3.4 understanding the Balance Sheet

Question 1

The balance sheet

Answer 1

provides information on resources (assets) and sources of capital (equity and liabilities)

povides a snapshot of its financial position at a specific point in time

Question 2

Assets

Answer 2

resources controlled by the company to generate future economic benefits for the company

Question 3

Liabilities

Answer 3

obligations of the company from past events

Question 4

Equity

Answer 4

owner’s residual interest in the company

Question 5

A classified balance sheet

Answer 5

separately classifies current and non-current assets and liabilities.

Question 6

Current assets

Answer 6

expected to be sold or used up within one year or one operating cycle, whichever is longer.

Current assets are normally consumed as a part of a company’s regular operations.

Question 7

Non-current assets

Answer 7

include items that are expected to be used over multiple operating cycles (e.g., machinery, vehicles).

Question 8

Current liabilities

Answer 8

expected to be settled within one year or one operating cycle.

Liabilities held primarily for trading purposes are also considered current.

Trade payables are also classified as current liabilities, even if the settlement date is more than one year off.

Question 9

Non-current liabilities

Answer 9

include long-term debt.

Question 10

Working capital

Answer 10

current assets less current liabilities.

Higher levels of working capital indicate that a company has a greater ability to meet its short-term obligations.

Question 11

Cash and Cash Equivalents

Answer 11

These are highly liquid financial assets with minimal risk.

They can be valued at either amortized cost or fair value, but the difference is likely immaterial. S

ome examples of cash equivalents include U.S. Treasury bills and commercial paper.

Question 12

Marketable securities

Answer 12

are equity and debt securities traded in public markets at observable prices.

Question 13

Trade receivables

Answer 13

are also called accounts receivable.

Customers owe these amounts from products and services already delivered.

The level of accounts receivable is important.

The company must also make an allowance for doubtful accounts.

Question 14

how is the allowance for doubtful accounts a contra asset account

Answer 14

because it offsets the accounts receivable balance.

Question 15

Inventories

Answer 15

are physical products that will be eventually sold to customers

Question 16

Trade payables (or accounts payable)

Answer 16

are owed to vendors for goods and services

Question 17

Notes payable

Answer 17

are owed to entities like banks

Question 18

Property, Plant, and Equipment (PPE)

Answer 18

tangible assets used in operations that last more than one period

This includes items such as land, buildings, and natural resources.

Question 19

Intangible assets

Answer 19

are identifiable non-monetary assets without physical substance (e.g., patents, licenses, trademarks)

Question 20

Under IFRS, identifiable intangible assets must be recognized on the balance sheet if:

Answer 20

1. They are likely to generate future benefits.
2. Their cost can be measured reliably.

Question 21

Goodwill

Answer 21

When a company makes an acquisition, the purchase price is allocated first to the fair value identifiable assets and liabilities.

The excess of the purchase price over the fair value is placed on the acquirer’s balance sheet as a goodwill asset.

A company will pay more than the fair value in an acquisition for items such as reputation, research and development, and potential synergies.

Question 22

Held-to-maturity assets

Answer 22

are held at amortized cost

They have principal and interest payments on fixed dates.

Question 23

Financial assets measured at fair value

Answer 23

either held for trading or available-for-sale

Question 24

If a financial asset is held for trading

Answer 24

any unrealized gains or losses are recognized on the income statement

Question 25

If a financial asset is held for available-for-sale classification

Answer 25

unrealized gains or losses bypass the income statement and get recorded as other comprehensive income.

Question 26

deferred tax asset

Answer 26

A company that pays income taxes before the associated income tax expense is recorded for financial reporting purposes

This can happen if certain income is reported immediately for tax purposes and deferred until a later period on the company’s financial statements

Question 27

Long-term Financial Liabilities

Answer 27

include loans and bonds, which are both usually reported at amortized cost.

Financial liabilities held for trading and derivatives are reported at fair value.

Question 28

Deferred Tax Liabilities

Answer 28

Deferred tax liabilities arise when actual taxable income is less than reported financial statement income.

This represents a timing difference in the tax payments.

This occurs when items are expensed earlier on tax statements than they are on other financial statements.

For example, accelerated depreciation could be used for tax statements while straight-line depreciation is used for financial statements.

Question 29

Capital Contributed by Owners (Common Stock)

Answer 29

The issuance of common shares represents ownership.

Those shares may or may not have a par value.

The number of shares authorized, issued, and outstanding must be disclosed.

The number of shares outstanding is the number of issued shares less treasury shares.

Question 30

Preferred Shares

Answer 30

are classified as either equity or financial liabilities.

Preferred shareholders have greater rights than common shareholders with respect to receiving dividends and liquidation claims.

Question 31

Treasury Shares

Answer 31

These are shares repurchased by the company.

A company could repurchase shares if management thinks the shares are undervalued or to prevent dilution from stock options.

Treasury shares are non-voting and do not receive any dividends.

Question 32

Retained Earnings

Answer 32

Retained earnings are the cumulative amount of earnings not paid to owners in the form of dividends.

Question 33

Noncontrolling Interest

Answer 33

This is the equity interest of minority shareholders in subsidiaries that the company does not wholly own.

Question 34

The statement of changes in equity

Answer 34

shows the increases or decreases in equity over a period

Question 35

The statement of changes in equity requires which of the following info according to the IFRS

Answer 35

Total comprehensive income

Effects of retrospectively applied accounting changes

Capital transactions with owners

Reconciliation of carrying amounts of each component

Question 36

Liquidity Ratios

Answer 36

Current ratio

Quick ratio/Acid test ratio

Cash ratio

Question 37

Current ratio

Answer 37

current assets / current liabilities

Question 38

Quick ratio/Acid test ratio

Answer 38

(cash + marketable securities + receivables) / current liabilities

Question 39

Cash ratio

Answer 39

(cash + marketable securities) / current liabilities

Question 40

Solvency Ratios

Answer 40

Long-term debt-to-equity ratio

debt-to-equity ratio

Total debt ratio

Financial leverage ratio

Question 41

Long-term debt-to-equity ratio

Answer 41

Total long-term debt / total equity

Question 42

debt-to-equity ratio

Answer 42

total debt / total equity

Question 43

Total debt ratio

Answer 43

total debt / total assets

Question 44

Financial leverage ratio

Answer 44

total assets / total equity

Question 45

A purchase of treasury shares most likely:

A
reduces shareholders’ equity.

B
has no net impact on shareholders equity.

C
reduces the number of non-voting shares.

Answer 45

A
reduces shareholders’ equity.