7.balance Sheet and Statement of Cash Flows

Balance Sheet and
Statement of Cash Flows
5-1
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.
5-2
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: Time required to convert an asset into cash or
liability to be paid.
Solvency: Ability to pay debts as they mature.
Financial flexibility: Ability to take effective actions to alter the
5-3 amounts and timing of cash flow to meet uncertainty.
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.
5-4
Balance Sheet
Classification
5-5
Balance Sheet
Classification
Illustration 5-1
5-6
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
5-7
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
5-8
Short-Term Investments
Portfolios Type Valuation Classification
Held-to- Amortized Current or

Debt
Maturity Cost Noncurrent
Debt or
Trading Fair Value Current
Equity
Available- Debt or Current or

Fair Value
for-Sale Equity Noncurrent
5-9
Short-Term Investments
Illustration 5-5
Balance Sheet Presentation of
Investments in Securities
5-10
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.
5-11
Receivables
Illustration 5-6
Balance Sheet Presentation
of Receivables
5-12
Inventories
Disclose:
Basis of valuation (e.g., lower-of-cost-or-market).
Cost flow assumption (e.g., FIFO or average cost).
Illustration 5-6
5-13 LO 2
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
5-14
Prepaid Expenses
Illustration 5-9
5-15
Current Assets - Summary

Cash and other assets
Balance Sheet (in thousands)
a company expects to Current assets
convert into cash, Cash $ 285,000

ST Investments 140,000
sell, or Accounts receivable 777,000
Inventory 402,000
consume Prepaid expenses 170,000
Total current assets 1,774,000
either in one year or in
Investments:
the operating cycle, Invesment in ABC bonds 321,657
whichever is longer. Investment in UC Inc. 253,980
5-16
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.
5-17
Balance Sheet Noncurrent Assets
Long-Term Investments
Portfolios Type Valuation Classification
Held-to- Amortized Current or

Debt
Maturity Cost Noncurrent
Debt or
Trading Fair Value Current
Equity
Available- Debt or Current or

Fair Value
for-Sale Equity Noncurrent
5-18
Long-Term Current assets
Investments Cash $ 285,000
Investments:
Securities Invesment in ABC bonds 321,657
Investment in UC Inc. 253,980
bonds, Notes receivable 150,000
stock, and Land held for speculation 550,000
Sinking fund 225,000
long-term notes
Pension fund 653,798
Cash surrender value 84,321
Investment in Uncon. Sub. 457,836
Total investments 2,696,592
Property, Plant, and Equip.
Building 1,375,778
Land 975,000
5-19
Investments:
Invesment in ABC bonds 321,657
Fixed Assets Investment in UC Inc. 253,980
Notes receivable 150,000
Land held for
Land held for speculation 550,000
speculation Sinking fund 225,000
Building 1,375,778
Land 975,000
5-20
Investments:
Special Funds Investment in UC Inc. 253,980
Sinking fund Land held for speculation 550,000
Pensions fund Sinking fund 225,000
Cash surrender
value of life Investment in Uncon. Sub. 457,836
insurance Total investments 2,696,592
Building 1,375,778
Land 975,000
5-21
Investments:
Investment in UC Inc. 253,980
Land held for speculation 550,000
Sinking fund 225,000
Nonconsolidated Pension fund 653,798
Subsidiaries or Cash surrender value 84,321
Affiliated Total investments 2,696,592
Companies Property, Plant, and Equip.
Building 1,375,778
Land 975,000
5-22
Illustration 5-10
Balance Sheet
Presentation of
5-23
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.
5-24
Property, Plant, and Current assets
Equipment Cash $ 285,000

Tangible assets used Building 1,375,778
in the regular Land 975,000
Machinery and equipment 234,958
operations of the Capital leases 384,650
business. Leasehold improvements 175,000
Accumulated depreciation (975,000)
Total PP&E 2,170,386
Intangibles
Goodwill 3,000,000
Patents 177,000
Trademarks 40,000
5-25 LO 2 Identify the major classifications of the balance sheet.
Illustration 5-11
Balance Sheet Presentation of
Property, Plant, and Equipment
5-26 LO 2 Identify the major classifications of the balance sheet.

