(Summary of Chapter

1,2,3)
Zainab Aftab
5221-FMS/BBA/S18

Ma’am Shumaila Bibi

A n a l y s i s o f fi n a n c i a l
statement

BBA 38 (6)
Summary
Chapter No.1
Fundamental Concepts And introduction to Financial Reporting
Financial Accounting Standards Board (FASB)
The Financial Accounting Standards Board (FASB) is an independent nonprofit organization
responsible for establishing accounting and financial reporting standards for companies and
nonprofit organizations in the United States, following generally accepted accounting principles
(GAAP).

Statement of financial accounting standards

o Statements of Financial Accounting Standards (SFAS), published by the Financial
Accounting Standards Board (FASB), provided guidance on a specific accounting topic.
SFAS laid the guidelines for accounting standards in the U.S.
o An SFAS became part of the FASB accounting standards once it was published. The FASB
sets accounting standards in the United States, which are published as the generally
accepted accounting principles (GAAP. GAAP includes standards for how U.S. companies
should report their income statement, balance sheet, and statement of cash flows.
These financial statements are compiled and used by regulators and investors.

FASB CONCEPTUAL FRAMEWORK

The Conceptual Framework for Accounting and Reporting was on the agenda of the FASB from
its inception in 1973. The Framework is intended to set forth a system of interrelated objectives
and underlying concepts that will serve as the basis for evaluating existing standards of financial
accounting and reporting.
To date, the Framework project has issued seven Concept Statements:
1. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 1, ‘‘Objectives of Financial
Reporting by Business Enterprises’’
2. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 2, ‘‘Qualitative Characteristics
of Accounting Information’’
3. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 3, ‘‘Elements of Financial
Statements of Business Enterprises’’
4. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 4, ‘‘Objectives of Financial
Reporting by Nonbusiness Organizations’’
5. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 5, ‘‘Recognition and Measurement
in Financial Statements of Business Enterprises’’
6. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 6, ‘‘Elements of Financial
Statements’’ (a replacement of No. 3)
7. STATEMENT OF FINANCIAL ACCOUNTING CONCEPTS NO. 7, ‘‘Using Cash Flow Information
and Present Value in Accounting Measurements’’

 SFAC No. 6, ‘‘Elements of Financial Statements,’’ which replaced SFAC No. 3 in 1985,
defines 10 interrelated elements directly related to measuring the performance and
financial status of an enterprise.
1. Assets
the resources control by the entity as the result of past events and from which the future
economic benefits are expected to flow the entity.
Here are examples of assets:
 Land
 Building
 Property
 Computer equipment
 Cash in bank
 Cash on hand
 Cash advance
 Petty cash
 Inventories
 Account receivables
 Prepaid expenses
 Goodwill
 And other assets that meet the definition of assets above.

2. Liability
A liability is a financial obligation of a company that results in the company’s future sacrifices of
economic benefits to other entities or businesses. A liability can be an alternative to equity as a
source of a company’s financing.
Here are examples of Liabilities in Financial Statements:
 Bank Loan
 Overdraft
 Interest payable
 Tax payable
 Account payable
 Noted payable
 Borrowing from parent company
 Intercompany account payable
 Salary payable
3. Equity
Equity is the residual interest in the assets of the entity after deducting all its liabilities.
The items that records in equity are:
 Share capital
 Retain earning or retain losses
 Revaluation gain
 Dividends payment

Equities = Assets – Liabilities

4. Investment by owner
Owner investment, is the amount of assets that the owner puts into the company. In other
words, this is the amount of money or other assets that the owner contributes to the business
either to start it or to keep it running.

5. Distribution to owners
A distribution to owners is a payment of the retained earnings of a business to its owners. This
distribution may be made in a smaller company because there is no other way for the owners
to gain value from the enterprise, as would normally be achieved through the sale of stock or
sale of the business.

6. Comprehensive income
Comprehensive income is the variation in a company's net assets from non-owner sources
during a specific period. Comprehensive income includes net income and unrealized income,
such as unrealized gains or losses on hedge/derivative financial instruments and foreign
currency transaction gains or losses.

