Chapter 4
The Balance Sheet and
the Statement of Changes
in Stockholders’ Equity
Intermediate Accounting 11th edition
Nikolai Bazley Jones
An electronic presentation
By Norman Sunderman
and Kenneth Buchanan
Angelo State University
COPYRIGHT © 2010 South-Western/Cengage Learning
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FASB Statement of Concepts No. 5
FASB Statement of Concepts
No. 5 recommends that a full
set of financial statements for
an accounting period should
show a company’s...
3
FASB Statement of Concepts No. 5
1.
2.
3.
4.
5.
Financial position at the end of the period
Net income for the period
Comprehensive income for the period
Cash flows for the period
Investments by and distributions to owners for
the period
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Basic Accounting Equation
Assets = Liabilities + Stockholders’
Equity
Economic Economic
resources obligations
Net assets
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Liquidity
The term liquidity is
used to describe how
quickly an asset can
be converted into
cash or a liability
paid.
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Financial Flexibility
Financial flexibility refers to the
ability of a company to use its
financial resources to adapt to
change.
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Operating Capability
Operating
capability refers
to the ability of a
company to
maintain a given
physical level of
operations.
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Three-Stage Process for Disclosing Information on the Balance Sheet
1. Identification of what items meet the definition
of the elements
2. Measurement (valuation) of the elements
3. Reporting (classification) of the elements
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Elements of the Balance Sheet: Assets
Assets are probable future economic
benefits obtained or controlled by a
company as a result of past transactions or
events.
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Elements of the Balance Sheet: Assets
1. The resource must be able to contribute
directly or indirectly to the company’s future
net cash inflows.
2. The company must be able to obtain the future
benefit and control others’ access to it.
3. The transaction or event giving the company
the right to or control over the benefit must
have occurred.
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Elements of the Balance Sheet: Liabilities
Liabilities are probable future
sacrifices of economic benefits
arising from present
obligations...
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Elements of the Balance Sheet: Liabilities
…of a company to transfer assets or
provide services in the future as a
result of past transactions or events.
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Elements of the Balance Sheet: Stockholders’ Equity
Stockholders’
Assets = Liabilities +
Equity
Equity is the residual
interest in the assets of a
company that remains after
deducting its liabilities.
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Measurement (Valuation) of the Elements of the Balance Sheet
Historical cost is the
exchange price in the
transaction in which an
asset was acquired.
The present value of an asset
is the net amount of
discounted future cash inflows
less the discounted future cash
outflows relating to the asset.
Fair value is the
price that a company
would receive to sell
an asset (or transfer a
liability) in an
orderly transaction
between market
participants on the
date of measurement.
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Fair Value Measurement
Need Fair Value
Select Highest Appropriate Level of Input for
Valuation (Hierarchy of Valuation Methods)
 Level 1: Quoted Price for Identical Asset (or
Liability) in Active Market
 Level 2: Adjusted Quoted Price (Exit Value) for
Similar Asset (or Liability)
 Level 3: Unobservable Inputs (e.g., Present
Value of Expected Cash Flows)
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Fair Value Measurement
Use Valuation Method Consistent with
 Market Approach (Identical or Comparable
Assets or Liabilities)
 Income Approach (Present Value)
 Cost Approach (Replacement Cost)
Measure Best Fair Value
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Limitations of the Balance Sheet
 The use of historical cost to value assets and
liabilities does not help users assess the likely
amounts of future cash flows.
 “Human resources” such as high-quality
management or highly creative employees are
not included as assets.
 Many of the amounts that a company reports
are based on estimates.
 In periods of inflation, some amounts listed do
not show the “purchasing power” of assets and
liabilities.
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Current Assets
Current assets are cash and
other assets that are expected to
be converted into cash, sold, or
consumed within one year or the
normal operating cycle,
whichever is longer.
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Operating Cycle
An operating cycle is the average time
taken by a company to spend cash for
inventory,...
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Operating Cycle
…process and sell the inventory, and
collect the receivables, converting
them back into cash.
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Current Assets
Cash equivalents are
risk-free securities, such
as money market funds
and treasury bills that
will mature in three
months or less from the
date acquired by the
holder.
Cash includes cash
on hand and readily
available in checking
and savings
accounts.
