CH 05

Intermediate Accounting
Seventeenth Edition
Kieso; Weygandt; Warfield
Chapter 5
Balance Sheet and Statement of

Cash Flows
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Learning Objectives
After studying this chapter, you should be able to:
1. Explain the uses, limitations, and content of the
balance sheet.
2. Prepare a classified balance sheet.
3. Explain the purpose, content, and presentation of the
statement of cash flows.
4. Describe additional types of information provided.
Copyright ©2019 John Wiley & Sons, Inc. 2

Preview of Chapter 5
Balance Sheet and Statement of Cash Flows
Balance Sheet
• Usefulness of the balance sheet
• Limitations of the balance sheet
• Classification in the balance sheet
Preparation of the Balance Sheet

• Account form
• Report form

Preview of Chapter 5
Hey, It Doesn’t Balance!
Statement of Cash Flows
• Purpose of the statement of cash flows
• Content of the statement of cash flows
• Preparation of the statement of cash flows
• Usefulness of the statement of cash flows
Additional Information
• Notes to the financial statements
• Techniques of disclosure
Learning Objective 1
Explain the Uses, Limitations, and Content
of the Balance Sheet

Balance Sheet (1 of 4)
Balance Sheet, sometimes referred to as the statement
of financial position:
1. Reports assets, liabilities, and equity at a specific date.
2. Provides information about resources, obligations to
creditors, and equity in net resources.
3. Helps in predicting amounts, timing, and uncertainty of
future cash flows.
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Usefulness of the Balance Sheet
• Computing rates of return
• Evaluating capital structure
• Assess risk and future cash flows
• Analyze the company’s:
• Liquidity
• Solvency
• Financial flexibility
Limitations of the Balance Sheet
1. Most assets and liabilities are reported at historical

cost
2. Use of judgments and estimates
3. Many items of financial value are omitted

Classification in the Balance Sheet
Elements of The Balance Sheet

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

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

Classification in the Balance Sheet (1 of 2)
Assets Liabilities and Owners' Equity
Current assets Current liabilities
Long-term investments Long-term debt
Property, plant, and equipment Owners' (stockholders') equity
Intangible assets
Other assets
In practice you usually see little departure from these major

subdivisions.

Classification in the Balance Sheet (2 of 2)
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.
Item Basis of Valuation
Cash and cash equivalents Fair value
Short-term investments Generally, fair value
Receivables Estimated amount collectible
Inventories Lower-of-cost-or-net realizable value/market
Prepaid expenses Cost

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Current Assets (1 of 2)
Short-Term Investments (Equity Securities)
All equity securities are recorded at fair value with
changes reported in net income unless:
• Accounted for under equity method or
• Not practicable to determine fair value

Current Assets (2 of 2)
Short-Term Investments (Debt Securities)
Three separate classifications for debt securities:
Held-to-maturity: Company has positive intent and ability
to hold to maturity.
Trading: Bought and held primarily for sale in the near
term to generate income on short-term price differences.
Available-for-sale: Not classified as held-to-maturity or
trading securities.

Current Assets
Receivables
Major categories of receivables should be shown in the
balance sheet or the related notes.
A company should clearly identify
• Anticipated loss due to uncollectibles
• Amount and nature of any nontrade receivables
• Receivables used as collateral

Current Assets
Inventories
Disclose
• Basis of valuation
• Lower-of-cost-or-net realizable value or
• Lower-of-cost-or-market
• Cost flow assumption (e.g., FIFO or LIFO)

Current Assets
Prepaid Expenses
Payment of cash, that is recorded as an asset because
service or benefit will be received in the future.
Cash Payment Before Expense Recorded
Prepayments often occur in regard to:
• insurance • rent
• supplies • taxes
• advertising

Noncurrent Assets
Long-Term Investments
1. Securities (bonds, common stock, or long-term notes).
2. Tangible fixed assets not currently used in operations
(land held for speculation).
3. Special funds (sinking fund, pension fund, plant
expansion fund, or cash surrender value of life
insurance).
4. Nonconsolidated subsidiaries or affiliated companies.