7. Revenues
Revenue is the income generated from normal business operations and includes discounts and
deductions for returned merchandise. It is the top line or gross income figure from which costs
are subtracted to determine net income.

8. Expenses
Expense is defined as decreased in economic benefits during the accounting period in the form
of outflows or depreciation of assets or incurred of liabilities that result in decreases in equity,
other than those relating to distributions to equity participants.
Those expenses are:
 Cost of goods sold
 Salaries expenses
 Depreciation
 Interest Expenses
 Tax expenses
 Utility expenses
 Transportation Cost
 Marketing Expenses
 Rental Expenses
 Repair and maintenance
 Internet Fee
 Telephone fee

9. Gains
A gain is a general increase in the value of an asset or property. A gain arises if the current price
of something is higher than the original purchase price.

10.Loss
In financial accounting, a loss is a decrease in net income that is outside the normal operations
of the business. Losses can result from a number of activities such as; sale of an asset for less
than its carrying amount

Recognition and Measurement in Financial Statements of Business Enterprises

(SFAC No. 5) indicates that in order to be recognized an item should meet four criteria, subject
to the cost-benefit constraint
DEFINITION. The item fits one of the definitions of the elements.
MEASURABILITY. The item has a relevant attribute measurable with sufficient reliability.
RELEVANCE. The information related to the item is relevant.
RELIABILITY. The information related to the item is reliable
This concept statement identifies five different measurement attributes currently used in
practiceand recommends the composition of a full set of financial statements for a period.
The following are five different measurement attributes currently used in practice:
 Historical cost (historical proceeds)
 Current cost
 Current market value
 Net realizable (settlement) value
 Present (or discounted) value of future cash flows

Emerging Issues Task Force (EITF)

o The Emerging Issues Task Force (EITF) is an organization formed by the Financial Accounting
Standards Board (FASB) in 1984 to identify, discuss and resolve financial accounting issues with
an aim to improve financial reporting. The EITF, consisting primarily of accountants from large
public firms as well as the chief accountant of the SEC, identifies and resolves accounting issues
through uniform practices and methods.
o Task Force meetings are held about once every six weeks. Issues come to the Task Force from a
variety of sources, including EITF members, the SEC, and other federal agencies. The FASB also
brings issues to the EITF in response to issues submitted by auditors and preparers of financial
statements.

A New Reality
The SEC requires companies to file an annual report on their internal control systems. The
report should contain the following:
 A statement of management’s responsibilities for establishing and maintaining an
adequate system
 Identification of the framework used to evaluate the internal controls
 A statement as to whether or not the internal control system is effective as of year-
end
 The disclosure of any material weaknesses in the system
 A statement that the company’s auditors have issued an audit report on
management’s assessment

Traditional Assumptions of the Accounting Model

o The FASB’s Conceptual Framework was influenced by several underlying assumptions.
Some of these assumptions were addressed in the Conceptual Framework, and others
are implicit in the Framework. These assumptions, along with the Conceptual
Framework, are considered when a GAAP is established.
o Accountants, when confronted with a situation lacking an explicit standard, should
resolve the situation by considering the Conceptual Framework and the traditional
assumptions of the accounting model.

BUSINESS ENTITY
The concept of separate entity means that the business or entity for which the financial
statements are prepared is separate and distinct from the owners of the entity. In other words,
the entity is viewed as an economic unit that stands on its own.

GOING CONCERN OR CONTINUITY

o Going concern is an accounting term for a company that is financially stable enough to meet its
obligations and continue its business for the foreseeable future. Certain expenses and assets
may be deferred in financial reports if a company is assumed to be a going concern.
o The going-concern assumption also influences liabilities. If the entity were liquidating, some
liabilities would have to be stated at amounts in excess of those stated on the conventional
statement. Also, the amounts provided for warranties and guarantees would not be realistic if
the entity were liquidating.

