Chapter 5: Balance Sheet
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Chapter 5: Balance Sheet

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Chapter 5: Balance Sheet Chapter 5: Balance Sheet Presentation Transcript

  • Chapter 5: Balance Sheet and Statement of Cash Flows Systems
  • Part 1: The Balance Sheet
    • Provides information for evaluating:
    • Capital structure
    • Rates of return
    Balance Sheet: Usefulness
    • Provides information for evaluating:
    • Analyzing an enterprise’s:
      • Liquidity
        • Time to elapse until converted to cash/liability has to be paid
      • Solvency
        • Ability to pay debts when due
      • Financial flexibility
        • Ability to alter amounts & timing of cash flows to respond to unexpected situations
        • Affected by liquidity & solvency
    Balance 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: 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: Classification
    • 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
    Balance Sheet: Classification Assets Liabilities and Equity
    • 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 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 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 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 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 Liabilities
    • Capital stock
    • Additional paid-in-capital
    • Retained earnings
    • Partnership/sole proprietors
      • Capital (permanent) drawing (temporary) separate
    • Illustration 5-15 page 182
    Owners’ Equity
    • Account form
      • Assets on left side
      • Liabilities & SE on right side
    • Report form
      • Pancake
      • Illustration 5-16 page 183
    Balance 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 Information Reported
    • Parenthetical explanations
    • Notes
      • Illustrations page 188
    • Cross references and contra/adjunct items
      • Illustrations page 189
    • Supporting schedules
      • Illustration page 189
    Balance Sheet: Techniques of Disclosure
  • Part 2: The Statement of Cash 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 Statement
    • Information comes from
      • Comparative BS
      • Current IS
      • Selected transaction data
    • Inflows and outflows are reported for:
      • Operating
      • Investing
      • Financing activities
    The 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 Statement
  • Cash 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 Cash Flows
  • The Statement of Cash Flows: Indirect Method 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
    • Ratio analysis expresses the relationship between selected financial data.
    • These relationships can be expressed as:
    • Percentages
    • Rates
    • Proportions
    Ratio Analysis
  • 06/02/10 Type What is measured Examples Types of Ratios Coverage ratios Some protection for LT creditors & investors Debt to total assets Times interest earned Liquidity ratios Short-term ability to pay maturing obligations Current ratio Quick assets ratio Profitability ratios Degree of success or failure for a given period Return on assets Earnings per share Activity ratios Effectiveness in using assets employed Receivables turnover Inventory turnover
    • 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 Analysis
    • Free cash flow
      • Measures financial flexibility
        • Discretionary cash flow available for
          • Additional investments
          • Debt retirement
          • Purchase treasury stock
      • Formula
        • Net cash from operating activities
        • Less
        • Capital outlay
        • Dividends
      • Illustration page 198
    Cash Flow Analysis
    • Class exercises
    • E5-3 E5-4 E5-6
    • E5-8 E5-9 E5-13
    • E5-14
    Balance Sheet & Statement of Cash Flows