Structure of the Balance Sheet and Statement of Cash Flows Revsine/Collins/Johnson/Mittelstaedt: Chapter 4 McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning objectives 1.How balance sheet accounts are measured and classified. 2.How balance sheet information is used. 3.Balance sheet terminology and format outside the U.S. 4.How footnotes aid your understanding of the firm’s accounting policies, subsequent events, and related-party transactions. 5.How successive balance sheet and the income statement can be used to identify cash inflows and outflows. 6.How the cash flow statements can be used to explain changes in successive balance sheets. 4-2

Learning objectives Concluded 7.The distinction between operating, investing, and financing sources and uses of cash. 8.How changes in current asset and current liability accounts can be used to compute “cash flows from operations” from accrual earnings. 9.Key changes under the FASB/IASB proposed exposure draft on financial statement presentation. 4-3

Elements of the balance sheet 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. ASSETSLIABILITIESEQUITY =+ How the money is invested Where the money came from 4-4

Balance sheet information LIABILITIES + EQUITY ASSETS Rates of return Capital structure Liquidity Solvency Flexibility ROA and ROCE Debt vs. Equity Cash conversion Ability to pay debt Operating and financial Helps assess Balance Sheet 4-5

Balance sheet measurement conventions LIABILITIES + EQUITY ASSETS Historical cost Current cost (fair value) Net realizable value Discounted present value Measurement methods Balance Sheet 4-6

Balance sheet classification: Overview 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 ASSETSLIABILITIESEQUITY =+ 4-7

Balance sheet presentation: International differences Current Assets Long-lived Assets Current Liabilities Non-current Liabilities Stockholders’ Equity Fixed Assets Current Assets Current Liabilities Non-current Liabilities Capital Employed U.S. Format:U.K. Format: + = = 4-8

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: 1. Summary of significant accounting policies. 2. Subsequent event disclosures. 3. Related party transactions 4-9

Statement of cash flows  Explains why a firm’s cash position changed between successive balance sheet dates. Here’s a balance sheet equation: CashNon-cash assets Stockholders’ equity Liabilities + =+ 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 Operating Activities Investing Activities Financing Activities Δ Cash Cash inflows and outflows from transactions and events that affect operating income Cash inflows and outflows from loaning money to others, investing in securities, or in assets (e.g., equipment) used to produce goods and services. Cash inflows and outflows from borrowing money, selling stock, and paying dividends 4-11

Deriving cash flows from operations: Indirect approach 4-12

Deriving cash flow information: Overview Beginning Balance sheet Ending Balance sheet Income statement Cash flow statement You can always derive any one financial statement from information available in the other three statements. 4-13

Global Vantage Point The proposed Exposure Draft issue by the FASB and the IASB recommends that the statement of financial position and statement of cash flows be broken down into the distinct sections, categories, and subcategories shown in Exhibit

Summary 1.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). 2.Be alert for differences in balance sheet measurement bases, account titles, and statement format. 3.Financial statement footnotes provide important information. 4.The cash flow statement shows the change in cash for a given period, broken down into operating, investing, and financing activities. 4-15

Summary concluded 5.Changes in certain balance sheet accounts help explain why operating cash flows differ from accrual income. 6.Conversely, the cash flow statement helps to explain changes in balance sheet accounts 7.T-accounts are a useful analytical device for deriving cash flow and accrual income information from successive balance sheets 4-16