Student 165 ACh 05

5
Balance Sheet and

Statement of Cash Flows
Intermediate
Accounting
Part-I
Learning Objectives
1.
Explain 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.
Indicate the purpose of the statement of cash flows.
5.
Identify the content of the statement of cash flows.
6.
Prepare a 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.

2
Balance
Balance Sheet
Sheet and
and Statement
Statement of
of Cash
Cash Flows
Flows
Balance Sheet
Statement of
Cash Flows
Usefulness
Purpose
Limitations
Content and format
Classification
Preparation
Additional
Information
Supplemental
disclosures
Techniques of
disclosure
Usefulness
Balance Sheet
Balance Sheet, also 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.
4
LO 1 Explain the uses and limitations of a balance sheet.
Balance Sheet
Usefulness of the Balance Sheet
Computing rates of return.
Evaluating the capital structure.
Assess risk and future cash flows.
Analyze the companys:
Liquidity,
Solvency, and
Financial flexibility.
5
Balance Sheet
Limitations of the Balance Sheet
Most assets and liabilities are reported at historical

cost.
Use of judgments and estimates.
Many items of financial value are omitted.
6
Balance Sheet
Classification
7
LO 2 Identify the major classifications of the balance sheet.
Balance Sheet
Classification
Illustration 5-1
In practice you usually see little departure from these major subdivisions.
8
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
9
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
102
LO

Cash
Illustration 5-4
Balance SheetRestricted Cash
11

Short-Term Investments
Portfolios
Type
Valuation
Classification
Held-toMaturity
Debt
Amortized
Cost
Current or
Noncurrent
Trading
Debt or
Equity
Fair Value
Current
Availablefor-Sale
Debt or
Equity
Fair Value
Current or
Noncurrent
12

Short-Term Investments
Illustration 5-5
Balance Sheet Presentation of
Investments in Securities
13

Receivables
Major categories of receivables should be shown in the
balance sheet or the related notes.
A company should clearly identify
Anticipated loss due to uncollectibles.
Amount and nature of any nontrade receivables.
Receivables used as collateral.

14

Receivables
Illustration 5-6
Balance Sheet Presentation
of Receivables
15

Inventories
Disclose:
Basis of valuation (e.g., lower-of-cost-or-market).
Cost flow assumption (e.g., FIFO or average cost).

Illustration 5-6
162
LO

Prepaid Expenses
Payment of cash, that is recorded as an asset because service or
benefit will be received in the future.
Cash Payment
BEFORE
Expense Recorded
Prepayments often occur in regard to:
insurance
rent
supplies
taxes
advertising
17

Prepaid Expenses
Illustration 5-9
18

Current Assets - Summary
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.
19

Non-Current Assets
Long-term Investments
1. Securities (bonds, common stock, or long-term notes).
2. Tangible fixed assets not currently used in operations
(land held for speculation).
3. Special funds (sinking fund, pension fund, or plant
expansion fund.
4. Non-consolidated subsidiaries or affilated companies.
20
Balance Sheet Noncurrent Assets

Long-Term Investments
Portfolios
Type
Valuation
Classification
Held-toMaturity
Debt
Amortized
Cost
Current or
Noncurrent
Trading
Debt or
Equity
Fair Value
Current
Availablefor-Sale
Debt or
Equity
Fair Value
Current or
Noncurrent
21

Long-Term
Investments
Securities
bonds,
stock, and
long-term notes
For marketable securities,

managements intent
determines current or
noncurrent classification.
LO 2
22

Long-Term
Investments
Fixed Assets
Land held for

speculation
LO 2
23

Long-Term
Investments
Special Funds
Sinking fund
Pensions fund
Cash surrender
value of life
insurance
LO 2
24

Long-Term
Investments
Nonconsolidated
Nonconsolidated
Subsidiaries
Subsidiaries or
or
Affiliated
Companies
Companies
LO 2
25

Illustration 5-10
Balance Sheet
Presentation of
26
Property, Plant, and Equipment

Tangible long-lived assets used in the regular operations
of the business.
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.
27

