The Balance Sheet-Liabilities and Shareholders’ Equity

Assets = Liabilities + Stockholders’ equity The Balance Sheet Also called the statement of condition or statement of financial position Financial Condition Assets = What the firm owns Liabilities = What the firm owes to outsiders Stockholders’ equity = What the firm owes to Internal owners (C) 2007 Prentice Hall, Inc.

Liabilities • obligations of an entity to make a future payment or to deliver goods or services to the third parties in the future in return for cash borrowed or service used or goods acquired • Classified according to their due dates • due within one year or the operating cycle are classified as current liabilities • loans or credits that mature in more than one year are classified as long-term liabilities (C) 2007 Prentice Hall, Inc.

Liabilities (cont.) Trade Payables • Short-term obligations that arise from credit extended by suppliers for the purchase of goods and services • Account is eliminated when the bill is satisfied • Significant changes from period to period often result from changes in sales volume, economic conditions or credit policies available to firm from its suppliers Trade Payables • Accounts Payable • Notes Payable (C) 2007 Prentice Hall, Inc.

Liabilities (cont.) When a firm has bonds, mortgages, or other forms of long-term debt outstanding, the portion of the principal that will be repaid during the upcoming year is classified as a current liability Current Maturities of Long-Term Debt (C) 2007 Prentice Hall, Inc.

Liabilities (cont.) • Result from recognition of expenses before they are actually paid • Under accrual accounting, expenses are recognized when INCURRED and thus ACCRUED, not when paid in cash • In this case, cash flow succeeds expense recognition Accrued Liabilities (C) 2007 Prentice Hall, Inc.

Liabilities (cont.) Unearned Revenue or Deferred Credits • Result from prepayments received in advance for services or products • Under accrual accounting, revenue is recognized when EARNED, not when cash is received • In this case, cash flow precedes revenue recognition (C) 2007 Prentice Hall, Inc.

Noncurrent Liabilities Obligations with maturities beyond one year • Long-Term Debt (Financial Liabilities) • Post-retirement Benefits Other Than Pensions • Provisions • Commitments and Contingencies • Hybrid Securities (C) 2007 Prentice Hall, Inc.

Provisions and Contingent Liabilities • a potential liability arising from a past transaction and that depends on a future event • could be disclosed in the body of the balance sheet with the liabilities • could be disclosed within notes to financial statements • certainty of the amount and the payment date determines where they will be disclosed (C) 2007 Prentice Hall, Inc.

Is the amount of the liability known? YES NO YES Can the amount of Liability be reasonably Estimated? YES Is the liability likely to occur? (Probable) NO NO Recognize liability on the balance sheet Disclose in the notes To the financial Statements (CONTINGENT LIABILITY) (C) 2007 Prentice Hall, Inc.

Product Warranty Liabilities • When goods and services are sold under warranty coverage • A good example of provision • matching principle - warranty expenses of sales in a period should be recorded in the same period • Subsequent expenditures of warranties are charged against warranty liability (C) 2007 Prentice Hall, Inc.

Noncurrent Liabilities (cont.) • Can appear under the liability section of the balance sheet • Can have a significant impact on corporate balance sheets • Can also impact profitability by substantially increasing the recognition of annual postretirement benefit expense Post-retirement benefits (C) 2007 Prentice Hall, Inc.

Noncurrent Liabilities (cont.) Refer to contractual agreements that will have a significant financial impact on the company in the future For example: An operating lease is a common type of commitment and is a form of off-balance-sheet financing Commitments (C) 2007 Prentice Hall, Inc.

Noncurrent Liabilities (cont.) Have the characteristics of both debt and equity Some companies have mandatorily redeemable preferred stock outstanding Hybrid Securities For example: (C) 2007 Prentice Hall, Inc.

Stockholders’ Equity (cont.) Shareholders: Do not ordinarily receive a fixed return Have voting privileges in proportion to ownership interest Dividends are declared at the discretion of a company’s board of directors Common Stock (C) 2007 Prentice Hall, Inc.

Stockholders’ Equity (cont.) Is the sum of every dollar a company has earned since its inception, less any payments made to shareholders in the form of cash or stock dividends Beginning retained earnings ± Net income (loss) – Dividends = Ending retained earnings Retained Earnings (C) 2007 Prentice Hall, Inc.

Stockholders’ Equity (cont.) Other accounts that can appear in the equity section include: Preferred stock Accumulated other comprehensive income Treasury stock Revaluation Fund Other Equity Accounts (C) 2007 Prentice Hall, Inc.

Nonowner changes to equityOther comprehensive income (GAAP) • Adjustments to fair value for available-for-sale securities • Foreign currency translation adjustment • Gains/losses on cash flow hedge derivatives • Gains/losses on investment hedge instruments • Adjustments related to underfunding a defined benefit pension plan (C) 2007 Prentice Hall, Inc.

Statement of Shareholders’ Equity • Provides details of changes in Equity • Stock • Other comprehensive income • Retained earnings • Includes beginning and ending balances in accounts (C) 2007 Prentice Hall, Inc.

The Balance Sheet-Liabilities and Shareholders’ Equity