Understanding Balance Sheets

Question 1

Balance sheet reports the firms financial position at a point in time. Consists of assets, liabilities, and equity

Answer 1

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Question 2

Assets

Answer 2

= resources controlled as a result of past transactions that are expected to provide future economic benefits

Question 3

Liabilities

Answer 3

= obligations because of a past event that requires an outflow of economic resources.

Question 4

Equity

Answer 4

= owners’ residual interest in the assets after deducting the liabilities

Question 5

Liquidity

Answer 5

the ability to meet ST obligations

Question 6

Solvency

Answer 6

ability to meet LT obligations

Question 7

The are numerous valuations per balance sheet

Answer 7

some historical, some amortized or present value

Question 8

Classified balance sheet

Answer 8

separately report current and noncurrent assets. IFRS and GAAP required.

Question 9

Liquidity based format

Answer 9

present assets and liabilities in order of liquidity. Often in banking industry.
- IFRS allows this format if it makes more sense for the business to calculate balance sheet as such.

Question 10

Current assets

Answer 10

cash and other assets that will likely be converted to cash within one year or operating cycle. Presented in order of greatest liquidity.

Question 11

Current liabilities

Answer 11

obligations that need to be met within 1 year or operating cycle.

If it meets any of the following criteria:

• settlement expected in operating cycle
• settlement expected in 1 year
• held primarily for trading purposed
• not an unconditional right to defer settlement

Question 12

Working capital

Answer 12

= current assets - current liabilities

• If WC is high = inefficient use of WC
  if WC is low = not enough liquidity

Question 13

If assets are not current, they are noncurrent assets.

Answer 13

Noncurrent assets shows indicators of the firms’ investing activities

Question 14

If liabilities are not current, they are noncurrent liabilities.

Answer 14

They highlight the long term financing activities of the firm.

Question 15

Current Assets examples:

Answer 15

• Cash and cash equivalents (MMF, Treasury bills @ fair value)
• Marketable securities (Treasury bills, notes, bonds and equity securities)
• Accounts Receivable: assets owed to firm from consumers on credit. Reveals collection problems.
• Inventories: separate from raw materials, works in process. Standard costing to measure inventory, which assigns predetermined amounts of materials labor and overhead to produced goods
• Other: prepaid expenses and deferred taxes

Question 16

Current Liabilities Examples

Answer 16

• Accounts Payable: amounts owed to suppliers that are on credit.
• Notes payable: obligations in the form of promissory notes owed to creditors and lenders. (if maturity > 1 year, it is a noncurrent liability)
• Accrued liabilities: expenses that are recognized in income statement but are not yet contractually due.
• Unearned Revenue: cash collected in advance for providing goods/services.

Question 17

Noncurrent Assets Examples

Answer 17

• Property, Plant and Equipment (PP&E): “ and tangible assets used in production of goods and services. Measured by cost model. (IFRS allows revaluation model).
• Investment Property: rental income or capital appreciation. Amortized cost or fair value model.
• Intangible Assets: non-monetary assets that lack physical substance. Measured by the cost model. (IFRS allows reevaluation.)
• Goodwill: the excess purchase price over the fair value of the identifiable net assets acquired in a business acquisition.
• Financial Assets: Investment securities, derivatives, loans and receivables. Measured by historical cost(loans and receivables), amortization or fair value(trading securities and derivatives).

Question 18

Cost model

Answer 18

PPE, other than land, is amortized

Question 19

Impaired Asset

Answer 19

when its carrying value exceeds recoverable amount

Question 20

Fair Value Model

Answer 20

Any change in fair value recognized in income statement.

Question 21

Through goodwill, firms can manipulate net income by allocating more acquisition price to goodwill and less identifiable assets, resulting in less depreciation and amortization expense.

Answer 21

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Question 22

Held-to-market securities

Answer 22

Debt securities acquired to hold to maturity

Question 23

Non-current Liabilities Examples

Answer 23

• LT financial liabilities: banks loans, notes payable, bonds payable, and derivatives. Usually amortized, sometimes fair value.
• Deferred tax liabilities: amounts of income taxes payable in future periods as a result of taxable temporary differences.

Question 24

Owners’ Equity

Answer 24

• the residual interest in assets that remains after subtracting an entity’s liabilities.
• Including: contributed capital, par value of common stock, preferred stock, retained earnings.

Question 25

Common size balance sheets

Answer 25

Expresses each item of the balance sheet as a percentage of total assets.
- eliminates the effect of size, allowing comparison by time-series and cross sectional.

Question 26

Current ratio

Answer 26

Current Assets / Current Liabilities

Question 27

Quick ratio

Answer 27

(Cash + marketable securities + Receivables) / Current Liabilities

Question 28

Cash ratio

Answer 28

(Cash + marketable securities) / Current Liabilities

Question 29

LT debt-to-equity

Answer 29

LT debt / total equity

Question 30

Total debt-to-equity

Answer 30

total debt / total equity

Question 31

debt ratio

Answer 31

total debt / total assets

Question 32

Financial leverage

Answer 32

total assets / total equity