AFA300 Chapter 5: Financial Position & Cash Flows

Chapter 5: Financial Position & Cash Flows

• The chapter covers financial position and cash flows.
• Instructor: Harjot Mehmi
• Email: [email protected]
• Office: YDI 1066 (1 Dundas St W)
• Office Hours: Mondays, 1–3 PM
• Course: AFA300 – Section 011
• Week: 5, Oct. 7, 2024

In-Class Questions

• Solutions to in-class questions (P5.3, P5.6, P5.7, P5.12) posted on D2L.
• Solutions to textbook brief exercises already on D2L.
• Solutions to other textbook questions available during office hours.

Statement of Financial Position (SFP)

• Also known as the balance sheet under ASPE.
• Shows a company's financial condition at a specific date.
• Provides information for users:
  • Calculating rates of return on invested assets (e.g., ROA, ROIC).
  • Evaluating capital structure (e.g., long-term debt to assets ratio).
  • Evaluating liquidity (e.g., current/quick ratio).
  • Evaluating solvency (ability to pay debts).
  • Assessing financial flexibility (responding to unexpected needs).
  • A higher long-term debt to assets ratio indicates higher insolvency risk.

SFP: Classes

• Assets: Present economic resources controlled by an entity.
• Liabilities: Present duty that obligates the entity to transfer an economic resource.
• Equity: Residual interest in the assets after deducting liabilities (net assets).
• SFP generally shows classes in the above order, but IFRS allows reversal.

SFP: Elements

• Assets:
  • Current assets
  • Long-term investments
  • Property, plant, and equipment
  • Intangible assets
  • Other assets
• Liabilities and Equity:
  • Current liabilities
  • Long-term debt
  • Shareholders' equity (capital shares, contributed surplus, retained earnings, accumulated OCI)

Current Assets

• Presented in order of liquidity (e.g., cash, short-term investments, receivables, inventory, prepaid items).
• Realized within 1 year or operating cycle (whichever is longer).
• Operating cycle: Time between acquiring assets and realizing cash (through sales).
• Includes cash, short-term investments, receivables, inventory, and prepaid items.
• Cash and cash equivalents: Cash, demand deposits, short-term, highly liquid investments readily convertible to cash; no significant risk of loss in value.
• Restrictions on cash availability must be disclosed.
• Companies need enough cash to settle current liabilities promptly.
• Excessive cash may result in opportunity cost.

Current Assets - Short-Term Investments

• Investments held for less than 12 months or for trading purposes.
• Valued at cost/amortized cost or fair value.
• Companies with excess cash frequently hold short-term investments.

Current Assets - Receivables

• Reported separately based on origin (ordinary trade accounts, related parties, other unusual items).
• Accrued uncollectible amounts (AFDA, bad debt expense).
• Valued at net realizable value (A/R less AFDA).

Current Assets - Inventories

• Includes items held for sale/in production/for use in service.
• Valued at lower of cost or net realizable value (NRV, selling price less selling costs).
• Cost formulas (FIFO, weighted average, or specific identification) must be disclosed.
• Manufacturers must indicate inventory stages (raw materials, work-in-progress, finished goods).

Current Assets - Prepaid Expenses

• Expenses paid in cash before related benefits are received.
• Benefits within 1 year or operating cycle (whichever is longer).
• Reported at the amount of the unexpired or unconsumed cost.
• Expire over time (e.g., rent, insurance).

Long-Term Investments

• Held for extended periods.
• Presented separately ("Investments") below current assets.
• Includes debt securities, equity securities, and other investments (e.g., sinking funds, land).
• Valued using fair value, amortized cost, or the equity method.

Property, Plant, and Equipment (PPE)

• Physical assets used in ongoing operations to generate income.
• Long-term nature, used over multiple periods.
• Examples: land, buildings, machinery, wasting resources (e.g., minerals, oil properties).
• Reported at cost or amortized cost.
• IFRS allows valuation at fair value.
• PPE is generally depreciable or depletable (e.g., minerals, oil reserves) except land.

Intangible Assets & Goodwill

• Non-physical capital assets with future benefit uncertainty.
• Examples include patents, copyrights, franchises, and trademarks.
• Initially recorded at cost and tested for impairment.
• Categorized as finite (amortized) or indefinite (tested for impairment) life.
• Goodwill represents future benefits from business combinations; not amortized, but tested for impairment.

Other Assets

• Assets not in other categories; usually individually immaterial.
• Listed below intangibles and goodwill.
• Examples include intangible assets, non-current receivables, assets in special funds, land held for speculation, and deferred income tax assets (IFRS applies).

Current Liabilities

• Obligations due within 1 year or operating cycle (whichever is longer).
• Examples include payables, collections received in advance, short-term financing (e.g., bank overdraft).
• Accounts payable normally listed first.

Long-Term Liabilities

• Obligations not expected to be liquidated within the operating cycle.
• Examples include specific financing (e.g., bonds, notes), ordinary operations (e.g., pensions), and future events (e.g., warranties).
• Portion due within the next year reported as current liability.

Shareholders' Equity

• Also known as owners' equity.
• The residual amount or net assets of a company.
• Consists of capital shares, contributed surplus, retained earnings, and accumulated OCI (IFRS only).

Statement of Cash Flows

• Details cash inflows and outflows during a specific period.
• Useful for evaluating a company's capacity to generate cash.
• Shows cash sources, uses, and changes in the cash balance.
• Three sections: operating, investing, and financing activities.

Statement of Cash Flows - Methods of Preparation

• Direct method: Shows cash inflows and outflows from specific transactions.
• Indirect method: Adjusts net income to arrive at net cash flow from operating activities.
• Only operating activities sections differ between the two methods.

Cash Inflows and Outflows (Indirect Method) for Operating Activities

• Calculate net income and adjustments to arrive at cash flow from operating activities.

Statement of Cash Flows - Format

• Shows cash flows from each activity type and the net change in cash.

Ratios

• Current Cash Debt Coverage Ratio: Measures financial liquidity; ratio of net cash from operating activities to average current liabilities.
• Cash Debt Coverage Ratio: Measures financial flexibility; ratio of net cash from operating activities to average total liabilities.
• Higher ratios suggest better ability to repay obligations.

Free Cash Flow

• Calculate as net cash from operating activities less capital expenditures and dividends.
• Indicates discretionary cash flow available for investments, debt reduction, or liquidity enhancement.
• Useful for assessing a company's ability to sustain operations without relying on external financing.

This quiz focuses on Chapter 5 of AFA300, covering the financial position and cash flows crucial for assessing a company's financial health. Key concepts include the statement of financial position, liquidity evaluation, and capital structure analysis. Utilize this review to enhance your understanding of financial statements and their implications.