Acctg 330 chp 5

Parenthetical Explanations

Companies often provide additional information by parenthetical explanations following the item. adds clarity and completeness in the body of the statement where it won't be overlooked. avoid long entries in this manner of disclosure as they are distracting. ex. Common Stock $0.01 per share (1,837 million shares issued)

Trading

Debt and equity securities bought and held primarily for sale in the near term to generate income on short-term price differences. report at fair value

Available-for-sale:

Debt and equity securities not classified as held-to-maturity or trading securities. report at fair value.

held-to-maturity investments

Debt securities that a company has the positive intent and ability to hold to maturity. report at amortized cost.

FAIR VALUES

Disclosures of fair values, particularly for financial instruments.

Contractual situations & SEC

Due to many recent accounting scandals, SEC mandated that companies disclose contractual obligations in a tabular summary in the management discussion and analysis section of the company's annual report

CONTRACTUAL SITUATIONS

Explanations of certain restrictions or covenants attached to specific assets or, more likely, to liabilities. Companies must disclose if material: obligations to maintain working capital, to limit the payment of dividends, to restrict the use of assets, and to require the maintenance of certain financial ratios. Management must exercise considerable judgment to determine whether omission of such information is misleading. The rule in this situation is, "When in doubt, disclose."

ACCOUNTING POLICIES

Explanations of the valuation methods used or the basic assumptions made concerning inventory valuations, depreciation methods, investments in subsidiaries, etc.

balance sheet

Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and stockholders' equity a.k.a statement of financial position

companies mus make the following fair value disclosures:

For major groups of assets and liabilities (1) the fair value measurement and (2) the fair value hierarchy level of the measurements as a whole, classified by Level 1, 2, or 3

Revaluation Equity

GAAP and IFRS differ in the IFRS provision for balance sheet revaluations of property, plant, and equipment. Under the revaluation model, revaluations are recorded and reported as part of equity.

treasury stock

Generally, the amount of ordinary shares repurchased. companies show any capital stock reacquired as a reduction of stockholders' equity

Cash Flows and IFRS/GAAP

IFRS requires a statement of cash flows. Both IFRS and GAAP specify that the cash flows must be classified as operating, investing, or financing.

long-term investments

Investments that companies expect to hold for many years. Examples are (1) investments in securities, such as bonds or common stock; (2) investments in tangible fixed assets not currently used in operations, such as land held for speculation; (3) investments set aside in special funds, such as a pension fund; and (4) investments in nonconsolidated subsidiaries. Companies usually present long-term investments on the balance sheet just below current assets.

FASB & IASB Project financial statement presentation

Key Features of proposed framework: *Statements will be in the same format *separate entity's financing activities from operating and investing *separate financing activities into transactions with owners and creditors

CONTINGENCIES

Material events that have an uncertain outcome. Examples of gain contingencies are tax operating-loss carryforwards or company litigation against another party. Typical loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations.

information to prepare the statement of cash flows obtained from ?

(1) comparative balance sheets (2) the current income statement (3) selected transaction data

International terminology

***Challenging Accounting Issue*** U.S.: Stock =Equity or Ownership Fixed Asset=property, plant, and equipment U.K. Stock=Inventory Fixed Asset=category includes more items than in U.S.

IFRS v. GAAP Balance Sheet (statement fo financial position) Statement of Cash Flows

*balance sheet (statement of financial position) and the statement of cash flows are required statements for IFRS *disclosure requirements are much more extensive and detailed in the United States (for balance sheet and cash flow statements) *

IFRS v. GAAP Similarities

1) Both allow the use of title "balance sheet" or "statement of financial position." IFRS recommends but does not require the use of the title "statement of financial position" rather than balance sheet. 2) Both require disclosures about (1) accounting policies followed (2) judgments that management has made in the process of applying the entity's accounting policies (3) the key assumptions and estimation uncertainty that could result in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Comparative prior period information must be presented and financial statements must be prepared annually. 3) Both require presentation of non-controlling interests in the equity section of the balance sheet.