Time Period
 o Some businesses select an accounting period, known as a natural business year, that
ends when operations are at a low ebb in order to facilitate a better measurement of
income and financial position. In many instances, the natural business year of a
company ends on December 31. Other businesses use the calendar year and thus end
the accounting period on December 31.
o Thus, for many companies that use December 31, we cannot tell if December 31 was
selected because it represents a natural business year or if it was selected to represent a
calendar year. Some select a 12-month accounting period, known as a fiscal year, which
closes at the end of a month other than December.

Historical Cost
Historical cost is the original cost of an asset, as recorded in an entity's accounting records.
Many of the transactions recorded in an organization's accounting records are stated at their
historical cost. This concept is clarified by the cost principle, which states that you should only
record an asset, liability, or equity investment at its original acquisition cost.

Conservatism
Conservatism is one of the generally accepted accounting principles (GAAP), which is a set of
guidelines drawn up to ensure that companies report financial information in a clear and
accurate way. This particular principle requires companies to exercise caution when recording
financial activity, opting for solutions that show the least favorable outcome..

REALIZATION
o Realization Concept of Accounting states that revenue is only recognized when goods or
services are delivered or rendered to the buyer.
o Conservatism concept suggests the period when revenue should be recognized.
However realization concept indicates that the amount of revenue that should be
recognized from a given sale. Realization basically refers to the inflows of cash or claims
to cash arising from the sale of goods or services.

Point of Sale
o Revenue is usually recognized at the point of sale. At this time, the earning process is
virtually complete, and the exchange value can be determined.
 o There are times when use of the point-of-sale approach does not give a fair result. Many
other acceptable methods of recognizing revenue should be considered, such as the
following:
End of production
The recognition of revenue at the completion of the production process is acceptable when the
price of the item is known and there is a ready market
Receipt of cash
The receipt of cash is another basis for revenue recognition. This method should be used when
collection is not capable of reasonable estimation at the time of sale.
During production
Some long-term construction projects recognize revenue as the construction progresses. This
exception tends to give a fairer picture of the results for a given period of time
Cost recovery
The cost recovery approach is acceptable for highly speculative transactions. For example, an
entity may invest in a venture search for gold, the outcome of which is completely
unpredictable. In this case, the first revenue can be handled as a return of the investment. If
more is received than has been invested, the excess would be considered revenue.

MATCHING
o The matching principle states that the related revenues and expenses must be matched
in the same period.
o The expense must relate to the period in which they were incurred rather than on the
period in which they were paid. For example, if a business pays a 10% commission to
sales representatives at the end of each month. If the company has $50,000 in sales in
the month of December, the company will pay the commission of $5,000 next January.
o The matching statement requires that the commission expense is reported in the
December income statement. If the company uses the cash basis of accounting, the
commission would be reported in January (in the month they were paid) rather than
December (the month they were incurred).

Transaction approach
The transaction approach is the concept of deriving the financial results of a business by
recording individual revenue, expense, and other purchase transactions. These transactions are
then aggregated to see if a business has earned a profit or a loss.

CASH BASIS
The cash basis recognizes revenue when cash is received and recognizes expenses when cash is
paid. The cash basis usually does not provide reasonable information about the earning
capability of the entity in the short run. Therefore, the cash basis is usually not acceptable.

Accrual basis
The accrual basis of accounting recognizes revenue when realized (realization concept) and
expenses when incurred (matching concept). If the difference between the accrual basis and
the cash basis is not material, the entity may use the cash basis as an alternative to the accrual
basis for income determination.

Chapter 2
Introduction to financial statement and other financial
reporting topics

Forms of Business Entities

A business entity may be a sole proprietorship, a partnership, or a corporation. A sole
proprietorship, a business owned by one person, is not a legal entity separate from its owner,
but the accountant treats the business as a separate accounting entity.

Proprietorship:
o A sole proprietorship also referred to as a sole trader or a proprietorship, is an
unincorporated business that has just one owner who pays personal income tax on
profits earned from the business.
o A sole proprietorship is the easiest type of business to establish or take apart, due to a
lack of government regulation. As such, these types of businesses are very popular
among sole owners of businesses, individual self-contractors, and consultants. Many
 sole proprietors do business under their own names because creating a separate
business or trade name isn't necessary.

