Ch 3 - Balance Sheet and Disclosure notes

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The purpose of the balance sheet

The purpose of the balance sheet, also known as the statement of financial position, is to present the financial position of the company on a particular date. Unlike the income statement, which is a change statement that reports events occurring during a period of time, the balance sheet is a statement that presents an organized array of assets, liabilities, and shareholders' equity at a point in time. It is a freeze frame or snapshot picture of financial position at the end of a particular day marking the end of an accounting period.

Why does the balance sheet not portray the market value of the entity

The balance sheet does not portray the market value of the entity (number of common stock shares outstanding multiplied by price per share) for a number of reasons. Most assets are not reported at fair value, but instead are measured according to historical cost. Also, there are certain resources, such as trained employees, an experienced management team, and a good reputation, that are not recorded as assets at all. Therefore, the assets of a company minus its liabilities, as shown in the balance sheet, will not be representative of the company's market value.

Current Assets

(1) Cash
(2) Cash equivalents
(a) commerical paper
(b) money market funds
(c ) U.S. treasury bills
(3) Short-term investments
(4) Recivables
(5) Inventories
(6) Pre-paid expenses

Current Liabilties

Refers to the time period of the following:
(1) Cash to acquire raw materials
(2) Convert raw materials to finished goods
(3) Deliver product to customer
(4) Collect cash

Operating cycle for a typical manufacturing company

The operating cycle for a typical manufacturing company refers to the period of time required to convert cash to raw materials, raw materials to a finished product, finished product to receivables, and then finally receivables back to cash

Current Vs. Noncurrent assets in investments in equity securities

Investments in equity securities are classified as current if the company's management
(1) intends to liquidate the investment in the next year or operating cycle, whichever is longer, and (2) has the ability to do so, i.e., the investment is marketable. If either of these criteria does not hold, the investment is classified as noncurrent.

Common characteristics of PPE

The common characteristics that these assets have in common are that they are tangible, long-lived assets used in the operations of the business. They usually are the primary revenue-generating assets of the business. These assets include land, buildings, equipment, machinery, furniture and other assets used in the operations of the business, as well as natural resources, such as mineral mines, timber tracts and oil wells.

PPE vs. Intangible assets

Property, plant, and equipment and intangible assets each represent assets that are long-lived and are used in the operations of the business. The difference is that property, plant, and equipment represent physical assets, while intangible assets lack physical substance. Generally, intangible assets represent the ownership of an exclusive right, such as a patent, copyright or franchise.

Paid-in-capital and retained earnings

Paid-in-capital consists of amounts invested by shareholders in the corporation. Retained earnings equals net income less dividends paid to shareholders from the inception of the corporation.

Disclosure notes are an integral part of the information provided in finacial statements. In what ways are the notes critical to understanding the financial statements and to evaluating the firm's performance and financial health?

Disclosure notes provide additional detail concerning specific financial statement items. Included are such data as the fair values of financial instruments and off-balance-sheet risk associated with financial instruments and details of pension plans, leases, debt, and assets. Common to all companies' disclosures are certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions. However, many notes are designed to fit the disclosure needs of the particular reporting company. In fact, any explanation that helps investors and creditors make decisions should be included.

A summary of the company's significant accounting policies is a required disclsure. Why is this disclosure important to external financial statement users

The disclosure of the company's significant accounting policies is extremely important to external users in terms of their ability to compare financial information across companies. It is critical to a financial analyst involved in assessing future cash flows of two construction companies to know that one company uses the percentage-of-completion method in recognizing gross profit, while the other company uses the completed contract method

Subsquent event

A subsequent event is an event that occurs after the date of the financial statements but prior to the date on which the statements are actually issued or "available to be issued." It may help to clarify a previously existing situation or it may represent a new event not directly affecting financial position at the end of the reporting period.

Every annual report of a public company includes an extensive discussion and analysis provided by the company's management. Specifically, which aspects of the company must this discussion address? Isn't management's perspective too biased to be of use to investors and creditors

The discussion provides management's views on significant events, trends and uncertainties pertaining to the company's (a) operations, (b) liquidity, and (c) capital resources. Certainly the Management Discussion and Analysis section may be slanted to management's biased perspective and therefore can lack objectivity. However, management can offer an informed insight that might not be available elsewhere, so if the reader maintains awareness of the information's source, it can offer a unique view of the situation.

The auditor's report includes the analyst with an independent and professional opinion about the fairness of the representations in the financial statements. What are the four main types of opinion an auditor might use?

(1) Unqualified - in conformity with GAAP
(2) Qualified - An exception but not significant enough to invalidate financial statements
(3) Adverse - exceptions are serious that a qualifed opinion is not justified
(4) Disclaimer - Insufficient information

What is a proxy statement and what information does it provide

A proxy statement must be sent each year to all shareholders. It usually is in the same mailing with the annual report. The statement invites shareholders to the shareholders' meeting to elect board members and to vote on issues before the shareholders. It also permits shareholders to vote using an enclosed proxy card. The proxy statement also provides for more disclosures on compensation to directors and executives, and in particular, stock options granted to executives.

Define working capital, current ration, and acid-test ratio (quick ratio)

Working capital is the difference between current assets and current liabilities. The current ratio is computed by dividing current assets by current liabilities. The acid-test ratio (or quick ratio) is computed by dividing quick assets (cash and cash equivalents, marketable securities, and accounts receivable) by current liabilities.

Debt to equity ratio and times interest earned ratio

- TL/SE
- NI+IE+TAX/IE

Where can we find authoritative guidance for balance sheet presentation under IFRS?

IAS No.1, revised, "Presentation of Financial Statements," provides authoritative guidance for balance sheet presentation under IFRS.

Differences between U.S. GAAP and IFRS in balance sheet presentation

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Segment reporting facilitates the financial statement analysis of diversified companies. What determine whether an operating segment is a reportable segment for this purpose

...

for segment reporting purposes, what amounts are reported by each operating segment

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Describe any differences in segment disclosure requirements between U.S. GAAP and IFRS

U.S. GAAP requires companies to report information about reported segment profit or loss, including certain revenues and expenses included in reported segment profit or loss, segment assets, and the basis of measurement. The international standard on segment reporting, IFRS No. 8, requires that companies also disclose the total liabilities of its reportable segments.

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