Understanding Balance Sheets

Question 1

What three things can an analyst gain from studying a company’s balance sheet?

Answer 1

1. Assess a firm’s liquidity,
2. solvency, and
3. ability to pay dividends to shareholders.

Question 2

What is a classified balance sheet?

Answer 2

A balance sheet that separately reports current and noncurrent assets and current and noncurrent liabilities.

Question 3

What is a liquidity-based balance sheet?

Answer 3

• Often used in the banking industry,
• Present assets and liabilities in order of liquidity.

Question 4

What are current assets?

Answer 4

Current (noncurrent) assets are those expected to be used up or converted to cash in less than (more than) one year or the firm’s operating cycle, whichever is greater.

Question 5

What are current liabilities?

Answer 5

Current liabilities are those the firm expects to satisfy in less than one year or the firm’s operating cycle, whichever is greater.

Question 6

What are cash equivalents?

Answer 6

• Short-term, highly liquid financial assets that are readily convertible to cash.
• Their balance sheet values are generally close to identical using either amortized cost or fair value.

Question 7

How are accounts receivable reported?

Answer 7

Reported at net realizable value by estimating bad debt expense.

Question 8

How are inventories reported for IFRS?

Answer 8

Lower of cost or net realizable value

Question 9

How are inventories reported under US GAAP?

Answer 9

Lower of cost or market.

Question 10

What two methods can be used to measure inventory costs?

Answer 10

Cost can measured using standard costing or the retail method.

Question 11

In what two ways can PP&E be reported under IFRS?

Answer 11

1. The cost model or
2. the revaluation model.

Question 12

How is PP&E reported under US GAAP?

Answer 12

Only the cost model is allowed

Question 13

When is PP&E impaired?

Answer 13

If its carrying value exceeds the recoverable amount.

Question 14

Are recoveries of impairment losses allowed under IFRS? US GAAP?

Answer 14

• IFRS: YES
• US GAAP: NO

Question 15

How are internally created intangible assets handled?

Answer 15

They are expensed as incurred.

Question 16

How are R&D expenses reported under IFRS?

Answer 16

Intangible assets created internally are expensed as incurred. Purchased intangibles are reported similar to PP&E. Under IFRS, research costs are expensed as incurred and development costs are capitalized. Both research and development costs are expensed under U.S. GAAP.

Question 17

How are R&D expenses reported under US GAAP?

Answer 17

Both research and development costs are expensed under U.S. GAAP.

Question 18

What is goodwill?

Answer 18

The excess of purchase price over the fair value of the identifiable net assets (assets minus liabilities) acquired in a business acquisition.

Goodwill is not amortized but must be tested for impairment at least annually.

Question 19

How are held-to-maturity securities reported?

Answer 19

Held-to-maturity securities are reported at amortized cost.

Question 20

How are trading securities, available-for-sale securities, and derivatives reported?

Answer 20

At fair value.

Question 21

For trading securities and derivatives, unrealized gains and losses are recognized where?

Answer 21

In the income statement.

Question 22

Where are unrealized gains and losses for available-for-sale securities reported?

Answer 22

Unrealized gains and losses for available-for-sale securities are reported in equity (other comprehensive income).

Question 23

What are accounts payable?

Answer 23

Amounts owed to suppliers for goods or services purchased on credit.

Question 24

What are accrued liabilities?

Answer 24

Expenses that have been recognized in the income statement but are not yet contractually due.

Question 25

What is unearned revenue?

Answer 25

Cash collected in advance of providing goods and services.

Question 26

How are financial liabilities not issued at face value, like bonds payable, reported?

Answer 26

Financial liabilities not issued at face value, like bonds payable, are reported at amortized cost.

Question 27

How are held-for-trading liabilities and derivative liabilities reported?

Answer 27

How are held-for-trading liabilities and derivative liabilities are reported at fair value.

Question 28

What six things does owners equity include?

Answer 28

1. Contributed capital
2. Preferred stock
3. Treasury stock
4. Retained earnings
5. Noncontrolling (minority) interest
6. Accumulated other comprehensive income

Question 29

What is contributed capital?

Answer 29

The amount paid in by common shareholders.

Question 30

What is preferred stock?

Answer 30

Capital stock that has certain rights and privileges not possessed by the common shareholders. Classified as debt if mandatorily redeemable.

Question 31

What is treasury stock?

Answer 31

Treasury stock—issued common stock that has been repurchased by the firm.

Question 32

What is retained earnings?

Answer 32

The cumulative undistributed earnings of the firm since inception.

Question 33

What is a noncontrolling(minority) interest?

Answer 33

The portion of a subsidiary that is not owned by the parent.

Question 34

What does accumulated other comprehensive income include?

Answer 34

Includes all changes to equity from sources other than net income and transactions with shareholders.

Question 35

What does the statement of changes in stockholder’s equity summarize?

Answer 35

The transactions during a period that increase or decrease equity, including transactions with shareholders.

Question 36

What does a liquidity ratio measure?

Answer 36

The firm’s ability to satisfy its short-term obligations as they come due.

Question 37

What are three popular liquidity ratios?

Answer 37

1. Current ratio,
2. Quick ratio, and
3. Cash ratio.

Question 38

What do solvency ratios measure?

Answer 38

The firm’s ability to satisfy its long-term obligations.

Question 39

What are four popular solvency ratios?

Answer 39

1. Long-term debt-to-equity ratio,
2. Total debt-to-equity ratio,
3. Debt ratio, and
4. Financial leverage ratio.