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Chapter 3 - The statement of financial position and financial disclosures. The purpose of this chapter is to provide an overview of the balance sheet and financial disclosures and to explore how this information is used by decision makers.
Chapter THE STATEMENT OF FINANCIAL POSITION AND FINANCIAL DISCLOSURES © 2013 The McGraw-Hill Companies, Inc Slide The Statement of Financial Position Reports a company’s financial position on a particular date Limitations: Limitations: The TheStatement Statementof ofFinancial Financial Position Positiondoes doesnot notportray portraythe the market marketvalue valueof ofthe theentity entityas as aagoing goingconcern concernnor norits its liquidation liquidationvalue value Resources Resourcessuch suchas as employee employeeskills skillsand and reputation reputationare arenot notrecorded recorded ininthe theStatement Statementof ofFinancial Financial Position Position Usefulness: Usefulness: The TheStatement Statementof ofFinancial Financial Position Positiondescribes describesmany manyof of the theresources resourcesaacompany company has hasfor forgenerating generatingfuture future cash cashflows flows ItItprovides providesliquidity liquidity information informationuseful usefulinin assessing assessingaacompany’s company’s ability to pay its ability to pay itscurrent current obligations obligations ItItprovides provideslong-term long-term solvency solvencyinformation informationrelating relating to tothe theriskiness riskinessof ofaa company companywith withregard regardto tothe the amount amountof ofliabilities liabilitiesininits its capital capitalstructure structure Slide The Statement of Financial Position Claims Claimsagainst against resources resources(Liabilities) (Liabilities) Resources Resources (Assets) (Assets) Remaining Remaining claims claims accruing accruingto toowners owners (Owners’ (Owners’ Equity) Equity) Assets Assetsare areresources resourcescontrolled controlled by bythe the entity entity as asaa result result of of past past events eventsand andfrom fromwhich whichfuture futureeconomic economicbenefits benefits are are expected expectedto toflow flow to tothe theentity entity Slide Current Assets Current Current Assets Assets Will Willbe beconverted converted to tocash cashor or consumed consumedwithin within one oneyear yearor orthe the operating operatingcycle, cycle, whichever whicheveris is longer longer Cash Cash Cash CashEquivalents Equivalents Short-term Short-term Investments Investments Receivables Receivables Inventories Inventories Prepaid PrepaidExpenses Expenses Cash equivalents include certain negotiable items such as commercial paper, money market funds, and Treasury bills Slide Operating Cycle of a Typical Manufacturing Company Use cash to acquire raw materials Convert raw materials to finished product Deliver product to customer Collect cash from customer Slide Noncurrent Assets Noncurrent Noncurrent Assets Assets Not Not expected expectedto to be beconverted convertedto to cash cashor or consumed consumedwithin within one oneyear yearor orthe the operating operating cycle, cycle, whichever whicheveris is longer longer Investments Investments Property, Property,Plant, Plant, && Equipment Equipment Intangibles Intangibles Other Other Assets Assets Slide Noncurrent Assets Investments Not used in the operations of the business Include both debt and equity securities of other corporations, noncurrent receivables, and cash set aside for special purposes Intangible Assets © Used in the operations of the business but have no physical substance Include patents, copyrights, and franchises Reported net of accumulated amortization Property, Plant, and Equipment Are tangible, long-lived, and used in the operations of the business Include land, buildings, equipment, machinery, and furniture Reported at original cost less accumulated depreciation Other Assets Include long-term prepaid expenses and any noncurrent assets not falling in one of the other classifications Liabilities Liabilitiesare are present present obligations obligationsof of the theentity entity arising arisingform form past pastevents, events, the thesettlement settlement of ofwhich whichis is expected expectedto to result resultin in outflow outflowfrom from the theentity entityof of resources resources embodying embodying economic economic benefits benefits Slide 10 Current Liabilities Current Current Liabilities Liabilities Obligations Obligationsexpected expected to tobe be satisfied satisfiedthrough through current current assets assetsor or creation creation of of other other current current liabilities liabilitieswithin withinone one year yearor orthe theoperating operatingcycle, cycle, whichever whicheveris islonger longer Accounts AccountsPayable Payable Notes NotesPayable Payable Accrued Accrued Liabilities Liabilities Unearned UnearnedRevenues Revenues Current CurrentMaturities Maturities of of Long-Term Long-Term Debt Debt Slide 12 Shareholders’ Shareholders’ Equity Equity is is residual residualinterest interest in in the theassets assets of of the theentity entityafter afterdeducting deductingall allits itsliabilities liabilities Slide 13 Shareholders’ Equity Issued Issued Capital Capital Retained Retained