Chapter 2: How is a Statement of Financial Position Prepared and Analyzed? Flashcards
Trial Balance
A trial balance is a financial statement that lists the titles of T-accounts, their ending debit or credit balances, and totals the columns to check for equality between debits and credits.
Current Ratio
The current ratio is a financial ratio used to assess a company’s short-term liquidity and its ability to pay current liabilities with current assets. It is calculated by dividing current assets by current liabilities.
Trial Balance Spreadsheet
A trial balance spreadsheet is an internal document that lists T-accounts in financial statement order, displaying ending debit and credit balances for each account.
Debit and Credit Balances
Debit balances are indicated in the left column, and credit balances are indicated in the right column of a trial balance, reflecting the nature of the accounts.
Financial Statement Order
T-accounts in a trial balance are typically arranged in the financial statement order, which includes assets, liabilities, shareholders’ equity, revenues, and expenses.
Equality Check
The trial balance is used to ensure that total debits equal total credits, serving as a check to identify errors in journal entries.
Investing and Financing Activities
The statement of financial position can be prepared based on investing and financing activities, even before operating activities occur. It provides valuable information to external users.
Shaded Accounts
In a trial balance, shaded accounts represent those whose balances changed due to investing and financing transactions, while non-shaded accounts retain their previous balances.
External Users
External users, such as investors and decision makers outside the business, rely on financial statements, including the statement of financial position, to assess a company’s financial health.
Example of a Trial balance
Classified Statement of Financial Position
A classified statement of financial position is a formal financial statement that provides a snapshot of a company’s financial position at a specific date.
It classifies assets and liabilities into current and non-current categories for clarity and analysis.
Comparative Data
Comparative data in a classified statement of financial position compares account balances at different dates, allowing for analysis of changes over time and assessing financial trends.
Dollar Signs
Dollar signs are typically used at the top and bottom of both the asset and liabilities/shareholders’ equity sections to indicate the monetary units, often in thousands or millions.
Financial Health Assessment
The classified statement of financial position is a critical tool for assessing a company’s financial health, as it provides a structured view of assets, liabilities, and equity, enabling stakeholders to gauge solvency and liquidity.
Statement Heading
The heading of a classified statement of financial position typically includes the company’s name, the statement title (e.g., “Balance Sheet” or “Statement of Financial Position”), the date, and may indicate whether amounts are in thousands or millions.
IFRS (International Financial Reporting Standards)
IFRS is a set of accounting standards used by many countries globally to improve the comparability and transparency of financial statements.
Financial Statement Structure
The structure of financial statements can vary between countries, leading to differences in the order and presentation of account titles.
Liquidity Order
Canadian companies often list assets in decreasing order of liquidity, while European companies tend to list assets in increasing order of liquidity.
Equity vs. Liabilities Order
Some companies emphasize longer-term financing sources by listing equity before liabilities, and within liabilities, they may list non-current liabilities before current liabilities.
Subheadings
Paying attention to subheadings in financial statements is crucial for understanding the classification of accounts.
Any account listed under the heading “liabilities” is a liability.
Current and Non-Current Classification
Current and non-current classifications on the statement of financial position are essential for distinguishing assets and liabilities expected to be used or settled within the next 12 months (current) from those with longer-term horizons (non-current).
Financial Ratio Analysis
Financial ratio analysis involves calculating and interpreting various ratios to assess a company’s past performance and financial condition. It serves as input for predicting future potential.
Change in Ratios Over Time
Monitoring changes in ratios over time provides insights into how a company’s financial health and strategies have evolved.
Comparison with Competitors
Comparing a company’s ratios with those of competitors or industry averages helps evaluate its relative performance and competitiveness.
Current Ratio
The current ratio is a financial ratio that assesses a company’s short-term liquidity by comparing current assets to current liabilities.
Net Profit Margin
Net profit margin is a financial ratio that measures a company’s profitability by expressing net profit as a percentage of revenue.
Total Asset Turnover Ratio
The total asset turnover ratio evaluates how efficiently a company uses its assets to generate revenue.
Return on Assets
Return on assets (ROA) is a financial ratio that indicates a company’s ability to generate profit from its assets.
Industry Analysis
Understanding the industry and business environment is crucial for interpreting financial ratios effectively and making informed investment decisions.
Predictive Role of Ratio Analysis
Ratio analysis serves as a tool for assessing a company’s financial health and performance, but the ultimate goal is to use this knowledge to make predictions about its future prospects.
Confusing Bookkeeping with Accounting
Bookkeeping involves data entry for straightforward and repetitive transactions, while accounting requires a professional accountant with extensive knowledge and expertise in complex financial analysis, reporting, and more.
Exactness of Accounting Numbers
Not all accounting numbers are precise; estimates play a role in financial statements, as demonstrated by examples like accounts receivable.
Reporting Market Value in Financial Statements
Financial statements often report values based on historical cost, not market value, because historical cost can be verified with documents.
Understanding Financial Statements
To interpret financial statements effectively, it’s crucial to understand their limitations and objectives. They provide valuable information but may not capture every detail
Presentation of Assets and Liabilities
Publicly accountable enterprises have options for presenting assets and liabilities.
They can list assets in increasing order of liquidity and emphasize longer-term financing sources, or they can choose a different order if it provides more relevant information to financial statement users.
Asset Valuation Methods
Publicly accountable enterprises can choose between the cost model and the revaluation model for reporting assets.
The revaluation model allows reporting assets at fair value, reflecting changes in their values over time.
Presentation in IFRS
Under IFRS, non-current assets are typically presented before current assets, and equity is listed before liabilities.
Liabilities are presented in order of increasing time to maturity. However, flexibility exists to prioritize liquidity and maturity when relevant.
Presentation in ASPE
Private enterprises, following ASPE (Accounting Standards for Private Enterprises), report assets in decreasing order of liquidity, with cash listed first.
Liabilities are reported in order of time to maturity, with current assets and liabilities appearing before non-current ones.
Asset Valuation in ASPE
Private enterprises using ASPE are required to report assets at historical cost and are not permitted to record increases in these assets over time, unlike the revaluation option available in IFRS for publicly accountable enterprises.
