Chapter 5-1

Chapter 5-2 C H A P T E R 5 BALANCE SHEET AND STATEMENT OF CASH FLOWS Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield

Chapter 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.Determine which balance sheet information requires supplemental disclosure. 5.Describe the 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. Learning Objectives

Chapter 5-4 Balance Sheet Statement of Cash Flows UsefulnessLimitationsClassification Additional information reported Techniques of disclosure Purpose Content and format PreparationUsefulness Balance Sheet and Statement of Cash Flows

Chapter 5-5 Evaluating the capital structure. Assess risk and future cash flows. Analyze the company’s:  Liquidity,  Solvency, and  Financial flexibility Balance Sheet Usefulness of the Balance Sheet LO 1 Explain the uses and limitations of a balance sheet.

Chapter 5-6 Balance Sheet  Analyze the company’s:  Liquidity “how quickly will my assets convert to cash “ Creditor are interested in short term liquidity ratios.This ratios indicates whether a company will have the resources to pay its obligations Greater Liquidity = lower risk of failure Greater Liquidity = lower risk of failure  Solvency : the ability of a company to pay its debts as they mature. Companies with higher debt are more risky because they need more of their assets to meet their obligations higher debt = Lower solvency higher debt = Lower solvency  Financial flexibility: ability to respond to threats or take advantage of opportunities Liquidity and Solvency affects a company's Financial flexibility. Company with higher degree of Financial flexibility is better able to survive bad times and to take advantage of profitable opportunities Company with higher degree of Financial flexibility is better able to survive bad times and to take advantage of profitable opportunities Greater Financial flexibility = lower risk of failure Greater Financial flexibility = lower risk of failure

Chapter 5-7 Most assets and liabilities are reported at historical cost. Use of judgments and estimates (e.g. useful life). Many items of financial value are omitted, (when a company cannot record objectively). e.g. the knowledge and skills of the employees. Limitations of the Balance Sheet Balance Sheet LO 1 Explain the uses and limitations of a balance sheet.

Chapter 5-8 Three General Classifications Assets, Liabilities, and Stockholders’ Equity Companies further divide these classifications: Classification in the Balance Sheet LO 2 Identify the major classifications of the balance sheet. Balance Sheet Illustration 5-1

Chapter 5-9 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. (Current assets are presented in order of liquidity ) Current Assets LO 2 Identify the major classifications of the balance sheet. Balance Sheet Illustration 5-2

Chapter 5-10 Review The correct order to present current assets is a. Cash, accounts receivable, prepaid items, inventories. a. Cash, accounts receivable, prepaid items, inventories. b. Cash, accounts receivable, inventories, prepaid items. b. Cash, accounts receivable, inventories, prepaid items. c. Cash, inventories, accounts receivable, prepaid items. c. Cash, inventories, accounts receivable, prepaid items. d. Cash, inventories, prepaid items, accounts receivable. d. Cash, inventories, prepaid items, accounts receivable. Balance Sheet LO 2 Identify the major classifications of the balance sheet.

Chapter 5-11 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. Cash Balance Sheet – “ Current Assets ” Illustration 5-3 LO 2 Identify the major classifications of the balance sheet. e.g. a company restricted cash to meet an obligation due currently.

Chapter 5-12 Portfolios Short-Term Investments LO 2 Identify the major classifications of the balance sheet. TypeValuationClassification Held-to- Maturity Debt Amortized Cost Current or Noncurrent TradingDebt or EquityFair ValueCurrent Available- for-Sale Debt or EquityFair Value Current or Noncurrent Balance Sheet – “ Current Assets ”

Chapter 5-13 Short-Term Investments LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ” Illustration 5-5 Balance Sheet Presentation of Investments in Securities

Chapter 5-14 Claims held against customers and others for money, goods, or services. Accounts receivable – oral promises Notes receivable – written promises Major categories of receivables should be shown in the balance sheet or the related notes. Receivables LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ”

Chapter 5-15 Accounts Receivable – Presentation Options LO 2 Identify the major classifications of the balance sheet. Current Assets: Cash $ 346 Accounts receivable500 Less allowance for doubtful accounts Inventory 812 Total current assets $1,633 Current Assets: Cash $ 346 Accounts receivable, net of $25 allowance475 Inventory 812 Total current assets $1, Balance Sheet – “ Current Assets ”

Chapter 5-16 Receivables LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ” Illustration 5-6 Balance Sheet Presentation of Receivables

Chapter 5-17 Inventories LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ” Company discloses: Basis of valuation (e.g., lower-of-cost-or-market). Method of pricing/ cash flow assupmtion (e.g., FIFO or LIFO). Illustration 5-7

Chapter 5-18 Payment of cash, that is recorded as an asset because service or benefit will be received in the future. insurancesuppliesadvertising Cash Payment Expense Recorded BEFORE rent maintenance on equipment Prepayments often occur in regard to: Prepaid Expenses LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ”

Chapter 5-19 Prepaid Expenses LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Current Assets ” Illustration 5-9

Chapter 5-20 Current Assets - “Summary” LO 2 Identify the major classifications of the balance sheet. 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.

