Week 4 plan

• Balance sheet
• Cash flow statement
• An introduction to revenue
recognition

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Statement of financial position
Theory
• Lists what the company owns, what it owes, and net worth
• Info about capital structure, e.g., liquidity, solvency
• But there are limitations
– Historical cost / mixed-attribute model
– Judgment and estimates in values
– Some items not reported (e.g., fair value of internally generated
intangible assets)

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Statement of financial position
General principle: Fair presentation
– IAS 1.15; ASPE 1521.02
• Classified: Similar items grouped together
– Generally, current and non-current assets, and current and non-
current liabilities
– IAS 1.60; ASPE 1521.03
– Current assets: cash and other assets that will ordinarily be
realized within one year or within the normal operating cycle
– Current liabilities: Obligations due within one year or within
operating cycle
– IAS 1.66, 1.69; ASPE 1510.03

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Statement of financial position
Considerations for separating items:
– Different function (inventory vs. capital assets)
– Different liquidity and flexibility (short vs. long term debt)
– Different measurement basis/inputs
– Monetary assets/financial instruments (you will learn more about
this later)
• Sufficient detail to:
– Assess amounts, timing, and uncertainty of future cash flows
– Evaluate liquidity, solvency, profitability
– Calculate ratios (e.g., current ratio)

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Mandatory items under IAS 1.54
(a) property, plant and equipment;
(b) investment property;
(c) intangible assets;
(d) financial assets (excluding amounts shown under (e), (h) and (i));
(e) investments accounted for using the equity method;
(f) biological assets within the scope of IAS 41 Agriculture;
(g) inventories;
(h) trade and other receivables;
(i) cash and cash equivalents;
(j) the total of assets classified as held for sale and assets included in disposal groups
classified as held for sale in accordance with IFRS 5 Non-current Assets Held for Sale and
Discontinued Operations;
(k) trade and other payables;
(l) provisions;
(m) financial liabilities (excluding amounts shown under (k) and (l));
(n) liabilities and assets for current tax, as defined in IAS 12 Income Taxes;
(o) deferred tax liabilities and deferred tax assets, as defined in IAS 12;
(p) liabilities included in disposal groups classified as held for sale;
(q) non-controlling interests, presented within equity; and
(r) issued capital and reserves attributable to owners of the parent.
- Note: ASPE has similar requirements

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Current assets
Cash and cash equivalents
– Cash, demand deposits, and short-term, highly liquid investments
that are readily convertible into known amounts of cash and have
an insignificant risk of changing in value
– For example, an investment with maturity three months or less
– IAS 7.6-7.7; ASPE 1540.06-1540.08
Short-term investments
– Investments expected to be sold/realized shortly
– Typically carried at amortized cost or fair value
Receivables
– Typically carried at net realizable value

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Current assets: Inventories
Inventories are assets:
– Held for sale in the ordinary course of business
– In the process of production for such sale, or
– Material or supplies to be consumed in production or to render
services
– IAS 2.6; ASPE 3031.07
• Carried at lower of cost and net realizable value (LCNRV)
– IAS 2.9; ASPE 3031.10

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Current assets: Inventories
• Cost formulas permitted:
– First-in, first-out (FIFO)
– Weighted average cost
– Specific identification (when items not ordinarily interchangeable)
– IAS 2.23-25; ASPE 3031.22-24
• Disclose cost formula
– IAS 2.36(a); ASPE 3031.35(a)
• Disclose carrying amounts of stage of inventories’
completion
– Raw materials, work in process, finished goods, etc.
– IAS 2.37; ASPE 3031.36

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Current assets: Prepaid expenses
• Expenses paid before incurred
• Sometimes, people put prepaid expenses as current even
if longer than one year or operating cycle
– Would you care if you were a securities regulator?