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Current Assets
Temporary investments in
marketable securities
include debt and equity
securities that are classified
as “trading securities,”
“available-for-sale
securities,” and “held-tomaturity” securities.
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Current Assets
Receivables include accounts receivable and
notes receivable with short-term maturity dates.
They are listed at their estimated collectible
amounts (net realizable values).
Inventories include goods held for resale in the
normal course of business plus, in the case of a
manufacturing company, raw materials and work
in process inventories.
Prepaid items such as insurance, rent, office
supplies, and taxes will not be converted into cash
but will be consumed.
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Current Liabilities
1. Obligations for items are in the operating cycle
(accounts payable and salaries payable).
2. Advance collections for the future delivery of
goods or performances of service (unearned
rent and unearned ticket sales).
3. Other obligations that will be paid within one
year or the operating cycle (the estimated
liability for short-term product warranties).
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Working Capital
Current Assets
– Current Liabilities
= Working Capital
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Long-Term Investments
Investment items that management expects to
hold for more than one year or the operating
cycle, whichever is longer, are classified as
long-term (noncurrent) investments.
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Property, Plant, and Equipment
Also called fixed
assets
Property, plant, and equipment includes the
tangible assets used in the firm’s operations.
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Intangible Assets
Intangible assets are those noncurrent economic
resources that a company uses in its operations but
have no physical existence.
Patents
Copyrights
Franchises
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Intangible Assets
Intangible assets are those noncurrent economic
resources that a company uses in its operations but
have no physical existence.
® a registered
trademark
Trademarks
Computer
software costs
Goodwill
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Other Assets
The Other Assets section
occasionally is used to report
miscellaneous assets that
may not be readily classified
within one of the previous
sections.
Sometimes referred to as “deferred charges”
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Long-Term Liabilities
Long-term liabilities are those
obligations of a company whose
liquidation is not expected to
require the use of current assets or
not expected to create current
liabilities within one year or the
normal operating cycle (whichever
is longer).
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Other Liabilities
Deferred tax liabilities and
obligations of a component of the
company that is being discontinued
are examples of items that might
be included as other liabilities.
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Conceptual Guidelines
FASB suggested guidelines for developing
homogeneous classes of assets and liabilities.
 Reporting assets according to their type or
expected function in the central operations or
other activities of the company.
 Reporting as separate items assets and
liabilities that affect the financial flexibility of
the company differently.
 Reporting assets and liabilities according to
the fair value method used to value the items.
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Stockholders’ Equity
Stockholders’ equity
is the residual interest of
the stockholders in the
assets of the
corporation.
A sole proprietorship
is a single-owner
company.
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Stockholders’ Equity
Stockholders’ equity
is the residual interest of
the stockholders in the
assets of the
corporation.
A partnership involves two
or more persons who have
agreed to combine their
capital and efforts in the
operations of a company.
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Stockholders’ Equity
Stockholders’ equity
is the residual interest of
the stockholders in the
assets of the
corporation.
The corporation is a
complex business
organization. Usually there is
absentee ownership.
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Stockholders’ Equity
Contributed Capital
Legal capital is the
minimum amount of
stockholders’ equity that
the corporation may not
distribute as dividends.
Preferred stock
receives preference
in declared
dividends.
Common stock
carries the right to vote
at the annual
stockholders’ meeting
and to share in residual
profits.
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Stockholders’ Equity
Retained earnings is the total amount of
corporate net income that has not been
distributed to stockholders as dividends.
Uses of net income
To use in daily operations
To maintain its productive
facilities
For growth
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Stockholders’ Equity
Comprehensive income includes both net income and
“other comprehensive income.” Accumulated other
comprehensive income might include four items:
1. Unrealized increases (gains) or decreases (losses) in the
fair value of investments in available-for-sale securities.
2. Transaction adjustments from converting the financial
statements of a company’s foreign operations into U. S.
dollars.
3. Certain gains and losses on “derivative” financial
instruments.
4. Certain pension plan gains, losses, and prior service cost
adjustments.
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Stockholders’ Equity
If a corporation has more than one item of other
comprehensive income, it may report the
amount of accumulated other comprehensive
income for each item in stockholders’ equity.
