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BU 127 – Intro to Financial AccountingLecture 1 – Course Introkmamo@wlu - LH3084 Tues 2:30-4:Four Financial Statements (Statement of...) Financial position Comprehensive income Changes in equity Changes in cash flow Midterm 1 – chapters 1-4, Feb 11 9:00-11:30amMidterm 2 – chapter 6-8, March 18 12:00...

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BU 127 – Intro to Financial Accounting

Lecture 1 – Course Intro [email protected] - LH3084 Tues 2:30-4:30

Four Financial Statements (Statement of…) -

Financial position Comprehensive income Changes in equity Changes in cash flow

Midterm 1 – chapters 1-4, Feb 11 9:00-11:30am Midterm 2 – chapter 6-8, March 18 12:00-1:30pm Final – everything in the class, emphasis on material not on midterms Boot camp – check My LS, held before each midterm Research bonus marks: http://wlu-ls.sona-systems.com

Lecture 2 – Chapter 1 Understanding the Business -

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The players: investors, creditors, managers o Investors: make money from dividends and capital appreciation o Creditors: make money from interest payments Business operations: o purchase materials and labour o manufacture products o collect cash from customers and pay creditors o sell products to consumers accounting tries to provide information about the business operations to the players of the business manufacturers and suppliers create products and provide inputs

The Accounting System

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keep track of transactions and operations that the business does organize the information into different types of reports report on different financial statements (4 main types) report the information to decision makers, therefore: o the main purpose is to provide information to make decisions information is provided to managers, investors, and creditors two kinds of accounting: o financial accounting: external information for creditors and investors  periodic financial statements and disclosures o managerial accounting: internal information for management  detailed plans and continuous performance reports

external vs internal transactions: -

external: exchange of money or items with an independent third party internal: exchange or money or items without a third party, only internal

accounts: -

notebook analogy: different courses have different books different transactions are recorded in different accounts (cash, assets, etc.) chart of accounts: keep track of all of the unique accounts of a company

Information Conveyed in Financial Statements -

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Questions to ask: o Categories of elements? o Time period? o How are elements related? o Why is each element important to players? Management uses of financial statements o Marketing and credit managers use customers’’ financial statements to decide credit information o Purchasing managers use suppliers’ statements to make choices about suppliers and their ability to meet demand o Employees’ union and HR managers use company financial statements as a basis for contract negotiations over pay rates

Four Financial Statements -

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Statement of financial position o Reports assets (resources owned), liabilities (amounts owed), and shareholder equity during a period  Assets: cash, short-term investments, inventory, etc.  Liabilities: accounts payable, taxes payable, bonds payable, etc.  Shareholder Equity: contributed capital, retained earnings

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o Elements: must be current, cannot be future or speculative  Assets: economic resources that create future benefits  Listed in order of liquidity (easiest to conv. to cash)  Liabilities: debt that must be paid in the future  Listed in order of urgency (how soon they are paid)  Shareholder Equity: financing provided by owners of the corporation and from earnings over time o The Accounting Equation: A = L + SE  Assets = Liabilities + Shareholder Equity  The resources you have should equal the funds you have received from creditors and investors Statement of comprehensive income (earnings) o Reports the revenues less the expenses of a period  Revenues: sales revenue, interest revenue, etc.  Expenses: cost of sales, wages expense, interest expense, etc. o Elements: Gross Profit = Revenues – Expenses (accounting profit)  Revenues: earnings from the sale of goods/services  Recognized in the period in which the goods/services are sold, not when the cash is received  Expenses: the dollar amount of resources used to earn revenues  Recognized in the period when goods/services are bought, not when cash is paid out Statement of changes in equity o Reports the way that profit, dividends, and other changes to equity affect the financial position during a period  Equity at the beginning of a period  + net earnings + other income – dividends +/- other changes  = equity at the end of a period Statement of cash flows o Reports inflows (receipts) and outflows (payments) of cash in operating, investing, and financing during a period  Operating activities: day to day of a company (ex: retail sales)  Investing activities: buying/selling assets or investments  Financing activities: debt payments in/out, issue shares, etc. o Sum of 3 activities = net change in cash Relationships Among the Statements o Net earnings from the income statement results in an increase in the ending retained earnings on the statement of changes in equity  Net earnings = net earnings o Ending retained earnings from statement of changes in equity is one of the three components of shareholder equity on the statement of financial position  Retained earnings = retained earnings

