Presentation on theme: "FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION."— Presentation transcript:
1 FINANCIAL ACCOUNTING RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY THEORY AND ANALYSIS: TEXT AND CASES 11 TH EDITION
2 CHAPTER 7 FINANCIAL STATEMENTS II: Balance Sheet Statement of Cash Flows
3 Introduction Financial reports can be divided into two categories 1. Results of the flows of resources over time (flows) Statement of Retained Earnings 2. The status of resources at a point in time (stocks) Balance Sheet Income Statement Statement of Cash Flows
4 Past Emphasis Income statement Based on the assumption that flows were more important than stocks Frequently resulted in the measurement of stocks at residual values
5 FASB Asset - Liability approach Changes in balance sheet amounts becoming more important in income determination
6 In this chapter Balance sheet and the associated measurement techniques for its elements Statement of cash flows and its evolution over time Balance Sheet Statement of Cash Flows
7 The Balance Sheet Should disclose wealth of a company at a point in time Wealth is present value of all Resources Obligations
8 The Balance Sheet This measurement technique is limited Consequently, a variety of measurement techniques are used to measure the elements of the balance sheet Historical (Historical cost) Current oriented (Current value) Future oriented (Expected realizable value)
9 Balance Sheet Elements The elements of the balance sheet were defined in SFAC No. 6 as: Assets Liabilities Equity Definitions arise from the FASB’s asset - liability approach to income determination Departure from previous definitions that resulted in valuations arrived at via the residual effect of income determination
10 Components of the Balance Sheet Assets Current assets Investments Property, plant, and equipment Intangible assets Other assets Liabilities Current liabilities Long-term debt Other liabilities Stockholder’s Equity Capital stock Additional paid-in capital Retained earnings
11 Asset Valuation Asset Cash Accounts receivable Marketable securities Inventory Investments Prepaid items Property, plant and equipment Measurement basis Current value Expected future value Fair value Current or past value Fair value, amortized cost, or equity method Historical cost Depreciated past value
12 Liabilities and Their Associated Measurement Techniques Liability Current Liabilities Long-term & Other Liabilities Measurement Liquidation Value Liquidation Value or Present Value Do measurement techniques bias statements in favor of current investors?
13 Stockholders’ Equity Accounts and Their Associated Measurement Techniques Account Common Stock Preferred Stock Retained Earnings & Other Comprehensive Income Measurement basis Historical Cost (Par Value vs Selling Price) Historical Cost Dependent upon income Recognition
14 Fair Value Measurements under SFAS No. 157 (Now FASB ASC 820) New definition for fair value Fair value Hierarchy for sources of information New disclosures of assets and liabilities Modification of presumption of transaction price
15 Illustration of Tabular Disclosures for Assets Remeasured on a Nonrecurring Basis ($ in millions)Fair Value Measurements Using DescriptionYear Ended 12/31/XX Quoted Prices in Active Markets for Inputs Identical 1 Assets (Level 1) Significant Other Observable (Level 2) Significant Unobservable Inputs (Level 3) Total Gains (Losses) Long-lived assets held and used$75 $(25) Goodwill30$30(35) Long-lived assets held for sale26 (15) $(75)
16 Modification of Transaction Price Presumption SFAS No 157 did away with presumption Entities should consider whether certain factors might indicate that transaction price does not represent fair value
17 FASB Staff Position FAS No. 157-4 Some critics of SFAS No.157 maintained that it caused or exacerbated the 2007–2008 market crises by forcing a downward spiral of valuations based on distressed institutions. They also raised concerns that as a result of SFAS No. 157 and SFAS No. 115 financial institutions were forced to book losses on securities that may have value after the credit market crisis has passed. However, proponents of the standard maintained that suspending or revising SFAS No. 157 would be a disservice
18 FASB Staff Position FAS No. 157-4 As a result of these differing viewpoints, financial institutions, accounting groups, and others requested guidance from the SEC and the FASB on how to determine fair value measurements in the then-current economic climate. On December 30, 2008, the SEC issued a study on fair value accounting. This study recommended that existing fair value accounting and mark-to-market standards, including SFAS No. 157, should not be suspended. Later, after some contentious hearings in Congress, where the FASB’s standard-setting authority was threatened by some of its members, the FASB amended SFAS No. 157 by issuing FASB Staff Position (FSP). FAS 157-4 (see FASB ASC 820-10-65).
