Financial Accounting:

Tools for Business Decision Making, 3rd Ed.

Kimmel, Weygandt, Kieso

Assoc. Prof. Dr. Hà Hồng Hạnh

S
EL

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Chapter 2
 Chapter 2
A Further Look at Financial Statements
After studying Chapter 2, you should be
able to:
 Explain the meaning of generally accepted
accounting principles and describe the
basic objective of financial reporting.
 Discuss the qualitative characteristics of
accounting information.
 Identify two constraints in accounting.
 Identify the sections of a classified balance
sheet.
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 Chapter 2
A Further Look at Financial Statements
 Identify and compute ratios for analyzing a
company's profitability.
 Explain the relationship between a retained earnings
statement and a statement of stockholders' equity.
 Identify and compute ratios for analyzing a
company's liquidity and solvency using a balance
sheet.
 Identify and compute ratios for analyzing a
company’s liquidity and solvency using a statement
of cash flows.

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 General Guide for
Financial Accounting
 Generally
 Accepted
 Accounting
 Principles

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What is financial accounting
supposed to accomplish?
Provide the the most useful financial information for…

Decision Making

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 Primary Accounting
Setting Body in the U.S.
 Financial
 Accounting
 Standards
 Board

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U.S. Government Agency That
Oversees Financial Markets

 Securities
 Exchange
 Commission

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 Remember…

GAAP Are the Rules

The FASB makes the rules.

The SEC enforces the rules.

 Basic Terms
 Relevance - information makes a difference
in decisions
 Reliability - information must be free of
error and bias
 Comparability - ability to compare
information of different companies because
they use the same accounting principles
 Consistency - use of same accounting
principles and methods from year to year
within the same company 10
Relevance Reliability Comparability Consistency
1. Provides a basis 1. Is verifiable Different Company uses
for forecasts companies use same accounting
2. Is a faithful
similar METHODS from
2.Confirms/corrects representation
accounting year to year
prior expectations
3. Is neutral PRINCIPLES
3. Is timely

Characteristics of Useful Information

11 11
 Constraints in Accounting
Permits companies to apply GAAP without
hurting the usefulness of information
 Materiality - The constraint of determining
whether an item is large enough to likely
influence a decision.
 Conservatism - The approach of choosing an
accounting method, when in doubt, that will be
least likely to overstate assets and net income.

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A Classified Balance Sheet...
Generally contains the following
standard classifications:
 Current Assets
 Long-Term Investments
 Property, Plant, and Equipment
 Intangible Assets
 Current Liabilities
 Long-Term Liabilities
 Stockholders' Equity 13
 Current Assets
 Assets that are expected to be converted to cash or used in
the business within one year.
 Current assets are listed in order of liquidity.
 Examples:
 Cash
 Short-term investments
 Receivables
 Inventories
 Supplies
 Prepaid expenses
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 Long-Term Investments
 Assets that can be converted into cash, but
whose conversion is not expected within
one year.
 Assets not intended for use within the
business.
 Example:
 Investments of stocks and bonds of
other corporations.
 Investments in long-term assets
such as land or buildings that are
not currently being used in the
company’s operating activities. 15
Property, Plant, and
Equipment
 Assets with relatively long
useful lives.
 Assets used in operating
the business.
 Examples:
 land
 buildings
 machinery
 delivery equipment
 furniture and fixtures
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 Depreciation is...
 Practice of allocating an asset’s full
purchase price to a number of years
instead of expensing full cost in year
of purchase.

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Accumulated Depreciation...
 Shows the total amount of
depreciation taken over the life of
the asset.

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AssetsCSU
That A Company
CORPORATION
Depreciates...
Balance Sheet
December 31, 2004

Should be shown at cost less

accumulated depreciation

Assets
Cash $ 2,000
Accounts receivable 4,000
Supplies 1,800
Equipment 24,000
Less: Accumulated Depreciation 8,000 16,000
Total assets $23,800

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 Intangible Assets
 Noncurrent assets
 Have no physical substance
 Examples:
 patents
 copyrights
 trademarks or trade names
 franchise
Intangible Assets have value
because of the exclusive
rights or privileges they possess. 20
 Current Liabilities
Obligations that are supposed to be paid
within the coming year...
 accounts payable
 wages payable
 bank loans payable
 interest payable
 taxes payable
 current maturities of
long-term bank
loans payable 21
 Long-Term Liabilities
Debts expected to be paid after
one year
Examples…
 bonds payable
 mortgages payable
 long-term notes payable
 lease liabilities and
 obligations under employee pension plans
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 Stockholders' Equity