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o Change in cash on statement of cash flows is added to the statement of financial positions  Ending cash balance = cash Statement Notes and Regulation o All financial statements should be accompanied by notes which provide the reader with more information about the financial condition and results of operations of the company o Three types:  Describe account rules applied  Present addition detail about an item on the statements  Provide additional information about an item not on the financial statement o Responsibilities for the accounting process  Effective communication means that the recipient understands what the sender intends to convey  Decision makers need to understand what financial statements mean  Rules: International Financial Reporting Standards (IFRS)  Securities Act 1933, Securities and Exchange Act 1934  USA: Securities and Exchange Commission (SEC)  CAN: Ontario Securities Commission (OSC)  Bodies given power to enforce reporting standards  Generally Accepted Accounting Principles (GAAP)  Accounting Standards Board (AcSB) form the GAAP o Companies incur the cost of preparing financial statements and bear these economic consequences:  Effects on the selling price of shares  Effects on the number of bonuses received by managers and other employees  Loss of competitive information to other companies Management Responsibility and Demand for Auditing o To ensure accuracy of financial statements, management:  Maintains a system of controls  Hires outside, independent auditors  Forms a committee of the board of directors to review these two safeguards o Independent Auditors  Express an opinion as to the fairness of financial statements  Independent auditors have responsibilities that extend to the general public  The CPAB issues detailed standards that auditors must follow Ethics o The Chartered Professional Accountants of Canada (CPA) require that all accountants adhere to a professional code of ethics

o In the business of selling info – therefore you must be trusted, making ethics important

Lecture 3 – Chapter 2: the statement of financial position (balance sheet) Understanding the Business -

To understand the financial statement, must understand: o What activities cause a change? o How to specific activities affect each balance? o How do companies keep track of each transaction?

Conceptual Framework of the Statement of Financial Position -

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Objective of external financial reporting: o to provide financial information about the reporting entity to players/stakeholders in that business o to provide useful economic information to external users for decision making and for assessing future cash flows Characteristics: o Fundamental (to be useful): relevance, faithful representation  Relevance: makes a difference in a decision, predictive value, feedback value  Faithful representation: complete, neutral, reasonably free from error or bias o Enhancing (degrees of usefulness): comparability, verifiability, timeliness, understandability  Comparability: across companies  Verifiability: similar results under independent measures  Timeliness: information must be available before it loses its usefulness  Understandability: allows reasonably informed users to see the significance of the information Elements to be measured and reported: o Assets, liabilities, shareholders’ equity, investments by owners, distribution to owners  Definitions featured in Chapter 1 notes o Revenues, expenses, gains and losses  Revenues and expenses: from day-to-day operations of a firm  Gains and losses: from one-time transactions of a firm o Comprehensive income Concepts for measuring and reporting information: o Assumptions: separate entity, stable monetary unit, continuity (going concern), periodicity

Separate entity: activities of the business are separate from the activities of owners  Continuity (going concern): the business is assumed to continue to operate into the foreseeable future  Stable monetary unit: accounting measurements will be in the national monetary unit (CAD) without any adjustments for changes in purchasing power (inflation) o Principles: mixed-attribute measurement, revenue recognition, full disclosure, historical cost  Historical cost (mixed-attribute measurement): cash equivalent cost given up is the basis for the initial recording of elements  Value of most assets is recorded as purchase price, not market value (ex: office space, physical capital)  Some financial assets are recorded at market value (ex: stock, loans) o Constraints: cost 