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Property, plant, and equipment (PPE)
Definition
– Held for use in business (production/supply of goods/services, for
rental, for admin)
– Expected to be used more than one period
– IAS 16.6; Similar definition under ASPE
• Most PPE depreciable (except land)
• Written down when impaired
• Generally carried at cost or amortized cost
– IFRS allows some PPE to be measured at fair value (Chapter
10/11)

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Intangible assets and goodwill
• Intangible asset: identifiable non-monetary asset without
physical substance
– Identifiable: separable (e.g., can be sold or transferred) or arises
from contractual/legal rights
– Monetary: fixed and determinable in terms of money
– IAS 38.8, 38.11; ASPE 3064.08, 3064.12
• Two categories:
– Finite life (e.g., patent): amortized
– Indefinite life (e.g., trademark): do not amortize
– Test for impairment
• Goodwill: Asset from business combinations
– Not amortized, tested for impairment

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Other non-current assets
• Investments (more in Chapter 9, Intermediate 2, and
advanced financial accounting)
• Deferred tax, assets in special funds, non-current
receivables, etc.
• Present enough information to inform users about nature
of asset

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Current liabilities
• Payables
• Some unearned revenue
• Short-term financing
• Derivative financial instruments

• Working capital: Current assets – current liabilities

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Long-term liabilities
• Financing
– Bonds / notes payable
• Ordinary business
– Deferred tax liabilities
– Lease obligations
– Pensions
– Some unearned revenues
• Specific future events
– Warranties

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Shareholders’ equity
• Capital shares
• Contributed surplus
• Retained earnings (Deficit)
• Accumulated other comprehensive income (AOCI)

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Additional disclosures
• Contingencies (ASPE) and provisions (IFRS)
– Material events with uncertain outcomes
• Accounting policies
– Principles and methods chosen by management
– Information about estimates
• Contractual obligations and commitments
• Subsequent events
• Parenthetical disclosures (on face of statements) or notes
• Cross references, supporting schedules

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Statement of cash flows intuition
• We’re really just reconciling beginning cash balance to
ending cash balance
• Beginning cash balance +/- STUFF = Ending cash
balance
• Beginning cash balance
• +/- Cash flows from operating activities (CFO)
• +/- Cash flows from investing activities (CFI)
• +/- Cash flows from financing activities (CFF)
• = Ending cash balance

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Statement of cash flows (SCF)
• Assess cash flow generation ability and quality of earnings
• Operating activities: Main operations of business
• Investing activities: Long-term assets/investments
• Financing activities: Equity transactions, borrowings

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Indirect method mechanics (roughly)
Net income
+ Non-cash expenses (e.g., depreciation, impairment)
+ Non operating losses (e.g., loss on sale of equipment)
– Non-operating gains
+ Decreases in current asset accounts (e.g., A/R)
– Increases in current asset accounts
+ Increases in current liability accounts (e.g., A/P)
– Decreases in current liability accounts
= Cash flow from operations

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Indirect method mechanics (roughly)
• To figure out whether you should add or subtract
something, or not at all, write out the simplest journal
entries you can think of, and analyze it!
• Depreciation entry:
– Depreciation hits net income but not cash
– DR Depreciation expense (NI); CR Accumulated depreciation
– Need to add depreciation to get from NI to CFO
• Impairment entry:
– DR Impairment expense (NI); CR Accumulated impairment
– Need to add impairment expense to get from NI to CFO

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Indirect method mechanics (roughly)
• Gain on sale of equipment:
– Net equipment on book for 1,000
– Sold for 1,500
– Entry: DR Cash 1,500; CR Equipment 1,000, CR Gain 500
– The DR Cash 1,500 is going to appear in the investing section
directly as “Proceeds from sale of equipment” 1,500
– The Gain goes in NI, so need to subtract it to avoid double
counting!
• In general, subtract non-operating gains and add non-
operating losses
– You are reversing out their effect in NI

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Indirect method mechanics (roughly)
• Accounts receivables
– If your receivables went up, more people owe you money, so you
have less money!
– Entry for increase in A/R: DR A/R, CR Sales (sale on credit)
– The sales part goes into net income, so net income increases but
cash doesn’t
– So subtract the increase in A/R from NI to get CFO
– Entry for decrease in A/R: DR Cash, CR A/R (collection of A/R)
– Cash went up, but NI didn’t
– So add decrease in A/R from NI to get to CFO

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Indirect method mechanics (roughly)
• Inventory
– If your inventory went up, more of your cash is “stuck” in inventory,
so you have less money!
– Entry for increase in inventory: DR inventory, CR cash (cash
purchase of inventory)
– Cash decreases but NI doesn’t
– Subtract the increase in Inventory from NI to get CFO

