acct ch 5

5 CA in order of liquidity

Cash and cash equivalents Short-term investments Receivables Inventories Prepaid expenses

Note that only debt secutities are classified as ___ with changes reported in stockholders' equity.

available for sale

By reporting information on assets, liabilities, and stockholders' equity, the _____ provides a basis for computing rates of return and evaluating the capital structure of the enterprise.

balance sheet

Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and stockholders' equity

balance sheet

This financial statement provides information about the nature and amounts of investments in enterprise resources, obligations to creditors, and the owners' equity in net resources. -It therefore helps in predicting the amounts, timing, and uncertainty of future cash flows

balance sheet

All equity securities are recorded at fair value with changes reported in net income (unless accounted for under the equity method or if it is not practicable to determine fair value).

short term investments

Companies with higher debt are relatively more risky because they will need more of their assets to meet their fixed obligations (interest and principal payments).

solvency

For example, when a company carries a high level of long-term debt relative to assets, it has lower __ than a similar company with a low level of long-term debt.

solvency

The ability of a company to pay its debts as they mature. A company with a high level of long-term debt relative to assets has lower solvency than a similar company with a low level of long-term debt.

solvency

refers to the ability of a company to pay its debts as they mature.

solvency

To determine the actual liquidity and availability of ___ to meet current obligations, however, requires analysis of the composition of the current assets and their nearness to cash.

working capital

represents the net amount of a company's relatively liquid resources. Also called net working capital.

working capital

Basis of evaluation for: Cash and cash equivalents Short-term investments Receivables Inventories Prepaid expenses

-fair value -generally, fair value -estimated amount collectible - LCNRV -cost

3 general classes of items on balance sheet

1 assets 2 liabilities 3 stockholders equity

5 subclassifications of assets

1 current assets 2 long-term investments 3 property, plant, and equipment 4 intangible assets 5 other assets

Companies group investments in debt securities into three separate portfolios for valuation and reporting purposes: (short-term investments) 3

1 held to maturity 2 trading 3 available for sales

To classify items in financial statements, companies group those items with similar characteristics and separate items with different characteristics.5 For example, companies should report separately: 3

1.Assets that differ in their type or expected function in the company's central operations or other activities. 2.Assets and liabilities with different implications for the company's financial flexibility. 3.Assets and liabilities with different general liquidity characteristics.

report separately: -For example, IBM reports merchandise inventories separately from property, plant, and equipment. -For example, a company that uses assets in its operations, like Walgreens, should report those assets separately from assets held for investment and assets subject to restrictions, such as leased equipment. -For example, Boeing Company reports cash separately from inventories.

1.Assets that differ in their type or expected function in the company's central operations or other activities. 2.Assets and liabilities with different implications for the company's financial flexibility. 3.Assets and liabilities with different general liquidity characteristics.

4 long term investments

1.Investments in securities, such as bonds, common stock, or long-term notes. 2.Investments in tangible fixed assets not currently used in operations, such as land held for speculation. 3.Investments set aside in special funds, such as a sinking fund, pension fund, or plant expansion fund. This includes the cash surrender value of life insurance. 4.Investments in nonconsolidated subsidiaries or affiliated companies.

Some of the major limitations of the balance sheet are: (3)

1.Most assets and liabilities are reported at historical cost. 2.Companies use judgments and estimates to determine many of the items reported in the balance sheet. 3The balance sheet necessarily omits many items that are of financial value but that a company cannot record objectively

current liabilities include 3

1.Payables resulting from the acquisition of goods and services: accounts payable, wages payable, taxes payable, and so on. 2.Collections received in advance for the delivery of goods or performance of services, such as unearned rent revenue or unearned subscriptions revenue. 3.Other liabilities whose liquidation will take place within the operating cycle, such as the portion of long-term bonds to be paid in the current period or short-term obligations arising from the purchase of equipment.

Assets of a durable nature used in the regular operations of the business. These assets consist of physical property (such as land, buildings, machinery) and wasting resources (timberland, minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets.

PPE

For example, the knowledge and skill of Intel employees in developing new computer chips are arguably the company's most significant assets. However, because Intel cannot reliably measure the value of its employees and other intangible assets (such as customer base, research superiority, and reputation), it does not recognize these items in the balance sheet. Similarly, many liabilities are reported in an "off-balance-sheet" manner, if at all.