Partnership:
o It is a business owned by two or more individuals. Each owner, called a partner, is
personally responsible for the debts of the partnership.
o A partnership is a formal arrangement by two or more parties to manage and operate a
business and share its profits. There are several types of partnership arrangements. In
particular, in a partnership business, all partners share liabilities and profits equally,
while in others, partners may have limited liability. There also is the so-called "silent
partner," in which one party is not involved in the day-to-day operations of the business.

Business Corporation:
A corporation is a business entity that is owned by its shareholder(s), who elect a board of
directors to oversee the organization's activities. Corporations can be for-profit, as businesses
are, or not-for-profit, as charitable organizations typically is. Basically it is a legal entity
incorporated in a particular state. Ownership is evidenced by shares of stock.

The Financial Statements

o Financial statements are formal records of the financial activities and position of a
business, person, or other entity. Relevant financial information is presented in a
structured manner and in a form which is easy to understand.
o The principal financial statements of a corporation are the balance sheet, income
statement, and statement of cash flows. Notes accompany these financial statements.
To evaluate the financial condition, the profitability, and cash flows of an entity, the user
needs to understand the statements and related notes.

BALANCE SHEET (STATEMENT OF FINANCIAL POSITION)

A balance sheet shows the financial condition of an accounting entity as of a particular date.
The balance sheet consists of three major sections: assets, the resources of the firm; liabilities,
the debts of the firm; and stockholders’ equity, the owners’ interest in the firm. At any point in
time, the total assets amount must equal the total amount of the contributions of the creditors
and owners. This is expressed in the accounting equation:
Assets = Liabilities + Stockholders’ Equity
INCOME STATEMENT (STATEMENT OF EARNINGS)
The income statement summarizes revenues and expenses and gains and losses, ending with
net income. It summarizes the results of operations for a particular period of time. Net income
is included in retained earnings in the stockholders’ equity section of the balance sheet. (This is
necessary for the balance sheet to balance.)

STATEMENT OF OWNERS’ EQUITY

Firms are required to present reconciliations of the beginning and ending balances of their
stockholders’ equity accounts. This is accomplished by presenting a “statement of stockholders’
equity.” Retained earnings are one of the accounts in stockholders’ equity. Retained earnings
links the balance sheet to the income statement. Retained earnings are increased by net
income and decreased by net losses and dividends paid to stockholders. There are some other
possible increases or decreases to retained earnings besides income (losses) and dividends. For
the purposes of this chapter, retained earnings will be described as prior earnings less prior
dividends.

STATEMENT OF CASH FLOWS (STATEMENT OF INFLOWS AND OUTFLOWS OF

CASH)
The statement of cash flows details the inflows and outflows of cash during a specified period
of time the same period that is used for the income statement. The statement of cash flows
consists of three sections: cash flows from operating activities, cash flows from investing
activities, and cash flows from financing activities.

Footnotes
The notes to the financial statements are used to present additional information about items
included in the financial statements and to present additional financial information. Notes are
an integral part of financial statements. A detailed review of notes is essential to understanding
the financial statements.
Footnotes to the financial statements refer to additional information that helps explain how a
company arrived at its financial statement figures. They also help to explain any irregularities or
perceived inconsistencies in year to year account methodologies

The Accounting Cycle

The sequence of accounting procedures completed during each accounting period is called the
accounting cycle. A broad summary of the steps of the accounting cycle includes:
1. Recording transactions
2. Recording adjusting entries
3. Preparing the financial statements

Transaction
An accounting transaction is a business event having a monetary impact on the financial
statements of a business. It is recorded in the accounting records of the business. It is an event
that causes a change in a company’s assets, liabilities, or stockholders’ equity, thus changing
the company’s financial position. Transactions may be external or internal to the company.

