Instructions:
Complete the each of following seven tabs in this MS Excel Workbook using the information contained in them:
– Post the Journal Entries (to record the transactions of FirstRate Company during the final week of its fiscal year ended [FYE]
Dec. 31, 20X5) to the consolidated Trial Balance of the company as of December 31, 20X5
– Consolidated Balance Sheet of the company as of December 31, 20X5
– Consolidated Income Statement, including comprehensive income, of the company for its FYE December 31, 20X5
– Statement of Cash Flows (SCF) Support Schedule, which provides information useful for preparing the SCF
– Consolidated Statement of Cash Flows (SCF) of the company for its FYE December 31, 20X5
– Consolidated Statement of Changes in Shareholders' Equity of the company for its FYE December 31, 20X5
Complete the assignment by working "from left to right." That is, first, complete the Trial Balance, followed by the Balance Sheet, then the
Income Statemet tab, etc.
The background paper, Financial Statement Concepts and Financial Reporting , provides useful guidance for completing this assignment.
The facilitator will grade this assignment, assigning up to 100 points for it as follows:
Maximum
– Trial Balance
15
– Balance sheet
20
– Income Statement
20
– Cash Flow Statement (SCF) and SCF Support Schedule
30
– Statement of Changes in Stockholders' Equity
Total points
Earned
points
15
100
-
FirstRate Company and subsidiaries
General Journal
(U.S. dollars in thousands)
(Assumes company does NOT use special journals, such as sales journal, purchases journal, cash journal, or payroll journal)
Date
General ledger accounts / Explanation
Debit
Credit
Dec. 31, 20X5
Dr.
Accounts receivable, gross
Cr.
800
Sales revenue (gross)
800
Explanation: To record credit sales for the last few days of 20X5
Dec. 31, 20X5
Dr.
Cost of goods sold (COGS) - other
Cr.
600
Inventory, at lower of cost or market
600
Explanation: To record cost of sales for the last few days of 20X5
Dec. 31, 20X5
Dr.
Cash and cash equivalents
Cr.
700
Accounts receivable, gross
700
Explanation: To record collections of accounts receivables for the last week of 20X5
Dec. 31, 20X5
Dr.
Allowance for uncollectible accounts receivable
Cr.
200
Accounts receivable, gross
200
Explanation: To record write-off of AR outstanding more than 6 months as of Dec. 28, 20X5
Dec. 31, 20X5
Dr.
Selling and administrative expenses - other
Cr.
200
Cash and cash equivalents
200
Explanation: To record payment of employee 20X5 bonuses, declared by board on Dec. 28, 20X5
Dec. 31, 20X5
Dr.
Inventory, at lower of cost or market
Cr.
500
Accounts payable
500
Explanation: To record purchases of raw materials during last week of 20X5 on credit (terms net 30 days)
Total debits and credits
3,000
3,000
Post the am
of these adj
entries (JEs
balance (in
workbook ta
BEFORE pr
complete th
tabs in the w
(Complete a
this workbo
Post the amount of each
of these adjusting journal
entries (JEs) to the trial
balance (in the next
workbook tab). Do this
BEFORE proceeding to
complete the remaining
tabs in the workbook.
(Complete all 6 tabs in
this workbook.)
17S8W2
FirstRate Company and subsidiaries
Trial Balance Fiscal Year 20X5
(U.S. dollars in thousands)
General ledger (GL) account
Cash and cash equivalents
Investment securities available for sale (market value)
Debit
Debit
Accounts receivable, gross
Debit
Allowance for uncollectible accounts receivable
Credit
FYE Dec. 31,
FYTD Dec.
20X4
24, 20X5
2,100
20,200
78,000
JEs Final Week of 20X5
Debits
FYE Dec. 31,
(Credits)
600
(2,700)
20X5
600
21,700
(3,800)
137,600
160,100
160,100
292,500
266,700
266,700
Credit
(129,700)
(105,200)
(105,200)
Accounts payable
Credit
(81,600)
(96,700)
(96,700)
Accrued income taxes payable
Credit
(2,300)
(1,800)
(1,800)
Dividends payable on common stock
Bank note payable - current portion
Bank note payable - noncurrent portion
Accrued interest payable
6% Preferred stock, at par value
Common stock, at par value
Additional paid-in capital (APIC)
Treasury stock
Accum. other comprehensive income (loss)
Retained earnings - beginning of year
Credit
(19,800)
(16,000)
(16,000)
Credit
(89,800)
(113,900)
(113,900)
Credit
(52,700)
(55,400)
(55,400)
Credit
(2,500)
(3,100)
(3,100)
Credit
(20,000)
(20,000)
(20,000)
Credit
(42,700)
(42,700)
(42,700)
Credit
Debit
(8,300)
1,100
Debit
Post JEs separately (individually)
Debit
94,600
(3,800)
Debit
Debit
Accumulated depreciation on PP&E
Debit
21,700
94,600
18S8W1
Inventory, at lower of cost or market
Property, plant, and equipment, at cost
(8,300)
(8,300)
1,100
Enter numbers or formulas in
shaded worksheet cells only,
leaving the remainder of this
worksheet tab unchanged. In the
preceding JE workbook tab, there
are only 6 debits and 6 credits; so,
most cells in the shaded (JE debit
and credit) columns of this
workbook tab will remain blank
(empty).
1,100
Dr (Cr)
200
(1,300)
(1,300)
Credit
(82,500)
(79,600)
(79,600)
FYE Dec.
FYTD Dec.
JEs Final Week of
31, 20X4
24, 20X5
Debits
600
Error
2,100
20,200
78,000
Credit
94,600
160,100
Error
266,700
Credit
(129,700)
(105,200)
Credit
(81,600)
(96,700)
Credit
(2,300)
(1,800)
Credit
(19,800)
(16,000)
Credit
(89,800)
(113,900)
Credit
(52,700)
(2,500)
(3,100)
(20,000)
(20,000)
Credit
(42,700)
(42,700)
Credit
Credit
(8,300)
1,100
600
94,600
(3,800)
Error
######
######
######
Error
######
(1,800)
######
######
(55,400)
Credit
Credit
FYE
Dec. 31,
Error
Error
Error
137,600
292,500
Dr (Cr)
Error
21,700
Error
(3,800)
Debit
Debit
Debit
Use care not to overwrite formulas
in some worksheet cells, provided
(2,700)
(Credits)
21,700
18S8W1
"Post" the amounts of each
adjusting journal entry (JE) in the
preceding workbook tab to the
appropriate GL account and debit
(credit) column in this trial balance
workbook tab. Complete this
workbook tab BEFORE proceeding
to complete the remaining tabs in
the workbook.
######
(3,100)
######
######
(8,300)
(8,300)
1,100
1,100
200
(1,300)
(1,300)
(82,500)
(79,600)
######
Dividends declared on preferred stock - current year
Debit
1,200
1,200
1,200
Debit
1,200
1,200
1,200
Dividends declared on common stock - current year
Debit
19,800
16,000
16,000
Debit
19,800
16,000
16,000
Sales revenue (gross)
Credit
(674,200)
(742,300)
(742,300)
Credit
(674,200)
(742,300)
Error
######
Sales returns and allowances
Debit
12,800
16,300
16,300
Debit
12,800
16,300
16,300
Cost of goods sold (COGS) - depreciation
Debit
11,400
10,000
10,000
Debit
11,400
10,000
10,000
Cost of goods sold (COGS) - other
Debit
469,400
523,600
523,600
Debit
469,400
523,600
Error
######
Selling and administrative expenses - depreciation
Debit
600
500
500
Debit
600
500
Selling and administrative expenses - other
Debit
109,200
122,900
122,900
Debit
109,200
122,900
Debit
23,800
24,000
24,000
Debit
9,900
12,300
12,300
Debit
23,800
24,000
Other operating expenses
Research and development (R&D) expenses
Debit
9,900
12,300
Gain on disposal of PP&E
Credit
-
Debit
-
Debit
9,900
12,500
7,100
Income tax provision
Debit
9,100
Loss from discontinued oper., (before tax effect)
Debit
-
Extraordinary loss (before tax effect)
Debit
Total debits (credits)
Net balance of nominal (or, temporary) accounts
17F8W2
(1,100)
7,100
-
(14,200)
Credit
-
12,500
-
(18,100)
24,000
12,300
(1,100)
Loss on disposal of PP&E
Interest on bank note
-
-
-
######
(1,100)
(1,100)
Debit
-
-
-
Debit
9,900
12,500
12,500
7,100
Debit
9,100
7,100
-
Debit
-
-
-
Debit
-
-
(18,100)
The background paper defines nominal (or, temporary) accounts.
Computing the net balance of these accounts in final 20X5 column
of this tab provides a helpful check figure for use in completing the
income statement tab of this workbook.
500
Error
-
(14,200)
-
-
-
A45
FirstRate Company and subsidiaries
17F8W2
FirstRate Company and subsidiaries
Consolidated Income Statement
17F8W2
Consolidated Income Statement
Fiscal year ended December 31, 20X5
Fiscal year ended December 31, 20X5
(U.S. dollars in thousands, except per share amounts)
(U.S. dollars in thousands, except per share amounts)
Sales revenue (net of returns and allowances)
Sales revenue (net of returns and allowances)
Complete this workbook tab using
the completed trial balance tab. It
may be be useful to review the
illustrative income statement in
the background paper, Financial
Statement Concepts and
Financial Reporting.
Operating expenses:
Enter numbers, formulas, or
labels, as appropriate, in shaded
worksheet cells only, leaving the
remainder of this worksheet tab
unchanged.
Other operating expenses
Total operating expenses
Operating income
To ensure maximum credit for
your work, use formulas
whenever possible. This will help
enable the faciliator 's
understanding of your reasoning,
which may justify "partial credit"
for inaccurate results.
