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Chapter 5

MGT220H5 Chapter Notes - Chapter 5: Petty Cash, Dete, Debt Service Coverage Ratio


Department
Management
Course Code
MGT220H5
Professor
Kathy Falk
Chapter
5

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Chapter 5: financial position and cash flows
Balance Sheet
Assets
Current
Cash
Short Term Investment
a/r
inventory
prepaid exp
Non current
Liabilities
Current
Non current
Shareholders Equity
Assess Earnings Quality
Concern users of fs is company insiders manipulate info to make earnings look better or worse
than they are for strategic reasons – can do this by reducing a for da or reducing inventory
obsolescence
SFP (statement of financial position)  aka balance sheet provides information:
for evaluating the capital structure and for computing rates of return on invested assets, e.g.
Return on Assets and Return on Equity
It is also useful for assessing an enterprise’s:
[ Liquidity (time until asset is converted to cash or liability has to be paid)  certain ratios help
assess overall liquidity (including current ratio, quick or acid test ratio and current cash debt
coverage ratio)
[ Solvency ] (ability to pay debts and related interest)
[ Flexibility ] (ability to respond to unexpected needs and opportunities)
SFP classification
Similar items are grouped together, with sub-total
Items with different characteristics are separated
Individual SFP items should be:
Reported separately, and in
Sufficient detail in order to:
Allow users to assess amounts, timing, and uncertainty of future cash
flows
Allow users to evaluate liquidity, financial flexibility, profitability, and
risk
Helps to calculate important ratios (e.g. current ratio to assess liquidity)
Considerations for reporting items separately
Assets that differ in their type or expected function (e.g. inventory vs. capital
assets)
2. Liabilities with different implications for the entity’s financial flexibility (e.g.
long term debt vs. current debt)
3. Assets and liabilities with different general liquidity characteristics (e.g. cash
vs. receivables)
Economic resources
claims

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Chapter 5: financial position and cash flows
4. Assets, liabilities, and equities with characteristics that allow for easy
measurement or valuation
Leverage ratios: L/A – L/E
Return on assets (ROA) : (earnings before interest and tax (EBIT) / total assets) x net income
ROE: net income / total shareholders equity
Monetary Assets represents either money itself or claims to future cash flows that are fixed and
determinable in amounts and timings
Contingencies: material events that have uncertain outcome
Accounting policies: explanations of valuation methods that are used or basic assumption that
are made for inventory valuations, amortization methods, investments in subsidiaries, etc
Contractual situations explanations of certain restrictions or covenanets that are attached to
specific assets or more likely to liabilities
Additional detail expanded details on specific statement of financial position line items
Subsequent events: events that happened after statement of financial position data were
compiled
SFP Limitations
1Many assets and liabilities are stated at historical cost
Information presented is [ reliable ], however
Less [ relevant ] than reporting at current fair value
2. Subject to judgement and estimates (e.g., A/R, inventory, patent, goodwill)
3. Does not report items that have financial value but cannot be recorded objectively
(e.g.reputation, internally generated goodwill)
Current Assets
Current assets are cash and other assets expected to be realized (i.e., converted into cash):
Within [ one year ] from the balance sheet date or
within the [ normal operating cycle ], whichever is longer
Generally presented in order of liquidity (normally: cash, short-term investments,
receivables, inventory, and prepaid expense)
Cash
Often includes cash and cash equivalents:
Cash, deposits, short-term liquid investments convertible to a known cash amount, and
not subject to material value changes
Any known restrictions to cash must be disclosed
Short-term investment
Investments in debt and equity securities are presented separately from other assets
Valued at cost/amortized cost or fair value
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
Separate disclosure required for:
Amount and nature of nontrade receivables

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Chapter 5: financial position and cash flows
Receivables pledged as collateral
Accounts receivable valued at net realizable value
Accounts receivable valued at net realizable value, i.e. the net amount expected to be
received in cash.  how to measure it? Cost allowance
Current Assets inventories (either held for sale in ordinary course of business, process of
production for such sale, or in form of materials or supplies ot be consumed in production
process or in rendering of service)
Valued at lower of cost and net realizable value (LC&NRV)
NRV of Inventory = selling price – cost to sell
Cost flow assumption method (e.g. FIFO, weighted average, specific item) must be
disclosed
Manufacturing enterprise will disclose completion stage of inventories:
Raw materials: In the form of materials or supplies to be consumed in the
production process or in the rendering of service (e.g., steel)
Work in progress: In the process of production (e.g., car frame)
Finished goods: Held for sale in the ordinary course of business (e.g., car)
Air Canada footnotes on cash and short term investments
Current Assets – Prepaid Expenses
Defined as: expenditures already made for benefits to be received within one year or the
operating cycle (whichever is longer)
Most common examples include:
Insurance
Rent
Advertising
Supplies
Current practice is to report some prepaid amounts where the benefit extends beyond one year
(or operating cycle)
P) CASH AND CASH EQUIVALENTS
Cash and cash equivalents include $186 pertaining to investments with original maturities
of three months or less at December 31, 2013 ($218 as at December 31, 2012).
Investments include bankers’ acceptances and bankers’ discount notes, which may be
liquidated promptly and have original maturities of three months or less.
Q) SHORT-TERM INVESTMENTS
Short-term investments, comprised of bankers’ acceptances and bankers’ discount notes,
have original maturities over three months, but not more than one year.
Noncurrent Investments
Noncurrent investments normally consist of one of the following:
Debt securities
Equity securities
Other investments, e.g., sinking funds
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