Classified Statement of Financial Position -

“Classified”: Sections and subsections for various elements of the balance sheet Current vs non-current assets/liabilities o Current: expected to be converted into cash (sell or pay) in one year  Assume that inventory is a current asset o Non-current: not expected to be converted into cash in one year

Environmental Disclosures – Environmental Liabilities -

IFRS require Canadian public accountable enterprises to report their best estimate of probable liabilities, including environmental liabilities Essentially – must keep track of environmental damage (externalities)

Nature of Business Transactions / Duality of Effects -

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Most transactions with external parties involve an exchange where business entity gives up something but receives something in return External events: exchanges of assets and liabilities between the business and one or more other parties o Ex: borrowing money from the bank Internal events: not an exchange between the business and other parties, but have a direct effect on the accounting entity o Ex: loss of a building due to fire damage

International Perspective -

IFRS has not mandated a single, consistent formation Canadian vs international companies may format their statements differently Group project: pay attention to subheadings and categories

Principles of Transaction Analysis -

A = L + SE o Assets = liabilities + shareholders’ equity Every transaction affects at least two accounts (duality of effects) The accounting equation must remain in balance after each transaction

Balancing the Accounting Equation (A = L + SE) 1. Identify and classify accounts and effects a. Identify the accounts by title and make sure at least two accounts change b. Classify them by type of account (A, L, or SE) c. Determine the direction of the effect (increase or decrease?) 2. Verify accounting equation is in balance a. Verify that the accounting equation (A = L + SE) is still in balance i. If not, return to step one Ex: Canadian Tire issues shares to new investors in exchange for $13 cash 1. Identify and classify a. Cash (+A) $13 b. Contributed capital (+SE) $13 2. Verify: $13 = $13 Ex: The company borrows $10 from the bank, signing a note to be paid in 2 years 1. Identify and classify a. Cash (+A) $10 b. Notes payable (+L) $10 2. Verify: $10 = $10 Ex: Can Tire opened a new store; the company bought equipment for $22, paid $15 in cash, signed a note for $7 payable in 2 years 1. Identify and classify a. Equipment (+A) $22 b. Cash (-A) $15 c. Notes payable (+L) $7 2. Verify: $22 - $15 = $7

The Accounting Cycle

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Start of new period During the period: o Analyze transactions o Record journal entries in the general journal o Post amount to the general ledger The end of the period: o Adjust revenues and expenses and related statement of financial position accounts o Prepare a complete set of statements o Close revenues, gains, expenses, and losses to Retained Earnings

Keeping Track of Accounts -

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General journal: o Chronological order of transactions General ledger: o The “drawer” where you keep all of your notebooks (accounts) T-accounts: a term for the entire ledger account; has a left side (debit) and a right side (credit) o Each notebook (account) for each subject Process: o Record of transactions in general journal  The journal entry (general journal)  Reference: letter, number, or date  Account titles: debited accounts on top, credited accounts on bottom and indented  Amounts: debited amount on the left, credited amount on the right o Moving that record to the different accounts (T-accounts) o Prepare financial statement from T-accounts  It is possible to prepare a statement of financial position at any point in time from the balances in the accounts Direction of transactions effects: o Assets: increase with debits; debit balances o Liabilities: increase with credits; credit balances o Shareholders’ equity: increase with credits; credit balances

Current Ratio -

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An important indicator of a company’s ability to meet its current obligations Current ratio = current assets / current liabilities o “for every dollar of liability due in a year, you have $x current assets to pay it” o ratio too low: will not be able to pay off current liabilities, could accumulate more debit

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o ratio too high: current assets are not reinvested into growth or make returns Remember: current asset does not always mean cash, must pay attention to what actually makes up the current assets and liabilities Working capital = current assets – current liabilities

Focus on Cash Flows -

Companies report cash inflows and outflows over a period in their statement of cash flows Buying investments: cash outflows Selling investments: cash inflows