Non-operating items:
Non-operating rev enues and gains:
Non-operating expense and losses:
Error
Error
Error
Operating expenses:
Error
Error
Other operating expenses
Total operating expenses
Operating income
Error
Error
Error
Non-operating items:
Non-operating rev enues and gains:
Non-operating expense and losses:
Interest on bank note
Interest on bank note
Income before income taxes
Income before income taxes
Net income
Net income
Error
Error
Error
Earnings per share:
Error
Earnings per share:
Net income
Weighted average number of common shares outstanding
Comprehensiv e income:
Net income
########
Weighted average number of common shares outstanding
Error
42,563,000
Comprehensiv e income:
Net income
Net income
Other comprehensiv e income:
Other comprehensiv e income:
Comprehensive income
Comprehensive income
Error
Error
Error
B1
FirstRate Company and subsidiaries
17F8W2
FirstRate Company and subsidiaries
Consolidated Balance Sheet
Consolidated Balance Sheet
December 31, 20X5
December 31, 20X5
(U.S. dollars in thousands)
(U.S. dollars in thousands)
Assets:
Assets:
Current assets:
Replace this text with an appropriate asset label
$
600
Total current assets
Property, plant, and equipment, net
Complete this workbook tab using
the completed trial balance tab. It
may be be useful to review the
illustrative balance sheet in the
background paper, Financial
Statement Concepts and
Financial Reporting.
Enter numbers, formulas, or
labels, as appropriate, in shaded
worksheet cells only, leaving the
remainder of this worksheet tab
unchanged.
To ensure maximum credit for
your work, use formulas
whenever possible. This will help
enable the faciliator 's
understanding of your reasoning,
which may justify "partial credit"
for inaccurate results.
Current assets:
Replace this text with an appropriate asset label
$
600
Error
Error
Error
Error
Total current assets
Error
Error
Error
Property, plant, and equipment, net
Error
Total assets
Total assets
Error
Liabilities:
Liabilities:
Current liabilities:
Current liabilities:
Error
Error
Error
Error
Error
Total current liabilities
Error
Bank note payable - noncurrent portion
Error
Total liabilities
Total liabilities
Error
Stockholders' equity:
Total current liabilities
Stockholders' equity:
Bank note payable - noncurrent portion
Error
Error
Error
Error
Error
Error
Total stockholders' equity
Total stockholders' equity
Error
Total liabilities and stockholders' equity
Total liabilities and stockholders' equity
Error
Hint: the balance of retained earnings in your completed balance sheet should include more than the balance of the "RE - beginning of year" account.
See the Background Paper for a discussion of financial statement articulation.
Check: Is your balance sheet "in balance"? (If you're $3,000 out-of-balance, it may be because you haven't taken the hint above properly into account!
B1
FirstRate Company and subsidiaries
Consolidated SCF Support Schedules (NOT for inclusion in U.S. GAAP-GPFS)
Fiscal year ended December 31, 20X5
Column C
(U.S. dollars in thousands)
December 31,
20X5
Working capital assets:
Accounts receivable, net of allowance
$
90,900
Increase (decrease)
20X4
$
75,300
$
15,600
Use of cash
Row 8
Inventory, at lower of cost or market
Row 9
Error In Cell
Working capital liabilities:
Row 10
Accounts payable
Row 11
Error In
Cell
Complete
this
workboo
completed
balance
Row 12 Error In Cell sh
and trial balance tabs.
Row 13 Error In Cell
It may be be useful to
Row 14
cash flow statement a
prepare it in the backg
Row 15
Statement Concepts a
Row 16
Enter numbers, formu
Row 17
appropriate, in shaded
leaving the remainder
Row 18
unchanged.
Row 19
To ensure maximum c
Row 20
formulas whenever po
Row 21
enable the faciliator 's
Row 22
reasoning, which may
Row 23
inaccurate results.
Accrued income taxes payable
Source of cash
Accrued interest payable
Net working capital
$
90,900
$
75,300
$
15,600
Net use of cash
Non-working capital asset accounts
Property, plant, and equipment (PP&E), at cost
Balance at beginning of period, reported in December 31, 20X4 balance sheet
$
Increase: Acquisitions of PP&E during 20X5
292,500
9,200
Decrease: Original cost of equipment sold in 20X5 (fully depreciated at date of disposal)
(35,000)
Balance at end of period, reported in December 31, 20X5 balance sheet
$
266,700
$
129,700
Row 24
10,500
Row 25
(35,000)
Row 26
105,200
Row 27
Accumulated depreciation (of PP&E)
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: Depreciation of PP&E for 20X5
Decrease: Accumulated depreciation on equipment sold in 20X5
Balance at end of period, reported in December 31, 20X5 balance sheet
$
Row 28
Non-working capital liability accounts
Row 29
Dividends payable on common stock
Row 30
Balance at beginning of period, reported in December 31, 20X4 balance sheet
$
19,800
Increase: Dividends declared on common stock on December 15, 20X5
Row 31
Row 32
Decrease: Dividends paid during FYE December 31, 20X5
(19,800)
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 33
Row 34
Row 35
Non-current
Bank note payable
Current portion
Balance at beg. of period, reported in Dec. 31, 20X4 balance sheet
Increase: Additional borrowings during 20X5 ("plugged" from remaining info)
89,800
portion
52,700
Row 36
Total
142,500
Row 37
(142,500)
Row 38
Decrease: None (FirstRate made no repayments during 20X5)
-
Row 39
Balance at end of period, reported in Dec. 31, 20X5 balance sheet
-
Row 40
Row 41
Stockholders' equity accounts
Row 42
Preferred stock, par value $100 per share
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: None
Decrease: None
Row 43
20,000
Row 44
-
Row 45
(20,000)
Row 46
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 47
Common stock, par value $1 per share
Row 48
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: NO shares issued in 20X5, at par value
Decrease: NA - see Treasury Stock, below
42,700
Row 49
-
Row 50
(42,700)
Row 51
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 52
Additional paid-in capital (APIC)
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: NO shares issued in 20X5
Decrease: None (not applicable)
Row 53
8,300
Row 54
-
Row 55
(8,300)
Row 56
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 57
Treasury stock
Row 58
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: NO shares repurchased in 20X5
Decrease: None (NO treasury shares re-sold in 20X5)
1,100
Row 59
(1,100)
Row 60
-
Row 61
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 62
Retained earnings
Row 63
Balance at beginning of period, reported in December 31, 20X4 balance sheet
79,600
Row 64
Increase: Net income for FYE December 31, 20X5, as reported in the income statement
14,200
Row 65
Decrease: Preferred dividends declared (and paid) in 20X5
Decrease: Common stock dividends declared (refer to analysis of dividends payable, above)
Row 66
(17,200)
Row 67
76,600
Determination of Supplemental Disclosures of Interest and Income Taxes Paid
Row 68
Row 69
Row 70
Accrued interest payable
Row 71
Balance at end of period, reported in December 31, 20X5 balance sheet
Balance at beginning of period, reported in December 31, 20X4 balance sheet
2,500
Increase: Interest on bank note, as reported in the income statement
Decrease: Interest paid during 20X5 (inferred, or "plugged," from remaining info)
Row 72
Row 73
(2,500)
Row 74
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 75
Accrued income taxes payable
Row 76
Balance at beginning of period, reported in December 31, 20X4 balance sheet
2,300
Increase: Income tax provision (i.e., income tax expense) reported in the income statement:
Decrease: Income taxes paid during 20X5 (inferred, or "plugged," from remaining info)
Balance at end of period, reported in December 31, 20X5 balance sheet
Row 77
Row 78
(2,300)
Row 79
Row 80
Column D
Column E
Column F
December 31,
20X5
Working capital assets:
Accounts receivable, net of allowance
Error In Cell
Error In Cell
Error In Cell
$
Inventory, at lower of cost or market
90,900
Increase (dec
20X4
$
75,300
$
15,600
Error
Error
Error
Accounts payable
Error
Error
Error
Accrued income taxes payable
Error
Error
Error
Accrued interest payable
Error
Error
Error
Working capital liabilities:
Error In
workbook
tabCell
usingError
the In Cell Error In Cell
anceError
sheet,
income
statement,
In Cell Error In Cell Error In Cell
ce tabs.
Error In Cell Error In Cell
seful to review the illustrative
Error
Cell ErrorofInhow
Cellto
ement
andInexplanation
e background paper, Financial
ncepts and Financial Reporting.
Net working capital
$
90,900
$
75,300
$
15,600
Non-working capital asset accounts
formulas, or labels, as
shaded worksheet cells only,
mainder of this worksheet tab
Property, plant, and equipment (PP&E), at cost
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: Acquisitions of PP&E during 20X5
ximum credit for your work, use
ever possible. This will help
liator 's understanding of your
ich may justify "partial credit" for
ults.
Decrease: Original cost of equipment sold in 20X5 (fully depreciated at date of disposal)
Balance at end of period, reported in December 31, 20X5 balance sheet
Accumulated depreciation (of PP&E)
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: Depreciation of PP&E for 20X5
Decrease: Accumulated depreciation on equipment sold in 20X5
Balance at end of period, reported in December 31, 20X5 balance sheet
Non-working capital liability accounts
Dividends payable on common stock
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Error In Cell
Increase: Dividends declared on common stock on December 15, 20X5
Decrease: Dividends paid during FYE December 31, 20X5
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Bank note payable
Balance at beg. of period, reported in Dec. 31, 20X4 balance sheet
Error In Cell
Current
Non-current
portion
portion
89,800
52,700
Increase: Additional borrowings during 20X5 ("plugged" from remaining info)
Decrease: None (FirstRate made no repayments during 20X5)
Error In Cell
Error In Cell
Error In Cell
Balance at end of period, reported in Dec. 31, 20X5 balance sheet
Stockholders' equity accounts
Preferred stock, par value $100 per share
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: None
Error In Cell
Decrease: None
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Common stock, par value $1 per share
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: NO shares issued in 20X5, at par value
Error In Cell
Decrease: NA - see Treasury Stock, below
Error
Error
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Additional paid-in capital (APIC)
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: NO shares issued in 20X5
Error In Cell
Decrease: None (not applicable)
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Treasury stock
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Error In Cell
Increase: NO shares repurchased in 20X5
Decrease: None (NO treasury shares re-sold in 20X5)
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Retained earnings
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Increase: Net income for FYE December 31, 20X5, as reported in the income statement
Error In Cell
Decrease: Preferred dividends declared (and paid) in 20X5
Error In Cell
Decrease: Common stock dividends declared (refer to analysis of dividends payable, above)
Balance at end of period, reported in December 31, 20X5 balance sheet
Determination of Supplemental Disclosures of Interest and Income Taxes Paid
Accrued interest payable
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Error In Cell
Increase: Interest on bank note, as reported in the income statement
Error In Cell
Decrease: Interest paid during 20X5 (inferred, or "plugged," from remaining info)
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
Accrued income taxes payable
Balance at beginning of period, reported in December 31, 20X4 balance sheet
Error In Cell
Increase: Income tax provision (i.e., income tax expense) reported in the income statement:
Error In Cell
Decrease: Income taxes paid during 20X5 (inferred, or "plugged," from remaining info)
Error In Cell
Balance at end of period, reported in December 31, 20X5 balance sheet
se (decrease)
Use of cash
Error
Error
Error
Source of cash
Net use of cash
$
292,500
9,200
(35,000)
$
266,700
$
129,700
10,500
(35,000)
$
$
105,200
19,800
Error
(19,800)
Error
Total
142,500
(142,500)
-
20,000
(20,000)
Error
42,700
(42,700)
Error
8,300
(8,300)
Error
1,100
(1,100)
-
79,600
14,200
Error
(17,200)
76,600
2,500
Error
(2,500)
Error
2,300
Error
(2,300)
Error
G66
FirstRate Company and subsidiaries
Consolidated Statement of Cash Flows
Fiscal year ended December 31, 20X5
Column B
(U.S. dollars in thousands)
Net income
Row 6
Adj ustments to reconcile net income to cash flows prov ided by operating activ ities:
Error In Cell
Complete
this workbook tab using
Row
7
Net income
Error
Adj ustments to reconcile net income to cash flows prov ided by operating activ ities:
the completed cash flow support
and8trial Error
balance
tabs. It may be
Row
In Cell
Depreciation of property, plant, and equipment
be useful to review the illustrative
Gain on disposal of equipment
Row
9 flowError
In Celland
cash
statement
Loss on sale of equipment
explanation of how to prepare it in
Row
the10
background paper, Financial
Changes in working capital accounts:
Statement
Concepts and
Row
11
Depreciation of property, plant, and equipment
Error
Gain on disposal of equipment
Error
Loss on sale of equipment
Changes in working capital accounts:
Financial Reporting.
