Intermediate Accounting Seventeenth Edition Kieso Weygandt Warfield Chapter

Intermediate Accounting Seventeenth Edition Kieso ● Weygandt ● Warfield Chapter 5 Balance Sheet and Statement of Cash Flows This slide deck contains animations. Please disable animations if they cause issues with your device.

Learning Objectives After studying this chapter, you should be able to: 1. Explain the uses and limitations of the balance sheet. 2. Prepare a classified balance sheet. 3. Explain the purpose, content, and presentation of the statement of cash flows. 4. Describe additional types of information provided. Copyright © 2019 John Wiley & Sons, Inc. 2

Preview of Chapter 5 Balance Sheet and Statement of Cash Flows Balance Sheet • Usefulness • Limitations • Classification Preparation of the Balance Sheet • Account form • Report form Copyright © 2019 John Wiley & Sons, Inc. 3

Preview of Chapter 5 Statement of Cash Flows • Purpose • Content • Preparation • Usefulness Additional Information • Notes to the financial statements • Techniques of disclosure Copyright © 2019 John Wiley & Sons, Inc. 4

Learning Objective 1 Explain the Uses, Limitations, and Content of the Balance Sheet LO 1 Copyright © 2019 John Wiley & Sons, Inc. 5

Balance Sheet, sometimes referred to as the statement of financial position: 1. Reports assets, liabilities, and equity at a specific date. 2. Provides information about resources, obligations to creditors, and equity in net resources. 3. Helps in predicting amounts, timing, and uncertainty of future cash flows. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 6

Balance Sheet Usefulness of the Balance Sheet • Computing rates of return • Evaluating capital structure • Assess risk and future cash flows • Analyze the company’s: LO 1 § Liquidity § Solvency § Financial flexibility Copyright © 2019 John Wiley & Sons, Inc. 7

Balance Sheet Limitations of the Balance Sheet 1. Most assets and liabilities are reported at historical cost 2. Use of judgments and estimates 3. Many items of financial value are omitted LO 1 Copyright © 2019 John Wiley & Sons, Inc. 8

Balance Sheet Classification in the Balance Sheet Elements of The Balance Sheet 1. Assets. Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. 2. 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. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 9

Classification in the Balance Sheet Elements of the Balance Sheet 3. Equity. Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 10

Classification in the Balance Sheet Assets Current assets Long-term investments Property, plant, and equipment Liabilities and Owners' Equity Current liabilities Long-term debt Owners' (stockholders') equity Intangible assets Other assets Blank In practice you usually see little departure from these major subdivisions. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 11

Classification in the Balance Sheet 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. Item Basis of Valuation Cash and cash equivalents Fair value Short-term investments Generally, fair value Receivables Estimated amount collectible Inventories Lower-of-cost-or-net realizable value/market Prepaid expenses Cost LO 1 Copyright © 2019 John Wiley & Sons, Inc. 12

Current Assets Cash • Generally any monies available “on demand” • Cash equivalents - short-term highly liquid investments that mature within three months or less • Restrictions or commitments must be disclosed LO 1 Copyright © 2019 John Wiley & Sons, Inc. 13

Cash Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 14

Current Assets Short-Term Investments (Equity Securities) All equity securities are recorded at fair value with changes reported in net income unless: • Accounted for under equity method or • Not practicable to determine fair value LO 1 Copyright © 2019 John Wiley & Sons, Inc. 15

Current Assets Short-Term Investments (Debt Securities) Three separate classifications for debt securities: Held-to-maturity: Company has positive intent and ability to hold to maturity. Trading: Bought and held primarily for sale in the near term to generate income on short-term price differences. Available-for-sale: Not classified as held-to-maturity or trading securities. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 16

Short-Term Investments Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 17

Current Assets Receivables Major categories of receivables should be shown in the balance sheet or the related notes. A company should clearly identify • Anticipated loss due to uncollectibles • Amount and nature of any nontrade receivables • Receivables used as collateral LO 1 Copyright © 2019 John Wiley & Sons, Inc. 18

Receivables Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 19

Current Assets Inventories Disclose • Basis of valuation § Lower-of-cost-or-net realizable value or § Lower-of-cost-or-market • Cost flow assumption (e. g. , F I F O or L I F O) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 20

Inventories Balance Sheet Presentation (Acer) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 21

