Chapter 5 Intermediate 15th Ed

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Chapter 5 Intermediate 15th Ed

  1. 1. INTERMEDIATE Intermediate ACCOUNTING Intermediate Accounting Accounting F I F T E E N T H 5-1 E D I T I O N Prepared by Prepared by Coby Harmon Prepared by Coby Harmon Coby Harmon University of California Santa Barbara University of California, Santa Barbara University of California, Santa Barbara Westmont College Westmont College kieso weygandt warfield team for success
  2. 2. PREVIEW OF CHAPTER 5 Intermediate Accounting 15th Edition Kieso Weygandt Warfield 5-2
  3. 3. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. 5. 5-3 Indicate the purpose of the statement of cash flows. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6.
  4. 4. Balance Sheet Balance Sheet, sometimes referred to as the statement of financial position: 1. Reports assets, liabilities, and equity at a specific date. 2. Provides information about resources, obligations to creditors, and equity in net resources. 3. Helps in predicting amounts, timing, and uncertainty of future cash flows. 5-4 LO 1 Explain the uses and limitations of a balance sheet.
  5. 5. Balance Sheet Usefulness of the Balance Sheet  Computing rates of return.  Evaluating the capital structure.  Assess risk and future cash flows.  Analyze the company’s: ► ► Solvency, and ► 5-5 Liquidity, Financial flexibility. LO 1 Explain the uses and limitations of a balance sheet.
  6. 6. GROUNDED WHAT’S YOUR PRINCIPLE The terrorist attacks of September 11, 2001, showed how vulnerable the major airlines are to falling demand for their services. Since that infamous date, major airlines have reduced capacity and slashed jobs to avoid bankruptcy. United Airlines, Northwest Airlines, US Airways, and several smaller competitors fi led for bankruptcy in the wake of 9/11. Delta Airlines made the following statements in its annual report issued shortly after 9/11: “If we are unsuccessful in further reducing our operating costs . . . we will need to restructure our costs under Chapter 11 of the U.S. Bankruptcy Code. . . . We have substantial liquidity needs and there is no assurance that we will be able to obtain the necessary financing to meet those needs on acceptable terms, if at all.” 5-6 These financial flexibility challenges have continued, exacerbated by ever-increasing fuel prices, labor costs, and the economic downturn in response to the financial crisis. Not surprisingly, several of the major airlines (Delta and Northwest, Continental and United, and Airtran and Southwest) merged recently as a way to build some competitive synergies and to bolster their financial flexibility. Others (American Airlines and US Airways) are exploring mergers. Source: R. Seaney, “Airline Mergers: Good for Travelers?” http:// abcnews.go.com/Travel/airline-merger-maniacost/story?id516227892 (April 27, 2012). LO 1 Explain the uses and limitations of a balance sheet.
  7. 7. Balance Sheet Limitations of the Balance Sheet   Use of judgments and estimates.  5-7 Most assets and liabilities are reported at historical cost. Many items of financial value are omitted. LO 1 Explain the uses and limitations of a balance sheet.
  8. 8. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. 5. 5-8 Indicate the purpose of the statement of cash flows. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6.
  9. 9. Balance Sheet Classification in the Balance Sheet 5-9 LO 2 Identify the major classifications of the balance sheet.
  10. 10. Balance Sheet Classification in the Balance Sheet Illustration 5-1 In practice you usually see little departure from these major subdivisions. 5-10 LO 2 Identify the major classifications of the balance sheet.
  11. 11. Classification in the Balance Sheet Current Assets Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Illustration 5-2 5-11 LO 2 Identify the major classifications of the balance sheet.
  12. 12. Classification in the Balance Sheet Question The correct order to present current assets is a. Cash, accounts receivable, prepaid items, inventories. b. Cash, accounts receivable, inventories, prepaid items. c. Cash, inventories, accounts receivable, prepaid items. d. Cash, inventories, prepaid items, accounts receivable. Order of Liquidity 5-12 LO 2 Identify the major classifications of the balance sheet.
