Chapter 2 Lecture Notes

I. The Classified Balance Sheet

Presents a snapshot of a companys financial position at a point in time

Current Assets converted to cash, sold, or consumed within one year or its operating
cycle, whichever is longer.
o Operating cycle: the average time that it takes to go from cash to cash in
producing revenue.

o Some examples of current assets:

Cash
Short-term investments or marketable securities
Investments made for the short-term (could be stocks, bonds,
treasury bills, etc.)
Accounts Receivable (A/R)
Notes Receivable
Inventory
Supplies
Prepaid Expenses (ex: prepaid insurance)

Non-current Assets anything that is not a current asset (longer than one year)

Long-term Investments
o Investments in stocks and bonds of other corporations that are held for more than
one year.
o Long-term assets that a company is not currently using in its operating activities.
(ex: land held for future expansion, buildings, machines not used for operations,
etc.)

Plant, Property and Equipment (PP&E) assets with long useful lives that are
currently used in operations

o Land
o Building
o Machine and Equipment

1
 o Furniture

(From Kimmel et al. 6th ed, p. 51)

o Everything in the PP&E category is subject to depreciation except land.

o Depreciation: allocating the cost of assets to a number of years
o Accumulated Depreciation (A/D): total amount of depreciation expensed thus
far in the assets life.
o A/D is a contra-asset account.
o Net Value of a long-term asset = Cost A/D
o Matching principle: match revenues and expenses. Matching depreciation
expense to each period over which the asset helps earn revenue.

Example: Comet Co. purchases a machine for $6,000. The estimated life for the machine
is 3 years. The estimated value of the machine after 3 years is $0.

2
 Intangibles assets that do not have physical substance
o Trademarks, copyrights, franchise rights, patents, goodwill
o Amortize if limited life

Current Liabilities obligations that the company is to pay within one year or operating
cycle, whichever is longer.

Some examples:
o Accounts Payable (A/P)
o Wages/Salary Payable
o Interest Payable
o Taxes Payable
o Notes Payable (can also be a long-term liabilitydepends on the maturity date)
o Unearned Revenue

Long-term Liabilities obligations that a company expects to pay after one year.

Some examples:
o Notes Payable
o Bonds Payable

Stockholders Equity owners claims to the assets of the company

o Common Stock (or contributed capital): investments of assets into the business by
the stockholders.
o Retained Earnings: income retained for use in the business.

Example (Kimmel et al., 6th ed, page 54)

3
 Balance Sheet Example

Assets Liabilities:
Current Assets: Current Liabilities:
Cash $ xx Accounts Payable $ xx
Accounts Receivable xx Notes Payable (short term) xx
Inventory xx Wages Payable xx
Supplies xx Unearned Revenues xx
Prepaid Expenses xx Total Current Liabilities $ xx
Total Current Assets $xx Long-Term Debt:
Long Term Investments xx Notes Payable $ xx
Fixed Assets: Bonds Payable xx
Land $ xx Total Long-Term Debt $xx
Building xx TOTAL LIABILITIES $xx
Equipment xx Stockholders Equity:
Less: Accum. Depr (xx) Common Stock $ xx
Total Fixed Assets xx Retained Earnings xx
Patents xx Total SHE $ xx
Total Assets $XX Total Liabilities & SHE $ XX

Liquidity Measures a companys ability to pay its debts as they come due within the
next year or operating cycle

1) Working Capital = (Current Assets Current Liabilities)

2) Current Ratio = (Current Assets / Current Liabilities)

4
5
Example:
Rangers Office Supplies
Balance Sheet
December 31, 2012

Cash $ 130,000 Accounts Payable $ 140,000

Prepaid Insurance 60,000 Salaries Payable 20,000
Accounts Receivable 100,000 Long-Term Notes Payable 160,000
Inventory 140,000 Total Liabilities $320,000
Land held for Investment 150,000
Land 180,000
Buildings $200,000 Common Stock $ ?
Less Accumulated Retained Earnings 500,000
Depreciation (40,000) 160,000 Total Stockholders Equity $740,000
Trademarks 140,000 Total Liabilities and
Total Assets $1,060,000 Stockholders Equity $1,060,000

Use the information above to determine

a. The dollar amount of common stock
b. The dollar amount of assets classified as current assets
c. The dollar amount of assets classified as property, plant and equipment
d. The dollar amount of long-term investments
e. The amount of working capital
f. The current ratio

6
II. The Standard Setting Environment

Generally Accepted Accounting Principles (GAAP):

A set of rules and practices, having substantial authoritative support, that the accounting
profession recognizes as a general guide for financial reporting purposes.

Securities and Exchange Commission (SEC):

The agency of U.S. government that oversees U.S. financial markets and accounting
standard-setting bodies

Financial Accounting Standards Board (FASB):

A private organization whose primary purpose is to set generally accepted accounting
principles (GAAP) within the United States. SEC designates FASB responsible for
setting accounting standards for public companies in the U.S.

International Accounting Standards Board (IASB) issues standards called

International Financial Reporting Standards (IFRS), which have been adopted by
many countries outside of the United States.

III. Quality of Useful Information

Primary Objective of Financial Reporting
The primary objective of financial reporting is to provide financial information that is
useful to investors and creditors in making decisions.

Fundamental Qualities:
Relevance The capacity of information to make a difference in a decision
Faithful Representation The information accurately depicts what really
happened, information must be complete and neutral.

Enhancing Qualities:
Comparability across firms
Consistency across time
Verifiability able to prove that it is free from error
Timeliness must be available before the information is outdated
Understandability comprehensible to users

IV. Assumptions of Financial Reporting

Monetary Unit Assumption Only transactions that can be expressed in terms of

money can be included in the accounting records
Economic Entity Assumption Activities of the business are separate from
activities of the owners
Time Period Assumption The long life of a company can be reported over a series
of shorter time periods
Going Concern Assumption The company will not go out of business in the near
future

7
V. Principles of Financial Reporting

Historical Cost Principle Record assets at the cost paid to acquire them

Fair Value Principle Assets and liabilities should be reported at fair value (the
price received to sell an asset or settle a liability).

Full Disclosure Principle Disclose all circumstances and events that would make a
difference to financial statement users.