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Indirect method mechanics (roughly)
• Prepaid expenses
– If you’ve prepaid more expenses, you have less cash!!
– Entry for prepayment of expense: DR Prepaid expense, CR Cash
– Subtract increase in prepaid expenses from NI to get CFO
• Current assets in general
– If a current asset went up, your cash is stuck in the current asset
– Subtract increases in current assets to get from NI to CFO
– Add decreases in current assets to get from NI to CFO

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Indirect method mechanics (roughly)
• Payables
– If your payables increase, it means you owe more money (and so
you have more cash now!)
– Entry for payables increase: DR Expense CR Payable (e.g.,
accrual of salaries)
– NI went down, but cash didn’t
– So add increase in Payable to get from NI to CFO
– Entry for payables decrease: DR Payable CR Cash (e.g., payment
of payables)
– Cash went down, but NI didn’t
– So subtract decrease in Payables to get from NI to CFO

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Indirect method mechanics (roughly)
• Payables
– If your payables increase, it means you owe more money (and so
you have more cash now!)
– Entry for payables increase: DR Expense CR Payable (e.g.,
accrual of salaries)
– NI went down, but cash didn’t
– So add increase in Payable to get from NI to CFO
– Entry for payables decrease: DR Payable CR Cash (e.g., payment
of payables)
– Cash went down, but NI didn’t
– So subtract decrease in Payables to get from NI to CFO
– Be careful: Long-term payables are typically financing activities
– Be careful: Dividends payable are tricky

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Indirect method mechanics (roughly)
• Unearned revenue
– If your unearned revenue goes up, you collected more cash
– Entry for increase in unearned revenue: DR Cash, CR Unearned
revenue
– Cash went up, but NI didn’t
– So add increase in unearned revenue to get from NI to CFO
• Current liabilities in general
– If a current liability went up, you owe more to people
– Add increases in current liabilities to get from NI to CFO
– Subtract decreases in current liabilities to get from NI to CFO

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Statement of cash flows
• Investing activities:
– Directly present cash transactions for long-term assets
– Your “investments” in the business
– Sold equipment? Just write down how much you sold it for!
– Bought land? Just write down how much you bought it for!
• Financing activities
– Directly present cash transactions for long-term liabilities and
equity transactions
– How your business gets funded
– Paid back bonds? Just write down how much money you paid!
– Issued shares? Just write down how much you got for the shares!

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Tip
To figure out items on cash flow statement, write out
accounts and transactions!
• Example: What is depreciation expense?
– Focus on accumulated depreciation account
– Beginning accumulated depreciation + depreciation expense –
accumulated depreciation on PPE sold = ending accumulated
depreciation
– If you know three of them, you can figure out the fourth!

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Tip
To figure out items on cash flow statement, write out
accounts and transactions!
• Example: How much PPE was bought?
– Focus on (gross) PPE account
– Suppose purchases made with cash
– Beginning PPE + cash purchases – sales (at cost) = ending PPE
– So if you know three of them, you can figure out the fourth!

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Tip
To figure out items on cash flow statement, write out
accounts and transactions!
• Example: How much dividends were paid?
– Focus on dividends payable account
– Beginning dividends payable + dividends declared – dividends
paid = ending dividends payable
– Dividends declared: Beginning retained earnings + net income –
dividends ceclared = ending retained earnings

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What about interest and dividends?
• IFRS: interest and dividends, both received and paid, may
be classified in any section (operating, investing,
financing)
– Why?????
– IAS 7.31
• ASPE:
– Interest and dividends received and paid in net income should be
classified as operating
– Dividends and interest paid charged to retained earnings should
be classified as financing
– ASPE 1540.31

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Direct method
• Note: Only cash flows from operations section is different!
• Investing and financing sections are “direct” even in the
“indirect” method
– “Indirect” refers only to CFO
– “Indirectly” converting NI from accrual basis to cash basis
• CFO in direct method is literally all the operating flows:
– Examples are as follows:
– Cash received from customers
– Cash paid to suppliers
– Cash paid for other operating expenses (e.g., salaries, taxes)
– You could go to your Cash GL and start classifying the entries
– Or you could do detective work

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Direct method
• Note: Do NOT start from NI!
Cash received from customers
– Cash paid to suppliers
– Cash paid for other operating expenses (e.g., salaries, taxes)
+/– Cash received from/used in other operating activities
= Cash flows from operations

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