Decrease (increase) in accounts receivable, net
Row 12
Decrease (increase) in inventory
labels,
appropriate,
Row
13 asError
In Cell in shaded
Error In Cell
Enter numbers, formulas, or
worksheet cells only, leaving the
Decrease (increase) in accounts receivable, net
Error
Decrease (increase) in inventory
Error
Increase (decrease) in accounts payable
Row
remainder
14 Error
of this
In Cell
worksheet tab
Increase (decrease) in accounts payable
Error
Increase (decrease) in accrued income taxes payable
Row 15
Increase (decrease) in accrued income taxes payable
Error
unchanged.
Error In Cell
To ensure maximum credit for
your
useIn
formulas
Row
16work,
Error
Cell
whenever possible. This will help
enable
faciliator
's
Row
17 the
Error
In
understanding
of Cell
your reasoning,
which may justify "partial credit"
Row
for 18
inaccurate results.
Increase (decrease) in accrued interest payable
Net cash provided by (used in) operating activities
Cash flows from inv esting activ ities:
Increase (decrease) in accrued interest payable
Error
Net cash provided by (used in) operating activities
Error
Cash flows from inv esting activ ities:
Proceeds on sale of equipment
Row 19
Error In Cell
Proceeds on sale of equipment
Error
Acquisitions of property, plant, and equipment
Row 20
Error In Cell
Acquisitions of property, plant, and equipment
Error
Row 21
Error In Cell
Net cash provided by (used in) investing activities
Error
Net cash provided by (used in) investing activities
Cash flows from financing activ ities:
Row 22
Cash flows from financing activ ities:
Net proceeds from issuance of common stock
Row 23
Net proceeds from issuance of common stock
Repurchases of common stock
Row 24
Repurchases of common stock
Redemption of preferred stock
Row 25
Redemption of preferred stock
Payment of dividends on preferred stock
Row 26
Error In Cell
Payment of dividends on preferred stock
Error
Payment of dividends on common stock
Row 27
Error In Cell
Payment of dividends on common stock
Error
Proceeds from borrowings under bank note agreement
Row 28
Error In Cell
Proceeds from borrowings under bank note agreement
Error
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Row 30
Error In Cell
Row 31
Error In Cell
Cash and cash equivalents, January 1, 20X5
Row 32
Error In Cell
Cash and cash equivalents, December 31, 20X5
Row 33
Row 34
Row 35
Error In Cell
Supplemental disclosures:
17F8W2
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Error
Error
Cash and cash equivalents, January 1, 20X5
Error
Cash and cash equivalents, December 31, 20X5
Error
Supplemental disclosures:
Row 36
Error In Cell
Error
Row 37
Error In Cell
Error
B38
FirstRate Company and subsidiaries
Statement of Changes in Stockholders’ Equity
Fiscal year ended December 31, 20X5
(U.S. dollars in thousands)
17S8W2
Balance at January 1, 20X5
Preferred
stock
Common
stock
Additional
paid-in
capital
Treasury
stock
Accum.
other
comprehens
ive income
Retained
earnings
Total
stockholde
rs' equity
$
-
Complete this workbook tab using
the completed trial balance tab. It
may be be useful to review the
illustrative statement of changes
in shareholders' equity in the
background paper, Financial
Statement Concepts and
Financial Reporting.
Column B
Column C
Column D
17S8W2
Enter7numbers,
formulas,
or In Cell Error In Cell Balance at January 1, 20X5
Row
In Cellin Error
labels,
as Error
appropriate,
shaded
worksheet
cells only, leaving the
Row
8
remainder of this worksheet tab
Preferred stock redeemed
unchanged.
Row
9
To ensure maximum credit for
Row
your10
work, use formulas
Common stock repurchased
Row
11 the faciliator 's
enable
Net income
Common stock issued
whenever possible. This will help
understanding of your reasoning,
which
Row
12may justify "partial credit"
for inaccurate results.
Other comprehensive income (loss)
Dividends on common stock
Dividends on preferred stock
Balance at December 31, 20X5
Row 13
17F8W2
Row 14
$
-
Row 15
Preferre
d stock
Error
Common
stock
Error
Additional
paid-in
capital
Error
Treasury
stock
Error
Accum.
other
compreh
ensive
Error
Retained
earnings
Error
Total
stockhol
ders'
equity
$
-
Preferred stock redeemed
Common stock repurchased
Net income
Common stock issued
Error
Other comprehensive income (loss)
Error
Error
Dividends on common stock
Error
Error
Dividends on preferred stock
Error In Cell Error In Cell Error In Cell Balance at December 31, 20X5
Error
Error
Error
Error
Error
Error
Error
Error
Error
$
~
-
A6
Background Paper:
Financial Statement
Concepts and Financial
Reporting
College of Business and Economics
Master of Business Administration
MBA C604 Accounting and Finance Concepts for Managers
Contents
Topic 3
Introduction and Purpose
General-Purpose Financial Statements
Regulatory Structure of Financial Reporting by U.S. Public Companies
Objective of Financial Reporting
The Accounting Information System and the Accounting Cycle
Events and Transactions Recognized in the Accounting Information System
Accrual Basis Accounting
Content and Meaning of General-Purpose Financial Statements
— Balance Sheet (or Statement of Financial Condition)
— Income (or Operating) Statement and Statement of Comprehensive Income
— Cash Flow Statement
— Statement of Changes in Stockholders’ Equity
— Footnote Disclosures
Financial Statement Articulation
Definitions of Financial Statement Elements
Desired Qualitative Characteristics of Accounting Information
Basic Assumptions and Principles of, and Constraint on, Financial Reporting
Topic 4
Limitations on the Usefulness of Financial Statements
—
—
—
—
Trade-offs between Relevance and Representational Faithfulness due to Articulation and Conservatism
Definitions of Financial Statement Elements and Measurement Uncertainty
Political Influence and Accountings Principles that Fail to Reflect Economic Reality
Management Judgment: Accounting Policy Choices, Accounting Estimates, and Earnings Management
Earnings Management: Cosmetic and Real
— Earnings Management Incentives
— Earnings Management Indicators
— Earnings Quality and Effects of Earnings Management
Ethical Dimensions of Financial Reporting
1
Introduction and Purpose
As a student in this course, you previously completed a financial accounting principles course (as well as a
managerial accounting principles course). Your financial accounting principles course introduced you to:
— General-purpose financial statements,
— Accrual accounting as the basis for such financial statements, and
— The essential accounting systems and processes that businesses maintain to support their financial
reporting
The users of these reports include managers and external parties, such as investors and creditors.
Of course, this foundational accounting skill and knowledge is necessary for students pursuing careers as
accounting, auditing, and finance professionals. However, as an effective manager of a business’ marketing,
operations, or other functions, you need the skill of financial reporting literacy. The purpose of this background
paper is to help you build on your foundational skills by acquiring this literacy.
Financial reporting literacy means that a manager is able to interpret general-purpose financial statements in
connection with making business decisions, including those related to a business’ strategy, operations,
investments, and finances. In making such business decisions, managers who have financial reporting literacy
appreciate the limitations of general-purpose financial statements. To acquire financial reporting literacy,
managers must examine:
The objective and basic regulatory framework of financial reporting
The content and meaning of general-purpose financial statements, including the elements comprising
them, and how they articulate with each other
The desired qualitative characteristics of accounting information
The basic assumptions, principles, and constraint underlying financial reporting
The limitations on the usefulness of financial statements resulting from trade-offs made necessary by
the present accounting model, political influences, and the need for managers’ judgment
The importance of earnings quality to the usefulness of financial statements and how earnings
management affects this quality, and
The ethical dimensions of financial reporting policies and practices, including managers’ incentives to
engage in earnings management
2
Topic 3
General-Purpose Financial Statements
Generally Accepted Accounting Principles in the U.S. (U.S. GAAP) has long required that businesses
preparing general-purpose financial statements for external (non-manager) users include each of the following
basic statements and disclosures:
Balance Sheet (or Statement of Financial Condition)
Assets
Liabilities
Stockholders’ equity
Income (or Operating) Statement
Sales
Cost of sales
Gross profit
Cash Flow Statement
Cash flows provided by operating activities
Net income
Adjustments to reconcile net income to cash flows provided by operating activities:
Statement of Changes in Stockholders’ Equity1
Preferred
stock
Common
stock
Treasury
stock
APIC
AOCI
Retained
earnings
Balance, Jan. 1
Common stock issued
Comprehensive income
Footnotes
Summary of Significant Accounting Policies . . .
Composition of Inventory . . .
Commitments and Contingencies . . .
______
1
Throughout this course, unless stated otherwise, assume that the organizational form of businesses is a corporation organized under
the state laws in which the business is domiciled. Recall from your foundation courses in financial accounting principles and business
finance that financial statements label owners’ equity interests in a corporation stockholders’ equity or shareholders’ equity, and
stockholders’ interest in the corporation take the form of shares of capital stock, more commonly referred to as common stock.