Inventories Balance Sheet Presentation (Weyerhaeuser) LO 1 Copyright © 2019 John Wiley & Sons, Inc. 22

Current Assets Prepaid Expenses Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Cash Payment Before Expense Recorded Prepayments often occur in regard to: • insurance • rent • supplies • taxes • advertising LO 1 Copyright © 2019 John Wiley & Sons, Inc. 23

Prepaid Expenses Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 24

Current Assets Illustration BE 5. 2 Koch Corporation’s adjusted trial balance contained the following asset accounts at December 31, 2020: Cash $7, 000, Land $40, 000, Patents $12, 500, Accounts Receivable $90, 000, Prepaid Insurance $5, 200, Inventory $30, 000, Allowance for Doubtful Accounts $4, 000, and Equity Investments (to be sold in the next quarter) $11, 000. Prepare the current assets section of the balance sheet, listing the accounts in proper sequence. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 25

Current Assets Illustration BE 5. 2 Prepare the current assets section of the balance sheet, listing the accounts in proper sequence. Current assets Cash Equity investments Accounts receivable Less: Allowance for doubtful accounts Inventory Prepaid insurance Total current assets LO 1 Copyright © 2019 John Wiley & Sons, Inc. $ $90, 000 4, 000 7, 000 11, 000 86, 000 30, 000 5, 200 $139, 200 26

Noncurrent Assets Long-Term Investments 1. Securities (bonds, common stock, or long-term notes). 2. Tangible fixed assets not currently used in operations (land held for speculation). 3. Special funds (sinking fund, pension fund, plant expansion fund, or cash surrender value of life insurance). 4. Nonconsolidated subsidiaries or affiliated companies. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 27

Long-Term Investments Usually presented on balance sheet below “Current assets, ” in a separate section called “Investments. ” • Debt investments classified as available-for-sale are reported at fair value • Held-to-maturity debt investments are reported at amortized cost • Equity investments are reported at fair value LO 1 Copyright © 2019 John Wiley & Sons, Inc. 28

Long-Term Investments Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 29

Long-Term Investments Illustration BE 5. 3 Included in Outkast Company’s December 31, 2020, trial balance are the following accounts: Prepaid Rent $5, 200, Debt Investments (to be held to maturity until 2023) $56, 000, Unearned Fees $17, 000, Land (held for investment) $39, 000, and Notes Receivable (longterm) $42, 000. Prepare the long-term investments section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 30

Long-Term Investments Illustration BE 5. 3 Prepare the long-term investments section of the balance sheet. Long-term investments Debt investments Land held for investment Note receivables (long-term) Total investments LO 1 Copyright © 2019 John Wiley & Sons, Inc. $ 56, 000 39, 000 42, 000 $137, 000 31

Noncurrent Assets Property, Plant, and Equipment Tangible, long-lived assets used in the regular operations of the business. • Physical property such as land, buildings, machinery, furniture, tools, and wasting resources (minerals). • With the exception of land, a company either depreciates (e. g. , buildings) or depletes (e. g. , oil reserves) these assets. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 32

Property, Plant, and Equipment Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 33

Property, Plant, and Equipment Illustration BE 5. 4 Lowell Company’s December 31, 2020, trial balance includes the following accounts: Inventory $120, 000, Buildings $207, 000, Accumulated Depreciation—Equipment $19, 000, Equipment $190, 000, Land (held for investment) $46, 000, Accumulated Depreciation—Buildings $45, 000, Land $71, 000, and Timberland $70, 000. Prepare the property, plant, and equipment section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 34

Property, Plant, and Equipment Illustration BE 5. 4 Prepare the property, plant, and equipment section of the balance sheet. Property, plant, and equipment Land Buildings Less: Accumulated depreciation Equipment Less: Accumulated depreciation Timberland Total property, plant, and equipment LO 1 Copyright © 2019 John Wiley & Sons, Inc. $207, 000 45, 000 190, 000 19, 000 $ 71, 000 162, 000 171, 000 70, 000 $474, 000 35

Noncurrent Assets Intangible Assets Lack physical substance and are not financial instruments. • Limited life intangibles amortized • Indefinite-life intangibles tested for impairment LO 1 Copyright © 2019 John Wiley & Sons, Inc. 36

Intangible Assets Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 37

Intangible Assets Illustration BE 5. 5 Crane Corporation has the following accounts included in its December 31, 2020, trial balance: Equity Investments (to be sold in the next 6 months) $21, 000, Goodwill $150, 000, Prepaid Insurance $12, 000, Patents $220, 000, and Franchises $130, 000. Prepare the intangible assets section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 38

