Part A: The Balance Sheet

1.  Usefulness and Limitations
   1. Assets minus liabilities, measured according to GAAP, is not likely to be representative of the market value of the entity.
   2. The balance sheet provides information useful for assessing future cash flows, liquidity, and long-term solvency.

2.  Classifications
   1. Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
      1.  Current assets include cash and all other assets expected to become cash or be consumed within one year or the  operating cycle, whichever is longer.

1. Cash and cash equivalents
2. Short-term investments
3. Accounts receivable
4. Inventories
5. Prepaid expenses
2.  Noncurrent assets are those assets that are expected to provide benefits beyond the next year (or operating cycle).
   1. Investments and funds
   2. Property, plant, and equipment
   3. Intangible assets
      Many valuable intangible assets are not even listed on company balance sheets. An article in Forbes highlights a study of how well companies  manage their intangibles. To access this article, you will need to become a member of forbes.com. Membership is free and only takes a couple of minutes to signup.
   4. Other assets
2.  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.
   1.  Current liabilities, in general, are expected to be satisfied within one year or the operating cycle, whichever is longer.
      1. Accounts payable
      2. Notes payable
      3. Unearned revenues
      4. Accrued liabilities
      5. Current maturities of long-term debt
   2.  Long-term liabilities are obligations that will not be satisfied in the next year or operating cycle, whichever is longer.

3.  Shareholders' equity is the residual interest in the assets of an entity that remains after deducting liabilities. It is comprised of paid-in capital and retained earnings.
   1. Paid-in capital represents the amounts invested by shareholders.
   2. Retained earnings represents the accumulated net income earned from the inception of the corporation and not yet paid to shareholders.
       Illustration

Part B: Financial Disclosures

1.  Disclosure Notes
   1. Disclosure notes include certain required notes as well as notes fashioned to suit the disclosure needs of the reporting enterprise.
   2. The summary of significant accounting policies conveys valuable information about the company's choices from among various alternative accounting methods.
      For an example, take a look at this disclosure note for  Apple Computer.
   3. A subsequent event is a significant development that takes place after the company's fiscal year-end but before the financial statements are issued.  Del Monte Foods Company recently included a subsequent events disclosure note in its financial statements.
   4. The economic substance of related-party transactions should be disclosed, including dollar amounts involved.
       Do disclosure requirements cause conflicts between a company and its auditors?
   
   
2.  Management Discussion and Analysis
   The management discussion and analysis provides a biased but informed perspective of a company's (a) operations, (b) liquidity, and (c) capital resources.
   
   

Annual reports include a management's responsibility section which:
1. Asserts the responsibility of management for the information contained in the annual report as well as an assessment of the company's internal control systems.
2. States the responsibility of the auditors to attest to the fairness of management's financial statements.

 Auditors' Report

1. The auditors' report provides the analyst with an independent and professional opinion about the fairness of the representations in the financial statements.
2. The standard report includes three paragraphs.
   1. The first two paragraphs describe the scope of the audit.
   2. The last paragraph contains the auditors' opinion.
3. Some audits result in the need to issue other than an unqualified opinion.
   1. Qualified opinion
   2. Adverse opinion
   3. Disclaimer

 Compensation of Directors and Top Executives

1. The proxy statement, which must be sent each year to all shareholders, serves as an invitation to attend the company's annual meeting and as a means to vote on issues before the shareholders.
2. The proxy statement also contains disclosures on compensation to directors and executives.

Part C: Risk Analysis

1. Using Financial Statement Information
   1. Financial analysts use various techniques when analyzing financial statement information.
   2. Comparative financial statements allow financial statement users to compare year-to-year financial position, results of operations, and cash flows.
      1. Horizontal analysis
      2. Vertical analysis
   3. The most common way of comparing accounting numbers to evaluate the performance and risk of a firm is ratio analysis.
   
   
2.  Liquidity Ratios
   1.  Liquidity refers to the readiness of assets to be converted to cash.
   2. Working capital, the difference between current assets and current liabilities, is a popular measure of a company's ability to satisfy its short-term obligations.
   3. The current ratio, calculated by dividing current assets by current liabilities, expresses working capital as a ratio that allows for interfirm comparisons.
   4. The acid-test ratio provides a more stringent indication of a company's ability to pay its current obligations. The ratio excludes inventories and prepaid expenses from current assets before dividing by current liabilities.
   
   
3.  Financing Ratios
   1. Financing ratios provide some indication of the riskiness of a company with regard to its ability to pay its long-term debts.
   2. The debt to equity ratio indicates the extent of reliance on creditors, rather than owners, in providing resources.
      1. The ratio is calculated by dividing total liabilities by total shareholders' equity.
      2. The debt to equity ratio indicates the extent of trading on the equity or financial leverage.
      3. Favorable  financial leverage means earning a return on borrowed funds that exceeds the cost of borrowing the funds.
   3. The  times interest earned ratio indicates the margin of safety provided to creditors. It is calculated by dividing income before subtracting either interest expense or taxes by interest expense.

 Here is a quiz to test your understanding of this chapter.