INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 5
Financial Position and
Cash Flows
Prepared by:
Dragan Stojanovic, CA
Rotman School of Management,
University of Toronto
CHAPTER 5
Financial Position and Cash Flows
After studying this chapter, you should be able to:
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Understand the statement of financial position and statement of cash flows from a business
perspective.
Identify the uses and limitations of a statement of financial position.
Identify the major classifications of a statement of financial position.
Prepare a classified statement of financial position.
Identify statement of financial position information that requires supplemental disclosure.
Identify major disclosure techniques for the statement of financial position.
Indicate the purpose and identify the content of the statement of cash flows.
Prepare a statement of cash flows using the indirect method.
Understand the usefulness of the statement of cash flows.
Identify differences in accounting between ASPE and IFRS.
Identify the significant changes planned by the IASB regarding financial statement
presentation.
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Financial Position and
Cash Flows
Usefulness from Statement of
a Business
Financial
Perspective
Position
•Analyzing a
statement of
financial position
•Assessing
earnings quality
•Assessing the
creditworthiness of
companies
•Usefulness
•Limitations
•Classification
•Preparation
•Additional
information
reported
•Techniques of
disclosure
Statement of
Cash Flows
•Purpose,
content, and
format
•Preparation
•Usefulness
•Perspectives
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IFRS / ASPE
Comparison
•A comparison of
IFRS and ASPE
•Looking ahead
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Business Perspective
• Statement of financial position (SFP) and the
statement of cash flows can be used to assess:
– Financial flexibility and risk of business failure
– Earnings quality
– Creditworthiness
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Statement of Financial Position:
Usefulness
• Statement of Financial Position (SFP) also known as
the balance sheet
• SFP provides information:
– for evaluating the capital structure and
– for computing rates of return on invested assets
• It is also useful for assessing an enterprise’s:
– Liquidity (time until asset is realized or liability has to
be paid)
– Solvency (ability to pay debts and related interest)
– Financial flexibility (ability to respond to unexpected
needs and opportunities)
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Statement of Financial Position:
Limitations
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Many assets and liabilities are stated at historical
cost
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Information presented is reliable, however
Reporting at current fair value would result in more
relevant information
2. Judgement and estimates are used in determining
many of the items reported on the SFP
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Many “soft” numbers (estimates) are included which
may be uncertain
3. SFP does not report items that cannot be recorded
objectively (e.g. internally generated goodwill)
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Statement of Financial Position:
Classification
• Similar items are grouped together, with sub-total
• Items with different characteristics are separated
• Individual SFP items should be:
– Reported separately, and in
– Sufficient detail in order to:
• Allow users to assess amounts, timing, and uncertainty of future
cash flows
• Allow users to evaluate liquidity, financial flexibility, profitability, and
risk
• Helps to calculate important ratios (e.g. current ratio to assess
liquidity)
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Statement of Financial Position:
Classification
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Considerations for reporting items separately:
1. Assets that differ in their type or expected function (e.g.
inventory vs. capital assets)
2. Liabilities with different implications for the entity’s
financial flexibility (e.g. long term debt vs. current debt)
3. Assets and liabilities with different general liquidity
characteristics (e.g. cash vs. receivables)
4. Assets, liabilities, and equities with characteristics that
allow for easy measurement or valuation
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Statement of Financial Position:
Classification
Assets
Liabilities and Equity
• Current assets
• Long-term investments
• Property, plant, and
equipment
• Intangible assets
• Other assets
• Current liabilities
• Long-term debt
• Shareholders’ equity
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Capital shares
Contributed surplus
Retained earnings
Accumulated other
comprehensive income /
other surplus
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Current Assets
• Current assets are cash and other assets
expected to be realized:
– within one year from the balance sheet date or
– within the normal operating cycle, whichever is longer
• Generally presented in order of liquidity
(normally: cash, short-term investments,
receivables, inventory, and prepaid expense)
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Current Assets–Cash
• Often includes cash and cash equivalents
• Defined as:
Cash, demand deposits, short-term liquid
investments convertible to a known cash
amount, and not subject to material value
changes
• Any known restrictions to cash must be
disclosed
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Current Assets–
Short-Term Investments
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Investments in debt and equity securities
are presented separately from other
assets
Valued at cost/amortized cost or fair
value
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Current Assets–Receivables
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Amounts should be reported separately based on
the nature of their origin:
1. Ordinary trade accounts
2. Amounts owing by related parties
3. Other (substantial) unusual items
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Separate disclosure required for:
1. Amount and nature of nontrade receivables
2. Receivables pledged as collateral
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Accounts receivable valued at net realizable value
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Current Assets–Inventories
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Valued at lower of cost and net realizable value
Cost flow assumption method (e.g. FIFO, weighted
average, specific item) must be disclosed
Manufacturing enterprise will disclose completion
stage of inventories:
1. Raw materials
2. Work in progress
3. Finished goods
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Current Assets–
Prepaid Expenses
• Defined as: expenditures already made for benefits
to be received within one year or the operating cycle
(whichever is longer)
• Most common examples include:
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Insurance
Rent
Advertising
Supplies
• Current practice is to report some prepaid amounts
where the benefit extends beyond one year (or
operating cycle)
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Noncurrent Investments
• Noncurrent investments normally consist of one of
the following:
– Debt securities
– Equity securities
– Sinking funds, tangible assets held as investments,
other
• Investments are intended to be held for an extended
period of time
• Valuation options are:
• Fair value
• Amortized cost
• Equity Method
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Property, Plant, and Equipment
• Physical (tangible) assets used in ongoing business operations of the business
to generate income
• Generally reported at cost or amortized
cost
• IFRS allows for valuation at fair value
• Most assets are depreciable, except for
land
• Written down when impaired
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Intangible Assets
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Capital assets without physical substance, held to
generate revenue
Higher degree of uncertainty regarding future benefits
Include (most common):
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patents
copyrights
franchises
goodwill
trademarks, and trade names
Intangibles are grouped into two categories:
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Those with finite life – amortized over useful life
Those with indefinite life – not amortized
Both are tested for impairment
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Other Assets
• Some of the items included are:
– Assets in special funds
– Non-current receivables
– Future income taxes
– Property held for sale
– Advances to subsidiaries
• Sufficient information to be disclosed to
inform users of the nature of the asset
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Current Liabilities
• Obligations due within one year (from balance sheet
date) or within the operating cycle, whichever is longer
• Examples of current liabilities include:
– Payables resulting from acquisitions of goods and services
– Collections received in advance of delivery of goods or
performance of services
– Other liabilities to be paid in the short term
– Short-term financing payable on demand (e.g. line of credit)
• Accounts payable normally listed first; however, current
liabilities not reported in any specific order
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Working Capital
Current
Assets
–
Current
Liabilities
=
Working
Capital
• A key indicator of the company’s short-term
liquidity
• Not usually disclosed on the SFP
• Often calculated by bankers and other
creditors
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Long-Term Liabilities
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Long-term obligations are those not expected to be
paid within the normal operating cycle
Three types:
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Obligations arising from specific financing situations (e.g.