Intangible Assets Illustration BE 5. 5 Prepare the intangible assets section of the balance sheet. Intangible assets Goodwill Patents Franchises Total intangible assets LO 1 Copyright © 2019 John Wiley & Sons, Inc. $150, 000 220, 000 130, 000 $500, 000 39

Noncurrent Assets Other Assets Items vary in practice. Can include • Long-term prepaid expenses • Deferred income taxes • Prepaid pension cost • Restricted cash or securities • Noncurrent receivables • Property held for sale • Assets in special funds LO 1 Copyright © 2019 John Wiley & Sons, Inc. 40

Classification in the Balance Sheet Liabilities Classified as current or long-term. Current Liabilities Obligations a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 41

Liabilities Current Liabilities 1. Payables resulting from the acquisition of goods and services: accounts payable, wages payable, taxes payable, and so on. 2. Collections received in advance, such as unearned rent revenue or unearned subscriptions revenue. 3. Other liabilities, such as the portion of long-term bonds to be paid in the current period or short-term obligations arising from the purchase of equipment. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 42

Current Liabilities Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 43

Current Liabilities Illustration BE 5. 8 Included in Adams Company’s December 31, 2020, trial balance are the following accounts: Accounts Payable $220, 000, Pension Liability $375, 000, Discount on Bonds Payable $29, 000, Unearned Rent Revenue $41, 000, Bonds Payable $400, 000, Salaries and Wages Payable $27, 000, Interest Payable $12, 000, and Income Taxes Payable $29, 000. Prepare the current liabilities section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 44

Current Liabilities Illustration BE 5. 8 Prepare the current liabilities section of the balance sheet. Current liabilities Accounts payable Unearned rent revenue Salaries and wages payable Interest payable Income taxes payable Total LO 1 Copyright © 2019 John Wiley & Sons, Inc. $220, 000 41, 000 27, 000 12, 000 29, 000 $329, 000 45

Liabilities Long-Term Liabilities Obligations that a company does not reasonably expect to liquidate within the normal operating cycle. Companies classify long-term liabilities that mature within the current operating cycle as current liabilities if payment of the obligation requires the use of current assets. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 46

Long-Term Liabilities Three types: 1. Obligations arising from specific financing situations, such as the issuance of bonds, long-term lease obligations, and long-term notes payable. 2. Obligations arising from pension obligations and deferred income tax liabilities. 3. Obligations that depend on the occurrence or nonoccurrence of one or more future events, such as service or product warranties and other contingencies. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 47

Long-Term Liabilities Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 48

Long-Term Liabilities Illustration BE 5. 9 Included in Adams Company’s December 31, 2020, trial balance are the following accounts: Accounts Payable $220, 000, Pension Liability $375, 000, Discount on Bonds Payable $29, 000, Unearned Rent Revenue $41, 000, Bonds Payable $400, 000, Salaries and Wages Payable $27, 000, Interest Payable $12, 000, and Income Taxes Payable $29, 000. Prepare the long-term liabilities section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 49

Long-Term Liabilities Illustration BE 5. 9 Prepare the long-term liabilities section of the balance sheet. Long-term liabilities Pension Asset/liability Bonds payable Discount on bonds payable Total LO 1 Copyright © 2019 John Wiley & Sons, Inc. $375, 000 400, 000 (29, 000) $746, 000 50

Classification in the Balance Sheet Owner’ Equity Stockholders' Equity Section 1. Capital Stock. Par or stated value of the shares issued. 2. Additional paid-in Capital. Excess of amounts paid in over the par or stated value. 3. Retained Earnings. Corporation's undistributed earnings. 4. Accumulated other Comprehensive Income. Aggregate amount of other comprehensive income items. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 51

Owners’ Equity Stockholders' Equity Section 5. Treasury Stock. Generally, the amount of ordinary shares repurchased. 6. Noncontrolling Interest (Minority Interest). Portion of the equity of subsidiaries not wholly owned by the reporting company. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 52

Owners’ Equity Balance Sheet Presentation LO 1 Copyright © 2019 John Wiley & Sons, Inc. 53

