Chapter 5 Notes Balance Sheet balance sheet reports the assets liabilities and stockholders equity of a business enterprise at a specific date o snapshot of a company s financial position o provides info about the nature and amounts of investments in enterprise resources obligations to creditors and the owner s equity in net resources o helps predict future cash flows Usefulness of the Balance Sheet helps evaluate the capital structure of a company also helps assess company s risk and cash flow o done by assessing liquidity solvency and financial flexibility liquidity describes the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid o investors are often interested in short term liquidity ability to pay back current and maturing obligations o the greater a company s liquidity the lower its risk of failure solvency the ability of a company to pay its debts as they mature o higher debt lower solvency o companies with higher debt are more risky because they need more of their assets to pay back their debts financial flexibility measures the ability of a company to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities o affected by liquidity and solvency o the greater a company s financial flexibility the lower its risk of failure Limitations of the Balance Sheet 1 most assets and liabilities are reported at historical cost o would be more relevant if fair value was reported more 2 judgments and estimates are used to determine many items on the balance sheet o i e a company s collectible receivables useful life of equipment returned inventory etc 3 items that are of financial value are sometimes omitted because they cannot be recorded objectively Classification in the Balance Sheet balance sheet accounts are classified companies should report separately o 1 assets that differ in their type expected function in the company s central operations or other activities i e inventory separate from property plant and equipment o 2 assets and liabilities with different implications for the company s financial flexibility i e assets used in operations should be reported separately from assets held for investment o 3 assets and liabilities with different general liquidity characteristics i e reporting cash separately from inventory 3 general classes of items included on the balance sheet o 1 Assets probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events i e current assets long term investments property plant and equipment intangible assets other assets o 2 Liabilities probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events i e current liabilities long term debt o 3 Equity residual interest in the assets of an entity that remains after deducting its liabilities equity ownership interest i e owners stockholders equity Current Assets current assets cash and other assets a company expects to convert into cash sell or consume either in one year or in the operating cycle whichever is longer o presented in the balance sheet in order of liquidity five major items in the current assets section Item Cash and cash equivalents Short term investments Receivables Inventories Prepaid expenses Basis of Valuation Fair value Generally fair value Estimated amount collectable Lower of cost or market Cost rule if a company expects to convert an asset into cash or to use it to pay a current liability within a year or the operating cycle whichever is longer it classifies the asset as current Cash considered to consist of currency and demand deposits cash equivalents short term highly liquid investments that will mature within three months or less o any restrictions commitments related to the availability of cash must be disclosed Short Term Investments 3 separate categories for investments in debt and equity securities o 1 held to maturity debt securities that a company has the positive intent and ability to hold to security reported as current or noncurrent assets depending on circumstances o 2 trading debt and equity securities bought and held primarily for sale in the near term to generate income on short term price differences should be reported as current assets o 3 available for sale debt and equity securities not classified as held tomaturity or trading securities reported as current or noncurrent assets depending on circumstances Receivables company should clearly identify o anticipated losses due to uncollectibles o amount and nature of any nontrade receivables o any receivables used as collateral receivables from unusual transactions i e sale of property loan to affiliate etc should be classified as noncurrent assets Inventories must disclose basis of valuation i e lower of cost or market and cost flow assumption used i e LIFO FIFO weighted average Prepaid Expenses included in current assets if company will receive benefits within one year operating cycle reported at the amount of the unexpired or unconsumed cost examples o prepaid insurance o rent o advertising o taxes o office operating supplies Noncurrent Assets Long Term Investments long term investments o consist of 1 of 4 types 1 investments in securities i e bonds common stock long term notes 2 investments in tangible fixed assets not currently used in operations i e land held for speculation 3 investments set aside in special funds i e sinking fund pension fund plant expansion fund includes cash surrender value of life insurance 4 investments in nonconsolidated subsidiaries or affiliated companies o expected to be held for many years o reported in the section titled Investments right below Current Assets Property Plant and Equipment property plant and equipment tangible long lived assets used in the regular operations of the business o consists of physical property i e land equipment machinery furniture tools etc o assets are either depreciated i e buildings equipment or depleted i e timberlands oil reserves except for land o basis used to value property plant and equipment is disclosed in the notes along with accumulated depreciation and any liens against the properties Intangible Assets intangible assets lack physical substance not financial instruments o include