ACCT1250_W09_Ch5_Lecture (1).pptx Intermediate Accounting 13th Canadian Edition, Volume 1 Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy

Intermediate Accounting
13th Canadian Edition, Volume 1
Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy

1. Intermediate Accounting 13th Canadian Edition, Volume 1 Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy Chapter 5 Financial Position and Cash Flows This slide deck contains animations. Please disable animations if they cause issues with your device. Copyright ©2022 John Wiley & Sons, Canada, Ltd.

2. Chapter 5: Financial Position and Cash Flows (LO 1 to LO 5) After studying this chapter, you should be able to: Understand the statement of financial position and statement of cash flows from a business perspective. Identify the uses and limitations of a statement of financial position. Identify the major classifications of a statement of financial position. Prepare a classified statement of financial position. Identify statement of financial position information that requires supplemental disclosure.

3. Chapter 5: Financial Position and Cash Flows (LO 6 to LO 10) After studying this chapter, you should be able to: Identify major disclosure techniques for the statement of financial position. Indicate the purpose and identify the content of the statement of cash flows. Prepare a statement of cash flows using the indirect and direct methods. Understand the usefulness of the statement of cash flows. Identify differences in accounting between I F R S and A S P E and identify the significant changes planned by the I A S B for financial statement presentation.

4. A Business Perspective A statement of financial position provides information about: Liquidity and solvency (to assess risk of investing) Details about the company’s financial structure (to assess financial flexibility) A statement of cash flows can be used to assess earnings quality Earnings manipulation Net income significantly higher than cash flows from operations Issuance of shares to offset negative cash flows from operations L O 1

5. Statement of Financial Position: Usefulness The statement of financial position (SFP) is also known as the balance sheet under ASPE The SFP provides information to users: For calculating rates of return on invested assets For evaluating the capital structure On liquidity (amount of time until an asset is converted to cash) On solvency (ability to pay debts and related interest) About financial flexibility (ability to respond to unexpected needs and opportunities) L O 2

6. Statement of Financial Position: Limitations Many assets and liabilities are stated at historical cost Information presented has higher reliability, however reporting at current fair value would result in more relevant information Judgement and estimates are used in determining many of the items reported in the S F P Many “soft” numbers (estimates) are included that could be significantly uncertain Materiality judgements are often needed The S F P leaves out many items that cannot be recorded objectively or are off-balance sheet L O 2

7. Classification in the S tatement of Financial Position Similar items are classified (grouped together) To arrive at significant subtotals Some parts and subsections are more informative than the whole Items with different characteristics are separated to provide additional information, for example Assets with different functions Long-term and current liabilities Debt and equity Property used and property held for sale (different liquidity characteristics) Items that can be measured or valued easily L O 3

8. Separate Reporting of S F P Items Assets that differ in their type or expected function (e.g., inventory versus capital assets) Liabilities with different implications for the entity’s financial flexibility (e.g., long term debt versus current debt) Assets and liabilities with different general liquidity characteristics (e.g., cash versus receivables) Assets, liabilities, and equity instruments with characteristics that allow for easy measurement or valuation L O 3

9. Monetary versus Nonmonetary Items Monetary assets and liabilities Money or claims to future cash and cash outflows Fixed or determinable in amount and timing Easy to measure Carrying values approximate net realizable values Such as accounts and notes receivable and payable, long-term debt Non-monetary assets and liabilities Measurement uncertainty Frequently recorded at historical cost (amortized cost) Such as inventory, PPE, certain investments, intangibles L O 3

10. Financial Instruments Contracts that create a financial asset for one party and a financial liability or equity instrument for the other Marketable (or tradeable) and easy to measure Many are monetary assets or liabilities Current standards require fair value accounting where market values are readily available I F R S and A S P E allow the fair value option—choice to value financial instruments at fair value as an accounting policy Normally should not be offset against each other on the S F P L O 3

11. Classes of Items on the S tatement of Financial Position Assets : present economic resources controlled by an entity as a result of past transactions or events with the potential to produce future economic benefits Liabilities : present duty or responsibility that obligates the entity to transfer an economic resource, arising from past transactions or events and which cannot be avoided Equity/Net Assets : residual interest in an entity’s assets after deducting its liabilities S F P shows classes in order: assets, liabilities, equity; I F R S allows the order to be reversed L O 3

12. Elements of the Statement of Financial Position Assets Liabilities and Equity Current assets Long-term investments Property, plant, and equipment Intangible assets Other assets Current liabilities Long-term debt Shareholders’ equity Capital shares Contributed surplus Retained earnings Accumulated other comprehensive income / other surplus L O 3

