2.1 - Statement of Financial Position

Question 1

Define Statement of Financial Position

Answer 1

AKA Balance Sheet
a financial statement that shows the accounting value of the firm at a particular date

Question 2

Define GAAP

Answer 2

Generally Accepted Accounting Principles: a framework for a common set of principles, rules and procedures of accounting

The practice in Canada is to retain the order used under GAAP

Question 3

Define IFRS

Answer 3

International Financial Reporing Standards
- in 2011, many public Canadian firms switched to IFRS because under IFRS they enjoy the flexibility of how to present its statement of financial position

Question 4

Model of Statement of Financial Position

Answer 4

Question 5

How are assets classified?

Answer 5

1. Current assets

• life less than 1 year (will be converted to cash within the year)
• ie. inventory (usually), cash, accounts receivable

2. Fixed assets / Capital Assets

a. tangible (ie. computer, truck)
b. intangible (copywright, trademark, patent)

Question 6

How are Liabilities Classified?

Answer 6

1. Current Liabilities
   - must be paid within 1 year
   - ie. accounts payable
2. Long-term Liabilities
   - debt that lasts longer than 1 year

Question 7

Define Bond and Bond Holder

Answer 7

Bond: Long-term debt
Bondholder: The creditor of the long term debt

Question 8

What is shareholder’s equity?

Answer 8

If the firm were to sell all the assets and pay off all the debts, the residual money left over would belong to the shareholders

Question 9

Define Net Working Capital

Answer 9

Net Working Capital = Current Assets - Current Liabilities

If net working capital is positive, the cash available in the next year exceeds cash to be paid in next year

positive net working capital is a sign of a healthy company

Question 10

What 3 things are important to examine in the statement of financial position

Answer 10

1. liquidity
2. debt vs. equity
3. Market value vs. book value

Question 11

Define Liquidity and how we define an asset that is highly liquid and one that is illiquid?

Answer 11

There are 2 components of liquidity:
1. ease of conversion of the asset to cash
2. loss of value from converting the asset to cash

This is because any asset can quickly be converted to cash if we cut the price enough

An asset that is highly liquid is one that can be converted to cash without significant loss of value
An asset that is illiquid is one that cannot be converted to cash without a significant price reduction

Question 12

How are assets normally ordered when they are listed on the stateement of financial position

Answer 12

from most liquid to least liquid

Question 13

How is liquidity valuable (advantageous), and how can it be disadvantageous

Answer 13

Liquidity is valuable because:
- the more liquid a firm is, the less likely they are to experience financial distress

Liquidity can be disadvantageous because:
- liquid assets are generally less profitable to hold
- ie. cash can be sitting there and generating no return

Question 14

What is financial leverage? how can it be useful? How can it be damaging?

Answer 14

Financial leverage is the use of debt in a firm’s capital structure
More debt as a percentage of assets = greater financial leverage

Financial leverage increases potential reward to shareholders:
- they can acquire more assets that generate returns higher than the interest of the debt
- tax benefits

Financial leverage also increases potential of financial distress and business faliure
- reduces operational flexibility
- more debt to pay which can be difficult if there isnt a lot of cash flow

Question 15

What is carrying value / book value of assets

Answer 15

the accounting value of a firm’s assets

Question 16

What is market value of assets?

Answer 16

the price at which willing buyers and sellers trade the assets

Question 17

What methods does the IFRS allow for valuing assets

Answer 17

1. Historical Cost Method
2. Revaluation Method (fair value)
   - all items in a class of assets should be revalued simultaneously
   - the revaluation period should be performed often enough that at the date of the balance sheet, the carrying amount (accounting value) is not materially different from the fair value amount

Question 18

What is the statement of financial position identity/equation

Answer 18

Assets = Liabilities + Shareholders equity