IFRS v. GAAP Differences

1) IFRS requires a classified statement of financial position except in very limited situations. IFRS follows the same guidelines as this textbook for distinguishing between current and non-current assets and liabilities. However, under GAAP, public companies must follow SEC regulations, which require specific line items. In addition, specific GAAP mandates certain forms of reporting for this information. 2) IFRS, current assets are usually listed in the reverse order of liquidity. For example, under GAAP cash is listed first, but under IFRS it is listed last. 3) IFRS has many differences in terminology that you will notice in this textbook. For example, in the sample statement of financial position illustrated on page 279, notice in the equity section common stock is called share capital—ordinary. 4) Use of the term "reserve" is discouraged in GAAP, but there is no such prohibition in IFRS.

SUPPLEMENTAL BALANCE SHEET INFORMATION

1. CONTINGENCIES. 2. ACCOUNTING POLICIES. 3. CONTRACTUAL SITUATIONS. 4. FAIR VALUES

Significant Non-cash Activities

1. Issuance of common stock to purchase assets. 2. Conversion of bonds into common stock. 3. Issuance of debt to purchase assets. 4. Exchanges of long-lived assets. not reported in the body of the statement of cash flows. reported in either a separate schedule at the bottom of the statement of cash flows or in separate notes to the financial statements

Limitations of The Balance Sheet

1. Most assets and liabilities are reported at historical cost 2. Companies use judgments and estimates to determine many of the items reported 3. The balance sheet necessarily omits many items that are of financial value

statement of cash flows (a.k.a cash flow statement)

A basic financial statement that provides information about cash receipts, cash payments, and the net change in cash resulting from the operating, investing, and financing activities of a company during the period, in a format that reconciles the beginning and ending cash balances. FASB required.

non-controlling interest (minority interest)

A portion of the equity of subsidiaries not wholly owned by the reporting company.sometimes referred to as minority interest, is also shown as a separate item (where applicable) as a part of equity

ratio analysis

An evaluation of the relationship among selected financial statement data, expressed in terms of either a percentage, a rate, or a simple proportion.

financial instruments

Assets consisting of cash, accounts receivable, an ownership interest, or a contractual right to receive or obligation to deliver cash or another financial instrument.

Property, Plant, and Equipment

Assets of a durable nature used in the regular operations of the business. These assets consist of physical property (such as land, buildings, machinery) and wasting resources (timberland, minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets.

Intangible Assets

Assets that lack physical substance and that are not financial instruments. Intangible assets derive their value from the rights and privileges granted to the company using them. They are normally classified as long-term assets. Companies write off (amortize) limited-life intangible assets over their useful lives, and they periodically assess indefinite-life intangibles (including goodwill) for impairment.

current assets

Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Companies present current assets in the balance sheet in order of liquidity.

operating activities

Cash flow activities include the cash effects of transactions that create revenues and expenses, and thus enter into the determination of net income.

financing activities

Cash flow activities that include (1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders and paying them dividends.

investing activities

Cash flow activities that include (1) purchasing and disposing of investments and productive long-lived assets using cash, and (2) lending money and collecting the loans.

Cross-Reference and Contra Items

Companies "cross-reference" a direct relationship between an asset and a liability on the balance sheet

ACTIVITY RATIOS.

Measures of how effectively the company uses its assets

LIQUIDITY RATIOS.

Measures of the company's short-term ability to pay its maturing obligations

COVERAGE RATIOS

Measures of the degree of protection for long-term creditors and investors.

Profitability ratios

Measures of the degree of success or failure of a given company or division for a given period of time.

current cash debt coverage

Net Cash (provided by operating activities)/ Average Current Liabilities Measure of liquidity that indicates a company's ability to pay its short-term debts. net cash provided by operating activities /average current liabilities.The higher the current cash debt coverage, the less likely a company will have liquidity Problems. a ratio near 1:1 is good. the company can meet current obligations from internally generated cash flow.

cash debt coverage

Net Cash (provided by operating activities)/ Average Total Liabilities (longer range view than current cash debt coverage) the higher the ratio, the less likely the company will have difficulty meeting obligations. Measure of solvency that indicates a company's ability to repay its liabilities from cash generated from operations (without having to liquidate productive assets). Computed as the ratio of net cash provided by operating activities to total debt, as represented by average total liabilities.

