Measuring Financial

Condition:
The Balance Sheet
C
hapter
2
Section 2.2
How Financial Statements are
Prepared?
Section 2.1
Why one must know the accounting process:
1. Accounting has a peculiar technical knowledge
that an analyst needs to understand.
2. Financial statements are interrelated.
3. Double-entry accounting ensures that recording
affects two or more accounts.
4. Accounting data may not be available to users in a
timely way.
5. Accounting involves management estimates.
Basic Accounting Rules
The set of accounting records is called books of
account.
The process of recording transactions and classifying
them into accounts is called bookkeeping.
Rules of recording transactions are based on the
double-entry system in accounting, called the debit-
credit mechanism. To debit an account means to
record a transaction on the left hand side of an
account while to credit an account means to record a
transaction on the right hand side of an account.

Accounting Cycle
Refers to the sequence of steps leading to
the preparation of financial statements.
These steps are:
1. Analysis of transaction.
2. Recording the transaction in a journal using
debit-credit mechanism.
3. Summarizing transactions in accounts.
4. Preparation of adjusting entries.
5. Preparation of financial statements.
Accounting Standards
Accounting standards in the Philippines are
adopted by the Philippines Financial
Reporting Standards Council (PFRSC) and
approved by the Securities and Exchange
Commission (SEC). The PFRSC has formed
the Philippine Interpretations Committee
(PIC), which issues implementation
guidance on PFRSs.
Balance Sheet
(Statement of Financial Position)
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Basic Accounting Equation
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Assets
=
Liabilities
+
Stockholders
Equity
Economic
resources
Economic
obligations
Net assets
It is a companys statement of financial
condition AS OF A GIVEN DATE.
Elements of the Balance Sheet: Assets
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Assets are probable future economic
benefits obtained or controlled by a
company as a result of past transactions or
events.
Assets: should provide future economic
benefits to the company
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Economic
Benefits
The use of fixed assets in the
production of goods
Profits on sale
of goods
Protection of value provided by
insurance
Income from
investments
Classification of Assets
1. Tangible/Intangible
Tangible assets- resources that have
physical or monetary existence.
Intangible assets- rights acquired by the
company representing access to resources that
could generate future income.
Examples: Trademarks,
Public Utility Franchise, A Mining Claim, and A Banking
License.

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Intangible Assets
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Intangible assets are those noncurrent economic
resources that a company uses in its operations but
have no physical existence.
Patents Copyrights Franchises
Intangible Assets
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Intangible assets are those noncurrent economic
resources that a company uses in its operations but
have no physical existence.
Trademarks
a registered
trademark
Computer
software costs
Goodwill
Classification of Assets
2. Financial/Physical
Physical assets- factories,
machinery, buildings, inventory and
other properties used in the business.
Financial/Monetary assets-
cash and claims by the company
against others.

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Classification of Assets
3. Fixed/Current
Fixed assets- used in the
operation of the business and have
economic lives longer than one year.
Current assets- resources that
can be converted to cash in the
normal course of business.

