Copyright © 2014 McGraw-Hill Ryerson Limited
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PowerPoint Author:
Robert G. Ducharme, MAcc, CPA, CAUniversity of Waterloo, School of Accounting and Finance
FINANCIALACCOUNTINGFifth Canadian Edition LIBBY, LIBBY, SHORT, KANAAN, GOWING
FINANCIALACCOUNTINGFifth Canadian Edition LIBBY, LIBBY, SHORT, KANAAN, GOWING
Financial Statements and Business Decisions
Chapter 1
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Understanding the Business
The PlayersInvestors Creditors
Managers
The Business
Operations
1. Purchase materialsand labour
2. Manufactureproduct
3. Sell productsto customers
4. Collect cash fromcustomers and pay
creditors
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Business owners (called investors or shareholders) look for two sources of possible gain:
Sellownership
interest in thefuture for more
than they paid.
Receive aportion of thecompany’s
earnings in cash(dividends).
Understanding the Business
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Creditors lend money to a company for a specific length of time and gain by charging interest on the money
loaned.
Mel’sDiner
Loan
Interest
Business Background
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Manufacturers either make the parts needed to produce its products or buy the parts from
suppliers.
Manufacturer Product Customer
Understanding Business Operations
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The Accounting System
Collects and processesfinancial information
Reportsinformationto decision
makers
Managers(internaldecisionmakers)
Investors and
Creditors(externaldecisionmakers)
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External Decision MakersInvestors, creditors,
suppliers, customers, etc.
Internal Decision MakersManagers throughout the
organization
The Accounting System
Accounting System
Financial Accounting ReportsPeriodic financial statements and
related disclosures
Managerial Accounting ReportsDetailed plans and continuous
performance reports
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The Accounting System and Decision Makers
Cash
Equipment
Inventory
Notes Payable
An organized format used by companies to accumulate the dollar effects of
transactions.
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Information Conveyed in Financial Statements
When studying the financial statements you should focus on these questions:
1. What categories of items (often called elements) are reported on each of the four statements? (What type of information does a statement convey, and where can you find it?)
2. What time period (monthly, quarterly, annual) is covered by the financial statements?
3. How are the elements within a statement related? These relationships are usually described by an equation that tells you how the elements fit together.
4. Why is each element important to managers’, owners’ or creditors’ decisions? (How important is the information to decision makers?)
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External Financial Reporting
Financial statements are often referred to as having been prepared using GAAP (Generally Accepted Accounting Principles)
In Canada, GAAP can be either: IFRS: International Financial Reporting Standards (IASB) ASPE: Accounting Standards for Private Enterprise (AcSB)
Companies that trade their securities (debt or equity) in a public market are required to use IFRS
Those companies that do not meet the above criteria, have an option of using either IFRS or ASPE (most will chose ASPE because it is less complex)
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The Four Basic Financial Statements -IFRS
1. STATEMENT OF FINANCIAL POSITION – reports the amount of assets (resources owned), liabilities (amounts owed), and shareholders’ equity of an accounting entity at a point in time.
2. STATEMENT OF COMPREHENSIVE INCOME – reports the revenues less the expenses of the accounting period.
3. STATEMENT OF CHANGES IN EQUITY – reports the way that profit, distribution of profit (dividends), and other changes to shareholders’ equity affected the financial position of the company during the accounting period.
4. STATEMENT OF CASH FLOWS – reports inflows (receipts) and outflows (payments) of cash during the accounting period in the categories of operating, investing, and financing.
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The Four Basic Financial Statements-ASPE
1. BALANCE SHEET– reports the amount of assets (resources owned), liabilities (amounts owed), and shareholders’ equity of an accounting entity at a point in time.
2. STATEMENT OF INCOME – reports the revenues less the expenses of the accounting period AND other gains and losses.
3. STATEMENT OF RETAINED EARNINGS – reports the accumulation of profits that have not been distributed to shareholders, distribution of profit (dividends) of the company during the accounting period.
4. STATEMENT OF CASH FLOWS – reports inflows (receipts) and outflows (payments) of cash during the accounting period in the categories of operating, investing, and financing.
