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Financial Accounting:
Tools for Business Decision Making, 4th Edition
Kimmel, Weygandt, Kieso
CHAPTER 2
Prepared by
Ellen L. Sweatt
Georgia Perimeter College
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Chapter 2
A FURTHER LOOK AT
FINANCIAL
STATMENTS
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Chapter 2
A Further Look at Financial Statements
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


Identify the sections of a classified balance sheet.
Identify and compute ratios for analyzing a
company's profitability.
Explain the relationship between a retained
earnings statement and a statement of
stockholders' equity.
Identify and compute ratios for analyzing a
company's liquidity and solvency using a balance
sheet.
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Chapter 2
A Further Look at Financial Statements


Explain the meaning of generally accepted
accounting principles.
Discuss financial reporting concepts.
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Identify the Sections of a
Classified Balance Sheet


Helps users see if company
has enough assets to pay
debts
Can determine the shortterm and long-term claims on
total assets
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Classified Balance Sheet
Generally contains the following standard
classifications:
Current Assets
 Long-Term Investments
 Property, Plant, and Equipment
 Intangible Assets
 Current Liabilities
 Long-Term Liabilities
 Stockholders' Equity
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Current Assets



Assets that are expected to be converted to cash
or used up within one year.
Current assets are listed in order of liquidity.
Examples:
 Cash
 Short-term investments
 Receivables
 Inventories
 Supplies
 Prepaid expenses
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Long-Term Investments


Investments of stocks and bonds of
other corporations which are
normally held for many years.
Investments in long-term assets
such as land or buildings that are not
currently being used in the
company’s operations
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Property, Plant, and Equipment



Assets with relatively long
useful lives.
Assets used in operating
the business.
Examples:
 land
 buildings
 machinery
 delivery equipment
 furniture and fixtures
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Depreciation is...

Practice of allocating an asset’s full
purchase price to a number of years
instead of expensing full cost in year of
purchase.
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Accumulated Depreciation...

Shows the total amount of depreciation
that the company has expensed thus
far in the asset’s life.
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Assets That A Company
Depreciates...
Should be shown at cost less
accumulated depreciation
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Intangible Assets



Non-current assets
Have no physical substance
Examples:
 patents
 copyrights
 trademarks or trade names
 franchise
Intangible Assets have value because of the exclusive
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rights or privileges they give the company.
Current Liabilities
Obligations that are supposed to be paid within the
coming year...






accounts payable
wages payable
bank loans payable
interest payable
taxes payable
current maturities of long-term bank
loans payable
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Long-Term Liabilities
Debts expected to be paid after one
year
Examples…
 bonds payable
 mortgages payable
 long-term notes payable
 lease liabilities and
 obligations under employee pension
plans
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Stockholders' Equity


Capital stock - investments of assets in
the business by the stockholders
Retained earnings - earnings kept for
use in the business
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Ratio Analysis


Expresses relationship among selected
items of financial statement data
Relationship can be expressed in terms
of…
 Percentage
 Rate
 Proportion
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Ratio Analysis

Profitability Ratios - Measures the
income or operating success of a company
for a given period of time
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Ratio Analysis

Liquidity Ratios - Measures short-term
ability of company to pay its maturing
obligations and meet unexpected needs for
cash
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Ratio Analysis

Solvency Ratios - Measures the ability
of the company to survive over a long
period of time
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Ratio Analysis –
Use Multiple Measures!



Intracompany comparisons - covering two
years of the same company
Industry average comparisons - based on
average ratios for a particular industry
Intercompany comparisons - based on
comparisons with a competitor in the
same industry
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Earnings Per Share
How does the company’s earning
performance compare with that of previous
years (on a per share basis)?
EPS=
Net income-Preferred stock dividends
Average common shares outstanding
Higher value = improved performance
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Review
For 2005 Stoneland Corporation reported net
income $24,000; net sales $400,000; and average
shares outstanding 6,000. There were no
preferred stock dividends. What was 2005
earnings per share?
a. $4.00
c. $16.67
b. $ .06
d. $66.67
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Review
For 2005 Stoneland Corporation reported net
income $24,000; net sales $400,000; and average
shares outstanding 6,000. There were no
preferred stock dividends. What was 2005
earnings per share?
a. $4.00
c. $16.67
b. $ .06
d. $66.67
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Statement of Retained
Earnings
From Chapter 1: The Statement of Retained
Earnings describes the changes in the retained
earnings for the period . . .
Retained earnings, January 1
Add: Net income
Less: Dividends
Retained earnings, Dec. 31
$
0
6,800
6,800
600
$ 6,200
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11
Statement of Retained
Earnings
From Chapter 1: The Statement of Retained
Earnings describes the changes in the retained
earnings for the period . . .
Retained earnings, January 1
Add: Net income
Less: Dividends
Retained earnings, Dec. 31
$
0
6,800
6,800
600
$ 6,200
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Statement of
Stockholders’ Equity
Stockholders’ equity has two parts:
Common Stock and
Retained Earnings,
Thus, The Statement of Stockholders’ Equity
reports ALL CHANGES in the common stock
and retained earnings accounts…
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Statement of
Stockholders’ Equity
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Liquidity Ratios

