Please enable JavaScript.
Coggle requires JavaScript to display documents.
Reading 22: Understanding Balance Sheet (Formats (Classified Balance sheet…
Reading 22: Understanding Balance Sheet
Elements of Balance Sheet
Assets
:
Resources controlled resulted from past transactions, and that are expected to provide future economic benefit.
Recognition
Probable flow of future economic benefit to the entity
Can be reliably measured
Liabilities
Obligations resulted from past events, and are expected to require an outflow of economic resources
Recognition
Probable sacrifice of future economic benefit to the entity as a result of past transactions/ events
Amount received but not reported as revenue in the income statement (deferred/ unearned revenue)
Amounts reported as expenses but which haven't been paid
Equity
Owner's residual interest in the assets, after deducting liabilities
Characteristics
Permanent
No mandatory charges against earnings
Legal subordination to creditors
Uses and limitations
Use
to assess a firm liquidity, solvency, and ability to pay dividends
Limitations
Assets, liabilities and equity should not be interpreted as market value or intrinsic value.
Balance sheet consists of a mixture of values: historical cost, amortized cost, fair value, etc.
Some assets and liabilities are difficult to quantify and/ or are not reported on the balance sheet.
Fair values may changes after balance sheet date
Formats
Classified Balance sheet
: Grouping of accounts into sub-categories ( current vs. noncurrent; financial vs. nonfinancial)
Liquidity-based Balance Sheet
Present assets and liability in order of liquidity
Report format
: Assets, liabilities, and equity in a single column
Account format
: Assets on the left, Liabilities and Equity on the right
Classes of Assets, Liabilities and Equities
Assets
Current
(< 1 year)
reflect firm's operating activities/capacity
Cash&Cash Equivalents
Highly liquid (typically money market instrument < 90 days)
BS values are generally identical when using either amortized cost or fair value
Account Receivable
Is reported at net realizable by estimating bad debt expense
is cash to be received before year end
Inventories
Are reported at the lower of cost or net realizable value (IFRS);
or the lower of cost or market value (GAAP)
Cost can be measured using standard costing or the retail method (banned in IFRS)
Different cost flow assumptions can affect inventory values
Prepaid expenses
:
Services that firm has paid for and will use before year end
Financial assets
Debts, equity investment of the company
Deferred tax assets
Has paid more tax now, so in the future will pay less tax
Marketable securities
Recorded at amortized cost (for holding securities) or fair value (for selling securities)
Non-current
(>1 year)
for continuing use, not resale
reflects firm's investing activities
Property, plant and equipment (PP&E)
Depreciation
(IFRS) is reported using Cost Model or Revaluation Model;
(GAAP) is reported only with Cost Model
If carrying value > recoverable amount --> PP&E is impaired.
Recovery of impairment is ok under IFRS but not GAAP.
Fixed assets used to operate the business
A contra account is used in a general ledger to reduce the value of a related account when the two are netted together.
Intangible assets
Amortization
If created internally then are expensed as incurred.
Purchased intangible assets are reported as PP&E
Types
Unidentifiable assets
Items that must be expensed
(cannot be capitalized)
R&D
GAAP:
both Research and Development costs are expensed.
IFRS:
Research cost is expensed; Development cost is capitalized.
Internally generated brands, mastheads, publishing titles, customer lists
Start-up costs
Training costs (as we don't know this would lead to higher earnings)
Administrative and general overhead
Advertising and promotion (as we don't know this would lead to higher earnings)
Relocation and reorganization costs
Redundancy and termination costs
Example
Goodwill:
The excess of purchase price over the fair value of the identifiable net assets acquired in a business acquisition.
management can subjectively decide how to value goodwill
Analysis: remove impact of goodwill from ratios
3 more items...