  13. 13. Balance Sheet – “Current Assets” Cash  Generally any monies available “on demand.”  Cash equivalents - short-term highly liquid investments that mature within three months or less.  Restrictions or commitments must be disclosed. Illustration 5-3 Balance Sheet—Restricted Cash 5-13 LO 2
  14. 14. Balance Sheet – “Current Assets” Cash Illustration 5-4 Balance Sheet—Restricted Cash 5-14 LO 2 Identify the major classifications of the balance sheet.
  15. 15. Balance Sheet – “Current Assets” Short-Term Investments Portfolios Valuation Classification Held-toMaturity Debt Amortized Cost Current or Noncurrent Trading Debt or Equity Fair Value Current Availablefor-Sale 5-15 Type Debt or Equity Fair Value Current or Noncurrent LO 2 Identify the major classifications of the balance sheet.
  16. 16. Balance Sheet – “Current Assets” Short-Term Investments Illustration 5-5 Balance Sheet Presentation of Investments in Securities 5-16 LO 2 Identify the major classifications of the balance sheet.
  17. 17. Balance Sheet – “Current Assets” Receivables Major categories of receivables should be shown in the balance sheet or the related notes. A company should clearly identify   Amount and nature of any nontrade receivables.  5-17 Anticipated loss due to uncollectibles. Receivables used as collateral. LO 2 Identify the major classifications of the balance sheet.
  18. 18. Balance Sheet – “Current Assets” Receivables Illustration 5-6 Balance Sheet Presentation of Receivables 5-18 LO 2
  19. 19. Balance Sheet – “Current Assets” Inventories Disclose: ► Basis of valuation (e.g., lower-of-cost-or-market). ► Cost flow assumption (e.g., FIFO or LIFO). Illustration 5-7 Balance Sheet Presentation of Inventories 5-19 LO 2
  20. 20. Balance Sheet – “Current Assets” Prepaid Expenses Payment of cash, that is recorded as an asset because service or benefit will be received in the future. Cash Payment Expense Recorded BEFORE Prepayments often occur in regard to:   rent  supplies  taxes  5-20 insurance advertising LO 2 Identify the major classifications of the balance sheet.
  21. 21. Balance Sheet – “Current Assets” Prepaid Expenses Illustration 5-9 Balance Sheet Presentation of Prepaid Expenses 5-21 LO 2 Identify the major classifications of the balance sheet.
  22. 22. Balance Sheet – “Current Assets” Summary Balance Sheet (in thousands) Cash and other assets a company expects to    Cash $ 285,000 140,000 Accounts receivable 777,000 402,000 Prepaid expenses sell, or ST Investments Inventory convert into cash, 170,000 Total current assets consume 1,774,000 Investments: either in one year or in the operating cycle, whichever is longer. 5-22 Current assets Invesment in ABC bonds 321,657 Investment in UC Inc. 253,980 LO 2 Identify the major classifications of the balance sheet.
  23. 23. Classification in the Balance Sheet Noncurrent Assets Long-term Investments 1. 2. Tangible fixed assets not currently used in operations (land held for speculation). 3. Special funds (sinking fund, pension fund, plant expansion fund, or cash surrender value of life insurance). 4. 5-23 Securities (bonds, common stock, or long-term notes). Nonconsolidated subsidiaries or affiliated companies. LO 2 Identify the major classifications of the balance sheet.
  24. 24. Balance Sheet – “Noncurrent Assets” Long-Term Investments Portfolios Valuation Classification Held-toMaturity Debt Amortized Cost Current or Noncurrent Trading Debt or Equity Fair Value Current Availablefor-Sale 5-24 Type Debt or Equity Fair Value Current or Noncurrent LO 2 Identify the major classifications of the balance sheet.
