Understanding Financial Reports PDF

The Merrill Lynch Guide to A Message from the Chief Financial Officer Merrill Lynch believes an informed investing public is critical to both the capital markets and the economy. We are committed to clear and accurate reporting of our own financial information and also to an enhanced understanding...

The Merrill Lynch Guide to A Message from the Chief Financial Officer Merrill Lynch believes an informed investing public is critical to both the capital markets and the economy. We are committed to clear and accurate reporting of our own financial information and also to an enhanced understanding of the reports of other corporations. This Guide to Understanding Financial Reports is an initiative by Merrill Lynch and its communications partner, Addison, to provide a clear, practical explanation on how to read and interpret a corporate report. We encourage you to use this resource to help you play a more active and informed role in working with your Financial Advisor—and ultimately gain better control of your investment activities. Ahmass Fakahany Chief Financial Officer Merrill Lynch & Co. About Merrill Lynch About Addison Merrill Lynch is one of the world’s leading financial With offices in New York and San Francisco, management and advisory companies, with offices Addison is a creative-services company specializing in 36 countries and total client assets of approxi- in business communications. For more than 40 years, mately $1.3 trillion. Addison has helped the world’s most successful companies tell their stories through singular, Through Global Markets and Investment Banking, award-winning annual reports. the company is a leading global underwriter of debt and equity securities and a strategic advisor Today, Addison also specializes in simplifying to corporations, governments, institutions and complex business communications for all audiences. individuals worldwide. Through Merrill Lynch In this Guide to Understanding Financial Reports, Investment Managers, it is one of the world’s both competencies converge to create a definitive, largest managers of financial assets. Through easy-to-understand explanation of an important its Global Private Client Group, it is a leading investment tool. In addition to annual report design worldwide provider of wealth management and and simplified communications, Addison also has investment services to high-net-worth individuals. practices in brand identity, business literature and naming.  PLACEHOLDER ONLY! THIS PAGE DOES NOT PRINT! page A Table of Contents 2 Introduction: About This Guide 4 Consolidated Financial Statements: The Key Components 5 The Balance Sheet: Assets 10 The Balance Sheet: Liabilities and Shareholders’ Equity 17 Analyzing the Balance Sheet 22 The Income Statement 27 Analyzing the Income Statement 32 The Statement of Changes in Shareholders’ Equity 36 The Statement of Cash Flows 38 Additional Disclosures and Audit Reports 40 The Long View 41 A Note on Selecting Stocks 42 Index page 1 Introduction: About This Guide The increasing number of accounting rules and disclosure requirements have made financial statements a larger and more complex—but not always transparent—vehicle for understanding a company’s true economic position. At Merrill Lynch, we are committed to following The difficulty investors have understanding the a principles-based approach to financial reporting, financial reports of public companies or their own an approach that is committed to showing the real retirement savings plans is increasingly recognized substance and business purpose of a company’s as the responsibility of the companies issuing those transactions. And, with Addison, we are also documents. In fact, as additional accounting rules committed to giving the average investor access and disclosure requirements have made financial to this information by promoting understanding statements larger and more complex, clarity matters and simplification of complex communications. more than ever. Complexity and Financial Communications How the Corporate Financial Report Evolved There’s a simple reason this Guide has been so Corporate consolidated financial statements are popular among Merrill Lynch clients for so many issued each quarter by public companies to share- years—it is because many people have trouble holders who have invested in their stock and are deciphering complex financial documents. intended to tell investors and Wall Street analysts how a company has performed financially. The typical corporate financial statement, clarified here, is merely one of them. Others appear in your However, these financial statements seldom function mailboxes every day: bank, brokerage, mutual fund alone. Instead, they