Chapter 2 – Classified Balance Sheets, Ratio Analysis, & Financial Reporting Concepts

Presents a financial snapshot at a point in time ➜ groups like items together to improve understanding.

Assets
- Current assets
- Long-term investments
- Property, plant, and equipment (PP&E)
- Intangible assets
Liabilities & Stockholders’ Equity
- Current liabilities
- Long-term liabilities
- Stockholders’ equity

Current Assets
- Definition: Assets expected to be converted to cash or used within one year or one operating cycle (whichever is longer).
- Listed in order of liquidity.
- Common categories: cash, short-term investments, receivables (A/R, notes, interest), inventories, prepaid expenses (insurance, supplies).
- Example – Franklin Corp. (Oct 31 2025) ➜ total current assets $=\$22{,}100$ .
Long-Term Investments
- Convertible to cash after one year.
- Types: >1-yr stock/bond holdings; land/buildings not currently used in operations; long-term notes receivable.
- Example – Alphabet: non-marketable investments $=\$5{,}183\text{ million}$ .
Property, Plant, & Equipment (PP&E)
- Long-lived, currently-used operational assets (land, buildings, equipment, delivery vehicles, furniture).
- Reported at book value = cost − accumulated depreciation.
- Depreciation = systematic cost allocation; Accumulated depreciation is the life-to-date total.
- Example – Franklin: equipment $=\$24{,}000$ − accumulated dep’n $=\$5{,}000$ ➜ net $=\$19{,}000$ .
Intangible Assets
- No physical substance; confer exclusive rights (goodwill, patents, copyrights, trademarks, FCC licenses).
- Sometimes grouped as “Other assets.”
- Example – Disney: total intangibles & goodwill $=\$34{,}759\text{ million}$ .

Current Liabilities
- Obligations due within next year/operating cycle (A/P, N/P, wages, interest, taxes, unearned revenue, current maturities of LT debt).
Long-Term Liabilities
- Obligations payable after one year (bonds, LT notes, mortgages, leases, pensions); often disclosed in notes.
Stockholders’ Equity
- Common stock = owners’ investments.
- Retained earnings = cumulative income retained in the business.
Example – Franklin (Oct 31 2022):
- Total liabilities $=\$27{,}350$ .
- Common stock $=\$14{,}000$ ; retained earnings $=\$20{,}050$ .

Expresses relationships among selected financial-statement items.
Three broad classes:
- Profitability – operating success over a period.
- Liquidity – short-term paying ability.
- Solvency – long-term survival.

Measures profit earned per share of common stock.
Formula: $\text{EPS}=\frac{\text{Net Income} - \text{Preferred Dividends}}{\text{Weighted Avg. Common Shares Outstanding}}$
Best Buy EPS:
- 2020 $=\$5.90$ ; 2019 $=\$5.33$ .
Use: compare one company over time (not across companies because of share-count differences).

Working Capital
- $\text{Working Capital}=\text{Current Assets}-\text{Current Liabilities}$
- Positive ➜ more likely to pay short-term debts; negative ➜ potential bankruptcy.
- Best Buy 2020: $8{,}857−8{,}060=\$797\text{ million}$ .
Current Ratio
- $\text{Current Ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$
- More reliable than working capital but ignores asset composition.
- Best Buy 2020: $\frac{8{,}857}{8{,}060}=1.10$ ➜ liquidity decreased.
Insight – REL Consultancy says excess working capital ties up $>\$1\text{ trillion}$ ; aim for “Goldilocks” level.

Debt to Assets Ratio
- $\text{Debt to Assets}=\frac{\text{Total Liabilities}}{\text{Total Assets}}$
- Higher % ➜ more creditor financing, greater risk.
- Best Buy 2020: $\frac{12{,}112}{15{,}591}=0.78\; (78\%)$ (up from 2019 ➜ solvency worsened).
Industry snapshot – Debt to Assets: Google 23%, Nike 41%, Microsoft 48%, Exxon 48%, Tesla 76%.

“Korean discount” – weak standards lowered share prices; adoption of IFRS aimed to increase transparency & investor confidence.
Best Buy investor message board case: following bullish poster would have turned $10{,}000$ into $>\$300{,}000$ in 5 yrs.

Objective: Provide information useful to investors & creditors for capital-allocation decisions.

Monetary Unit – only -measurable items.
Economic Entity – separate entity (no mixing personal & business transactions).
Periodicity – life divisible into time periods.
Going Concern – entity will continue operating.

Measurement Principles
- Historical Cost – record assets at purchase price; remains unless GAAP permits change.
- Fair Value – report at market value when assets/liabilities are actively traded; chosen based on relevance & faithful representation trade-off.
Full Disclosure – include all info that influences users, either in statements or accompanying notes.

\text{Working Capital}=\text{CA}-\text{CL}
\text{Current Ratio}=\dfrac{\text{CA}}{\text{CL}}
\text{Debt to Assets}=\dfrac{\text{Total Liabilities}}{\text{Total Assets}}
\text{EPS}=\dfrac{\text{NI}-\text{Preferred Dividends}}{\text{Weighted Avg. Shares}}

GAAP = set of authoritative standards (Answer a).
Current ratio example (Sam Inc.): liquidity fell from 2.15:1 $to$ 2.04:1.
Debt to Assets (Sam Inc.): improved from 45.5\% $to$ 43.75\%$$.
Concept matches:
1 Comparability, 2 Going concern, 3 Materiality, 4 Full disclosure, 5 Periodicity, 6 Relevance, 7 Historical cost, 8 Consistency, 9 Economic entity, 10 Faithful representation, 11 Monetary unit.

Too‐much liquidity wastes resources; managers must balance.
High leverage (debt) increases returns and risk; industry norms matter.
Adopting transparent standards (IFRS) can eliminate market discounts and spur growth.
Full disclosure & faithful representation protect investor trust, forming ethical backbone of financial reporting.