Chapter 5 Notes

Chapter 5 Notes - Chapter 5: Balance Sheet and Statement of...

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Chapter 5: Balance Sheet and Statement of Cash Flows Section 1: Balance Sheet - Balance sheet - (sometimes referred to as the statement of financial position) reports assets, liabilities, and stockholders’ equity of a business enterprise at a specific date o Provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners’ equity in net resources o Helps in predicting the amounts, timing, and uncertainty of future cash flows Usefulness of the Balance Sheet - Provides basis for computing rates of return and evaluating the capital structure of the enterprise - Also use information to assess a company’s risk and future cash flows - Assess a company’s liquidity, solvency, and financial flexibility - Liquidity - 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 o Creditors are interested in short-term liquidity ratios - Solvency - the ability of a company to pay its debts as they mature - Financial flexibility - ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected need sand opportunities Limitations of the Balance Sheet - Some of the major limitations of the balance sheet are: 1) Most assets and liabilities are reported at historical cost. 2) Companies use judgments and estimates to determine many of the items reported in the balance sheet. 3) The balance sheet necessarily omits many items that are of financial value but that a company cannot record objectively.
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Classification in the Balance Sheet - Balance sheets group together similar items to arrive at significant subtotals - Material is arrange so that important relationships are shown - Companies should report and classify individual items in sufficient detail to permit users to assess the amounts, timing, and uncertainty of future cash flows - Such classification also makes it easier for users to evaluate the company’s liquidity and financial flexibility, profitability, and risk - Companies should report separately: 1) Assets that differ in their type or expected function in the company’s central operations or other activities. 2) Assets and liabilities with different implications for the company’s financial flexibility. 3) Assets and liabilities with different general liquidity characteristics. - 3 general classes of items included in the balance sheet: 1) Assets - probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events 2) Liabilities - probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events 3) Equity - residual interest in the assets of an entity that remains after deducting its liabilities; in a business enterprise, the equity is the ownership interest
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This note was uploaded on 02/22/2011 for the course BUAD 362 taught by Professor Frazer during the Spring '10 term at Millersville.

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Chapter 5 Notes - Chapter 5: Balance Sheet and Statement of...

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