usually come packaged inside and 401(k) statements; health insurance benefit annual reports, surrounded by other corporate summaries and claim forms; credit card disclosures information. For example, adjacent to the financial and insurance policies. All these documents contain statements is Management’s Discussion and Analysis information vital to your financial and sometimes (MD&A), a section required by the Securities and even your physical well-being. Few are written or Exchange Commission that is intended to provide designed for the average investor. insight into the financial statement with analytical data and commentary. At the front, before the financial section begins, there is typically soft information that tells the company’s story in narrative terms. page 2 Introduction: About This Guide One might assume that of the two sections, up-front Then in 1959, Paul Rand, a nationally prominent narrative and back-end financial statements, the book designer, was invited by IBM to design its latter is the more frequently referenced and read. annual report. In large part because it was published In fact, quite the opposite is true, at least where by one of the most closely watched and innovative the average investor is concerned. A glance through of the era’s new technology companies, the report a few typical corporate reports suggests why. made a splash, and the high-concept annual report was born. Financial statements and the MD&A section in which they are contained are generally presented in What’s Next? a highly technical language foreign to the average Given today’s renewed emphasis on clarity and person. These sections are often characterized by communication between companies and their dense blocks of copy and lengthy footnotes. For investors, and because of more stringent reporting investors lacking formal training in business or and disclosure requirements, another evolution accounting, this kind of writing and design is at of the annual report seems likely soon. Addison’s best difficult, and at worst daunting. It is not that experts suggest that there will likely be a new good, useful information is not in the annual emphasis on what is now the back end of the report. Rather, this information is often written report—the financial statements and MD&A— in a way that makes communication with the and a new focus on clarity. average investor difficult. We have prepared this booklet to make this How did annual reports and the financial statements important financial information more easily come to be this way? understood by the average investor. The annual report as we know it today started, inauspiciously enough, with the Securities Act of 1933, passed to prohibit the kind of financial and business excesses that led to the Great Depression. The Securities Act stipulated very little—simply that companies file a Form 10-K with the Securities and Exchange Commission describing their current finan- cial condition. The next year, the SEC asked that the financial statements contained within the 10-K actually be published, along with a letter to share- holders describing how the numbers came to be and their impact on the company’s prospects. For years, this was all the annual report consisted of—just the statement with a letter from the company’s chief executive officer. page 3 Consolidated Financial Statements: The Key Components This page shows the key components of the basic financial statements of an imaginary company, ABC Manufacturing. Annual financial statements are usually stated at historical cost and are accompanied by an independent auditors’ report, which is why they are called “audited” financial statements. Balance Sheet CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) December 31 December 31 December 31 December 31 Statement of Changes Assets 2004 2003 Liabilities and Shareholders’ Equity 2004 2003 Gives a “snapshot” of the Current Assets: Cash and cash equivalents Marketable securities $ 19,500 46,300 $ 15,000 32,000 Current Liabilities: Accounts payable Notes payable $ 60,000 51,000 $ 57,000 61,000 in Shareholders’ Equity Accounts receivable— Accrued expenses 30,000 36,000 net of allowance for doubtful accounts 156,000 145,000 Current income taxes payable 17,000 15,000 company’s financial position at a Inventories Prepaid expenses and other current assets Total Current Assets 180,000 4,000 405,800 185,000 3,000 380,000 Other liabilities Current portion of long-term debt Total Current Liabilities 12,000 6,000 176,000 12,000 — 181,000 Reconciles the activity in Total property, plant and equipment 385,000 346,600 Long-Term Liabilities: specific point in time—showing Less accumulated depreciation Net Property, Plant and Equipment Other Assets: 