Adjusting entries
An adjusting journal entry is an entry in a company's general ledger that occurs at the end of an
accounting period to record any unrecognized income or expenses for the period. ... Adjusting
journal entries can also refer to financial reporting that corrects a mistake made previously in
the accounting period.
Financial Statements
The accountant uses the accounts after the adjustments have been made to prepare the
financial statements. These statements represent the output of the accounting system. Two of
the principal financial statements, the income statement and the balance sheet, can be
prepared directly from the adjusted accounts.

Chapter 3
Balance sheet

Consolidated Statements
The financial statement of the parents and the subsidiary are consolidated for all majority
owned subsidiaries unless control is temporary or does not rest with the majority owner. There
are termed consolidated financial statements. Consolidated financial statements are financial
statements of an entity with multiple divisions or subsidiaries.

Basic Elements of the Balance Sheet

A balance sheet shows the financial condition of an accounting entity at a specific point in time.
The balance sheet consists of assets, the resources of the firm; liabilities, the debts of the firm;
and stockholders’ equity, the owners’ interest in the firm.
Assets = Liabilities + Stockholders’ Equity

ASSETS
An asset is a resource with economic value that an individual, corporation, or country owns or
controls with the expectation that it will provide a future benefit. Assets may be physical, such
as land, buildings, inventory of supplies, material, or finished products. Assets may also be
intangible, such as patents and trademarks.
Assets are normally divided into two major categories:
• Current Assets
• Fixed Assets

Current assets
Current assets represent all the assets of a company that are expected to be conveniently sold,
consumed, used, or exhausted through standard business operations with one year. Current
assets appear on a company's balance sheet, one of the required financial statements that
must be completed each year.
Current assets would include cash, cash equivalents, accounts receivable, stock inventory,
marketable securities, pre-paid liabilities, and other liquid assets. Current assets may also be
called current accounts.
1. Cash
Cash, the most liquid asset, includes negotiable checks and unrestricted balances in checking
accounts, as well as cash on hand.
2. Marketable Securities
Marketable securities (also labeled short-term investments) are characterized by their
marketability at a readily determinable market price. A firm holds marketable securities to earn
a return on near-cash resources. Management must intend to convert these assets to cash
during the current period for them to be classified as marketable securities.
3. Accounts Receivable
Accounts receivable (AR) is the balance of money due to a firm for goods or services delivered
or used but not yet paid for by customers. Accounts receivables are listed on the balance sheet
as a current asset. Account receivables are any amount of money owed by customers for
purchases made on credit.
 4. Inventory
Inventory is the term for the goods available for sale and raw materials used to produce goods
available for sale. Inventory represents one of the most important assets of a business because
the turnover of inventory represents one of the primary sources of revenue generation and
subsequent earnings for the company's shareholders.it involves raw material, finished goods,
work in process and supplies.
• Raw materials: Raw materials consist of all the items that are processed to make the
final p Work in progress
• Work in process: When raw materials have been sent for processing but have not yet
been approved as finished goods.
• Finished goods: Finished goods are the final items that are ready for sale in the market.
• Supplies: These are items used indirectly in production of good and services. E.g., tapes,
pencil, needle.
For costing of inventory there are two methods:
• FIFO (first in first out)
• LIFO ( last in first out)
First-In, First-Out (FIFO)
The First-In, First-Out (FIFO) method assumes that the first unit making its way into inventory–
or the oldest inventory–is the sold first. FIFO can be a better indicator of the value for ending
inventory because the older items have been used up while the most recently acquired items
reflect current market prices.
Last-In, First-Out (LIFO)
The Last-In, First-Out (LIFO) method assumes that the last or more units to arrive in inventory is
sold first. The older inventory, therefore, is left over at the end of the accounting period. Since
LIFO uses the most recently acquired inventory to value COGS, the leftover inventory might be
extremely old or obsolete. As a result, LIFO doesn't provide an accurate or up-to-date value of
inventory because the valuation is much lower than inventory items at today's prices.
5. Prepaid
A prepaid is an expenditure made as future expenses that are paid in advance. On the balance
sheet, prepaid expenses are first recorded as an asset.