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The Statement of Financial Position
AssetsCashShort-Term InvestmentTrade ReceivablesNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsLandEquipmentBuildingsIntangibles
AssetsCashShort-Term InvestmentTrade ReceivablesNotes ReceivableInventory (to be sold)SuppliesPrepaid ExpensesLong-Term InvestmentsLandEquipmentBuildingsIntangibles
LiabilitiesTrade PayablesAccrued LiabilitiesNotes PayableTaxes PayableDeferred Revenue Bonds Payable
LiabilitiesTrade PayablesAccrued LiabilitiesNotes PayableTaxes PayableDeferred Revenue Bonds Payable
Shareholders’ EquityContributed CapitalRetained Earnings
Shareholders’ EquityContributed CapitalRetained Earnings
Typical Account Titles
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ElementsAssets
Economic resources controlled by the entity as a result of past business events from which future economic benefits may be obtained.
LiabilitiesDebts or legal obligations of the entity that result from past business events.
Shareholders’ EquityAmount of financing provided by owners of the corporation and from earnings over time.
The Statement of Financial Position
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The Statement of Financial PositionThe Accounting Equation
A = L + SE(Assets) (Liabilities) (Shareholders’
Equity)
Economic Resources
Sources of Financing for Economic Resources
Liabilities: From CreditorsShareholders’ Equity: From Shareholders
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ASSETSCash 3,727 Trade receivables 14,047 Inventories 29,149 Prepayments 502 Property, plant, and equipment 42,041 Goodwill 1,061 Other assets 446 Total assets $ 90,973
LIABILITIESTrade payables 25,672 Short-term borrowings 3,646 Provisions 1,687 Long-term borrowings 8,781 Other liabilities 4,151 Total liabilities 43,937 SHAREHOLDERS' EQUITYContributed capital 18,421 Retained earnings 28,681 Other components (66) Total shareholders' equity 47,036 Total liabilities and shareholders' equity $ 90,973
SUN-RYPE PRODUCTS LTD.Statement of Financial Position
(in thousands of Canadian dollars)At December 31, 2012
The Statement of Financial Position
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The Statement of Comprehensive Income
RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
RevenuesSales RevenueFee RevenueInterest RevenueRent Revenue
ExpensesCost of SalesWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
ExpensesCost of SalesWages ExpenseRent ExpenseInterest ExpenseDepreciation ExpenseAdvertising ExpenseInsurance ExpenseRepair ExpenseIncome Tax Expense
Typical Account Titles
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Statement of Comprehensive Income
Revenues Net sales $ 152,795Expenses Cost of sales 125,474 Sales and marketing 11,699 Distribution 6,813 General and administrative 5,987 Finance costs 708 Total expenses 150,681 Earnings before income taxes 2,114 Income tax expense 847 Net earnings for the year $ 1,267Other comprehensive income (loss) Foreign currency translation differences (13) Total comprehensive income (loss) for the year $ 1,254
Earnings per share $ 2.92
SUN-RYPE PRODUCTS LTD.Statement of Comprehensive Income
(in thousands of Canadian dollars, except for EPS)For the Year Ended December 31, 2012
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June 2015
Cash from salecollected on June 10.X
May 2015
$1,000 sale madeon May 25.
X
RevenuesEarnings from the sale of goods or services.
Statement of Comprehensive Income
Revenue is recognized in the period in whichgoods and services are sold, not necessarily
the period in which cash is received.
When will the revenue from this transaction be recognized?
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May 2015
$1,000 revenuerecognized in May
June 2015
Statement of Comprehensive Income
When will the revenue from this transaction be recognized?
Earnings from the sale of goods or services.
Revenue is recognized in the period in whichgoods and services are sold, not necessarily
the period in which cash is received.
Revenues
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May 2015 June 2015
Paid $75 cash on May 11 for newspaper ad.
X
Ad appearson June 8.
X
ExpensesThe dollar amount of resources used up by the entity
to earn revenues during a period.
Statement of Comprehensive Income
An expense is recognized in the period in whichgoods and services are used, not necessarily
the period in which cash is paid.
When will the expense for this transaction be recognized?
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May 2015 June 2015
Advertising expenserecognized in June.
Statement of Comprehensive Income
The dollar amount of resources used up by the entity to earn revenues during a period.
An expense is recognized in the period in whichgoods and services are used, not necessarily
the period in which cash is paid.
When will the expense for this transaction be recognized?