  25. 25. Balance Sheet – “Noncurrent Assets” Balance Sheet (in thousands) Long-Term Investments Current assets Cash $ 285,000 Investments: Securities Securities   5-25 225,000 Pension fund LO 2 550,000 Sinking fund For marketable securities, management’s intent determines current or noncurrent classification. 150,000 Land held for speculation Long-term notes 253,980 Notes receivable Stock, and 321,657 Investment in UC Inc. Bonds,  Invesment in ABC bonds 653,798 Cash surrender value Investment in Uncon. Sub. Total investments 84,321 457,836 2,696,592 Property, Plant, and Equip. Building Land 1,375,778 975,000
  26. 26. Balance Sheet – “Noncurrent Assets” Balance Sheet (in thousands) Long-Term Investments Current assets Cash $ 285,000 Investments: Fixed Assets Fixed Assets Investment in UC Inc. 253,980 Notes receivable 150,000 Land held for speculation 550,000 225,000 Pension fund Land held for speculation 321,657 Sinking fund  Invesment in ABC bonds 653,798 Cash surrender value Investment in Uncon. Sub. Total investments 84,321 457,836 2,696,592 Property, Plant, and Equip. Building 5-26 LO 2 Land 1,375,778 975,000
  27. 27. Balance Sheet – “Noncurrent Assets” Balance Sheet (in thousands) Long-Term Investments Current assets Cash $ 285,000 Investments: Special Funds Special Funds   150,000 Land held for speculation 550,000 Sinking fund 225,000 Pension fund Cash surrender value of life insurance 253,980 Notes receivable Pensions fund 321,657 Investment in UC Inc. Sinking fund  Invesment in ABC bonds 653,798 Cash surrender value Investment in Uncon. Sub. Total investments 84,321 457,836 2,696,592 Property, Plant, and Equip. Building 5-27 LO 2 Land 1,375,778 975,000
  28. 28. Balance Sheet – “Noncurrent Assets” Balance Sheet (in thousands) Long-Term Investments Current assets Cash $ 285,000 Investments: Nonconsolidated Nonconsolidated Subsidiaries or Subsidiaries or Affiliated Affiliated Companies Companies Invesment in ABC bonds 321,657 Investment in UC Inc. 253,980 Notes receivable 150,000 Land held for speculation 550,000 Sinking fund 225,000 Pension fund 653,798 Cash surrender value Investment in Uncon. Sub. Total investments 84,321 457,836 2,696,592 Property, Plant, and Equip. Building 5-28 LO 2 Land 1,375,778 975,000
  29. 29. Balance Sheet – “Noncurrent Assets” Long-Term Investments 5-29 Illustration 5-10 Balance Sheet Presentation of Long-Term Investments LO 2 Identify the major classifications of the balance sheet.
  30. 30. Balance Sheet – “Noncurrent Assets” Property, Plant, and Equipment Tangible long-lived assets used in the regular operations of the business.   5-30 Physical property such as land, buildings, machinery, furniture, tools, and wasting resources (minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets. LO 2 Identify the major classifications of the balance sheet.
  31. 31. Balance Sheet – “Noncurrent Assets” Property, Plant, and Equipment A company discloses the basis it uses to value property, plant, and equipment. 5-31 Balance Sheet (in thousands) Current assets Cash Total investments Property, Plant, and Equip. Building Land Machinery and equipment Capital leases Leasehold improvements Accumulated depreciation Total PP&E Intangibles Goodwill Patents Trademarks $ 285,000 2,696,592 1,375,778 975,000 234,958 384,650 175,000 (975,000) 2,170,386 3,000,000 177,000 40,000 LO 2 Identify the major classifications of the balance sheet.
  32. 32. Balance Sheet – “Noncurrent Assets” Property, Plant, and Equipment Illustration 5-11 Balance Sheet Presentation of Property, Plant, and Equipment 5-32 LO 2 Identify the major classifications of the balance sheet.
  33. 33. Balance Sheet – “Noncurrent Assets” Intangible Assets Lack physical substance and are not financial instruments.   5-33 Limited life intangibles amortized. Indefinite-life intangibles tested for impairment. Balance Sheet (in thousands) Current assets Cash Total PP&E Intangibles Goodwill Patents Trademark Franchises Copyright Total intangibles Other assets Prepaid pension costs Deferred income tax Total other Total Assets $ 285,000 2,170,386 2,000,000 177,000 40,000 125,000 55,000 2,397,000 133,000 40,000 173,000 $ 9,210,978 LO 2
  34. 34. Balance Sheet – “Noncurrent Assets” Illustration: Patrick Corporation adjusted trial balance contained the following asset accounts at December 31, 2014: Prepaid Rent $12,000; Goodwill $50,000; Franchise Fees Receivable $2,000; Franchises $47,000; Patents $33,000; Trademarks $10,000. Prepare the intangible assets section of the balance sheet. Intangible Assets Goodwill $ 50,000 Franchises 47,000 Patents 33,000 Trademarks 10,000 Total 5-34 $140,000 LO 2 Identify the major classifications of the balance sheet.
