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Assets Liabilities Equity Investment by Owners Distributions to Owners Comprehensive Income Revenues Expenses Gains Losses Basic Elements of Financial Statements
Recognition and Measurement Criteria Basic Assumptions Principles Constraints 1. Historical cost 2. Revenue recognition 3. Matching 4. Full disclosure 1. Cost benefit 2. Materiality 3. Industry practices 4. Conservatism 1. Economic entity 2. Going concern 3. Monetary unit 4. Periodicity
Balance Sheet: Usefulness The balance sheet provides information for evaluating: • Capital structure • Rates of return • Analyzing an enterprise’s: • Liquidity • Solvency • Financial flexibility
Balance Sheet: Limitations • Most assets and liabilities are stated at historical cost. • Judgments and estimates are used in determining many of the items. • The balance sheet does not report items that can not be objectively determined. • It does not report information regarding off-balance sheet financing.
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 Assets Liabilities and Equity Balance Sheet: Classification
Current Assets Current assets are expected to be consumed, sold, or converted into cash: either in one year or in the operating cycle, whichever is longer. Current assets are presented in order of liquidity. The following valuation principles are used: • Short-term investments at fair value • Accounts receivable at net realizable value
Long-Term Investments Long-term investments may be: • Investments in securities (bonds, stock) • Investments in fixed assets (land not used in operations) • Investments set aside in special funds (e.g., sinking fund) • Investments in non-consolidated subsidiaries or affiliated companies
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
Long-Term Liabilities Long-term obligations are those not expected to be paid within the operating cycle. Examples are: • obligations arising from specific financing situations (issuance of bonds) • obligations arising from ordinary business operations (pension obligations) • obligations that are contingent (product warranties)
Balance Sheet: Additional Information Reported Additional information may be: • Information not presented elsewhere, or • Information that qualifies items in the balance sheet Supplemental information examples: • Material events having an uncertain outcome • Explanations regarding accounting policies • Covenant restrictions
Balance Sheet: Techniques of Disclosure • Parenthetical explanations • Notes • Cross references and contra items • Supporting schedules
Preparing a Statement of Cash Flows There are two methods of preparing the statement of cash flows: • Indirect method: derives cash flows from accrual based statements • Direct method: derives cash flows directly for each source or use of cash
Accrual Based Statements Cash Flow Statement Income Statement items & Changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals and non-cash charges to get cash flows Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and Outflows from purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions The Statement of Cash Flows: Indirect Method