Intangibles Current assets
Cash $ 285,000
Lack physical substance
Total PP&E 2,170,386
and are not financial Intangibles
instruments. Goodwill 2,000,000
Patents 177,000
Limited life Trademark 40,000
intangibles amortized. Franchises 125,000
Copyright 55,000
Indefinite-life Total intangibles 2,397,000
intangibles tested for Other assets
impairment. Prepaid pension costs 133,000
Deferred income tax 40,000
Total other 173,000
Total Assets $ 9,210,978
5-27
LO 2
Intangibles : Patrick Corporation adjusted trial balance contained

the following asset accounts at December 31, 2012: 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
5-28
Intangible Assets
Illustration 5-12
Balance Sheet
Presentation of
Intangible Assets
5-29
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
5-30
Other Assets Current assets
Cash $ 285,000
This section should Total PP&E 2,170,386

Intangibles
include only unusual items
Goodwill 2,000,000
sufficiently different from Patents 177,000
Trademark 40,000
assets in the other
Franchises 125,000
categories. Copyright 55,000
Total intangibles 2,397,000
Other assets
Prepaid pension costs 133,000
Deferred income tax 40,000
Total other 173,000
Total Assets $ 9,210,978
5-31
LO 2
Current Liabilities Balance Sheet (in thousands)

Current liabilities
Notes payable $ 233,450
Obligations that a
Accounts payable 131,800
company reasonably Accrued compensation 43,000
expects to liquidate either Unearned revenue 17,000
Income tax payable 23,400
through the use of current Current maturities LT debt 121,000
assets or the creation of Total current liabilities 569,650
Long-term liabilities
other current liabilities. Long-term debt 979,500
Obligations capital lease 345,800
Deferred income taxes 77,909
Total long-term liabilities 1,403,209
Stockholders' equity
5-32
Current Liabilities
Illustration 5-13
of Current Liabilities
5-33
Long-Term Liabilities Balance Sheet (in thousands)

Current liabilities
Obligations that a Notes payable $ 233,450
Accounts payable 131,800
company does not Accrued compensation 43,000
reasonably expect to Unearned revenue 17,000
Income tax payable 23,400
liquidate within the normal Current maturities LT debt 121,000
operating cycle. Total current liabilities 569,650
All covenants and Long-term debt 979,500
Obligations capital lease 345,800
restrictions must be
Deferred income taxes 77,909
disclosed. Total long-term liabilities 1,403,209
Stockholders' equity
5-34
Balance Sheet Long-Term Liabilities
Long-Term Liabilities : Included in Adams Companys December
31, 2012, trial balance are the following accounts: Accounts Payable
$220,000; Pension Asset/Liability $375,000; Discount on Bonds
Payable $29,000; Unearned Revenue $41,000; Bonds Payable
$400,000; Salaries and Wages Payable $27,000; Interest Payable
$12,000; Income Taxes Payable $29,000. Prepare the long-term
liabilities section of the balance sheet.
Pension Asset/liability $375,000
Bonds payable 400,000
Discount on bonds payable (29,000)
Total 746,000
5-35
Balance Sheet Long-Term Liabilities
Non-Current Liabilities
Illustration 5-14
of Non-Current Liabilities
5-36
Balance Sheet Owners Equity
Owners Equity
5-37
Balance Sheet Owners Equity
Owners Equity
Illustration 5-15
of Stockholders Equity
5-38
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.
5-39
Balance Sheet Format
Account Form Illustration 5-16
5-40
Balance Sheet
Format
Report Form
Illustration 5-16
5-41
LO 3
One of the three basic objectives of financial

reporting is
assessing the amounts, timing, and

uncertainty of cash flows.
5-42
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?
5-43
Content and Format

Three different activities:
Operating, Investing, Financing
Illustration 5-17
Basic Format of Cash
Flow Statement
5-44
Content and Format
Operating Investing Financing

Cash inflows and Cash inflows and Cash inflows and
outflows that outflows from outflows from
enter into the non-current non-current
determination of assets. liabilities and
net income. equity.
The statements value is that it helps users evaluate liquidity, solvency,

and financial flexibility.
5-45
Illustration 5-18
5-46 LO 5 Identify the content of the statement of cash flows.

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.
5-47 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.
5-48
Illustration 5-19
Illustration 5-20
5-49 LO 6
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.
5-50
Illustration 5-19
Illustration 5-20
Cash provided by operating activities Illustration 5-21

Illustration 5-19
Illustration 5-20
Statement of
Cash Flows
Next, the company

determines its investing
and financing activities.
Illustration 5-21
5-52
Statement of Cash Flows (BE 5-12): Keyser Beverage

Company reported the following items in the most recent year.
Activity
Net income $40,000 Operating
Dividends paid 5,000 Financing
Increase in accounts receivable 10,000 Operating
Increase in accounts payable 7,000 Operating
Purchase of equipment 8,000 Investing
Depreciation expense 4,000 Operating
Issue of notes payable 20,000 Financing
Required: Compute net cash provided by operating activities.

