Chapter 05 - Slides

Chapter 05 - Slides - Chapter 5 Objectives Objectives...

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Unformatted text preview: Chapter 5 Objectives Objectives Balance Sheet Statement Balance Sheet & Statement of Cash Flows of Cash Flows Professor Dennis Chambers Dennis Chambers ACC 301 Identify the uses and limitations of the balance sheet Identify the major classifications of the balance sheet Prepare a classified balance sheet using the report and account formats Identify balance sheet information requiring supplemental disclosure Identify major disclosure techniques for the balance Identify major disclosure techniques for the balance sheet sheet Discuss the purpose of the statement of cash flows Understand the usefulness of the statement of cash Understand the usefulness of the statement of cash flows flows Identify the content of the statement of cash flows Prepare a statement of cash flows statement of cash flows 6/10/2008 ACC 301 2 Usefulness of the Balance Sheet of the Balance Sheet Provides information as of a point in time—a “snap shot” of the firm’s current condition Allows evaluation of liquidity – What is liquidity? – How do we use the balance sheet to measure liquidity? liquidity? Limitations Reflects historical cost (mostly) Result of many estimates – e.g., collectability of receivables, contingencies, useful useful lives of assets Omits many real economic items – – – – – Research and Development and Development Management and employee skills Trademarks Self-developed good will SelfReputation Measures financial flexibility – Ability to take actions to respond to changing conditions conditions by altering the amounts and timing of cash flows – Measured using debt-to-equity ratio using debt ratio 6/10/2008 ACC 301 3 6/10/2008 ACC 301 4 Classification Principles Classification Principles Guidelines for reporting assets and liabilities separately: Type or expected function in the central operations – Inventories vs. PP&E Balance Sheet Classification Sheet Classification Assets – Current assets – Long-term investments – Property, plant and equipment – Intangible assets – Other assets Liabilities – Current liabilities – Long-term debt Implications for the enterprise financial Implications for the enterprise’s financial flexibility flexibility – e.g., operations separate from investments Owners Equity – Capital stock – Additional paid-in paidcapital capital – Retained earnings Liquidity characteristics – Short-term reported separately from long-term Shortlong6/10/2008 ACC 301 5 6/10/2008 ACC 301 6 Current Assets Assets Assets that are cash or will be turned into cash within a year or within the current operating cycle (whichever is longer) within the current operating cycle (whichever is longer) – Operating cycle: Invest cash in materials and labor to produce products (or purchase completed products) Sell those products to customers those prod to Collect the cash related to those sales Treatment of bank overdrafts of bank overdrafts Bank overdraft defined: overdraft defined: – Occurs when a check is presented for collection and there are not sufficient funds on deposit to make normal normal payment. Presented in order of liquidity – Cash – Short-term investments Short“Trading” and “Available-for-Sale” securities are shown at market (fair) value “Available-for- US GAAP Treatment: – Do not net against cash balance – List as a current liability (we need to make the check good) good) – – – – Receivables Inventories Pre-paid expenses PreOther IFRS Treatment: – Net the overdraft against the cash balance the overdraft against the cash balance 6/10/2008 ACC 301 7 6/10/2008 ACC 301 8 Non Non-Current Assets Assets Long-term investments investments – e.g., bonds, stocks, etc. Current Liabilities Liabilities No required order No required order…but, commonly listed commonly listed in in this order: – Accounts payable payable – Notes payable – Short-term debt debt – Other payables – Short-term portion of long-term debt ong- Property, plant, and equipment plant and equipment – Productive tangible assets Intangible assets – e.g., patents, copyrights, franchises Other assets 6/10/2008 ACC 301 9 6/10/2008 ACC 301 10 Long-Term Liabilities Liabilities Generally three types: three types: – Obligations arising from financing activities Loans, bonds, etc. bonds etc Owners Equity Equity Capital stock stock – Usually stated at some nominal “par” value such as $1 per share such as $1 per share – Obligations arising from operating activities Pension obligations, taxes, etc. obligations taxes etc Additional paid-in capital paid– Amount of capital stock in excess of par of capital stock in excess of par – Contingent obligations Dependent on the occurrence or non-occurrence on the occurrence or non occurrence of of some future event Retained earnings Other items – Accumulated other comprehensive income 6/10/2008 ACC 301 11 6/10/2008 ACC 301 12 Additional Information Reported Additional Information Reported Contingencies – Possible future gains or losses that do not qualify for inclusion in the balance sheet Disclosure Techniques Techniques Parenthetical explanations explanations Notes Cross-references rossContra accounts Supporting schedules