Long-term Assets (fixed assets):

Long-term assets (also called fixed or capital assets) are those a business can expect to use,
replace and/or convert to cash beyond the normal operating cycle of at least 12 months. Often
they are used for years. Long-term assets appear on the balance sheet along with current
assets. These ate divides into four categories: Tangible assets, investments, intangible assets
and other assets.
1. Tangible Assets
These are the physical facilities used in the operations of the business. The tangible assets
involve land, buildings, machinery, and construction in progress. Accumulated depreciation
related to buildings and machinery.
Land: it is shown at acquisition cost and is not depreciated because land does not get used up.
Land containing resources that will be used up, however, such as mineral deposits and
timberlands, is subject to depletion. It is similar to depreciation except that depreciation deals
with a tangible fixed asset and depletion deals with a natural resource.
Buildings Structures: These are presented at cost plus the cost of permanent improvements.
Buildings are depreciated (expensed) over their estimated useful life.
Machinery: It is listed at historical cost, including delivery and installation, plus any material
improvements that extend its life or increase the quantity or quality of service. Machinery is
depreciated over its estimated useful life.
Construction in progress: It represents cost incurred for projects under construction. These
costs will be transferred to the proper tangible asset account upon completion of construction.
The firm cannot use these assets while they are under construction. Some analysis is directed at
how efficiently the company is using operating assets. This analysis can be distorted by
construction in progress, since construction in progress is classified as part of tangible assets.
Accumulated depreciation: is the process of allocating the cost of buildings and machinery over
the periods benefited. The depreciation expense taken each period is accumulated in a
separate account (Accumulated Depreciation). Accumulated depreciation is subtracted from
the cost of plant and equipment.
There are a number of depreciation methods that a firm can use.
 Straight-Line Method
 Declining Balance Method
 Sum-of-the-Years- Digits methods
 Unit of Production Method
Three factors are usually considered when computing depreciation:
 The asset cost
 Length of the life of the asset
  Its salvage value when retired from service
Salvage value is the estimated book value of an asset after depreciation is complete,
based on what a company expects to receive in exchange for the asset at the end of its useful
life.
Straight-Line Method
The straight-line method recognizes depreciation in equal amounts over the estimated life of
the asset.
Formula: Cost − Salvage Value = Annual Depreciation
Declining-Balance Method
The declining-balance method, an accelerated method, applies a multiple times the straight-line
rate to the declining book value (cost minus accumulated depreciation) to achieve a declining
depreciation charge over the estimated life of the asset. This will use double the straight-line
rate, which is the maximum rate that can be used.
Formula: 1/estimated life of asset (2 × Book Amount at Beginning of the Year = Annual
Depreciation)
Sum-of-the-Years’-Digits Method
The sum-of-the-years’-digits method is an accelerated depreciation method. Thus, the
depreciation expense declines steadily over the estimated life of the asset. This method takes a
fraction each year times the cost less salvage value. The numerator of the fraction changes each
year. It is the remaining number of years of the asset’s life. The denominator of the fraction
remains constant; it is the sum of the digits representing the years of the asset’s life.
Formula: (remaining no.of years of life/sum of digits of year) x cost –salvage value
Unit-of-Production Method
The unit-of-production method relates depreciation to the output capacity of the asset,
estimated for the life of the asset. The capacity is stated in terms most appropriate for the
asset, such as units of production, hours of use, or miles.
2. Investment
A long-term investment is an account a company plans to keep for at least a year such as
stocks, bonds, real estate, and cash. The account appears on the asset side of a company's
balance sheet. These are different from short-term investments, which are meant to be sold
within a year.
3. Intangible Assets
An intangible asset is an asset that is not physical in nature. Goodwill, brand recognition and
intellectual property, such as patents, trademarks, and copyrights, are all intangible assets.
Intangible assets exist in opposition to tangible assets, which include land, vehicles, equipment,
and inventory.
4. Other Assets
These assets termed ‘other’ might include noncurrent receivables and noncurrent prepaid.
Noncurrent receivables: An account that can be collected more than a year from the date of
the balance sheet.
Noncurrent prepaid: Prepaid assets may be classified as noncurrent assets if the future benefit
is not to be received within one year

