Financial Modeling

Understanding Balance Sheet 127

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Components & Format of a Balance Sheet

Apple Inc. - Balance Sheet Year ended 26 September 2009 2008 Assets Current assets: Cash and cash equivalents Short Term Investments Accounts receivable - net Inventories Deferred tax assets Prepaid expenses and other current assets Total current assets Property and equipment, Net Goodwill Purchased intangible assets, Net Other Assets Investments Total Assets

5,263 18,201 3,361 455 2,101 6,884 36,265 2,954 206 247 3,651 10,528 53,851

11,875 10,236 2,422 509 1,447 5,822 32,311 2,455 207 285 1,935 2,379 39,572

Year ended 26 September 2009 2008 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Income taxes payable Accrued compensation Deferred revenue Other accrued liabilities Short Term Debt Total current liabilities Long Term Debt Other long term liablities Minority interest Deferred tax liabilities Product Deferred Revenue Shareholders' equity: Common stock and additional paid-in capital Retained earnings Accumulated other comprehensive income Less:Treasury Stock Total shareholders' equity Total Liabilities and Shareholders' Equity

128

5,601 3,376 10,305 19,282 2,252 4,485

5,520 3,719 4,853 14,092 1,421 3,029

8,210 19,538 84 27,832 53,851

7,177 13,845 8 21,030 39,572

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Assets, Liabilities and Accrual Process •

129

Differences in accrued revenue and expenses and cash flows result in assets and liabilities – Revenue reported on Income Statement before cash is received • Increase in accounts receivable – an asset • Increase in Retained earnings – a liability – Cash received before revenue is reported • Deferred Revenue liability increases • Cash increases on assets side – Expense reported on income statement before cash is paid • Increase in accrued expense – a liability • Decrease in retained earning – a liability – Cash paid before expense is reported in income statement • Deferred Expense/ Prepaid expense asset increases • Cash decreases – an asset

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Format of Balance Sheet

• Assets, Liabilities and Equity in a single Column Report Format

• Assets on Left • Liabilities and Equity on the right of a central dividing line Account Format

Balance Sheet Classification

130

• Grouping of accounts into subcategory • Current v/s Non Current • Liquidity based presentation

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Current v/s Non Current Assets • • • • • • •

Assets expected to be liquidated (changed to cash) or used up within one year or one operating cycle of the business, whichever is greater, are classified as current assets Operating Cycle is the time it takes to produce inventory, sell the product and collect the cash Current assets are presented in the order of liquidity Difference between current assets and current liabilities is called working capital Non Current Assets are assets held for continuing use within the business not for sale Assets not consumed in the current period of operation Provide the information of the investing activities of the firm

Current Liabilities • • • •

131

Expected to be settled in the entities normal operating cycle Held primarily for the purpose of being traded Is due to be traded in less than 12 months from balance sheet date All other liabilities are non current in nature

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Balance Sheet Format of IFRS/ US GAAP IFRS

    

US GAAP      

Non Current Assets Current Assets Non-Current Liabilities Minority Interests Equity Component

Current Assets Non-Current Assets Current Liabilities Non-Current Liabilities Minority Interest (mezzanine or in-between item) Equity Component

Measurement Bases of Assets and Liabilities •

132

Measurement of assets and liabilities happens at  Fair Value  Historical Cost

Fair Value

• Amount at which an asset can be exchanged • Liability can be settled • Market Price = Fair Market Value

Historical Cost

• Cost or Fair Value at acquisition • Includes other costs involved at acquisition

Other Bases

• Current Cost (Replacement cost method) • Present Value Method

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Measurement Disclosures - IFRS • • • • • • •

Accounting Policies, including the cost formulas used Total carrying amount of inventory and amount per category Amount of inventories carried at fair value less costs to sell Amount of any write-downs and reversals of any write-downs Circumstances or events that led to the reversal of a write-down Inventories pledged as security for liabilities Amount of inventories recognized as expense

Other balance Sheet Disclosures • • • • • • •

133

Specific accounting policies used Terms of debt agreement Lease information Off-balance sheet financing Breakdowns of operations by important segments Contingent assets and liabilities Detailed pension plan disclosure

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Current Assets • •

Recall the Balance Sheet of Apple Inc. Current Assets of this Balance Sheet Looks as shown

Apple Inc. - Balance Sheet Year ended 26 September 2009 2008 Assets Current assets: Cash and cash equivalents Short Term Investments Accounts receivable - net Inventories Deferred tax assets Prepaid expenses and other current assets

134

5,263 18,201 3,361 455 2,101

11,875 10,236 2,422 509 1,447

6,884

5,822

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Inventories • •

•

Inventory should be measured at lower of cost or net realizable value Cost of inventory comprises of • Costs of purchase • Cost of Conversion • Other costs to bring the inventories to present location It excludes • Abnormal amounts of wasted material, labor and overheads • Storage Costs • Administrative overheads • Selling costs Net realizable Value is estimated • NRV = Selling Price – Estimated Cost of Completion – Selling Costs