Chapter 5-21 Generally consists of four types:Securities Fixed assets Special funds Nonconsolidated subsidiaries Nonconsolidated subsidiaries or affiliated companies. Long-Term Investments LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ”

Chapter 5-22 Long-Term Investments SecuritiesSecurities LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” bonds, stock, and long-term notes For marketable securities, management’s intent determines current or noncurrent classification.

Chapter 5-23 Fixed Assets LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” Land held for speculation Long-Term Investments

Chapter 5-24 Special Funds LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” Sinking fund Pensions fund Cash surrender value of life insurance Long-Term Investments

Chapter 5-25 Nonconsolidated Subsidiaries or Affiliated Companies LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” Long-Term Investments

Chapter 5-26 Property, Plant, and Equipment LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” Assets of a durable nature used in the regular operations of the business.

Chapter 5-27 Intangibles LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” Lack physical substance and are not financial instruments. Limited life intangibles amortized. Indefinite-life intangibles tested for impairment.

Chapter 5-28 LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Exercise ” Intangibles (BE5-6): KC’s adjusted trial balance contained the following asset accounts at December 31, 2010: 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. Intangibles Goodwill $ 50,000 Franchises 47,000 Patents 33,000 Trademarks 10,000 Total $140,000

Chapter 5-29 Other Assets LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Noncurrent Assets ” This section should include only unusual items sufficiently different from assets in the other categories.

Chapter 5-30 “Obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.” LO 2 Identify the major classifications of the balance sheet. Balance Sheet Current Liabilities

Chapter 5-31 LO 2 Identify the major classifications of the balance sheet. Balance Sheet “Obligations that a company does not reasonably expect to liquidate within the normal operating cycle.” All covenants and restrictions must be disclosed. Long-Term Liabilities

Chapter 5-32 LO 2 Identify the major classifications of the balance sheet. Balance Sheet – “ Exercise ” Long-Term Liabilities (BE5-9): Included in Adams Company’s December 31, 2010, trial balance are the following accounts: Accounts Payable $220,000; Pension Liability $375,000; Discount on Bonds Payable $29,000; Advances from Customers $41,000; Bonds Payable $400,000; 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 liability $375,000 Bonds payable 400,000 Discount on bonds payable (29,000) Total 746,000

Chapter 5-33 Three parts, (1) Capital Stock, (2) Additional Paid-In Capital, and (3) Retained Earnings. LO 2 Identify the major classifications of the balance sheet. Balance Sheet Owners’ Equity Illustration 5-15

Chapter 5-34 (a)Investment in preferred stock LO 2 Identify the major classifications of the balance sheet. Balance Sheet Classification Exercise Account (b)Treasury stock (c)Common stock (d)Cash dividends payable (e)Accumulated depreciation (f)Interest payable (g)Deficit (h)Trading securities (i)Unearned revenue (a)Current asset/Investment (b)Stockholders’ Equity (c)Stockholders’ Equity (d)Current liability (e)Contra-asset (f)Current liability (g)Stockholders’ Equity (h)Current asset (i)Current liability Classification

Chapter 5-35 Classified Balance Sheet Account form Report form Balance Sheet - Format Accounting Trends and Techniques—2007 (New York: AICPA) indicates that all of the 600 companies surveyed use either the “ report form ” (524) or the “ account form ” (76), sometimes collectively referred to as the “ customary form. ” LO 3 Prepare a classified balance sheet using the report and account formats.

Chapter 5-36 LO 3 Prepare a classified balance sheet using the report and account formats. Balance Sheet - Format Account Form Illustration 5-16

Chapter 5-37 Balance Sheet - Format LO 3 Report Form Illustration 5-16

Chapter 5-38 Contingencies Accounting Policies Contractual Situations Fair Values Additional Information Reported There are normally four types of information that are supplemental to account titles and amounts presented in the balance sheet: LO 4 Determine which balance sheet information requires supplemental disclosure.

Chapter 5-39 Parenthetical Explanations Notes Cross-Reference and Contra Items Supporting Schedules Terminology Techniques of Disclosure LO 5 Describe the major disclosure techniques for the balance sheet.

Chapter 5-40 The Statement of Cash Flows LO 6 Indicate the purpose of the statement of cash flows. One of the three basic objectives of financial reporting is “ assessing the amounts, timing, and uncertainty of cash flows. ”

Chapter 5-41 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? Purpose of the Statement of Cash Flows The Statement of Cash Flows LO 6 Indicate the purpose of the statement of cash flows.

