Ch 5 Flashcards
Balance sheet is sometimes referred to as?
Statement of financial position, that reports assets, liabilities and stockholders equity of a business enterprise at a specific date.
The balance sheet provides a basis for?
Computing rates of return and evaluating the capital structure of the enterprise.
Analysts use the information on the. A lance sheet to assess?
Companies risk and future cash flows
Liquidity
Describes “the amount of time that is expected to elapse until an asset is realized or otherwise converted into Cash or until a liability has to be paid.
It is how quickly will my assets convert to cash?
Creditors are interested in short term liquidity ratios such as ratio of cash to short term liabilities bc?
The ratios indicate whether a company has the resources to pay its current and maturing obligations
Solvency
Refers to the ability of the company to pay its debts as they mature.
When a company has high level of long term debt relative to assets it has what kind of solvency?
Lower
What affects the company’s financial flexibility?
Liquidity and solvency
Which measures the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows it it can respond to unexpected needs and opportunities.
A company with higher degree of financial flexibility is able to
Survive the bad times and to recover from unexpected setbacks and to take advantage of profitable and unexpected investment opportunities
What are the limitations of the balance sheet?
- Most assets and liabilities are reported at historical cost. So the information provided is criticized for not reporting a more relevant fair value
- Companies use judgments and estimates to determine many of the items reported in the balance sheet
- The balance sheet omits many items that are of financial value but that a company cannot record objectively.
Balance sheets are what?
Classified.
That means that balance sheets group together similar items to arrive at significant sub totals
FASB has often noted what?
Parts and subsections of the financial statements are more informative than the whole.
FASB therefore discourages the reporting of summary accounts alone (total asserts, net assets , total liabilities etc)
FASB suggest that company’s should report and classify….
Individual items in sufficient detail to permit users to assess the amounts, timing and uncertainty of cash flows.
Companies should report separately
Assets that differ in their diff type or expected function in comp central operations . (Ex: mercy inv recorded separately from property, plant and equipment)
Assets and liabilities with different implications for the company’s financial flexibility.
Assets and liabilities with diff general liquidity characteristics.
Current assists
Are cash and other assets a company expects to convert to cash sell or consume either in one year or in the operating cycle.
The operating cycle is the
Average time between when a company acquires materials and supplies and when it receives cash for sales of the product. (For which it acquired the materials and supplies) was
The cycle operates from what?
Cash through inventory, production, receivables and back to cash
Cash
Generally consisted of currency and demand deposit is
Cash equivalents
Short term high liquid investment that will mature within three months or less.
When there is any restrictions or commitments related to the availability of cash, what should the company do?
Disclose
Short term investments
1
2
3
Held to maturity : debt securities that a company has the positive intent and ability to hold to maturity
Trading: debt securities bought and held primarily for sale in the near term to generate income on short term price differences
Available for sale: not classified as the first two.
Trading securities should be reported as what?
Current assets
Reporting held to maturity securities at
Amortized cost
All trading and available for sale debt securities should be reported as
Fair value
Receivables ppjiuffyfycyfycyfcfttcxgxa
A company should clearly identify any expected loss due to uncollectivkes, the amount and nature of any nontrade receivables and any receivables used as collateral s
In order to present inventories properly,
A company discloses the basis of valuation ( lower cost or net realizeable value or lower cost or market) and the cost flow assumption (FIFO AND LIFO)
Prepaid expenses are included in current assets only when
They will receive benefits (usually services) within one year or the operating cycle whichever is longer.
How are prepaid expenses recorded
At the amount of unexpired or unconsumed cost.
Non current Assets:
Long term investments
Referred to simply as investments which includes the four types:
1) investments in securities, such as bonds, common stock, or long term notes
2) investments in tangible fixed assets not currently used in operations such as land held for speculation
3) investments set aside in special funds such as sinking fund, pension fund, or plant expansion.
4) investments investments in non consolidated subsidiaries or affiliated companies. J
Companies expect to hold long term investments and they are put in a section called
Investments
Companies do not include long term investments as current assets
Unless it intends to covert them to cash in short term.
