Presentation on theme: "Chapter 5 Financial Position and Cash Flows"— Presentation transcript:
1 Chapter 5 Financial Position and Cash Flows Prepared by:Patricia Zima, CA Mohawk College of Applied Arts and TechnologyUpdated for IFRS by:Anupma Goel, CASeneca College of Applied Arts and Technology
2 Financial Position and Cash Flows Balance SheetUsefulnessLimitationsClassificationFormatAdditional informationTechniques of disclosureTerminologyStatement of Cash FlowsPurposeContent and formatPreparation of the statement of cash flowsUsefulnessPerspectivesInternationalAppendix 5A Ratio Analysis-A ReferenceUsing ratios to analyse financial performanceAppendix 5B Specimen Financial StatementsStantec Inc.
4 Balance Sheet: Usefulness Also known as Statement of Financial PositionThe balance sheet provides informationfor evaluating the capital structure andfor computing rates of return on invested assetsIt is also useful for assessing an enterprise’sLiquidity (ability to pay current and maturing liabilities)Solvency (ability to pay debt and related interest)Financial flexibility (ability to respond to unexpected needs and opportunities)
5 Balance Sheet: Limitations Many assets and liabilities are stated at historical costInformation presented is reliable, howeverReporting at current fair value would result in more relevant information2. Judgement and estimates are used in determining many of the items reported on the Balance SheetMany “soft” numbers (estimates) are included which may be uncertain3. The balance sheet does not report items that cannot be recorded objectively (e.g. internally generated goodwill)
6 Balance Sheet: Classification Similar items are grouped together, with sub-totalItems with different characteristics are separatedIndividual balance sheet items should be:Reported separately, and inSufficient detail in order to:Allow users to assess amounts, timing, and uncertainty of future cash flowsAllow users to evaluate liquidity, financial flexibility, profitability, and riskHelps to calculate important ratios (e.g. current ratio to assess liquidity)More choice and flexibility is permitted under IFRS with respect to the format of the balance sheet (reverse order liquidity is more common).
7 Balance Sheet: Classification Considerations for reporting items separately:Assets that differ in their type or expected function in the central operations (e.g. inventory vs. capital assets)2. Liabilities with different implications for the entity’s financial flexibility (e.g. long term debt vs. current debt)3. Assets and liabilities with different general liquidity characteristics (e.g. cash vs. receivables)4. Assets, liabilities, and equities with characteristics that allow for easy measurement or valuationIFRSInformation to be Presented :Caption line items that are sufficiently different based on size, function, nature and liquidity, nature, timingDifferent measurement basesSpecific items are required to be presented separatelyMay present relevant subcategoriesDetails required about share capital
8 Elements Of The Balance Sheet Assets: Probable future economic benefits as a result of past transactions or events and controlled by an entityLiabilities: Probable future sacrifices of economic benefits that presently exist as a result of past transactions or events, and cannot be avoidedEquity (or net assets): The residual interest in assets after liabilities are deducted
9 Balance Sheet: Classification Current liabilitiesLong-term debtShareholders’ equityCapital sharesContributed surplusRetained earningsAccumulated other comprehensive incomeCurrent assetsLong-term investmentsProperty, plant, and equipmentIntangible assetsOther assetsLiabilities and EquityAssetsBoth IFRS and Canadian GAAP require classification of the balance sheet to distinguish working capital items from other assets and liabilities. IFRS allows the use of both labels – current/non-current and short-term/long-term. Generally, though, the current/non-current is used to classify items on the face of the financial statement and the short/long-term description is used to indicate recognition and measurement of items (e.g. short-term provisions) within the current/non-current sections of the statement.
