Acc 303 Chapter 5

Front 1

Uses of Balance Sheet

Back 1

1. Provides information about an entity's assets, liabilities & equity
2. Aids in assessing risk and predicting future cash flows
3. Evaluation of liquidity, solvency & financial flexability

Front 2

Liquidity

Back 2

The amount of time that is expected for an asset to be realized or otherwise converted into cash or until a liability has to be paid. In general, the greater a company's liquidity, the lower its risk of failure

Front 3

Solvency

Back 3

The ability of a company to pay its debts as they mature. A company with a high level of long-term debt relative to assets has lower solvency than a similar company with a low level of long-term debt

Front 4

Financial flexibility

Back 4

The ability of a company to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. A company's liquidity and solvency affect its financial flexibility

Front 5

Limitations of Balance Sheet

Back 5

1. Fair value not reflected (Most assets and liabilities are reported at historical cost)
2. Estimates & judgements must be utilized in determining the
- collectibility of receivables
-useful lives of long-term assets
3. Omits many items that are financial value to the business
-value of company's human resources
-value of company's R&D
-some liabilities are omitted (off balance sheet leases & certain contractual arrangements)

Front 6

Main classification of the balance sheet

Back 6

1. Assets
2. Liabilities
3. Stockholder's equity (capital)

Front 7

Current assets

Back 7

-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
-presented in order of liquidity
1. Cash and cash equivalents (Fair Value)
2. Short-term investments (Generally, fair value)
3. Receivables (Estimated amount collectible)
4. Inventories (Lower-of-cost-or-market)
5. Prepaid expense (Cost)

Front 8

Long-term investments

Back 8

1. Investments in securities (bonds, common stock, long-term notes)
2. Investments in tangible fixed assets not currently used in operations (speculative land investment)
3. Investments set aside in special funds (sinking fund, pension fund, plant expansion fund)
4. Investments in nonconsolidated subsidiaries or affiliated companies.

Front 9

Property, plant, and equipment

Back 9

Tangible, long-lived assets such as land, buildings, machinery, furniture & wasting resources (timberland, mineral rights)
1. Most assets in this category are depreciable
2. Details of this category are fully disclosed in a footnote to the balance sheet

Front 10

Intangible assets

Back 10

-Assets that lack physical substance and are not financial instruments that represent significant economic resources
-Usually a high degree of uncertainty exists regarding realizability of future benefits
-limited life intangible assets are amortized over their useful life
-indefinite life in tangible assets (goodwill) are not amortized but are assessed for impairment
-Examples:
1. patents
2. franchise rights
3. copyrights
4. trademarks
5. customer list

Front 11

Other assets

Back 11

Unusual items not included in one of the other categories. Example:
1. long-term prepaid expenses
2. deferred income taxes
3. assets in special funds
4. property held for sale
5. restricted cash or securities

Front 12

Current liabilities

Back 12

The obligations that are reasonably expected to be paid within the next year. Examples:
1. Accounts payable
2. Wages payable
3. Taxes payable
4. Current portion of long-term debt
5. Accrued compensation
6. Unearned revenue

Front 13

Long-term liabilities

Back 13

-Obligations that are not reasonably expected to be paid within the next operating cycle.
-All covenants & restrictions must be disclosed
-Examples: bank debt, bonds

Front 14

Stockholder's equity

Back 14

1. Capital stock: The par or stated value of the shares issued.
2. Additional paid in capital: The excess of amounts paid in over the par or stated value.
3. Retained earnings: The corporation's undistributed earnings
4. Treasury stock (contra equity account): debited, buybacks of stocks

Front 15

Prepare a classified balance sheet using the report & account formats

Back 15

Report format (top-bottom):
-list assets first, followed by liabilities & stockholder's equity
Account format (left-right):
-list assets on the left side & liabilities & stockholder's equity on right side

Front 16

Purpose of the Statement of Cash Flow

Back 16

-To provide relevant information about the cash receipts in cash payments of the company during a period
-Answers the following questions:
1. Where did the cash come from during the period
2. What was the cash used for during the period
3. What was the change in the cash balance during the period

Front 17

Content of the Statement of Cash Flows

Back 17

1. Operating activities
-involve the cash effects of transactions that enter into the determination of net income
2. Investing activities
-involve making and collecting loans and acquiring and disposing of investments (both debt and equity) and property, plant, and equipment.
3. Financing activities
-involve liability and owners' equity items. They include
(a) obtaining resources from owners and providing them with a return on their investment
(b) borrowing money from creditors and repaying the amounts borrowed.

Front 18

Significant non-cash activities

Back 18

Reported in either a separate schedule at the bottom of the statement of cash flows or in separate notes to the financial statements. Examples:
1. Issuance of common stock to purchase assets
2. Conversion of bonds into common stock
3. Issuance of debt to purchase assets
4. Exchanges of long-lived assets

Front 19

Usefulness of the Statement of Cash Flows

Back 19

1. Current cash debt coverage
2. Financial flexibility
3. Free cash flow

Front 20

Current cash debt coverage

Back 20

"Net cash provided by operating activities / average current liabilities"
-Measure of liquidity that indicates a company's ability to pay its short-term debts.
-The higher the current cash debt coverage ratio, the less likely a company will have liquidity problems.

Front 21

Financial flexibility (Current debt coverage ratio)

Back 21

"Net cash provided by operating activities / average total liabilities"
-Measure of solvency that indicates a company's ability to repay its liabilities with cash generated from operations (without having to liquidate productive assets)
-The higher this ratio, the less likely the company will experience difficulty in meeting its obligations as they come due.
- It signals whether the company can pay its debts and survive if external sources of funds become limited or too expensive.

Front 22

Free cash flow

Back 22

"Net cash provided by operating activities - capital expenditures - dividends"
Used to determine the discretionary cash the company has to purchase of additional investments, retire its debt, purchase treasury stock or add to its liquidity

Front 23

Balance sheet information that requires supplemental disclosure (footnotes)

Back 23

1. Contingencies: loss contingencies
-litigation
-environmental issues
-tax assessments
-governmental investigations
2. Accounting policies:
-significant accounting principles & method
3. Contractual situations:
-lease contracts
-pension obligations
-stock option plans
4. Financial instruments
-Assets consisting of cash, accounts receivable, an ownership interest, or a contractual right to receive or obligation to deliver cash or another financial instrument

Front 24

Major disclosure techniques for the balance sheet

Back 24

1. parenthetical explanations
2. footnotes
3. supplemental schedules