INTERMEDIATE
ACCOUNTING
CCOUNTING
INTERMEDIATE A
Chapter 4
The Balance Sheet and the Statement of Shareholders’ Equity
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What is the Purpose of the Balance Sheet?
•
The FASB and the IASB have established the balance
sheet as the cornerstone of financial reporting
because it reports the accounting equation,
representing the financial position of the company:
•
Assets = Liabilities + Shareholders’ Equity
• The balance sheet reports the financial position from
two perspectives:
• Specific resources the company controls
• Claims on the company by the persons or entities that
provided the resources, including the creditors and lenders
(liabilities) and investors (shareholders’ equity)
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Articulation of Financial Statements
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Recognition on the Balance Sheet
• To provide relevant and faithfully represented information
about assets, liabilities, and shareholders’ equity, the company
must determine what, how, and where to report the elements
of the balance sheet.
• Step 1. What: Identify the elements that must be recognized.
• Step 2. How: Measure (value) the elements.
• Step 3. Where: Report (classify) the elements.
• Recognition is the process of formally recording and reporting
an element in the financial statements.
• In order to meet the definition of a balance sheet element, an
item must be measurable, relevant and faithfully represented.
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Assets
• Assets are the economic resources used to carry out
a company’s business activities.
• An economic resource must possess all of the following
characteristics to be considered an asset:
• Probable Future Economic Benefit: The resource must be expected to
contribute future economic benefits either directly or indirectly to the
company.
• Control: The company must be able to obtain the future benefit and
control others’ access to it. Control means that the company can deny
or regulate the ability of others to use the asset.
• Acquisition: The transaction or event giving the company the right to
or control over the benefit must have occurred.
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Liabilities
• Liabilities are the probable future sacrifices of economic
benefits arising from a company’s present obligations to
transfer assets or provide services in the future to other entities
as a result of past transactions or events.
• A company’s obligation must have all of the following
characteristics to be recognized as a liability:
• Transfer: It must involve a responsibility that will be settled by a sacrifice
involving the transfer of assets, provision of services, or other use of
assets at a specified or determinable date, on occurrence of a specified
event, or on demand.
• Obligation: The responsibility must obligate the company so that it has
little or no discretion to avoid the future sacrifice.
• Incurred: The transaction, event, or arrangement obligating the company
must have occurred.
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Shareholders’ Equity
• Equity is the residual interest in the assets of a
company after deducting its liabilities.
• Balance sheets separate total shareholders’ equity
into three general categories:
• Contributed capital accounts—amounts invested by
shareholders for an ownership interest in a company
• Earned capital accounts—retained earnings
• Noncontrolling interests—equity capital amounts
invested by minority shareholders in consolidated
subsidiaries
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How Are Elements of
a Balance Sheet Measured?
•
Mixed attribute measurement model
•
Measurement models that reflect historical values include
•
•
•
•
•
Historical cost or acquisition cost (assets) and historical proceeds
Originally incurred obligation amounts (liabilities)
Allocated historical amounts (for assets and liabilities allocated
over time)
Initial present value (assets) and adjusted present value (liabilities)
Measurement models that reflect current values or a
combination of historical and current values include
•
•
•
Fair value (assets and liabilities)
Current replacement cost (assets)
Net realizable value (assets)
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How Are Items Classified and
Reported on the Balance Sheet?
• Assets
• Current assets, Long-term investments, Property, plant,
and equipment, Intangible assets and Other assets
• Liabilities
• Current liabilities, Long-term liabilities and Other
liabilities
• Shareholders’ Equity
• Contributed capital, Common stock, Additional paid-in
capital, Retained earnings and Accumulated other
comprehensive income
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Current Assets
• Current assets are cash and other assets that a
company expects to convert into cash, sell, or
consume within one year or the normal operating
cycle, whichever is longer.
• An operating cycle is the average length of time taken
by a company to convert operational cash
expenditures into operational cash receipts.
• Presented in order of liquidity.
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Types of Current Assets
• Cash (cash on hand and
readily available in checking
and savings accounts) and
cash equivalents (highlyliquid, low-risk securities)
• Short term investments
including investments in
marketable securities (debt,
trading securities, availablefor-sale securities, held-tomaturity securities that will
mature within a year)
• Receivables (accounts
receivable, notes receivable
with short-term maturity
dates)
• Inventories (goods held for
resale, raw materials, work
in process inventories)
• Other Current Assets
(prepaid items that will be
consumed instead of
converted into cash)
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Current Liabilities
• Current liabilities are obligations that the company
expects to settle or satisfy within one year or the
normal operating cycle, whichever is longer.
• Companies commonly report the following types of
current liabilities: payable and accrued expenses,
deferred revenues (unearned revenues), shortterm debt and current maturities of long-term
debt.
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Types of Current Liabilities
• Payables and accrued
expenses obligations for
items (goods or services) that
have been received but not
yet paid
• Deferred revenues
(unearned revenues)
obligations from advance
payments from customers for
the future delivery of goods
or services
• Short-term debt and Current
maturities of long-term
debt short-term financing
instruments that will be paid
within one year or the
operating cycle and the
portions of long- term
financing instruments that
mature during the next
period
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Long-Term Investments
• If a company expects to hold the investment for
more than one year or the operating cycle,
whichever is longer, it is classified as a long-term
investment, or noncurrent investment.
• Reasons that companies invest
• Primary objective is to increase shareholder value
• Appreciation of the market value of the investment
• Income from interest or dividends
• Exercising control over other companies
• Saving cash for specific future purposes
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Property, Plant and Equipment
• The property, plant, and equipment section of a
company’s balance sheet includes the long-lived
tangible assets used in its operations.