10 Current AssetsCurrent assets are cash and other assets expected to be realized:within one year from the balance sheet date orwithin the normal operating cycle, whichever is longerPresented in order of liquidity (normally: cash, short-term investments, receivables, inventory, and prepaid expense)
11 Current Assets–Cash Often includes cash and cash equivalents Defined as:Cash, demand deposits, short-term liquid investments convertible to a known cash amount, and not subject to material value changesAny known restrictions to cash must be disclosed
12 Current Assets– Temporary Investments Investments are categorized for valuation and presentation purposesHeld-to-maturityHeld-for-tradingAvailable-for-saleTrading and available-for-sale measured and reported at fair valueHeld-to-maturity measured and reported at amortized costHeld-for-trading is normally a current asset, while the other categories can be either current or non-current
13 Current Assets–Receivables Amounts should be reported separately based on the nature of their origin:Ordinary trade accountsAmounts owing by related partiesOther (substantial) unusual itemsSeparate disclosure required for:Anticipated losses (uncollectibles)Amount and nature of nontrade receivablesReceivables pledged as collateralAccounts receivable valued at net realizable value
14 Current Assets–Inventories Valuation basis (lower of cost and net realizable value) disclosedCost flow assumption method (e.g. FIFO, weighted average) must be disclosedManufacturing enterprise will disclose completion stage of inventories:Raw materialsWork in progressFinished goods
15 Current Assets– Prepaid Expenses Defined as: expenditures already made for benefits to be received within one year or the operating cycle (whichever is longer)Most common examples include:InsuranceRentAdvertisingSuppliesCurrent practice is to report some prepaid amounts where the benefit extends beyond one year (or operating cycle)
16 Long-Term Investments Long-term investments normally consist of one of the following:Debt securitiesEquity securitiesSinking funds, tangible assets held as investments, otherInvestments are intended to be held for an extended period of timeValuation Securities:Fair value if available for saleAmortized cost if held to maturityEquity method if significant influence
17 Property, Plant, and Equipment Physical (tangible) assets used in ongoing business operations of the business to generate incomeReported at cost or amortized costMost assets are depreciable, except for landDisclosure requirements include:Basis of valuationNature of any liens held against the assetAccumulated amortization
18 Intangible AssetsCapital assets without physical substance, held to generate revenueHigh degree of uncertainty regarding future benefitsInclude (most common):patentscopyrightsfranchisesgoodwilltrademarks, and trade namesIntangibles are grouped into two categories:Those with finite life – amortized over useful lifeThose with indefinite life – not amortizedBoth are tested for impairment
19 Other Assets Some of the items included are: Assets in special funds Non-current receivablesFuture income taxesProperty held for saleAdvances to subsidiariesSufficient information to be disclosed to inform users of the nature of the asset
20 Current LiabilitiesObligations due within one year (from balance sheet date) or within the operating cycle, whichever is longerExamples of current liabilities include:Payables resulting from acquisitions of goods and servicesCollections received in advance of delivery of goods or performance of servicesOther liabilities to be paid in the short termShort-term financing payable on demand (e.g. line of credit)Accounts payable normally listed first; however, current liabilities not reported in any specific order
21 Working Capital=–Working CapitalCurrent LiabilitiesCurrent AssetsA key indicator of the company’s short-term liquidityNot usually disclosed on the balance sheetOften calculated by bankers and other creditors
22 Long-Term Liabilities Long-term obligations are those not expected to be paid within the normal operating cycleThree types:Obligations arising from specific financing situations (e.g. bonds)Obligations from ordinary operations of the enterprise (e.g. pension obligations)Obligations arising from ordinary business operations that are contingent on future events (e.g. product warranty)Balance sheet presentation requires reporting the portion due within the next year as a current liability
23 Shareholders’ Equity Capital Shares Number of authorized and issued sharesOutstanding amountsContributed SurplusUsually reported as one amountIncludes issued share premiumsRetained EarningsThe amount of undistributed earningsPresented as one itemAccumulated Other Comprehensive IncomeIncludes unrealized gains and losses on available-for-sale securities, certain types of donations etc.
