Structure of the Balance Sheet and Statement of Cash Flows Revsine/Collins/Johnson/Mittelstaedt: Chapter 4 McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, All Rights Reserved.

Learning objectives How balance sheet accounts are measured and classified. How balance sheet information is used. Balance sheet terminology and format outside the U.S. How footnotes aid your understanding of the firm’s accounting policies, subsequent events, and related-party transactions. How successive balance sheet and the income statement can be used to identify cash inflows and outflows. How the cash flow statements can be used to explain changes in successive balance sheets.

Learning objectives Concluded The distinction between operating, investing, and financing sources and uses of cash. How changes in current asset and current liability accounts can be used to compute “cash flows from operations” from accrual earnings.

Elements of the balance sheet How the money is invested Where the money came from ASSETS LIABILITIES EQUITY = + Probable future economic benefits Obtained from past transactions or events Probable future sacrifices of economic benefits Arising from present obligations To transfer assets or provide services in the future As a result of past transactions or events The residual interest in net assets.

Balance sheet information Rates of return ROA and ROCE ASSETS Capital structure Debt vs. Equity Helps Liquidity Cash conversion LIABILITIES + EQUITY assess Solvency Ability to pay debt Flexibility Operating and financial Balance Sheet

Balance sheet measurement conventions Historical cost ASSETS Current cost (fair value) Measurement LIABILITIES + EQUITY methods Net realizable value Discounted present value Balance Sheet

Balance sheet classification: Overview ASSETS LIABILITIES EQUITY = + Current assets Property, plant and equipment Investments Other assets Current liabilities Long-term debt Other liabilities Preferred and common stock Additional paid-in capital Retained earnings

Balance sheet presentation: International differences U.S. Format: U.K. Format: Current Assets Fixed Assets + + Long-lived Assets Current Assets - = Current Liabilities - Current Liabilities Non-current Liabilities + Non-current Liabilities = + Stockholders’ Equity Capital Employed

Financial statement footnotes Footnotes are an integral part of companies’ financial reports. These “notes” help users better understand and interpret the numbers presented in the body of the financial statements. Three important notes: Summary of significant accounting policies. Subsequent event disclosures. Related party transactions

Statement of cash flows Explains why a firm’s cash position changed between successive balance sheet dates. Here’s a balance sheet equation: Cash + Non-cash assets = Liabilities + Stockholders’ equity Cash Non-cash assets Liabilities = + - Stockholder’s equity ΔCash Δ Stockholders’ equity = + At the same time, it explains why non-cash assets, liabilities, and stockholders’ equity have changed. Δ Non-cash assets Δ Liabilities -

Cash flow statement format Cash inflows and outflows from transactions and events that affect operating income Operating Activities Cash inflows and outflows from loaning money to others, investing in securities, or in assets (e.g., equipment) used to produce goods and services. Investing Activities Cash inflows and outflows from borrowing money, selling stock, and paying dividends Financing Activities Δ Cash

Deriving cash flows from operations: Indirect approach

Deriving cash flow information: Overview Income statement Beginning Balance sheet Ending Balance sheet Cash flow statement You can always derive any one financial statement from information available in the other three statements.

Summary The balance sheet shows the assets owned by a company at a given point in time, and how those assets are financed (debt vs. equity). Be alert for differences in balance sheet measurement bases, account titles, and statement format. Financial statement footnotes provide important information. The cash flow statement shows the change in cash for a given period, broken down into operating, investing, and financing activities.

Summary concluded Changes in certain balance sheet accounts help explain why operating cash flows differ from accrual income. Conversely, the cash flow statement helps to explain changes in balance sheet accounts T-accounts are a useful analytical device for deriving cash flow and accrual income information from successive balance sheets