Chapter 11 Presentation of Financial Statements Review Questions The statement of financial information provides information about the nature and amounts of investments in enterprise resources, obligations to enterprise creditors, and the owners’ equity in net enterprise resources That information not only complements information about the components of income, but also contributes to financial reporting by providing a basis for (1) computing rates of return, (2) evaluating the capital structure of the enterprise, and (3) assessing the liquidity and financial flexibility of the enterprise Liquidity describes the amount of time that is expected to elapse until an asset is converted into cash or until a liability has to be paid The ranking of the assets given in order of liquidity is: (1) (2) (3) (4) (5) (d) (e) (b) (c) (a) Short-term investments Accounts receivable Inventories Buildings Goodwill (1) The values stated are generally historical and not current (2) Estimates have to be used in many instances, such as in the determination of collectibility of receivables or finding the approximate useful life of long-term tangible and intangible assets (3) Many items, even though they have financial value to the business, presently are not recorded One example is the value of a company’s human resources Classification in financial statements helps users by grouping items with similar characteristics and separating items with different characteristics Current assets are expected to be converted to cash within one year or one operating cycle, while property, plant and equipment, will provide cash inflows over a longer period of time Thus, separating long-term assets from current assets facilitates computation of useful ratios such as the current ratio 2 Chapter 11 Separate amounts should be reported for accounts receivable and notes receivable The amounts should be reported gross, and an amount for the allowance for doubtful accounts should be deducted The amount and nature of any nontrade receivables, and any amounts pledged or discounted, should be clearly stated Working capital is the excess of total current assets over total current liabilities This excess is sometimes called net working capital, with current assets and current liabilities being the components of working capital Current assets and current liabilities consist of items that will be converted into cash or paid within a year or the operating cycle, whichever is longer The working capital components are the financial resources utilized by an enterprise in its operating cycle (a) Equity “Share Capital ( shares) reacquired and held in treasury—at cost.” Note: This is a reduction of equity (b) Current Assets Included in “Cash.” (c) Investments “Land held as an investment.” (d) Equity “Appropriation for bonded redemption” or “Appropriation for sinking fund.” (e) Long-term debt (adjunct account to bonds payable) “Unamortized premium on bonds payable.” (f) Intangible Assets “Copyrights.” (g) Investments “Employees’ pension fund,” with subcaptions of “Cash” and “Securities” if desired (Assumes that the company still owns these assets.) (h) Equity “Premium on share capital” or “Additional paid-in capital in excess of par value.” (i) Investments Nature of investments should be given together with parenthetical information as follows: “pledged to secure loans payable to banks.” (a) Allowance for doubtful accounts receivable should be deducted from accounts receivable (b) Merchandise held on consignment should not appear on the consignee’s balance sheet except possibly as a note to the financial statements (c) Advances received on sales contract are normally a current liability and should be shown as such in the balance sheet (d) Cash surrender value of life insurance should be shown as a long-term investment Presentation of Financial Statements (e) Land should be reported in property, plant, and equipment unless held for investment (f) Merchandise out on consignment should be shown among current assets under the heading of inventories (g) Pension fund on deposit with trustee should be shown among noncurrent assets under a separate heading or grouped with similar funds and deposits in investment section Note: Some pension funds are not reported on the balance sheet This situation occurs when the company funds the pension plan through another party such that the company loses control over the funds (h) Franchises should be itemized in a section for intangible assets (i) Accumulated depreciation of plant and equipment should be deducted from the plant and equipment accounts (j) Materials in