Intermediate Accounting, 11th ed.

Kieso, Weygandt, and Warfield

Chapter 5: Balance Sheet and Statement of Cash Flows Systems

Prepared by Jep Robertson New Mexico State University

Chapter 5: Balance Sheet and Statement of Cash Flows Systems

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

Chapter 5: Balance Sheet and Statement of Cash Flows Systems

5. Identify major disclosure techniques for the balance sheet. 6. Indicate the purpose of the statement of cash flows. 7. Identify the content of the statement of cash flows. 8. Prepare a statement of cash flows. 9. Understand the usefulness of the statement of cash flows.

Part 1: The Balance Sheet

Balance Sheet: Usefulness

The balance sheet provides information for evaluating: Capital structure Rates of return Analyzing an enterprises:
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.

Balance Sheet: Classification

Guidelines for reporting assets and liabilities separately: Type or expected function in the central operations Implications for the enterprises financial flexibility Liquidity characteristics

Balance Sheet: Classification

Assets Liabilities and Equity

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

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

1 2

Long-Term Investments
Long-term investments may be:
1 2 3 4

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:
1 2

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: 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

Balance Sheet: Techniques of Disclosure

Parenthetical explanations Notes Cross references and contra items Supporting schedules

Part 1: The Statement of Cash Flows

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

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

The Statement of Cash Flows: Indirect Method

Accrual Based Statements
Income Statement items & Changes in Current Assets and Current Liabilities Balance Sheet: Changes in Non-Current Assets Balance Sheet: Changes in Non-Current Liabilities and Equity

Cash Flow Statement

Operating activities: Adjust net income for accruals and non-cash charges to get cash flows Investing activities: Inflows from sale of assets and Outflows from purchases of assets Financing activities: Inflows and outflows from loan and equity transactions

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

Types of Ratios
Type Liquidity ratios Activity ratios Profitability ratios Coverage ratios What is measured
Short-term ability to pay maturing obligations Effectiveness in using assets employed Degree of success or failure for a given period Degree of protection for long-term creditors and investors

Examples
Current ratio Quick assets ratio Receivables turnover Inventory turnover Rate of return on assets Earnings per share

Debt to total assets Times interest earned

COPYRIGHT
Copyright 2004 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.