Chapter 2: A Further Look at Financial Statements
Currents assets Current liabilities
Investments Non-current liabilities
Property, plant, and equipment Shareholders’ equity
Intangible assets Share capital
Goodwill Retained earnings
Current assets: are assets that are expected to be converted into cash (sold or
used up) within one year of the company’s financial statement date or its
operating cycle (whichever is longer).
Operating cycle: the average time it takes to go from cash to cash in
o Can exceed one year depending on the type of business.
Common types of current assets:
o Short-term investments (trading investments)
Investments in debt securities (i.e. bonds of another company)
or equity securities (i.e. shares of another company) that are
held in hopes of generating interest income and/or gains from
profitable resale in the near term.
o Accounts receivable
Amounts owed to the company by customers who purchased
products/services on account.
o Accrued receivables
Amounts owed to the company for interest, sales tax, rent, and
o Notes receivable (including loans receivable)
Amounts owed to the company by customers or others that are
supports by a written promise to repay.
o Merchandise inventory
Goods held for sale to customers.
Can include finished and unfinished goods.
Consumable items like office supplies and cleaning supplies.
o Prepaid expenses
The cost of things like rent and insurance paid in advance of
Current because they are unused benefits available for
use during the year.
North American companies normally list current assets in order of liquidity
while some international companies list current assets in the reverse order. Cash equivalents: very liquid investments in debt securities that can be easily
converted into cash.
Non-current assets: assets not expected to be converted into cash (sold or
used up) by the business within one year of the financial statement date or
its operating cycle.
Common types of non-current assets:
o [Long-term] investments
Multi-year investments in debt securities that
management intends to hold to earn interest.
Equity securities of other companies that management
plans to hold for many years to generate investment
revenue or for strategic reasons.
o Property, plant, and equipment
Tangible assets of a long-lived nature that are being used to
operate the business.
They are listed on the balance sheet in their order of
permanency (i.e. longest life).
Revaluation model: recording these assets at fair value rather
than at cost.
Depreciation: allocating a portion of the cost of these assets to
expense each year of their useful lives (except land which is
assumed to have an indefinite life).
Accumulated depreciation: the amount of depreciation take so
far over the life of the asset it relates to.
Contra asset account: an account that is offset against
(reduces) an asset account on the balance sheet.
Carrying amount (book value): cost – accumulated
o Intangible assets and goodwill
Assets that do not have physical substance and that represent a
privilege or a right granted to, or held by, a company.
I.e. patents, copyrights, franchises etc.
Intangible assets can be grouped into assets with:
o Their cost is allocated over the future periods
and this is called amortization under IFRS.
o Their cost is not allocated over the future
Goodwill = the difference between the price paid for the
acquisition of a company and the fair value of the assets
acquired in the acquisition.
o Other assets
Can include: Non-current receivables
Deferred tax assets
Properties held for sale
Current liabilities: obligations that are to be paid or settled within one year of
the company’s statement date or its operating cycle (whichever is longer).
Common current liabilities:
o Bank indebtedness
A short-term loan from a bank (usually resulting from a credit
o Accounts payable
Amounts owed by the company to suppliers for purchases
made on account.
o Accrued liabilities
Amounts owed by the company for salaries, interest, sales tax,
rent, income tax etc.
o Notes payable (including bank loans payable)
Amounts owed, often to banks but also to suppliers or others,
that are supported by a written promise to repay.
o Current maturities of long-term debt
The portion of a non-current or long-term loan that is
repayable in the current year.
Remainder is classified as a non-current liability.
Non-current (long-term) liabilities: obligations that are expected to be paid
or settled after one year.
Common non-current liabilities:
o Notes payable (including bank loans payable, mortgages payable,
Mortgages payable have property pledged as security for the
o Lease obligations
Amounts to be paid in the future on long-term rental contracts
used for equipment or other property.
o Pension and benefit obligations
Amounts companies owe past and current employees for
o Deferred income tax liabilities
Income tax that is expected to be payable in a later year or
years when a company prepares its future corporate income
Non-current liabilities are generally accompanied by notes to the financial
statements revealing further information about each item (i.e. maturity date).
There is no generally prescribed order for reporting non-current liabilities.
Shareholders’ equity is divided into:
o Share capital If only one class of shares are issued, the name is common
o Retained earnings
The cumulative profits that have been retained for use in a
Ratio analysis expresses the relationships between selected items of financial
Three types of ratios are:
o Liquidity ratios
Measure a company’s short-term ability to pay its maturing
obligations and to meet unexpected needs for cash.
Liquidity: a company’s ability to pay obligations that are
expected to become due within the next year.
Working capital = current assets – current liabilities
o If > 0, a greater likelihood exists that the
company will be able to pay its liabilities.
o If < 0, the company may need to borrow money
to pay short-term creditors.
Current ratio =
o It show how much a company has in current
assets for every $1 in current liabilities.
I.e. 2:1 means $2 in current assets for
every $1 in current liabilities.
o A higher current ratio of company A than
company B does not mean A is better off.
A may have more current assets tied up in
items such as inventory and uncollectable
receivables while B may have more in
o Solvency ratios
Measure a company’s ability to survive over a long period of
Solvency: a company’s ability to pay interest as it comes due
and to repay the face value of debt at maturity.
Insolvent: when a company is unable to pay its debts.
Debt to total assets =
o Measures the percent of assets that are financed
by lenders and other creditors.
I.e. a ratio of 55% means 55 cents of every
dollar that the company invested in assets
came from lenders and other creditors. o Debt is riskier than equity as debt has to be
repaid at specific points in time whereas equity
Free cash flow = income from operating activities –
capital expenditures - dividends
o Profitability ratios
Measure a company’s operating success for a given period of
Earnings per share (EPS) =
o Measures the profit earned on each common
o If no preferred shares have been issued, than he
profit available to common shareholders is the
same as the profit repo