Expenses
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Statement of Changes in Equity
Equity, beginning of the periodPlus: Net earnings for the yearPlus: Other comprehensive incomeLess: DividendsPlus/Less: Other changes, netEquity, end of the period
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Statement of Changes in Equity
Contributed Retained OtherCapital Earnings Components
Balance as at Jan. 1, 2012 $ 18,518 $ 27,914 ($ 53) Net earnings for the year 1,267 Other comprehensive income (loss) (13) Repurchase and cancellation of shares (97) Distribution of dividends (500) Balance as at Dec. 1, 2012 $ 18,421 $ 28,681 ($ 66)
SUN-RYPE PRODUCTS LTD.Statement of Changes in Equity
(in thousands of Canadian dollars)For the Year Ended December 31, 2012
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Because revenues reported do not always equal
cash collected. . .
. . . and expensesreported do not
always equalcash paid . . .
Net earnings areusually not equal
to the changein cash forthe period.
Statement of Cash Flows
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Statement of Cash Flows
Operating activities Cash collected from customers 152,181 Cash paid to trade suppliers (111,202) Cash paid for operating expenses (23,907) Cash paid for interest (826) Cash received for taxes (income tax refund) 1,690 Net cash flow from operating activities 17,936 Investing Activities Cash paid to purchase property, plant, and equipment (1,418) Net cash flow used for investing activities (1,418) Financing Activities Cash received from borrowings 1,502 Repayment of borrowings (14,264) Repurchase of own shares (97) Cash paid for dividends (500) Net cash provided by financing activities (13,359) Net increase in cash during the year 3,159 Cash at beginning of year 571 Effect of exchange rate changes on cash (3) Cash at end of year 3,727$
SUN-RYPE PRODUCTS LTD.Statement of Cash Flows
(in thousands of Canadian dollars)For the Year Ended December 31, 2012
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Relationships Among the Statements
1. Net earnings from the income statement results in an increase in ending retained earnings on the statement of changes in equity.
Income Statement
Revenues $ 152,795 Statement of Changes in Equity Expenses 151,518 Beginning retained earnings $ 27,914 Net earnings $ 1,267 Net earnings 1,267 Dividends (500) Ending retained earnings $ 28,681
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Relationships Among the Statements
2. Ending retained earnings from the statement of changes in equity is one of the three components of shareholders’ equity on the statement of financial position.
Statement of Changes in Equity Statement of Financial PositionRetained Earnings Cash $ 3,727
Beginning retained earnings $ 27,914 Other assets 87,246 Net earnings 1,267 Total assets $ 90,973 Dividends (500) Liabilities $ 43,937 Ending retained earnings $ 28,681 Contributed capital 18,421 Retained earnings 28,681 Other equity components (66)
Total liabilities and equity $ 90,973
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Relationships Among the Statements
3. The change in cash on the statement of cash flows is added to the beginning-of-year balance in cash to arrive at end-of-year cash on the statement of financial position.
Statement of Cash Flows Statement of Financial Position Cash flows from operating activities $ 17,933 Cash $ 3,727 Cash flows from investing activities (1,418) Other assets 87,246 Cash flows from financing activities (13,359) Total assets $ 90,973 Change in cash $ 3,156 Liabilities $ 43,937 Beginning cash balance 571 Contributed capital 18,421 Ending cash balance $ 3,727 Retained earnings 28,681 Other equity components (66)
Total liabilities and equity $ 90,973
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Notes
All financial statements should be accompanied by notes which provide the reader with supplemental
information about the financial condition and results of operations of the company.
Three types . . .Describe accounting rules applied.Present additional detail about an item on the
financial statements.Provide additional information about an item not on
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Marketing managers and credit managers use customers’ financial statements to decide
whether to extend credit.
Purchasing managers use suppliers’ financial statements to decide whether suppliers have the
resources to meet the demand for products.
Employees’ union and human resource managers use the company’s financial
statements as a basis for contract negotiations over pay rates.
Management Uses of Financial Statements
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Decision makers need to understandaccounting measurement rules.
Decision makers need to understandaccounting measurement rules.
Responsibilities for the Accounting Communication Process
Effective communication means that the recipient understands what the
sender intends to convey.
Effective communication means that the recipient understands what the
sender intends to convey.
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Responsibilities for the Accounting Communication Process
International Financial Reporting Standards
(IFRS)
The Rules
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How are IFRS and Generally Accepted Accounting Principles Determined?
Our accounting system has a long and distinguished history. An
Italian monk named Luca Pacioli, published the first elements of
double-entry bookkeeping in 1494.