125,000 260,000 97,000 249,600 Unfunded retiree benefit obligation Deferred income taxes Long-term debt — 16,000 130,000 — 9,000 130,000 the Shareholders’ Equity Deferred charges — — Other long-term debt — 6,000 what the company owns and what Intangibles (goodwill, patents)— net of accumulated amortization Investment securities, at cost 1,950 300 2,000 — Total Liabilities Shareholders’ Equity: Preferred stock 322,000 6,000 326,000 6,000 section of the balance Total Other Assets 2,250 2,000 Common stock 75,000 72,500 it owes at the report date. The sheet from period to period. Total Assets $668,050 $631,600 Additional paid-in capital 20,000 13,500 Retained earnings 249,000 219,600 Foreign currency translation adjustments (net of taxes) 1,000 (1,000) Unrealized gain on available-for-sale securities (net of taxes) 50 — balance sheet is always divided into Less treasury stock at cost Total Shareholders’ Equity (5,000) 346,050 (5,000) 305,600 Generally, changes in share- two halves: Assets (presented first), holders’ equity result from and Liabilities and Shareholders’ company profits or losses, Equity (presented below or to the dividends and/or stock CONSOLIDATED INCOME STATEMENTS CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY right of Assets). In the standard (Dollars in Thousands, Except Per-Share Amounts) Year Ended December 31 Year Ended December 31 (Dollars in Thousands) Year Ended December 31, 2004 issuance. 2004 2003 Foreign Additional Currency Unrealized accounting model, Assets = Net sales Cost of sales Gross margin $765,050 535,000 230,050 $725,000 517,000 208,000 Balance January 1, 2003 Preferred Stock $6,000 Common Stock $72,500 Paid-in Capital $13,500 Retained Earnings $219,600 Translation Adjustments $(1,000) Security Gain $ – Treasury Stock $(5,000) $305,600 Total Operating expenses: Statement of Net income 47,750 47,750 Liabilities + Shareholders’ Equity, Depreciation and amortization Selling, general and administrative expenses Operating income 28,050 96,804 105,196 25,000 109,500 73,500 Dividends paid on: Preferred stock Common stock (350) (18,000) (350) (18,000) Other income (expense): Common stock issued 2,500 6,500 9,000 so the two halves will always be Dividend and interest income Interest expense Income before income taxes and extraordinary loss 5,250 (16,250) 94,196 10,000 (16,750) 66,750 Foreign currency translation gain Net unrealized gain on available-for-sale 2,000 2,000 Cash Flows Income tax expense 41,446 26,250 securities 50 50 in balance. From an economic Income before extraordinary loss Extraordinary items, net of tax Net Income 52,750 (5,000) $ 47,750 40,500 $ 40,500 — Balance December 31, 2004 $6,000 $75,000 $20,000 $249,000 $1,000 $50 $(5,000) $346,050 Reports on the company’s Earnings Per Common Share viewpoint, each dollar of assets Before extraordinary loss $ 3.55 $ 2.77 cash movements during the must be offset by a dollar of period(s), separating them liabilities or equity. Shareholders’ into operating, investing Equity represents a company’s and financing activities. ownership structure and the net CONSOLIDATED STATEMENT OF CASH FLOWS (Dollars in Thousands, Except Per-Share Amounts) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Year Ended 1. Basis of Presentation. Lorem ipsum dolor sit amet, 6. Translation of Foreign Securities. Lorem ipsum dolor sit assets available to shareholders Cash Flows from Operating Activities: December 31 2004 consectetuer adipiscing elit, sed diam nonummy nibh euis- mod tincidunt ut laoreet dolore magna aliquam erat volutpat. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullamcorper suscipit lobortis nisl ut aliquip ex ea commodo amet, consectetuer adipiscing elit, sed diam nonummy nibh euismod tincidunt ut laoreet dolore magna aliquam erat volutpat. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullamcorper suscipit lobortis nisl ut aliquip ex ea com- Notes Net earnings $ 47,750 consequat. Duis autem vel eum iriure dolor in hendrerit in modo consequat. vulputate velit esse molestie consequat, vel illum dolore eu after all liabilities have been paid. Adjustments to reconcile net earnings to net cash from operating activities Net cash flows provided by operating activities 27,050 74,800 feugiat nulla. 