24 Balance Sheet: Additional Information Reported Additional information may include:Information not presented elsewhere, orInformation that qualifies items in the balance sheetFive main types of additional informationContingenciesAccounting PoliciesContractual SituationsAdditional DetailSubsequent Events
25 Balance Sheet: Techniques of Disclosure Parenthetical explanations (following the items in the balance sheet)Notes (to the balance sheet)Cross references and contra items (where assets and liabilities may be cross referenced)Supporting schedules (as for capital assets’ depreciation)
26 IFRS Selected Statements – reverse order liquidity
27 IFRS Samples of and Excerpts from Selected Statements
28 Statement of Cash Flows Section 2Statement of Cash Flows
29 Statement of Cash Flows To assess the firm’s ability to generate cash and cash equivalents andTo assess the firm’s cash requirementsStatement of Cash Flows shows:Where the cash came fromWhat the cash was used forWhat was the change in the cash balance
30 Statement of Cash Flows Cash activities are divided into three main categories:Operating ActivitiesMain revenue-producing activitiesInvesting ActivitiesChanges in long-term assets and investmentsFinancing ActivitiesChanges in equity and non-operating liabilities
31 Cash Inflows and Outflows Operating ActivitiesWhen operating cash receipts > cash expendituresInvesting ActivitiesSale of property, plant, and equipmentSale of debt or equity securities of other entitiesCollection of loans to other entitiesFinancing ActivitiesIssuance of equity securitiesIssuance of debt (bonds and notes)Cash PoolCash Inflows
32 Cash Inflows and Outflows Cash OutflowsCash PoolOperating ActivitiesWhen operating cash expenditures > cash receiptsInvesting ActivitiesPurchase of property, plant, and equipmentPurchase of debt or equity securities of other entitiesLoans to other entitiesFinancing ActivitiesPayment of dividendsRedemption of debtReacquisition of capital stock
33 Usefulness of the Statement of Cash Flows Cash is a “company’s lifeblood”Provides creditors with useful information about a company, such as:Company’s ability to generate net cash from operating activitiesNet cash flow trends or patterns from operating activitiesMajor reasons for positive or negative net cash from operating activitiesWhether the cash flows are renewable or sustainable
34 Usefulness of the Statement of Cash Flows Provides insight into the following areas:Financial LiquidityCurrent Cash Debt Coverage Ratio =Net Cash Provided by Operating Activities Average Current LiabilitiesFinancial FlexibilityCash Debt Coverage Ratio =Net Cash Provided by Operating Activities Average Total Liabilities
35 Usefulness of the Statement of Cash Flows Cash Flow PatternsThere may be useful patterns identified of cash inflows and outflows from operating, investing and financing activitiesFree Cash FlowCalculated as net cash from operations less capital expenditures and dividendsIndicates discretionary cash flow (cash left to invest or expand) to make additional investments, to retire its debt, or to add to its liquidity
36 Current IFRS GAAP Comparisons Main differences:More choice and flexibility is permitted under IFRS with respect to the format of the balance sheet (also known as the statement of financial position under IFRS). IFRS requires additional line item disclosure on the face of the statement for biological assets, investment property, and provisions; there are no equivalent standards in Canadian GAAP for these line items IFRS requires additional line items, sub-totals and headings when these would be relevant to the users.
37 Current IFRS GAAP Comparisons Main differences:Both IFRS and Canadian GAAP require classification of the balance sheet to distinguish working capital items from other assets and liabilities. IFRS allows the use of both labels – current/non-current and short-term/long-term. Generally, though, the current/non-current is used to classify items on the face of the financial statement and the short/long-term description is used to indicate recognition and measurement of items (e.g. short-term provisions) within the current/non-current sections of the statement.Under IFRS, all deferred income taxes are classified as non-current.
38 Current IFRS GAAP Comparisons Main differences (continued):Under IFRS, if there is a breach of a covenant or long-term agreement that makes the liability due on demand at the balance sheet date, the loan must be classified as current. If there are renegotiations, any new agreement must be in place by the balance sheet date in order to classify the loan as non- current.
39 Current IFRS GAAP Comparisons Main differences (continued):Under IFRS, an accounting policy choice is required to classify these cash flows in a consistent manner. These cash flows should be classified as operating, investing or financing depending on the nature of the underlying cash flows. This differs from Canadian GAAP under which these cash flows are classified as operating activities if it the item is included in the income statement; if the cash flow is not included in the income statement, it should be classified according to its nature (e.g. dividends charged to retained earnings would be classified as financing activities).
40 Looking AheadThe IASB is involved in “Financial Statement Presentation” project which consists of three phases:Phase A - What constitutes a complete set of financial statementsPhase B - Presentation of information on the face of the statementsPhase C - Interim financial reportingThe three objectives for financial statement presentation are that information should be presented in the financial statements in a manner that:Portrays a cohesive financial picture of an entity’s activities.Disaggregates information so that it is useful in predicting an entity’s future cash flows.Helps users assess an entity’s liquidity and financial flexibility.