Purchased patents and copyrights
Purchased brand and trademarks
Direct response advertising (e.g. coldcalling)
Purchased franchise and license costs
Computer software development costs
if the software can do its purpose, from that moment any further incurring costs can be capitalized
Cannot be acquired singularly and has indefinite benefit period (e.g. goodwill)
Not amortized; annual impairment review
May only be recognized if they can be measured reliably
Generally exclude internally generated intangibles
Identifiable assets
Can be acquired singularly, linked to rights and privileges having finite benefit periods
Amortized over estimated useful life
Nonphysical assets used to operate the business
Investment assets
(IFRS only)
Held-to-maturity securities
reported at amortized cost
Trading securities
are reported at fair value
Unrealized gain/loss are reported in the income statement.
Available for sale securities
Gain/ loss are reported in equity.
Equity account investments
Associates/ affiliates
Companies that the firm has noncontrolling influences on
Natural resources
Depletion
Deferred tax assets
recognized when taxes payable (tax return) > income tax expense (income statement)
difference is temporary
pay more tax now but less tax in the future
Liabilities
Current
(<1 year)
Account payable
Amounts owed to supplier for G&S purchased on credit
Unearned revenue
Cash collected in advance of providing G&S
Bank borrowings
Notes payable
Provisions
(estimated future liabilities)
Accrued liabilities
Expenses that have been recognized in income statement, but not yet contractually due
Tax payable
amount that firm owes to tax authority
Non-current
(>1 year)
Bond payable
Reported at amortized cost
Held-for-trading liabilities & derivatives
Reported at fair value
Equities
Contributed capital
Amount paid in by common shareholder at historical cost
Common stock at par
Additional paid in capital
Preferred stock
Capital stock that has certain rights and privilege
Irredeemable (if redeemable, treated as debt)
Treasury stock
Issued common stock that has been repurchased by firm
Retained earnings
Cumulative undistributed earnings of the firm since inception
Non-controlling (minority) interest
Proportion of a subsidiary not owned by the parent
Accumulated other comprehensive income
Includes all changes to equity from sources other than net income and transaction with shareholders
Common-size balance sheet
Express each item of balance sheet as % of total assets.
Liquidity & Solvency Ratio
Liquidity Ratios
Current Ratio =\(\frac{Asset_{current}}{Liability_{current}}\)
Quick Ratio (a.k.a Acid test) =\(\frac{Asset_{current} - Inventory}{Liability_{current}}\)
Cash Ratio=\(\frac{Cash + MarketableSecurities}{Liability_{current}}\)
Solvency Ratios
Long-term debt to equity Ratio=\( \frac{Debt_{LongTerm}}{Equity}\)
Total debt to equity Ratio=\(\frac{Debt_{Total}}{Equity}\)
Debt Ratio=\( \frac{Debt_{total}}{Asset_{total}}\)
Financial leverage ratio= \(\frac{Asset_{total}}{Equity_{total}}\)
Depreciation and Depletion
Balance sheet value are
Historical cost - accumulated depreciation (GAAP & IFRS)
Historical cost: total of all initial costs to get the asset running
Unless the assets are impaired
Fair value - accumulated depreciation (IFRS)
Since IFRS allows to revalue assets
Financial Asset
(Current Asset)
GAAP Held-to-maturity Securities
IFRS: Securities measured at amortized cost
Debt securities that company hold to maturity, loans/ note receivable, unlisted equity securities if fair value cannot be determined
Interest income and REALIZED gains/ losses on disposal reported on income statement
are measured at amortized cost
GAAP Available-for-sale Securities
IFRS: Securities measured at fair value through other comprehensive income
Debt securities acquired with intent to collect interest payments but sell prior to maturity
Fair (market) value on balance sheet
Change in fair value is recorded into Other Comprehensive Income
Interest income and REALIZED gains/ losses on disposal on income statement
UNREALIZED gains/losses are not recorded on income statement and instead are part of
other comprehensive income
GAAP Trading Securities
IFRS: Securities measured at fair value through profit and loss
Debt securities that will be sold in near term, equity securities, derivatives
Fair value on balance sheet
Dividend income and UNREALIZED gains/ losses are reported on income statement and flow to equity as part of retained earnings
IFRS: at time of purchase, firm can
(irrevocably)
choose to
Account for an equity security as measured at fair value through other comprehensive income, or
Account for any security as measured at fair value through profit and loss