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Chapter 1 - Overview of Corporate Financial Accounting Define financial accounting and understand its relationship to economic decision- making=/ Identify the main users of financial accounting information and explain how they use this information. Describe the major forms of business organization a...

Description

Chapter 1 - Overview of Corporate Financial Accounting -

Define financial accounting and understand its relationship to economic decisionmaking=/ Identify the main users of financial accounting information and explain how they use this information. Describe the major forms of business organization and explain the key distinctions between them. Explain the three categories of business activities and identify examples of transactions related to each category. Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements.

What is Financial accounting? -

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Financial accounting: the process by which information on the transactions of an organization is captured, analyzed, and used to report to decision makers outside of the organization’s management team. MD&A: Management’s Discussion and Analysis

Users of Financial Statement Information Internal Users: - Management External Users - Shareholders, the board of directors, and potential investors - Creditors (ex: banks and suppliers) - Regulators (ex: stock exhange) - Taxing Authorities (ex: Canada Revenue Agency) - Other corporations, including competitors - Securities (stock) analysts - Credit-rating agencies - Labour unions - Journalists Forms of Business Organization Distinguishing Feature

Corporation

Proprietorship

Partnership

Number of owners

Single or multiple owners

Single owner

Multiple owners

Separate legal entity

Yes - personal assets of owner are not at

No - personal assets of owner are at risk in

No - partner’s personal assets are

Owner(s) responsible for debts of the business, taxed

risk in the event of legal action against company

the event of legal action

at risk in the event of legal action

Yes, taxed separately

No, profits taxed in hands of owners

No, profits taxed in hands of owners

Activities of a Business 1. Financing activities: A company’s activities that involve raising funds to support the other activities of the company or represent a return of these funds. The two major ways to raise funds are to issue new shares or borrow money. Funds can be returned via debt ]’repayment, dividend payments, or the repurchase of shares. 2. Investing activities: Company activities involving long-term investments. Primarily investments in property, plant, and equipment, and in shares of the other companies. 3. Operating activities: The activities of a company that are related to selling goods and services to customers, and other basic day-to-day activities related to operating the business.

Typical Financing Activities

Typical Investing Activities

Typical Operating Activities

Inflows: Borrowing money Issuing shares Outflows: Repaying loan principal Paying dividends

Inflows: Proceeds from the sale of property, plant, and equipment Proceeds from the sale of shares of other companies Outlfows: Purchase of property, plant, and equipment Purchase of shares of other companies

Inflows: Sales to customers Collections of amounts owed by customers Outflows: Purchase of inventory Payments of amounts owed to suppliers Payments of expenses such as wages, rent and interest Payments of taxes owed to government

Financial Reporting Components of the Financial Statements Statement of income Statement of changes in equity Statement of financial position Statement of cash flows Notes to the financial statements

Statement of Income -

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Statement of income: Financial statement showing company’s revenues and expenses, indicating the operating performance over a period of time. Objective - to measure the company’s performance by the results of its operating activities, for a month, quarter or a year Profit is the expenses subtracted from the income. Profit is also known as net income, net earnings and earnings. Consolidated financial statements: Financial statements that represent the combined financial results of a parent company and its subsidiaries. Companies are required to provide comparative information (the results of both the current period and the preceding period) so that users can assess the changes from the previous period. Fiscal year: the one-year period that represents a company’s operating year. Gross profit (gross margin): sales revenue minus cost of goods sold Earnings per share (EPS): A ratio calculated by dividing the earnings for the period by the average number of shares outstanding (owned by shareholders of the company) during the period. Earning per share disclosure is at the bottom of the statement of income. This is useful to a shareholder since, they can determine his or her share of the earnings or loss during the period.

Common Statement of Income Items Sales revenues: The total amount of sales of goods and/or services for the period Other income: Various types of revenue or income to the company other than sales, including interest or rental income. Cost of goods sold (COGS): The cost of the inventory that was sold during the period Selling, general and administrative expense: The total amount of the other expenses (such as salaries and rent) during the period that do not fit into any other category. Depreciation expense (Amortization expense): The allocation of part of the cost of long-lived items such as equipment or patent. Interest expense: The amount of interest incurred on the company’s debt during the period. Income tax expense (provision for taxes): The taxes levied on the company’s profits during the period. The difference between amortization and depreciation: The key difference between amortization and depreciation is that amortization charges off the cost of an intangible asset, while depreciation does so for a tangible asset.

Another difference between the two concepts is that amortization is almost always conducted on a straight-line basis, so that the same amount of amortization is charged to expense in every reporting period. Conversely, it is more common for depreciation expense to be recognized on an accelerated basis, so that more depreciation is recognized during earlier reporting periods than later reporting periods. Yet another difference between amortization and depreciation is that the calculation of amortization does not usually incorporate any salvage value, since an intangible asset is not typically considered to have any resale value once its useful life has expired. Conversely, a tangible asset may have some salvage value, so this amount is more likely to be included in a depreciation calculation.

