UNDERSTANDING FINANCIAL STATEMENTS

1
UNDERSTANDING FINANCIAL STATEMENTS

• BALANCE SHEET Liabilities Stockholders
  Equity

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LIABILITIES

• Liabilities- probable future sacrifices of
  economic benefits arising from present
  obligations of a particular entity to transfer
  assets or provide services to other entities in
  the future, as a result of past transactions or
  events.
• May be CURRENT or LONG-TERM -- same criteria of
  one-year or operating cycle, whichever is
  longer

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Current Liabilities

• Accounts Payable
• Short-term Notes Payable
• Accrued Liabilities
• Unearned Revenues (Deferred Credits)
• Current Maturity Portion of Long-term Debt
• Deferred Taxes

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Long-Term Liabilities

• Notes or Mortgages Payables
• Bonds Payable
• Leases Payable (capital leases)
• Pension Obligations
• Post-retirement benefits other than pensions
• Deferred Taxes
• Warranty Obligations
• Contingencies Payable

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Accounts Payable

• Usually defined as obligations arising from
  purchases of merchandise for resale or of raw
  materials
• Few valuation or reporting issues
• Significant changes from period to period often
  result from changes in sales volume

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Short-Term Notes Payable

• Promissory notes due within a year (or operating
  cycle if more appropriate)
• Usually are interest-bearing
• Usually reported at face value because of
  short-term nature

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Accrued Liabilities

• Result from accrual basis of accounting
• Represent expenses that have been INCURRED and
  thus ACCRUED, but have NOT BEEN PAID in cash
• Examples are Interest Payable and Wages Payable

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Unearned Revenue

• Examples
• Unearned rent revenue
• Advances from customers
• Sometimes called deferred credits
• Results from a prepayment received in advance for
  services or products
• Under accrual accounting, revenue is recognized
  when EARNED, not when received in cash -- in this
  case, cash flow precedes revenue recognition

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Current Maturities - LT Debt

• Represent principal payments (not interest) on
  debt that are due within one year
• Includes principal payments on notes, mortgages,
  bonds, leases

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Long-term Liabilities

• Notes or Mortgages Payable
• Bonds Payable
• Leases Payable (Capital Leases Payable) -
  recorded at the present value of expected future
  cash outflows starting when the lease begins (PPE
  will also be recorded)
• (Operating leases are recorded as lease expense
  and no liability nor PPE are recorded)
• Pension Obligations - reported at the present
  value of expected future cash outflows
• Warranty Obligations - Represent estimated
  liability of a firm to repair or replace
  merchandise that it sells

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Long-term Liabilities

• Postretirement benefits other than pensions
• An estimate of the obligation for paying medical
  insurance premiums or medical expenses of retired
  employees and spouses.
• These future benefits are accrued as the
  employees are working for the company.

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Long-term Liabilities

• Contingencies potential liabilities such as
  possible losses assessed in a lawsuit
• If the loss is probable, then record the
  liability and loss and disclose in a footnote. If
  the loss is not estimable, then do not record the
  liability and loss, but must disclose in a
  footnote.
• If the loss reasonably possible, then do not
  record the liability and loss, but must disclose
  in a footnote.
• If remote, then do not record, must not
  disclose.

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Deferred Income Taxes

• Taxes paid are based on taxable income on Tax
  Return
• Tax expense reported on income statement is based
  on FINANCIAL Income Statement
• Deferred Income Taxes result from TIMING
  (temporary) differences in taxable and financial
  statement income
• Classification may be current or long-term
  depending on the asset or liability underlying
  the temporary difference
• Examples
• depreciation
• pension expense
• installment sale accounting

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OWNERS EQUITY

• Forms of business contrasted as to owners equity
  section.
• a. Proprietorship report owners equity as a
  single capital account.
• b. Partnership report separate capital account
  for each partner.
• c. Capital account reflects all changes
  investments, withdrawals, earnings, and losses.
• d. Corporations report stockholders equity,
  including contributed capital and retained
  earnings.

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STOCKHOLDERS EQUITY

• Common stock, at par value
• Preferred stock
• Additional Paid-in Capital (also called Paid- in
  Capital in Excess of Par)
• Retained Earnings
• Accumulated Other Comprehensive Income
• Less Treasury Stock (at cost)
• Total Stockholders Equity

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Common Stock and Additional Paid-In Capital

• Common stock represents ownership of the company
• Voting privileges
• No fixed return (no required dividend rate)
• But over the companys lifetime the common stock
  dividends should be higher than the preferred
  stock dividends
• Must disclose par value and number shares
• Authorized
• Issued
• Outstanding

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Preferred Stock

• No voting privileges
• If company terminates, then their investment is
  returned before the common stockholders
• Stated dividend rate (i.e., 8)
• Usually annual dividend is not required, but when
  dividends are declared by B of D, then the
  current year preferred stock dividends would be
  paid before the common stock dividends.
• If cumulative preferred stock, then missed
  dividends (called dividends in arrears) would be
  paid first when dividends are declared by B of D.
• If redeemable preferred stock (preferred
  stkhlders are repaid their investment after a
  stated period, like bonds), then the company is
  not allowed to show in SE section (show between
  liabilities and SE section.

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Retained Earnings

• Represents the cumulative undistributed earnings
  of the business since its inception
• Accumulated net income (net loss) less dividends
  declared since inception
• Current year detail is shown in Statement of
  Retained Earnings (Beg. RENet Income-Dividends
  declared Ending RE)
• Only Ending RE balance is shown on BS

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Treasury Stock

• Repurchased shares of stock to be retained and
  possibly reissued later is called Treasury Stock.
• The stock may be repurchased
• To distribute the stock to employees under stock
  option plans or retirement plans.
• To prevent a hostile takeover.

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Treasury Stock

• The repurchase of a companys own stock can be
  accounted for by one of two methods
• (1) At Cost Method (the amount paid to
  repurchase the stock is shown as a separate line
  item as a subtraction from stockholders equity)
• (2) Par Value Method (the amount paid to
  repurchase the stock reduces Common Stock and
  Additional Paid-In Capital)