Par value of prefer stock

Paid-in capital in excess of par value

The Balance Sheet and Financial Disclosures

Increase of assets without outflows of

Net income not distributed to

The Balance Sheet and Financial Disclosures

Other Disclosure Issues

APB opinion No. 22 (ASC 235-10-05)

Other Disclosure Issues

The Balance Sheet and Financial Disclosures

Significant events occurred after the

The Balance Sheet and Financial Disclosures

Subsequent Event - Introduction

Investors should be informed of significant

Subsequent Event - Overview

There are two types of subsequent

Events Require Adjustment of B/S