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Stockholders’ Equity
Or, it may report the total amount of
accumulated other comprehensive income for all
the items in stockholders’ equity. This approach
requires a note to the statements.
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Statement of Changes in Stockholders’ Equity
This
statement should
show, among
A corporation
must disclose
the
other
information,
investments
by
changes
in its stockholders’
equity
and
distributions
to owners
during
account
when issuing
financial
the
period.
statements.
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Statement of Changes in Stockholders’ Equity
FASB Statement of Concepts No. 6 defines
investments by owners and distributions to owners
as follows:
 Investments by owners are increases in the
equity of a company resulting from transfers of
something valuable to the company from other
entities to obtain or increase ownership
interests.
 Distributions to owners are decreases in the
equity of a company caused by transferring
assets, rendering services, or incurring
liabilities to owners.
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Summary of Accounting Policies
GAAP requires that a company must include a
description of all its significant accounting
policies as an integral part of its financial
statements.
In particular, when these principles and methods
involve:
 A selection from existing acceptable
alternatives
 Principles and methods peculiar to the
industry in which the company operates
 Unusual or innovative applications of GAAP
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Accounting for Loss Contingencies
Loss
No
Probable?
or
No
Disclosure
Yes
and
Reasonably
estimated?
Reasonably possible
Report amount
in financial
statements
Yes
Disclose in notes
to the financial
statements
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Subsequent Events
A subsequent event is one that occurs
between a company’s balance sheet date and
the date of issuance of the annual report.
End of
Accounting Period
Subsequent Events
Annual Report
Publication Date
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SEC Integrated Disclosures
The Securities and Exchange Commission has
the legal authority to prescribe accounting
principles and reporting practices for all
regulated companies.
A regulated company must file a Form 10-K
annual report with the SEC within 60 days of its
fiscal year-end. This report must be filed
electronically according to the EDGAR
requirements.
Continued
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SEC Integrated Disclosures
The SEC requires comparative balance sheets
for two years and comparative income
statements and statements of cash flows for three
years.
The SEC requires specific disclosures of
important accounting information for a five-year
period. These include net sales or operating
revenues, income (loss) from continuing
operations and related earnings per share, total
assets, long-term obligations and redeemable
stock, and cash dividends declared per share.
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SEC Integrated Disclosures
Management must include a
discussion and analysis of the
company’s financial condition,
changes in financial condition,
and results of operations.
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SEC Integrated Disclosures
Several disclosures must be made about the
common stock market prices and dividends:
 The principal trading markets for the
company’s common stock
 The high and low market prices for each
quarter in the last two years
 The approximate number of shareholders
 The dividends paid in the last two years
 Any dividend transactions
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IFRS vs. U.S. GAAP
 The financial statements required by the
International Accounting Standards Board
(IASB) are similar to those in the United
States.
 Unlike U.S. GAAP, in which a company
typically presents either a classified or
nonclassified balance sheet, International
Financial Reporting Standards (IFRS) do not
require a particular format; the appropriate
format depends on the type of company.
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IFRS vs. U.S. GAAP
 IFRS do require that companies classify assets
on the balance sheet as either noncurrent or
current.
 Noncurrent assets include property, plant,
and equipment, as well as other items such as
investments, long-term receivables, and
intangibles.
 Current assets are defined similarly to those
under U.S. GAAP.
 Typically, noncurrent assets are presented
first, followed by current assets.
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IFRS vs. U.S. GAAP
 “Capital and reserves,” which includes issued
capital (capital stock and additional paid-in
capital), reserves, and accumulated profits or
losses (retained earnings), is usually listed
first.
 Reserves may result from upward
revaluations of properties and investments, as
well as currency translation differences.
 Noncurrent liabilities are usually listed next,
followed by current liabilities.
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Balance Sheet Formats
Report Form
Assets
xxxx
xxxx
Total assets
$xxx
xxx
$xxx
Liabilities and Stockholders’ Equity
xxxx
$xxx
xxxx
xxx
Total liabilities and
stockholders’ equity
$xxx
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Balance Sheet Formats
Account Form
Assets
xxxx
xxxx
Total assets
$xxx
xxx
$xxx
Liabilities and
Stockholders’ Equity
xxxx
$xxx
xxxx
xxx
Total liab. & stock. eq. $xxx
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Chapter 4
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