19 FASB Staff Position FAS No. 157-4 FSP FAS 157-4 provided guidance on how to determine when the volume and level of activity for an asset or liability has significantly decreased and identified the circ*mstances in which a transaction is not orderly. Subsequently, after considering the significance and relevance of each of the factors, judgment should be used to determine whether the market is active and if a significant adjustment to the transactions or quoted prices may be necessary to estimate fair value.
20 FASB Staff Position FAS No. 157-4 Although proponents and opponents of the amendment differed on the economic consequences of its adoption, both expected it to have a major impact. The expectation was that it would result in the revaluation upward of troubled assets, especially mortgage-based securities, by lowering their fair value hierarchy measurements from Level 2 to Level 3 and that bank profits might increase by as much as 20 percent. However, as noted earlier in Chapter 1, a subsequent study of the impact of the adoption of FSP FAS 157-4 on seventy-three of the largest banks in the United States found that a large majority of the banks reported that adoption of the new requirements had no material impact
21 Proposed Format of Statement of Financial Position FASB-IASB Project (Phase B) Groups assets and liabilities together Operating Investing Financing Provides separate section for stockholders’ equity Assets & Liabilities Operating Investing Financing Stockholders’ Equity
22 Evaluating A Company’s Financial Position Return on Assets Net income Average total assets Profit margin Net income Net sales Asset turnover ratio Net sales Average total assets
23 Hershey 20112010 $628,962 ($4,412,199 + 4,272,732)/2 =14.48% $509,799 ($4,272,732 + 3,675,031)/2 =12.83% Hershey & Tootsie Roll Return on Assets Tootsie Roll 20112010 $43,938 ($857,856 + 857,959)/2 =5.12% $53,063 ($857,959 + 838,247)/2 =6.26%
24 Hershey and Tootsie: Return on Assets
25 Hershey & Tootsie Roll Other Ratios 2011 Hershey Tootsie Roll Profit margin 11.25% 8.33% Asset turnover 1.40 0.62
26 Evolution of the Statement of Cash Flows Prior to 1971 Only two required financial statements Firms were preparing funds statements No guidelines - Methods of preparing statement: 1 Cash 2 Working capital 3 All financial resources APB No. 3 - recommended APB No. 19 - mandatory - all financial resources
27 APB Opinions 3 and 19 Designed to answer the following questions 1 Where did the profits go? 2 Why weren’t dividends larger? 3 How was it possible to distribute dividends in the presence of a loss? 4 Why are current assets down when there was a profit? 5 Why is extra financing required? 6 How was the expansion financed? 7 Where did the funds from the sale of securities go? 8 How was the debt retirement accomplished? 9 How was the increase in working capital financed?
28 Cash Flow Information Should enable financial statement users to Predict the amount of cash that is likely to be distributed as dividends or interest Evaluate risk Presentation of cash flow information assists in evaluating Liquidity Nearness to cash Solvency Going concern Financial flexibility React to crisis
29 Historical Perspective Discussion memorandum “Reporting Funds Flows, Liquidity, and Financial Flexibility” Preceded the issuance of SFAS No. 95 Questions raised in this DM included: 1. Which concept of funds should be adopted? 2. How should transactions not having a direct impact on funds be reported? 3. Which of the various approaches should be used for presenting funds flow information? 4. How should information about funds flow from operations be presented? 5. Should funds flow information be separated into outflows for (a) Maintenance (b) Expansion of operating capacity, and (c) Nonoperating purposes
30 Historical Perspective Exposure Draft “Reporting Income, Cash Flows and Financial Position of Business Enterprises” SFAC No. 5 “Recognition and Measurement in Financial Statements of Business Enterprises”
31 Purpose of the Statement of Cash Flows Objectives of accounting originally discussed in SFAC No’s. 1 and 5 led to conclusion Statement of cash flows should replace the previously required statement of changes in financial position Provide relevant information about cash receipts and cash payments of an enterprise
32 Statement Format Report changes during an accounting period in cash and cash equivalents for Net cash flows from operations Investing transactions Financing transactions Fiscal 2011: Hershey had a net decrease in cash of $190,956,000 Tootsie Roll had a net decrease in cash of $37,364,000
33 Cash Flows From Operating Activities Cash effect from transactions that enter into the determination of net income exclusive of financing and investing activities Direct vs Indirect method SFAS No. 95 Encouraged companies to report operating activities in major classes Hershey vs Tootsie Roll 2011 Hershey $580,867,000 Tootsie $50,390,000