  35. 35. Balance Sheet – “Noncurrent Assets” Intangible Assets Illustration 5-12 Balance Sheet Presentation of Intangible Assets 5-35 LO 2 Identify the major classifications of the balance sheet.
  36. 36. Balance Sheet – “Noncurrent Assets” Other Assets Items vary in practice. Can include Long-term prepaid expenses Non-current Assets receivables in special funds Deferred income taxes Property held for sale Restricted 5-36 cash or securities LO 2 Identify the major classifications of the balance sheet.
  37. 37. Balance Sheet – “Noncurrent Assets” Other Assets This section should include only unusual items sufficiently different from assets in the other categories. 5-37 Balance Sheet (in thousands) Current assets Cash Total PP&E Intangibles Goodwill Patents Trademark Franchises Copyright Total intangibles Other assets Prepaid pension costs Deferred income tax Total other Total Assets $ 285,000 2,170,386 2,000,000 177,000 40,000 125,000 55,000 2,397,000 133,000 40,000 173,000 $ 9,210,978 LO 2
  38. 38. Classification in the Balance Sheet Liabilities Balance Sheet (in thousands) Companies classify liabilities as current or long-term. 5-38 Current liabilities Notes payable Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities LT debt Total current liabilities Long-term liabilities Long-term debt Obligations capital lease Deferred income taxes Total long-term liabilities Stockholders' equity $ 233,450 131,800 43,000 17,000 23,400 121,000 569,650 979,500 345,800 77,909 1,403,209 LO 2 Identify the major classifications of the balance sheet.
  39. 39. Balance Sheet – “Liabilities” Current Liabilities Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. 5-39 Balance Sheet (in thousands) Current liabilities Notes payable Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities LT debt Total current liabilities Long-term liabilities Long-term debt Obligations capital lease Deferred income taxes Total long-term liabilities Stockholders' equity $ 233,450 131,800 43,000 17,000 23,400 121,000 569,650 979,500 345,800 77,909 1,403,209 LO 2 Identify the major classifications of the balance sheet.
  40. 40. Balance Sheet – “Liabilities” Current Liabilities Illustration 5-13 Balance Sheet Presentation of Current Liabilities 5-40 LO 2 Identify the major classifications of the balance sheet.
  41. 41. Balance Sheet – “Liabilities” Long-Term Liabilities Obligations that a company does not reasonably expect to liquidate within the normal operating cycle. All covenants and restrictions must be disclosed. 5-41 Balance Sheet (in thousands) Current liabilities Notes payable Accounts payable Accrued compensation Unearned revenue Income tax payable Current maturities LT debt Total current liabilities Long-term liabilities Long-term debt Obligations capital lease Deferred income taxes Total long-term liabilities Stockholders' equity $ 233,450 131,800 43,000 17,000 23,400 121,000 569,650 979,500 345,800 77,909 1,403,209 LO 2 Identify the major classifications of the balance sheet.
  42. 42. “SHOW ME THE ASSETS!” WHAT’S YOUR PRINCIPLE Before the dot-com bubble burst, concerns about liquidity and solvency led creditors of many dotcom companies to demand more assurances that these companies could pay their bills when due. A key indicator for creditors is the Some vendors demanded that their dot-com customers sign notes stating that the goods shipped to them would serve as collateral for the transaction. Other vendors began shipping goods on consignment—an arrangement whereby the vendor retains ownership of the goods until a third party buys and pays for them. Another recent bubble in the real estate market created a working capital and liquidity crisis for no less a revered financial institution than Bear Stearns. What happened? Bear Stearns was one of the biggest investors in mortgage backed securities. But when the housing market cooled off and the value of the collateral backing Bear Stearns’s mortgage 5-42 amount of working capital. For example, when a report predicted that Amazon.com’s working capital would turn negative, the company’s vendors began to explore steps that would ensure that Amazon would pay them. securities dropped dramatically, the market began to question Bear Stearns’s ability to meet its obligations. The result: The Federal Reserve stepped in to avert a collapse of the company, backing a bailout plan that guaranteed $30 billion of Bear Stearns’s investments. This paved the way for a buy-out by JPMorgan Chase at $2 per share (later amended to $10 a share)—quite a bargain since Bear Stearns had been trading above $80 a share just a month earlier. Source: Robin Sidel, Greg Ip, Michael M. Phillips, and Kate Kelly, “The Week That Shook Wall Street: Inside the Demise of Bear Stearns,” Wall LO 2 Identify the Street Journal (March 18, 2008), p. A1. major classifications of the balance sheet.