Property plant and equipment
Tangible long lived assets used in regular operations of the business.
Such as land buildings machinery furniture tools and wasting resources
Intangible assets
Lack a physical substance are not financial instruments.
Such as patents copyrights franchises good will trademarks trade names and customer lists.
How does a company write off intangible assets?
Over their useful lives .
What is included in other assets?
Long term prepaid expenses
Prepaid pension cost
Noncurrent receivables
Current liabilities
Are obligations that a company hexpects to liquidate either through the use of current assets or the creation of other current liabilities
Sometimes a liability that is phablet within the next year is not included in the current liabilities section becaus
A company expects to refinance the debt through another long term issue.
Or to retire the debt out of non current assets.
Why is that approach used?
Because liquidation does not result from the use of current assets.or the creation of other current liabilities.
Companies do not report current liabilities in
A consistent order
Working capital
Is the excess of total current assets over total current liabilities
What does working capital represents
The net amount of a company’s relatively liquid resources
Which is the liquidity buffer available to meet the financial demands of the operating cycle.
How do you determine the actual liquidity and availability of working capital to meet current obligations
Is the analysis of the composition of current assets and their nearness to cash
Long term liabilities
Are obligations that a company does not reasonably expect to liquidate with the normal accounting cycle.
Examples of long term liabilities
Bonds payable
Notes payable
Deferred income tax liabilities
Lease obligations
Pension obligations
Companies classify long term liabilities that mature within the current operating cycle as
Current liabilities if the payment of obligation requires the use of current assets
Long term liabilities are 3 types
- Obligations arising from specific financing situations such as issuance of bonds
- Obligations arising from ordinary operations of company such as pension obligations
- Obligations that depend on occurrence or non occurrence of one or more future events to confirm the amount payable
Owners equity
Most difficult sections to prepare and understand
Owners equity includes
Capital stock: par or stated value of shares issued.
APIC: excess of amounts paid in over the par or stated value
R/E: undsitributed earnings
Accumulated other comprehensive income: aggregate amount of the other comprehensive items
Treasury stock: cost of shares repurchased
Non controlling interest: portion of the equity of subsidiaries not wholly owned by the reporting company.
For capital stock, what must the companies disclose?
Par value and authorized issued and outstanding share amounts
Retained earnings may be divided into a
Unappropriated (amount usually available for dividend distribution)
Redistributed (by bond indentures or other loan agreements)
Any capital stock that is reacquired is
Is a reduction of stockholders equity
Accumulated other comprehensive income includes
Items such as unrealized gains and losses on available for sad debt investments and unrealized gains and losses on derivative transactions
Non controlling interest is sometimes referred as
Minority interest
The common arrangement that companies used in presenting a classified balance sheet is
Account form.
The assets are listed by sections in the left side, and liabilities and stockholders equity on the right side
Often two pages
The main disadvantage for the account form
Is the need for wide space to present items side by side
A way to avoid the disadvantage of the account form is to use report form because
It lists the sections one above the other on the same page.
Statement of cash flows
Cash inflows and outflows, and uses of cash during the period
Purpose of statement of cash flows is
Provide relevant information about the cash receipts and cash payments of an enterprise during period.
Cash flows reports the following to achieve the purpose of cash flows
1) cash effects on operations during a period
2) investing transactions
3) financing
4) the net increase or decrease in cash during the period.
Cash flows provides answers to the following:
Where did the cash come from during the period
What was the cash used for during the period?
What was the change in cash balance during the period?
Three activities in statements of cash flows
Operating : Involved the cash effects of transactions that enter into the determination of net income
Investing: Includes making and collecting loans and acquiring and disposing of investments (both debt and equity) and property plant and equipment
Financing: involves liability and owners equity items.
Such as obtaining resources from owners and providing them a return on investment
And
Borrowing money from creditors repaying the amounts borrowed.