transit should not be shown on the balance sheet of the buyer, if purchased f.o.b destination (a) Trade accounts receivable should be stated at their estimated realizable value The method most generally followed is to deduct from the total accounts receivable the amount of the allowance for doubtful accounts (b) Land is generally stated in the balance sheet at cost (c) Inventories are generally stated at the lower of cost or market to provide for any possible losses and to avoid the anticipation of profits not yet realized (d) Trading securities consisting of ordinary shares are generally stated at fair value (e) Prepaid expenses should be stated at cost less the amount apportioned to and written off over the previous accounting periods 10 The statement of comprehensive income is important because it provides investors and creditors with information that helps them predict the amount, timing, and uncertainty of future cash flows It helps investors and creditors predict future cash flows in a number of different ways First, investors and creditors can use the information on the statement of comprehensive income to evaluate the past performance of the enterprise Second, the statement of comprehensive income helps users of the financial statements to determine the risk (level of uncertainty) of income revenues, expenses, gains, and losses and highlights the relationship among these various components It should be emphasized that the statement of comprehensive income is used by parties other than investors and creditors For example, customers can use the statement of comprehensive income to determine a company’s ability to Chapter 11 provide needed goods or services, unions examine earnings closely as a basis for salary discussions, and the government uses the statements of comprehensive income of companies as a basis for formulating tax and economic policy 11 The major distinction between revenues and gains (or expenses and losses) depends on the typical activities of the enterprise Revenues can occur from a variety of different sources, but these sources constitute the entity’s ongoing major or central operations Gains also can arise from many different sources, but these sources occur from peripheral or incidental transactions of an entity The same type of distinction is made between an expense and a loss 12 Items that are considered prior period adjustments should be charged or credited to the opening balance of retained earnings Prior period adjustments would ordinarily be either corrections of errors made in a prior period discovered after issuance of financial statements for that period or retroactive adjustments required 13 Other comprehensive income must be displayed (reported) in one of three ways: (1) a second separate income statement, (2) a combined income statement of comprehensive income, or (3) as part (separate columns) of the statement of equity Exercises Exercise Current assets Cash Accounts receivable Less allowance for doubtful accounts Inventories Prepaid insurance Total current assets P27,000 P110,000 (8,000) 102,000 290,000 9,500 P428,500 Presentation of Financial Statements Exercise Current assets Cash Trading securities Accounts receivable Less allowance for doubtful accounts Inventory Prepaid insurance Total current assets P 7,000 11,000 P90,000 (4,000) 86,000 34,000 5,200 P143,200 Exercise Long-term investments Held-to-maturity securities Land held for investment Long-term receivables Total investments P 61,000 39,000 42,000 P142,000 Exercise Property, plant, and equipment Land Buildings Less accumulated depreciation Equipment Less accumulated depreciation Capital leases Total property, plant, and equipment P 61,000 P207,000 (45,000) P190,000 (19,000) 162,000 171,000 70,000 P464,000 Exercise Intangible assets Goodwill Patents Franchises Total intangibles P150,000 220,000 110,000 P480,000 Chapter 11 Exercise Current liabilities Accounts payable Accrued salaries Notes payable Income taxes payable Total current liabilities P72,000 4,000 12,500 7,000 P95,500 Exercise Current liabilities Accounts payable Advances from customers Wages payable Interest payable Income taxes payable Total current liabilities P240,000 41,000 27,000 12,000 29,000 P349,000 Exercise Equity Share capital - Ordinary Additional paid-in capital Retained earnings Accumulated other comprehensive loss Total equity P700,000 200,000 120,000 (150,000) P870,000 Exercise 9 10 h d f f c a f g a a 11 12 13 14 15 16 17 18 19 20 b f a h c b a a g f Presentation of Financial Statements Exercise 10 Michelle Inc Statement of Financial Position December 31, 