This document discusses balance sheet and statement of cash flows systems. It covers the uses and limitations of the balance sheet, how to classify assets and liabilities on the balance sheet, and techniques for disclosing balance sheet information. It also explains the purpose and content of the statement of cash flows, how to prepare one using the indirect method, and the usefulness of the statement of cash flows. Finally, it briefly discusses ratio analysis and types of financial ratios.

1. Balance Sheet and Statement of Cash
Flows Systems

2. Chapter 5: Balance Sheet and
Statement of Cash Flows Systems
1. Identify the uses and limitations of a balance
sheet.
After studying this chapter, you should be
2. Identify the major classifications of the
able to: sheet.
balance
3. Prepare a classified balance sheet using the
report and account formats.
4. Identify balance sheet information requiring
supplemental disclosure.

3. Chapter 5: Balance Sheet and
Statement of Cash Flows Systems
1. Identify major disclosure techniques for the
balance sheet.
2. Indicate the purpose of the statement of cash
flows.
3. Identify the content of the statement of cash
flows.
4. Prepare a statement of cash flows.
5. Understand the usefulness of the statement of
cash flows.

4. Part 1: The Balance Sheet

5. Balance Sheet: Usefulness
The balance sheet provides information for
evaluating:
 Capital structure
 Rates of return
 Analyzing an enterprise’s:
 Liquidity
 Solvency
 Financial flexibility

6. 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.

7. Balance Sheet: Classification
Guidelines for reporting assets and
liabilities separately:
• Type or expected function in the central
operations
• Implications for the enterprise’s
financial flexibility
• Liquidity characteristics

8. Balance Sheet: Classification
 Current Assets  Current liabilities
Assets
 Long-term  Long-term debt Equity
Liabilities and
investments  Owners’ equity
 Property, plant, and Capital stock
equipment  Additional paid-in
 Intangible assets capital
 Other assets  Retained earnings

9. 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:
1 Short-term investments at fair value
2 Accounts receivable at net realizable value

10. Long-Term Investments
Long-term investments may be:
1 Investments in securities (bonds, stock)
2 Investments in fixed assets (land not used in
operations)
3 Investments set aside in special funds (e.g.,
sinking fund)
4 Investments in non-consolidated subsidiaries
or affiliated companies

11. Current Liabilities
Current liabilities are liquidated:
1 Either through the use of current assets, or
2 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

12. 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)

13. Balance Sheet: Additional
Information Reported
Additional information may be:
1 Information not presented elsewhere, or
2 Information that qualifies items in the balance
sheet
Supplemental information examples:
• Material events having an uncertain outcome
• Explanations regarding accounting policies
• Covenant restrictions

14. Balance Sheet: Techniques of
Disclosure
• Parenthetical explanations
• Notes
• Cross references and contra items
• Supporting schedules

15. Part 1: The Statement of Cash Flows

16. The Cash Flow Statement
The cash flow statement provides
information about:
 cash receipts (cash inflows)
 uses of cash (cash outflows)
 during a period of time
Inflows and outflows are reported for:
• operating
• investing
• financing activities

17. Cash Inflows and Outflows

18. 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

19. The Statement of Cash Flows:
Indirect Method
Accrual Based Statements Cash Flow Statement
Income Statement Operating activities:
items & Changes in Adjust net income for accruals
Current Assets and and non-cash charges to get
Current Liabilities cash flows
Investing activities:
Balance Sheet: Changes in Inflows from sale of assets and
Non-Current Assets Outflows from purchases of
assets
Balance Sheet: Changes in Financing activities:
Non-Current Liabilities Inflows and outflows
and from loan and equity
Equity transactions

20. Ratio Analysis
Ratio analysis expresses the relationship
between selected financial data.
These relationships can be expressed as:
 percentages
 rates, or
 proportions

21. Types of Ratios
Type What is measured Examples
Short-term ability to Current ratio
Liquidity ratios pay maturing Quick assets ratio
obligations
Activity ratios Effectiveness in using Receivables turnover
assets employed Inventory turnover
Degree of success or Rate of return on assets
Profitability failure for a given Earnings per share
ratios period
Degree of protection for
Debt to total assets
Coverage ratios long-term creditors and
Times interest earned
investors