Horngren Ima16 stppt16

CopyrightIntroduction
2005 Prentice Hall Business Publishing, 2014 Pearson Education, Inc.

to Management publishing 13/e,
Accounting as Prentice Hall
Horngren/Sundem/Stratton 1616- -11
Chapter 16
Understanding Corporate
Annual Reports:
Basic Financial Statements
Chapter 16 Learning Objectives
1. Recognize and define the main types of assets in the

balance sheet of a corporation.
2. Recognize and define the main types of liabilities in
the balance sheet of a corporation.
3. Recognize and define the main elements of the
stockholders equity section of the balance sheet of a
corporation.
4. Recognize and define the principal elements in the
income statement of a corporation.
5. Recognize and define the elements that cause changes
in stockholders equity accounts.
Chapter 16 Learning Objectives
6. Explain the purposes of the cash flow statement,

identify activities that affect cash, and classify the
activities as operating, investing, or financing activities.
7. Assess financing and investing activities using the
statement of cash flows.
8. Use both the direct method and the indirect method to
explain cash flows from operating activities.
9. Explain the role of depreciation in the statement of cash
flows.
10.Describe and assess the effects of the four major
methods of accounting for inventories (Appendix 16A).
Learning
Objective 1 The Balance Sheet
Balance Sheet
The five main sections of a balance sheet:
Current Assets Current Liabilities
Noncurrent Assets Noncurrent Liabilities
Shareholders Equity
Operating Cycle
Current assets include cash and all other assets

that a company reasonably expects to convert
to cash or sell or consume within one year or
during the normal operating cycle
A companys operating cycle is the time span

during which it spends cash to acquire goods
and services that it uses to produce its outputs,
which in turn it sells to customers, who in turn
pay for their purchases with cash.
Operating Cycle
Note that the box, Accounts Receivable (amounts

customers owe to the business), is larger than
the other two boxes because the objective of a
business is to sell goods at a price higher than
their acquisition cost.
Classified Balance Sheet:
Assets Section
Nike, Inc. Classified Balance Sheet: Assets Section
Cash Equivalents
Cash equivalents are short-term

investments that can easily be
converted into cash with little delay.
What are some examples?
Money market funds Treasury bills
Short-Term Investments
Short-term investments are temporary

investments in marketable securities. Companies
often invest idle cash in short-term investments.
Stocks or bonds Debt securities

of other companies issued by governments
Horngren/Sundem/Stratton 1616- 10
- 10
Accounts Receivable
Accounts receivable is the total amount

owed to the company by its customers.
Often classified as current assets,

even though they may not be
collected within one year.
The account is reduced to net value by an

allowance account for doubtful accounts.
11
Inventories
Inventories for wholesalers and retailers consist

of merchandise held for sale. Accountants
regard all inventories as current assets.
Manufacturing companies generally have

three inventory accounts: raw materials,
goods in process, and finished products.
FIFO Stated at lower of Cost

LIFO Or Market price
Weighted Average
Specific Cost
- 12
Prepaid Expenses
and Other Current Assets
Prepaid expenses are advance

payments to suppliers.
Rent Insurance
Other current assets are miscellaneous

assets that do not fit in other categories.
- 13
Noncurrent Assets:
Property, Plant, and Equipment
Fixed Assets or
Tangible Assets:
Physical items that a person can see and touch.
Details about fixed assets are an

integral part of the financial statements.
- 14
Noncurrent Assets:
Land is not subject to depreciation.
Typical assets subject to depreciation:
Equipment
Buildings Machinery
- 15
Depreciation
Acquisition cost
Estimated residual value
= Depreciation expense Cost
Expense
The purpose of depreciation is to allocate

the assets original cost to the particular
periods that benefit from the use of the asset.
- 16
Noncurrent Assets:
Amount of depreciation charged

each year depends on 3 things:
1. The depreciable amount
2. The estimated useful life of asset
3. The depreciation method
- 17
Noncurrent Assets:
1. Depreciable Amount:
Difference between the total acquisition

cost and the estimated residual value.
Residual value is the amount a company

expects to receive when selling the asset
at the end of its economic life.
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Noncurrent Assets:
2. Assets Estimated Useful Life:
Estimate often depends more on technological

changes and economic obsolescence than on
physical wear and tear.
The useful life is usually

Less than the physical life.
- 19
Noncurrent Assets:
3. Depreciation Methods:
Straight-line method Accelerated methods
Activity-based method
On the balance sheet, assets

are reported at net book value:
Cost Accumulated depreciation = Book value
- 20
Leasehold Improvements
Investments made by a lessee (tenant) in items

such as painting, decorating, fixtures, and air-
conditioning equipment that it cannot remove
from the premises when a lease expires.
Costs of leasehold improvements are written

off in the same manner as depreciation but the
periodic write-off is called amortization.
- 21
Intangible Assets
Intangible assets are a class of

long-lived assets that are not
physical in nature.
Patents Copyrights Goodwill
Franchises Trademarks
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Intangible Assets
Intangible assets are divided into two categories:
(1) Those with definite lives