Earnings Earnings Treasury Treasuryshares, shares, capital capital reserve, reserve,translation translation reserve reserveand and other other reserves, reserves, and andother other comprehensive comprehensiveincome incomeitems items Disclosure Notes Summary of Significant Accounting Policies Conveys valuable information about the company’s choices from among various alternative accounting methods Subsequent Events A significant development that takes place after the company’s financial year-end but before the financial statements are issued Noteworthy Events and Transactions Transactions or events that are potentially important to evaluating a company’s financial statements, e.g., related-party transactions, errors, and fraud Slide 15 Management Discussion and Analysis Provides Provides aa biased biased but but informed informed perspective perspective of of aa company company’s ’s operations, operations, liquidity, liquidity, and and capital capital resources resources Management’s Responsibilities Preparing the financial statements and other information in the annual report Included in annual reports to assert the responsibility of management and directors Auditors’ Report Expresses the auditors’ opinion as to the fairness of presentation of the financial statements in conformity with accounting standards Must comply with the auditing standards of the specific jurisdictions over which the company operates Auditors’ Opinions Unqualified Issued when the financial statements present fairly the financial position, results of operations, and cash flows are in conformity with accounting standards Qualified Issued when there is an exception to the standard unqualified opinion but is not of sufficient seriousness to invalidate the financial statements as a whole Adverse Issued when the exceptions are so serious that a qualified opinion is not justified Disclaimer Issued when there is insufficient information on which to express an opinion Slide 19 Compensation of Directors & Top Executives Disclosure Directors’ remuneration Remuneration policies and practices Auditor’s report on remuneration policies In the U.S., a proxy statement is sent each year to all shareholders, usually in the same mailing with the annual report Using Financial Statement Information Comparative Financial Statements Allow financial statement users to compare year-to-year financial position, results of operations, and cash flows Horizontal Analysis Expresses each item in the financial statements as a percentage of that same item in the financial statements of another year (base amount) Vertical Analysis Involves expressing each item in the financial statements as a percentage of an appropriate corresponding total, or base amount, within the same year Ratio Analysis Allows analysts to control for size differences over time and among firms Slide 21 Liquidity Ratios Current ratio = Current assets Current liabilities Measures a company’s ability to satisfy its short-term liabilities Acid-test ratio = Quick assets Current liabilities Provides a more stringent indication of a company’s ability to pay its current liabilities Slide 22 Financing Ratios Total liabilities Debt to equity = ratio Shareholders’ equity Indicates the extent of reliance on creditors, rather than owners, in providing resources Times interest earned ratio = Net income + Interest expense + Taxes Interest expense Indicates the margin of safety provided to creditors Appendix 3: Reporting by Operating Segment Many companies operate in several business segments as a strategy to achieve growth and to reduce operating risk through diversification Segment reporting facilitates the financial statement analysis of diversified companies Reportable Operating Segment Characteristics Engages in business activities from which it may earn revenues and incur expenses Discrete financial information is available Operating results are regularly reviewed by the entity’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance What Amounts Are Reported By An Operating Segment? General information about the operating segment Segment profit or loss, segment assets, segment liabilities, and the basis of measurement Reconciliations of the totals of segment revenues, reported segment profit or loss, segment assets, segment liabilities and other material segment items Segment Reporting Reporting by Geographic Area IFRS No requires an entity to report certain geographic information unless it is impracticable to so Information About Major Customers Revenues from customers generating 10% or more of the revenue of an entity must be disclosed End of Chapter © 2013 The McGraw-Hill Companies, Inc ... skillsand and reputation reputationare arenot notrecorded recorded ininthe theStatement Statementof ofFinancial Financial Position Position Usefulness: Usefulness: The TheStatement Statementof ofFinancial...Slide The Statement of Financial Position Reports a company’s financial position on a particular date Limitations: Limitations: The TheStatement Statementof ofFinancial Financial Position Positiondoes... assert the responsibility of management and directors Auditors’ Report Expresses the auditors’ opinion as to the fairness of presentation of the financial statements in conformity with accounting