13. Current Assets Current assets are cash and other assets expected to be realized: Within one year from the date of the S F P or Within the normal operating cycle, whichever is longer First classification on the statement of financial position Generally presented in order of liquidity (normally: cash, short-term investments, receivables, inventory, and prepaid items ) L O 4

14. Current Assets – Cash Includes cash and cash equivalents Defined as: Cash, demand deposits, short-term highly liquid investments readily convertible into known amounts of cash Have an insignificant risk of changing in value Any known restrictions to availability of cash must be disclosed L O 4

15. Current Assets – Short-Term Investments Investments in debt and equity securities are presented separately from other assets Considered short-term if expected to be sold or realized within 12 month of the SFP date or if held for trading purposes Valued at cost/amortized cost or fair value Companies with excess cash often have significant amounts of short-term investments L O 4

16. Current Assets – Receivables Amounts should be reported separately based on the nature of their origin: Ordinary trade accounts Amounts owing by related parties Other (substantial) unusual items Anticipated losses due to uncollectibles should be accrued Separate disclosure required for: Amount and nature of nontrade receivables Receivables pledged as collateral Accounts receivable valued at net realizable value L O 4

17. Current Assets – Inventories Assets that are: Held for sale in the ordinary course of business In the process of production for such sale, or In the form of materials or supplies to be consumed in the production process or in the rendering of service Valued at lower of cost and net realizable value with cost formula disclosed (F I F O, weighted average) Manufacturing enterprise should disclose completion stage of inventories for Raw materials, Work-in-progress, Finished goods L O 4

18. Current Assets – Prepaid Expenses Defined as: expenditures already made for benefits (usually services) that will be received within one year or operating cycle (whichever is longer) Reported as the unexpired or unconsumed cost Common prepaid expenses: rent, advertising, property taxes, and office or operating supplies Current practice is to report some prepaid amounts as current assets even if the benefit extends beyond one year (or operating cycle) L O 4

19. Non-current Investments Presented on the SFP just below current assets in a separate section called “Investments” Investments that will be held for an extended period Non-current investments normally consist of one of the following: Debt securities Equity securities Sinking funds, tangible assets held as investment Valuation options are: Fair value, amortized cost, equity method L O 4

20. Property, Plant, and Equipment Physical (tangible) assets used in on-going business operations of the business to generate income Land, buildings, machinery, furniture, wasting resources Generally reported at cost or amortized cost IFRS allows option for valuation at fair value Most assets are depreciable, except for land Written down when impaired L O 4

21. Intangible Assets & Goodwill Intangible assets are capital assets without physical substance and with a higher degree of uncertainty regarding future benefits Include (most common): Patents, copyrights, franchises, trademarks, and trade names Initially recorded at cost, and tested for impairment Intangibles are grouped into two categories: Those with finite life – amortized over useful life Those with indefinite life – not amortized Goodwill arises in a business combination Is not amortized, but is tested for impairment L O 4

22. Other Assets Listed below intangibles and goodwill on the SFP Some of the items included are: Assets in special funds Non-current receivables Intangibles Deferred income tax assets Land held for speculation Advances to subsidiaries Sufficient information must be disclosed to inform users of the nature of the asset L O 4

23. Current Liabilities Obligations due within one year (from the date of the S F P ) or within the operating cycle, whichever is longer Examples of current liabilities include: Payables resulting from acquisitions of goods and services Collections received in advance of delivery of goods or performance of services Other liabilities to be paid in the short term Short-term financing payable on demand Derivative financial instruments Accounts payable normally listed first; however, current liabilities are not reported in any specific order L O 4

24. Working Capital Total Current Assets − Total Current Liabilities = Working Capital A key indicator of the company’s short-term liquidity Not usually disclosed on the SFP Often calculated by bankers and other creditors L O 4

25. Long-Term Liabilities Long-term obligations are those not reasonably expected to be liquidated within the normal operating cycle Three types—arising From specific financing situations From ordinary enterprise operations Depending on the occurrence or non-occurrence of one or more future events Presentation requires reporting the portion due within the next year as a current liability Terms are reported in notes to the financial statements L O 4

26. Owners’/Shareholders’ Equity Section can be difficult to prepare due to the complexity of share agreements and restrictions on capital Consists of four parts Capital shares : authorized, issued, and outstanding amounts Contributed surplus : presented as one number Retained earnings : presented as one number Accumulated other comprehensive income (I F R S) Partnerships: separate accounts for permanent capital accounts and drawings accounts Proprietorships: usually use a single capital account L O 4