Owners’ Equity Illustration BE 5. 10 Hawthorn Corporation’s adjusted trial balance contained the following accounts at December 31, 2020: Retained Earnings $120, 000, Common Stock $750, 000, Bonds Payable $100, 000, Paid-in Capital in Excess of Par—Common Stock $200, 000, Goodwill $55, 000, Accumulated Other Comprehensive Loss $150, 000, and Noncontrolling Interest $35, 000. Prepare the stockholders’ equity section of the balance sheet. LO 1 Copyright © 2019 John Wiley & Sons, Inc. 54

Owners’ Equity Illustration BE 5. 8 Prepare the stockholders’ equity section of the balance sheet. Stockholders’ equity Common stock Paid-in capital in excess of par Retained earnings Accumulated other comprehensive income Equity attributable to Hawthorn Corporation Noncontrolling interest Total stockholders’ equity LO 1 Copyright © 2019 John Wiley & Sons, Inc. $750, 000 200, 000 $950, 000 120, 000 (150, 000) 920, 000 35, 000 $955, 000 55

Learning Objective 2 Prepare a Classified Balance Sheet LO 2 Copyright © 2019 John Wiley & Sons, Inc. 56

Preparation of the Balance Sheet Classified Balance Sheet • Account form • Report form Accounting Trends and Techniques (New York: A I C P A) indicates that all of the 500 companies surveyed use either the “report form” (484) or the “account form” (16), sometimes collectively referred to as the “customary form. ” LO 2 Copyright © 2019 John Wiley & Sons, Inc. 57

Report Form Assets LO 2 Copyright © 2019 John Wiley & Sons, Inc. 58

Report Form Liabilities and Equity LO 2 Copyright © 2019 John Wiley & Sons, Inc. 59

Learning Objective 3 Explain the Purpose, Content, and Preparation of the Statement of Cash Flows LO 3 Copyright © 2019 John Wiley & Sons, Inc. 60

Purpose of the Statement of Cash Flows To provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement provides answers to the following questions: 1. Where did the cash come from? 2. What was the cash used for? 3. What was the change in the cash balance? LO 3 Copyright © 2019 John Wiley & Sons, Inc. 61

Content of the Statement of Cash Flows Three different activities: 1. Operating activities involve the cash effects of transactions that enter into the determination of net income. 2. Investing activities include making and collecting loans and acquiring and disposing of investments and property, plant, and equipment. 3. Financing activities involve liability and owners’ equity items. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 62

Content of the Statement of Cash Flows Basic Format of Cash Flow Statement of Cash Flows Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities Net increase (decrease) in cash Cash at beginning of year Cash at end of year LO 3 Copyright © 2019 John Wiley & Sons, Inc. $XXX XXX XXX $XXX 63

Cash Inflows and Outflows LO 3 Copyright © 2019 John Wiley & Sons, Inc. 64

Preparation of the Statement of Cash Flows Sources of Information obtained from several sources: 1. comparative balance sheets, 2. the current income statement, and 3. selected transaction data. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 65

Preparation of the Statement of Cash Flows Illustration On January 1, 2020, in its first year of operations, Telemarketing Inc. issued 50, 000 shares of $1 par value common stock for $50, 000 cash. The company rented its office space, furniture, and telecommunications equipment and performed marketing services throughout the first year. In June 2020, the company purchased land for $15, 000. The following illustration shows the company’s comparative balance sheets at the beginning and end of 2020. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 66

Statement of Cash Flows Illustration Comparative Balance Sheets LO 3 Copyright © 2019 John Wiley & Sons, Inc. 67

Statement of Cash Flows Illustration Income Statement LO 3 Copyright © 2019 John Wiley & Sons, Inc. 68

Preparing the Statement of Cash Flows Four steps: 1. Determine the net cash provided by (or used in) operating activities. 2. Determine the net cash provided by (or used in) investing and financing activities. 3. Determine the change (increase or decrease) in cash during the period. 4. Reconcile the change in cash with the beginning and the ending cash balances. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 69

Cash Provided by Operating Activities LO 3 Copyright © 2019 John Wiley & Sons, Inc. 70

Statement of Cash Flows Next, the company determines its investing and financing activities. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 71

Statement of Cash Flows Illustration BE 5. 12 Keyser Beverage Company reported the following items in the most recent year. Net income Dividends paid Increase in accounts receivable Increase in accounts payable Purchase of equipment Depreciation expense Issue of notes payable $40, 000 5, 000 10, 000 7, 000 8, 000 4, 000 20, 000 Required: Compute net cash provided by operating activities. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 72