  43. 43. Balance Sheet – “Liabilities” Illustration: Included in Adams Company’s December 31, 2014, trial balance are the following accounts: Accounts Payable $220,000; Pension Asset/Liability $375,000; Discount on Bonds Payable $29,000; Unearned Revenue $41,000; Bonds Payable $400,000; Salaries and Wages Payable $27,000; Interest Payable $12,000; Income Taxes Payable $29,000. Prepare the long-term liabilities section of the balance sheet. Long-term liabilities Pension Asset/liability Bonds payable Discount on bonds payable Total 5-43 $375,000 400,000 (29,000) $746,000 LO 2 Identify the major classifications of the balance sheet.
  44. 44. Balance Sheet – “Liabilities” Long-Term Liabilities Illustration 5-14 Balance Sheet Presentation of Long-Term Liabilities 5-44 LO 2
  45. 45. Classification in the Balance Sheet Owners’ Equity 5-45 LO 2 Identify the major classifications of the balance sheet.
  46. 46. Classification in the Balance Sheet Owners’ Equity Illustration 5-15 Balance Sheet Presentation of Stockholders’ Equity 5-46 LO 2 Identify the major classifications of the balance sheet.
  47. 47. Classification in the Balance Sheet Account Classification (a) Investment in preferred stock (b) Treasury stock (b) Stockholders’ Equity (c) Common stock (c) Stockholders’ Equity (d) Cash dividends payable (d) Current liability (e) Accumulated depreciation (e) Contra-asset (f) Interest payable (f) Current liability (g) Deficit (g) Stockholders’ Equity (h) Trading securities (h) Current asset (i) Unearned revenue 5-47 (a) Current asset/Investment (i) Current liability LO 2 Identify the major classifications of the balance sheet.
  48. 48. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-48
  49. 49. Balance Sheet Format Classified Balance Sheet  Account form  Report form Accounting Trends and Techniques—2011 (New York: AICPA) indicates that all of the 500 companies surveyed use either the “report form” (4848) or the “account form” (16), sometimes collectively referred to as the “customary form.” 5-49 LO 3 Prepare a classified balance sheet using the report and account formats.
  50. 50. Balance Sheet Format Report Form Illustration 5-16 5-50 LO 3
  51. 51. WARNING SIGNALS WHAT’S YOUR PRINCIPLE 5-51 LO 3 Prepare a classified balance sheet using the report and account formats.
  52. 52. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-52
  53. 53. Statement of Cash Flows The income statement, the statement of stockholders’ equity, and the balance sheet—each present SOME information about the cash flows of an enterprise during a period. The statement of cash flows presents a DETAILED SUMMARY of all the cash inflows and outflows, or the sources and uses of cash during the period. 5-53 LO 4 Indicate the purpose of the statement of cash flows.
  54. 54. Statement of Cash Flows Purpose of the Statement of Cash Flows To provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement provides answers to the following questions: 1. Where did the cash come from? 2. What was the cash used for? 3. What was the change in the cash balance? 5-54 LO 4 Indicate the purpose of the statement of cash flows.