20– Assets Current assets Cash Less cash restricted for plant expansion Accounts receivable Less allowance for doubtful accounts Notes receivable Receivables—officers Inventories Finished goods Work in process Raw materials Total current assets Long-term investments Preference share investments Land held for future plant site Cash restricted for plant expansion Total long-term investments Property, plant, and equipment Buildings Less accum depreciation— buildings Intangible assets Copyrights Total assets PXXX XXX XXX PXXX XXX XXX XXX XXX XXX XXX XXX XXX PXXX XXX XXX XXX XXX XXX XXX XXX XXX PXXX Chapter 11 Liabilities and Equity Current liabilities Accrued salaries payable Note payable Unearned subscriptions Unearned rent Total current liabilities PXXX XXX XXX XXX PXXX Long-term debt Bonds payable, due in four years Discount on bonds payable PXXX (XXX) Total liabilities Equity Share capital: Ordinary shares Additional paid-in capital: Premium on ordinary shares Total paid-in capital Retained earnings Total paid-in capital and retained earnings Less: Treasury shares, at cost Total equity Total liabilities and equity XX X XXX PXXX XXX XXX XXX XXX (XXX) XXX PXXX Exercise 11 Computation of net income Change in assets: Change in liabilities: Change in equity: P79,000 + P45,000 +P127,000 – P47,000 = P204,000 Increase P 82,000 – P51,000 = 31,000 Increase P173,000 Increase Presentation of Financial Statements Change in equity accounted for as follows: Net increase Increase in ordinary shares Increase in additional paid-in capital Decrease in retained earnings due to dividend declaration Net increase accounted for Increase in retained earnings due to net income P173,000 P125,000 13,000 (19,000) 119,000 P 54,000 Exercise 12 (a) Total net revenue: Sales Less: Sales discounts Sales returns Net sales Dividends revenue Rental revenue Total net revenue (b) Net income: Total net revenue (from a) Expenses: Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Income before taxes Income taxes Net income (c) Dividends declared: Ending retained earnings Beginning retained earnings P390,0000 P 78,000 124,000 202,000 3,698,000 710,000 65,000 P4,473,000 P4,473,000 1,844,000 994,000 825,000 127,000 3,790,000 683,000 310,000 P 373,000 P1340,000 1,144,000 10 Chapter 11 Net increase Less net income Dividends declared 196,000 (373,000) P 177,000 ALTERNATE SOLUTION Beginning retained earnings Add net income P1,144,000 373,000 1,517,000 ? P1,340,000 Deduct dividends declared Ending retained earnings Dividends declared must be P177,000 (P1,517,000 – P1,340,000) Exercise 13 (a) Multiple-Step Form W Brothers Corp Statement of Comprehensive Income For the Year Ended December 31, 2007 (In thousands, except earnings per share) Sales Cost of goods sold Gross profit Operating Expenses Selling expenses Sales commissions Depr of sales equipment Transportation-out Administrative expenses Officers’ salaries Depr of office furn and equip Income from operations Other Revenues and Gains Rental revenue P965,000 605,700 359,300 79,800 64,800 26,900 171,500 49,000 39,600 88,600 260,100 99,200 172,300 Presentation of Financial Statements 11 271,500 Other Expenses and Losses Interest expense 18,600 Income before taxes Income taxes Net income 252,900 90,700 P162,200 Earnings per share (P162,200  405,500) (b) P0.40 Single-Step Form W Brothers Corp Statement of Comprehensive Income For the Year Ended December 31, 2007 (In thousands, except earnings per share) Revenues Net sales Rental revenue Total revenues Expenses Cost of goods sold Selling expenses Administrative expenses Interest expense Total expenses Income before taxes Income taxes Net income Earnings per share (c) Single-step: Simplicity and conciseness Probably better understood by user P 965,000 172,300 1,137,300 605,700 171,500 88,600 18,600 884,400 252,900 90,700 P 162,200 P0.40 12 Chapter 11 Emphasis on total costs and expenses and net income Does not imply priority of one expense over another Multiple-step: Provides more information through segregation of operating and nonoperating items Expenses are matched with related revenue Note to instructor: Students’ answers will vary due to the nature of the question; i.e., it asks for an opinion However, the discussion supporting the answer should include the above points Exercise 14 CG Corporation Statement of Comprehensive Income For the Year Ended December 31, 2007 Sales Cost of goods sold Gross profit Selling and administrative expenses Net income P1,200,000 750,000 450,000 320,000 P 130,000 Net income Unrealized holding gain Comprehensive income P 130,000 18,000 P 148,000 Exercise 15 