3
Regulatory Structure of Financial Reporting by U.S. Public
Companies
Since 1973, the Financial Accounting Standards Board (the FASB) has had primary responsibility for
establishing U.S. GAAP. In the case of public companies – those having debt and equity securities traded on
U.S. securities exchanges (such as the NYSE and NASDAQ) – the FASB obtained this authority from the U.S.
Securities Exchange Commission (the SEC). This is because the Securities Exchange Act of 1934 (the 1934
Act) created the SEC and empowered it to establish U.S. GAAP. The SEC largely delegated this authority to
the FASB (and its predecessor standard-setters) since its inception in 1934. However, the SEC continues to
oversee the FASB and has occasionally overridden the FASB’s accounting policy decisions, as set forth in the
FASB’s Statements of Financial Accounting Standards.
The SEC also regulates companies’ issuance of debt and equity securities that investors trade on U.S.
exchanges (or by inter-state mail), the exchanges themselves, and certain activities of various market
participants. These market participants include (among others) investment advisors, mutual funds, securities
brokers and dealers, investment bankers, and independent auditors of public companies’ financial statements.
The SEC refers to public companies as registrants. Regulations of the SEC require registrants to issue
periodic reports that include general-purpose financial statements:
Annual Report on Form 10-K. Public companies must file these reports within 60 days of their fiscal year
end and include financial statements audited by an independent auditor. These audited financial
statements must include:
— Balance sheets as of the two most recent fiscal year-end dates, presented in comparative form
— Income statements, cash flow statements, and statements of changes in stockholders’ equity for the
three most recent fiscal years, each presented in comparative form for all years included, and
— Footnote disclosures of information necessary to amplify, explain, or supplement the content of the
basic financial statements.
Quarterly Reports on Form 10-Q. Public companies must file these reports within 40 days of their fiscal
quarter end, for each of the first three fiscal quarters of the companies’ fiscal year. The purpose of these
reports is to update the information included in the most recently filed report on Form 10-K. The Form 10Q includes unaudited, interim general-purpose financial statements. These financial statements must
include:
— Balance sheets of the most recent quarter end and the most recent fiscal year end dates, presented in
comparative form
— Income statements for the most recent fiscal quarter and fiscal year-to-date, and for the comparable
periods of the previous fiscal year, presented in comparative form for all such periods, and
— Cash flow statements for the most recent fiscal year-to-date and for the comparable period of the
previous fiscal year, presented in comparative form.
SEC regulations require public companies to obtain a review (but not an audit) of their interim, quarterly
financial statements, included in Forms 10-Q filed with the SEC. A review is much more limited in scope
than an independent audit. (The A605 course examines this point in detail.)
Current Reports on Form 8-K. Public companies must file these reports within four business days of the
occurrence of certain events that the SEC has deemed sufficiently important to affect financial statement
users’ judgments and decisions about the company. The SEC’s instructions for completing reports on
Form 8-K includes an extensive list of reportable events, a sample of which includes:
— The registrant has changed its independent auditor
— Information comes to light that indicates users should no longer rely on previously issued financial
statements, or a related audit report, or completed interim review
4
— The registrant has issued an “earnings release” reporting summarized results of operations and
financial condition
— The registrant has determined that it has experienced material impairment in the realizable
(recoverable) value of significant operating assets
— A director or principal officer has departed the registrant, or there has been an election of directors or
appointment of principal officers
— The registrant has amended it code of ethics, or waived a provision of its code of ethics
— An exchange has notified the registrant that it is delisting its securities or the registrant has failed to
satisfy a rule or standard for continued listing
— The registrant has materially modified the rights of security holders
— There has been a change in control of the registrant
— The registrant has entered into bankruptcy or receivership
— The registrant has entered into a definitive agreement relating to a material acquisition or disposition of
assets
The principal regulations of the SEC affecting financial reporting by public companies are Regulation S-X
(affecting the form and content of general-purpose financial statements) and Regulation S-K (affecting the form
and content of other financial information and disclosures included in reports filed with the SEC, but not within
the financial statements that comprise a part of these reports).
Outside the U.S., in recent years, many countries have adopted International Financial Reporting Standards
(IFRS), established by the International Accounting Standards Board (the IASB), as the basis for financial
reporting by companies domiciled within their borders and therefore subject to securities and business
regulations in those countries. The FASB and the IASB are engaged in a long-running effort to “harmonize”
their respective accounting standards with the ultimate goal of complete “convergence” of their respective
standards. In that regard, in 2008, the SEC adopted a rule that will eventually, and gradually, require
registrants to prepare their financial statements (included in reports filed with the SEC) using IFRS. While
there are both significant and minor differences between present U.S. GAAP and IFRS, the basic financial
reporting concepts and principles examined in this course are largely unaffected by the transition from existing
U.S. GAAP to the eventual, “converged” IFRS. (The A608 course examines IFRS in detail.)
5
Learning
Objective 3
Objective of Financial Reporting
The U.S. Congress passed the Securities Act of 1933 (the 1933 Act) and the 1934 Act in response to the
market abuses that contributed to the stock market “crash” of 1929. Recall that the 1929 “crash” was a
material contributing factor in the Great Depression of the early 1930s. One of Congress’ objectives in
adopting these statutes was to improve the quality and transparency of financial reporting as a means to
protect the integrity and enhance the efficiency of the securities markets. The securities markets include
principally the national securities exchanges.
Consistent with this legislative objective, the FASB determined that the objective of general-purpose financial
statements is to provide financial information about a business that is useful for making capital allocation
decisions by
Equity investors and
Creditors, such as
— Banks
— Insurance and finance companies, and
— Investors in bonds and other debt securities
In addition to current and potential investors and creditors (collectively, the capital markets), financial statement
user groups include (among others)
—
—
—
—
—
Managers of public companies (financial statement issuers)
Employees and unions
Customers and suppliers
Government agencies with oversight responsibility (such as the SEC, FCC, FRB, and FTC), and
Environmental and social interest groups
6
The Accounting Information System and the Accounting Cycle
The Topic 1-2 background paper defines the accounting information system within a business as the collection
of people, policies, procedures, information technology, and processes that identifies, classifies, processes,
summarizes, and distributes economic and financial information to the various financial statement user groups.
Check your understanding of the accounting information system (examined in detail in your financial
accounting principles course) by reviewing the essential steps of the accounting cycle and the related basic
terminology (identified in bold type) below:
Steps in the Accounting Cycle
1. Enter transactions and events of the period in the appropriate accounting journal (such as the cash
receipts journal, purchases journal, cash disbursements journal, sales journal, and general journal).
These entries, also called journal entries, use the double-entry rules that employ the customary
debits (left) and credits (right), which businesses maintain in equality.
2. Post from the various journals to the accounts, including
— Real (or permanent) accounts such as cash, accounts receivable, accounts payable, and
equipment, and
— Nominal (or temporary) accounts such as sales, purchases, and salaries
Collectively, the accounts comprise the general ledger.
3. Prepare an unadjusted trial balance from the general ledger
4. Prepare adjusting journal entries and post these to the general ledger
5. Prepare an adjusted trial balance from the general ledger after posting adjusting journal entries
6. Prepare the financial statements from the adjusted trial balance. These include the balance sheet,
income statement, statement of comprehensive income, and statement of changes in
stockholders’ equity.
7. Prepare closing journal entries and post these to the general ledger
8. Prepare a post-closing trial balance from the general ledger after posting the closing journal entries
A business will normally perform all these steps at the end of each of its fiscal years.
7
Learning
Objective 1
Events and Transactions Recognized in
the Accounting Information System
Under U.S. GAAP, businesses do not recognize (that is, record) in their accounting information systems every
transaction and event. For example, even though they may have important effects on the business,
companies do not recognize in their financial statements:
—
—
—
—
Increases in customer credit limits
Extension of customer payment terms
Modifications to personnel policies, or
Adoption of business strategies or dividend policies
Transactions and events that businesses do recognize in their accounting information systems may be either
external or internal in nature:
Internal transactions and events occur within a business. These include, for example:
— Consumption of plant and equipment in the process of producing goods for sale
— Transfers of raw materials into production, and
— Application of labor and other conversion costs to the production of goods for sale
External transactions and events occur between a business and other parties or its environment. These
include, for example:
— Purchases or sales of goods and services
— A customer’s refusal or inability to pay amounts owed to the business
— A change in an interest rate affecting the value of fixed-rate securities in which the business holds an
investment, and
— The introduction by a competitor of technology superior to that used by a business in its products,
indicating the business’ product inventory is now obsolete
Transactions and events that businesses recognize in the accounting information systems must result in items
meeting the definition of financial statement element, as this background paper discusses, below.
8
Accrual Basis Accounting
Throughout your financial accounting principles course, you examined the application of accrual basis
accounting to each major business cycle 2, such as:
—
—
—
—
Revenue cycle – sales, shipping, billing, and collections
Acquisition cycle – purchasing, receiving, and disbursements
Conversion (production) cycle, and
Payroll cycle
Financial statements prepared using the accrual basis of accounting are more relevant (useful for financial
statement users) than those prepared using cash basis (“check book”) accounting.
This background paper reviews the basic principles of financial reporting, below. Together, two of these
principles – the revenue recognition principle and the matching principle – form the basis of accrual accounting
that has been the foundation of the financial reporting model used in the U.S. for more than a century (and has
become the basis of financial reporting in virtually all economically developed, market-based economies).
_____
2
The application of accrual basis accounting is too voluminous and varied for a summary review that would be helpful to you, here. If
you need a refresher on basic accrual accounting concepts, crack open your dusty, ol’ financial accounting text and spend a couple of
hours reviewing the accounting for:
— Sales “on credit” (accounts receivable) and purchases of goods and services “on credit” (accounts payable)
— Acquisitions and depreciation of PP&E
— Unpaid-but-incurred expenses, such as interest on borrowing between interest payment dates, employee services between payroll
distribution dates, services rendered but not yet billed (as in the case of legal and accounting services)
— Customers’ payments received before the seller has fully earned them (as in the case of prepaid subscription fees), and
— Businesses’ advance payments for goods and services that relate to current and future periods (as in case of annual insurance
premiums paid at the beginning of the policy year, “bulk” purchases office supplies, and pre-paid advertising space for use over the
next (say) six months)
If you got rid of your financial accounting principles text long ago (shame on you!), you can probably access comparable material – for
free – by doing a bit of research on the Internet (e.g., Google, U-Tube, Wikipedia, Investopedia, etc.)
