Financial Statements

Financial Statements - Finacial Statements Uses and...

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Finacial Statements Uses and Limitations of the Balance Sheet 1.For many years financial statement users generally considered the income statement to be superior to the balance sheet as a basis for judging the economic well-being of an enterprise. However, the balance sheet can be a very useful financial statement. If a balance sheet is examined carefully, users can gain a considerable amount of information related to liquidity, solvency and financial flexibility. Liquidity is generally related to the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid. Solvency refers to the ability of an enterprise to pay its debts as they mature. Financial flexibility is the ability of an enterprise to take effective action to alter the amounts and timing of cash flow so that it can respond to unexpected needs and opportunities. 2.Criticism of the balance sheet has revolved around the limitations of the information presented therein. These limitations include: (a) failure to reflect current value information, (b) the extensive use of estimates, and (c) failure to include items of financial value that cannot be recorded objectively. 3.The problem with current value information concerns the reliability of such information. The estimation process involved in developing current-value type information causes a concern about the objectivity of the resulting financial information. The use of estimates is extensive in the development of balance sheet data. These estimates are required by generally accepted accounting principles, but reflect a limitation of the balance sheet. The limitation concerns the fact that the estimates are only as good as the understanding and objectivity of the person(s) making the estimates. The final limitation of the balance sheet concerns the fact that some significant assets of the entity are not recorded. Items such as human resources (employee workforce), managerial skills, customer base, and reputation are not recorded because such assets are difficult to quantify. Classification in the Balance Sheet 4. The major classifications used in the balance sheet are assets, liabilities, and equity. To provide the financial statement reader with additional information, these major classifications are divided into several subclassifications. Assets are further classified as current or noncurrent, with the noncurrent divided among long-term investments; property, plant, and equipment; intangible assets; and other assets. Liabilities are classified as current or noncurrent. Owners’ equity includes capital stock, additional paid-in capital, and retained earnings. These items are defined as follows:
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Assets. Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Liabilities.
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Financial Statements - Finacial Statements Uses and...

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