Statement of Cash Flows Illustration BE 5. 12 Compute net cash provided by operating activities. Operating Activities Net income Depreciations expense Increase in accounts receivable Increase in accounts payable Net cash provided by operating activities LO 3 Copyright © 2019 John Wiley & Sons, Inc. $40, 000 4, 000 (10, 000) 7, 000 8, 000 73

Statement of Cash Flows Illustration BE 5. 12 Keyser Beverage Company reported the following items in the most recent year. Net income Dividends paid Increase in accounts receivable Increase in accounts payable Purchase of equipment Depreciation expense Issue of notes payable $40, 000 5, 000 10, 000 7, 000 8, 000 4, 000 20, 000 Required: Compute net change in cash during the year. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 74

BE 5. 12 Illustration Operating Activities Net income Depreciation expense Increase in accounts receivable Increase in accounts payable Net cash provided by operating activities Investing Activities Purchase of equipment Financing Activities Issue notes payable Dividends paid Net cash flow from financing activities Net increase in cash LO 3 Copyright © 2019 John Wiley & Sons, Inc. $40, 000 4, 000 (10, 000) 7, 000 8, 000 (8, 000) 20, 000 (5, 000) 15, 000 $48, 000 75

Statement of Cash Flows Review Question In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. Sale of equipment at book value b. Sale of merchandise on credit c. Declaration of a cash dividend d. Issuance of bonds payable at a discount. LO 3 Copyright © 2016 John Wiley & Sons, Inc. 76

Statement of Cash Flows Review Question In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. Sale of equipment at book value b. Sale of merchandise on credit c. Declaration of a cash dividend d. Issuance of bonds payable at a discount. LO 3 Copyright © 2016 John Wiley & Sons, Inc. 77

Significant Noncash Activities Significant financing and investing activities that do not affect cash are reported in either a separate schedule at the bottom of the statement of cash flows or in the notes. Examples include: • Issuance of common stock to purchase assets • Conversion of bonds into common stock • Issuance of debt to purchase assets • Exchanges on long-lived assets LO 3 Copyright © 2019 John Wiley & Sons, Inc. 78

Comprehensive Statement of Cash Flows LO 3 Copyright © 2019 John Wiley & Sons, Inc. 79

Usefulness of the Statement of Cash Flows Without cash, a company will not survive. Cash flow from Operations: • High amount – company is able to generate sufficient cash to pay its bills. • Low amount - company may have to borrow or issue equity securities to pay bills. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 80

Usefulness of the Statement of Cash Flows Financial Liquidity Ratio indicates whether the company can pay off its current liabilities from internally generated cash flows. A ratio near 1: 1 is good. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 81

Usefulness of the Statement of Cash Flows Financial Flexibility Ratio indicates a company’s ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 82

Usefulness of the Statement of Cash Flows Free Cash Flow The amount of discretionary cash flow a company has that may be used for purchasing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity. LO 3 Copyright © 2019 John Wiley & Sons, Inc. 83

Usefulness of the Statement of Cash Flows Free Cash Flow Computation LO 3 Copyright © 2019 John Wiley & Sons, Inc. 84

Learning Objective 4 Describe Additional Types of Information Provided LO 4 Copyright © 2019 John Wiley & Sons, Inc. 85

Additional Information Notes to the Financial Statements • An integral part of reporting financial statement information • Explain in qualitative terms information related to specific financial statement items • Provide supplemental data of a quantitative nature to expand information in financial statements • Explain restrictions imposed by financial arrangements or basic contractual agreements LO 4 Copyright © 2019 John Wiley & Sons, Inc. 86

Notes to the Financial Statements Accounting Policies • Specific principles, bases, conventions, rules, and practices applied in financial information • GAAP recommends disclosure for all significant accounting principles and methods • For instance, LIFO and FIFO, double-declining-balance and straight-line, carrying investments at amortized cost, equity, and fair value • First footnote generally “Summary of Significant Accounting Policies” LO 4 Copyright © 2019 John Wiley & Sons, Inc. 87

Notes to the Financial Statements Contractual Situations • Disclose in the notes, if significant • Must clearly state essential provisions of lease contracts, pension obligations, and stock compensation plans in the notes • Must disclose the following commitments if amounts are 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 LO 4 Copyright © 2019 John Wiley & Sons, Inc. 88