Long-Term Investments (1 of 4)
Usually presented on balance sheet below “Current
assets,” in a separate section called “Investments.”
• Debt investments classified as available-for-sale are
reported at fair value
• Held-to-maturity debt investments are reported at
amortized cost
• Equity investments are reported at fair value or by
using the equity method

Noncurrent Assets
Property, Plant, and Equipment
Tangible, long-lived assets used in the regular operations
of the business.
• Physical property such as land, buildings, machinery,
furniture, tools, and wasting resources (minerals).
• With the exception of land, a company either
depreciates (e.g., buildings) or depletes (e.g., oil
reserves) these assets.

Noncurrent Assets
Intangible Assets
Lack physical substance and are not financial instruments.
• Limited life intangibles amortized
• Indefinite-life intangibles tested for impairment

Noncurrent Assets
Other Assets
Items vary in practice. Can include
• Long-term prepaid • Deferred income taxes

expenses • Property held for sale
• Prepaid pension cost • Restricted cash or
• Noncurrent receivables securities
• Assets in special funds

Liabilities
Classified as current or long-term.
Current Liabilities
Obligations a company reasonably expects to liquidate
either through the use of current assets or the creation of
other current liabilities.

Liabilities
Current Liabilities
1. Payables resulting from the acquisition of goods and
services: accounts payable, wages payable, taxes
payable, and so on.
2. Collections received in advance, such as unearned rent
revenue or unearned subscriptions revenue.
3. Other liabilities, 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.

Liabilities
Long-Term Liabilities
Obligations that a company does not reasonably expect
to liquidate within the normal operating cycle.
Companies classify long-term liabilities that mature
within the current operating cycle as current liabilities if
payment of the obligation requires the use of current
assets.

Long-Term Liabilities (1 of 4)
Three types:
1. Obligations arising from specific financing situations,
such as the issuance of bonds, long-term lease
obligations, and long-term notes payable.
2. Obligations arising from pension obligations and
deferred income tax liabilities.
3. Obligations that depend on the occurrence or non-
occurrence of one or more future events, such as
service or product warranties and other contingencies.

Owners’ Equity
Stockholders' Equity Section
1. Capital Stock. Par or stated value of the shares issued.
2. Additional Paid-in Capital. Excess of amounts paid in
over the par or stated value.
3. Retained Earnings. Corporation's undistributed earnings.
4. Accumulated Other Comprehensive Income. Aggregate
amount of other comprehensive income items.

Owners’ Equity
Stockholders' Equity Section
5. Treasury Stock. Generally, the cost of shares
repurchased.
6. Noncontrolling Interest (Minority Interest). Portion of
the equity of subsidiaries not wholly owned by the
reporting company.

Prepare a Classified Balance Sheet

Preparation of the Balance Sheet
Classified Balance Sheet
• Account form
• Report form
Accounting Trends and Techniques (New York: AICPA)

indicates that all of the 500 companies surveyed use either
the “report form” (484) or the “account form” (16),
sometimes collectively referred to as the “customary form.”

Report Form (1 of 2)
Assets

Report Form (2 of 2)
Liabilities and Equity

Explain the Purpose, Content, and
Preparation of the Statement of Cash Flows

Purpose of the Statement of Cash
Flows
To provide relevant information about the cash receipts
and cash payments of an enterprise during a period.
The statement provides answers to the following
questions:
1. Where did the cash come from?
2. What was the cash used for?
3. What was the change in the cash balance?

Content of the Statement of Cash Flows
Three different activities:
1. Operating activities involve the cash effects of
transactions that enter into the determination of net
income.
2. Investing activities include making and collecting loans
and acquiring and disposing of investments and
property, plant, and equipment.
3. Financing activities involve liability and owners’ equity
items.
Preparation of the Statement of Cash
Flows
Sources of Information
Information obtained from several sources:
1. comparative balance sheets,
2. the current income statement, and
3. selected transaction data.