2. Financial Instruments. Facilisis at vero eros et accumsan 7. Income Taxes. Duis autem vel eum iriure dolor in hen- drerit in vulputate velit esse molestie consequat, vel illum dolore eu feugiat nulla facilisis at vero eros et accumsan et Cash Flows from Investing Activities: Securities purchases: Trading (14,100) et iusto odio dignissim qui blandit praesent luptatum zzril delenit augue duis dolore te feugait nulla facilisi. Lorem ipsum dolor sit amet, consectetuer adipiscing elit, sed diam nonummy nibh euismod tincidunt ut laoreet dolore magna ali- iusto odio dignissim qui blandit praesent luptatum zzril delenit augue duis dolore te feugait nulla facilisi. Lorem ipsum dolor sit amet, consectetuer adipiscing elit, sed diam nonummy nibh euismod tincidunt ut laoreet dolore magna ali- Provide more detailed Held-to-maturity (350) quam erat volutpat. quam erat volutpat. Available-for-sale Principal payment received on held-to-maturity securities (150) 50 3. Customer Transactions. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullamcorper suscipit lobortis nisl ut aliquip ex ea commodo consequat. Duis autem vel eum iriure 8. Earnings Per Share. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullamcorper suscipit lobortis nisl ut aliquip ex ea commodo consequat. Duis autem vel eum iriure information about the Income Statement Purchase of fixed assets Net cash flows used in investing activities (38,400) (52,950) dolor in hendrerit in vulputate velit esse molestie consequat, vel illum dolore eu feugiat nulla facilisis at vero eros et accumsan et iusto odio dignissim qui blandit praesent lupta- dolor in hendrerit in vulputate velit esse molestie consequat, vel illum dolore eu feugiat nulla facilisis at vero eros et accumsan et iusto odio dignissim qui blandit praesent lupta- Cash Flows from Financing Activities: Net cash flows used in financing activities Effect of exchange rate changes on cash flows (19,350) 2,000 tum zzril delenit augue duis dolore te feugait nulla facilisi. Nam liber tempor cum soluta nobis eleifend option congue nihil imperdiet doming id quod mazim placerat facer possim assum. Lorem ipsum dolor. tum zzril delenit augue duis dolore te feugait nulla facilisi. 9. Statement of Cash Flows. Nam liber tempor cum soluta nobis eleifend option congue nihil imperdiet doming id quod financial statements. Reports on how the company Increase in cash flows Cash and cash equivalents at beginning of year Cash and Cash Equivalents at the End of Year 4,500 15,000 $ 19,500 4. Collateralized Securities Transactions. Sit amet, con- sectetuer adipiscing elit, sed diam nonummy nibh euismod tincidunt ut laoreet dolore magna aliquam erat volutpat. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullam- mazim placerat facer possim assum. Lorem ipsum dolor sit amet, consectetuer adipiscing elit, sed diam nonummy nibh euismod tincidunt ut laoreet dolore magna aliquam erat volutpat. Ut wisi enim ad minim veniam, quis nostrud exerci tation ullamcorper suscipit lobortis nisl ut aliquip ex ea com- corper suscipit lobortis nisl ut aliquip ex ea commodo modo consequat. performed during the period(s) consequat. 5. Fixed Assets. Duis autem vel eum iriure dolor in hendrerit in vulputate velit esse molestie consequat vel illum dolore 10. Stock-Base Compensation. Duis autem vel eum iriure dolor in hendrerit in vulputate velit esse molestie consequat, vel illum dolore eu feugiat nulla facilisis presented and shows whether its operations resulted in a profit or a loss. Audit A systematic examination of a company’s financial statements to determine if the amounts and disclosures in the reports are fairly stated and follow generally accepted accounting principles, or GAAP. Dividends Payments to shareholders as a return on their investment. Generally Accepted Accounting Principles (GAAP) The rules and standards followed in recording transactions and in preparing financial statements. Historical Cost Assets are reported as the amount of cash or cash equivalents paid to purchase them, and liabilities are reported as the amount of cash and cash equivalents received when the obligation was incurred. page 4 The Balance Sheet: Assets The assets section includes all the goods and property owned by the company, as well as uncollected amounts, called “receivables,” that are due to the company from others. Like the other sections of the financial statements, this section is subdivided into line items, or groups of similar “accounts” having a dollar amount or “balance.” CONSOLIDATED BALANCE SHEETS (Dollars in Thousands) December 31 December 31 Assets 2004 2003 1 Current Assets: 2 Cash and cash equivalents $ 19,500 $ 15,000 3 Marketable securities 46,300 32,000 4 Accounts receivable— net of allowance for doubtful accounts 156,000 145,000 5 Inventories 180,000 185,000 6 Prepaid expenses and other current assets 4,000 3,000 Total Current Assets 405,800 380,000 7 Total property, plant and equipment 385,000 346,600 8 Less accumulated depreciation 125,000 97,000 Net Property, Plant and Equipment 260,000 249,600 Other Assets: 9 Deferred charges — — 10 Intangibles (goodwill, patents)— net of accumulated amortization 1,950 2,000 11 Investment securities, at cost 300 — Total Other Assets 2,250 2,000 Total Assets $668,050 $631,600 Note Line items are numbered to facilitate the discussion on the following pages. page 5  The Balance Sheet: Assets This section of the balance sheet represents ABC Manufacturing’s assets at the end of one particular day, December 31, 2004. The company’s assets for the previous year end are also presented, making it possible to compare the balance sheets for those dates. Current Assets
