Intermediate Accounting 1 Chapter 3 Rockhurst

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Balance sheet

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report a company's financial position on a particular date. Presents an organized array of assets, liabilities, and equity at a point in time.

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Usefulness and limitations of the balance sheet

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Limitation: doesn't portray market value as a going concern nor it's liquidation value. They are measured at historical costs instead of fair value. Also many items reported on the BS are heavily reliant on estimates rather than determinable amounts. An imp feature is that it describes many resources the co has avail for future cash flows. Informative in relation to income statement items. It shows the relation between net income and assets whihc provides a measure of return useful for predicting future profitability.

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Liquidity

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period of time before an asset is converted to cash or until a liability is paid. Useful in assessing a co's ability to pay it's current obligations.

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long term solvency

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refers to the riskiness of a co with regard to the amount of liabilities in it's capital structure. Other things equal the risk to an investor or creditor increases as the percentage of liabilities to equity increases.

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Current assets

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Include cash and other assets that are reasonably expected to be converted to cash or consumed within the coming year or normal op cycle. Includes cash and cash equivalents, short term investments that will be sold within a year, accounts receivable, notes receivable, inventories, prepaid expenses.

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Cash and cash equivilanets

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Most liquid is listed first. Cash: Includes cash on hand, cash in banks, bank drafts, cashier's checks, money orders.
Cash equivelents: includes certain negotiable items such as commercial paper, money market funds, and US treasury bills. Can be quickly converted into cash. Short term investments qualify as cash equiv if they will be converted 3 months or less from date of purchase. Cash restricted for special purpose shouldn't be included as a current asset.

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Short term investments

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Investments in stock and debt securities of other corporations are included as short term investments if the company has the ability and intent to sell those securities with in the year.

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Accounts receivable

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Results from the sale of goods or services on credit. Valued net, less the amount not expected to be collected. When receivables are supported by a note they are called notes receivable. Usually they are due in 30-60 days. If they are not expected to be due within a year they are classified as a non current asset: investment.

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Inventories

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Includes goods awaiting sale, goods in the course of production, and goods to be consumed directly or indirectly in the course of production. Reported as CA b/c they are expected to be sold within the operating cycle.

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Prepaid expenses

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Represents an asset recorded when an expense is paid in advance, creating benefits beyond the current period. Whether it is current or non current depends on hen it's benefits will be realized. If rent were pd for aperiod extending beyond the year, a portion of the payment is classified as an other asset.

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3 types of noncurrent assets

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1. Investments
2. Property, plant, and equip.
3. Intangible Assets

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Investments

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Most companies acquire assets that aren't directly used in the ops of a business. These include investments in equity and debt securities of other corps. land held for speculation, noncurrent receivables, and cash set aside for special purposes. These are classified as noncurrent.

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Property plant, and equip

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The common characteristics are they are tangible, long lived, and used in the ops of the business. Includes land, buildings, equipment, machinery, and furniture, as well as natural resources, such as mineral mines, timber tracts, and oil wells. Reported at original cost less depreciation. Often will only present the net amount and provide disclosure details in a note.

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Intangible assets

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No physical substance. Generally they represent the ownership of an exclusive right to somethign such as a product, process, or name. Copyrights, patents, and franchises are examples. Reported net of amortization.

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Other assets Noncurretn

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catch all for long term prepaids, and any other noncurrent asset. If a co's noncurrent investments are not material they may be reported in other asset classification rather than in a separate investments category.

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Current liabilities

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Obligations expected to be satisfied through use of current assets or creation of other current liabilities. Expected to be satisfied within a year. An exception is if managers decide to refinance. If they refinance it's not current. Most common are accounts payable, notes payable, unearned revenues, accrued liabilities.

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Accounts payable

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obligations to suppliers of merch or services purchased on open account with payment due in 60-90 days.

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Notes payable

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written promise to pay in some future date. They require payment of explicit interest in addition to the value of the note.

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Unearned revenues

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Represent cash received from a customer for goods or services that will be provided in the future.

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Accrued liabilities

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Obligations created when expenses have been incurred but will not be paid until a subsequent reporting period. Accrued salaries payable, interest payable, and accrued taxes payable.

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Current maturities of long term debt

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These are classified as a current liability

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Long term debt

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Debt that will not be pd off within a years time. Long term notes, bonds, pension obligations, and lease obligations.