9
Under the accrual basis of accounting, businesses recognize revenues and expenses in their income
statements according to these two principles, rather than based on the timing of cash receipts or expenditures:
Revenue Recognition Principle
Businesses (sellers) recognize revenueA from the exchange of goods or services,
based on completed transactions, once it is both;
Earned – The seller has delivered the goods or provided the service, and
Realizable – The seller receives a collectible accounts receivable, even if it has not
yet realized (collected) the selling price in cash
As a result, a seller may not recognize revenue before it has delivered goods or
provided services, even if the buyer has already paid the selling price “in advance.” On
the other hand, the seller may recognize revenue from goods delivered or services
provided before it receives the selling price in cash.
Matching Principle
Whenever reasonable and practical, businesses recognize costs incurred as expensesA in the
income statement in the same period in which they recognize the revenueA to which those costs
contributed.
Whenever not reasonable and practical to match costs with revenues, businesses recognize costs
as expensesA
— In the income statement of the period in which they incur them, even if they have not yet paid
them in cash, or
— In the income statements of multiple periods beyond the period in which the business made
the related cash expenditure using a depreciation or amortization method (as in the case of
equipment and certain software development costs)
A
This background paper defines each of the financial statement elements, including revenues and expenses, below
Recall that accounting accruals are either short-term or long-term in nature:
Short-term accruals include principally working capital assets and liabilities (examined further below),
such as accounts receivable, inventory, and accounts payable; and
Long-term accruals relate principally to the cost of assets that businesses allocate over multiple
accounting periods benefitting from their services, such as plant and equipment. In the case of plant
and equipment, accountants refer to this “inter-temporal cost allocation” as depreciation.
10
Learning
Objective 2
Content and Meaning of General-Purpose Financial Statements
Recall from your financial accounting principles course the essential content and meaning of general-purpose
financial statements, as summarized below.
Balance Sheet (or Statement of Financial Condition)
The balance sheet presents the assets, liabilities, and stockholders’ equity elements of a business as of a
specified date, most often as of the end of the business’ fiscal year or interim fiscal quarter. Public companies
include fiscal yearend and quarter-end financial statements in reports filed with the SEC and otherwise make
them available to the public. In addition, most businesses also prepare balance sheets as of each month end
during a fiscal year strictly for managers’ use in their on-going decision-making.
Your financial accounting principles courses introduced you to the “basic accounting equation” and the
concepts of debits (left) and credits (right). Within the basic accounting information system (summarized in this
background paper, above) the equality of aggregate debits with aggregate credits ensures that the basic
accounting equation remains valid:
ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY
Consistent with the form of the basic accounting equation, businesses present assets on the left side (or top) of
the balance sheet, and present liabilities, followed by stockholders’ equity, on the right side (or bottom) of the
balance sheet.
Critically, a business’ balance sheet contains clear headings that include:
The identity of the reporting entity (including any group of consolidated companies that includes a
corporate parent and the subsidiary companies that its controls)
A proper title, and
The date of the statement
The following graphic illustrates the form of the balance sheet (or statement of financial condition):
11
FirstRate Company and subsidiaries
Consolidated Balance Sheets (or Consolidated Statements of Financial Condition)
December 31, 20X1 and 20X0
(U.S. dollars in thousands)
20X1
20X0
20X1
20X0
$45,000
$42,800
3,000
3,300
Dividends payable on common stock
12,000
13,200
3
60,500
56,200
Assets:
Liabilities:
Current assets 3:
Current liabilities 3:
Cash and cash equivalents
$9,900
$14,300
Investment securities available for sale,
at market
20,200
21,200
Accounts payable
Accrued income taxes payable
Accounts receivable, net allowance
43,300
41,300
Bank note payable – current portion
Inventory, at lower of cost or market
91,000
86,600
Accrued interest payable
1,300
1,200
Total current assets
164,400
163,400
Total current liabilities
121,800
116,700
Property, plant, and equipment, at cost
209,600
206,000
Bank note payable – noncurrent
portion3
20,100
18,700
94,800
105,300
Total liabilities
141,900
135,400
114,800
100,700
Stockholders’ equity:
Preferred stock, par value $100 per share
20,000
20,000
Common stock, par value $10 per share
42,700
42,700
8,300
8,300
(1,100)
–
(200)
800
67,600
56,900
137,300
128,700
$279,200
$264,100
Less: Accumulated depreciation
Property, plant, and equipment, net
Additional paid-in capital (APIC)
Treasury stock, at cost
Accum. other comprehensive income
Retained earnings
Total stockholders’ equity
Total assets
A
$279,200
$264,100
Total liabilities and stockholders’
equity
L+E
_____
3
This background paper examines the classification of assets and liabilities in the balance sheet (as current or noncurrent) below.
12
Assets, liabilities, and stockholders’ equity refer to categories of financial statement elements that businesses
report in their balance sheets. (This background paper defines each of the principal financial statement
elements, such as assets, in a separate section, below.)
Assets. Recall that balance sheet elements meeting the definition of assets include, for example:
— Cash and so-called “cash equivalents” (as described further below)
— Investments in marketable debt and equity securities
— Trade accounts receivable from customers arising from sales made “on credit”
— Amounts owed to the business under notes receivable arising from loans by the business and from
extended trade credit arrangements with customers, and
— Capitalized costs of resources having future economic utility, such as
Inventory (principally, raw materials and finished goods available for sale to customers)
Computer software, supplies, and insurance policy premiums paid
Plant and equipment (such as, buildings, computer hardware, and vehicles), and
Certain intangible assets (such as goodwill, intellectual property rights, and rights arising from
licensing or other contractual arrangements)
Liabilities. Balance sheet elements meeting the definition of liabilities include, for example:
— Trade accounts payable to suppliers arising from purchases of goods and services “on credit”
— Deposits received from customers (to secure their performance under trade credit arrangements) and
amounts received from customers for goods that the business has not yet delivered (or for services the
business has not provided)
— Income and other types of taxes owed to governmental tax authorities
— Accrued expenses, such as:
Estimated obligations to customers under anticipated warranty claims
Accrued compensation payable to employees for regular payroll, commissions, bonuses, and other
arrangements
Future income taxes owed to governmental tax authorities upon the reversal certain temporary
differences in the accounting treatment of income or expenditures under income tax accounting
regulations and U.S. GAAP, and
Estimated amounts that managers believe the business will probably pay to plaintiffs or other
claimants upon the eventual resolution of litigation (in the form of settlements or court judgments)
— Dividends declared by the company’s board of directors on its common stock but not yet distributed,
and
— Principal and accrued interest amounts owed under various borrowing arrangements, such as:
Notes or mortgages payable to banks and other financial institutions
Bonds payable to investing bondholders, and
Future rental payments (as a lessee) under certain lease agreements
13
Equity. Balance sheet elements meeting the definition of stockholders’ equity principally include:
— Common stock and related items, such as:
Additional paid-in capital (APIC), representing amounts paid to the company by stockholders for the
company’s shares of common stock in excess of the shares’ par or stated value, as set forth in the
company’s articles of incorporation, and
Treasury stock, representing the company’s cost to reacquire shares of its own common stock from
stockholders
— Preferred (or preference) stock4 issued to preferred stockholders, if any
— Retained earnings, representing the cumulative net income of the company, as reported in its income
statements, to the extent that the company has not distributed such income to stockholders as
dividends, and
— Accumulated other comprehensive income (AOCI), representing the cumulative change in the market
prices of certain investment securities, derivative financial instruments, and foreign currencies that
businesses do not report as gains or losses in their income statements
Balance Sheet Classifications. Accountants classify assets and liabilities in the balance sheet generally in
terms of their nearness to cash or availability for settling liabilities. A classified balance sheet reports assets
and liabilities as current or noncurrent:
Current assets are (a) cash and “cash equivalents” (defined to include most negotiable instruments and
highly liquid investments, such as U.S. Treasury Bills, having original maturities of three months or less)
and (b) other recognized assets that the business will either:
— Consume or convert into cash within one year (or the business’ normal operating cycle, if longer than
one year), or
— Use to settle current liabilities
Current liabilities are recognized obligations that a business expects to settle or refund (replace with other
current liabilities) within one year (or the business’ normal operating cycle, if longer than one year) 5.
A business’ operating cycle is the average length of time between when it orders materials for production (in a
manufacturing business) to the point that the business collects cash from customers as a result of the sale of
goods produced by the business. The graphic below illustrates the concept of the operating cycle:
Company receives materials
used in producing goods. After
delivery of materials, company
uses cash to pay for them
Materials issued into
production. Labor and
other conversion costs
applied (see Topic 1-2)
Finished goods remain in
warehouse facility until
shipped based on
customer orders
Company (seller)
receives payment
for finished goods
shipped
_____
4
The F602 course considers preferred stock in the context of determining a business’ appropriate capital structure. Recall from your
foundational business finance course that, preferred stock has characteristics of both common stock (equity) and debt. The financial
structure and terms of preferred stock vary considerably among companies that use this form of financial capital. In the past two
decades, relatively few public companies have used preferred stock as a part of their long-term capital structure.
5
However, a business classifies as noncurrent a liability (such as bonds or bank notes) due within the next year to the extent that it will
refinance it upon its maturity with another long-term liability or newly issued equity securities, or defease (retire) it with specifically
identified noncurrent assets. The A603 course examines this special rule in detail.
14
Interpreting and Using the Balance Sheet. A business’ balance sheet presents its investments and sources
of financing for those investments. Recalling the basic accounting equation, the following graphic illustrates
the alternative ways of describing the relationship between these groups of financial statement elements:
Left side of balance sheet
ASSETS
Right side of balance sheet
=
LIABILITIES + STOCKHOLDERS’ EQUITY
or
INVESTMENTS
=
SOURCES OF FINANCING FOR THOSE INVESTMENTS
or
RESOURCES
=
CLAIMS ON THOSE RESOURCES
Together with the business’ income and cash flow statements, investors, creditors,
and managers use the balance sheet of a business to evaluate its:
Liquidity (the nearness of the business’ assets to cash)
Solvency or capital structure (the business’ ability to pay its debts as they
mature)
Profitability and asset utilization (or efficiency)
Asset quality, and
Financial flexibility
Proper classification of balance sheet elements as current (or non-current) assets and liabilities is critical to
financial statement users’ analysis of a business’ liquidity. This is because financial statement users
commonly examine businesses’ working capital (the balance of current assets less the balance of current
liabilities, as reported in businesses’ balance sheets) to evaluate businesses’ liquidity, even though businesses
do not show the working capital measurement on their balance sheets. Of course, liquidity is essential to a
business’ daily operations. It is cliché, but essentially correct that cash is the lifeblood of a business.
