Structure of the Balance

Sheet and Statement of

Cash Flows

Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 4
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without the prior written consent of McGraw-Hill Education
 Learning objectives
1. How balance sheet accounts are measured and classified.
2. How balance sheet information is used.
3. Balance sheet terminology and format outside the U.S.
4. How notes aid your understanding of the firm’s accounting
policies, subsequent events, and related-party transactions.
5. How successive balance sheet and the income statement can be
used to identify cash inflows and outflows.
6. How the cash flow statements can be used to explain changes in
successive balance sheets.
7. The distinction between operating, investing, and financing
sources and uses of cash.
8. How changes in current asset and current liability accounts can
be used to compute “cash flows from operations” from accrual
earnings.
9. Differences between IFRS and U.S. GAAP for certain items on
the statement of cash flows.
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 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.

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 Balance sheet information

Rates of return ROA and ROCE

Capital structure Debt/Equity ratio

ASSETS
Helps
Liquidity Cash conversion
LIABILITIES assess
+
Solvency Ability to pay debt
EQUITY

Flexibility Operating and financial

Balance Sheet

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 Balance sheet measurement
conventions

Historical cost

ASSETS
Current cost (fair value)
Measurement
LIABILITIES methods
Net realizable value
+
EQUITY
Discounted present value

Balance Sheet

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 Balance sheet classification:
Overview

ASSETS = LIABILITIES + EQUITY

• Current assets
• Property, plant and equipment
• Investments
• Current liabilities
• Other assets
• Long-term debt
• Other liabilities

• Preferred and common stock

• Additional paid-in capital
• Retained earnings

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 Balance sheet classification:
Current assets

Amortized cost
or current
market value

Net realizable
value

Lower or (historical)
cost or current market
value

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 Balance sheet classification:
Other assets

Historical cost minus accumulated

depreciation except that fair market
value is used when “impaired”

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 Balance sheet classification:
Liabilities

Amount due
at maturity

Historical
cost
Discounted
present value

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 Balance sheet classification:
Stockholders’ equity

Historical
par value

Historical
cost

Combination of different
measurement bases

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 Which company is?
Deere

Analytical insights: E-Trade

Potomac Electric Power
Understanding the business Wal-Mart

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 Balance sheet presentation:
International differences

U.S. Format: U.K. Format:

Current Assets Fixed Assets
+ +
Long-lived Assets Current Assets
-
=
Non-current Liabilities
Current Liabilities -
+ Current Liabilities
Non-current Liabilities =
+
Stockholders’ Equity Capital Employed

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 Notes to Financial statements
 Notes are an integral part of companies’ financial reports.

 Help users better understand and interpret the numbers

presented in the body of the financial statements.

 Three important notes:

1. Summary of significant accounting policies.
2. Subsequent event disclosures.
3. Related-party transactions

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 Statement of cash flows
 Explains why a firm’s cash position changed between successive
balance sheet dates. Here’s the balance sheet equation:

Assets = Liabilities + Stockholders’ equity

Cash + Non-cash assets = Liabilities + Stockholders’ equity

Cash = Liabilities - Non-cash assets + Stockholder’s equity

ΔCash = Δ Liabilities - Δ Non-cash assets + Δ Stockholders’ equity

 At the same time, it explains why non-cash assets, liabilities, and

stockholders’ equity have changed.

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Cash flow statement format

Cash inflows and outflows from

Operating Activities transactions and events that affect
operating income

Cash inflows and outflows from loaning

money to others, investing in securities, or
Investing Activities in assets (e.g., equipment) used to produce
goods and services.

Cash inflows and outflows from

Financing Activities borrowing money, selling stock, and
paying dividends

Δ Cash

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 Cash flow statement:
Wal-Mart example

Adjustments to accrual earnings

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Cash flow statement:
Wal-Mart example

4-17
Deriving cash flows from operations:
Indirect approach

4-18
HRB’s cash flow statement:
Indirect approach

4-19
Deriving cash flow information:
HRB one year later

Bank loan
refinanced

Stock issued

4-20
Deriving cash flow information:
HRB’s accrual earnings

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Deriving cash flow information:
HRB’s cash flows

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Deriving cash flow information:
Overview

Income
statement

Beginning Ending
Balance sheet Balance sheet

Cash flow
statement

You can always derive any one financial statement from

information available in the other three statements.

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Deriving cash flow information:
Cash collected from customers

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Deriving cash flow information:
Salaries paid

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Deriving cash flow information:
Rent paid

4-26
Deriving cash flow information:
Utilities paid

4-27
Deriving cash flow information:
Cash paid for supplies

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Deriving cash flow information:
Interest paid

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Deriving cash flow information:
Office equipment cash flows

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Deriving cash flow information:
Cash receipts and disbursements

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 Global Vantage Point
IFRS (IAS 7) encourages, but does not require, entities to report cash
flows from operating activities using the direct method.

Why: believed to provide information that

is not available under the indirect method

Both FASB and IASB tabled a proposal to mandate the use of the
direct method for reporting operating cash flows since most computer
systems aren’t set up to efficiently process the requisite data

Subtle differences between IFRS and U.S. GAAP:

one is how to report cash interest from investments

U.S. GAAP reports these as IAS 7 allows the option to report these
part of operating cash flows as cash flows from investing activities

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 Global Vantage Point
An example – EMC Corporation

Direct Method

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 Global Vantage Point
An example – EMC Corporation

Indirect
Method

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Global Vantage Point
An example – EMC Corporation

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 Summary

1. 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).

2. Be alert for differences in balance sheet measurement bases,

account titles, and statement format.

3. Financial statement notes provide important information.

4. The cash flow statement shows the change in cash for a given
period, broken down into operating, investing, and financing
activities.

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 Summary concluded

5. Changes in certain balance sheet accounts help explain why

operating cash flows differ from accrual income.

6. Conversely, the cash flow statement helps to explain changes in

balance sheet accounts

7. Understanding the interrelationships between successive balance

sheets and the statement of cash flows

8. Understanding the basic differences between IFRS and U.S.

GAAP as well as differences between the direct and indirect
approach to presenting cash flows from operations

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