Property, Plant, and
Equipment
Tangible assets used
in the regular
operations of the
business.
28

Illustration 5-11
Balance Sheet Presentation of
Property, Plant, and Equipment
29

Intangibles
Lack physical substance
and are not financial
instruments.
Limited life intangibles

amortized.
Indefinite-life
intangibles tested for
impairment.
30 2
LO

Intangible Assets
Illustration 5-12
Balance Sheet
Presentation of
Intangible Assets
31

Other Assets
Items vary in practice. Can include:
Long-term prepaid expenses
Non-current receivables
Assets in special funds
Property held for sale
Restricted cash or securities

32
Other Assets
This section should
include only unusual items
sufficiently different from
assets in the other
categories.
33
LO 2
Current Liabilities
Obligations that a
company reasonably
expects to liquidate either
through the use of current
assets or the creation of
other current liabilities.
34

Current Liabilities
Illustration 5-13
of Current Liabilities
35

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.
36
Balance Sheet Long-Term Liabilities

Non-Current Liabilities
Illustration 5-14
of Non-Current Liabilities
37
Balance Sheet Owners Equity
Owners Equity
38
Balance Sheet Owners Equity
Owners Equity
Illustration 5-15
of Stockholders Equity
39

Account
Classification
(a) Investment in preferred stock
(a) Current asset/Investment
(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
(i) Current liability
40
Balance Sheet Format

Classified Balance Sheet
Account form
Report form
Accounting Trends and Techniques2009 (New York:

AICPA) indicates that all of the 500 companies surveyed
use either the report form (438) or the account form (62),
sometimes collectively referred to as the customary form.
41
LO 3 Prepare a classified balance sheet using the report and account formats.
Balance Sheet Format
Account Form
Illustration 5-16
42
Balance Sheet
Format
Report Form
Illustration 5-16
43
LO 3
One of the three basic objectives of financial

reporting is
assessing the amounts, timing, and

uncertainty of cash flows.
44
LO 4 Indicate the purpose of the 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?

45
LO 4 Indicate the purpose of the statement of cash flows.

Content and Format
Three different activities:
Operating,
Investing,
Financing
Illustration 5-17
Basic Format of Cash
Flow Statement
46

Content and Format
Operating
Investing
Financing
Cash inflows and

outflows that
enter into the
determination of
net income.
Cash inflows and

outflows from
non-current
assets.
Cash inflows and

outflows from
non-current
liabilities and
equity.
The statements value is that it helps users evaluate liquidity, solvency,

and financial flexibility.
47
48
Preparation of the Statement of Cash Flows
Sources of Information
Information obtained from several sources:
(1) comparative balance sheets,
(2) the current income statement, and
(3) selected transaction data.
49
LO 6 Prepare a basic statement of cash flows.
Statement of Cash Flows: On January 1, 2012, 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 2012 the company purchased land for
$15,000. Illustration 5-19 shows the companys comparative
balance sheets at the beginning and end of 2012.
50

Illustration 5-19
Illustration 5-20
516
LO

Preparing the Statement of Cash Flows
Determine:
1. Cash provided by (or used in) operating activities.
2. 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.
52
Cash provided by operating activities
53
Statement of
Cash Flows
Next, the company
determines its investing
and financing activities.
54

Statement of Cash Flows (BE 5-12)
Noncash credit to
revenues.
Noncash charge to
expenses.
55

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:
Issuance of common stock to purchase assets.
Conversion of bonds into common stock.
Issuance of debt to purchase assets.
Exchanges on long-lived assets.
56
Illustration 5-23
Comprehensive
57
Usefulness of the Statement of Cash Flows

Without cash, a company will not survive.
Cash flow from Operations:
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.
58
LO 7 Understand the usefulness of the statement of cash flows.