Preparing the Statement of Cash Flows
Four steps:
1. Determine the net cash provided by (or used in) operating
activities.
2. Determine the net cash provided by (or used in) investing
and financing activities.
3. Determine the change (increase or decrease) in cash
during the period.
4. Reconcile the change in cash with the beginning and the
ending cash balances.

Statement of Cash Flows (1 of 2)
Review Question
In preparing a statement of cash flows, which of the following
transactions would be considered an investing activity?
a. Sale of equipment at book value
b. Sale of merchandise on credit
c. Declaration of a cash dividend
d. Issuance of bonds payable at a discount.

Statement of Cash Flows (2 of 2)
Review Question Answer
In preparing a statement of cash flows, which of the following
transactions would be considered an investing activity?
a. Answer: Sale of equipment at book value
b. Sale of merchandise on credit
c. Declaration of a cash dividend
d. Issuance of bonds payable at a discount.

Significant Noncash Activities
Significant financing and investing activities that do not affect
cash are reported in either a separate schedule at the bottom
of the statement of cash flows or in the notes.
Examples include:
• Issuance of common stock to purchase assets
• Conversion of bonds into common stock
• Issuance of debt to purchase assets
• Exchanges of long-lived assets

Usefulness of the Statement of Cash
Flows (1 of 5)
Without cash, a company will not survive.
Cash flow from Operations:
• High amount – company is able to generate sufficient cash
to pay its bills.
• Low amount - company may have to borrow or issue equity
securities to pay bills.

Flows (2 of 5)
Financial Liquidity
Net Cash Provided by Operating Activities Current Cash

Average Current Liabilities Debt Coverage
Ratio indicates whether the company can pay off its

current liabilities from internally generated cash flows. A
ratio near 1:1 is good.

Flows (3 of 5)
Financial Flexibility
Net Cash Provided by Operating Activities Cash Debt

Average Total Liabilities Coverage
Ratio indicates a company’s ability to repay its liabilities

from net cash provided by operating activities, without
having to liquidate the assets employed in its operations.

Flows (4 of 5)
Free Cash Flow
Net Cash Provided
Capital Free
by Operating   Cash Dividends 
Expenditures Cash Flow
Activities
The amount of discretionary cash flow a company has

that may be used for purchasing additional investments,
retiring its debt, purchasing treasury stock, or simply
adding to its liquidity.

48
Describe Additional Types of Information
Provided

Additional Information
Notes to the Financial Statements
• An integral part of reporting financial statement
information
• Explain in qualitative terms information related to specific
financial statement items
• Provide supplemental data of a quantitative nature to
expand information in financial statements
• Explain restrictions imposed by financial arrangements or
basic contractual agreements
Notes to the Financial Statements (1 of 6)
Accounting Policies
• Specific principles, bases, conventions, rules, and practices
applied in preparing and presenting financial information
• GAAP recommends disclosure for all significant accounting
principles and methods
• For instance, LIFO and FIFO, double-declining-balance and
straight-line, carrying investments at amortized cost, equity,
and fair value
• First footnote generally “Summary of Significant Accounting
Policies”
Contractual Situations
• Disclose in the notes, if significant
• Must clearly state essential provisions of lease contracts,
pension obligations, and stock compensation plans in the
notes
• Must disclose the following commitments if amounts are
material: obligations to maintain working capital, to limit
the payment of dividends, to restrict the use of assets, and
to require the maintenance of certain financial ratios

Contingencies
• Existing situation involving uncertainty as to possible gain
(gain contingency) or loss (loss contingency)
• Are material events with an uncertain future
• Gain contingencies include tax operating–loss carryforwards
or company litigation against another party
• Loss contingencies relate to litigation, environmental issues,
possible tax assessments, or government investigations

