Problem Solving Survival Guide to accompany Intermediate Accounting, Volume 1: Chapters 1 - 14, 15th Edition

CHAPTER 5

BALANCE SHEET AND STATEMENT OF CASH FLOWS

OVERVIEW

A balance sheet reports on the financial position of an entity at a point in time. A statement of cash flows reports reasons for cash receipts and cash payments during the period. In this chapter, we discuss the classifications of a balance sheet and a statement of cash flows along with related disclosure issues. It is extremely important that items are properly classified. Errors in classification will result in incorrect ratio analyses which can lead to misinterpretations of the meaning of the information conveyed. This can affect the decisions that are being made based on that information.

SUMMARY OF LEARNING OBJECTIVES

1. Explain the uses and limitations of a balance sheet. The balance sheet provides information about the nature and amounts of investments in a company's resources, obligations to creditors, and the owners' equity in resources. The balance sheet contributes to financial reporting by providing a basis for: (1) computing rates of return, (2) evaluating the capital structure of the enterprise, and (3) assessing the liquidity, solvency, and financial flexibility of the enterprise. Three limitations of a balance sheet are as follows: (1) The balance sheet does not reflect fair value because accountants use a historical cost basis in valuing and reporting most assets and liabilities. (2) Companies must use judgments and estimates to determine certain amounts, such as the collectibility of receivables and ...