Free Cash Flow

Net Cash Capital Dividends Free provided by - Expenditures - = Cash operating Flow activities Measure of the cash remaining from operating activities after adjusting for capital expenditures and dividends paid. Some analysts prefer free cash flow to the measure of net cash provided by operating activities because free cash flow takes into account the outflows needed to maintain current operations. Questions that a free cash flow analysis answers are: 1. Is the company able to pay its dividends without resorting to external financing? 2. If business operations decline, will the company be able to maintain its needed capital investment? 3. What is the amount of discretionary cash flow that can be used for additional investment, retirement of debt, purchase of treasury stock, or addition to liquidity?

retained earnings

The corporation's undistributed earnings. . may be divided between the unappropriated (the amount that is usually available for dividend distribution) and restricted (e.g., by bond indentures or other loan agreements) amounts

additional paid in capital

The excess of amounts paid in over the par or stated value. usually presents in one amount although subtotals are informative if the sources of additional capital are varied and material

working capital (or net working capital)

The excess of total current assets over total current liabilities; represents the net amount of a company's relatively liquid resources.

current liabilities

The obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. This concept includes 1)payables resulting from the acquisition of goods and services, (2) collections received in advance for the delivery of goods or performance of services, and (3) other liabilities whose liquidation will take place within the operating cycle. In general, companies most commonly list notes payable, accounts payable, or short-term debt as the first item. Income taxes payable, current maturities of long-term debt, or other current liabilities are commonly listed last.

Usefulness of the Statement of Cash Flows

creditors look in the company's cash flow statements for: 1. How successful is the company in generating net cash provided by operating activities? 2. What are the trends in net cash flow provided by operating activities over time? 3. What are the major reasons for the positive or negative net cash provided by operating activities?

Other Assets

include items such as long-term prepaid expenses, prepaid pension cost, and non-current receivables. assets in special funds, deferred income taxes, property held for sale, and restricted cash or securities

Prepaid Expenses

includes prepaid expenses in current assets if it will receive benefits (usually services) within one year or the operating cycle, whichever is longer. reports prepaid expenses at the amount of the unexpired or unconsumed cost

Value of the statement of cash flows

it helps users evaluate liquidity, solvency, and financial flexibility

Offsetting

offsetting hides the existence of assets and liabilities, making it difficult to evaluate liquidity, solvency, and financial flexibility GAAP does not permit the reporting of summary accounts alone (e.g., total assets, net assets, and total liabilities). IASB & FASB: worked to develop common criteria for offsetting on balance sheet. IFRS more restrictive than GAAP Boards have not been able to agree on a converged standard, thereby stalling this project. Boards have issued converged disclosure requirements. The disclosure rules require companies to disclose both gross information and net information about instruments and transactions

Techniques Of Disclosure

parenthetical explanations notes cross-reference contra items supporting schedules

Purpose of the Statement of Cash Flows

provide relevant information about the cash receipts and cash payments of an enterprise during a period. reports the following: (1) the cash effects of operations during a period (2) investing transactions (3) financing transactions (4) the net increase or decrease in cash during the period

Cash equivalents

short-term highly liquid investments that will mature within three months or less

reserve

the profession has recommended that companies use the word to mean: An appropriation of retained earnings. Also called appropriated earnings. the text recommends using the term "appropriated" feeling it appears more logical, and encourages its use.

surplus

the profession has recommended that the use of the word be discontinued in balance sheet presentations of stockholders' equity. The use of the terms capital surplus, paid-in surplus, and earned surplus is confusing.

Non-current Assets

those not meeting the definition of current assets: Long-term Investments Property, Plant, and Equipment Intangible Assets

fair value measurements

to increase consistency and comparability companies follow this fair value hierarchy: Level 1 measures (the least subjective) are based on observable inputs, such as market prices for identical assets or liabilities Level 2 measures (more subjective) are based on market-based inputs other than those included in Level 1, such as those based on market prices for similar assets or liabilities Level 3 measures (most subjective) are based on unobservable inputs, such as a company's own data or assumptions (GAAP has expanded disclosures regarding fair value measurmentsFASB ASC 820-10-15) .