LS Co Statement of Changes in Equity For the Year Ended December 31, 2007 Beginning balance Comprehensive income Net income* Other comprehensive income Unrealized holding loss Comprehensive income Dividends Total P520,00 Comprehensive Income 120,000 P120,000 (60,000) (60,000) P 60,000 (10,000) Retained Earnings P 90,000 Accumulated Other Comprehensive Income P80,000 Ordinary Shares P350,000 120,000 (60,000) (10,000) _ Presentation of Financial Statements Ending balance P570,00 P200,000 P20,000 13 P350,000 *(P700,000 – P500,000 – P80,000) Test Material Test Material 11-1 Luntian Corporation Statement of Financial Position As of December 31, 2007 Assets Current assets Cash Accounts receivable Inventories Total current assets P175,900 170,000 312,100 P658,000 Long-term investments Assets allocated to trustee for expansion: Cash in bank BSP Treasury notes, at fair value Property, plant, and equipment Land Buildings Less accum depreciation— buildings P 70,000 138,000 750,000 P1,070,000 410,00 Total assets a 660,000 1,410,000 P2,276,000 Liabilities and Equity Current liabilities 208,000 14 Chapter 11 Notes payable—current installment Income taxes payable Total current liabilities P100,000 75,000 P 175,000 Presentation of Financial Statements Long-term liabilities Notes payable Total liabilities Equity Ordinary shares, no par; 1,000,000 shares authorized and issued; 950,000 shares outstanding Retained earnings Less treasury shares, at cost (50,000 shares of no par ordinary) Total equity Total liabilities and equity 15 500,000b 675,000 P1,150,000 538,000c 1,688,000 (87,000) 1,601,000 P2,276,000 a P1,640,000 – P570,000 (to eliminate the excess of appraisal value over cost from the building account Note that the appreciation capital account is also deleted.) b P600,000 – P100,000 (to reclassify the currently maturing portion of the note payable as a current liability.) c P658,000 – P120,000 (to remove the value of goodwill from retained earnings Apparently, retained earnings was credited, either directly or indirectly through the income summary, for the value of the goodwill since no separate equity account existed for goodwill Note that the goodwill account is also deleted.) Note: As an alternate presentation, the cash restricted for plant expansion would be added to the general cash account and then subtracted The amount reported in the investments section would not change 16 Chapter 11 Test Material 11-2 Makulay Corp Statement of Comprehensive Income For the Year Ended December 31, 2007 Sales Revenue Sales Less: Sales returns and allowances Sales discounts Net sales revenue Cost of goods sold Gross profit Operating Expenses Selling expenses Admin and general expenses Income from operations P1,380,000 P150,000 45,000 194,000 97,000 Other Revenues and Gains Interest revenue 291,000 273,000 86,000 359,000 Other Expenses and Losses Interest expense Income before taxes and extraordinary item Income taxes Income before extraordinary item Extraordinary item Loss from earthquake damage Less applicable tax reduction Net income 195,000 1,185,000 621,000 564,000 60,000 299,000 101,660 197,340 150,000 51,000 Per ordinary share: Income before extraordinary item (P197,340  100,000) Extraordinary item (net of tax) Net income (P98,340  100,000) 99,000 P 98,340 P1.97 (.99) P 98 Presentation of Financial Statements 17 Test Material 11-3 Bahag-Hari Corporation Equity December 31, 2007 Share capital Preference shares, P4 cumulative, par value P50 per share; authorized 60,000 shares, issued and outstanding 10,000 shares Ordinary shares, par value P1 per share; authorized 600,000 shares, issued 200,000 shares, and outstanding 190,000 shares Total share capital Additional paid-in capital— In excess of par value From sale of treasury shares Total paid-in capital Retained earnings Total paid-in capital and retained earnings Less treasury shares, 10,000 shares at cost Total equity P 500,000 200,000 700,000 1,300,000 160,000 2,160,000 301,000 2,461,000 170,000 P2,291,000 ... the past performance of the enterprise Second, the statement of comprehensive income helps users of the financial statements to determine the risk (level of uncertainty) of income revenues, expenses,... statement of comprehensive income is used by parties other than investors and creditors For example, customers can use the statement of comprehensive income to determine a company’s ability to Chapter. .. (reported) in one of three ways: (1) a second separate income statement, (2) a combined income statement of comprehensive income, or (3) as part (separate columns) of the statement of equity Exercises