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Current Assets
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Current assets are cash and
other assets that are expected to
be converted into cash, sold, or
consumed within one year or the
normal operating cycle,
whichever is longer.
Operating Cycle
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An operating cycle is the average time
taken by a company to spend cash for
inventory,...
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process and sell the inventory, and
collect the receivables, converting
them back into cash.
Operating Cycle
Steps in Operating Cycle
Purchasing
Production
Warehousing
Sale on
Credit
Collection
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Current Assets
Cash includes cash
on hand and readily
available in checking
and savings
accounts.
Cash equivalents are
risk-free securities, such
as money market funds
and treasury bills that
will mature in three
months or less from the
date acquired by the
holder.
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Current Assets
Temporary investments in
marketable securities
include debt and equity
securities that are classified
as trading securities,
available-for-sale
securities, and held-to-
maturity securities.
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Receivables include accounts receivable and
notes receivable with short-term maturity dates.
They are listed at their estimated collectible
amounts (net realizable values).
Inventories include goods held for resale in the
normal course of business plus, in the case of a
manufacturing company, raw materials and work
in process inventories.
Prepaid items such as insurance, rent, office
supplies, and taxes will not be converted into cash
but will be consumed.
Current Assets
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Other Assets
The Other Assets section
occasionally is used to report
miscellaneous assets that
may not be readily classified
within one of the previous
sections.
Sometimes referred to as deferred charges
Long-Term Investments
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Investment items that management expects to
hold for more than one year or the operating
cycle, whichever is longer, are classified as
long-term (noncurrent) investments.
Property, Plant, and Equipment
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Property, plant, and equipment includes the
tangible assets used in the firms operations.
Also called fixed
assets
Elements of the Balance Sheet: Liabilities
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Liabilities are probable future
sacrifices of economic benefits
arising from present
obligations...
Elements of the Balance Sheet: Liabilities
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of a company to transfer assets or
provide services in the future as a
result of past transactions or events.
Current Liabilities
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1. Obligations for items are in the operating cycle
(accounts payable and salaries payable).
2. Advance collections for the future delivery of
goods or performances of service (unearned
rent and unearned ticket sales).
3. Other obligations that will be paid within one
year or the operating cycle (the estimated
liability for short-term product warranties).
Long-Term Liabilities
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Long-term liabilities are those
obligations of a company whose
liquidation is not expected to
require the use of current assets or
not expected to create current
liabilities within one year or the
normal operating cycle (whichever
is longer).
Other Liabilities
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Deferred tax liabilities and
obligations of a component of the
company that is being discontinued
are examples of items that might
be included as other liabilities.
Elements of the Balance Sheet: Stockholders Equity
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Assets
=
Liabilities
+
Stockholders
Equity
Equity is the residual
interest in the assets of a
company that remains after
deducting its liabilities.
Stockholders Equity
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Stockholders equity
is the residual interest of
the stockholders in the
assets of the
corporation.
A sole proprietorship
is a single-owner
company.
Stockholders Equity
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Stockholders equity
is the residual interest of
the stockholders in the
assets of the
corporation.
A partnership involves two
or more persons who have
agreed to combine their
capital and efforts in the
operations of a company.
Stockholders Equity
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Stockholders equity
is the residual interest of
the stockholders in the
assets of the
corporation.
The corporation is a
complex business
organization. Usually there is
absentee ownership.
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Stockholders Equity
Legal capital is the
minimum amount of
stockholders equity that
the corporation may not
distribute as dividends.
Preferred stock
receives preference
in declared
dividends.
Common stock
carries the right to vote
at the annual
stockholders meeting
and to share in residual
profits.
Contributed Capital
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Stockholders Equity
Retained earnings is the total amount of
corporate net income that has not been
distributed to stockholders as dividends.
Uses of net income
To use in daily operations
To maintain its productive
facilities
For growth
Summary of Accounting Policies
A selection from existing acceptable
alternatives
Principles and methods peculiar to the
industry in which the company operates
Unusual or innovative applications of GAAP
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GAAP requires that a company must include a
description of all its significant accounting
policies as an integral part of its financial
statements.
In particular, when these principles and methods
involve:
Subsequent Events
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A subsequent event is one that occurs
between a companys balance sheet date and
the date of issuance of the annual report.
End of
Accounting Period
Annual Report
Publication Date
Subsequent Events
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Report Form
Assets
xxxx $xxx
xxxx xxx
Total assets $xxx

Liabilities and Stockholders Equity
xxxx $xxx
xxxx xxx
Total liabilities and
stockholders equity $xxx

Balance Sheet Formats
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Liabilities and
Stockholders Equity
xxxx $xxx
xxxx xxx
Total liab. & stock. eq. $xxx
Account Form
Assets
xxxx $xxx
xxxx xxx
Total assets $xxx
Balance Sheet Formats
Limitations of the Balance Sheet
The use of historical cost to value assets and
liabilities does not help users assess the likely
amounts of future cash flows.
Human resources such as high-quality
management or highly creative employees are
not included as assets.
Many of the amounts that a company reports
are based on estimates.
In periods of inflation, some amounts listed do
not show the purchasing power of assets and
liabilities.
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Usefulness of
Book Values
C
hapter
2
Section 2.3


A balance sheet measures a
companys value, called
BOOK VALUE.

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APPRAISED VALUE

an estimate by professional
appraisers of the current value of a
fixed asset.
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Neither cost nor appraised value is
consistent with the measurement of value
in managerial finance.

A finance manager would like
to know the selling price of an
asset or the future income that
the asset will generate.
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The cash realized from the sale of
an asset rather than its book value
represents the recovery of
investment.

Another way to realize the
investments benefits is to use the
asset profitability.
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The book value of the asset at
the end of period is defined
as:

Book Value=
Original Cost Accumulated
Depreciation
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Accumulated Depreciation

Is the sum of periodic
depreciation up to the period.

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Market Values

Refer to current and future
values and opportunities.
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Book Value: The Entire
Business
The book value of the company is the total
book value of assets less the total liabilities of
the business.

Book value of owners equity=
Book value of assets- Book value
of liabilities
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