What helps users evaluate liquidity solvency and financial flexibility
The statement value
Companies obtain information to prepare statement of cash flows from several source
Comparative balance sheets
Current income statement
Selected transaction data
Preparing statement of cash flows involves 4 steps
Determine net cash provided by (or used in) operating activities
Determine the net cash provided (or used in) investing and financing activities
Determine the change (increase or decrease) in cash during the period
Reconcile the change in cash with the beginning and ending cash balances
The net cash provided by operating activities is what
Excess of cash receipts over cash payments from operating activities
To determine this amount they convert income on accrual basis to cash basis
Company must analyze the current years kncome statament but also comparative balance sheets and selected transaction data.
Examples of significant non cash activities
1 issuance of common stock to purchase assets
- Conversion of bonds into common stock
- Issuance of debt to purchase assets
- Exchange of long lived assets.
Significant investing and financing activities that do not affect cash are not reported where?
Body of statement of cash flows but reported in separate schedule ag the bottom of statament of cash flows or seperate notes to financial statament s
Net income provides
Long term measure of a company success or failur e
A company will not survive without
Cash
Why do creditors examine cash flow statament
Because they are concerned about getting paid
They begin the examination in finding net cash provided operating activities
A high amount indicates that a company is able to generate sufficient cash from operations to pay its bills without further borrowing
A low or negative amount of net cash provided by operating activities indicates that
They may have to borrow or issue equity securities to acquire sufficient cash to pay its bills
Creditors wants answers to the following
How successful is the company able to generate cash flows by operating activities
What are the trends in net cash provided by operating activities over time
What are the major reasons for positive or negative net cash provided by operating activities
Companies can fail even if they report what?
Net income
Current cash debt coverage
It indicates whether a company can pay off its current liabilities from its operations given in a year
The higher the current debt cash ecoverage is the less likely a company will have liquidity problems
Cash debt coverage
Provides information on financial flexibility.
It indicates that s company ability to repay its liabilities from net cash provided by operating activities without having to liquidate assets employees in its operations
The higher the ratio the less likely the company will experience dodficulting in meeting its obligations
Free cash flow
Mount of discretionary cash flow a company has
The greater the amount of free cash flow
The greater the company’s financial flexibility will be
Free cash flow wuestions
Is the company able to pay its dividends without resorting to external financing
If a business operations decline will the company. S able to maintain its needed capital investment.
What is the amount of discretionary cash flow that can be used for additional investments, retirement of debt, purchase of treasury stock or addition to liquidity
4 types of info that is supplemental balcne sheet info
Contingencies: material events that have uncertain outcome
Accounting policies: explanation of the valuation methods used or basis assumptions made corncerning inventory valuations
Contractual situations: explanations of certain restrictions or covenants attached to specific asset or more likely to liabilities
Fair values: disclosures of fair values particularly for financial instrument s
Contingency
An exsiditing situation involving uncertainty as to possible gain or loss that will be resolved when one or more future events occur or fail to occur
Contractual situations should be disclosed if significant
In the notes to fisncnail statements
Financial instruments
Defined as cash , ownership interest or contractual right to receiver or obligation to deliver cash or another financial instruments
Examples of financial instruments
Cash
Investments
Account receivable
Payables
To increase the consistency and comparability in the use of fair value measures
Companies follow a fair value hierarchy that provides insight. How to determine fair value
Hierarchy has 3 levels
- Measure the observable inputs (least subjective)
- Level 2: measures are based on market inputs other than those (more subjective)
- Measures are based on unserbable inputs (most subjective)
Companies must make the following fair value disclosures
- Fair value measurement
- Fair value hierarchy level of the measurements as a whole
3 most provided disclosure to level 3 , must identify what assumptions the company used to. Generate fair value numbers and any related income effects
Paranthetical explanations
Following the item , provides clarity and completeness
Paranthetical explanations has an advantage over a note because it brings additional info to body of statament
Shah
Notes are used when
If they cannot conveniently show additional explanations as parenthetical explanations
Contra asset on a balance sheet reudeces
Either asset liability or owners equity
Adjunct account
Increases asset or liability or equity.
Such as premium on Bonds payable