Prior to 1933, the management teams of most companies were largely free to choose their own
financial reporting practices.
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The Securities and Exchange Commission (SEC)has been given broad powers to determine
measurement rules for financial statements in the U.S.The Ontario Securities Commission (OSC)has been given broad powers to determine
measurement rules for financial statements in Canada.
The Securities and Exchange Commission (SEC)has been given broad powers to determine
measurement rules for financial statements in the U.S.The Ontario Securities Commission (OSC)has been given broad powers to determine
measurement rules for financial statements in Canada.
Securities Act of 1933Securities and Exchange Act of 1934
Securities Act of 1933Securities and Exchange Act of 1934
Generally Accepted Accounting Principles
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Currently, the Accounting Standards Board (AcSB)is recognized as the body to formulate GAAP in Canada.
Currently, the Accounting Standards Board (AcSB)is recognized as the body to formulate GAAP in Canada.
The OSC has worked closely with theaccounting profession to
work out the detailed rules that havebecome known as GAAP.
The OSC has worked closely with theaccounting profession to
work out the detailed rules that havebecome known as GAAP.
Generally Accepted Accounting Principles
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Companies incur the cost of preparing the financial statements and bear the
following economic consequences . . .
Effects on the selling price of shares. Effects on the amount of bonuses
received by managers and other employees. Loss of competitive information to other
companies.
Generally Accepted Accounting Principles
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International PerspectiveInternational Financial Reporting Standards
Since 2002, there has been substantial movement toward the adoption of International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB).
Examples of jurisdictions currently requiring the use of IFRS include:• All countries in the European Union• Australia and New Zealand• Hong Kong, China, India, Malaysia, and South Korea• Israel and Turkey• Argentina, Brazil and Chile• Canada and MexicoIn the United States, the Securities and Exchange Commission (SEC) now allows foreign companies whose shares are traded in the U.S. to use IFRS and is considering allowing the same for domestic companies in the future.
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To ensure the accuracy of the company’sfinancial information, management: Maintains a system of controls. Hires outside independent auditors. Forms a committee of the board of directors to
review these two safeguards.
Management Responsibility and the Demandfor Auditing
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Auditors express an opinion as to the fairness of the financial statements.
Independent auditors have responsibilities that extend to the general public.
The CPAB issues detailed auditing standards that auditors must follow.
Independent Auditors
Overall, I believethese financialstatements are
fairly stated.
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Independent Auditors
An audit involves . . . Examining the financial reports to
ensure compliance with GAAP. Examining the underlying transactions
incorporated into the financial statements.
Expressing an opinion as to the fairness of presentation of financial information.
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Chartered Professional Accountant = CPA(newly amalgamated organization of many provincial CA,
CMA, and CGA organizations effective January 1, 2013)Chartered Accountant = CA
Certified Management Accountant = CMA Certified General Accountant = CGA
Certified Public Accountant = CPA*(* in USA)
Accounting Designations
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Ethics, Reputation, and Legal Liability
The Chartered Professional Accountants of Canada (CPA) and the Canadian Institute of Chartered Accountants (CA) require that all members adhere to a professional code of
ethics. The other accounting professions have similar requirements.
Code of
Ethics
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A CPA’s reputation for honesty and competence is his/her most important asset.
Like physicians, CPAs, CAs, CMAs, and CGAs
have liability for malpractice.
Ethics, Reputation, and Legal Liability
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Appendix 1A: Types of Business Entities
Sole Proprietorship: owned by a single individual.
Partnership: owned by two or more individuals.
Corporation: ownership represented by shares of stock.
Sole Proprietorship: owned by a single individual.
Partnership: owned by two or more individuals.
Corporation: ownership represented by shares of stock.
Advantages of a Corporation
Limited liability
Continuity of life
Ease of transfer of ownership
Opportunity to raise large amounts of money
Disadvantage of a Corporation
Double taxation
Advantages of a Corporation
Limited liability
Continuity of life
Ease of transfer of ownership
Opportunity to raise large amounts of money
Disadvantage of a Corporation
Double taxation
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Appendix 1B: Employment in the Accounting Profession Today
Professional Designations
CPA
CA
CMA
Career Opportunities Public Accounting Audit and Assurance Services Management Consulting Services Tax ServicesEmployment by Organizations Internal accounting External reporting Tax planning Various other functionsEmployment in the Public and Not-for-Profit Sector
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CGA