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Chapter 1: Financial Statements and Business Decisions

The Four Basic Financial Statements: An Overview


Statement of financial position, statement of comprehensive income, statement of changes
in equity, statement of cash flow
Inform investors, creditors, external decision makers
Summarize financial activities of the business
Prepared at any point in time; quarterly (quarterly reports), yearly (annual reports)
The Statement of Financial Position
Reports financial position (assets, liabilities, shareholders equity)
Structure; heading: name, title of financial statement, date of statement, unit of measure
Accounting entity: organization for which financial data is collected and reported
First lists assets, then liabilities followed by shareholders equity
Assets = liabilities + shareholders equity
Financial position: economic resources that the company owns and the financing for those
resources
Assets: economic resources controlled by the entity as a result of past business events from
which future economic benefits can be obtained; cash, land, plant and equipment,
prepayments (future economic benefits), inventories, trade receivables (sells on credit),
investments, intangible assets, other assets
Liabilities: entitys legal obligations that result from past business events; purchases, cash
borrowings
o Trade payables (from purchase on credit, no note), short-term borrowings, income taxes
payable (due to tax authorities from profits), accrued liabilities (amounts owed for
services; rent, utilities), long-term borrowings (cash borrowings on written contracts;
provisions are estimated amounts payable in future), other liabilities
Shareholders equity: financing provided by owners; share capital (investment of cash or
assets), retained earnings (amount of earnings reinvested into business), other components
(reflect changes in assets, liabilities)
Assets listed in order of liquidity, liabilities in order of maturity
The Statement of Comprehensive Income
Reports change in shareholders equity during a period, from business activities other than
investments by owners (issuance of shares) or distribution to shareholders (dividends)
2 parts: primary measure of companys performance (revenues expenses = profit), and
comprehensive income (income and expense not in income statement)
Can present in one statement or two: income statement, and statement of comprehensive
income
Revenue: sale of goods and services (when sold to customers whether they paid or not);
sales revenue (from sales), other income (from investments, selling property, plant and
equipment)
Expenses: monetary value of resources used up or consumed; cost of sales (cost to produce
products sold), depreciation, distribution expenses, distribution expenses (salaries, related to
distribution of products), marketing and administrative expenses, research and development
expenses, other expenses, interest expense, income tax expense
Profit (net income/net earnings): excess of revenues expenses
Profit =/= net cash generated by operations
The Statement of Changes in Equity
Reports the way profit, distribution of profit, other changes to shareholders equity
Beginning retained earnings + profit dividends = ending retained earnings
Includes balance of share capital, retained earnings, other components at beginning, +profit,
-dividends, +/- increase/decrease in share capital, +other comprehensive income, +/-other
changes

Shows the income statement, statement of financial position linked through retained
earnings
The Statement of Cash Flows
Divides cash inflows, outflows divided into three categories: operating, investing, financing
Describes the causes of change in cash reported
Cash flows from operating activities: directly related to earning income
Cash flows from investing activities: related to the acquisition or sale of companys
productive assets
Cash flows from financing activities: related to the financing of company
Relationships among the Four Financial Statements
Profit from income statements increases retained earnings on statement of changes in equity
Ending retained earnings from statement of changes in equity is one of the three
components of shareholders equity on statement of financial position
Change in cash on cash flow statement added to cash balance at beginning equals cash at
the end
Management Uses of Financial Statements
Marketing managers, credit managers use customers financial statements to decide whether
or not to extend credit
Purchasing managers analyze of suppliers to judge whether suppliers can meet demands
Human resource managers, employees union use companys as basis for contract
negotiations, computing employee bonuses
Notes to Financial Statements
Provide information about financial condition of company
3 types: provides descriptions of accounting rules in statements, provides additional detail
about a line on financial statements, provides financial disclosures about items not on
statements
Responsibilities for the Accounting Communication Process
Effective communications means recipient understands what sender intended to convey
Need to know amounts reported fairly represent what is claimed
Decision maker needs to understand measurement rules based on IFRS(International
Financial Reporting Standards)
International Financial Reporting Standards (IFRS)
Foundations from Italian monk, mathematician, Fr. Luca Pacioli; Italian merchants account for
activities as owner-managers of business ventures
After stock market decline, Securities Act, Securities Exchange Act created Securities and
Exchange Commission (SEC) gave it powers for rules of financial statements; in Canada its
provincial: OSC (Ontario Securities Commission)
Current group is Accounting Standards Board (AcSB) of CICA; establish standards for
accounting
International Accounting Standards Board (IASB) independent standard-setting board
Accounting standards important to preparers and readers of statements
IFRS provides guidance to companies to best reflect results of operations
IFRS enhances comparability by limiting number of acceptable accounting methods
Enables external users to assess quality of information
By preparing statements incur economic consequences: changes to selling price of shares,
changes to bonuses received by management and employees, loss of competitive advantage
Management Responsibility and the Demand for Auditing
Management responsible for accuracy of statements; take important steps to assure records
are accurate: develop and maintain internal controls, hire independent auditors to attest to
fairness, form board of directors to oversee integrity of the two safeguards
Accountant may be a CA, CGA, or CMA; granted by professional accounting organizations
In audit: examines statements to ensure represent accurately