The balance sheet necessarily omits many items that are of financial value but that a company cannot record objectively

It should report held-to-maturity securities at ____. -All trading and available-for-sale debt securities are reported at ___.

amortized cost fair value

Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.

assets

Debt securities not classified as held-to-maturity or trading securities.

available for sale

sometimes referred to as the statement of financial position, reports the assets, liabilities, and stockholders' equity of a business enterprise at a specific date. .

balance sheet

to present inventories properly, a company discloses the ___ (e.g., lower-of-cost-or-net realizable value or lower-of-cost-or-market) and the ___ used (e.g., FIFO or LIFO).

basis of valuation cost flow assumption

A company must disclose any restrictions or commitments related to the availability of __ -As an example, see the excerpt from the annual report of Alterra Healthcare Corp. in Illustration 5.3.

cash

_ is generally considered to consist of currency and demand deposits (monies available on demand at a financial institution).

cash

Most companies use the caption "_," and they indicate that this amount approximates fair value.

cash and cash equivalents

short-term highly liquid investments that will mature within three months or less.

cash equivalents

Major ____ of receivables should be shown in the balance sheet or the related notes.

categories

Balance sheet accounts are ___. That is, balance sheets group together similar items to arrive at significant subtotals. Furthermore, the material is arranged so that important relationships are shown.

classified

The FASB has often noted that the parts and subsections of financial statements can be more informative than the whole. Therefore, the FASB discourages the reporting of summary accounts alone (total assets, net assets, total liabilities, etc.). Instead, companies should report and ____ individual items in sufficient detail to permit users to assess the amounts, timing, and uncertainty of future cash flows. Such ___ also makes it easier for users to evaluate the company's liquidity, financial flexibility, profitability, and risk.

classify classification

For example, in its balance sheet, Dell estimates the amount of receivables that it will collect, the useful life of its warehouses, and the number of computers that will be returned under warranty.

companies use judgments and estimates to determine many of the items reported on the balance sheet

This rule, however, is subject to interpretation. A company classifies an investment in common stock as either a current asset or a noncurrent asset depending on management's intent. When it has small holdings of common stocks or bonds that it will hold long-term, it should not classify them as __

current

Generally, 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 asset

A company does not report these five items as ___s if it does not expect to realize them in one year or in the operating cycle, whichever is longer. For example, a company excludes from the current assets section cash restricted for purposes other than payment of current obligations or for use in current operations.

current assets

A company includes prepaid expenses in __ if it will receive benefits (usually services) within one year or the operating cycle, whichever is longer. -As we discussed earlier, these items are current assets because if they had not already been paid, they would require the use of cash during the next year or the operating cycle.

current assets

A company should report trading securities as _

current assets

If a company restricts cash for purposes other than current obligations, it excludes the cash from _

current assets

are 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.

current assets

At times, a liability that is payable within the next year is not included in the ___ section. This occurs either when the company expects to refinance the debt through another long-term issue or to retire the debt out of noncurrent assets. This approach is used because liquidation does not result from the use of current assets or the creation of other current liabilities.

current liabilities

are the obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities.

current liabilities

include such items as trade and nontrade notes and accounts payable, advances received from customers, and current maturities of long-term debt. If the amounts are material, companies classify income taxes and other accrued items separately.

current liabilities

3 subclassifications of L and SE

current liabilities long term debt owners (stockholders) equity

It classifies individual equity investments and held-to-maturity and available-for-sale debt securities as ___ or ___ depending on the circumstances (based on management's intent).

current or noncurrent

Residual interest in the assets of an entity that remains after deducting its liabilities. In a business enterprise, the equity is the ownership interest

equity

A company with a high degree of ____ is better able to survive bad times, to recover from unexpected setbacks, and to take advantage of profitable and unexpected investment opportunities.

financial flexibility

For example, a company may become so loaded with debt—so financially inflexible—that it has little or no sources of cash to finance expansion or to pay off maturing debt.

financial flexibility

Liquidity and solvency affect a company's ____, which measures the "ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities."

financial flexibility

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. A company's liquidity and solvency affect its financial flexibility.

financial flexibility

Debt securities that a company has the positive intent and ability to hold to maturity.

held to maturity

Assets that lack physical substance and that are not financial instruments. Intangible assets derive their value from the rights and privileges granted to the company using them. They are normally classified as long-term assets. Companies write off (amortize) limited-life intangible assets over their useful lives, and they periodically assess indefinite-life intangibles (including goodwill) for impairment.

intangible assets

They include patents, copyrights, franchises, goodwill, trademarks, trade names, and customer lists.

intangible assets

lack physical substance and are not financial instruments (for the definition of a financial instrument).

intangible assets

represent significant economic resources, yet financial analysts often ignore them, because valuation is difficult.

intangible assets

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.

liabilities

Similar to assets, companies classify ___ as current or long-term.

liabilities

An indicator of the speed to which an asset will be realized or otherwise converted into cash or until a liability has to be paid. In general, the greater a company's liquidity, the lower its risk of failure.

liquidity

That is, it is the liquidity buffer available to meet the financial demands of the operating cycle.

working capital

Creditors are interested in short-term ___ ratios, such as the ratio of cash (or near cash) to short-term liabilities. These ratios indicate whether a company, like Amazon.com, will have the resources to pay its current and maturing obligations.

