1. Structure of the Balance Sheet and Statement of Cash Flows
Revsine/Collins/Johnson: Chapter 4

2. Learning objectives
How balance sheet accounts are measured and classified.
How balance sheet information is used.
Balance sheet terminology and format outside the U.S.
How footnotes aid your understanding of the firm’s accounting policies, subsequent events, and related-party transactions.
How successive balance sheet and the income statement can be used to identify cash inflows and outflows.
How the cash flow statements can be used to explain changes in successive balance sheets.

3. Learning objectives Concluded
The distinction between operating, investing, and financing sources and uses of cash.
How changes in current asset and current liability accounts can be used to compute “cash flows from operations” from accrual earnings.

4. Elements of the balance sheet
How the money is invested
Where the money came from
ASSETS
LIABILITIES
EQUITY = +
Probable future economic benefits
Obtained from past transactions or events
Probable future sacrifices of economic benefits
Arising from present obligations
To transfer assets or provide services in the future
As a result of past transactions or events
The residual interest in net assets.

5. Balance sheet information
Rates of return
ROA and ROCE
ASSETS
Capital structure
Debt vs. Equity
Helps
Liquidity
Cash conversion
LIABILITIES +
EQUITY
assess
Solvency
Ability to pay debt
Flexibility
Operating and financial
Balance Sheet

6. Balance sheet measurement conventions
Historical cost
ASSETS
Current cost (fair value)
Measurement
LIABILITIES +
EQUITY
methods
Net realized value
Discounted present value
Balance Sheet

7. Balance sheet classification: Overview
ASSETS
LIABILITIES
EQUITY = +
Current assets
Property, plant and equipment
Investments
Other assets
Current liabilities
Long-term debt
Other liabilities
Preferred and common stock
Additional paid-in capital
Retained earnings

8. Balance sheet classification: Current assets
Current market value
Amortized cost or current market value
Net realizable value
Lower of (historical) cost or current market value

9. Balance sheet classification: Other assets
Historical cost minus accumulated depreciation
except that fair market value is used when “impaired”

10. Balance sheet classification: Liabilities
Amount due at maturity
Historical cost
Discounted present value
Mezzanine section

11. Balance sheet classification: Stockholders’ equity
Historical par value
Historical cost
Mixture of different measurement bases

12. Analytical insights: Understanding the business
$676.7
$5,285.9
Which company is:
Deere
E-Trade
Potomac
Electric Power
Wal-Mart

13. Balance sheet presentation: International differences
U.S. Format:
U.K. Format:
Current Assets
Fixed Assets + +
Long-lived Assets
Current Assets - =
Current Liabilities -
Current Liabilities
Non-current Liabilities +
Non-current Liabilities = +
Stockholders’ Equity
Capital Employed

14. Balance sheet differences: Cadbury Schweppes PLC
Consolidated
Holding company only

15. Balance sheet differences: Cadbury Schweppes PLC (continued)

16. Balance sheet differences: Cadbury Schweppes PLC (concluded)
Common stock par
Capital in excess of par
Retained earnings

17. Financial statement footnotes
Footnotes are an integral part of companies’ financial reports.
These “notes” help users better understand and interpret the numbers presented in the body of the financial statements.
Three important notes:
Summary of significant accounting policies.
Subsequent event disclosures.
Related party transactions

18. Financial statement notes: Significant accounting policies

19. Financial statement notes: Subsequent events

20. Financial statement notes: Related party transactions
Related parties

21. Statement of cash flows
Explains why a firm’s cash position changed between successive balance sheet dates. Here’s a balance sheet equation:
Cash +
Non-cash assets =
Liabilities +
Stockholders’ equity
Cash
Non-cash assets
Liabilities = + -
Stockholder’s equity
ΔCash
Δ Stockholders’ equity = +
At the same time, it explains why non-cash assets, liabilities, and stockholders’ equity have changed.
Δ Non-cash assets
Δ Liabilities -

22. Cash flow statement format
Cash inflows and outflows from transactions and events that affect operating income
Operating Activities
Cash inflows and outflows from loaning money to others, investing in securities, or in assets (e.g., equipment) used to produce goods and services.
Investing Activities
Cash inflows and outflows from borrowing money, selling stock, and paying dividends
Financing Activities
Δ Cash

23. Cash flow statement: Wal-Mart example
Adjustments to accrual earnings

24. Cash flow statement: Wal-Mart example

25. Cash flow versus accrual earnings: HRB Advertising Company
Opened for business on April 1, when each partner contributed $3,500 cash.
Transactions for the year:
Profit (accrual earnings) for the year was $3,725 but the checking account was overdrawn by $11,200

26. Here’s what happened at HRB

27. Deriving cash flows from operations: Indirect approach

28. HRB’s cash flow statement: Indirect approach

29. Deriving cash flow information: HRB one year later
Bank loan refinanced
Stock issued

30. Deriving cash flow information: HRB’s accrual earnings and cash flows

31. Deriving cash flow information: Overview
Income
statement
Beginning
Balance sheet
Ending
Balance sheet
Cash flow
statement
You can always derive any one financial statement from information available in the other three statements.

32. Deriving cash flow information: Cash collected from customers

33. Deriving cash flow information: Salaries paid

34. Deriving cash flow information: Rent paid

35. Deriving cash flow information: Utilities paid

36. Deriving cash flow information: Cash paid for supplies

37. Deriving cash flow information: Interest paid

38. Deriving cash flow information: Office equipment cash flows
Balance Sheet Office Equipment
$15,000
Purchase (cash basis)
$1,500
$16,500
Income Statement Depreciation Expenses
Accumulated
Depreciation
$2,250
$3,250
3,250
$5,500
accrual basis

39. Deriving cash flow information: Bank loan and note cash flows
$10,000
$10,000 $0
Note
Payable
Refinancing $0
$10,000
$10,000

40. Deriving cash flow information: Common stock and retained earnings
$10,500
Stock issued (cash basis)
$6,000
$16,500
Retain Earnings
$3,735
Net losses (accrual basis)
$1,725
$2,000

41. Deriving cash flow information: Cash receipts and disbursements

42. Summary
The balance sheet shows the assets owned by a company at a given point in time, and how those assets are financed (debt vs. equity).
Be alert for differences in balance sheet measurement bases, account titles, and statement format.
Financial statement footnotes provide important information.
The cash flow statement shows the change in cash for a given period, broken down into operating, investing, and financing activities.

43. Summary concluded
Changes in certain balance sheet accounts help explain why operating cash flows differ from accrual income.
Conversely, the cash flow statement helps to explain changes in balance sheet accounts
T-accounts are a useful analytical device for deriving cash flow and accrual income information from successive balance sheets