Chapter 5-42 Three different activities: Operating, Content and Format The Statement of Cash Flows LO 7 Identify the content of the statement of cash flows. Investing,Financing Illustration 5-24

Chapter 5-43 Content and Format The Statement of Cash Flows OperatingOperating Cash inflows and outflows from operations. InvestingInvesting Cash inflows and outflows from non-current assets. FinancingFinancing Cash inflows and outflows from non-current liabilities and equity. The statement ’ s value is that it helps users evaluate liquidity, solvency, and financial flexibility. LO 7 Identify the content of the statement of cash flows.

Chapter 5-44 The Statement of Cash Flows LO 7 Identify the content of the statement of cash flows. Illustration 5-25

Chapter 5-45 Information obtained from several sources: (1) comparative balance sheets, (2) the current income statement, and (3) selected transaction data. Preparation The Statement of Cash Flows LO 8 Prepare a statement of cash flows.

Chapter 5-46 The Statement of Cash Flows LO 8 Prepare a statement of cash flows. Statement of Cash Flows: On January 1, 2010, 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 2010 the company purchased land for $15,000. Illustration 5-26 shows the company ’ s comparative balance sheets at the beginning and end of 2010.

Chapter 5-47 The Statement of Cash Flows LO 8 Illustration 5-26 Illustration 5-27

Chapter 5-48 The Statement of Cash Flows LO 8 Preparing the Statement of Cash Flows LO 8 Prepare a 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. Reconcile the change in cash with the beginning and the ending cash balances.

Chapter 5-49 The Statement of Cash Flows LO 8 Prepare a statement of cash flows. Cash provided by operating activities Illustration 5-28 Illustration 5-26 Illustration 5-27 Solution on notes page

Chapter 5-50 The Statement of Cash Flows LO 8 Prepare a statement of cash flows. Illustration 5-29 Illustration 5-26 Solution on notes page Illustration 5-27 Next, the company determines its investing and financing activities.

Chapter 5-51 The Statement of Cash Flows LO 8 Prepare a statement of cash flows. Statement of Cash Flows (BE 5-12): Keyser Beverage Company reported the following items in the most recent year. Activity Operating Financing Operating Investing Operating Financing Required: Prepare a Statement of Cash Flows Net income $40,000 Dividends paid 5,000 Increase in accounts receivable 10,000 Increase in accounts payable 7,000 Purchase of equipment 8,000 Depreciation expense 4,000 Issue of notes payable 20,000

Chapter 5-52 The Statement of Cash Flows LO 8 Prepare a statement of cash flows. Noncash credit to revenues. Noncash charge to expenses. Statement of Cash Flows (BE 5-12)

Chapter 5-53 Review In preparing a statement of cash flows, which of the following transactions would be considered an investing activity? a. Sale of equipment at book value a. Sale of equipment at book value b. Sale of merchandise on credit b. Sale of merchandise on credit c. Declaration of a cash dividend c. Declaration of a cash dividend d. Issuance of bonds payable at a discount receivable. d. Issuance of bonds payable at a discount receivable. LO 8 Prepare a statement of cash flows. The Statement of Cash Flows

Chapter 5-54 Issuance of common stock to purchase assets. Conversion of bonds into common stock. Issuance of debt to purchase assets. Exchanges on long-lived assets. The Statement of Cash Flows 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: LO 8 Prepare a statement of cash flows. Significant Noncash Activities

Chapter 5-55 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. Usefulness of the Statement of Cash Flows Without cash, a company will not survive. Cash flow from Operations: LO 9 Understand the usefulness of the statement of cash flows.

Chapter 5-56 Usefulness of the Statement of Cash Flows Ratio indicates whether the company can pay off its current liabilities from its operations. A ratio near 1:1 is good. LO 9 Understand the usefulness of the statement of cash flows. Financial Liquidity Net Cash Provided by Operating Activities Average Current Liabilities Current Cash Debt Coverage Ratio =

Chapter 5-57 Usefulness of the Statement of Cash Flows 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. LO 9 Understand the usefulness of the statement of cash flows. Financial Flexibility Net Cash Provided by Operating Activities Average Total Liabilities Cash Debt Coverage Ratio =

Chapter 5-58 Usefulness of the Statement of Cash Flows 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. LO 9 Understand the usefulness of the statement of cash flows. Free Cash Flow Illustration 5-35

Chapter 5-59 Review The current cash debt coverage ratio is often used to assess a. financial flexibility. a. financial flexibility. b. liquidity. b. liquidity. c. profitability. c. profitability. d. solvency. d. solvency. LO 9 Understand the usefulness of the statement of cash flows. Usefulness of the Statement of Cash Flows