Financial flexibility describes businesses’ ability to
— Exploit new investment opportunities, and
— Withstand adverse changes, such as the effects of an economic downturn on the businesses’ industry,
or tightening in the availability of credit.
Analysts assess a businesses’ financial flexibility using such measurements as free cash flow and ratios of
operating cash flow (OCF) to noncurrent (or total) liabilities. (The Topic 8 background paper and the A602
course discuss financial statement analysis of this kind in detail.)
15
Income (or Operating) Statement
The income statement presents the revenues, expenses, gains, and losses (financial statement elements) of a
business for a specified period, most often for the fiscal year or interim fiscal quarter of the business. As
indicated above, public companies include fiscal year and quarterly interim financial statements in publicly
available reports filed with the SEC. In addition, most businesses also prepare income statements at each
month end (and for the corresponding year-to-date period) during a fiscal year strictly for managers’ use.
An expanded version of the basic accounting equation captures the essential relationship between (or
articulation6 of) the income statement, which reports net income of the current period, and the balance sheet:
ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY
where
STOCKHOLDERS’ EQUITY = PERMANENT EQUITY + NET INCOME OF CURRENT PERIOD
and
PERMANENT EQUITY =
PREFERRED + COMMON + APIC – TREASURY +
STOCK
STOCK
AOCI
STOCK
(IF ANY)
+
RETAINED
EARNINGS
AS OF
BEGINNING
OF PERIOD A
– DIVIDENDS
OF
CURRENT
PERIOD
and
NET INCOME = REVENUES + GAINS – EXPENSES – LOSSES, EACH FOR THE CURRENT PERIOD
A
As defined above retained earnings represents the cumulative net income of the company, as reported in its
income statements, to the extent that the company has not distributed such income to stockholders as
dividends.
The following graphic illustrates the form of the multiple-step income statement (or operating statement).
Critically, a business’ income statement contains clear headings that include:
The identity of the reporting entity
A proper title, and
The period of activity that the statement reports
_____
6
This background paper examines the articulation of financial statements, below.
16
FirstRate Company and subsidiaries
Consolidated Income Statement (or Consolidated Operating Statement)
Fiscal year ended December 31, 20X1
(U.S. dollars in thousands, except per share amounts)
Sales revenue (net of returns or allowances)
$519,700
Cost of goods (or services) sold
363,800
Gross profit
155,900
Operating expenses:
Selling and administrative expenses
78,000
Research and development expenses
26,000
Other operating expenses
5,200
Total operating expenses
109,200
Operating income
46,700
Non-operating items:
Non-operating revenues and gains A
–
B
Non-operating expense and losses :
Loss on disposal of equipment
Interest on bank note
900
5,400
Income from continuing operations before income taxes
40,400
Taxes on income from continuing operations
13,500
Income from continuing operations
26,900
Income (loss) from discontinued operations, net related income tax benefit of $1,000
(2,000)
Income before extraordinary items
24,900
Extraordinary gain (loss), net of related income tax benefit of $500
(1,000)
Net income
$23,900
Earnings per share:
Income from continuing operations
$0.63
Income (or loss) from discontinued operations, net of tax benefit
(0.04)
Income before extraordinary items
0.59
Extraordinary gain (or loss), net of tax of tax benefit
(0.03)
Net income
$0.56
Weighted average number of common shares outstanding during the year
42,463,000
17
A
Non-operating revenues and gains include, for example:
— Interest from investments in debt securities and dividends from certain marketable equity securities
— Gains on disposition of investment securities, and
— Gains on sales of PP&E
B
Non-operating expenses and losses include, for example:
— Interest on debt, such on notes, mortgages, and bonds payable and certain lease obligations
— Provision of an allowance for a decline in inventory’s market value below its original cost
— Write-downs of inventory or long-lived operating assets (such as PP&E) to recognize “permanent”
impairment in their recoverable value, and
— Losses on investment securities or dispositions of PP&E
Intermediate subtotals. Compared to net income, intermediate subtotals (shaded
elements in the illustrative income statement, above) are frequently of equal or greater
importance to financial statement users as indicators of a business’ earnings quality or
sustainability, particularly when users examine the period-to-period trend of such
intermediate totals. The Topic 8 background paper examines this point further in
connection with financial ratio analysis.
Note the following important principles implicit in this income statement format (bold type indicates key income
statement terminology):
Irregular items and the “modified all-inclusive income concept.” All income statement elements presented
below income from continuing operations are irregular items. The content and format of the income
statement illustrated above represents what the FASB calls the “modified all-inclusive income concept.”
The modification here relates to the concept of “other comprehensive income,” described below.
Non-operating expenses and losses. Non-operating expenses and losses represent items that are
either unusual or infrequent in nature, but not both. These are not irregular items and consequently
included in income from continuing operations. In contrast, extraordinary items are (by definition) both
unusual and infrequent in nature and reported as irregular items. Non-operating expenses include any
interest expense on company borrowings even though such costs are commonplace. Non-operating
expenses also include any write-downs representing anticipated losses on the disposition of inventory;
businesses should not include such losses in COGS because they have not yet sold the related products.
Intraperiod income tax allocation. U.S. GAAP requires businesses to use intraperiod income tax allocation.
This means that businesses must present (a) income statements elements above income from
continuing operations without any related income tax effects and (b) income from continuing
operations and each irregular item along with its proportionate share of the business’ total income tax
expense. Thus, intraperiod income tax allocation emphasizes the irregular nature of each such item and
the “of a piece” nature (“the whole”) of income from continuing operations.
EPS presentation requirements. Companies must present EPS amounts for net income, each irregular
item, and the intervening subtotals. This permits a more complete analysis and understanding of this
widely used measurement. Under U.S. GAAP, companies present no other statistical measures (such as
the effective tax rate, current ratio, solvency ratio, etc.) on the face of the financial statements, including the
income statement. Recall from your financial accounting principles course that companies compute basic
EPS by dividing the relevant income statement amount (such as income from continuing operations) by the
average number of shares of common stock outstanding (excluding any preferred stock outstanding)
during the period corresponding to income statement period.
18
Accounting Changes. Businesses do not report the effects of accounting changes – including changes in
accounting principles, changes in accounting estimates, and corrections of material accounting errors – as
irregular items. Instead, U.S. GAAP requires businesses to account for such items prospectively (changes in
estimates), retrospectively (changes in accounting principles), or by restatement of previously issued financial
statements (corrections of errors). The A602, A603, and A605 courses examine accounting changes under
U.S. GAAP.
Comprehensive Income. Businesses generally include in the income statement and the determination of net
income all revenues, gains, expenses, and losses recognized during the accounting period. Since 1998, U.S.
GAAP has required businesses to report comprehensive income, in addition to net income. Comprehensive
income is net income increased by other items of comprehensive income (OCI). The FASB defined OCI to
include only a limited number of specific items. Items of OCI relate to changes in the market prices of certain
investment securities, derivative financial instruments, and foreign currencies that businesses do not report as
gains or losses in their income statements. Perhaps the most frequently appearing item of OCI is the
unrealized gain (or loss) a business experiences on debt and equity securities that it holds as investments
“available for sale” in the event the business needs additional cash for operating purposes (working capital),
plant expansion, or any other purpose.
The FASB permits businesses two alternative methods of presenting elements of OCI and comprehensive
income:
— In the income statement, immediately below net income (as illustrated below), or
— As a separate statement of comprehensive income that begins with net income
FirstRate Company and subsidiaries
Consolidated Income Statement and Statement of Comprehensive Income
Fiscal year ended December 31, 20X1
(U.S. dollars in thousands, except per share amounts)
Sales revenue (net of returns or allowances)
$519,700
Cost of goods (or services) sold
:
:
Net income
363,800
:
:
$23,900
Other comprehensive income:
Unrealized loss on investments available for sale
(1,000)
Other comprehensive income (loss)
(1,000)
Comprehensive income
$22,900
As indicated above, the FASB defined OCI to include only a limited number of specific items, such as
— Unrealized holding gains (or losses) experienced on debt and equity securities that companies continue
to hold as investments “available for sale”
— Unrealized gains or losses on certain derivative instruments used to hedge anticipated cash transactions
— Unrealized gains or losses resulting from translation of the financial statements of consolidated foreign
subsidiaries operating in a foreign “functional” currency
19
Note that underlying each of these items of OCI are market prices that fluctuate with changes in
— Economic conditions,
— Interest rates (effectively, the market prices for the “rental” of money)
— Currency exchange rates (effectively, the market prices for foreign currencies, priced in terms of the U.S.
dollar), and
— Prices of debt and equity securities, commodities, and derivative financial instruments (such as interest
rate or currency swaps, interest rate futures, and commodity options)
These are so-called “exogenous” factors that a business’ managers have no ability to control, and may have
very limited, near-term effects on a business’ on-going operations.
20
Cash Flow Statement
The statement of cash flows (SCF) provides information about a business’ cash receipts and payments for a
specified period, most often for the fiscal year-to-date of the business. As indicated above, public companies
include fiscal year and interim period (fiscal year-to-date) SCFs in publicly available reports filed with the SEC.
In addition, many businesses also prepare SCFs at each month-end (and for the corresponding year-to-date
period) during a fiscal year strictly for managers’ use.
In preparing the SCF, U.S. GAAP requires that businesses classify cash flow information as operating,
investing, and financing in nature, presenting such information in this order, beginning with operating cash flow
(OCF). Investors, creditors, and managers use the SCF to:
Obtain an understanding of a business’ sources and uses of cash, and
Evaluate a business’ earnings quality, as set forth in its income statement.
For example, a business may report significant and growing earnings over several periods, but have
declining or even negative OCF during the same period. Such a relationship between income and
OCF is rarely sustainable over many periods and consequently may foretell (or confirm present)
financial difficulty for the business. By analyzing OCF and earnings quality, users may learn much
about a business’ financial flexibility (defined above). This background paper examines earnings
quality below, in connection with Topic 4. (The A602 and A605 courses also examine earnings
quality). Therefore, the proper classification of cash flows in the SCF as operating, investing, and
financing in nature is critical to users’ assessment of a business’ liquidity and earnings quality.
