Intermediate Accounting, 11th ed.
Kieso, Weygandt, and Warfield
Chapter 5: Balance Sheet and
Statement of Cash Flows Systems

Chapter 5: Balance Sheet and
Statement of Cash Flows Systems
After studying this chapter, you should be able to:
1. Identify the uses and limitations of a balance sheet.
2. Identify the major classifications of the balance sheet.
3. Prepare a classified balance sheet using the report and account formats.
4. Identify balance sheet information requiring supplemental disclosure.

Chapter 5: Balance Sheet and
Statement of Cash Flows Systems
5. Identify major disclosure techniques for the balance sheet.
6. Indicate the purpose of the statement of cash flows.
7. Identify the content of the statement of cash flows.
8. Prepare a statement of cash flows.
9. Understand the usefulness of the statement of cash flows.

Part 1: The Balance Sheet

Balance Sheet: Usefulness
The balance sheet provides information for evaluating:
 Capital structure
 Rates of return
 Analyzing an enterprise’s:
 Liquidity
 Solvency
 Financial flexibility

Balance Sheet: Limitations
•
•
•
•
Most assets and liabilities are stated at historical cost .
Judgments and estimates are used in determining many of the items.
The balance sheet does not report items that can not be objectively determined.
It does not report information regarding off-balance sheet financing .

Balance Sheet: Classification
Guidelines for reporting assets and liabilities separately:
• Type or expected function in the central operations
• Implications for the enterprise’s financial flexibility
• Liquidity characteristics

Balance Sheet: Classification
Assets
• Current Assets
• Long-term investments
• Property, plant, and equipment
• Intangible assets
• Other assets
Liabilities and Equity
• Current liabilities
• Long-term debt
• Owners’ equity
Capital stock
• Additional paid-in capital
• Retained earnings

Current Assets
1
2
Current assets are expected to be consumed, sold, or converted into cash: either in one year or in the operating cycle, whichever is longer.
Current assets are presented in order of liquidity.
The following valuation principles are used:
Short-term investments at fair value
Accounts receivable at net realizable value

Long-Term Investments
Long-term investments may be:
1 Investments in securities (bonds, stock)
2
3
4
Investments in fixed assets (land not used in operations)
Investments set aside in special funds
(e.g., sinking fund)
Investments in non-consolidated subsidiaries or affiliated companies

Current Liabilities
1
2
Current liabilities are liquidated:
Either through the use of current assets, or
By creation of other current liabilities
•
•
•
Examples of current liabilities include:
Payables resulting from acquisitions of goods and services
Collections received in advance of services
Other liabilities which will be paid in the short term

Long-Term Liabilities
•
•
•
Long-term obligations are those not expected to be paid within the operating cycle.
Examples are: obligations arising from specific financing situations (issuance of bonds) obligations arising from ordinary business operations (pension obligations) obligations that are contingent (product warranties)

Balance Sheet: Additional
Information Reported
Additional information may be:
1 Information not presented elsewhere, or
2 Information that qualifies items in the balance sheet
Supplemental information examples:
•
•
•
Material events having an uncertain outcome
Explanations regarding accounting policies
Covenant restrictions

Balance Sheet: Techniques of
Disclosure
• Parenthetical explanations
• Notes
• Cross references and contra items
• Supporting schedules

Part 1: The Statement of Cash Flows

The Cash Flow Statement
The cash flow statement provides information about:
• cash receipts (cash inflows)
• uses of cash (cash outflows)
• during a period of time
Inflows and outflows are reported for:
• operating
• investing
• financing activities

Cash Inflows and Outflows

Preparing a Statement of Cash Flows
There are two methods of preparing the statement of cash flows:
• Indirect method : derives cash flows from accrual based statements
• Direct method : derives cash flows directly for each source or use of cash

The Statement of Cash Flows:
Indirect Method
Accrual Based Statements
Income Statement items & Changes in
Current Assets and
Current Liabilities
Balance Sheet: Changes in
Non-Current Assets
Balance Sheet: Changes in
Non-Current Liabilities and
Equity
Cash Flow Statement
Operating activities :
Adjust net income for accruals and non-cash charges to get cash flows
Investing activities :
Inflows from sale of assets and
Outflows from purchases of assets
Financing activities :
Inflows and outflows from loan and equity transactions

Ratio Analysis
Ratio analysis expresses the relationship between selected financial data.
These relationships can be expressed as:
• percentages
• rates, or
• proportions

Types of Ratios
Type
Liquidity ratios
Activity ratios
Profitability ratios
Coverage ratios
What is measured
Short-term ability to pay maturing obligations
Examples
Current ratio
Quick assets ratio
Effectiveness in using assets employed
Degree of success or failure for a given period
Degree of protection for long-term creditors and investors
Receivables turnover
Inventory turnover
Rate of return on assets
Earnings per share
Debt to total assets
Times interest earned

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