Purpose of balance sheet
- Reports assets, liabilities and equity at a specific date
- Provides information about resources, obligations to creditors and equity in net resources
- Helps in predicting amounts, timing and uncertainty of future cash flows
Usefulness of balance sheet
- Compute rates of return
- Evaluate the capital structure
- Assess risk and future cash flows
- Assess company’s liquidity, solvency and financial flexibility
Limitations of balance sheet
- Most assets and liabilities are reported at historical cost
- Use of judgements and estimates (i.e. FIFO)
- Many items of financial value are omitted (i.e. human capital)
***More companies favor reporting current assets first
Non-current assets: not expected to be converted to cash or consumed within 1 year or the operating cycle
1. Long-term investments
- Securities: bonds, ordinary shares, long-term notes
o Held-for-collection: investments held with the objective of holding assets in order to collect
contractual cash inflows (i.e. interests)
o Trading: investments that are bought and held primarily for sale in the near term to generate
income on short-term price differences
o Non-trading: investments that are bought and held for strategic reasons (i.e. regulatory issues,
enhancement the coordination or bargaining power)
Type
Valuation
Classification
Held-for-collection
Debt
Amortized cost
Current or non-current
Trading
Debt / equity
Fair value
Current
Non-trading
Equity
Fair value
Current or non-current
- Tangible assets: not currently used in operations (i.e. land held for speculation)
- Special funds: sinking fund (money set aside to pay for the debt in the future), pension fund
- Non-consolidated subsidiaries or associated companies (i.e. companies in joint ventures)
2. Property, plant and equipment
- Tangible long-lived assets used in the regular operations of the business
- Example: physical property such as land, buildings, machinery, furniture, tools and wasting resources
- Companies depreciates or depletes PP&E except land (value of land goes up with infinite useful life
unless the land is seriously damaged)
3. Intangible assets
- Lack physical substance and are not financial instruments
- Example: patents, copyrights, franchises, goodwill, trademarks, trade names and customer lists
- Amortize limited-life intangible assets over their useful lives
- Periodically assess indefinite-life intangibles for impairment
4. Other assets i.e. long-term prepaid expense, non-current receivable, property held for sale, restricted cash
Current assets: expected to be converted to cash, sell or consumed within 1 year or the operating cycle
1. Inventories
- Basis of valuation (i.e. lower-of-cost or net realizable value)
- Cost flow assumption (i.e. FIFO or average cost)
o LIFO is not permitted under IFRS. For LIFO, COGS used current prices but ending balance of
balance sheet uses old prices, which is not reasonable. IFRS focuses more on the balance sheet
than income statement.
2. Prepaid expenses
- Payment of cash that is recorded as an asset because service or benefit will be received in the future,
expecting economic inflow (cash payment before expense recorded)
3. Receivables
- Major categories of receivables should be shown in the statement of financial position or the related
notes
- Company should clearly identify anticipated loss due to uncollectibles, amount and nature of any nontrade receivables and receivables used as collateral
4. Cash and cash equivalents
- Generally consist of currency and demand deposits
- Cash equivalent: short-term, highly liquid investments that mature within three months or less
o Example: commercial paper, certificate of deposit, short-term government bonds
- Restrictions or commitments must be disclosed
o Restricted cash for long-term obligation should not be reported in the cash section
5. Short-term investments
Non-current liabilities: obligations that a company does not expect to liquidate in its normal operating cycle
or one year
- Arise from specific financing situations
- Arise from the ordinary operations of the company
- Depend on the occurrence or non-occurrence of one or more future events to confirm the amount
payable or the payee, or the date payable
Current liabilities: obligations that a company expects to settle in its normal operating cycle or one year
- Payables resulting from the acquisition of goods and services
- Collection received in advance for the delivery of goods or services (i.e. unearned revenue)
- Other liabilities whose liquidation will take place within the operating cycle or one year
Equity
-
Share capital: par or stated value of shares issued, including ordinary shares and preferred shares
Share premium: excess of amounts paid-in over the par or stated value
Retained earnings
Accumulated other comprehensive income
Treasury shares: ordinary shares repurchased
Non-controlling interest (minority interest)
Why is cash flow important?
- Sustain business operation (buy supply, pay wages)
- Prepare firms to cope with bad business environment
- Prepare firms to take good investment opportunities
IASB requires the publication of statement of cash flows
Statement of cash flows provides relevant information about the cash receipts and cash payments of an
enterprise during a period
- Where did the cash come from?
- What was the cash used for?
- What was the change in the cash balance?
- Source of information: comparative statements of financial position, income statement and selected
transaction data for financing and investing activities
Operation activities are transactions that determines of net income.
- Convert net income on an accrual basis to a cash basis
- Add to or deduct from net income those items in the income statement that do not affect cash
Account receivable – 1000
Account receivable increases
Cash same
Revenue – 1000
Revenue increases
Net income increases
Minus increase in account receivable
Cash – 800
Cash increases
Account receivable – 800
Account receivable decreases
Add decrease in account receivable
Account receivable – 1000
Account receivable increases
Revenue – 1000
Revenue increases
Minus increase in account receivable
Supply expense – 1000
Supply expense increases
Accounts payable – 1000
Account payable increases
Add increase in account payable
Accounts payable – 800
Account payable decreases
Cash – 800
Cash decreases
Minus decrease in account payable
COGS – 5000
COGS increases
Inventory – 5000
Inventory decreases
Add decrease in inventory
Inventory – 1000
Inventory increases
Cash – 1000
Cash decreases
Minus increase in inventory
Depreciation – 5000
Depreciation increases
Accumulated depreciation
– 5000
Add increase in depreciation
Net income increases  minus / net income decreases  add
Cash increases  add / cash decreases  minus
Increase in account receivable  minus
Increase in inventory  minus
Increase in account payable  add
Cash increases
Net income same
Cash same
Net income increases
Cash same
Net income decreases
Cash decreases
Net income same
Cash same
Net income decreases
Cash decreases
Net income same
Cash same
Net income decreases
Investing activities are transactions related to loans, investments and PP&E.
Financing activities are transactions involving liability and equity items.
Significant non-cash activities reported in a separate not to the financial statements.
- Example: issuance of ordinary shares to purchase assets, conversion of bonds into ordinary shares,
issuance of debt to purchase assets, exchanges on long-lived assets
Usefulness of Statement of Cash Flows
- Financial liquidity
o Current cash debt coverage ratio = Cash from operating activities / Average current liabilities
(indicate the ability to pay off the current liabilities from operation, ratio near 1:1 is good)
- Financial flexibility
o Cash debt coverage ratio = net cash provided by operating activities / average total liabilities
(indicate the ability to repay liabilities from net cash provided by operating activities, without
having to liquidate assets employed in operations  longer view)
Accruals = net income – net operating cash flow
- Represents investments in net current assets and adjustments for accounting items that are not cash
items