  55. 55. WATCH THAT CASH FLOW WHAT’S YOUR PRINCIPLE Investors usually focus on net income measured on an accrual basis. However, information on cash flows can be important for assessing a company’s liquidity, financial flexibility, and overall financial performance. The graph below shows W. T. Grant’s financial performance over 7 years. Although W. T. Grant showed consistent profits and even some periods of earnings growth, its cash flow began to “go 5-55 south” starting in about year 3. The company fi led for bankruptcy shortly after year 7. Financial statement readers who studied the company’s cash flows would have found early warnings of its problems. The Grant experience is a classic case, illustrating the importance of cash flows as an early warning signal of financial problems. A more recent retailer case is Target. Although Target has shown good profits, some are concerned that a bit too much of its sales have been made on credit rather than cash. Why is this a problem? Like W. T. Grant, the earnings of profitable lenders can get battered in future periods if they have to start adding large amounts to their bad-loan reserve to catch up with credit losses. And if losses ramp up on Target-branded credit cards, Target may get hit in this way. Source: Peter Eavis, “Is Target Corp.’s Credit Too Generous?” Wall 1 Street Journal (March 11, 2008), p. C1. LO 4
  56. 56. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-56
  57. 57. Statement of Cash Flows Content and Format Three different activities:  Operating,  Investing,  Financing Illustration 5-17 Basic Format of Cash Flow Statement 5-57 LO 5 Identify the content of the statement of cash flows.
  58. 58. Statement of Cash Flows Content and Format Operating Operating Financing Financing Cash effects of transactions that enter into the determination of net income. 5-58 Investing Investing Making and collecting loans and acquiring and disposing of investments and property, plant, and equipment. Obtaining resources from owners and providing them with a return on their investment, and borrowing money from creditors and repaying the amounts borrowed. LO 5 Identify the content of the statement of cash flows.
  59. 59. Statement of Cash Flows Illustration 5-18 5-59 LO 5 Identify the content of the statement of cash flows.
  60. 60. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-60
  61. 61. Statement of Cash Flows Overview of the Preparation of the Statement Information obtained from several sources: 1) comparative balance sheets, 2) the current income statement, and 3) selected transaction data. 5-61 LO 6 Prepare a basic statement of cash flows.
  62. 62. Statement of Cash Flows Illustration: On January 1, 2014, in its first year of operations, Telemarketing Inc. issued 50,000 shares of $1 par value common stock for $50,000 cash. The company rented its office space, furniture, and telecommunications equipment and performed marketing services throughout the first year. In June 2014 the company purchased land for $15,000. Illustration 5-19 shows the company’s comparative balance sheets at the beginning and end of 2014. 5-62 LO 6 Prepare a basic statement of cash flows.
  63. 63. Statement of Cash Flows Illustration 5-19 Illustration 5-20 5-63 LO 6
  64. 64. Statement of Cash Flows Preparing the Statement of Cash Flows Four steps: 1. Determine the net cash provided by (or used in) operating activities. 2. Determine the net cash provided by (or used in) investing and financing activities. 3. Determine the change (increase or decrease) in cash during the period. 4. Reconcile the change in cash with the beginning and the ending cash balances. 5-64 LO 6 Prepare a basic statement of cash flows.
  65. 65. Statement of Cash Flows Illustration 5-19 Illustration 5-20 Cash provided by operating activities 5-65 Advance slide in presentation mode to reveal answers. Illustration 5-21 LO 6 Prepare a basic statement of cash flows.
  66. 66. Illustration 5-19 Illustration 5-20 Statement of Cash Flows Next, the company determines its investing and financing activities. 5-66 Advance slide in presentation mode to reveal answers. Illustration 5-22
  67. 67. Statement of Cash Flows Illustration: Keyser Beverage Company reported the following items in the most recent year. Activity Net income Dividends paid Increase in accounts receivable Increase in accounts payable Purchase of equipment Depreciation expense Issue of notes payable $40,000 5,000 10,000 7,000 8,000 4,000 20,000 Operating Financing Operating Operating Investing Operating Financing Required: Compute net cash provided by operating activities. 5-67 Advance slide in presentation mode to reveal answers. LO 6 Prepare a basic statement of cash flows.