Trading securities—debt and equity securities, 1 bought and sold frequently, primarily to generate In general, current assets include cash and other short-term profits, and carried at fair market assets that, in the normal course of business, will value. Any changes in such values are included be turned into cash within a year from the balance in the statement of earnings as unrealized gains sheet date. These other assets primarily include and losses from trading activities. marketable securities, accounts receivable, invento- ries and prepaid expenses. Current assets are listed
Held-to-maturity securities—debt securities on the balance sheet in order of their “liquidity,” that the company has the ability and intent i.e., the amount of time it takes to convert these to hold to maturity, i.e., the date when debt assets into cash. instruments, such as Treasury bills, are due and payable. These securities are reported at Current assets are “working” assets in the sense amortized cost (their original cost, adjusted for that they are liquid—they can, and will, be con- changes in any purchase discount or premium, verted into cash for other business purposes, or be less any principal payments received). consumed in the business. Inventories, when sold, become accounts receivable; receivables, upon
Available-for-sale securities—debt or equity collection, become cash; the cash can then be used securities not classified as either trading or held- to pay the company’s debt and operating expenses. to-maturity. They are recorded at fair value, with changes in such values included as a component Cash and Cash Equivalents 2 of other comprehensive income as unrealized Money on deposit in the bank, cash on hand (petty gains and losses from available-for-sale securities. cash) and highly liquid securities such as Treasury bills. ABC Manufacturing owns short-term, high-grade Marketable Securities commercial paper, classified as “trading securities,” 3 as well as preferred stock, classified as “available Short-term securities that are readily salable and for sale.” ABC, however, has no short-term “held- usually have quoted prices. May include: to-maturity” securities. Fair Market Value The amount at which an item could be exchanged between willing unrelated parties, other than in a forced liquidation. It is usually the quoted market price when a market exists for the item. page 6  The Balance Sheet: Assets Accounts Receivable
Work-in-process—partially completed goods in 4 the process of manufacture (e.g., pieces of fabric The amounts due from customers but not yet such as a sleeve and cuff sewn together during the collected. When goods are shipped to customers process of making a blouse). before payment or collection, an account receivable is created whereby customers are generally given
Finished goods—completed items ready for their an agreed-upon time period in which to pay— intended use. normally 30, 60 or 90 days. The amount of each of these types of inventories is In this example, the total amount due from customers generally disclosed either on the face of the balance is $158,375,000. Experience shows, however, that sheet or in the notes. For ABC, inventory represents some customers fail to pay their bills, which means the cost of items on hand that were purchased it is unlikely that the entire balance recorded as due and/or manufactured for sale to customers. To and receivable will be collected. Therefore, in order provide a conservative figure, inventories are valued to show the accounts receivable balance as a figure using the lower of cost or market rule. For balance- representing expected receipts, an allowance for sheet purposes, the lower of the two will usually doubtful accounts is deducted from the total be cost; however, if the market price is lower due amount recorded. In this instance, the allowance to deterioration, obsolescence, declining prices or for doubtful accounts is $2,375,000. other factors that are expected to result in the selling or disposing of inventories below cost, the market Inventories 5 price is used. A manufacturing company’s inventory consists of quantities of physical products assembled from The value of finished goods includes the direct various materials, which fall into one of the three costs of purchasing the materials used to produce following categories: the company’s products, as well as an allocation (i.e., an apportionment or dividing up) of the pro-
