chapter 5: balance sheet
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Chapter 5: Balance Sheet Chapter 5: Balance Sheet and Statement of Cash and Statement of Cash
Flows SystemsFlows Systems
Part 1: The Balance SheetPart 1: The Balance Sheet
Provides information for evaluating:
Capital structureRates of return
Balance Sheet: UsefulnessBalance Sheet: Usefulness
Provides information for evaluating:Analyzing an enterprise’s:
LiquidityTime to elapse until converted to cash/liability
has to be paidSolvency
Ability to pay debts when dueFinancial flexibility
Ability to alter amounts & timing of cash flows to respond to unexpected situations
Affected by liquidity & solvency
Balance Sheet: UsefulnessBalance Sheet: Usefulness
• Most assets & liabilities stated at historical cost
• Judgments & estimates used• Does not report items that can not
be objectively determined• Does not report information
regarding off-balance sheet financing– FIN 45 & FIN 46
Balance Sheet: LimitationsBalance Sheet: Limitations
Guidelines for reporting assets & liabilities separately:
• Type/expected function in central operations– Inventories vs. PP&E
• Implications for financial flexibility– Assets used in operations vs. invested
• Liquidity characteristics– Cash vs. inventories vs. AR
Balance Sheet: Balance Sheet: ClassificationClassification
• Current Assets• Long-term
investments• Property, plant,
& equipment• Intangible
assets• Other assets
• Current liabilities• Long-term debt• Owners’ equity
– Capital stock– Additional paid-in
capital– Retained earnings
Assets Liabilities and Equity
Balance Sheet: Balance Sheet: ClassificationClassification
• Expected to be consumed, sold, or converted into cash:– Either in one year or in operating cycle,
whichever is longer
• Presented in order of liquidity– Illustration 5-9 page 177
• Valuation principles– Certain short-term investments = fair
value• Trading, available-for-sale, held-to-maturity
– Accounts receivable = net realizable value
Current AssetsCurrent Assets
• Don’t meet definition for current– LT investments
• Illustration page 178
– PP&E• Illustration page 178
– Intangibles• Illustration page 179
– Other assets• Vary widely in practice
Non Current AssetsNon Current Assets
Long-term investments may be:• Securities
– Bonds, stocks• Fixed assets
– Land not used in operations, held for investment
• Amounts set aside in special funds– Sinking fund
• Unconsolidated subsidiaries or affiliated companies
Long-Term InvestmentsLong-Term Investments
• Current liabilities are liquidated:– Either through the use of current assets, or– By creation of other current liabilities– Exception = refinanced/retired from LT assets
• Examples– Payables resulting from acquisitions of goods &
services– Collections received in advance of services– Other liabilities which will be paid in the short
term
• Illustration 5-13 page 180
Current LiabilitiesCurrent Liabilities
• Long-term obligations are those not expected to be paid within the operating cycle
• Examples – Obligations arising from specific
financing situations (issuance of bonds)– Obligations arising from ordinary
business operations (pension obligations)
– Obligations that are contingent (product warranties)
• Illustration 5-14page 181
Long-Term LiabilitiesLong-Term Liabilities
• Capital stock• Additional paid-in-capital• Retained earnings• Partnership/sole proprietors
– Capital (permanent) drawing (temporary) separate
• Illustration 5-15 page 182
Owners’ EquityOwners’ Equity
• Account form– Assets on left side– Liabilities & SE on right side
• Report form– Pancake – Illustration 5-16 page 183
Balance Sheet FormatBalance Sheet Format
• Supplemental information – Not presented elsewhere– Qualifies items in the balance sheet– Examples
• Accounting policies (FN 1 or 2)• Contractual situations• Covenant restrictions• Fair values
– Illustration page 187• Material events having an uncertain
outcome– Illustration page 185
Balance Sheet: Additional Balance Sheet: Additional Information ReportedInformation Reported
• Parenthetical explanations• Notes
– Illustrations page 188
• Cross references and contra/adjunct items– Illustrations page 189
• Supporting schedules– Illustration page 189
Balance Sheet: Techniques Balance Sheet: Techniques of Disclosureof Disclosure
Part 2: The Statement of Part 2: The Statement of Cash FlowsCash Flows
• Provides information about:– Cash receipts (cash inflows)– Uses of cash (cash outflows) – During a period of time
• Helps users evaluate– Liquidity
• Nearness of cash
– Solvency• Ability to pay debts
– Financial flexibility • Ability to respond & adapt to changes
The Cash Flow StatementThe Cash Flow Statement
• Information comes from– Comparative BS– Current IS– Selected transaction data
• Inflows and outflows are reported for:– Operating– Investing – Financing activities
The Cash Flow StatementThe Cash Flow Statement
•Steps– Determine cash provided/used by
operations– Determine cash provided/used by
• Investing•Financing
– Determine change in cash for period
– Reconcile change in cash• Illustrations page 194 & 195
The Cash Flow StatementThe Cash Flow Statement
Cash Inflows and OutflowsCash Inflows and Outflows
• There are two methods of preparing:– Indirect method
• Most common in practice• Derives cash flows from accrual
based statements• Illustration page 194
– Direct method• Derives cash flows directly for each
source or use of cash
Preparing a Statement of Preparing a Statement of Cash FlowsCash Flows
Accrual Based Statements Cash Flow Statement
Income Statementitems & Changes inCurrent Assets andCurrent Liabilities
Operating activities:Adjust net income for accrualsand non-cash charges to get cash flows
Balance Sheet: Changes inNon-Current Assets
Investing activities:Inflows from sale of assets and Outflows from purchases of assets
Balance Sheet: Changes inNon-Current Liabilities
andEquity
Financing activities:Inflows and outflowsfrom loan and equitytransactions
The Statement of Cash The Statement of Cash Flows: Indirect MethodFlows: Indirect Method
Ratio analysis expresses the relationship between selected financial data.
These relationships can be expressed as:
• Percentages • Rates• Proportions
Ratio AnalysisRatio Analysis
25Intermediate Accounting, 10th Edition, Ch. 5 (Kieso et al.)
04/10/23Coverage ratiosSome protection forLT creditors &investors
Debt to total assetsTimes interest earned
Type What is measured Examples
Liquidity ratiosShort-term ability to pay maturing obligations
Current ratioQuick assets ratio
Profitability ratios
Degree of success orfailure for a given period
Return on assetsEarnings per share
Activity ratios Effectiveness in using assets employed
Receivables turnoverInventory turnover
Types of RatiosTypes of Ratios
• Liquidity ratio (high)– Current assets / current liabilities
• Current cash debt coverage ratio (high)– Ability to pay CL in given year from operations
• Net cash operating activities / average current liabilities
• Cash debt coverage ratio (high)– Ability to pay liabilities from net cash from
operations w/o liquidating assets• Net cash operating activities / average total liabilities
Ratio AnalysisRatio Analysis
• Free cash flow– Measures financial flexibility
• Discretionary cash flow available for – Additional investments– Debt retirement– Purchase treasury stock
– FormulaNet cash from operating activitiesLess
Capital outlayDividends
– Illustration page 198
Cash Flow AnalysisCash Flow Analysis
Class exercisesE5-3 E5-4 E5-6E5-8 E5-9 E5-13E5-14
Balance Sheet & Balance Sheet & Statement of Cash FlowsStatement of Cash Flows