  68. 68. Statement of Cash Flows Statement of Cash Flow (in thousands) Operating activities Net income Increase in accounts receivable Increase in accounts payable Depreciation expense Cash flow from operations Investing activities Purchase of equipment Financing activities Proceeds from notes payable Dividends paid Cash flow from financing Increase in cash 5-68 $ 40,000 (10,000) 5,000 40,000 75,000 Noncash credit to revenues. Noncash charge to expenses. (8,000) 20,000 (5,000) 15,000 $ 82,000 LO 6 Prepare a basic statement of cash flows.
  69. 69. Statement of Cash Flows Question In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. b. Sale of merchandise on credit c. Declaration of a cash dividend d. 5-69 Sale of equipment at book value Issuance of bonds payable at a discount receivable. LO 6 Prepare a basic statement of cash flows.
  70. 70. Statement of Cash Flows Significant Noncash Activities Significant financing and investing activities that do not affect cash are reported in either a separate schedule at the bottom of the statement of cash flows or in the notes. Examples include:   Conversion of bonds into common stock.  Issuance of debt to purchase assets.  5-70 Issuance of common stock to purchase assets. Exchanges on long-lived assets. LO 6 Prepare a basic statement of cash flows.
  71. 71. Statement of Cash Flows Illustration 5-23 Comprehensive Statement of Cash Flows 5-71
  72. 72. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-72
  73. 73. Statement of Cash Flows Usefulness of the Statement of Cash Flows Without cash, a company will not survive. Cash flow from Operations:   5-73 High amount - company able to generate sufficient cash to pay its bills. Low amount - company may have to borrow or issue equity securities to pay bills. LO 7 Understand the usefulness of the statement of cash flows.
  74. 74. Usefulness of the Statement of Cash Flows Financial Liquidity Current Cash Debt Coverage = Ratio Illustration 5-25 Net Cash Provided by Operating Activities Average Current Liabilities Ratio indicates whether the company can pay off its current liabilities from internally generated cash flows. A ratio near 1:1 is good. 5-74 LO 7 Understand the usefulness of the statement of cash flows.
  75. 75. Usefulness of the Statement of Cash Flows Financial Flexibility Cash Debt Coverage Ratio = Illustration 5-26 Net Cash Provided by Operating Activities Average Total Liabilities This ratio indicates a company’s ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. 5-75 LO 7 Understand the usefulness of the statement of cash flows.
  76. 76. Usefulness of the Statement of Cash Flows Free Cash Flow Illustration 5-28 The amount of discretionary cash flow a company has that may be used for purchasing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity. 5-76 LO 7 Understand the usefulness of the statement of cash flows.
  77. 77. Usefulness of the Statement of Cash Flows Question The current cash debt coverage ratio is often used to assess a. financial flexibility. b. liquidity. c. profitability. d. solvency. 5-77 LO 7 Understand the usefulness of the statement of cash flows.
  78. 78. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-78
  79. 79. Additional Information Supplemental Disclosures Four types of information that are supplemental to account titles and amounts presented in the balance sheet: 5-79 LO 8 Determine which balance sheet information requires supplemental disclosure.
  80. 80. 5 Balance Sheet and Statement of Cash Flows LEARNING OBJECTIVES After studying this chapter, you should be able to: 1. 2. Explain the uses and limitations of a balance sheet. Identify the major classifications of the balance sheet. 3. Indicate the purpose of the statement of cash flows. 5. Identify the content of the statement of cash flows Prepare a basic statement of cash flows. 7. Understand the usefulness of the statement of cash flows. 8. Determine which balance sheet information requires supplemental disclosure. 9. Describe the major disclosure techniques for the balance sheet. Prepare a classified balance sheet using the report and account formats. 4. 6. 5-80
  81. 81. Additional Information Techniques of Disclosure   Notes  Cross-Reference and Contra Items  Supporting Schedules  5-81 Parenthetical Explanations Terminology LO 9 Describe the major disclosure techniques for the balance sheet.
  82. 82. APPENDIX 5A Ratio Analysis—A Reference Using Ratios to Analyze Performance Analysts and other interested parties can gather qualitative information from financial statements by examining relationships between items on the statements and identifying trends in these relationships. 5-82 LO 10 Identify the major types of financial ratios and what they measure.
  83. 83. APPENDIX 5A Using Ratios 5-83 Ratio Analysis—A Reference Illustration 5A-1 A Summary of Financial Ratios LO 10 Identify the major types of financial ratios and what they measure.
