Sub: Financial Accounting Topic:
Changes in Balance Sheet Accounting
The total assets of a firm and the claims on assets change over time because of investing andfinancing activities.
, a firm may issue common stock for cash; acquire a building bymortgaging a portion of the purchase price, or issue common stock in exchange for convertiblebonds. These investing and financing activities affect the amount and structure
of a firm’s assets,
ties, and shareholders’ equity.
The total assets of a firm and the claims on assets also changeevery day because of operating activities. The firm engages in daily business operations to generaterevenues and create assets, but to do so, the firm must consume resources and incur obligations.Ideally, the firm sells goods or services to customers for an amount larger
than the firm’s
cost toacquire or produce the goods and services. Creditors and owners provide capital to a firm with theexpectation that the firm will use the capital to conduct profitable business operations and providean adequate return to the suppliers of capital for the level of risk involved. The balance sheet is the
summary of the firm’s f
inancial position at the end of each period; therefore, it summarizes theresults of the operating, investing, and financing activities. Analysts frequently examine the relationbetween items in the balance sheet when assessing
a firm’s financial position and credit risk.
, an excess of current assets over current liabilities suggests that a firm has sufficient liquidresources to pay short-term creditors. A relatively low percentage of long-term debt toshare
holders’ equity suggests that a
firm likely has sufficient long-term assets to repay the long-termdebt at maturity, or at least an ability to take on new debt financing using the long-term assets ascollateral to repay debt coming due. However, when using the balance sheet for these purposes, theanalyst must recognize the following:1.
Certain valuable resources of a firm that generate future cash flows, such as a patent for apharmaceutical firm or a brand name for a consumer products firm such as PepsiCo, appear