liquidity

Current assets are presented in the balance sheet in order of _

liquidity

Similarly, stockholders assess ____ to evaluate the possibility of future cash dividends or the buyback of shares. In general, the greater Amazon's ____, the lower its risk of failure. (same)

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.

liquidity

Analysts also use information (rates of return and capital structure) in the balance sheet to assess a company's risk and future cash flows. In this regard, analysts use the balance sheet to assess a company's ___, ____, and ____

liquidity, solvency, and financial flexibility

For receivables arising from unusual transactions (such as sale of property, or a loan to affiliates or employees), companies should separately classify these as ____, unless collection is expected within one year.

long term

Companies expect to hold ___ for many years. They usually present them on the balance sheet just below "Current assets," in a separate section called "Investments."

long term investments

Investments that companies expect to hold for many years. Examples are (1) investments in securities, such as bonds or common stock; (2) investments in tangible fixed assets not currently used in operations, such as land held for speculation; (3) investments set aside in special funds, such as a pension fund; and (4) investments in nonconsolidated subsidiaries. Companies usually present long-term investments on the balance sheet just below current assets.

long term investments

Realize that many securities classified as ____ are, in fact, readily marketable. But a company does not include them as current assets unless it intends to convert them to cash in the short-term—that is, within a year or in the operating cycle, whichever is longer.

long term investments

often referred to simply as investments

long term investments

Examples are bonds payable, notes payable, deferred income tax amounts, lease obligations, and pension obligations.

long term liabilities

Obligations that a company expects to pay at some date beyond the normal operating cycle.

long term liabilities

Generally, the greater an enterprise's financial flexibility, the __ its risk of failure.

lower

As a result, the information provided in the balance sheet is often criticized for not reporting a more relevant fair value. For example, Georgia-Pacific owns timber and other assets that may appreciate in value after purchase. Yet, Georgia-Pacific reports any increase only if and when it sells the assets.

most assets and liabilities are reported at historical cost

__ are those not meeting the definition of current assets. They include a variety of items, as we discuss in the following sections

noncurrent

A company discloses the basis it uses to value property, plant, and equipment; any liens against the properties; and accumulated depreciation—usually in the ____ to the financial statements.

notes

The cycle operates from cash through inventory, production, receivables, and back to cash.

operating cycle

_ is the average time between when a company acquires materials and supplies and when it receives cash for sales of the product (for which it acquired the materials and supplies).

operating cycle

When several __s occur within one year (which is generally the case for service companies), a company uses the one-year period. If the operating cycle is more than one year, a company uses the longer period.

operating cycles

Companies do not report current liabilities in any consistent ____. In general, though, companies most commonly list notes payable, accounts payable, or short-term debt as the first item. Income taxes payable, current maturities of long-term debt, or other current liabilities are commonly listed last.

order

A company should limit this section to include only unusual items sufficiently different from assets included in specific categories.

other assets

Other items that might be included are assets in special funds, deferred income taxes, property held for sale, and restricted cash or securities.

other assets

The items included in the section "___" vary widely in practice. Some include items such as long-term prepaid expenses, prepaid pension cost, and noncurrent receivables.

other assets

Another problem occurs in the current-asset definition when a company consumes ___ during the operating cycle. Conceptually, it seems that a company should place in the current assets section an amount equal to the current depreciation charge on the plant assets, because it will consume them in the next operating cycle. However, this conceptual problem is ignored. This example illustrates that the formal distinction made between some current and noncurrent assets is somewhat arbitrary.

plant assets

A common example is the prepayment for an insurance policy. A company classifies it as a ___ because the payment precedes the receipt of the benefit of coverage.

prepaid expense

Although a current asset is well defined, certain theoretical problems also develop. For example, how is including __ in the current assets section justified? The rationale is that if a company did not pay these items in advance, it would instead need to use other current assets during the operating cycle. If we follow this logic to its ultimate conclusion, however, any asset previously purchased saves the use of current assets during the operating cycle and would be considered current.

prepaid expenses

Other common ___ include prepaid rent, advertising, taxes, and office or operating supplies.

prepaid expenses

are tangible long-lived assets used in the regular operations of the business. These assets consist of physical property such as land, buildings, machinery, furniture, tools, and wasting resources (timberland, minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., timberlands or oil reserves) these assets.

property plant and equipment

A company should clearly identify any expected loss due to uncollectibles, the amount and nature of any nontrade receivables, and any receivables used as collateral.

receivables

CL: A company should fully describe in the notes any information about a ___ liability—for example, stock held as collateral on notes payable—to identify the assets providing the security.

secured

The excess of total current assets over total current liabilities;

working capital

Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences.

trading

A company reports prepaid expenses at the amount of the ___ or unconsumed cost.

unexpired

Companies seldom disclose on the balance sheet an amount for ___. But bankers and other creditors compute it as an indicator of the short-run liquidity of a company.

working capital