Classified Balance Sheet

Classified Balance Sheet

• Groups together similar assets and liabilities
• Uses standard classifications and sections

Standard Classifications

• Assets include Current assets, Long-term investments, Property, plant & equipment, and Intangible assets
• Liabilities & Stockholders’ Equity includes Current liabilities, Long-term liabilities, and Stockholder’s equity
• Accounting equation: Asset = Liabilities & Stockholders’ Equity

Current Assets

• Assets a company expects to convert to cash or use up within one year or the operating cycle, whichever is longer
• Operating cycle calculates the time to purchase inventory, sell it on account, and collect cash from customers
• For businesses, a one-year cutoff is typically used
• Current assets are listed by liquidity

Common Current Assets (in order of liquidity)

• Cash
• Short Term Investments
• Receivables
• Inventories
• Prepaid expenses

Long-Term Investments

• Includes stocks & bonds of other companies held for more than one year
• Also includes long-term assets, such as land not used in operating activities
• Includes long-term notes receivable expected to be collected more than one year from the balance sheet date

Property, Plant, and Equipment (PP&E)

• Assets with long useful lives currently used in operating a business
• Examples include land, buildings, trucks, office furniture, computers, equipment
• PP&E are also called fixed assets or plant assets
• Depreciation (expense) is used to allocate the cost of these assets over a number of years, impacting the income statement
• Accumulated depreciation account reports the total depreciation a company has taken; it appears on the balance sheet
• Depreciated assets are shown at cost less accumulated depreciation on the balance sheet

Intangibles

• Assets lacking physical substance, however are valuable
• Examples include goodwill, copyrights, patents, franchises, and trademarks

Current Liabilities

• Obligations a company must pay within the coming year or operating cycle, whichever is longer; typically one year
• Includes accounts payable, unearned revenue, interest payable, salaries/wages payable, short-term notes payable, taxes payable
• Usual order is notes payable, accounts payable, and then others in order of magnitude

Long-Term Liabilities

• Obligations a company expects to pay after one year
• Examples include mortgage payable, bonds payable, and long-term notes payable

Stockholder's Equity

• Consists of common stock and retained earnings
• Common stock represents investments of assets into the business by stockholders
• Retained earnings is income retained for use in the business

Ratio Analysis

• Expresses the relationship among selected items of financial statement data
• Expresses the mathematical relationship between two quantities
• Comparisons aid in ratio analysis

Comparisons

• Intra-company: comparing data over two or more years for the same company
• Industry: comparing to industry averages
• Inter-company: comparing with a competitor

Types of Ratios

• Profitability measures income or operating success (e.g., EPS)
• Liquidity measures the ability to pay maturing obligations and meet unexpected cash needs (e.g., current ratio, working capital)
• Solvency measures the ability to survive over a long period of time (e.g., debt to assets)

Earnings Per Share (EPS)

• Measures the income earned on each share of common stock
• Calculated as (net income – preferred dividends) / (weighted average common shares outstanding)
• An increase is regarded as favorable

Liquidity

• Ability to pay obligations expected to be due within the current year
• Working Capital = Current Assets – Current Liabilities
• Current Ratio = Current Assets / Current Liabilities
• A current ratio above 1 indicates more current assets than current liabilities

Solvency

• Measures a company's ability to pay interest as it comes due and repay the balance of debt due at maturity
• Debt to Assets Ratio = Total Liabilities / Total Assets

Generally Accepted Accounting Principles (GAAP)

• A set of rules and practices recognized by the accounting profession as a general guide for financial reporting purposes
• Standard-setting bodies establish these guidelines

Standard-Setting Organizations

• SEC (Securities and Exchange Commission): federal government agency which oversees the U.S. financial markets (public companies)
• FASB (Financial Accounting Standards Board): private organization setting accounting standards
• PCAOB (Public Company Accounting Oversight Board): establishes auditing standards for auditors
• IASB (International Accounting Standards Board): issues international accounting standards

Financial Reporting Objective

• To provide useful information to investors and creditors for making decisions about providing capital
• FASB believes useful information should possess two fundamental qualities: relevance and faithful representation

Enhancing Qualities of Useful Information

• Comparability
• Consistency
• Verifiability
• Timeliness
• Understandability

Financial Reporting Assumptions

• Monetary unit assumption dictates that only items expressible in money are included in accounting records
• Economic entity assumption states that each economic entity can be separately identified and accounted for
• Periodicity assumption states that the life of a business can be divided into time periods
• Going concern assumption states that the business will remain in operation for the foreseeable future

Measurement Principles

• Cost principle requires companies to record assets at their cost
• Fair value principle indicates that assets and liabilities should be recorded at fair value
• In most cases, GAAP dictates using the cost principle, except for actively traded investments where fair value is used

Cost Constraint

• Providing information is costly; FASB considers if the benefit of accounting standards outweigh the costs