bonds)
Obligations from ordinary operations of the enterprise (e.g.
pension obligations)
Obligations arising from ordinary business operations that are
contingent on future events (e.g. product warranty)
SFP presentation requires reporting the portion due
within the next year as a current liability
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Shareholders’ Equity
Capital Shares
• Exchange value of issued shares
• Disclose authorized, issued, and outstanding amounts
Contributed Surplus
• Usually reported as one amount
• Includes issued share premiums
Retained Earnings
• The amount of undistributed earnings
• Presented as one item
Accumulated Other Comprehensive Income
• Includes unrealized gains and losses on available-for-sale
securities, certain types of donations etc.
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Additional Information Reported
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Additional information reported on the SFP may
include:
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Information not presented elsewhere, or
Information that qualifies items in the SFP
Five main types of additional information
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Contingencies
Accounting policies
Contractual situations
Additional detail
Subsequent events
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Techniques of Disclosure
1. Parenthetical explanations (following the
items in the SFP)
2. Notes (to the SFP)
3. Cross references and contra items
(where assets and liabilities may be cross
referenced)
4. Supporting schedules (as for capital
assets’ depreciation)
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Statement of Cash Flows
• To assess the firm’s ability to generate
cash and cash equivalents and
• To allow comparison of cash flows
between different entities
• Statement of Cash Flows shows:
– Where the cash came from
– What the cash was used for
– The change in the cash balance
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Statement of Cash Flows
• Cash activities are divided into three main
categories:
– Operating Activities
• Main revenue-producing activities
– Investing Activities
• Changes in long-term assets and
investments
– Financing Activities
• Changes in equity and borrowings
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Cash Inflows and Outflows
Operating
Activities
• When operating
cash receipts >
cash expenditures
Investing Activities
• Sale of property, plant,
and equipment
• Sale of debt or equity
securities of other
entities
• Collection of loans to
other entities
Financing Activities
• Issuance of equity
securities
• Issuance of debt
(bonds and notes)
Cash
Pool
Cash Inflows
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Cash Inflows and Outflows
Cash Outflows
Cash Pool
Operating
Activities
• When operating
cash expenditures
> cash receipts
Investing Activities
Financing Activities
• Purchase of property,
plant, and equipment
• Purchase of debt or
equity securities of
other entities
• Loans to other entities
• Payment of dividends
• Redemption of debt
• Reacquisition of capital
stock
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Statement of Cash Flows Presentation
• Presentation methods
– Direct method: includes specific cash inflows/outflows
(e.g. cash received from customers, cash paid to
suppliers and employees, interest paid/received,
taxes paid, etc.)
– Indirect method: begins with net income and
reconciles to cash (e.g. adds back non-cash charges
deducted from net income, such as depreciation)
• Both methods are acceptable, but direct method
is preferred
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Usefulness of the
Statement of Cash Flows
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Cash is a “company’s lifeblood”
Provides creditors with useful information about a
company, such as:
– Company’s ability to generate net cash from
operating activities
– Net cash flow trends or patterns from
operating activities
– Major reasons for positive or negative net
cash from operating activities
– Whether the cash flows are renewable or
sustainable
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Usefulness of the
Statement of Cash Flows
Provides insight into the following areas:
→ Financial Liquidity
Current Cash Debt Coverage Ratio =
Net Cash Provided by Operating Activities
Average Current Liabilities
→ Financial Flexibility
Cash Debt Coverage Ratio =
Net Cash Provided by Operating Activities
Average Total Liabilities
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Usefulness of the Statement of Cash
Flows
• Cash Flow Patterns
– There may be useful patterns identified of cash
inflows and outflows from operating, investing and
financing activities
• Free Cash Flow
– Calculated as net cash from operations less capital
expenditures and dividends
– Indicates discretionary cash flow (cash left to invest or
expand) to make additional investments, to retire its
debt, or to add to its liquidity
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Looking Ahead
• IASB and FASB are preparing a converged standard
on “Financial Statement Presentation”
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