CHAPTER 7

1. CHAPTER 7 FINANCIAL STATEMENTS II: THE BALANCE SHEET AND THE STATEMENT OF CASH FLOWS

2. The Balance Sheet • Should disclose the wealth of a company at a point in time. Wealth is present value of all resources and obligations • This measurement technique is limited; consequently, a variety of measurement techniques are used to measure the elements of the balance sheet. • Historical (Historical cost) • Current oriented (Current value) • Future oriented (Expected realizable value) • The balance sheet actually contains a variety of measurement techniques

3. Balance Sheet Elements • Assets • Liabilities • Equity • Definitions arise from the FASB’s asset - liability approach to income determination • Departure from previous definitions that resulted in valuations arrived at via the residual effect of income determination

4. Components of the Balance Sheet • Assets • Current assets • Investments • Property, plant, and equipment • Intangible assets • Other assets • Liabilities • Current liabilities • Long-term debt • Other liabilities • Stockholder’s Equity • Capital stock • Additional paid-in capital • Retained earnings

5. Measurement Techniques for Assets • Current assets - definition and placement • Cash and cash equivalents • Temporary investments • Receivables • Inventories • Prepaid expenses • Investments • Securities acquired for specific purposes - stock of affiliated companies • Assets not currently in use - land for future building site • Special funds - sinking funds • Property, plant and equipment and intangibles • Other assets

6. Asset Valuation Asset Measurement basis Cash Current value Accounts receivable Expected future value Marketable securities Fair value Inventory Current or past value Investments Fair value or amortized cost Property, plant and Fair value or Depreciated past valueequipment

7. Liabilities and Their Associated Measurement Techniques • Current liabilities - liquidation value • Long-term and other liabilities - liquidation value or present value • Liability valuation • Question: Do measurement techniques bias statements in favor of current investors?

8. Stockholders’ Equity Accounts and Their Associated Measurement Techniques • Common stock - historical cost • Par value vs. selling price • Preferred stock - historical cost • Retained earnings and other comprehensive income - dependent upon income recognition

9. Cash Flow Information • The presentation of cash flow information should enable financial statement users to • Predict the amount of cash that is likely to be distributed as dividends or interest • Evaluate risk • Presentation of cash flow information assists in evaluating • Liquidity - nearness to cash • Solvency - going concern • Financial flexibility- react to crisis

10. Statement Format • Report changes during an accounting period in cash and cash equivalents for • Net cash flows from operations • Investing transactions • Financing transactions

11. Cash Flows From Operating Activities • Consists of the cash effect from transactions that enter into the determination of net income exclusive of financing and investing activities • Examples • Direct vs Indirect method

12. Cash Flows From Investing Activities • Making and collecting loans, acquiring and disposing of debt or equity securities of other companies; and acquiring and disposing of property, plant, and equipment and other productive resources • Examples

13. Cash Flows From Financing Activities • Results from obtaining resources from owners, providing owners with a return of and a return on their investment, borrowing money and repaying the amount borrowed and obtaining and paying for other resources from long-term creditors. • Examples

14. Uses of Cash Flow Information • A major objective of accounting is to provide data allowing the presentation of cash flows to investors and creditors to allow evaluation of risk • Net income is not directly associated with cash • Investors expect return equal to market rate of interest for investments with equal risk - discounted future cash flows > investment • Past cash flows are the best indicators of future cash flows • Empirical research indicates that cash flow information has an incremental value over earnings and is superior to disclosure of changes in working capital

15. International Accounting Standards • The IASC has: • Discussed the statement of financial position and the various measurement bases used in accounting, and defined assets, liabilities and equity in “Framework for the Preparation and Presentation of Financial Statements • Discussed the information to be disclosed on the balance sheet in IAS No. 1 “Presentation of Financial Statements” • Discussed the presentation of the statement of cash flows in IAS No. 7, “Cash Flow Statements.”

16. “Preparation and Presentation of Financial Statements” • The discussion of the statement of financial position indicated: • Economic decisions made by users require an evaluation of the ability of an enterprise to generate cash • The financial position of an enterprise is affected by its financial structure, liquidity and solvency, and its capacity to adapt to change (financial flexibility • Measurement bases include historical cost, current cost, realizable value and present value with the most common being historical cost • The definitions of assets, liabilities and equity are similar to U. S. GAAP

17. IAS No. 1Presentation of Financial Statements • Recommends disclosures similar to U. S. GAAP • However, the allows companies to decide whether or not to present current assets and current liabilities separately • Defined minimum categories to be disclosed • Additional items should be disclosed based on their materiality and nature

18. IAS No. 7 • The required presentation of the statement of cash flows is very similar to U. S. GAAP • Operating, financing and investing activities are to be disclosed • Indirect or direct method of disclosing operating activities may be used but stated a preference for the direct method.