Costs are spread over the life of the asset using
a method identical to straight-line depreciation
except it is called amortization.
(2) Those with indefinite lives

Costs are not depreciated or amortized these
assets. Companies annually apply an impairment
test to assure that the asset has kept its value.
- 23
Learning Classified Balance Sheet:
Objective 2
Liabilities Section
Nike, Inc. Classified Balance Sheet: Liabilities Section
- 24
Current Liabilities
Current Liabilities are an organizations

debts that fall due within the coming
year or within the normal operating
cycle, whichever is longer.
Current portion Accrued

of long-term Liabilities
debt
Notes
Accounts
Payable
Payable
- 25
Current Liabilities
Current portion of long-term debt: payments due

in the next year on bonds and other long-term debt.
Notes payable: short-term debts backed by formal

promissory notes held by a bank or creditors.
Accounts payable: amounts owed to suppliers who

extended credit for purchases on open account.
Accrued Liabilities (also called accrued expenses

payable): amounts owed for wages, salaries, etc..
- 26
Noncurrent Liabilities
Noncurrent liabilities (long-term)

are an organizations debts that
fall due beyond one year.
Bonds
Notes
payable Deferred
income taxes
Long-term
debt
- 27
Long-Term Debt
Long-term debt may be secured or

unsecured.
Secured debt Debentures: Formal

provides debt Unsecured certificates
holders with debt with a promise
first claims to pay interest
on assets
Notes
Bonds Loans
Mortgage Subordinated Convertible

bonds debentures debt
- 28
Learning
Objective 3 Stockholders Equity
The main elements of stockholders

equity arise from two sources:
Contributed or paid-in capital
Retained income and comprehensive income
- 29
Common Stock
Common stock has no predetermined

rate of dividends and is the last to
obtain a share in the assets when
the corporation is dissolved.
Common stockholders usually have

voting power to elect the board
of directors of the corporation.
- 30
Preferred Stock
Preferred stock has some priority over

other shares regarding dividends or the
distribution of assets upon liquidation.
Preferred dividends must be paid in full before

a company pays dividends. to any other classes
of stock. Preferred shareholders in most other
corporations have no voting privileges.
- 31
Par Value (Stated Value)
The face of a stock certificate shows the

par or stated value. For preferred stock,
par is a basis for determining the amount
of dividends or interest. Par value has
no practical importance for common stock
Capital in excess of stated (or par) value is the

difference between the amount a company
receives when issuing new shares and the
stated or par value of the shares issued.
- 32
Retained Earnings and
Other Comprehensive Income
Retained earnings (retained income) is the

balance in stockholders equity due to the
cumulative effect over the life of the corporation
of all profits or losses generated less
amounts distributed to shareholders.
Other comprehensive income consists of a few

special types of gains and losses that do not
appear on the income statement and thus do
not become part of retained earnings.
- 33
Treasury Stock
This is a corporations own stock

that was issued and subsequently
repurchased by the company and
is being held for a specific purpose.
- 34
Learning
Objective 4 Income Statement
Nike, Inc. Statement of Income (millions except per share data)
- 35
Income Statement
Income statements first list revenues, the total

sales value of products delivered and services
rendered to customers. From revenues they
deduct expenses to get net income.
Statement of Statement of
Earnings Profit or Loss
P&L Statement
- 36
Income Statement
An income statement can take one of two forms:
Single step lists all expenses without drawing

subtotals. It provides an overall measure of
performance, but it does not allow direct
assessment of performance in specific areas.
A multiple-step statement contains one or more

subtotals. By dividing expenses into categories,
a companys performance can be more easily
evaluate in different dimensions.
- 37
Financial Management
How much Should we

cash should we borrow
Should
hold in our money or
we pay a
checking issue
dividend?
accounts? stock?
Financial management focuses on

where to get cash and how to use cash
for the benefit of the organization.
- 38
Income, Earnings, and Profits
The final expense on most income statements

is income tax expense. Income statements
usually deduct income taxes as a separate
item placed immediately before net income.
The amount left after deducting all operating

and nonoperating expenses from revenue is
net income, sometimes called net earnings
or net profits or simply the bottom line.
- 39
Earnings per Share
Income statements conclude with

disclosure of earnings per share,
which is net income divided by the
average number of common shares
outstanding during the year.
- 40
Statement of Changes
in Stockholders Equity
To explain the changes in the stockholders equity