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Retained earnings

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accumulated net income earned since the inception of the company and not yet pd out as dividends.

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Financial statement disclosures are provided:

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1. By including additional info, often parenthetically, on the face of the statement following a financial statement item and
2. In disclosure notes that often include supporting schedules.

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Disclosure notes

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Typically span several pages and explain or elaborate upon the data presented in financial statements themselves, or provide info not directly related to any specific item in the statements. Some examples include:
Pension plans, leases, long term debt, investments, income taxes, property, plant, and equipment, employee benefit plans. the notes must include specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third party transactions. Any explanation that contributes to investors and creditors understanding should be disclosed.

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Summary of significant accounting policies

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Include whether a co uses straight line or DDB. Or if they use FIFO. LIFO, or Avg. cost. Typically the notes consist of a summary of acct. policies that discloses the choices a co makes.

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Subsequent events

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When an event that has material effect occurs after the fiscal year but before the statements are issued, the event is described in a subsequent disclosure note. Examples include, issuance of debt or equity securities, a business combo or sale, sale of assets, an event that sheds light on a loss contingency, orany other event taht is material

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Noteworthy events and transactions

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Some transactions occur only ocasionally but when they do they are important to evaluating a co's statements. In this category are related party transactions, errors and irregularities, and illegal acts.

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Related party transactions

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sometimes co's will engage in transactions with owners, managers, families of owners, affiliated co's and oher parties that can significantly influence the co. the potential problem is that their economic substance can differ from their legal form. Borrowing or lending money at an interest rate that differs significantly from market rate is an example of a transaction that could result. When they occur, companies must disclose the nature of relationship, provide a description of transactions, and report dollar amounts of transactions and any other amounts due from related parties.

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Irregulaties and errors

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An irregularity is an intentional distortion of a financial statement. An error is unintentialn

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illegal acts

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such as bribes, kickbacks, illegal contributiions to political candidates, and other violations of law. A number of factors should be considered when determining materiality. If it's illegal, it's material.

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Management discussion and analysis

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Each annual report of a public co requires a lengthy discussion and analysis provided by management. They provide their views on significant events, trends, and uncertainties pertaining to the co's operations, liquidity, and capital resources. It embodies manager's biased perspective but can still offer informed insight that may not be avail elsewhere.

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Managemet's responsibilities

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Managers are responsible for the finanicla statments and other info in the annual report. Annual reports of public co' include a management's responsibilities section that asserts the responsibility of management for info contained in the annual report as well as an assessment of the company's internal control proceedures. `

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Auditor's report

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Auditors examine financial statements and internal control procedures designed to support the content of those statements. Their role is to attest to the fairness of the financial statements based on that examination. The auditor's attest function results in an opinion stated in the auditor's report.

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Auditor's options

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Can say they are presented fairly. Sometimes they include an explanatory paragraph in addition to standard wording which can be due to lack of consistency, uncertainty, or emphasis

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Qualified opinion

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Contains an exception to the standard unqualified opinion but not of sufficient seriousness to invalidate the fin statements as a whole.

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Adverse opinion

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Necessary when lack of consistency and uncertainty are so serious that a qualified isn't justified. Rare b.c auditors are usually able to persuade management to rectify probs.

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Dislaimer

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an auditor will disclaim an opinion for emphasis if insufficient info has been gathered to express an opinion

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Unqualified opionin

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states that the financial statement is presented fairly in accordance with GAAP.

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Compensation of top executives

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SEC requires disclosures on this and in particular on the stock options they get. Included in the proxy statement which is sent to shareholders with the annual report which invites shareholders to the meeting to elect board members and vote on issues.

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comparative financial statement

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every fin statement is issued is accompanied by corresponding fin statement of preceding year and often previous two years this allows analysts to detect trends.

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current ratio

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current assets / current liabilities Analysis is indicative of ability to pay debts. Useuful to determining if short term credit should be issued.

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Working capital

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Current assets - current liabilities

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Acid test ratio

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excludes inventories and prepaid items. CA - Inventory - prepaids / CL

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Debt to equity

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compares resources provided by creditors with resoures provided by owners. Measure of creditor protection in event of insolvency higher the ration, higher the risk. Total liabilities / shareholder equity

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times interest earned

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Net income + interest expense _ taxes / interest expense