LIABILITIES
Liabilities are probable future sacrifices of economic benefits arising from present obligations of
a particular entity to transfer assets or provide services to other entities in the future as a result
of past transactions or events. Liabilities are usually classified as either current or long- term
liabilities.
1. Current Liabilities:
Current liabilities are a company's short-term financial obligations that are due within one year
or within a normal operating cycle. Basically it is the obligation whose liquidation requires the
use of current asset or creation of liability within 1 year. It involves payables and unearned
income.
• Payables: Accounts Payable is a short-term debt payment which needs to be paid to
avoid default. It is the obligation created by wage payable, tax payable, account payable etc.
• Unearned Income: payment collected in advance of the performance of services are
termed unearned.
2. Other current liabilities:
It involves long term liabilities.
Long-term liabilities are financial obligations of a company that are due more than one year in
the future. It includes note payables and bond payables.
Note payable: A note payable is a written promissory note greater than one year or one
operating cycle.
Bond payable: it is a debt security normally issued with $1,000 par per bond required semi-
annual coupon interest rate.
Credit Agreements
Many firms arrange loan commitment from banks or insurance companies for future loans.
Often, the firm does not intend to obtain these loans but has arranged the credit agreement
just in case a need exists for additional funds. Such credit agreements do not represent a
liability unless affirm actually request the fund. Credit agreement is the positive condition in
that it could relieve pressure on firm in time of trouble.

Liability relating to operational obligations

Deferred Taxes:
A deferred tax liability is a tax that is assessed or is due for the current period but has not yet
been paid meaning that it will eventually come due. Basically it is the tax that is paid in future.
Warranty obligations:
Warranty Obligations means all liabilities and obligations arising out of or relating to the repair,
rework, replacement or return of, or any claim for breach of warranty in respect of or refund of
the purchase price of, any Business Products.
Minority Interest
A minority interest is ownership of less than 50% of a subsidiary's equity by an investor or a
company other. It reflects the ownership of minority shareholder in the equity of consolidated
subsidiaries less than wholly owned.

3. Other noncurrent Liabilities

It includes long-term loans and lease obligations, bonds payable and deferred revenue.
Redeemable preferred stock:
Redeemable preferred stock is a type of preferred stock that allows the issuer to buy back the
stock at a certain price and retire it, thereby converting the stock to treasury stock. These terms
work well for the issuer of the stock.

STOCKHOLDERS’ EQUITY
Stockholders' equity is the amount of assets remaining in a business after all liabilities have
been settled. It is calculated as the capital given to a business by its shareholders, plus donated
capital and earnings generated by the operation of the business, less any dividends issued.
On the balance sheet, stockholders' equity is calculated as:
 Total assets - Total liabilities = Stockholders' equity

Paid in capital
Paid in capital is the payments received from investors in exchange for an entity's stock. Paid in
capital can involve either common stock or preferred stock. These funds only come from the
sale of stock directly to investors by the issuer; it is not derived from the sale of stock on the
secondary market between investors, nor from any operating activities.
Paid in capital is only comprised of funds received from the sale of stock; it does not include
proceeds from ongoing company operations.
Thus, the formula for paid in capital is:
Paid in capital = Par value + Additional paid in capital

Common stock
Common stock is an ownership share in a corporation that allows its holders voting rights at
shareholder meetings and the opportunity to receive dividends. If the corporation liquidates,
then common stockholders receive their share of the proceeds of the liquidation after all
creditors and preferred stockholders have been paid. However, if a business is highly profitable,
most of the benefits accrue to the common stockholders.

