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Chapter 3
The Balance Sheet
and the Statement of
Changes in
Stockholders’ Equity
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Objectives
 Understand the purposes of the balance sheet.
 Define the elements of a balance sheet.
 Explain how to measure the elements of a
balance sheet.
 Classify the assets of a balance sheet.
 Classify the liabilities of a balance sheet.
 Report the stockholders’ equity of a balance
sheet.
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Objectives
 Prepare a statement of changes in
stockholders’ equity.
 Understand the other disclosure issues for a
balance sheet.
 Describe the SEC integrated disclosures.
 Explain the reporting techniques used in an
annual report.
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FASB Statement of Concepts No. 5
…recommends that
a full set of financial
statements for an
accounting period
should show a
company’s...
5
FASB Statement of Concepts No. 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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Interrelationship of
Financial Statements
Beginning
Balance Sheet
 Assets
 Liabilities
 Stockholders’ Equity
Transactions
and Events
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Interrelationship of
Financial Statements
Income Statement
 Revenues
 Expenses
Transactions
and Events
Statement of
Cash Flows
 Operating Activities
 Investing Activities
 Financing Activities
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Interrelationship of
Financial Statements
Income Statement
 Revenues
 Expenses
Statement of
Cash Flows
 Operating Activities
 Investing Activities
 Financing Activities
Ending
Balance Sheet
 Assets
 Liabilities
 Stockholders’ Equity
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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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Process for Disclosing Information
on the Balance Sheet
 Identification of what
items meet the definition
of the elements.
 Measurement (valuation)
of the elements.
 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
 The resource must be able to contribute
directly or indirectly to the company’s future
net cash inflows.
 The company must be able to obtain the future
benefit and control others’ access to it.
 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 -Assets
Assets may be natural or manmade, tangible or intangible, and
exchangeable or useful in the
company’s activities.
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Elements of the Balance Sheet -Liabilities
… of a company
Liabilitiestoare
transfer
probable
assets
or provide
futureservices
sacrifices
to other
of economic
entities
in the
benefits
futurearising
as a result
fromofpresent
past
transactions
obligations...L
or events.
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Elements of the Balance Sheet -Stockholders’ Equity
Assets = Liabilities + Stockholders’
Equity
Equity is residual interest in the
assets of a company that remain
after deducting liabilities.
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Measurement of the Elements of
the Balance Sheet
Present Value
Net Realizable
Value
Current Market
Value
Current Cost
Historical Cost
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Measurement of the Elements of
the Balance Sheet
The historical cost of an
The current cost of an
asset is the exchange price Theasset
is the amount
of cash
net realizable
value
in the
in which
(orasset
equivalent)
that would
of an
is the amount
Thetransaction
current market
value
The present
value
of equivalent)
an on theinto
theofasset
was
acquired.
be
required
date of
of
cash
(or
an asset isasset
the amount
is the which
net amount
of issheet
the
balance
to obtain
the
asset
expected
of cash (or equivalent)
that
discounted expected
cash
the sameinasset.
to
be
converted
the
could be obtained
on
the
inflows less ordinary
the discounted
operations of the
date of the balance
sheet
expected cash company,
outflows less any
by selling the asset
in an
related
to
the asset.
expected
conversion costs.
orderly liquidation.
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Limitations of the Balance Sheet
• Use of historical cost to value assets and liabilities
does not help assess the likely amounts of future
cash flows.
• “Human resources” such as high-quality
management or highly motivated workers are not
included as assets.
• Many of the amounts that a company reports are
based on estimates.
• In periods of inflation, the 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
…process
andcycle
sell is
thethe
inventory,
An
operating
average
collect
receivables,
timeand
taken
by a the
company
to spend
converting
them
back into cash.
cash for
inventory,...
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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” and “availablefor-sale securities.”
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Current Assets
Receivables include accounts
receivable and notes receivable
Inventories
include goods held
with short-term
maturity dates.
for resale
in the normal course
They are listed
at their
of business
plus, in the case of a
estimated collectible
amounts
Prepaid
items
include
manufacturing
(net realizable values). company, raw
insurance,
rent,
materials
andoffice
goods in process.
supplies and taxes that will
not be converted into cash
but will be consumed.
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Current Liabilities
Current liabilities are those
obligations whose liquidation is
expected to require the use of existing
current assets, or the creation of other
current liabilities.
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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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Long-Term Investments
A company makes investments for a variety of
reasons.
 The company expects the market value of the
investment to increase.
 The company wishes to receive income from
interest or dividends.
 The company may desire to exercise control over
another company or a supplier.
 The company may acquire property, plant, or
equipment for future expansion.
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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 are used in the
operations of the
business but have no
physical existence.