Raw materials—items to be used in making a duction expenses required to make those products. product (e.g., the fabric used in making a blouse). To do this, manufacturers use “cost accounting,” a specialized set of accounting procedures focusing on specific products, to determine individual product costs. When the individual direct costs for manu- factured inventory are added up, they comprise the value of finished goods. Allowance for Doubtful Accounts Amounts deducted from the total accounts receivable balance as a way of recognizing that some customers will not pay what they owe. Also called Provision for Doubtful Accounts, Reserve for Doubtful Accounts or Bad Debt Reserve. Lower of Cost or Market Rule A rule providing that inventories be valued at either their cost or market value, whichever is lower. The intent is to provide a conservative figure in valuing a company’s inventories. page 7  The Balance Sheet: Assets Prepaid Expenses and Other Current Assets Accumulated Depreciation 6 8 Payments made for which the company has not The practice of charging to or expensing against yet received benefits, but for which it will receive income the cost of a fixed asset over its estimated benefits within the coming year. These are listed useful life. For accounting purposes, depreciation among current assets as prepaid expenses. In ABC’s is the decline in useful value of a fixed asset due to case, the company paid fire insurance premiums and “wear and tear” from use and the passage of time. advertising charges covering periods after the date Taking these factors into consideration, the cost on the balance sheet. Because ABC has the contrac- related to property, plant and equipment must be tual right to the insurance and advertising services allocated over the item’s expected useful life. after that date, it has an asset that will be used after year-end. The company has simply “prepaid”—paid For example, suppose a delivery truck costs $10,000 in advance—for the right to use these services. and is expected to last five years. Using the straight- line method (equal periodic depreciation charges Total Property, Plant and Equipment over the life of the asset), $2,000 of the truck’s cost is 7 charged or expensed to each year’s income statement. Often referred to as fixed assets, this line item consists of long-lived assets (i.e., assets with a useful life greater than one year) not intended for sale that Straight-Line Depreciation: Year-to-Year are used to manufacture, display, warehouse and Year 1 Year 2 transport the company’s products, along with  buildings and improvements used in operations. Truck (Cost) $10,000 Truck (Cost) $10,000 The category includes land, buildings, leasehold Less Accumulated Less Accumulated improvements (i.e., improvements made to leased Depreciation (2,000) Depreciation (4,000)   property), machinery, equipment, furniture, auto- Net Depreciated Net Depreciated mobiles and trucks. In the standard accounting Cost $ 8,000 Cost $ 6,000 model, Fixed Assets = Cost – Accumulated Depreciation. ABC Manufacturing’s balance sheet shows The total property, plant and equipment figure accumulated depreciation—the total of accumulated displayed is not intended to reflect present market depreciation for buildings, machinery, leasehold value or replacement cost, because there is generally improvements, furniture and fixtures. Land is no intention of selling or replacing these assets in the not subject to depreciation. Its reported balance near term. The cost of replacing plant and equipment remains unchanged from year to year at the at a future date might, and probably will, be higher. original purchase price. Fixed Assets The property, plant and equipment used in the operation of a business. Market Value In these examples, the current cost of replacing the inventory by purchase or manufacture (with certain exceptions). Also sometimes referred to as Market Price. Estimated Useful Life The period of time over which the owner of a physical or intangible asset estimates that that asset will continue to be of productive use or have continuing value. page 8  The Balance Sheet: Assets Deferred Charges Investment Securities, at Cost 9 11 Expenditures for items that will benefit future Investments in debt securities are carried at amor- periods more than one year from the balance sheet tized cost only when the company has the ability date. Costs of debt issuance would be one example and intent to hold them to maturity. In the example, of a deferred charge. Deferred charges are similar to early in 2004, ABC Manufacturing purchased prepaid