chapter 7 balance sheet statement of cash flows financial statements ii:
TRANSCRIPT
CHAPTER 7
Balance
Sheet
Statementof Cash Flows
FINANCIAL STATEMENTS II:
Introduction
Financial reports can be divided into two categories
1. Results of the flows of resources over time (flows)
Statementof
Retained Earnings
StatementofCash FlowsIncome
Statement
2. The status of resources at a point in time (stocks)
BalanceSheet
Past Emphasis
Income statement based on the assumption that flows were more important than stocks
Frequently resulted in the measurement of stocks at residual values
FASB
asset - liability approach
changes in balance sheet amounts becoming more important in income determination
In this chapter
Balance sheet and the associated measurement techniques for its elements
Statement of cash flows and its evolution over time
Balance
Sheet
Statementof Cash Flows
The Balance Sheet
Should disclose wealth of a company at a point in time
Wealth is present value of allresources
obligations
The Balance Sheet
This measurement technique is limited
Consequently, a variety of measurement techniques are used to measure the elements of the balance sheet
Historical (Historical cost)
Current oriented (Current value)
Future oriented (Expected realizable value)
Balance Sheet Elements
The elements of the balance sheet were defined in SFAC No. 6 as:
Assets
Liabilities Equity
Definitions arise from the FASB’s asset - liability approach to income determinationDeparture from previous definitions that resulted in valuations arrived at via the residual effect of income determination
Components of the Balance Sheet
AssetsCurrent assetsInvestmentsProperty, plant, and equipmentIntangible assetsOther assets
LiabilitiesCurrent liabilitiesLong-term debtOther liabilities
Stockholder’s EquityCapital stockAdditional paid-in capitalRetained earnings
Asset Valuation
Asset
Cash
Accounts receivable
Marketable securities
Inventory
Investments
Property, plant and equipment
Measurement basis
Current value
Expected future value
Fair value
Current or past value
Fair value or amortized cost
Depreciated past value
Liability
Current Liabilities
Long-term &Other Liabilities
Measurement
Liquidation Value
Liquidation Valueor Present Value
Liabilities and Their Associated Measurement Techniques
Do measurement techniques bias statements in favor of
current investors?
Account
Common Stock
Preferred Stock
Retained Earnings& OtherComprehensiveIncome
Measurement basis
Historical Cost(Par Value vs Selling Price)
Historical Cost
Dependent upon incomeRecognition
Stockholders’ Equity Accounts and Their Associated Measurement Techniques
Evaluating A Company’s Financial Position
Return on AssetsNet operating profit after taxes
Average total assetsProfit margin
Net operating profit after taxesNet sales
Asset utilization rateNet sales
Average total assets
Best Buy and Circuit City
Best Buy Circuit City
Return on assets 8.52% 1.01%
Profit margin 3.06% 0.43%
Asset turnover 2.79 2.39
Evolution of the Statement of Cash Flows
Prior to 1971only two required financial statements
Firms were preparing funds statementsNo guidelines - Methods of preparing statement:1 Cash2 Working capital3 All financial resources
APB No. 3 - recommendedAPB No. 19 - mandatory - all financial resources
APB Opinions 3 and 19
Designed to answer the following questions 1 Where did the profits go?2 Why weren’t dividends larger?3 How was it possible to distribute dividends
in the presence of a loss?4 Why are current assets down when there was a profit?5 Why is extra financing required?6 How was the expansion financed?7 Where did the funds from the sale of securities go?8 How was the debt retirement accomplished?9 How was the increase in working capital financed?
