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Class 3

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    1. Class 3 (Chapter 5) 1 Class #3 Chapter 5

    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 firms: financial performance 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 Long-term investments Property, plant, and equipment Intangible assets Other assets Current liabilities Long-term debt Owners equity Capital stock Additional paid-in capital Retained earnings

    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 Defined as: cash demand deposits 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 raw materials work in progress finished goods

    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 insurance rent advertising supplies 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 accumulated amortization

    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): Patents Copyrights Franchises Goodwill 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 siteclassify as property, plant and equipment. (2) Land owned by a realty company and held for saleclassify as current asset. (3) Land held for speculationclassify as long-term investment. (4) Idle land and facilities that have been withdrawn from productionclassify 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 Examples are: 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: Contingencies Accounting policies Contractual situations Additional detail Subsequent events

    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 firms ability to generate cash and cash equivalents Assesses the firms 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: Operating Activities Normal day-to-day activities Investing Activities Changes in long-term assets and investments Financing Activities 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) Information required: 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 Financing Activities 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 firms 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)