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

Structure of the Balance Sheet and Statement of Cash

Flows

Revsine/Collins/Johnson: Chapter 4

2RCJ: Chapter 4 © 2005

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.


Learning objectivesConcluded

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.


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.

ASSETS LIABILITIES EQUITY= +

How the money is invested Where the money came from


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


Balance sheet measurement conventions

LIABILITIES+

EQUITY

ASSETS

Historical cost

Current cost (fair value)

Net realized value

Discounted present value

Measurement

methods

Balance Sheet


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

ASSETS LIABILITIES EQUITY= +


Balance sheet classification:Current assets

Current market value

Amortized cost or current market value

Net realizable value

Lower of (historical) cost or current market value


Balance sheet classification:Other assets

Historical cost minus accumulated depreciation

except that fair market value is used when “impaired”


Balance sheet classification:Liabilities

Amount due at maturity

Historical cost

Discounted present value

Mezzanine section


Balance sheet classification:Stockholders’ equity

Historical par value

Historical cost

Mixture of different measurement bases


Analytical insights:Understanding the business

Which company is: Deere E-Trade Potomac Electric Power Wal-Mart

$676.7

$5,285.9


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:

+

=

+

+

+

-

-

=


Balance sheet differences:Cadbury Schweppes PLC

Consolidated Holding company only


Balance sheet differences:Cadbury Schweppes PLC (continued)


Balance sheet differences:Cadbury Schweppes PLC (concluded)

Common stock par

Capital in excess of par

Retained earnings


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


Financial statement notes:Significant accounting policies


Financial statement notes:Subsequent events

Subsequent events


Financial statement notes:Related party transactions

Related parties


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 Stockholders’ equityLiabilities+ = +

Cash Non-cash assetsLiabilities= +- 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 assetsΔ 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


Cash flow statement:Wal-Mart example

Adjustments to accrual earnings


Cash flow statement:Wal-Mart example


Cash flow versus accrual earnings:HRB Advertising Company

Opened for business on April 1, when each partner contributed $3,500 cash. Transactions for the year:

Profit (accrual earnings) for the year was $3,725 but the checking account was overdrawn by $11,200


Here’s what happened at HRB


Deriving cash flows from operations:Indirect approach


HRB’s cash flow statement:Indirect approach


Deriving cash flow information:HRB one year later

Bank loan refinanced

Stock issued


Deriving cash flow information:HRB’s accrual earnings and cash flows


Deriving cash flow information:Overview

BeginningBalance sheet

EndingBalance sheet

Incomestatement

Cash flowstatement

You can always derive any one financial statement from information available in the other three statements.


Deriving cash flow information:Cash collected from customers


Deriving cash flow information:Salaries paid


Deriving cash flow information:Rent paid


Deriving cash flow information:Utilities paid


Deriving cash flow information:Cash paid for supplies


Deriving cash flow information:Interest paid


Deriving cash flow information:Office equipment cash flows

Balance Sheet Office Equipment

$15,000

$1,500

$16,500

Purchase (cash basis)

Accumulated Depreciation

$2,250

$5,500

Income Statement Depreciation Expenses

$3,250 3,250

accrual basis


Deriving cash flow information:Bank loan and note cash flows

Bank Loan

$10,000

$10,000

$0

NotePayable

$0

$10,000

$10,000

Refinancing


Deriving cash flow information:Common stock and retained earnings

Common Stock

$10,500

$6,000

$16,500

Retain Earnings

$3,735

$2,000

$1,725Net losses

(accrual basis)

Stock issued (cash basis)


Deriving cash flow information:Cash receipts and disbursements


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.


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

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

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