Measure of short-term ability to pay
maturing obligations and to meet
unexpected needs for cash
•Working capital
•Current ratio
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Working Capital
•Measure of short-term ability to pay
obligations
•Difference between current assets and
current liabilities
Working Capital = Current Assets - Current Liabilities
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Current Ratio
Current Ratio =
Current Assets
Current Liabilities
•More dependable indicator
•Does not consider composition of current
assets
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Solvency Ratios

Measure the ability of a company to
survive over a long period of time
Debt to Total Asset Ratio = Total Debts
Total Assets
•Measures percentage of assets financed by
creditors rather than stockholders
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Review
Statement of Cash Flows
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
Provides information about sources and
uses of cash, organized as:



Operating Activities
Investing Activities
Financing Activities
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Free Cash Flow
Free Cash Flow
Cash Provided _
Capital
By Operations
Expenditures
_
Cash
Dividends
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Primary Accounting
Setting Body in the U.S.
Financial
 Accounting
 Standards
 Board

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U.S. Government Agency
That Oversees Financial
Markets
Securities
 Exchange
 Commission

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GAAP Are the Rules
The FASB makes the rules.
The SEC enforces the rules.
IASB = International Accounting Standards Board
Review
What organization issues United States
accounting standards?
a. Financial Accounting Standards Board
b. Internal Accounting Standards Committee
c. Internal Auditing Standards Committee
d. Securities and Exchange Committee
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Review
What organization issues United States
accounting standards?
a. Financial Accounting Standards Board
b. Internal Accounting Standards Committee
c. Internal Auditing Standards Committee
d. Securities and Exchange Committee
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Basic Terms


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
Relevance - information makes a difference in
decisions
Reliability - information must be free of error
and bias
Comparability - ability to compare
information of different companies because
they use the same accounting principles
Consistency - use of same accounting
principles and methods from year to year
within the same company
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Characteristics of Useful Information
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Accounting Assumptions
Accounting Principles
Constraints In Accounting
Illustration 23
Review
What is the primary criterion by which
accounting information can be judged?
a. Consistency
b. Predictive Value
c. Usefulness for decision making
d. Comparability
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Review
What is the primary criterion by which
accounting information can be judged?
a. Consistency
b. Predictive Value
c. Usefulness for decision making
d. Comparability
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Review
What accounting constraint refers to the tendency
of accountants to resolve uncertainty in a way
least likely to overstate assets and revenues?
a. Comparability
b. Materiality
c. Conservatism
d. Consistency
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Review
What accounting constraint refers to the tendency
of accountants to resolve uncertainty in a way
least likely to overstate assets and revenues?
a. Comparability
b. Materiality
c. Conservatism
d. Consistency
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Review
Which is not an indicator of profitability?
a. Current ratio
b. Earnings per share
c. Net income
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Review
Which is not an indicator of profitability?
a. Current ratio
b. Earnings per share
c. Net income
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Review
The balance in retained earnings is not
affected by:
a. Net income.
b.Issuance of common stock.
c. Dividends.
d.Net Loss.
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Review
The balance in retained earnings is not
affected by:
a. Net income.
b.Issuance of common stock.
c. Dividends.
d.Net Loss.
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Review
Selected financial information for
Drummond Company at 12/31/2006:
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets
$60,000
$80,000
$70,000
$330,000
$540,000
Current Liabilities
Long-term debt
Total Liabilities
$140,000
$130,000
$270,000
Let’s compute current ratio . . .
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Review
Compute Current Ratio
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets
$60,000
$80,000
$70,000
$330,000
$540,000
Current Liabilities
Long-term debt
Total Liabilities
$140,000
$130,000
$270,000
$210,000

$140,000
=
1.5 : 1
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Review
Selected financial information for
Drummond Company at 12/31/2006:
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets
$60,000
$80,000
$70,000
$330,000
$540,000
Current Liabilities
Long-term debt
Total Liabilities
$140,000
$130,000
$270,000
Compute debt to total assets . . .
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Review
Cash
Receivables (net)
Inventory
Long-term assets
Total Assets
$60,000
$80,000
$70,000
$330,000
$540,000
Current Liabilities
Long-term debt
Total Liabilities
$140,000
$130,000
$270,000
$270,000  $540,000 = 50%
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