  84. 84. APPENDIX 5A Using Ratios 5-84 Ratio Analysis—A Reference Illustration 5A-1 A Summary of Financial Ratios LO 10 Identify the major types of financial ratios and what they measure.
  85. 85. APPENDIX 5A Using Ratios 5-85 Ratio Analysis—A Reference Illustration 5A-1 A Summary of Financial Ratios LO 10 Identify the major types of financial ratios and what they measure.
  86. 86. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company The following are the traditional financial portions of the annual report: • Letter to the Stockholders • Financial Highlights • Management’s Discussion and Analysis • Management Certification of Financial Statements • Management’s Report on Internal Control • Auditor’s Reports • Financial Statements • Notes to the Financial Statements • Supplementary Financial Information (e.g., 10-year financial summary) 5-86
  87. 87. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company Consolidated Statement of Earnings 5-87
  88. 88. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company Consolidated Balance Sheets 5-88
  89. 89. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company Consolidated Balance Sheets 5-89
  90. 90. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company Consolidated Statement of Shareholders’ Equity Dollars in millions/Shares in thousands Statements for the year ended 2010 and 2009 not presented. 5-90
  91. 91. APPENDIX 5B Specimen Financial Statements: The Procter & Gamble Company Consolidated Statement of Cash Flows 5-91
  92. 92. RELEVANT FACTS - Similarities   Both IFRS and GAAP require disclosures about (1) accounting policies followed, (2) judgments that management has made in the process of applying the entity’s accounting policies, and (3) the key assumptions and estimation uncertainty that could result in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Comparative prior period information must be presented and financial statements must be prepared annually.  5-92 Both IFRS and GAAP allow the use of title “balance sheet” or “statement of financial position.” IFRS recommends but does not require the use of the title “statement of financial position” rather than balance sheet. IFRS and GAAP require presentation of noncontrolling interests in the equity section of the balance sheet. LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  93. 93. RELEVANT FACTS - Differences   Under IFRS, current assets are usually listed in the reverse order of liquidity. For example, under GAAP cash is listed first, but under IFRS it is listed last.  IFRS has many differences in terminology. For example in the equity section common stock is called share capital—ordinary.  5-93 IFRS requires a classified statement of financial position except in very limited situations. IFRS follows the same guidelines as this textbook for distinguishing between current and noncurrent assets and liabilities. However under GAAP, public companies must follow SEC regulations, which require specific line items. Use of the term “reserve” is discouraged in GAAP, but there is no such prohibition in IFRS. LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  94. 94. ON THE HORIZON The FASB and the IASB are working on a project to converge their standards related to financial statement presentation. A key feature of the proposed framework is that each of the statements will be organized, in the same format, to separate an entity’s financing activities from its operating and investing activities and, further, to separate financing activities into transactions with owners and creditors. Thus, the same classifications used in the statement of financial position would also be used in the statement of comprehensive income and the statement of cash flows. The project has three phases. You can follow the joint financial presentation project at the following link: http://www.fasb.org/project/financial_statement_ presentation.shtml. 5-94 LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  95. 95. IFRS SELF-TEST QUESTION Current assets under IFRS are listed generally: a. by importance. b. in the reverse order of their expected conversion to cash. c. by longevity. d. alphabetically. 5-95 LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  96. 96. IFRS SELF-TEST QUESTION Companies that use IFRS: a. may report all their assets on the statement of financial position at fair value. b. are not allowed to net assets (assets 2 liabilities) on their statement of financial positions. c. may report noncurrent assets before current assets on the statement of financial position. d. do not have any guidelines as to what should be reported on the statement of financial position. 5-96 LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  97. 97. IFRS SELF-TEST QUESTION A company has purchased a tract of land and expects to build a production plant on the land in approximately 5 years. During the 5 years before construction, the land will be idle. Under IFRS, the land should be reported as: a. land expense. b. property, plant, and equipment. c. an intangible asset. d. a long-term investment. 5-97 LO 11 Compare the accounting procedure related to the balance sheet under GAAP and IFRS.
  98. 98. Copyright Copyright © 2013 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 5-98

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