Statement of Changes in Equity -

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Statement of Changes in Equity: Financial statement that measures the changes in equity in the company over a period of time, differentiating between changes that result from transactions with shareholders and those resulting from the company’s operations. Objective - to illustrate the changes to a number of different components of equity. Equity: The net assets of a company's (assets less liabilities), representing the interest of shareholders in the company. It is the sum of a company’s share capital and retained earnings. Share capital: The shares issued by a company to its owners. Shares represent the ownership interest in the company. Common shares: Certificates that represent portions of ownership in a corporation. These shares usually carry a right to vote. Preferred shares: An ownership right in which the shareholder has some preference over common shareholders as to dividends; that is, if dividends are declared, the preferred shareholders receive them first. Other rights that are normally held by common shareholder may also be changed in preferred shares; for example, most preferred shares are non-voting. Issued shares: The shares of a corporation that have been issued. Initial Public Offering (IPO): The initial offering of a corporation’s shares to the public. Capital assets: Long-lived assets that are normally used by a company in generating revenues and providing services (such as buildings and equipment). This statement will explain changes to each class of shares issued by the company if the company issued additional shares during the year or repurchased and cancelled others. This statement also explains the changes in the company’s retained earnings during the year, which will be equal to the net income for the period less any dividends declared during the period; that is , the amount of earnings that have been retained rather than distributed.

Retained Earnings = Opening Retained Earnings +Net Income -Dividends Declared______ Ending Retained Earnings

Common Shareholder’s Equity Components Share capital: Represents the shares issued, by the company, usually stated at an amount equal to what the company received from investors on the initial issuance of the shares. There can be different types of shares (common shares and preferred shares). There can also be different classes of shares; in other words, shares that have different rights and privileges. Retained earnings: The company’s earnings (as measured on the statement of income) that have been kept (retained) and not paid out as dividends.

Statement of Financial Position -

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Statement of Financial Position (balance sheet): Financial statement that indicates the resources controlled by a company (assets) and the claims on those resources (by creditors and investors) at a given point in time. In the transition from one accounting period to the next, the ending balances of one accounting period become the beginning balances of the next accounting period. The format of this statement of financial position is known as a classified statement of financial position and is typical of most Canadian statements of financial position, which present information in order of liquidity. Liquidity: An organization’s ability to convert its assets into cash to be able to meet its obligations and pay its liabilities. Working capital: A common measure of liquidity. It is the difference between a company’s current assets (assets that can be converted to cash within 12 months) and its current liabilities (liabilities that can be settled within the next 12 months). Working Capital

Working Capital = Current Assets - Current Liabilities

The Accounting Equation Assets = Liabilities + Shareholders’ Equity

Assets Characteristic of an Asset 1. It is a resource controlled by an entity. 2. The company expects future economic benefits from the use or sale of the resource. 3. The event that gave the company control of the resource has already happened.

Common Assets Cash: The amount of currency that the company has, including amounts in bank accounts. Short-term investments: Short-term investments in shares of other companies. Accounts receivable: Amounts owed to the company by its customers as a result of credit sales. Inventory: Goods held for resale to customers. Prepaid expenses and deposits Property, plant and equipment (PPE) Intangible assets: Licenses, patents, trademarks, copyrights, computer software and other assets that lack physical form. Goodwill Liabilities Characteristics of a Liability 1. It is a present obligation of the entity. 2. The company expects to settle it through an outflow of resources that represent future economic benefits. 3. The obligation results from an event that had already happened.

Common Liabilities Bank Indebtedness: Amounts owed to the bank on short-term credit. Accounts payable (Trade payables): Amounts owed to suppliers from the purchase of goods on credit. Deferred revenue (Unearned revenue): Amounts owed to customers for advance payments until the related goods or services have been provided.

Dividends payable: Amount owed to shareholders for dividends that have been declared by the board of directors. Accrued liabilities: Amounts owed related to expenses that are not yet due, such as interest and warranty expense. Incomes taxes payable: Amount owed to taxing authorities. Notes payable: Amount owed to a creditor (bank or supplier) that are represented by a formal agreement called a note (sometimes called a promissory note). Notes payable often have an interest component, whereas accounts payable usually do not. Long-term debt: Amounts owed to creditors due beyond one year. Deferred income taxes: Amounts representing probable future taxes the company will have to pay. Shareholders’ Equity -

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Shareholders’ equity: The shareholders’ claim on total assets, represented by the investment of the shareholders (share capital) and undistributed earnings (retained earnings) generated by the company. Is the amount of assets that would remain after all the company’s liabilities were settled. Market value differs from book value of shareholders’ equity because it reflects the market’s expectations of future earnings and events. The higher the proportion of debt to equity, the greater the financial risk facing the company.

