Class 3 (Chapter 5). 2. Balance Sheet: Usefulness. Displays the assets, liabilities and equity of the firmThe balance sheet provides information for evaluating the capital structure/financial risk of the firmThe balance sheet in conjunction with the income statement provides information useful in analyzing the firm's:financial performance short-term liquidity (ability to pay current liabilities)solvency (ability to pay interest and debt, as it matures).
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1. Class 3 (Chapter 5) 1 Class #3
2. Class 3 (Chapter 5) 2 Balance Sheet: Usefulness Displays the assets, liabilities and equity of the firm
The balance sheet provides information for evaluating the capital structure/financial risk of the firm
The balance sheet in conjunction with the income statement provides information useful in analyzing the firm’s:
short-term liquidity (ability to pay current liabilities)
solvency (ability to pay interest and debt, as it matures)
3. Class 3 (Chapter 5) 3 Balance Sheet: Limitations Most assets and liabilities are stated at historical cost.
information presented is reliable, however
reporting at current fair value may result in more relevant information
Judgements and estimates are used in determining many of the items reported. “soft” numbers (estimates) less reliable than “hard” numbers. (e.g., how much receivables will we collect, is inventory obsolete, useful lives of long-term assets)
The balance sheet does not report items that can not be objectively determined (e.g., the ‘value’ of experienced staff).
4. Class 3 (Chapter 5) 4 Balance Sheet: Classification Current Assets
Property, plant, and equipment
Other assets Current liabilities
Additional paid-in capital
5. Class 3 (Chapter 5) 5 Current Assets Current assets are expected to be consumed, sold, or converted into cash:
either in one year or
in the normal operating cycle, whichever is longer.
They are presented in order of liquidity
Intent and marketability are important considerations in classifying certain assets as current (e.g., marketable equity securities).
The following valuation principles are used:
short-term investments at fair value
accounts receivable at net realizable value
6. Class 3 (Chapter 5) 6 Current Assets - Cash Includes cash and cash equivalents
short-term, liquid investments readily convertible to a known cash amount, and not subject to material value changes
Any known restrictions to cash must be disclosed
7. Class 3 (Chapter 5) 7 Current Assets - Receivables Amounts should be reported separately based on the nature of their origin:
ordinary trade accounts
amounts owing by related parties
other (material) unusual items
Separate disclosure required for:
anticipated losses (uncollectibles)
amount and nature of non-trade receivables
receivables pledged as collateral
8. Class 3 (Chapter 5) 8 Current Assets - Inventories Valuation basis (lower of cost or market) disclosed
Method of pricing (FIFO or LIFO) disclosed
Manufacturing enterprise will disclose completion stage of inventories
work in progress
9. Class 3 (Chapter 5) 9 Current Assets – Prepaid Expenses Defined as: expenditures already made for benefits to be received within one year or within the operating cycle
Most common examples include
Current practice is to report some prepaid amounts where the benefit extends beyond one year (or operating cycle)
10. Class 3 (Chapter 5) 10 Long-Term Investments Four common types of Long-Term Investments:
investments in securities
investments in tangible fixed assets not used in current operations
investments set aside in special funds for specific purposes
investments in non-consolidated subsidiaries or affiliated companies
The intent of these investments is that they are:
- held for an extended period of time
- reported at cost or amortized cost
- only adjusted to current value if there is a non-temporary decline in value
11. Class 3 (Chapter 5) 11 Property, Plant and Equipment Physical (tangible) assets used in the regular operations of the business to generate revenue
Disclosure requirements include:
basis of valuation
nature of any liens held against the asset
12. Class 3 (Chapter 5) 12 Intangible Assets Those assets without physical substance, held to generate revenue
High degree of uncertainty regarding future benefits
Subject to arbitrary write-downs or write-offs due to valuation/measurement difficulties
Include (most common):
Trademarks, and trade names
13. Class 3 (Chapter 5) 13 Classifying Assets Can Be Tricky Classification of assets depends on both the nature of the item and use to which it is put. For example:
(1) Land used as factory site—classify as property, plant and equipment.
(2) Land owned by a realty company and held for sale—classify as current asset.
(3) Land held for speculation—classify as long-term investment.
(4) Idle land and facilities that have been withdrawn from production—classify as other assets.