Financial Liquidity
Current Cash
Debt Coverage
Ratio
Net Cash Provided by

Operating Activities
=
Average Current Liabilities
Ratio indicates whether the company can pay off its current
liabilities from its operations. A ratio near 1:1 is good.
59

Financial Liquidity
Cash Debt
Coverage
Ratio
Net Cash Provided by

Operating Activities
=
Average Total Liabilities
This ratio indicates a companys ability to repay its liabilities

from net cash provided by operating activities, without having
to liquidate the assets employed in its operations.
60

Free Cash Flow
The amount of discretionary cash flow a company has for

purchasing additional investments, retiring its debt, purchasing
treasury stock, or simply adding to its liquidity.
61
Supplemental Disclosures
Four types of information that are supplemental to account
titles and amounts presented in the balance sheet:
LO 8 Determine which balance sheet information

62
requires supplemental disclosure.
Techniques of Disclosure
Parenthetical Explanations
Notes
Cross-Reference and Contra Items
Supporting Schedules
Terminology
63
LO 9 Describe the major disclosure techniques for the balance sheet.
APPENDIX
5A
Ratio AnalysisA 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.
64
APPENDIX
5A
Illustration 5A-1
A Summary of Financial Ratios
65
LO 10 Identify the major types of financial ratios and what they measure.
APPENDIX
5A
Illustration 5A-1
66
APPENDIX
5A
Illustration 5A-1
67
APPENDIX
5B
Specimen Financial Statements:

The Procter & Gamble Company
68
APPENDIX
5B

69
APPENDIX
5B

70
APPENDIX
5B

71
APPENDIX
5B

72
APPENDIX
5B

73
APPENDIX
5B

74
RELEVANT FACTS
IFRS recommends but does not require the use of the title
statement of financial position rather than balance sheet.
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. In addition,
specific GAAP standards mandate certain forms of reporting this
information.
Under IFRS, current assets are usually listed in the reverse order of
liquidity. For example, under GAAP cash is listed first, but under
75
IFRS it is listed last.
RELEVANT FACTS
IFRS has many differences in terminology that you will notice in this
textbook.
Both IFRS and GAAP require disclosures about (1) accounting

policies followed, (2) judgments that management has made in the
process of applying the entitys 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.
Use of the term reserve is discouraged in GAAP, but there is no

such prohibition in IFRS.
76
Summary
1.
Explain 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.
Indicate the purpose of the statement of cash flows.
5.
Identify the content of the statement of cash flows.
6.
Prepare a 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.

77

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5

Balance Sheet and

Explain the uses and limitations of a balance sheet.

Identify the major classifications of the balance sheet.

Indicate the purpose of the statement of cash flows.

Identify the content of the statement of cash flows.

Prepare a statement of cash flows.

Understand the usefulness of the statement of cash flows.

Determine which balance sheet information requires supplemental

Describe the major disclosure techniques for the balance sheet.

Content and format

Computing rates of return.

Evaluating the capital structure.

Assess risk and future cash flows.

Analyze the companys:

Limitations of the Balance Sheet

Most assets and liabilities are reported at historical

Use of judgments and estimates.

Many items of financial value are omitted.

Classification in the Balance Sheet

Balance Sheet Current Assets

Generally any monies available on demand.

Cash equivalents - short-term highly liquid investments

Restrictions or commitments must be disclosed.

Balance Sheet Current Assets

Balance Sheet Current Assets

Balance Sheet Current Assets

Balance Sheet Current Assets

Anticipated loss due to uncollectibles.

Amount and nature of any nontrade receivables.

Receivables used as collateral.

Balance Sheet Current Assets

Balance Sheet Current Assets

Basis of valuation (e.g., lower-of-cost-or-market).

Cost flow assumption (e.g., FIFO or average cost).

Balance Sheet Current Assets

Prepayments often occur in regard to:

Balance Sheet Current Assets

Balance Sheet Current Assets

convert into cash,

either in one year or in

Classification in the Balance Sheet

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

For marketable securities,

Balance Sheet Noncurrent Assets

Land held for

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Property, Plant, and Equipment

Physical property such as land, buildings, machinery,

With the exception of land, a company either depreciates

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Limited life intangibles

Balance Sheet Noncurrent Assets

Balance Sheet Noncurrent Assets

Long-term prepaid expenses

Assets in special funds

Property held for sale