Ch 4 - Balance Sheet & Statement of Cash Flows

Question 1

What is the purpose of the Balance Sheet?

Answer 1

report assets, liabilities, and equity at a specific date

Question 2

What are the benefits does the Balance Sheet Provide? (4)

Answer 2

• Computing rates of return
• Evaluating the capital structure
• Assess amount, timing, and risk about future cash flows
• analyze the company’s liquidity (ability to pay off short term debt), solvency (ability to pay off long term debt), and financial flexibility

Question 3

What are the limitations of the Balance Sheet? (3)

Answer 3

• most assets and liabilities are reported at historical cost
• use of judgements and estimates
• many items of financial value are omitted (ex: human capital)

Question 4

What is the definition of an asset?

Answer 4

past transaction resulting in probable future economic benefit

Question 5

What is the definition of a liability?

Answer 5

past transaction resulting in probable future economic sacrifice

Question 6

What is the definition of equity?

Answer 6

residual (ownership) interest in the assets that remains after duducting the liabilities

Question 7

List 5 items that would be classified under Current Assets in a Balance Sheet

Also provide the basis of valuation for each item

Answer 7

• Cash and cash equivalent (fair value
• short-term investments (generally fair value)
• receivables (estimated amount collectible)
• inventories (lower-of-cost-or net realizable value)
• prepaid expenses (cost)

Question 8

List 6 items that would be classified under Current Liabilities in a Balance Sheet

Answer 8

• Notes Payable
• Accounts Payable
• Accrued compensation
• Unearned revenue
• Income tax payable
• Current maturities of LT debt

Question 9

List 3 items that would be classified under Long-Term Liabilities in a Balance Sheet

Answer 9

• Long-term debt
• Obligations capital lease
• Deferred income taxes

Question 10

List 5 items that would be classified under Owner’s Equity in a Balance Sheet

Answer 10

• Capital Stock
• Additional paid-in capital
• Retained Earnings
• Accumulated Other Comprehensive Income (AOCI)
• Treasury Stock

Question 11

What is Capital Stock?

Answer 11

the stated value of the shares of stock issued

Question 12

What is additional paid-in capital?

Answer 12

the excess of amounts paid in over the par or stated value

Question 13

What are Retained Earnings?

Answer 13

the corporation’s cumulative undistributed earnings

Question 14

What is accumulated other comprehensive income?

Answer 14

the cumulative amount of the other comprehensive income items

Question 15

What is Treasury Stock?

Answer 15

A contra-equity account for stock buybacks

Question 16

What are the 4 types of supplemental information provided in Balance Sheets?

List & Define

Answer 16

• Contingencies: material events that have an uncertain outcome
• Accounting Policies: explanations of the valuation methods used or basic assumptions made
• Contractual Situations: explanations of certain restrictions or covenants attached to specific assets or liabilities
• Fair Values: disclosures of fair values

Question 17

What is the purpose of the Statement of Cash Flows?

Answer 17

to provide relevant information about the cash receipts and cash payments during a period

Also explains change in the balance sheet

Question 18

What are the 3 questions that the Statement of Cash Flows answers?

Answer 18

• Where did the cash come from?
• What was the cash used for?
• What was the change in the cash balance?

Question 19

Provide Examples of Cash Equivalents

Answer 19

• treasury bills
• commercial paper
• CDs

Question 20

What activities are included on the Statement of Cash Flows?

Answer 20

Cash provided by and used for:
- operating activities (expenses and revenues)
- investing activities (PPE, debt and equity securities of other companies)
- financing activities (dividends, issuance of equity securities, debt-bonds and notices, reacquisition of capital stock)
Net increase (decrease) in cash
Cash beginning balance
Cash ending balance

Question 21

What is Capital Structure?

Answer 21

relative ratio between liabilities (debt) and equity

Question 22

What is the direct approach to record Operating Activities?

Answer 22

• cash inflow: the receipt of cash (counterpart of revenue)
• cash outflow: cash paid (counterpart of expense) to supplies or employees

Question 23

What is the indirect approach to record Operating Activities?

Answer 23

• start with net income (from income statement)
• add back non-cash expenses (depreciation & amortization; gain/loss of noncurrent assets)
• Adjust for movement (between this year and last) in working capital (current assets-current liabilities)
• (increase)/decrease in inventory
• (increase)/decrease in receivables
• increase/(decrease) in payabe=les
• reconcile/adjust it to net cash provided by (or used for) operating activities)

US GAAP mandates indirect approach for the operating section

Important example on slide 19

Question 25

According to US GAAP, how is interest recevied classified in the Statement of Cash Flows?

Answer 25

operating activities

Question 26

According to US GAAP, how is interest paid classified in the Statement of Cash Flows?

Answer 26

operating activities

Question 27

According to US GAAP, how is dividend recevied classified in the Statement of Cash Flows?

Answer 27

operating activities

Question 28

According to US GAAP, how is dividend paid classified in the Statement of Cash Flows?

Answer 28

financing activities

Question 29

Provide examples of significant financing and investing activities that do not affect cash (noncash acttivities) that are provided at bottom of SCF (4)

Answer 29

• issuance of common stock to purchase assets
• conversion of bonds into common stock
• issuance of debt to purchase assets
• exchanges on long-lived assets