Statement of Cash Flows -

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Statement of Cash Flows: Financial statement that summarizes the cash flows of a company during the accounting period, categorized into operating, investing, and financing activities. Objective - to enable financial statement users to assess the company’s inflows and outflows of cash related to each of these activities, so they can see where the company’s cash came from and how it was used.

Subsections of the Statement of Cash Flows Cash flow from operating activities Cash flow from financing activities Cash flow from investing activities

Chapter 2 - Analyzing Transactions and Their Effects on Financial Statements

Net Income Sales Revenue Net Income Returnon Equity= AverageTotal Shareholder ' s Equity Net Income Returnon Assets= Average Total Assets Net Profit Margin=

What are the limitations of the accounting equation template approach? - One of the main limitations of the template method is the number of columns that can be included within the template. - Another significant limitation of the template method is the lack of specific revenue, expense, and dividends declared accounts.

Chapter 3 - Double-Entry Accounting and the Accounting Cycle Double Entry Accounting -

Double-entry accounting system: an accounting system that maintains the equality of the basic accounting equation by requiring that each entry have equal amounts of debits and credits.

Normal Balance -

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Normal balance: The balance (debit or credit) that an account is normally expected to have. Assets, expenses and losses normally have debit balances. Liabilities, shareholders’ equity, revenues and gains normally have credit balances. It is also used to indicate how the account is increased in a journal entry. The opposite of an account’s normal balance balance is used to record a decrease to the account. Revenue accounts have a credit balance. Expense accounts have a debit balance. Dividends Declared account normally has a debit balance.

Accounting Cycle

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General journal: A chronological listing of all the events that are recorded in a company’s accounting system. General ledger: The financial records containing details on a company’s asset, liability, and shareholder’s equity, revenue, and expense accounts. Trial balance: A listing of all general ledger accounts and their balances. Used to check whether the total of the debit. Used to check whether the total of the debit balances is equal to the total of the credit balances.

Chart of Accounts -

Chart of accounts: A listing of the names of the accounts used in a particular accounting system. Establishing the chart of accounts is the starting point for a company’s initial accounting cycle.

Opening Balances -

Ending balances for one period become the opening balances of the next accounting cycle. Permanent accounts: Accounts whose balances carry over from one period to the next. All statement of financial position accounts are permanent accounts. Temporary accounts: Accounts used to keep track of information temporarily during each accounting period. The balances in these accounts are eventually transferred to a permanent account at the end of the period by making closing entries.

Adjusting Entries

Chapter 4 - Revenue Recognition and the Statement of Income Learning Objective -

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Explain the nature of revenue and why revenue is of significance to users. Identify and explain the general criteria for revenue recognition and the specific revenue recognition criteria related to the sale of goods, the provision of services, and the receipt of interest, royalties, and dividends. Explain how revenues are measured. Understand the difference between a single-step statement of income and a multistep statement of income. Understand the difference between comprehensive income and net income. Understand the difference between the presenting of expenses by function or by nature of the item on the statement of income. Calculate and interpret a company’s basic earnings per share.

What is revenue and why is it significant to users?

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Revenue: Inflow of resources to a company that result from the sale of goods or services. Also defined as the inflow of economic benefits from a company’s ordinary activities. There does not a receipt of cash in order for a company to recognize revenue. This is why the term economic benefit is used when defining revenue. While the economic benefit will ultimately be the inflow of cash, the sale and the receipt does not have to occur at the same time. When assessing revenues, financial statement users evaluate both quantity and quality. Quantity refers to the amount of revenues and whether or not the trend shows an increase or decrease over a number of accounting periods. Quality refers to the sources of revenue and the company’s ability to sustain the revenue over the longer term.

Revenue Recognition When are revenue recognized? 1. 2. -

Revenues are recognized when they have been earned. Two general revenue recognition criteria state that revenue is earned when: It is probable that economic benefits will flow to the company. The amount of these benefits can be reliably measured. Sales transactions where professional judgement is required, specific revenue recognition criteria is used as reference. - Specific revenue recognition criteria for three common categories of revenue-generating activities: 1. The sale of goods 2. The provision of services 3. The receipt of interest, royalties, and dividends

Criteria

Sales of Goods

Provision of Services

Receipt of Interest, Royalties, and Dividends

1) The significant risks and rewards of ownership of the goods have been transferred to the buyer.

Yes

Not applicable

Not applicable

2) The seller has no continuing involvement or control over goods.

Yes

Not applicable

Not applicable

3) The amount of the revenue can be reliably measured.

Yes

Yes

Yes

4) It is probable that the economic benefits from the transaction will flow to the seller.

Yes

Yes

Yes,

5) The costs incurred or that will be incurred to complete the transaction can be readily measured.

Yes

Yes

Not applicable

6) The portion of the total services completed can be reliably measured (if services are ongoing).

Not ap...