UNDERSTANDING FINANCIAL
STATEMENTS
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BALANCE SHEET – Liabilities &
Stockholders’ Equity
LIABILITIES
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Liabilities- probable future sacrifices of economic
benefits arising from present obligations of a
particular entity to transfer assets or provide services
to other entities in the future, as a result of past
transactions or events.
May be CURRENT or LONG-TERM -- same
criteria of “one-year or operating cycle, whichever is
longer”
Current Liabilities
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Accounts Payable
Short-term Notes Payable
Accrued Liabilities
Unearned Revenues (Deferred Credits)
Current Maturity Portion of Long-term Debt
Deferred Taxes
Long-Term Liabilities
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Notes or Mortgages Payables
Bonds Payable
Leases Payable (capital leases)
Pension Obligations
Post-retirement benefits other than pensions
Deferred Taxes
Warranty Obligations
Contingencies Payable
Accounts Payable
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Usually defined as obligations arising from
purchases of merchandise for resale or of raw
materials
Few valuation or reporting issues
Significant changes from period to period
often result from changes in sales volume
Short-Term Notes Payable
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Promissory notes due within a year (or
operating cycle if more appropriate)
Usually are interest-bearing
Usually reported at face value because of
short-term nature
Accrued Liabilities
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Result from accrual basis of accounting
Represent expenses that have been
INCURRED and thus ACCRUED, but have
NOT BEEN PAID in cash
Examples are Interest Payable and Wages
Payable
Unearned Revenue
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Examples:
Unearned rent revenue
Advances from customers
Sometimes called “deferred credits”
Results from a prepayment received in advance for
services or products
Under accrual accounting, revenue is recognized
when EARNED, not when received in cash -- in this
case, cash flow precedes revenue recognition
Current Maturities - LT Debt
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Represent principal payments (not interest) on
debt that are due within one year
Includes principal payments on notes,
mortgages, bonds, leases
Long-term Liabilities
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Notes or Mortgages Payable
Bonds Payable
Leases Payable (Capital Leases Payable) -
recorded at the present value of expected future cash
outflows starting when the lease begins (PPE will also be
recorded)
(Operating leases are recorded as lease expense and
no liability nor PPE are recorded)
 Pension Obligations - reported at the present value of
expected future cash outflows
 Warranty Obligations - Represent estimated liability
of a firm to repair or replace merchandise that it sells
Long-term Liabilities
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Postretirement benefits other than pensions
An estimate of the obligation for paying medical
insurance premiums or medical expenses of
retired employees and spouses.
These future benefits are accrued as the
employees are working for the company.
Long-term Liabilities
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Contingencies – potential liabilities such as possible
losses assessed in a lawsuit
If the loss is probable, then record the liability and
loss and disclose in a footnote. If the loss is not
estimable, then do not record the liability and loss,
but must disclose in a footnote.
If the loss reasonably possible, then do not record
the liability and loss, but must disclose in a footnote.
If remote, then do not record, must not disclose.
Deferred Income Taxes
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Taxes paid are based on taxable income on Tax Return
Tax expense reported on income statement is based on
FINANCIAL Income Statement
Deferred Income Taxes result from TIMING (temporary)
differences in taxable and financial statement income
Classification may be current or long-term depending on
the asset or liability underlying the temporary difference
Examples:
 depreciation
 pension expense
 installment sale accounting
OWNERS’ EQUITY
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Forms of business contrasted as to owners’ equity
section.
a. Proprietorship: report owners’ equity as a
single capital account.
b. Partnership: report separate capital account for
each partner.
c. Capital account reflects all changes:
investments, withdrawals, earnings, and losses.
d. Corporations report stockholders’ equity,
including contributed capital and retained
earnings.
STOCKHOLDERS’ EQUITY
Common stock, at par value
Preferred stock
Additional Paid-in Capital (also called
Paid- in Capital in Excess of Par)
Retained Earnings
Accumulated Other Comprehensive Income
Less: Treasury Stock (at cost)
Total Stockholders’ Equity
Common Stock and
Additional Paid-In Capital
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Common stock represents ownership of the company
Voting privileges
No fixed return (no required dividend rate)
But over the company’s lifetime the common stock
dividends should be higher than the preferred stock
dividends
Must disclose par value and number shares:
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Authorized
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Issued
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Outstanding
Preferred Stock
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No voting privileges
If company terminates, then their investment is returned
before the common stockholders
Stated dividend rate (i.e., 8%)
Usually annual dividend is not required, but when dividends
are declared by B of D, then the current year preferred stock
dividends would be paid before the common stock dividends.
If “cumulative preferred stock”, then missed dividends (called
dividends in arrears) would be paid first when dividends are
declared by B of D.
If “redeemable preferred stock” (preferred stkhlders are
repaid their investment after a stated period, like bonds), then
the company is not allowed to show in SE section (show
between liabilities and SE section.
Retained Earnings
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Represents the cumulative undistributed
earnings of the business since its inception
Accumulated net income (net loss) less
dividends declared since inception
Current year detail is shown in Statement of
Retained Earnings (Beg. RE+Net IncomeDividends declared= Ending RE)
Only Ending RE balance is shown on BS
Treasury Stock
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Repurchased shares of stock to be retained
and possibly reissued later is called Treasury
Stock.
The stock may be repurchased:
To distribute the stock to employees under
stock option plans or retirement plans.
To prevent a hostile takeover.
Treasury Stock
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The repurchase of a company’s own stock can be
accounted for by one of two methods:
(1) At Cost Method (the amount paid to
repurchase the stock is shown as a separate line
item as a subtraction from stockholders’ equity)
(2) Par Value Method (the amount paid to
repurchase the stock reduces Common Stock and
Additional Paid-In Capital)