Current Liabilities •

•

135

Liabilities expected to be settled in the entity’s normal operating cycle, held for trading and due to be settled within 12 months after the balance sheet date Recall Current Liabilities section from balance sheet of Apple Inc

Apple Inc. - Balance Sheet Year ended 26 September 2009 2008 Liabilities and Shareholders' Equity Current liabilities: Accounts payable Income taxes payable Accrued compensation Deferred revenue Other accrued liabilities Short Term Debt Total current liabilities

5,601 3,376 10,305 19,282

5,520 3,719 4,853 14,092

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Tangible Assets •

•

Long term assets with physical substance that are used in company operations. • E.g. Land, buildings and equipment • Tangible assets are carried at their historical costs less any accumulated depreciation It also includes natural resources like oil fields, mines, etc. • Natural resources get used up over time and thus get depleted • Natural resources are carried at their historical costs less any accumulated depletion

Intangible Assets •

•

136

Identifiable Intangible Asset – • Can be acquired singly and is typically linked to specific rights and privileges having finite benefit periods (e.g. Patents,etc.) • Useful life is finite • Are amortized over the useful life of the intangible asset Unidentifiable Intangible Asset – • Cannot be acquired singularly and has infinite benefit period (e.g. Goodwill) • Useful life is infinite • They are not amortized • Annual impairment review are conducted to adjust the value of these assets

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Intangible Assets • •

•

•

Intangibles may be recognized if they can be reliably measured Typical examples • Purchased patents and copyrights • Purchased franchise and license costs • Goodwill • Computer software development costs All other expenses related to following categories are expensed off • Internally generated brands, Start-up costs, Training costs • Admin and overhead expenses • Advertising and promotion costs • Relocation and reorganization costs R&D Costs • Under US GAAP almost all research and development costs should be expensed off • Under IFRS development stage and costs related project should be capitalized

Goodwill • • • • • •

137

Goodwill is the difference between the acquisition price and the fair market value of the acquired firm’s net assets. The additional amount paid represents the amount paid for assets not recorded on the balance sheet Goodwill is not amortized as it is an intangible asset with infinite life Impairment of goodwill is a non cash expense If goodwill is deemed to be impaired, it is charged against income in the current period To remove the impact of goodwill from ratios – Remove goodwill from assets – Remove impairment from IS – Evaluate business acquisitions considering • Purchase Price • Net Assets • Earnings Prospects Copyright© - IMS Proschool Pvt. Ltd.

Classification of Marketable Securities

Held to maturity securities

• Securities (debt) that company intends to hold to maturity • Securities are carried at cost • IS Impact – Interest Income and realized gains on disposal • BS Impact – Increase in Deposits (cash) account (asset) and Retained earning (liability) due to increment in the interest income

Available for sale securities

• Securities (debt & equity) that may be sold to satisfy the company needs • IS Impact – Same as HTM • Securities carried at market value • BS Impact – Unrealized gains in Asset side and Other comprehensive income in the equity (liabilities side)

Trading securities

• Acquired for the purpose of selling in near term • Carried in balance sheet as assets at imaret value • IS impact – Interest Income and Unrealized gains • BS Impact – Unrealized gains in Assets and Retained earning in equity (liabilities)

Securities are classified based upon the company’s intent with regard to eventual sale 138

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Example : Marketable Securities Impact • • •

ABC Intl purchased 10,000 shares on 1 Jan 2009 for $50 per share. The market price of shares on 31st Dec 2009 was $75. Dividends of $2 were paid during the year Show the balance sheet and Income statement entries if these share are classified as – Held to maturity – Available for sale – Trading securities

Solution : Marketable Securities Impact Share Price Number of shares Cost Fair Value Unrealized Gains (Losses) Dividend Income ($2 per share)

Jan-09

Dec-09

50 10,000 500,000 500,000 -

75 10,000 500,000 750,000 250,000 20,000

Held to Maturity Available for sale Securities securities

Trading Securities

Balance Sheet (31/12/2009) Assets Deposits (Cash) 20,000 Cost of Securities (Investments) 500,000 Unrealized gains/(losses) on securities -

20,000 500,000 250,000

20,000 500,000 250,000

Total Impact

520,000

770,000

770,000

Liabilities Equity Paid in Capital Retained earnings Other Comprehensive Income

500,000 20,000 -

500,000 20,000 250,000

500,000 270,000

Total Impact Checksum

520,000 -

770,000 -

770,000 -

20,000 20,000

20,000 20,000

20,000 250,000 270,000

Income Statement (31/12/2009) Dividend Income (Other Income) Unrealized gains/(losses) Total Impact

139

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Equity •

140

Components of equity • Capital Contributed by owners • Minority Interests (Under IFRS) • Retained Earnings • Treasury Stock (negative entry of shares repurchased) • Accumulated Other comprehensive income • Comprehensive Income = Net Income + Other Comprehensive Income • Cumulative other comprehensive income

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