Chapter 5 Class Notes

Chapter 5 Class Notes - Chapter 5 BALANCE SHEET &...

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Chapter 5 The Balance Sheet , sometimes referred to as the Statement of Financial Position, reports the assets, liabilities, and stockholders’ equity of a business enterprise at a specific date. This financial statement provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners’ equity in net resources. It therefore helps in predicting the amounts, timing, and uncertainty of future cash flows – one of the primary objectives of financial reporting as covered earlier in this course. By providing information on assets, liabilities, and stockholders’ equity, the Balance Sheet provides a basis for computing rates of return and evaluating the capital structure of the enterprise. Financial analysts and credit analysts use information in the Balance Sheet to assess a company’s risk and future cash flows. In this regard, analysts use the balance sheet to assess a company’s liquidity, solvency, and financial flexibility. Usefulness of the Balance Sheet Evaluating the capital structure Assess risk and future cash flows Analyze the company’s 1. Liquidity – 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. 2. Solvency – the ability of the company to repay its debts as they mature and survive over the long term . Liquidity and solvency affect a company’s financial flexibility , which measures the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities. Limitations of the Balance Sheet most assets and liabilities are reported at their historical cost ; the information is highly reliable but is considered by many to not be relevant ; hence, the increasing tendency of the FASB to adopt fair values for many assets and liabilities Accountants must use judgment and estimates to determine many of the items reported on the Balance Sheet many items that may be of financial value but cannot be recorded objectively are omitted 1
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IMPORTANT DEFINITIONS: ASSETS – probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events 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 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 Balance Sheet Classifications Significant items are grouped together to arrive at significant subtotals and the material is arranged so that important relations are shown. Individual items should be reported in sufficient detail to permit users to assess the amounts, timing and uncertainty of future
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Chapter 5 Class Notes - Chapter 5 BALANCE SHEET &...

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