14. Class 3 (Chapter 5) 14 Current Liabilities Current liabilities are liquidated:
either through the use of current assets, or
by creation of other current liabilities
Examples of current liabilities include:
payables resulting from acquisitions of goods and services
collections received in advance of services
other liabilities which will be paid in the short term
15. Class 3 (Chapter 5) 15 Working Capital Current Assets -
16. Class 3 (Chapter 5) 16 Long-term Liabilities Long-term obligations are those not expected to be paid within the year (or operating cycle)
Long-term means “non-current”
obligations arising from specific financing situations
obligations arising from ordinary business operations
obligations that are contingent
Balance sheet presentation requires reporting that portion due within the next year as a current liability
17. Class 3 (Chapter 5) 17 Owners’ Equity
18. Class 3 (Chapter 5) 18 Balance Sheet: Additional Information Reported Additional information may be:
- information not presented elsewhere, or
- information that qualifies items in the balance sheet
Five main types of additional information:
19. Class 3 (Chapter 5) 19 Contingencies Events that involve uncertainty as to possible gain (gain contingency) or loss (loss contingency) that will ultimately be resolved by a future event.
Examples of gain contingencies are operating loss-carryforwards, or company litigation against a third party.
Typical loss contingencies relate to litigation, environmental issues, possible tax assessments or government investigation.
20. Class 3 (Chapter 5) 20 CONTINGENCIES
21. Class 3 (Chapter 5) 21 Accounting Policies CICA Handbook, Section 1505, recommends description of all significant accounting principles and methods that involve selection from among alternatives and/or those that are peculiar to a given industry be disclosed.
This disclosure is usually given in the first note or in a separate Summary of Significant Accounting Policies preceding the notes.
22. Class 3 (Chapter 5) 22 Contractual Situations It is mandatory that essential provisions of lease contracts, pension obligations, and stock option plans be clearly stated in the notes to the financial statements.
23. Class 3 (Chapter 5) 23 Balance Sheet: Techniques of Disclosure Parenthetical explanations (following the items in the balance sheet)
Notes (to the balance sheet)
Cross references and contra items (where assets and liabilities may be cross-referenced)
Supporting schedules (as for fixed assets depreciation)
24. Class 3 (Chapter 5) 24 SUBSEQUENT EVENTS
25. Class 3 (Chapter 5) 25 Statement of Cash Flows Assesses the firm’s ability to generate cash and cash equivalents
Assesses the firm’s cash requirements or uses
Statement of Cash Flows shows
Where did the cash come from?
What was the cash used for?
What was the change in the cash balance?
26. Class 3 (Chapter 5) 26 Statement of Cash Flows Cash activities are divided into three main categories:
Normal day-to-day activities
Changes in long-term assets and investments
Changes in equity and non-operating liabilities
27. Class 3 (Chapter 5) 27 Statement of Cash Flows
28. Class 3 (Chapter 5) 28 Preparing a Cash Flow Statement Alternative #1 (Indirect Method)
Comparative Balance Sheets
Current Income Statement
Other information and transaction data
29. Class 3 (Chapter 5) 29 Indirect Method Operating Activities
Start with Net Income (Loss)
Changes in Current Assets (other than cash) and Liabilities
Increase in a current asset = use of funds (Decrease = source of funds)
Increase in a current liabilities = source of funds (Decrease = use of funds)
Non-cash expenses (e.g. amortization, bad debts expense)
Non-operating gains and losses
Gains are treated as a use of funds from operating activities
Losses are treated as a source of funds from operating activities
30. Class 3 (Chapter 5) 30 Indirect Method Investing Activities
Changes in Long-term assets
Increase = use of funds
Decrease = source of funds
If assets have been disposed, report only the cash proceeds of disposition
Changes in Long-term liabilities and equity
Increase = source of funds
Decrease = use of funds
31. Class 3 (Chapter 5) 31 Usefulness of the Statement of Cash Flows Cash is the long-term indicator of a firm’s success or failure
Useful to creditors in answering three main questions
Success in generating net cash from operating activities
Operating cash flow trends or patterns
Major reasons for positive or negative net cash from operating activities (Diagnostics)
32. Class 3 (Chapter 5) 32 Free Cash Flow Net cash from operations less capital expenditures and dividends
Indicates discretionary cash flow (cash left to invest or expand)