To acquire financial reporting literacy, you must understand the relationship between each of these categories
of cash flows, the balance sheet, and the income statement. To acquire this understanding, you will practice
preparing the SCF, even though you previously studied the SCF in your financial accounting principles course.
Cash Flow Category
Operating cash
flows (OCF)
Relationship to balance sheet or income statement
Corresponds with:
Activities presented in the income statement, and
Changes during the period in working capital assets and liabilities presented in the
balance sheet:
— Working capital assets generally includes all current asset elements, except
investments in debt and marketable equity securities and cash and cash
equivalents – the element whose change during the period the SCF explains.
— Working capital liabilities generally includes all current liability elements except:
Dividends payable (on the company’s common or preferred stock), and
The current portion of any borrowings, such as notes, mortgages, and bonds
payable and capital lease obligations (so-called “funded debt”)
Investing cash
flows
Corresponds with changes during the period in all assets, other than working capital
assets, as presented in the balance sheet (such as investments and PP&E)
Financing cash
flows
Corresponds with changes during the period in:
All liabilities other than working capital liabilities, (such as “funded debt”), and
Stockholders’ equity elements
each as presented in the balance sheet
21
The following graphic illustrates the form of the SCF using the indirect method for presenting OCF, as
discussed below. Critically, a business’ SCF contains clear headings that include:
The identity of the reporting entity
A proper title, and
The period of activity that the statement reports
FirstRate Company and subsidiaries
Consolidated Statement of Cash Flows
Fiscal year ended December 31, 20X1
(U.S. dollars in thousands)
Net income
Adjustments to reconcile net income to cash flows provided by operating activities:
Depreciation of property, plant, and equipment
Amortization of limited-life intangibles
Loss (gain) on sale of equipment
Impairment loss on long-lived assets [such as intangibles, PP&E]
Changes in working capital accounts:
Increase in accounts receivable, net
Increase in inventory
Increase in accounts payable
Decrease in accrued income taxes payable
Increase in accrued interest payable
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Proceeds on sale of equipment
Acquisitions of property, plant, and equipment
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Net proceeds from issuance of common stock
Repurchases of common stock
Redemption of preferred stock
Payment of dividends on preferred stock
Payment of dividends on common stock
Proceeds from borrowings under bank note agreement
Repayments of borrowings under bank note agreement
$23,900
10,500
–
900
–
(2,000)
(4,400)
2,200
(300)
100
30,900
2,100
(27,600)
(25,500)
–
(1,100)
–
(1,200)
(13,200)
5,700
–
Net cash provided by (used in) financing activities
(9,800)
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents, January 1, 20X1
Cash and cash equivalents, December 31, 20X1
(4,400)
14,300
$9,900
Supplemental disclosures:
Cash paid in 20X1 for interest
Cash paid in 20X1 for income taxes
$5,300
12,300
22
Preparing the SCF Using the Indirect Method. Businesses prepare their balance sheets and income
statements directly from trial balance listings of general ledger accounts and their corresponding balances, as
summarized above and examined in detail in your financial accounting principles course. In contrast,
businesses prepare their SCFs using, in large part, information obtained from these other statements, rather
than directly from the underlying accounting records (such as trial balances and the general ledger). The
reason for this difference in financial statement preparation methodologies is that businesses maintain their
accounting records using the accrual method of accounting, rather than the cash method. (This background
paper reviewed accrual basis accounting, above.) Although the general ledger – maintained using the accrual
method – facilitates preparation of the balance sheet and income statement, it does not directly enable
preparation of the SCF.
In order to prepare the SCF for the current accounting period, accountants begin by gathering:
Balance sheets of the business as of the end of the current period and as of the beginning of the current
period (i.e., the end of the previous period). The accountant will analyze:
— Significant changes in all non-working capital asset accounts (such as PP&E) and all non-working
capital liability accounts (such as bonds payable), and
— Changes in each stockholders’ equity account, such as common stock and retained earnings.
Income statements of the business for the current period. The accountant will identify:
— Non-cash charges against and credits to income during the period
Non-cash charges include, for example, depreciation of PP&E, amortization of certain recognized
intangible assets, and losses on the write-downs of inventory and other long-lived assets such as
PP&E
Non-cash credits include the business’ share of earnings in certain investee companies to the
extent the investee has not distributed those earnings to the business as dividends
— Any gains or losses that relate to investing or financing activities, such as sales of PP&E or investment
securities
Selected transaction data from the business’s general ledger. For this purpose, the accountant obtains
information relating to particular types of operating, investing, and financing transactions.
When complete, the SCF must explain the net change during the period in total cash and cash equivalents.
Accountants readily determine this net change by computing the net increase or decrease in this element from
the balance sheets of the business as of the end of the current period and as of the beginning of the current
period (i.e., the end of the previous period).
After gathering the required information, the accountant must determine whether the business will present OCF
in the SCF using the direct (operating statement) method or the indirect (reconciliation) method. U.S.
GAAP permits businesses to choose either type of presentation. A significant majority of public companies use
the indirect method because it is easier and less costly to implement than the direct method. In any event,
U.S. GAAP requires that businesses selecting the direct method also provide a supplemental schedule that
provides the same information that the indirect method provides. Many analysts prefer the indirect method
because it facilitates their evaluation of a business’ earnings quality. In this course, use the indirect method in
all assignments or other course activities.
Supplemental Cash Flow Disclosures. U.S. GAAP requires that businesses choosing the indirect method of
presentation of OCF in their SCF also disclose the amounts of cash paid for interest and cash paid for income
taxes during the reported period. (This is information that businesses adopting the direct method report
directly in the OCF section of the SCF.)
23
Illustration of Methodology for Preparing SCF using Indirect Method
Using the illustrative consolidated balance sheets and income statement of FirstRate
Company and subsidiaries, presented above, an explanation of the methodology for
preparing the SCF of FirstRate for the fiscal year ended (FYE) December 31, 20X1, above,
follows:
A FirstRate accountant obtained the following transaction data – relating to the company’s operating,
investing, and financing activities – from FirstRate’s general ledger, general journal, and other accounting
records for the fiscal year ended (FYE) December 31, 20X1:
— In March 20X1, FirstRate sold equipment with an original cost of $24,000,000 and accumulated
depreciation of $21,000,000 for proceeds of $2,100,000.
— FirstRate made no repayments during FY 20X1 under the bank note agreement.
— On September 1, 20X1, FirstRate repurchased 137,500 shares of its outstanding common stock for net
cost of $8 per share.
— In January 20X1, FirstRate paid dividends totaling $13,200,000 on its common stock that its board
declared in December 20X0. On December 1, 20X1, FirstRate declared dividends on its common stock
totaling $12,000,000 and paid them on January 15, 20X2 to stockholders of record on January 1, 20X2.
— In July 20X1, FirstRate declared and paid the regular annual dividend on its 6% preferred stock.
FirstRate’s accountant prepared the following schedule using the company’s end-of-year balance sheet
and beginning-of-year (end-of-prior-year) balance sheet to identify its working capital assets, working
capital liabilities, and the changes in each of these elements during FY 20X1. She used this information to
help prepare the OCF section of the SCF under the indirect (reconciliation) method:
(U.S. dollars in thousands)
December 31,
Working capital assets:
20X1
20X0
Increase (decrease)
Accounts receivable, net allowance
$43,300
$41,300
$2,000 Use of cash
Inventory, at lower of cost or market
91,000
86,600
4,400 Use of cash
45,000
42,800
2,200 Source of cash
Accrued income taxes payable
3,000
3,300
Accrued interest payable
1,300
1,200
100 Source of cash
$85,000
$80,600
$4,400 Net use of cash
Working capital liabilities:
Accounts payable
Net working capital
(300) Use of cash
With regard to the increases or decreases in working capital assets and liabilities in the table above, recall
the following concepts from your financial accounting principles course:
— Working capital assets. An increase in working capital assets represents a use of cash. A decrease in
working capital assets represents a source of cash. Stated differently, increases in working capital
assets require the use of cash to finance (fund) such increases, while decreases in working capital
assets provide (“free up”) cash for other purposes.
— Working capital liabilities. An increase in working capital liabilities represents a source of cash. A
decrease in working capital liabilities represents a use of cash. Stated differently, increases in working
capital liabilities provide (“free up”) cash for other purposes, while decreases in working capital liabilities
require the use of cash to liquidate (settle) the related liabilities.
24
FirstRate’s accountant identified a non-cash charge recorded during FY 20X1 for depreciation of PP&E
totaling $10,500,000, as determined below.
FirstRate’s accountant also identified the $900,000 loss on the sale of equipment, a category of PP&E.
(The sale of PP&E is an investing activity.) The complete journal entry included: debit cash (proceeds of
sale), $2,100,000; debit loss on sale of equipment, $900,000; debit accumulated depreciation of
equipment, $21,000,000; and credit equipment (original cost), $24,000,000
FirstRate’s accountant analyzed the changes during FY20X1 in the following balance sheet elements:
— Non-working capital asset accounts,
— Non-working capital liability accounts, and
— Stockholders’ equity accounts
using the company’s end-of-year balance sheet, beginning-of-year (end-of-prior-year) balance sheet, and
the transaction data above:
(U.S. dollars in thousands)
Non-working capital asset accounts
Property, plant, and equipment (PP&E), at cost
Balance at beginning of period, reported in December 31, 20X0 balance sheet
$206,000
Increase: Acquisitions of PP&E during 20X1 (inferred, or “plugged,” from remaining info)
27,600
Decrease: Original cost of equipment sold in March 20X1
(24,000)
Balance at end of period, reported in December 31, 20X1 balance sheet
$209,600
Accumulated depreciation (of PP&E)
Balance at beginning of period, reported in December 31, 20X0 balance sheet
$105,300
Increase: Depreciation of PP&E for 20X1 (inferred, or “plugged,” from remaining info)
10,500
Decrease: Accumulated depreciation on equipment sold in March 20X1
(21,000)
Balance at end of period, reported in December 31, 20X1 balance sheet
$94,800
Non-working capital liability accounts
Dividends payable on common stock
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: Dividends declared on common stock on December 1, 20X1
$13,200
12,000
Decrease: Dividends paid during FYE December 31, 20X1
(13,200)
Balance at end of period, reported in December 31, 20X1 balance sheet
$12,000
— Dividends relate to financing, not operating, activities, even though the company properly classified
the dividend payable as a current liability in its balance sheet.