Cash Flow Information
Should enable financial statement users to
Predict the amount of cash that is likely to be distributed as dividends or interestEvaluate risk
Presentation of cash flow information assists in evaluating
Liquidity nearness to cash
Solvency going concern
Financial flexibilityreact to crisis
Historical Perspective
Discussion memorandum “Reporting Funds Flows, Liquidity, and Financial Flexibility”preceded the issuance of SFAS No. 95
Questions raised in this DM included:1. Which concept of funds should be adopted?2. How should transactions not having a direct impact on funds
be reported?3. Which of the various approaches should be used for
presenting funds flow information?4. How should information about funds flow from operations be
presented?5. Should funds flow information be separated into outflows for
(a) maintenance(b)expansion of operating capacity, and(c) nonoperating purposes
Historical Perspective
Exposure Draft “Reporting Income, Cash Flows and Financial Position of Business Enterprises”
SFAC No. 5“Recognition and Measurement in Financial Statements of Business Enterprises”
Purpose of the Statement of Cash Flows
Provide relevant information about cash receipts and cash payments of an enterprise during a period
Objectives of accounting discussed in SFAC No’s. 1 and 5 led to conclusion
Statement of cash flows should replace the previously required statement of changes in financial position
Statement Format
Report changes during an accounting period in cash and cash equivalents for
Net cash flows from operations
Investing transactions
Financing transactions
Cash Flows From Operating Activities
Cash effect from transactions that enter into the determination of net income
exclusive of financing and investing activities
Direct vs Indirect method
Cash Flows From Investing Activities
Making and collecting loans
Acquiring and disposing of debt or equity securities of other companies
Acquiring and disposing of property, plant, and equipment and other productive resources
Cash Flows From Financing Activities
Obtaining resources from owners
Providing owners with a return of and a return on their investment
Borrowing money and repaying the amount borrowed
Obtaining and paying for other resources from long-term creditors
Results from…
Uses of Cash Flow Information
A major objective of accounting to provide data allowing the presentation of cash flows to investors and creditors
to allow evaluation of risk
Net income is not directly associated with cash
Investors expect return equal to market rate of interest for investments with equal risk
discounted future cash flows > investment
Uses of Cash Flow Information
Past cash flows are the best indicators of future cash flowsEmpirical research indicates cash flow information
has an incremental value over earnings and is superior to disclosure of changes in working capital
Uses of Cash Flow Information
Net cash provided (used) from operating activities
- Net cash provided (used) from investing activities
Free Cash Flow
Uses of Cash Flow Information
Fr ee Cash Fl ow (in mil l ions)
962
21
627
-409-500
0
500
1,000
1,500
Best Buy Cir cuit City2002 2003
Uses of Cash Flow Information
These results indicate Both companies experienced deteriorating free cash flow positions during fiscal year 2003
Circuit City’s results indicate a more serious possible problem
large negative free cash flow in fiscal 2003
International Accounting Standards
The IASC has discussed:1 The statement of financial position
and the various measurement bases used in accounting
Defined assets, liabilities and equity in “Framework for the Preparation and Presentation of Financial Statements”
2 The information to be disclosed on the balance sheet and statement of cash flows in a revised IAS No. 1
3 The presentation of the statement of cash flows in IAS No. 7, “Cash Flow Statements”
“Preparation and Presentation of Financial Statements”
Economic decisions made by users require an evaluation of the ability of an enterprise to generate cashFinancial position of an enterprise is affected by its financial structure liquidity and solvency capacity to adapt to change (financial flexibility)
Measurement bases include historical cost (most common) current cost realizable value present value
Definitions of assets, liabilities and equity are similar to U. S. GAAP
IAS No. 1: Presentation of Financial Statements
Recommends disclosures similar to U. S. GAAP Revised IAS No. 1
requires assets to be classified as current and noncurrent
unless a liquidity presentation provides more relevant and reliable information
recognizes that there are differences in the nature and function of assets, liabilities, and equity
so fundamental that they should be presented on the face of the balance sheet.
Specifies specific categories of items to be disclosed
IAS No. 7
The required presentation of the statement of cash flows is very similar to U. S. GAAP
Operating, financing and investing activities are to be disclosed
Indirect or direct method of disclosing operating activities may be used
stated a preference for the direct method.
FASB staff reaction
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Prepared by Richard Schroeder, DBDKathryn Yarbrough, MBA