Chapter 4
The Balance Sheet and
the Statement of
Changes in
Stockholders’ Equity
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An electronic presentation
by Norman Sunderman
Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.
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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.
4
Interrelationship of
Financial Statements
Beginning
Balance Sheet
 Assets
 Liabilities
 Stockholders’ Equity
Continued
Transaction
s and Events
5
Interrelationship of
Financial Statements
Income Statement
 Revenues
 Expenses
Transaction
s and Events
Continued
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.
10
Operating Capability
Operating
capability refers
to the ability of a
company to
maintain a given
physical level of
operations.
11
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 -- Assets
Simply,
assets have
future
value.
Assets may be natural or manmade, tangible or intangible, and
exchangeable or useful only in the
company’s activities.
14
Elements of the
Balance Sheet -- Liabilities
Liabilities are probable
future sacrifices of
economic benefits arising
from present
obligations...L
15
Elements of the
Balance Sheet -- Liabilities
… of a company to transfer
Liabilities are probable
assets or provide services to
future sacrifices of economic
other entities in the future as a
benefits arising from present
result of past transactions or
obligations...L
events.
16
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.
17
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
asset is the exchange price
in the transaction in which
the asset was acquired.
The current market value
of an asset is the amount
of cash (or equivalent)
that could be obtained on
the date of the balance
sheet by selling the asset in
an orderly liquidation.
The current cost of an
asset is the amount of
cash (or equivalent) that
would be required on the
date of the balance sheet
to obtain the same asset.
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Measurement of the Elements
of the Balance Sheet
The net realizable value
of an asset is the amount
of cash (or equivalent)
into which the asset is
expected to be converted
in the ordinary
operations of the
company, less any
expected conversion
costs.
The present value of
an asset is the net
amount of discounted
expected cash inflows
less the discounted
expected cash outflows
related to the asset.
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Measurement of the Elements
of the Balance Sheet-Liabilities
Initially, the amount of
cash received when an
obligation was incurred
(historical proceeds);
subsequent to
incurrence, the historical
amount may be adjusted
for amortization.
The current proceeds is
the amount of cash that
would be obtained if the
same obligation were
incurred.
The current market
value of a liability is the
amount of cash that
would be required
currently to eliminate the
liability.
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Measurement of the Elements
of the Balance Sheet-Liabilities
The present value of
future cash outflows to
eliminate the liability
in due course of
business.
The net realizable
value of a liability is
the amount of cash
expected to be paid
to eliminate the
liability in due
course of business.
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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
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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Operating Cycle Flow
Make Collections of
Accounts
Receivable
1. Collect cash
2. Incur bad debts
Acquire Inventory
1. Pay cash
2. Incur accounts
payable
Make Sales (Revenues)
1. Collect cash
2. Increase accounts
receivable
3. Reduce deferred revenues
Incur Cost of Goods Sold
1. Reduce inventory
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Current Assets
1.
Cash-Unrestricted
2.
Short-term investments
3.
Accounts receivable
4.
Inventories
5.
Prepaid expenses
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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
“available-for-sale
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 goods
in process.
Prepaid items include insurance, rent, office
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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Current Liabilities
1. Obligations for items that have entered into 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 (estimated liabilities
for short-term product warranties).
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Working Capital
Current Assets
Current Liabilities
= Working Capital
34
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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Plant Assets
Also called fixed
assets
Property, plant, and equipment includes the
tangible assets used in the firm’s operations.
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Plant Assets
Land
Buildings
Equipment
Furniture
Natural Resources
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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.
Patents
Copyrights
Franchises
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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
software costs
Goodwill
40
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 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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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.
44
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
Components of Stockholders’ Equity
 Contributed capital
 Retained earnings
 Accumulated other
comprehensive income
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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
47
Stockholders’ Equity
Contributed Capital
A corporation sells 100 shares of its $5 par
common stock for $30 per share.
Cash
3,000
Common Stock, $5 par
500
Additional Paid-in Capital
on Common Stock
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
2,200
Preferred Stock, $100 par
2,000
Additional Paid-in Capital
on Preferred Stock
200
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Stockholders’ Equity
Contributed Capital
A corporation sells 100 shares of its nopar common stock at $50 per share.
Cash
Common Stock--No-Par
Value
5,000
5,000
50
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.
2.
3.
4.
Unrealized increases (gains) or decreases (losses) in
the market value of investments in available-for-sale
securities.
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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Stockholders’ Equity
If a corporation has more than one
item of other comprehensive
income, it may report the amount of
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
statement
should
showthe
AThis
corporation
must
disclose
investments
by and
changes
in its stockholders’
distributions
to owners
during
equity account
when issuing
the period,
among
other items.
financial
statements.
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Statement of Changes in
Stockholders’ Equity
FASB Statement of Concepts No. 6 defined 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 in order 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
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.
58
Derivative Financial Instruments
FASB Statement No. 107 requires a
company to disclose the fair value of all its
financial instruments, whether recognized
or not on its balance sheet. The Statement
also requires a company to disclose all
significant concentrations of credit risk
due to its financial instruments. A
company typically makes these disclosures
in the notes to its financial statements.
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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
could be
either assets or liabilities on purchased or
the balance sheet.
sold 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.
2. Its objectives in holding the instruments.
3. Its strategies for achieving these
objectives.
1.
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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
62
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
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Chapter 4
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