Ethics, Reputation, and Legal Liability


Financial statements only useful if fair; need confidence that auditors meet professional
standards of ethics
Accounting organizations adhere to ethics; principles supported by rules govern performance
of audits
Penalties if fail to comply w/ professional rules of conduct, economic effects of damaged
reputation, personal financial penalties
Financial statement fraud is rare due to efforts of accountants; frauds identified by
accountants
Types of Business Entities
Sole proprietorship: unincorporated business owned by one person; small, common in
service, retailing, farming
o Legally, same entity but for accounting business and owner separate entity
Partnership: unincorporated business owned by two or more people; some large in size,
agreement by partnership contract
o Legally not separate from business, but accounted separately
Corporation: incorporated under Canada Business Corporations Act; owners called
shareholders, represented by number of shares, charter for business, legal entity separate
from owner, limited liability, unlimited liability of board of directors, executives, officers for
their wrongdoing
o Advantages: limited liability, continuity, transfer of ownership, opportunity to raise large
amounts of money
o Disadvantages: loss of control by shareholders, complex reporting, potential for double
taxation
Practice of Public Accounting
Usually two or more organize accounting firm as partnership
Assurance services: independent professional services that improve quality of information for
decision makers: auditing; lend credibility to financial reports, integrity and security of
electronic commerce, reliability of information systems
Management consulting services: accounting based, encompass design and installation of
accounting, data processing, profit planning, control (budget) systems, financial advice,
forecasting, internal controls, cost effectiveness studies, operational analysis
Tax services: income tax services; tax planning as part of decision making, determination of
income tax liability
Employment by Organizations
Profit making, not for profit, and government organizations
General management, general accounting, cost accounting, profit planning, control
(budgeting), internal auditing, computerized data processing
Employment in the Public and Not-For-Profit Sectors
Perform similar functions to those in private organizations

Article 1: IFRS Report Card

IFRS started in 2011; reports transitioned to meet proper balance of informed judgement in
compliance with IFRS
Publicly accountable enterprises (PAE) last to get IFRS down; trying to adapt to new
standards
OSC satisfied with results in 2011 first quarter
Needed large amount of resources to transition to IFRS
Pengrowth followed industrys long-established method of full-cost accounting: costs in
exploration, acquisition, development accumulated in pool of properties subjected to
depletion and impairment; IFRS required more granular capitalization of assets
Banks have reconciled financials since 2011; bank easily see potential for market reaction

Transition plan to prepare statements to speak to stakeholders, analysts in terms of


performance measurement, management
ASPE (Accounting standards for private enterprises) user-friendly; private companies had
choice of ASPE or IFRS
Caters more to users ability to assess liquidity, ability to service debt
ASPE reasonable and cost-friendly; with new ASPE able to quickly look at income statement
Bigger private companies choose ASPE or IFRS?; compete with IFRS competitors
Little in new standards to ensure companies disclose all relevant information

Article 2: The Question of IFRS Adoption: A Very Long Engagement

Best course of action for SEC is to prolong engagement with IFRS


If U.S. commits to IFRS, serious about global regulation, enhance reputation of IFRS for
smaller countries
But may blow momentum, decelerating accounting globalization
U.S. likely to benefit from IFRS, lower cost to participate in U.S. capital markets, attract
international stock exchanges
Unsure whether IFRS improves U.S.s GAAP; Americas GAAP more conservative, unable to
manipulate financials