Accounting policies – The first note following the financial statements is a summary of significant accounting policies Contractual situations Fair values – Required to disclose the fair value of many financial instruments instruments 6/10/2008 ACC 301 13 6/10/2008 ACC 301 14 In-class Exercise Exercise Let’s pause and work Exercise #1 pause and work Exercise #1 6/10/2008 ACC 301 15 Statement of Cash Flows Statement of Cash Flows Provides information about cash receipts Provides information about cash receipts and and cash payments Companion to the income statement which Companion to the income statement which strips strips away accruals and deferrals, leaving just the changes in cash Three primary classifications – Cash flows from operations – Cash flows from investing activities – Cash flows from financing activities 6/10/2008 ACC 301 17 6/10/2008 Cash Inflows and Outflows Inflows and Outflows ACC 301 18 Operating Cash Flows Cash Flows Two ways to present Cash Flows from Two ways to present Cash Flows from Operations Operations – Indirect method method – Direct method – We will concentrate on the indirect method for now now Indirect Method Method Start with net income with net income Adjust it by adding or deducting those items that are not affecting cash items that are not affecting cash – e.g., receivable, payables, depreciation The adjustment process transforms net income (an accrual number) into cash flows (a cash-only number) cash- 6/10/2008 ACC 301 19 6/10/2008 ACC 301 20 General General Description of Indirect Method Method Begin with Net Income with Net Income – Adjustments Depreciation expense Amortization of intangibles Increase (decrease) in acct. rec. Increase (decrease) in inventory (d Increase (decrease) in prepaid exp. Increase (decrease) in payables (decrease) in payables Gain (loss) on sale of assets + + - (+) - (+) - (+) + (-) - (+) Why do we adjust net income for gains or losses on sale of assets? Notice we subtract gains and add losses to net income to get cash flows – Isn’t the sale of an asset a cash event??? XXXXXXX Here’s why we adjust for them: – Suppose we sold a machine for $100 and it had a book value of $60 The gain would be $40 book value of $60. The gain would be $40. – Notice that the gain ($40) is not the same as the cash received ($100). – We have to remove the non-cash gain amount and th non-cas then then add back the cash amount (in the investing section) 6/10/2008 ACC 301 22 Operating cash flow 6/10/2008 ACC 301 XXXXXXX 21 Cash Flows from Investing Activities Activities List cash flows from buying and selling List cash flows from buying and selling assets assets – Investments like stocks and bonds like stocks and bonds – Equipment – Land – Buildings Cash Flows from Financing Activities Activities List cash flows from obtaining and paying List cash flows from obtaining and paying back back financial obligations – Issue common stock common stock – Borrow money – Issue bonds bonds – Pay dividends – Pay off loans or bonds – Re-purchase outstanding stock Re23 6/10/2008 ACC 301 24 6/10/2008 ACC 301 Cash Flow Statement Example Cash Flow Statement - Example Ajax Inc. Comparative Balance Sheet Assets Cash Accounts Receivable Equipment Less: accumulated depreciation Total Ajax Inc. Statement of Cash Flows For the year ended December 31, 2006 31-Dec-2006 31-Dec-2005 Difference $ 47,500 $ 13,000 $ 34,500 Cash Flows from Operating Activities 91,000 88,000 3,000 Net Income $ 34,500 28,000 22,000 6,000 Adjustments: (9,000) (11,000) 2,000 Depreciation expense $ 6,000 $ 157,500 $ 112,000 Loss on sale of equipment 500 Increase in accounts receivable Increase in accounts receivable (3,000) Increase in accounts payable 5,000 8,500 Liabilities & Stockholders' Equity Accounts payable $ 20,000 $ 15,000 $ 5,000 Net cash provided by operating activities 43,000 Common stock 100,000 80,000 20,000 Retained earnings 37,500 17,000 20,500 Cash Flows from Investing Activities $ 157,500 $ 112,000 Purchase equipment (17,000) Total Sale of equipment Sale of equipment 2,500 (14,500) (14,500) Cash Flows from Financing Activities Issuance of common stock Payment of cash dividends Net cash provided by financing activities Net increase in cash Cash at beginning of the year Cash at end of the year Strange Treatment of Interest Treatment of Interest US GAAP requires interest received and interest US GAAP requires interest received and interest paid paid to be reported as operating cash flow – Seems contrary to our intuition: Interest received seems like it should be an investing cash flow Interest paid seems like it should be a financing cash flow. paid seems like it should be financing cash flow. Equipment Sold: Cash proceeds of sale Historical cost Accumulated depreciation Net Income Depreciation expense Dividends $ 2,500 11,000 8,000 34,500 ????? 14,000 20,000 (14,000) 6,000 34,500 13,000 47,500 $ IFRS allows interest to be reported where we IFRS allows interest to be reported where we conceptually expect— conceptually expect—unlike US GAAP 6/10/2008 6/10/2008 ACC 301 25 6/10/2008 ACC 301 26 In-class Exercise Exercise Let’s pause and work Exercise #2 pause and work Exercise #2 6/10/2008 ACC 301 27 ...
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