27. Statement of Financial Position Example L O 4

28. Statement of Financial Position Example…cont. L O 4

29. Other Required Disclosures Part 1 Contingencies (A S P E) and provisions (I F R S) Material (or potentially material) events that have an uncertain future Contingent gains not recognized under I F R S or A S P E A liability is recognized when it is probable or likely and measurable (A S P E) and if it meets the definition of a liability (I F R S) Accounting policies Disclose all significant accounting principles/methods; then users can assess the impact on income and key ratios Required to disclose information about estimates when there are measurement uncertainties L O 5

30. Other Required Disclosures Part 2 Contractual obligations If significant, how different contractual terms and conditions affect the company now, and in the future Essential provisions of guarantees, lease contracts, pension obligations and stock options (if material) Disclose obligations that require certain action by the entity—e.g., maintain certain financial ratios Additional detail on S F P items to make them clearer Subsequent events Any significant financial events after the formal date of the SFP but before the date it is issued Could be events that affect a condition that existed at the date of the S F P, or occurred after L O 5

31. Techniques of Disclosure Parenthetical explanations (following the items in the SFP )—brings the information into the body of the statement Notes (to the SFP )—reduces amount of detail on statements Cross references on the SFP –when there is a direct relationship between an asset and a liability L O 6

32. Additional Techniques of Disclosure Contra or adjunct account—an item that reduces or increases an asset or liability (e.g., Accumulated depreciation, Allowance for Expected Credit Losses or Premium on Bonds Payable) Supporting schedules to provide more detail for single line items, and definitions of technical vocabulary L O 6

33. Purpose and Content of a Statement of Cash Flows To assess the firm’s capacity to generate cash and cash equivalents and To enable users to compare the operating performance and cash flows of different entities Statement of cash flows shows: Where the cash came from What the cash was used for What was the change in the cash balance L O 7

34. Format of a Statement of Cash Flows Cash flow activities are divided into three sections Operating Activities—main revenue-producing activities Investing Activities—acquisitions and disposals of long-term assets and other investments Financing Activities—changes in equity and borrowings L O 7

35. Cash Inflows and Outflows L O 7

36. Preparation Methods for the Statement of Cash Flows Direct method : restates operations on a cash basis; includes specific cash inflows/outflows (e.g., cash received from customers, cash paid to suppliers and employees, interest paid/received, taxes paid, etc.) Indirect method: reconciles accrual net income to cash-based net income (e.g., adds back non-cash charges deducted from net income, such as depreciation) Only the operating activities sections differ between the two methods L O 8

37. Steps for Preparing the Statement of Cash Flows Determine the change (increase or decrease) in cash and cash equivalents during the period Record the information from the income statement into the operating activities section of the statement Analyze the change in each S F P account to identify associated cash flows and record the effects on the statement of cash flows Reconcile the change in cash and cash equivalents with the beginning and ending cash and cash equivalent balances. L O 8

38. Preparation of the Statement of Cash Flows Example Jan 1, 2023: issued shares for $10,000 cash Patents were sold at their carrying value of $20,000 Dec 31, 2023: purchased land with fair value of $150,000 for $100,000 in bonds and $50,000 cash Paid dividends: $15,000 Using the indirect method L O 8

39. Preparation of the Statement of Cash Flows Step 1 Determine the change (increase or decrease) in cash and cash equivalents during the period Ending balance, 2023 $61,000 Ending balance, 2022 $ 30,000 Change in cash and cash equivalents for the year: $61,000 − $30,000 = $31,000 (Increase) L O 8

40. Preparation of the Statement of Cash Flows Step 2 For operating activities , adjust net income of $75,000 on an accrual basis to a cash basis for those items on the income statement that do not affect cash (+) Depreciation Expense, $30,000 for those items that are affected by changes in current asset and liability accounts (−) Increase in accounts receivable, $41,000 (+) Decrease in inventory, $20,000 (+) Increase in accounts payable, $12,000 Net cash provided by operating activities: $75,000 + $30,000 - $41,000 + $20,000 + $12,000 = $96,000 L O 8

41. Preparation of the Statement of Cash Flows for Operating Activities Adjustments to reconcile net income to net cash provided by operating activities: L O 8

