1. Structure of the Balance Sheet and Statement of Cash Flows
Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 4

2. 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 notes 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.
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.
Differences between IFRS and U.S. GAAP for certain items on the statement of cash flows.
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3. 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.
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4. Balance sheet information
Rates of return
ROA and ROCE
ASSETS
Capital structure
Debt/Equity ratio
Helps
Liquidity
Cash conversion
LIABILITIES +
EQUITY
assess
Solvency
Ability to pay debt
Flexibility
Operating and financial
Balance Sheet
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5. Balance sheet measurement conventions
Historical cost
ASSETS
Current cost (fair value)
Measurement
LIABILITIES +
EQUITY
methods
Net realizable value
Discounted present value
Balance Sheet
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6. 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
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7. Balance sheet classification: Current assets
Amortized cost or current market value
Net realizable value
Lower or (historical) cost or current market value
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8. Balance sheet classification: Other assets
Historical cost minus accumulated depreciation except that fair market value is used when “impaired”
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9. Balance sheet classification: Liabilities
Amount due at maturity
Historical cost
Discounted present value
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10. Balance sheet classification: Stockholders’ equity
Historical par value
Historical cost
Combination of different measurement bases
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11. Analytical insights: Understanding the business
Which company is?
Deere
E-Trade
Potomac Electric Power
Wal-Mart
Analytical insights: Understanding the business
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12. Balance sheet presentation: International differences
U.S. Format:
U.K. Format:
Current Assets
Fixed Assets + +
Long-lived Assets
Current Assets - =
Non-current Liabilities
Current Liabilities - +
Current Liabilities
Non-current Liabilities = +
Stockholders’ Equity
Capital Employed
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13. Notes to Financial statements
Notes are an integral part of companies’ financial reports.
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
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14. Statement of cash flows
Explains why a firm’s cash position changed between successive balance sheet dates. Here’s the balance sheet equation:
Assets =
Liabilities +
Stockholders’ equity
Cash
Non-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 -
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15. 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
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16. Cash flow statement: Wal-Mart example
Adjustments to accrual earnings
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17. Cash flow statement: Wal-Mart example
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18. Cash flow versus accrual earnings: HRB Advertising Company
Opened for business on April 1, Transactions for the year include:
Herb Wilson, Robin Hansen and Barbara Reynolds each contributed $3,500 cash on April 1 for shares of the company’s common stock.
HRB rented office space beginning April 1 and paid the full year’s rental of $2,000 per month, or $24,000 in advance.
The company borrowed $10,000 from a bank on April 1. The principal plus accrued interest payable is payable January 1, 2015 with interest at a rate of 12% per year.
HRB purchased office equipment with a five-year life for $15,000 cash on April 1. Salvage value is zero and the equipment is being depreciated using the straight-line method.
HRB sold and billed customers for $65,000 of advertising services rendered between April 1 and December 31. Of this amount $20,000 was still uncollected by year end.
By year-end, the company incurred and paid the following operating costs: (a) utilities, $650; (b) salaries, $36,250; and (c) supplies, $800
The company had accrued (unpaid) expenses at year-end as follows: (a) utilities, $75 (b) salaries, $2,400; and (c) interest, $900.
Supplies purchase on account and unpaid at year-end amounted to $50. When supplies are purchased they are charged to an asset account
Supplies inventory on hand at year-end amounted to $100.
Annual depreciation on office equipment is $15,000/5 = $3,000. Because the equipment was acquired on April 1, the depreciation expense for 2014 is $3,000 x 9/12 = $2,250.
Profit (accrual earnings) for the year was $3,725 but the checking account was overdrawn by $11,200
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19. Here’s what happened at HRB
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20. Deriving cash flows from operations: Indirect approach
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21. HRB’s cash flow statement: Indirect approach
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22. Deriving cash flow information: HRB one year later
Bank loan refinanced
Stock issued
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23. Deriving cash flow information: HRB’s accrual earnings
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24. Deriving cash flow information: HRB’s cash flows
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25. 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.
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26. Deriving cash flow information: Cash collected from customers
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27. Deriving cash flow information: Salaries paid
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28. Deriving cash flow information: Rent paid
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29. Deriving cash flow information: Utilities paid
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30. Deriving cash flow information: Cash paid for supplies
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31. Deriving cash flow information: Interest paid
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32. Deriving cash flow information: Office equipment cash flows
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33. Deriving cash flow information: Cash receipts and disbursements
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34. Global Vantage Point
IFRS (IAS 7) encourages, but does not require, entities to report cash flows from operating activities using the direct method.
Why: believed to provide information that is not available under the indirect method
Both FASB and IASB tabled a proposal to mandate the use of the direct method for reporting operating cash flows since most computer systems aren’t set up to efficiently process the requisite data
Subtle differences between IFRS and U.S. GAAP: one is how to report cash interest from investments
U.S. GAAP reports these as part of operating cash flows
IAS 7 allows the option to report these as cash flows from investing activities
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35. Global Vantage Point An example – EMC Corporation
Direct Method
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36. Global Vantage Point An example – EMC Corporation
Indirect Method
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37. Global Vantage Point An example – EMC Corporation
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38. 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 notes provide important information.
The cash flow statement shows the change in cash for a given period, broken down into operating, investing, and financing activities.
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39. 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
Understanding the interrelationships between successive balance sheets and the statement of cash flows
Understanding the basic differences between IFRS and U.S. GAAP as well as differences between the direct and indirect approach to presenting cash flows from operations
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