5-53
Statement of Cash Flows (BE 5-12)
Statement of Cash Flow (in thousands)
Noncash credit to
Operating activities
revenues.
Net income $ 40,000
Increase in accounts receivable (10,000)
Increase in accounts payable 5,000 Noncash charge to
Depreciation expense 40,000 expenses.
Cash flow from operations 75,000
Investing activities
Purchase of equipment (8,000)
Financing activities
Proceeds from notes payable 20,000
Dividends paid (5,000)
Cash flow from financing 15,000
Increase in cash $ 82,000
5-54
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
b. Sale of merchandise on credit
c. Declaration of a cash dividend
d. Issuance of bonds payable at a discount receivable.

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.

Illustration 5-23
Comprehensive
5-57
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.
5-58 LO 7 Understand the usefulness of the statement of cash flows.

Financial Liquidity
Net Cash Provided by

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

Financial Liquidity
Net Cash Provided by

Cash Debt Operating Activities
Coverage =
Ratio 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.

Free Cash Flow

Illustration 5-28
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.

Review
The current cash debt coverage ratio is often used to assess
a. financial flexibility.
b. liquidity.
c. profitability.
d. solvency.

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

5-63 requires supplemental disclosure.
Techniques of Disclosure
Parenthetical Explanations
Notes
Cross-Reference and Contra Items
Supporting Schedules
Terminology
5-64 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.
5-65 LO 10 Identify the major types of financial ratios and what they measure.

Illustration 5A-1
A Summary of Financial Ratios

Illustration 5A-1

Illustration 5A-1
Specimen Financial Statements:
APPENDIX 5B The Procter & Gamble Company
5-69
5-70
5-71
5-72
5-73
5-74
5-75
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
IFRS it is listed last.
5-76
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.
5-77
IFRS SELF-TEST QUESTION
Current assets under IFRS are listed generally:
a. by importance.
b. in the reverse order of their expected conversion to cash.
c. by longevity.
d. alphabetically.
5-78
Companies that use IFRS:
a. may report all their assets on the statement of financial position
at fair value.
b. are not allowed to net assets (assets 2 liabilities) on their
statement of financial positions.
c. may report noncurrent assets before current assets on the
statement of financial position.
d. do not have any guidelines as to what should be reported on the
statement of financial position.
5-79
A company has purchased a tract of land and expects to build a
production plant on the land in approximately 5 years. During the 5
years before construction, the land will be idle. Under IFRS, the land
should be reported as:
a. land expense.
b. property, plant, and equipment.
c. an intangible asset.
d. a long-term investment.
5-80
Copyright
Copyright 2012 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
5-81

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Balance Sheet and

Statement of Cash Flows

Balance Sheet, also referred to as the statement of

1. Reports assets, liabilities, and equity at a specific date.

2. Provides information about resources, obligations to

3. Helps in predicting amounts, timing, and uncertainty of

Usefulness of the Balance Sheet

Limitations of the Balance Sheet

Portfolios Type Valuation Classification

Held-to- Amortized Current or

Available- Debt or Current or

A company should clearly identify

Anticipated loss due to uncollectibles.

Amount and nature of any nontrade receivables.

Receivables used as collateral.

Cash Payment BEFORE Expense Recorded

Prepayments often occur in regard to:

Current Assets - Summary

convert into cash, Cash $ 285,000

2. Tangible fixed assets not currently used in operations

3. Special funds (sinking fund, pension fund, or plant

4. Non-consolidated subsidiaries or affilated companies.

Portfolios Type Valuation Classification

Held-to- Amortized Current or

Available- Debt or Current or

Property, Plant, and Equipment

Physical property such as land, buildings, machinery,

With the exception of land, a company either depreciates

Equipment Cash $ 285,000

Total investments 2,696,592

5-26 LO 2 Identify the major classifications of the balance sheet.

Intangibles : Patrick Corporation adjusted trial balance contained

Long-term prepaid expenses

Assets in special funds

Property held for sale

Restricted cash or securities

This section should Total PP&E 2,170,386

Current Liabilities Balance Sheet (in thousands)

Long-Term Liabilities Balance Sheet (in thousands)

Classified Balance Sheet

Accounting Trends and Techniques2009 (New York:

Account Form Illustration 5-16

One of the three basic objectives of financial

assessing the amounts, timing, and

Purpose of the Statement of Cash Flows

The statement provides answers to the following

1. Where did the cash come from?

2. What was the cash used for?

3. What was the change in the cash balance?

Content and Format

Content and Format

Operating Investing Financing

The statements value is that it helps users evaluate liquidity, solvency,

5-46 LO 5 Identify the content of the statement of cash flows.

(1) comparative balance sheets,

(2) the current income statement, and

(3) selected transaction data.

5-47 LO 6 Prepare a basic statement of cash flows.

Statement of Cash Flows: On January 1, 2012, in its first

Preparing the Statement of Cash Flows

2. Cash provided by or used in investing and financing

3. Determine the change (increase or decrease) in cash

4. Reconcile the change in cash with the beginning and the