42. Preparation of the Statement of Cash Flows Step 3a Analyze the balances for land and property, plant and equipment and intangibles for investing activity Land increased by $150,000, offset by issuance of $100,000 bonds (−) Purchase of land, $50,000 Property, plant and equipment (net of accumulated depreciation) increased by $100,000; $100,000 + $30,000 impact of depreciation (−) Purchase of property, plant and equipment, $130,000 Proceeds from the sale of patents, $20,000 (+) Sale of patents, $20,000 Net cash used by investing activities : $50,000 + $130,000 - $20,000 = $160,000 L O 8

43. Preparation of the Statement of Cash Flows for Investing Activities Cash flows from investing activities L O 8

44. Preparation of the Statement of Cash Flows Step 3b Analyze long-term liabilities and equity for financing activities $10,000 from the increase of common shares (+) Issuance of common shares, $10,000 Paid dividends of $15,000 (−) Paid dividends, $15,000 Issued bonds, $200,000 − $100,000 non-cash increase (+) Issued bonds, $100,000 Net cash provided by financing activities : $10,000 − $15,000 + $100,000 = $95,000 L O 8

45. Preparation of the Statement of Cash Flows for Financing Activities Cash flows from financing activities L O 8

46. Condensed (Partial) Statement of Cash Flows Step 4 L O 8

47. Preparation of the Statement of Cash Flows Using the Direct Method Using the same information as for the indirect method Cash received from customers ($580,000 − $41,000) Cash paid to suppliers and employees ($300,000 + $150,000 − $20,000 − $12,000) Paid taxes, $25,000 L O 8

48. Usefulness of the Statement of Cash Flows Provides creditors with useful information about a company, such as: Company’s ability to generate net cash from operating activities Net cash flow trends or patterns from operating activities Major reasons for positive or negative net cash from operating activities Whether the cash flows are renewable or sustainable L O 9

49. Financial Liquidity Current cash debt coverage ratio Indicates a company’s ability to repay its current liabilities from its operations The higher the ratio, the less likely there will be liquidity issues The denominator is “average current liabilities” L O 9

50. Financial Liquidity cont. Cash debt coverage ratio Measures the ability to repay liabilities from net cash provided by operating activities without having to liquidate revenue-producing assets The higher this ratio, the less likely it is that a company will have difficulty in meeting its obligations as they come due The denominator is “average total liabilities” L O 9

51. Perspectives—Cash Flow Patterns Refers to positive or negative cash flows from operating, investing and financing activities Cash flow patterns can reveal significant information For example:, a company with a ( + − +) pattern is raising funds in the marketplace which shows they are supported and likely have ability to prosper On the other hand, a company with (− + +) may be selling off revenue-producing assets to finance operations, jeopardizing revenue-producing potential If capital asset purchases are financed through operations, solvency risk does not increase L O 9

52. Perspectives—Free Cash Flow Calculated as net cash from operations minus capital expenditures and dividends Indicates discretionary cash flow (cash left to invest or expand) to make additional investments, to retire debt, or to add to liquidity Free cash flow analysis answers questions: Can the company pay dividends without external financing? If operations decline, will the company be able to maintain its required capital investment? L O 9

53. A Comparison of IFRS and ASPE –Statement of Financial Position IFRS ASPE Items in the statement of financial position/balance sheet Traditional elements plus: Investment property FV-OCI Investments and Accumulated OCI Provisions Traditional elements plus: Government assistance receivable Specific investments accounted for using the cost or equity method Current vs. non-current liabilities Show as current if no unconditional right to defer payment of a financial liability beyond one year as at the SFP date Show as non-current if debt has been refinanced by issue date of the financial statements L O 10

54. A Comparison of IFRS and ASPE –Statement of Cash Flows IFRS ASPE Investments Certain preferred shares close to maturity may be classified as cash or cash equivalents Equity investments are excluded from cash and cash equivalents Interest and dividends Received: May be classified as operating, investing or financing activities Paid: Operating or Financing Included in net income: operating activity Part of retained earnings: financing activities Disclosure of cash flow per share information Allowed Prohibited Date financial statements authorized for issue Must be disclosed No requirement for disclosure L O 10

55. Looking Ahead Exposure Draft—General Presentation and Disclosure Statement of Cash Flows – IASB Exposure Draft proposes Starting with operating profit and loss in the operating section for those using the indirect method Showing interest and dividends received as investing; showing interest and dividends paid as financing SFP - IASB Exposure Draft proposes Presenting separate information for investments in integral associates and joint ventures Choice whether to use Balance Sheet or Statement of Financial Position for title L O 10

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