Chapter 5 Statement of financial position and statement of cash flows

Statement of financial position (Balance sheet)

  1. Report assets, liabilities, and equity at a specific date

  2. Provide information about resources (assets), obligations (liabilities) to creditors, and equity (residual claim) in net resources

  3. Helps in predicting amount, timing, and uncertainty of future cash flows

Usefulness of the statement of financial position

  • Computing notes of return

  • Evaluating the capital structure (whether a company is financed by debt or equity)

  • Assess risk and future cash flows

  • Assess the company's:

    • Liquidity = assesses the company's ability to meet short-term financial obligations with its current assess

    • Solvency = evaluates the company's ability to meet long-term financial obligations

    • Financial flexibility = measures the company's capacity to adapt to changing financial circumstances or seize new opportunities without jeopardizing its fiancial stability

Limitations of the statement of financial position

  • Most assets and liabilities are reported at historical cost

  • Use of judgement and estimates

  • Many items of financial value are omitted

Non-current assets

  • Long-term investments: securities, tangible assets, special funds, non-consolidated subsidiaries

  • Property, plants, and equipment

  • Intangible assets

  • Other assets

Equity

  • Share capital = the par or stated value of shares issued. Ordinary and preferred shares

  • Share premium = the excess of amounts paid-in over the par or stated value

  • Retained earnings = the company's accumulated undistributed earnings

  • Accumulated other comprehensive income = the aggregated amount of the other comprehensive income items

  • Treasury shares = the amount of ordinary shares repurchased. The company buys their own shares bach, which is possible but with some limitations

  • Non-controlling interest = a portion of the equity of subsidiaries not owned by the reporting company

Non-current liabilities

= obligations that a company does not reasonably expect to liquidate within the longer of one year or the normal operating cycle.

  • Three types of non-current liabilities:

    1. Obligations arising from specific financing situations

    2. Obligations arising from the ordinary operations of the company

    3. Obligations that depends on the accurence or non-occurrence of one or more future events to confirm the amount payable, or the payee, or the date payable

Current liabilities

= obligations that a company generally expects to settle in its normal operating cycle or one year, whichever is longer.

  1. Payables resulting from the acquisition of goods and services

  2. Collections received in advance for the delivery of goods or performacne of services

  3. Other liabilities whose liquidation will take place within the operating cycle or one year

Purpose of the statement of cashfows: to provide relevant information about the cash receipts and cash payments of an enterprise during a period.

Content of the cashflow statement

  1. Operating activities = involves transactions that affect the net income. These include cashflows related to the company's primary business operations

  2. Investing activities = cashflows related to the acquisition and disposal of long-term assets. These activities reflect the company's investments in its own operations and other entities

  3. Finacing activities = involves transactions related to the company's liability and equity items. These activities reflect the company's efforts to raise capital and manage its financial structure

Two methods to prepare a statement of cashflow

  • Direct method = begins with the amount of all cash received from customers and subtract the amount of cash that has been used for operating

    • Operating activities: Cash received from customers - Cash paid to suppliers - Employee compensations - Other operating expenses paid = Net cash from operating activites

    • Investing activities: Net cash from operating activities + Sale of property - Puchase of equipment = Net cash from investing activities

    • Financial activities: Net cash from investing activities - Common share dividends - Payment on long-term debt = Net cash from financial activities

    • Ending cash balance = Net cash from financial activities + Beginning cash balance

  • Indirect method = net income from the income statement and adjust it for non-cash items and changes in working capital to arrive at the net cash provided by operating activities

    • Three steps:

      1. Find the net profit/loss from the income statement

      2. Add back all of the non-cash expenses that exist in the profit/loss: Depreciation, amortization and the gain/loss on the disposal of non-current assets

      3. Adjust for the movement in working capital: Work capital = current assets (inventory and receivables) - current liabilities (payables)

IFRS on financial statements

  1. Statement of financial position (balance sheet)

  2. Statement of comprehensive income

    • One single statement of comprehensive income

    • A seperate income statement and statement of comprehensive income

  3. Statement of changes in equity

  4. Statement of cashflow

Common mistakes made in accounting

  1. Contra accounts = often misunderstood as seperate accounts, but they are actually paired with related accounts to show the net balance. Accumulated depreciation is a contra account paired with the asset account to reflect the net carrying amount of the asset

  2. Receivables represent amounts owed to a company by its customers. They are recorded as assets on the balance sheet because they represent future economic benefits

  3. Payables represent amount owed by a company to its suppliers or creditors. They are recorded as liabilities on the balance sheet

  4. Revenues are earned when goods are sold/services are rendered, regardless of when payment is received. Receipts represent actual cash inflows from customers

  5. Expenses are costs incurred in the process of generating revenue, and they are recognized when incurred, regardless of if cash is paid. Expenditures represent cash payments for goods or services.