Preferred stock
preferred stock, are shares of a company’s stock with dividends that are paid out to
shareholders before common stock dividends are issued. If the company enters bankruptcy,
preferred stockholders are entitled to be paid from company assets before common
stockholders. Most preference shares have a fixed dividend. Preferred stock shareholders also
typically do not hold any voting rights.
Some other preferred stock characteristics include the following:

 Preference as to dividends
means that preferred shareholders have priority or preference over common shareholders
when it comes to dividend distributions. This feature implies that under no circumstances
can dividends be paid to common shareholders before preferred shareholders
 Accumulation of dividends
An accumulated dividend is a dividend on a share of cumulative preferred stock that has not
yet been paid to the shareholder. Accumulated dividends are the result of dividends that
are carried forward from previous periods. Shareholders of cumulative preferred stock will
receive their dividends before any other shareholders.
 Participation in excess of stated dividend rate
Participating preferred stock is a type of preferred stock that gives the holder the right to
receive dividends equal to the customarily specified rate that preferred dividends are paid
to preferred shareholders, as well as an additional dividend based on some predetermined
condition.
 Convertibility into common stock
Convertible preferred stock can be converted to common shares at the conversion ratio.
The conversion ratio is set by the company before the preferred stock is issued. For
example, one preferred stock may be converted into two, three, four, and so on, common
shares. If the common shares rise, the preferred shareholder may option to convert their
shares into common stock, thus realizing an immediate profit.
 Callability by the corporation
Callable stock is shares in a company that the issuer can buy back. Callable stock may be
issued in order to have the option of retaining tighter control over a business or to avoid
paying interest on preferred stock. The issuer buys back the shares under the terms of an
agreement that states the buy back price (known as the call price) and the dates or
circumstances under which the issuer can buy back the shares. The term "callable stock" is
almost always applied to preferred stock.
 Redemption at future maturity date
If redeemed at the time of maturity, an investor receives the par value or the face value of
the security. Corporations that issue bonds or other securities may pay investors a
redemption value when they buy back their securities on or before the maturity date.
 Preference in liquidation
A liquidation preference is a clause in a contract that dictates the payout order in case of a
corporate liquidation. Typically, the company's investors or preferred stockholders get their
money back first, ahead of other kinds of stockholders or debtholders, in the event that the
company must be liquidated.

Donated capital
Donated capital is assets given to an entity as a gift. This amount is recorded at its fair value as
of the date when the gift was received.

Retained Earnings
Retained earnings refer to the portion of the earnings left with the company after the distribution of
dividend to its shareholders. Retention of earnings is from the profits of the business for a financial year.
A company cannot pay dividends or retain earnings in the case of net loss in any financial year.

QUASI-REORGANIZATION
o A quasi-reorganization is an accounting procedure equivalent to an accounting fresh start. A
company with a deficit balance in retained earnings ‘‘starts over’’ with a zero balance rather
than a deficit.
o A quasi-reorganization involves the reclassification of a deficit in retained earnings. It removes
the deficit and an equal amount from paid-in capital. A quasi-reorganization may also include a
restatement of the carrying values of assets and liabilities to reflect current values.
o When a quasi-reorganization is performed, the retained earnings should be dated as of the
readjustment date and disclosed in the financial statements for a period of five to ten years.

EMPLOYEE STOCK OWNERSHIP PLANS (ESOPS)

o An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers
ownership interest in the company. ESOPs give the sponsoring company, the selling
shareholder, and participants receive various tax benefits, making them qualified plans.
o From a company’s perspective, an ESOP has both advantages and disadvantages. One advantage
is that an ESOP serves as a source of funds for expansion at a reasonable rate. Other possible
advantages are as follows:

1. A means to buy the stock from a major shareholder or possibly an unwanted shareholder.

2. Help in financing a leveraged buyout.

3. Reduction of potential of an unfriendly takeover.

4. Help in creating a market for the company’s stock.

Treasury stock
o Treasury stock refers to previously outstanding stock that is bought back from stockholders by
the issuing company. The result is that the total number of outstanding shares on the open
market decreases.
o Treasury stock consists of shares issued but not outstanding. Thus, treasury shares are not
included in earnings per share or dividend calculations, and they do not have voting rights. In
general, an increase in treasury stock can be a good thing because it indicates that the company
thinks the shares are undervalued.