Stockholders Equity Section

typically divided in to 6 parts: 1. Capital Stock 2. Additional paid in capital 3. Retained earnings 4. Accumulated other comprehensive income 5. Treasury stock 6. Non-controlling interest (minority interest)

Notes

used if disclosures cannot be shown as parenthetical explanations commonly used to disclose: existence/amount of preferred stock dividends in arrears terms of obligations imposed by purchase commitments special financial arrangements and instruments depreciation policies changes in application of accounting principles existence of contingencies

accumulated other comprehensive income

aggregate amount of other comprehensive income items. Accumulated other comprehensive income includes such items as unrealized gains and losses on available-for-sale investments and unrealized gains and losses on certain derivative transactions

analysts use the balance sheet to

assess a company's liquidity, solvency, and financial flexibility.

operating cycle

average time between when a company acquires materials and supplies and when it receives cash for sales of the product .several operating cycles within one year a company uses the one-year period. more than one year, a company uses the longer period.

Z-score

bankruptcy-prediction model.companies with Z-scores above 3.0 are unlikely to fail. Those with Z-scores below 1.81 are very likely to fail.

current assets and valuation basis

cash and cash equivalents fair value short term receivables generally fair value receivables estimated amt collectible inventories lower of cost or market pre-paid expense cost **only reports as current assets if going to be realized in one year or operating cycle, whichever is longer ***

Receivables

clearly identify any anticipated loss due to uncollectibles, the amount and nature of any non-trade receivables, and any receivables used as collateral. Long-term: classify separately unless collection expected in less than a year. (resulting from unusual transactions)

Long-term liabilities

Obligations that a company expects to pay at some date beyond the normal operating cycle. Examples are bonds payable, notes payable, some deferred income tax amounts, lease obligations, and pension obligations. Also referred to as long-term debt. Companies provide a great deal of supplementary disclosure for long-term liabilities because they often are subject to covenants and restrictions for the protection of lenders. It is desirable to report any premium or discount separately as an addition to or subtraction from the bonds payable

Supporting Schedules

Often needed to present more detailed information about certain assets or liabilities

account form

Presentation in a classified balance sheet that lists assets by sections on the left side and liabilities and stockholders' equity by sections on the right side. main disadvantage is the need for a sufficiently wide space in which to present the items side by side. Often, the account form requires two facing pages

report form

Presentation in a classified balance sheet that lists liabilities and stockholders' equity directly below assets on the same page.

solvency

The ability of a company to pay its debts as they mature. A company with a high level of long-term debt relative to assets has lower solvency than a similar company with a low level of long-term debt.

financial flexibility

The ability of a company to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. A company's liquidity and solvency affect its financial flexibility. (ability to adapt to financial adversity and unexpected needs and opportunities)

liquidity

The amount of time that is expected for an asset to be realized or otherwise converted into cash or until a liability has to be paid. In general, the greater a company's liquidity, the lower its risk of failure. ('nearness to cash of assets and liabilites')

full disclosure principle

The basis for including information: the information should be of sufficient importance to influence the judgment of an informed user.

owners' equity

The ownership claim on a company's total assets. The owners' equity section of the corporate balance sheet consists of capital stock, additional paid-in capital, and retained earnings. The ownership accounts (stockholders' equity) in a corporation differ considerably from ownership accounts in a partnership or proprietorship. Partners show separately their permanent capital accounts and the balance in their temporary accounts (drawing accounts). Proprietors ordinarily use a single capital account that handles all of the owner's equity transactions.

capital stock

The par or stated value of the shares issued. companies must disclose the par value and the authorized, issued, and outstanding share amounts

Inventories

a company discloses the basis of valuationand (lower of cost or market) the cost flow assumption used (FIFO/LIFO). manufactures also indicate stage of completion of inventory.