Classified Balance Sheet Quiz

Accounting: Tools for Business Decision Making

• This is an accounting textbook, eighth edition, by Kimmel, Weygandt, and Mitchell.
• The book's Chapter 2, prepared by Diane Tanner of the University of North Florida, focuses on financial statements.
• The learning objectives for Chapter 2 are:
  • Identifying sections of a classified balance sheet.
  • Using ratios to evaluate profitability, liquidity, and solvency.
  • Discussing financial reporting concepts.

Learning Objective 1: Identifying Sections of a Classified Balance Sheet

• A classified balance sheet presents a snapshot of a company's financial position at a specific point in time.
• It enhances user understanding by grouping similar assets & liabilities
• Standard Classifications:
  • Assets:
    • Current assets (expected to convert to cash within a year or operating cycle)
    • Long-term investments
    • Property, plant, and equipment
    • Intangible assets
  • Liabilities and Stockholders' Equity:
    • Current liabilities
    • Long-term liabilities
    • Stockholders' equity

Current Assets

• Current assets are converted to cash or used up within a year or the operating cycle whichever is longer.
• The operating cycle is the average time to purchase inventory, sell on account, and collect cash.
• Often one year.
• Listed in order of liquidity (the order in which they are expected to become cash).
• Examples include:
  • Cash
  • Investments (short-term US government securities)
  • Receivables (accounts receivable, notes receivable, interest receivable)
  • Inventories
  • Prepaid expenses (insurance, supplies)

Long-Term Investments

• Realizable in cash, but conversion not expected within a year.
• Often referred to as investments.
• Consist of investments in stocks and bonds of corporations held for longer than one year.
• Long-term assets not currently used in operating activities (e.g., land, buildings).
• Long-term notes receivable.

Property, Plant, and Equipment

• Assets with relatively long useful lives used in operations.
• Sometimes called fixed assets or plant assets.
• Includes land, buildings, equipment, delivery vehicles, and furniture.
• Reported on the balance sheet at book value (cost less accumulated depreciation).
• Depreciation: systematic allocation of cost to expense over a number of years.
• Accumulated depreciation: total amount of depreciation that the company has expensed.

Intangible Assets

• Assets without physical substance.
• Give exclusive right of use for a specific time period (e.g., goodwill, patents, copyrights, and trademarks).
• Sometimes reported under the broader category "other assets."

Learning Objective 2: Using Ratios to Evaluate Company Performance

• Ratio analysis expresses the mathematical relationship among selected items of financial statement data.
• Profitability ratios measure income or operating success over a specific time period.
• Liquidity ratios measure a company's ability to pay short-term obligations and meet unexpected cash needs.
• Solvency ratios measure a company's ability to survive in the long term.
• Ratio comparisons are critical, such as intra-company comparisons (same company over two years) and industry-average comparisons for industries.

Using the Income Statement

• The income statement reveals how successful a company is at generating profit from selling products or services.
• It reports annual revenues and related expenses during a specific period.
• Profitability is evaluated using profitability ratios.
• Earnings per share (EPS) is a key profitability ratio. It calculates the net income earned on each share of common stock.

Liquidity: Working Capital and Current Ratio

• Working capital: Current assets less current liabilities. A positive working capital indicates a greater likelihood that the company will pay its liabilities. A negative value raises concerns about the company's ability to meet short-term obligations.
• Current ratio: Current assets divided by current liabilities. A higher ratio suggests better short-term liquidity.

Solvency: Debt to Asset Ratio

• Debt to assets ratio: total liabilities divided by total assets. This ratio shows the percentage of financing from creditors (loans). A higher ratio indicates greater risk of default.

Learning Objective 3: Discussing Financial Reporting Concepts

• Generally accepted accounting principles (GAAP): sets of rules and practices with authoritative support, used by companies. It guides the type, format, and measurement of information.
• Standard-setting bodies:
  • Securities and Exchange Commission (SEC) oversees US financial markets & standard-setting bodies.
  • Financial Accounting Standards Board (FASB). The primary standard-setting body in the US.
  • International Accounting Standards Board (IASB) creates international accounting standards (IFRS).
• Qualitative characteristics of useful information:
  • Relevance: predictive & confirmatory value, materiality.
  • Faithful representation: complete, neutral, free from material error.
  • Enhancing qualities: comparability, consistency, verifiability, timeliness, and understandability.
• Concepts and principles:
  • Monetary unit assumption: uses only measurable items in $
  • Economic entity assumption: separate company records from personal accounts.
  • Going concern assumption: expects the company to remain in operation.
  • Periodicity assumption: divides the company's life into accounting periods.
  • Historical cost principle: assets are recorded at their purchase price.
  • Fair value principle: assets & liabilities are recorded at their current market price.
  • Full disclosure principle: all significant information is revealed.
  • Cost constraint: weighs information cost versus benefits to users