Notes to the Financial Statements Contingencies • Existing situation involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) • Are material events with an uncertain future • Gain contingencies include tax operating–loss carryforwards or company litigation against another party • Loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations LO 4 Copyright © 2019 John Wiley & Sons, Inc. 89

Notes to the Financial Statements Fair Values • Fair value information may be more useful than historical cost for certain assets and liabilities • Financial instruments are defined as cash, an ownership interest, or a contractual right to receive or obligation to deliver cash or another financial instrument • Cash, investments, accounts receivable, and payables are examples of financial instruments LO 4 Copyright © 2019 John Wiley & Sons, Inc. 90

Notes to the Financial Statements Three Levels of Fair Value Hierarchy • Level 1 measures (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 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. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 91

Notes to the Financial Statements Fair Values For major groups of assets and liabilities, companies must make the following fair value disclosures: 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. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 92

Techniques of Disclosure • Parenthetical Explanations • Cross-Reference and Contra Items • Supporting Schedules • Terminology LO 4 Copyright © 2019 John Wiley & Sons, Inc. 93

Techniques of Disclosure Parenthetical Explanations LO 4 Copyright © 2019 John Wiley & Sons, Inc. 94

Techniques of Disclosure Cross-Referencing and Contra Items LO 4 Copyright © 2019 John Wiley & Sons, Inc. 95

Techniques of Disclosure Supporting Schedules LO 4 Copyright © 2019 John Wiley & Sons, Inc. 96

Techniques of Disclosure Terminology • Balance sheets should contain descriptions that readers will generally understand clearly interpret • Profession has recommended that LO 4 § companies use the word reserve only to describe an appropriation of retained earnings § use of the word surplus be discontinued in balance sheet presentations of stockholders’ equity Copyright © 2019 John Wiley & Sons, Inc. 97

Appendix 5 A: Ratio Analysis—a Reference Major Types of Ratios Liquidity Ratios. Measures of the company's short-term ability to pay its maturing obligations. Activity Ratios. Measures of how effectively the company uses its assets. Profitability Ratios. Measures of the degree of success or failure of a given company or division for a given period of time. Coverage Ratios. Measures of the degree of protection for longterm creditors and investors. LO 4 Copyright © 2019 John Wiley & Sons, Inc. 98

Appendix 5 A: Ratio Analysis—a Reference (Liquidity and Activity) LO 4 Copyright © 2019 John Wiley & Sons, Inc. 99

Appendix 5 A: Ratio Analysis—a Reference (Profitability) LO 4 Copyright © 2019 John Wiley & Sons, Inc. 100

Appendix 5 A: Ratio Analysis—a Reference (Coverage) LO 4 Copyright © 2019 John Wiley & Sons, Inc. 101

Learning Objective 5 Compare the Accounting Procedure Related to the Balance Sheet Under GAAP and IFRS LO 5 Copyright © 2019 John Wiley & Sons, Inc. 102

I F R S Insights Relevant Facts - Similarities • Both IFRS and GAAP 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. • Both IFRS and GAAP require disclosures about (1) accounting policies followed, (2) judgments that management has made in the process of applying the entity’s accounting policies, and (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. • IFRS and GAAP require presentation of non-controlling interests in the equity section of the balance sheet. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 103

I F R S Insights Relevant Facts - Differences • 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 noncurrent assets and liabilities. However under G AAP, public companies must follow SEC regulations, which require specific line items. • Under 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. • IFRS has many differences in terminology. For example in the equity section common stock is called share capital—ordinary. • Use of the term “reserve” is discouraged in G AAP, but there is no such prohibition in IFRS. LO 5 Copyright © 2019 John Wiley & Sons, Inc. 104

I F R S Insights On The Horizon The FASB and the IASB are working on a project to converge their standards related to financial statement presentation. A key feature of the proposed framework is that each of the statements will be organized, in the same format, to separate an entity’s financing activities from its operating and investing activities and, further, to separate financing activities into transactions with owners and creditors. Thus, the same classifications used in the statement of financial position would also be used in the statement of comprehensive income and the statement of cash flows. The project is currently on hold. You can follow the joint financial presentation project at the following link: www. fasb. org LO 5 Copyright © 2019 John Wiley & Sons, Inc. 105

Copyright © 2019 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Copyright © 2019 John Wiley & Sons, Inc. 106