expenses, but are not included in current mortgage bonds issued by one of its major suppliers. assets because their benefits will be realized in peri- The bonds are due in full in five years and bear ods more than one year from the balance sheet date. annual interest of 8%. In 2004, the issuer made The cost incurred will be gradually expensed over an unscheduled principal prepayment of $50,000. the asset’s future benefit period(s), not fully charged Since ABC intends to maintain a continuing relation- off in the year payment is made. ship with the issuer and to hold the bonds until they mature—and appears to have the financial strength Intangibles to do so—this investment is classified as “held-to- 10 maturity,” and therefore the $50,000 prepayment Assets having no physical existence that nonetheless would reduce the cost of the debt security. have substantial value to the company. Examples include a patent for exclusive manufacture of an All investments of this type must be reviewed to item, a franchise allowing exclusive service in a ensure that all contractually specified amounts are specific area, a trademark or a copyright. Goodwill fully collectible. If not fully collectible, an investment is another intangible asset found on the balance would be considered permanently impaired, and it sheet. It is presumed to represent the value of would be necessary to write it down to its fair value. the company’s name, reputation, customer base, In the example, however, the issuer is in a strong intellectual capital and workforce. financial condition, as shown by: Intangible assets reported on the balance sheet are
The issuer’s unscheduled prepayment of principal. generally those purchased from others. They are amortized over their estimated useful lives, but
Increased property values where the plant that usually not longer than 40 years. In the standard secures the bonds is located. accounting model, Net Intangible Assets = Intangible Assets – Accumulated Amortization. Thus, there is no reason to suspect that all contractual Accumulated amortization is the total amount of amounts will not be collected. There is no impair- the periodic charges against income. ment, and no required write-down in investment security value. Goodwill The amount by which the price of an acquired company exceeds the fair value of the related net assets acquired. It is presumed to represent the value of the company’s name, reputation, customer base, intellectual capital and workforce. Amortization Periodic charges to income to recognize the allocation of the cost of the company’s intangible assets over the estimated useful lives of those assets. Permanent Impairment The probability that the investor will not collect all amounts in accordance with the loan agreement. page 9 The Balance Sheet: Liabilities and Shareholders’ Equity The balance sheet is always divided into two halves: Assets and Liabilities, and Shareholders’ Equity. The two halves should always be in balance. From an economic viewpoint, each dollar of assets must be offset by a dollar of liabilities or shareholders’ equity. Liabilities and CONSOLIDATED BALANCE SHEETS Shareholders’ Equity (Dollars in Thousands) December 31 December 31 December 31 December 31 Assets 2004 2003 Liabilities and Shareholders’ Equity 2004 2003 The Liabilities and Shareholders’ Current Assets: Cash and cash equivalents $ 19,500 $ 15,000 Current Liabilities: Accounts payable $ 60,000 $ 57,000 Equity section of the balance sheet Marketable securities Accounts receivable— 46,300 32,000 Notes payable Accrued expenses 51,000 30,000 61,000 36,000 net of allowance for doubtful accounts 156,000 145,000 Current income taxes payable 17,000 15,000 details what the company owes. Inventories Prepaid expenses and other current assets 180,000 4,000 185,000 3,000 Other liabilities Current portion of long-term debt 12,000 6,000 12,000 — This section always appears to Total Current Assets Total property, plant and equipment 405,800 385,000 380,000 346,600 Total Current Liabilities Long-Term Liabilities: 176,000 181,000 Less accumulated depreciation 125,000 97,000 Unfunded retiree benefit obligation — — the right of, or below, the Assets Net Property, Plant and Equipment 260,000 249,600 Deferred income taxes 16,000 9,000 Other Assets: Long-term debt 130,000 130,000 section of the balance sheet. Deferred charges Intangibles (goodwill, patents)— — — Other long-term debt Total Liabilities — 322,000 6,000 326,000 net of accumulated amortization 1,950 2,000 Shareholders’ Equity: Remember that, in the standard Investment securities, at cost Total Other Assets 300 2,250 — 2,000 Preferred stock 6,000 6,000 Common stock 75,000 72,500 accounting model, Assets = Total Assets $668,050 $631,600