• The depreciable costs of all the fixed assets are
allocated to expense over the expected service life of
the asset, except for construction in progress (which will
become depreciable once it is completed and put into
service) and land.
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Intangible Assets
(Slide 1 of 2)
• Intangible assets are noncurrent economic
resources that have no physical or financial nature.
• They generally derive their value from the legal,
intellectual, and intangible benefits they convey to
the company.
• Intangible resources are normally recognized as
assets only when they have been acquired by a
company in an external transaction.
© 2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Intangible Assets
(Slide 2 of 2)
• The following three categories of intangible assets
that have been acquired in external market
transactions:
• Intangible assets with finite useful lives are amortized
over their useful lives and reported on the balance sheet at
their adjusted historical cost.
• Intangible assets with indefinite useful lives are not
amortized but are reviewed for impairment annually.
• Goodwill represents the purchase premium paid when one
company acquires another company and is reviewed for
impairment annually.
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Other Assets
• Other assets include miscellaneous assets that do not
fit in one of the previous categories
• Examples include long-term prepayments (such as for rent,
insurance, or licenses), deferred tax assets (net), assets of a
component of the company that is being discontinued,
advances to officers, security deposits paid by the
company, and assets temporarily restricted by foreign
countries.
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Long-Term Liabilities
• Long-term liabilities (noncurrent liabilities)
obligations that are not expected to settle within
one year or the normal operating cycle (whichever
is longer)
• Most are reported at their present value, unless the
company elects the fair value option.
• Interest rates, maturity values, and other provisions
are disclosed parenthetically on the balance sheet
or in the notes to the financial statements
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Types of Long-Term Liabilities
• Long-term accruals include
obligations that may be
outstanding for many years
including obligations for
pension and other postemployment benefits,
estimated liabilities from
long-term warranties, and
deferred tax liabilities.
• Long-term financing
instruments formal
borrowings to finance the
assets and operations of the
company including long-term
notes payable, capital lease
obligations, mortgages
payable and bonds
payable
• Other liabilities
miscellaneous liabilities that
do not fit into one of the
previous categories
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Shareholders’ Equity
• Shareholders’ equity is the residual interest of the
shareholders in the assets of the corporation, after
deducting the liabilities
• Shareholders’ rights are defined by the laws of the
state granting the corporate charter
• Consists of two components: contributed capital and
earned capital
• A third component can arise when equity capital is
invested by noncontrolling interests
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Contributed Capital
• Contributed capital is recognized when a shareholder acquires
shares directly from the corporation
• Can involve as many as four or more components
•
•
•
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Common stock
Additional paid-in capital
Treasury stock (debit balance)
Preferred stock (different ownership rights from common stock)
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Earned Capital
• Earned capital consists of retained earnings and
accumulated other comprehensive income
• Retained earnings is the total amount of corporate net
income that has been earned but not been distributed to
shareholders as dividends
• Deficit arises when cumulative net losses and/or dividends exceed
cumulative net income
• Accumulated Other Comprehensive Income (Loss) is the
cumulative amount of other comprehensive income (or loss)
• Noncontrolling interests arise when a parent company
consolidates a less than 100% owned subsidiary company’s
financial statements with its own financial statements
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What is the Statement of Shareholders’ Equity?
• Financial statements must include a disclosure of the
ending balances and the changes in its
shareholders’ equity accounts
• The SEC requires a separate financial statement for
publicly traded companies, but smaller companies
and private companies may report it in a
supporting schedule or a note to the financial
statements
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Additional Balance Sheet Disclosures
• Not all the relevant financial information about a
company’s financial position and activities are in the
body of the financial statements
• Many issues may instead be disclosed in
accompanying notes to the financial statements
• Summary of accounting policies
• Fair value and risk of financial instruments
• Loss and gain contingencies
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Summary of Accounting Policies
• Usually the first financial statement note
• Informs external users about the company’s
accounting policies, practices, and methods
• Includes principles relating to revenue recognition
and asset allocation, particularly when these
principles and methods are
• choices from existing acceptable alternatives
• peculiar to the industry in which the company operates
• unusual or innovative applications of GAAP
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Fair Value and Risk of Financial Instruments
• Financial instruments include items such as stocks, bonds, and
notes payable and receivable as well as more exotic instruments
• U.S. GAAP requires disclosure in the notes the fair values of all
financial instruments, whether or not they are measured at fair
value on its balance sheet
• A company is also required to disclose all significant
concentrations of credit risk due to its financial instruments.
• GAAP requires disclosure of the fair value of all derivative
financial instruments on its balance sheet
• A derivative financial instrument derives its value from changes
in the price of the underlying resource to which it is linked
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Loss and Gain Contingencies
• Uncertain situations that exist on the balance sheet
date as to contingent losses or gains are known as
loss contingencies or gain contingencies
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Subsequent Events
• A subsequent event is one that occurs between a
company’s balance sheet date and the date when it issues
its annual report
• An adjustment to the financial statements is required if a
subsequent event provides additional evidence about
conditions that existed on the balance sheet date
• A material subsequent event that does not affect a
company’s closed financial statements is instead disclosed in
a note, in a pro forma (“as if”) statement, or in an
explanatory paragraph in the audit report
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Related Party Transactions
• Transactions between related parties may not be
conducted at arms length and could be viewed as
self-dealing
• GAAP requires certain disclosures by the company
including the following:
• Nature of the relationship involved
• Description of the transactions
• Dollar amounts of the transactions
• Any amounts due to or from the related parties on the
balance sheet date
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How Do We Analyze
Balance Sheet Information?
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