accounts, companies prepare a statement of
stockholders equity which shows the changes
in each of the stockholders equity accounts:
1. Common Stock
2. Capital in Excess of Stated Value
3. Accumulated Other Comprehensive Income
4. Retained Earnings
- 41
Learning Statement of Changes in
Objective 5
Stockholders Equity
Nike, Inc. Statement of Stockholders Equity for

the Year Ended May 31, 2011 (millions of dollars)
- 42
Statement of Cash Flows
. . . reports the cash receipts and cash payments

of an organization during a particular period.
It shows the relationship of net income to changes

in cash balances. Cash balances can decline
despite positive net income and vice versa. It
reports past cash flows as an aid in:
a. predicting future cash flows.
b. evaluating managements generation and use
of cash.
c. determining a companys ability to pay interest
and dividends and pay debts when they are due.
- 43
Learning
Objective 6 Activities Affecting Cash
List the activities that increased

or decreased cash.
Place each cash inflow and outflow

into one of three categories.
Operating activities
Investing activities
Financing activities
- 44
Activities Frequently Found in
Statements of Cash Flows
- 45
Activities Frequently Found in
Statements of Cash Flows
Cash flows from operating activities are

generally the effects of transactions that
affect the income statement.
Cash flows from investing activities include

(1) lending and collecting principle repayments
on loans
(2) acquiring and selling long-term assets.
Cash flows from financing activities include

obtaining cash from creditors and owners,
repaying creditors or buying back stock from
owners, and paying cash dividends.
- 46
Learning
Objective 7 Financing and Investing Activities
The general rule for financing activities is:

Increases in cash (cash inflows) stem from
increases in liabilities or paid-in capital.
Decreases in cash (cash outflows) stem from
decreases in liabilities or paid-in capital or
payment of dividends.
- 47
Financing and Investing Activities
The general rule for investing activities is:

Increases in cash (cash inflows) stem from sales of long-
lived assets, collection of loans, and sales of investments.
Decreases in cash (cash outflows) stem from purchases
of long-lived assets, loans made to others, and purchases
of investments.
- 48
Noncash Investing and Financing Activities
Sometimes financing or investing activities

do not affect cash but are similar to
transactions that have a cash-flow effect.
Suppose a purchase of fixed assets was not for

cash but was financed by issuing common stock
or by signing a note payable. There is no entry
to the statement of cash flows.
Companies must list such activities in

a separate schedule accompanying the
statement of cash flows.
- 49
Learning Cash Flow from Operating
Objective 8
Activities
Users of financial statements are concerned with

assessing managements operating decisions.
They focus on the first major section of cash flow
statements, cash flows from operating activities
(or cash flows from operations).
Two methods are used to compute

cash flows from operating activities:
1. Direct Method
2. Indirect Method
- 50
Cash Flow from Operating Activities
The direct method for operating cash

flows subtracts operating cash disbursements
from cash collections to arrive at cash
flows from operations.
The indirect method for operating cash flows

adjusts the previously-calculated accrual
net income from the income statement to reflect
only cash receipts and cash disbursements.
- 51
Cash Flow from Operating Activities
Analysis of Effects of Transactions on Cash Flows

from Operating Activities
- 52
Cash Flow from Operations:
The Direct Method
The direct method consists of a listing of cash

receipts (inflows) and cash disbursements
(outflows).
The easiest way to construct the statement of

cash flows from operations using the direct
method is to examine the cash column of the
balance sheet equation.
- 53
The Indirect Method
Most income statement items have a parallel

item in the statement of cash flows. Each sale
eventually results in cash inflows; each
expense entails cash outflows at some time.
When the cash inflow from a sale or the cash

outflow for an expense occurs in one accounting
period and is recorded in another, net income
can differ from the cash flows from operations.
- 54
The Indirect Method
The indirect method reconciles these differences

by starting with net income and then listing all
the adjustments necessary to turn net income
into cash flows from operating activities.
We construct the indirect method cash flow

statement from the current income statement
and the beginning and ending balance sheets.
- 55
The Indirect Method
The indirect method cash flow statement requires a

current income statement and the beginning and
ending balance sheets.
A general approach to adjustments:

Adjust for revenue and expenses not requiring cash
Add back depreciation and other noncash expenses
Adjust for changes in noncash assets and liabilities
relating to operating activities
Add decreases in assets
Deduct increases in assets
Add increases in liabilities
Deduct decreases in liabilities
- 56
Reconciliation Statement
If a company uses the direct method to report

cash flows from operating activities, users of the
financial statements would miss information
that relates net income to operating cash flows.
Direct-method statements must also include a

supplementary schedule reconciling net income
to net cash provided by operations, essentially
an indirect-method cash flow statement.
In essence, companies that choose to use the direct

method must also report using the indirect method.
- 57
Reconciliation Statement
Without the statement of cash flows, readers of

the annual report would have to conduct their own
analyses of the beginning and ending balance
sheets, the income statement, and the changes in
retained income to get a grasp of the impact of
financial management decisions.
Many analysts focus on free cash flow - cash flows

from operations less capital expenditures - the
cash flow left over after undertaking the firms
operations and making the investments necessary
to ensure its continued operation.
- 58
Learning
Objective 9 Role of Depreciation
Depreciation expense does not

entail a current outflow of cash. It is an
allocation of historical cost to expense.
We add depreciation to net income to

compute cash flow because it was earlier
subtracted in calculating net income.
Adding back depreciation merely cancels
its earlier deduction.
- 59
Annual Reports
Companies prepare annual reports for the

companys shareholders.
The annual report includes all four statements:

the balance sheet, the income statement, the
statement of cash flows, and the statement of
changes in stockholders equity.
- 60
Learning Appendix 16A:
Objective 10
Accounting for Inventories
Specific identification
FIFO LIFO
Weighted Average
- 61
Appendix 16A:
Specific identification recognizes

the actual cost paid for the
specific physical item.
FIFO: First-In-First-Out
assumes that a company sells or uses
up first the stock acquired earliest. It uses
the latest costs to measure the ending inventory.
- 62
Appendix 16A:
LIFO: Last-In-First-Out
Assumes that a company sells or uses up
first the stock acquired most recently. It
treats the most recent costs as cost of goods sold.
Weighted-Average-Cost:
Assigns the same unit cost to each unit available
for sale. Unit cost is the cost of all units available
for sale divided by the number of units available.
- 63
Appendix 16A:
Regardless of the inventory method used,

accountants must decrease the inventory value
if the inventorys market price drops
below its acquisition cost.
Accountants compare current market price of

inventory with its cost and select the lower of the
two as the inventory value. Market generally
means the current replacement cost under U.S.
GAAP or net realizable value under IFRS.
- 64
Appendix 16B: Reporting
Reports to stockholders must abide by generally

accepted accounting principles (GAAP).
Shareholder reporting
Reports to income tax authorities must abide

by the income tax rules and regulations.
Income tax laws are patchworks that governments

often design to give taxpayers special incentives.
- 65
All rights reserved. No part of this publication
may be reproduced, stored in a retrieval system,
or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording,
or otherwise, without the prior written permission
of the publisher. Printed in the United States of
America.
- 66

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CopyrightIntroduction

2005 Prentice Hall Business Publishing, 2014 Pearson Education, Inc.

1. Recognize and define the main types of assets in the

6. Explain the purposes of the cash flow statement,

The five main sections of a balance sheet:

Current Assets Current Liabilities

Noncurrent Assets Noncurrent Liabilities

Current assets include cash and all other assets

A companys operating cycle is the time span

Note that the box, Accounts Receivable (amounts

Cash equivalents are short-term

What are some examples?

Money market funds Treasury bills

Short-term investments are temporary

What are some examples?

Stocks or bonds Debt securities

Accounts receivable is the total amount

Often classified as current assets,

The account is reduced to net value by an

Inventories for wholesalers and retailers consist

Manufacturing companies generally have

FIFO Stated at lower of Cost

Prepaid expenses are advance

What are some examples?

Other current assets are miscellaneous

Physical items that a person can see and touch.

Details about fixed assets are an

Land is not subject to depreciation.

Typical assets subject to depreciation:

The purpose of depreciation is to allocate

Amount of depreciation charged

1. The depreciable amount

2. The estimated useful life of asset

3. The depreciation method

Difference between the total acquisition

Residual value is the amount a company

2. Assets Estimated Useful Life:

Estimate often depends more on technological

The useful life is usually

Straight-line method Accelerated methods

On the balance sheet, assets

Cost Accumulated depreciation = Book value

Investments made by a lessee (tenant) in items

Costs of leasehold improvements are written

Intangible assets are a class of

What are some examples?

Patents Copyrights Goodwill

Intangible assets are divided into two categories:

(1) Those with definite lives

(2) Those with indefinite lives

Nike, Inc. Classified Balance Sheet: Liabilities Section

Current Liabilities are an organizations

Current portion Accrued

Current portion of long-term debt: payments due

Notes payable: short-term debts backed by formal

Accounts payable: amounts owed to suppliers who

Accrued Liabilities (also called accrued expenses

Noncurrent liabilities (long-term)

Long-term debt may be secured or

Secured debt Debentures: Formal

Mortgage Subordinated Convertible

The main elements of stockholders

Contributed or paid-in capital