— Recall from your financial accounting principles course that companies record a liability for
dividends (credit to dividends payable) at the time they declare them, recording an accompanying
reduction in (i.e., debit to) retained earnings. Dividends become a legal obligation upon their
declaration by a company’s board of directors. When they subsequently pay dividends, companies
record a reduction of (debit to) dividends payable, with an offsetting reduction of (credit to) cash.
25
(U.S. dollars in thousands)
Non-working capital liability accounts (continued)
Current
portion
Non-current
portion
Bank note payable
Balance at beg. of period, reported in Dec. 31, 20X0 balance sheet
$56,200
$18,700
Increase: Additional borrowings during 20X1 (inferred, or “plugged,” from remaining info)
Decrease: None (FirstRate made no repayments during 20X1)
Balance at end of period, reported in Dec. 31, 20X1 balance sheet
$60,500
$20,100
Total
$74,900
5,700
–
$80,600
Bank notes payable (and any other borrowings) relate entirely to financing, not operating, activities,
even though the company properly classified a portion of the note as a current liability.
Stockholders’ equity accounts
Preferred stock, par value $100 per share
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: None
Decrease: None
Balance at end of period, reported in December 31, 20X1 balance sheet
$20,000
–
–
$20,000
Common stock, par value $1 per share
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: None (no new shares issued during 20X1)
Decrease: None (inferred, or “plugged,” from remaining info)
Balance at end of period, reported in December 31, 20X1 balance sheet
$42,700
–
–
$42,700
Additional paid-in capital (APIC)
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: None (no new shares issued in 20X1)
Decrease: None (inferred, or “plugged,” from remaining info)
Balance at end of period, reported in December 31, 20X1 balance sheet
$8,300
–
–
$8,300
Treasury stock
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: 137,500 outstanding shares repurchased by company in 20X1 for $8 per share
Decrease: None (inferred, or “plugged,” from remaining info)
Balance at end of period, reported in December 31, 20X1 balance sheet
$– .
1,100
–
$1,100
Retained earnings
Balance at beginning of period, reported in December 31, 20X0 balance sheet
Increase: Net income for FY 20X1, as reported in the income statement
Decrease: Common stock dividends declared (refer to analysis of dividends payable, above)
Decrease: Preferred stock dividends declared in 20X1
Balance at end of period, reported in December 31, 20X1 balance sheet
$56,900
23,900
(12,000)
(1,200)
$67,600
26
Note that the completed SCF explains the net decrease of $4,400,000 in the balance of
cash and cash equivalents during the FY 20X1 from $14,300,000 in the December 31,
20X0 balance sheet to $9,900,000 in the December 31, 20X1 balance sheet.
Determining Supplemental Disclosure of Interest and Income Taxes Paid during Reported Period. By
analyzing the changes in accrued interest payable and accrued income taxes payable, as reported in the
balance sheets, FirstRate’s accountant determined the amounts of interest paid and income taxes paid by
the company during the FYE December 31, 20X1:
(U.S. dollars in thousands)
Accrued interest payable
Balance at beginning of period, reported in December 31, 20X0 balance sheet
$ 1,200
Increase: Interest on bank note, as reported in the income statement
5,400
Decrease: Interest paid during 20X1 (inferred, or “plugged,” from remaining info)
(5,300)
Balance at end of period, reported in December 31, 20X1 balance sheet
$ 1,300
Accrued income taxes payable
Balance at beginning of period, reported in December 31, 20X0 balance sheet
$3,300
Increase: Income tax provision (i.e., income tax expense) reported in the income statement:
Taxes on income from continuing operations
$13,500
Tax benefit related to loss from discontinued operations
($1,000)
Tax benefit related to extraordinary loss
($500)
12,000
Decrease: Income taxes paid during 20X1 (inferred, or “plugged,” from remaining info)
(12,300)
Balance at end of period, reported in December 31, 20X1 balance sheet
$3,000
27
Supplemental Disclosure of Non-cash Investing and Financing Activities. U.S. GAAP requires that
businesses (using either the direct or the indirect method of presenting OCF) provide information about
significant non-cash investing and financing activities during the reported period. Businesses may present
these supplemental disclosures either in the footnotes to the financial statements (discussed further below) or
immediately below the SCF, as illustrated below.
Global Corp. and subsidiaries
Consolidated Statement of Cash Flows
Fiscal year ended December 31, 20X9
(U.S. dollars in thousands)
Net income
$52,000
Adjustments to reconcile net income to cash flows provided by operating activities:
Depreciation of property, plant, and equipment
:
19,500
:
Net cash provided by (used in) financing activities
94,200
Net increase in cash and cash equivalents
Cash and cash equivalents, January 1, 20X9
8,200
12,500
Cash and cash equivalents, December 31, 20X9
$20,700
Supplemental cash flow information:
Cash paid during 20X9 for interest
$15,100
Cash paid during 20X9 for income taxes
19,900
Significant non-cash investing and financing activities:
Acquisition of equipment under capital lease
Conversion of preferred stock to common stock
$115,000
34,900
Distribution of stock dividend to common stockholders
Exchange of equipment (non-cash portion of transaction)
1,100
22,600
Refinancing of bank note agreement
40,000
28
Statement of Changes in Stockholders’ Equity
The statement of changes in stockholders’ equity analyzes the change during a specified period (most often for
the fiscal year of a business) in each of the financial statement elements comprising a company’s total
stockholders’ equity. This background paper discusses these financial statement elements, above, in
connection with its examination of the balance sheet. In addition, as noted above, public companies must
include in the financial statements contained in their annual reports on Form 10-K, statements of changes in
stockholders’ equity for their three most recently completed fiscal years, presented in comparative form for all
such years.
Recall, too, the basic accounting equation: ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY, where stockholders’
equity is comprised of:
—
—
—
—
—
—
Preferred stock, if any
Common stock
Additional paid-in capital on preferred or common stock (APIC)
Accumulated other comprehensive income (AOCI)
Retained earnings, and
Reduced by the balance of any treasury stock
Retained earnings represents the cumulative net income of the company, reduced by cumulative cash (or
stock) dividends paid or declared on common and preferred stock.
The following graphic illustrates the form of the statement of changes in stockholders’ equity.
Critically, a business’ statement of changes in stockholders’ equity contains clear headings that include:
The identity of the reporting entity
A proper title, and
The period of activity that the statement reports
FirstRate Company and subsidiaries
Statement of Changes in Stockholders’ Equity
For the year ended December 31, 20X1
(U.S. dollars in thousands)
Preferred
stock
Balance at January 1, 20X1
$20,000
Common
stock
$42,700
Additional
paid-in
capital
$8,300
Common stock repurchased
Treasury
stock
–
Accum. other
comprehensive
income
$800
Retained
earnings
$56,900
(1,100)
Total
stockholders’
equity
$128,700
(1,100)
Net income
23,900
23,900
Dividends on preferred stock
(1,200)
(1,200)
Dividends on common stock
(12,000)
(12,000)
$67,600
$137,300
Other comprehensive income
Balance at December 31, 20X1
(1,000)
$20,000
$42,700
$8,300
$(1,100)
$(200)
29
Footnote Disclosures
U.S. GAAP and regulations of the SEC require that companies provide additional information in their financial
statements about the elements reported in their balance sheets and income statements sufficient to permit
users to understand and evaluate the company’s financial condition and performance. A company may
provide this information parenthetically on the face of balance sheet or (more commonly) in footnotes,
whichever is more effective. Such disclosures include, for example:
A summary of the significant accounting policies of a business (the so-called “SOSAP footnote”) that
describes, among other accounting policies, a business’:
— Policy for recognizing sales revenue
— Choice of depreciation methods for PP&E (straight-line or an “accelerated” method), and
— Inventory cost flow assumption (“LIFO,” “FIFO,” or another method) adopted
Information about borrowings under bank note or mortgage agreements, bond indentures, or capital
leases, including key terms and conditions, such as financial covenants
Components of financial statement elements – assets, liabilities, revenues, and expenses – for example:
— PP&E, such as land, buildings, equipment, vehicles, etc., and
— Inventory, such as finished goods, work-in-process, raw materials, and supplies
Nature and terms of purchased or licensed intangible assets, such as patents and royalty agreements
Descriptions of items not meeting the definition of liabilities and consequently not reported (recognized) in
the business’ balance sheet, but relevant to financial statement users, including:
— Unrecognized commitments, such as
Long-term, fixed-price vendor supply agreements, and
Operating leases
— Unrecognized contingencies, such as
Pending litigation, and
Tax disputes with governmental authorities
This background paper provides definitions of financial statement elements, below.
The cost of investment securities classified “available for sale” and reported at their fair value in the
balance sheet
Descriptions of significant events affecting the business that occurred subsequent to the date of the
financial statements, but before the business issued the financial statements, such as a material business
acquisition, plant destruction from an environmental disaster, or refinancing of significant borrowings –
each occurring after the reported fiscal year-end of the business
The nature and extent of concentrations of credit risk represented in accounts receivable, such as
significant amounts of receivables due from customers operating in the same industry or geographic region
and consequently subject to common economic variables, like recession
This background paper examines the full disclosure principle further below.
30
Financial Statement Articulation
Your financial accounting principles courses explained the links between the balance sheet,
income statement, SCF, and statement of changes in stockholders’ equity – that is, how the
statements articulate with each other. The principal concept underlying financial statement
articulation is “clean surplus,” readily explained below by examining a portion of the previous
illustrative statement of changes in stockholders’ equity:
FirstRate Company and subsidiaries
Statement of Changes in Stockholders’ Equity
For the year ended December 31, 20X1
(U.S. dollars in thousands)
Preferred
stock
Balance at January 1, 20X1
$20,000
Common
stock
$42,700
Additional
paid-in
capital
Treasury
stock
–
$8,300
Common stock repurchased
Accum. other
comprehensive
income
$800
Retained
earnings
$56,900
(1,100)
Total
stockholders’
equity
$128,700
(1,100)
Net income
23,900
23,900
Dividends on preferred stock
(1,200)
(1,200)
Dividends on common stock
(12,000)
(12,000)
$67,600
$137,300
Other comprehensive income
Balance at December 31, 20X1
(1,000)
$20,000
$42,700
$8,300
$(1,100)
$(200)
In the absence of dividends, net income for a period, as reported in the company’s income statement, explains
the change in retained earnings from the beginning-of-period balance sheet to the end-of-period ...
Purchase answer to see full
attachment