Bookkeeping vs Financial Accounting -

Bookkeeping involves the routine, clerical part of accounting and requires only minimal knowledge of accounting An accountant is a trained professional who can design information systems, analyze complex transactions, and interpret financial data Almost all account numbers are influenced by estimates, subject to precise and objective measurement Financial statements report the cost of assets, liabilities, and shareholders’ equity, not the market value of a company

In Class Example: -

November: owners invest $50,000 in cash for shares in the business, borrow $30,000 cash from the bank payable in three years December: buy $30,000 worth of inventory on credit, pay $20,000 of the $30,000 owed for the inventory purchase, purchase a piece of equipment for $10,000 paying $2000 and financing the rest through a bank payable in 2 years

Record transactions and prepare statement of financial positions at Dec 31, 2015 -

Cash +50,000 = contributed capital +50,000 Cash +30,000 = bank loan + 30,000 Inventory +30,000 = trade payables +30,000 Cash -20,000 = trade payables -20,000 Equipment +10,000, cash -2,000 = bank loan +8,000

Journal Entries

Debit

1 Cash (+A)

50,000

Contributed capital (+SE)

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Credit

50,000

2 Cash (+A)

30,000

Bank loan (+L)

30,000

3 Inventory (+A)

30,000

Trade payables (+L) 4 Trade payables (-L)

30,000 20,000

Cash (-A) 5 Equipment (+A)

20,000 10,000

Cash (-A)

2,000

Bank loan (+L)

8,000

T-Account: break up transactions into debit and credit to each account title

Lecture 4 – Practice Questions -

Know what classifies as an asset, liability, or shareholder equity Know what is a debit or credit to a T-account o Assets have debit balances, SE / L have credit balances A = L + SE (every transaction modifies both to balance the equation) o Start with journal entry – lay out the transaction in debits and credits o Apply those journal entries to T-accounts o Once comfortable, go straight to t-account transfers

Trial Balance -

List all assets with a debit balance List all shareholder equity and liabilities with a credit balance Ensure that debits = credits (A = L + SE)

Lecture 5 – Chapter 3 The Operating Cycle -

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The time that it takes for a company to pay cash to suppliers, sell those goods and services to customers, and collect cash from customers o Think: cycle times, BU 111 o Vary from business to business – car manufacturer vs chewing gum Prepare financial statements at the end of operating cycles Operating cycles can overlap one another, as many companies do not wait for one cycle to finish to begin another

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Creates a dilemma: when do we report financial statements? o Create quarters – consistent period for a business to report o Divides the life of a business into regular intervals (3 months) Time period: the long life of a company can be reported over a series of shorter time periods Recognition issues: when should the effects of operating activities be recognized Measurements issues: what should be recognized?

Classified Statement of Earnings – elements -

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Three major sections: o Results of continuing operations  = revenue – expenses + gains – losses  Single step format: list all revenues followed by all expense items; show the different between revenue and expenses  Multi step format: cost of goods sold are deducted from sales to present gross margin (profit) as a subtotal; other operating expenses are then deducted to show operating earnings (income) as a second subtotal o Results of discontinued operations  Results of operations that no longer occur  Must be a large division of the company  Ex: closing a branch is not a discontinued operation, closing a sector of the company is o Net earnings  Results of continued + results of discontinued o Earnings per share  Net earnings divided by weighted average number of shares outstanding Revenues: increases in assets or settlement of liabilities from ongoing operations Expenses: decreases in assets or increases in liabilities from ongoing operations Gains: increases in assets or settlement of liabilities from peripheral transactions Losses: decrease in assets or increases in liabilities from peripheral transactions

How are Operating Activities Recorded? -

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Accrual accounting, NOT cash basis o Assets, liabilities, revenues, and expenses should be recognized when the transaction that causes them occurs o In line with the IFRS and the GAAP Recognize revenue when: o T...