® a registered trademark
Trademarks
Computer
Goodwill
Franchises
Patents
Copyrights
software
costs
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Long-Term Liabilities
Long-term liabilities are those
obligations that are not expected
to require the use of current
assets or not expected to create
current liabilities within one year
or the normal operating cycle (if
longer than a year).
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Other Liabilities
Deferred tax liabilities and
obligations of a segment of
the company that is being
discontinued are examples
of items that might be
included in this section.
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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
measurement method used to value the items.
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Stockholders’ Equity
Stockholders’ equity is
the residual interest of
the stockholders in the
The corporation is a
assets of the
A partnership
involves two
A sole proprietorship
complex business
corporation.
or more
who have
is apersons
single-owner
organization. Usually
agreed to
combine their
company.
there is absentee
capital and efforts in the
ownership.
operations of a company.
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Stockholders’ Equity
Components of Stockholders’ Equity
 Contributed capital
 Retained earnings
 Accumulated other
comprehensive income
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Stockholders’ Equity
Contributed Capital
Preferred stock
Legal capital is the
receives preference
minimum amount of
in declared
stockholders’ equity that the
dividends.
corporation may
not
Common stock carries
distribute as dividends.
the right to vote at the
P
annual stockholders’
meeting and to share
in residual profits.
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Stockholders’ Equity
Contributed Capital
A corporation sells 100 shares of its $5 par
common stock for $30 per share.
Cash
Common Stock, $5 par
Additional Paid-in Capital
on Common Stock
3,000
500
2,500
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Stockholders’ Equity
Contributed Capital
A corporation sells 20 shares of its $100 par
preferred stock for $110 per share.
Cash
Preferred Stock, $100 par
Additional Paid-in Capital
on Preferred Stock
2,200
2,000
200
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Stockholders’ Equity
Contributed Capital
A corporation sells 100 shares of its no-par
common stock at $50 per share.
Cash
Common Stock--No-Par
Value
5,000
5,000
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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
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
Click to review the balance sheet.
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Stockholders’ Equity

Comprehensive
Unrealized increases
income (gains)
includesorboth
decreases
net income
(losses)
and
other
in thecomprehensive
market value of
income.
investments
Accumulated
in availableother
comprehensive
for-sale securities.
income might include four items:
 Transaction adjustments from converting the
financial statements of a company’s foreign
operations into U. S. dollars.
 Certain gains and losses on “derivative” financial
instruments.
 Certain pension liability adjustments.
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Stockholders’ Equity
A company is required to
report its total
comprehensive income for
the accounting period.
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Statement of Changes in
Stockholders’ Equity
statement
should
show
A This
corporation
must
disclose
the
investments
distributions
changes inby
itsand
stockholders’
to owners
during
the issuing
period,
equity
account
when
among other
items.
financial
statements.
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Statement of Changes in
Stockholders’ Equity
SCHEDULE A
CARON MANUFACTURING COMPANY
Exhibit 3-8
Statement of Changes in Stockholders’ Equity
For Year Ended December 31, 2000
Accumulated
Common Additional
Other
Stock
Paid-in
Retained Comprehensive
$5 par
Capital
Earnings
Income
Total
$65,000 $143,400 $ 64,900 $10,000
$283,300
Balance, Jan. 1, 2000
Unrealized increase in
value of availablefor-sale securities
Net income
Cash dividends paid
Common stock issued
6,500
Balance, Dec. 31, 2000 $71,500
2,000
62,500
(11,200)
30,500
$173,900
$116,200
$12,000
2,000
62,500
(11,200)
37,000
$373,600
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Summary of Accounting Policies
APB Opinion No. 22 requires that a company include
a description of all 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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Derivative Financial Instruments
FASB Statement No. 133
Fair value is the
requires a company to
amount at which
recognize all derivative
the instrument
financial instruments as either
could be
assets or liabilities on the
purchased or sold
balance sheet.
in a current
transaction
These instruments should be between willing
measured at fair value.
parties.
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Derivative Financial Instruments
FASB Statement No. 133 also requires the following
information:
 The type of derivative instruments it holds.
 Its objectives in holding the instruments.
 Its strategies for achieving these objectives.
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Contingent Liabilities and Assets
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 the balance sheet date and the date
of issuance of the annual report.
End of Accounting
Period
Subsequent Events
Annual Report
Publication Date
52
SEC 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 90 days of its fiscal
year-end. This report must be filed electronically
according to the EDGAR requirements.
Continued
53
SEC 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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Balance Sheet Formats
Most companies use the
report form or the account
form format in presenting
their balance sheets.
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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 eq. $xxx
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Balance Sheet Formats
Account Form
Liabilities and
In the seldom-used financial
Assets
Stockholders’
Equity
position format, current
xxxx
$xxx xxxx
$xxx
assets and current liabilities
xxxx
xxx xxxx
xxx
are
listed
first
to
emphasize
Total assets
$xxx Total liab. & stock. eq. $xxx
working capital.
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Chapter 3