 Capital stock - investments in the

business by the stockholders
 Retained earnings - earnings kept for
use in the business

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 HUMANA CORPORATION
Balance Sheet
December 31, 200X
(in millions)
Assets
Current Assets
Current

Cash $ 272
Marketable securities (current) 609
Receivables 74
Other current assets 83
Total current assets 1,038
Property and equipment (net) 317
Marketable securities (long-term) 322
Other long-term assets 280
Total Assets $1,957
Liabilities and Stockholders’ Equity
Liabilities
Current Liabilities
Current

Medical costs payable $ 527

Accounts payable 233
Income taxes payable 56
Total current liabilities 816
Long-term debt 83
Total liabilities 899
Stockholders’ equity
Common stock 830
Retained earnings 228
Total Liabilities and stockholders’ equity $1,957 24
 Ratio Analysis...
 Expresses relationship among selected
items of financial statement data
 Relationship can be expressed in term
of…
 percentage
 rate
 proportion

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 Ratio Analysis Classifications...
 Liquidity Ratios - measures of short-term
ability of the company to pay its maturing
obligations and to meet unexpected needs
for cash
 Profitability Ratios - Measures of the
income or operating success of a company
for a given period of time
 Solvency Ratios - Measures of the ability
of the company to survive over a long
period of time

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 Ratio Analysis
 Intracompany comparisons - covering two
years of the same company

 Industry average comparisons - based on

average ratios for a particular industry
 Intercompany comparisons - based on
comparisons with a competitor in the
same industry

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 Profitability Ratios...
Measures of the income or operating
success of a company for a given period of
time
Two Examples…
 Earnings Per Share
 Price-Earnings Ratio

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 Earnings Per Share

How does the company’s earning

performance compare with that of
previous years?
Net income-Preferred stock dividends
EPS=
Average common shares outstanding

Higher value = improved performance

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 Price-Earnings Ratio

Stock price per share

Price-Earnings Ratio =
Earnings per share

How does the market perceive the

company’s prospect for future
earnings?
High ratio suggests market has favorable
expectations
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 Statement of
Retained Earnings

Describes the events that caused changes in

the retained earnings account for the
period.

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 CSU CORPORATION
Retained Earnings Statement
For the Year Ended December 31, 200X

Retained earnings, January 1 $ 0

Add: Net Income 6,800
6,800
Less: Dividends 0
Retained earnings, December 31 $ 6,800

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 Statement of Retained
Earnings and Statement of
Stockholders Equity

Stockholders’ Equity:
 Retained Earning
 Common Stock
Since both of these parts affect
stockholders’ equity…
a statement of stockholders’ equity
provides better information than a
statement of retained earnings.
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Financial Ratio Classifications
 Liquidity Ratios - measures of short-term
ability of the company to pay its maturing
obligations and to meet unexpected needs for
cash
 Profitability Ratios -measures of the income
or operating success of a company for a given
period of time
 Solvency Ratios - measures of the ability of a
company to survive over a long period of time

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 Liquidity Ratios
 Working capital

 Current ratio

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 Working Capital

Measures short-term ability to

pay liabilities
Current Assets - Current Liabilities = Working Capital

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 Current Ratio

Measure of short - term ability

to pay obligations
Current Assets
Current Ratio =
Current Liabilities

37
 Solvency Ratio

Debt to Total Assets Ratio

measures % of assets financed by
creditors.

Total Debts
Debt to Total Asset Ratio =
Total Assets

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 Purpose of
Statement Of Cash Flows
To provide information about
 cash receipts
 cash payments
 net changes in cash

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 Changes Result From
 Operating activities
 Financing activities
 Investing activities

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 Operating Activities

Cash inflows
and cash
outflows
associated with
the primary
operations of the
business.
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 Financing Activities
Cash inflows/ outflows come from
sources funding the business…
 Sale of Stock/ Payment of
Dividends
 Issuing Debt/Repaying Debt

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 Investing Activities
Cash inflows/ outflows result from
changes in investments and long-
term assets…
 purchasing/disposing of investments
and long-lived assets using cash
 lending money and collecting the
loans
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Current Cash Debt Coverage Ratio

Cash Provided by Operating Activities

=
Average Current Liabilities

44
 Cash Debt Coverage Ratio

Cash Provided by Operating Activities

=
Average Total Liabilities

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 COPYRIGHT

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