Fair Values
• Fair value information may be more useful than
historical cost for certain assets and liabilities
• Financial instruments are defined as cash, an
ownership interest, or a contractual right to receive or
obligation to deliver cash or another financial
instrument
• Cash, investments, accounts receivable, and payables
are examples of financial instruments

Three Levels of Fair Value Hierarchy
• Level 1 measures (least subjective) are based on
observable inputs, such as market prices for identical
assets or liabilities
• Level 2 measures (more subjective) are based on
market-based inputs such as those based on market
prices for similar assets or liabilities
• Level 3 measures (most subjective) are based on
unobservable inputs, such as a company’s own data or
assumptions.

Fair Values
For major groups of assets and liabilities, companies must
make the following fair value disclosures:
1. the fair value measurement and
2. the fair value hierarchy level of the measurements as a
whole, classified by Level 1, 2, or 3.

Techniques of Disclosure (1 of 5)
• Parenthetical Explanations
• Cross-Reference and Contra Items
• Supporting Schedules
• Terminology

Techniques of Disclosure (5 of 5)
Terminology
• Balance sheets should contain descriptions that readers
will generally understand and clearly interpret
• Profession has recommended that
• companies use the word reserve only to describe an
appropriation of retained earnings
• use of the word surplus be discontinued in balance sheet
presentations of stockholders’ equity

Identify the Major Types of Financial Ratios
and What They Measure

Appendix 5A: Ratio Analysis — A
Reference (1 of 4)
Major Types of Ratios
Liquidity Ratios. Measures of the company's short-term ability to
pay its maturing obligations.
Activity Ratios. Measures of how effectively the company uses its
assets.
Profitability Ratios. Measures of the degree of success or failure of
a given company or division for a given period of time.
Coverage Ratios. Measures of the degree of protection for long-
term creditors and investors.

Compare the Accounting Procedure Related
to the Balance Sheet Under GAAP and IFRS

IFRS Insights (1 of 3)
Relevant Facts - Similarities
• Both IFRS and GAAP allow the use of title “balance sheet” or “statement of
financial position.” IFRS recommends but does not require the use of the title
“statement of financial position” rather than balance sheet.
• Both IFRS and GAAP require disclosures about (1) accounting policies
followed, (2) judgments that management has made in the process of
applying the entity’s accounting policies, and (3) the key assumptions and
estimation uncertainty that could result in a material adjustment to the
carrying amounts of assets and liabilities within the next financial year.
Comparative prior period information must be presented and financial
statements must be prepared annually.
• IFRS and GAAP require presentation of non-controlling interests in the equity
section of the balance sheet.

IFRS Insights (2 of 3)
Relevant Facts - Differences
• IFRS requires a classified statement of financial position except in very limited
situations. IFRS follows the same guidelines as this text for distinguishing
between current and noncurrent assets and liabilities. However, under G AAP,
public companies must follow SEC regulations, which require specific line
items.
• Under IFRS, current assets are usually listed in the reverse order of liquidity.
For example, under GAAP cash is listed first, but under IFRS it is listed last.
• IFRS has many differences in terminology. For example in the equity section
common stock is called share capital—ordinary.
• Use of the term “reserve” is discouraged in GAAP, but there is no such
prohibition in IFRS.

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Intermediate Accounting

Kieso; Weygandt; Warfield

Balance Sheet and Statement of

Copyright ©2019 John Wiley & Sons, Inc. 2

Preparation of the Balance Sheet

Copyright ©2019 John Wiley & Sons, Inc. 3

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1. Most assets and liabilities are reported at historical

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Elements of The Balance Sheet

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In practice you usually see little departure from these major

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• Long-term prepaid • Deferred income taxes

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Accounting Trends and Techniques (New York: AICPA)

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Ratio indicates whether the company can pay off its

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Ratio indicates a company’s ability to repay its liabilities

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The amount of discretionary cash flow a company has

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