34 Cash Flows From Investing Activities Making and collecting loans Acquiring and disposing of debt or equity securities of other companies Acquiring and disposing of property, plant, and equipment and other productive resources Hershey vs Tootsie Roll 2011 Hershey ($333,005,000) Tootsie Roll ($51,157,000)
35 Cash Flows From Financing Activities Obtaining resources from owners Providing owners with a return of and a return on their investment Borrowing money and repaying the amount borrowed Obtaining and paying for other resources from long-term creditors Hershey vs Tootsie Roll 2011 Hershey ($438,818,000) Tootsie ($36,597,000) Results from…
36 Proposed Statement of Cash Flows Proposed Format of Statement of Cash Flows Phase B of FASB-IASB Presentation Project Expanded version of direct method Additional disclosures for each category New schedule, in notes, to reconcile cash flows to operating income
37 Proposed Statement of Cash Flows Proposed Format of Statement of Cash Flows Categories: Business Operating Investing Financing Income Taxes Discontinued Operations Equity
38 Financial Analysis of Cash Flow Information A major objective of accounting To provide data allowing the presentation of cash flows to investors and creditors To allow evaluation of risk Net income is not directly associated with cash Investors expect return equal to market rate of interest for investments with equal risk discounted future cash flows > investment
39 Uses of Cash Flow Information Past cash flows are the best indicators of future cash flows Empirical research indicates cash flow information Has an incremental value over earnings And is superior to disclosure of changes in working capital
40 Uses of Cash Flow Information Net cash provided (used) from operating activities - Net cash used in acquiring PP&E Free Cash Flow Indicator of a company’s ability to pay off debt & maintain growth.
41 Free Cash Flows Hershey remained positive but metric deteriorated Tootsie Roll was also positive in both years but deteriorated from 2010 to 2011 HersheyTootsie Roll 2010201120102011 $721,855$256,906$69,492$34,039 (in thousands)
42 International Accounting Standards The IASB has discussed: 1 The statement of financial position and the various measurement bases used in accounting Defined assets, liabilities and equity in “Framework for the Preparation and Presentation of Financial Statements” 2 The information to be disclosed on the balance sheet and statement of cash flows in a revised IAS No. 1 3 The presentation of the statement of cash flows in IAS No. 7, “Cash Flow Statements” 3 Discussed the presentation of fair value measurements in IFRS No. 13, “Fair Value Measurement”
43 Preparation and Presentation of Financial Statements Economic decisions made by users require an evaluation of the ability of an enterprise to generate cash Financial position of an enterprise is affected by its Financial structure Liquidity and solvency Capacity to adapt to change (financial flexibility) Measurement bases include Historical cost (most common) Current cost Realizable value Present value Definitions of assets, liabilities and equity are similar to U. S. GAAP
44 IAS No. 1: Presentation of Financial Statements Recommends disclosures similar to U. S. GAAP Revised IAS No. 1 Requires assets to be classified as current and noncurrent Unless a liquidity presentation provides more relevant and reliable information Recognizes that there are differences in the nature and function of assets, liabilities, and equity So fundamental that they should be presented on the face of the balance sheet. Specifies specific categories of items to be disclosed
45 IAS No. 7 Operating, financing and investing activities are to be disclosed Indirect or direct method of disclosing operating activities may be used Stated a preference for the direct method. Cash flows from extraordinary items required to be disclosed separately as operating, investing or financing. Acquisition or disposal of subsidiaries Will significantly change presentation of statement of cash flows.
46 IFRS No. 13 Applies to IFRSs that require or permit fair value measurements or disclosures IFRS No. 13 achieves convergence with U. S. GAAP. Specifically, it: Defines fair value Provides framework for measuring fair value Requires disclosures about fair value measurements Attempts to provide consistency and comparability in fair value measurements and related disclosures.
47 IFRS No. 13: Fair Value Hierarchy Level 1 inputs Quoted prices in active markets for identical assets or liabilities Level 2 inputs Inputs other than quoted market prices that are observable for the assets or liability Level 3 inputs Unobservable inputs for the asset or liability Level 3 Level 2 Level 1
48 Copyright © 2014 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back- up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. Prepared by Kathryn Yarbrough, MBA End of Chapter 7
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