Question

Why should a financial statement reader care about whether a balance sheet is correctly classified?

Answer 1

A financial reader should care about whether a balance sheet is correctly classified as the balance sheet gives insight into the following factors:

• The company's degree of liquidity: Does the company have enough cash, other liquid assets, or credit to pay its obligations promptly? Does the capital structure match the asset structure?
• The nature of the business: What are its inherent risks? Where is there subjectivity? Are the accounting prinnciples and the methods appropriate, conservative, or aggresive as compared to others in its industry? Are judgements about the selection and method of application of accounting principles based on substance, rather than form?
• The use of historical cost or fair value measurement methods: How great a difference is there between the amounts resulting from the historical cost and fair value methods? To what extent have acquisitions caused a larger portion of the balance sheet to be started at fair value?
• The estimates and assumptions used in the financial statements: Are the estimates and assumptions reasonable and supportable? Are they determined consistently? Do reserves based on management estimates represent a significant porion of liability or asset valuations?
• The possibility of impairment: Are the company's policies for evaluating impairment reasonable? Do any economic, performance, or industry trends raise questions regarding the ability to recover assets at their recorded amounts?