Lesson 1 (Mos 1023) - Lecture notes 1 PDF

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A detailed explanation of topics discussed in the lesson, textbook readings have been integrated into these lecture notes, contains pictures for visual learners like myself....

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MOS 1023, Western University

Lesson 1: The Purpose and use of Financial Statements Topics:   

Accounting - its uses and its necessity How we classify financial information Different types/forms of business

Accounting and its uses:  As a global language used and relied upon by businesses to provide accurate and reliable information about economic events of an organization to provide to interested parties Users of Financial Information:  Internal (Primary users) o Management: for determining organization's state and implement changes to fix any shortfalls o Employees: for assessing their job status and future profitability o Owners: to analyze the potential profitability of their investment  External (Secondary users) o Creditors: use the information to determine the credit worthiness of a business o Tax authorities: to determine validity of tax returns o Customers: to determine financial stability of business o Investors: to determine if an investment would prove worthwhile Primary Focus of Financial Accounting: to provide information useful for Investing and Credit decisions. Ethical Behaviour:  For accounting information to have value and credibility to all interested parties it must be factual  Companies, accountants, and other professionals all have strict codes of conduct they must follow Forms of Business Organizations:  Proprietorship: o Single owner with full control over business o Is not a separate legal entity o Easy to set up and run o Unlimited liability o Not taxable entities  Partnership: o Owned by more than one person o Formal agreement is met and signed by co-owners o Not a separate legal entity o Each partner has shared unlimited liability (you get screwed so do I) o Not taxable entities  Corporation:

MOS 1023, Western University

o o o

Long life span not dependent on one person Shared (Limited) liability amongst shareholders Either public or private (Public organizations are on the Stock Exchange and have their shares available for purchase) o Are taxable entities Types of Business: 1. Manufacturing Business: make stuff a. Toy Factory is an example (a Farm) 2. Merchandizing Business: buy and sell a. A Toy Store (Grocery store) 2. Service Business: fix or help make stuff work, provide their skills to you a. A Toy Repair office Types of Business Activities: 1. Financing: obtaining and repaying funds required to finance business operations (getting cash to run business, and repaying of money to keep business afloat) a. External: Borrowing money; selling shares b. Internal: Using equity (value of shares issued by a company) (or rather instead of giving the profit earned each year to the owners, you keep it and reinvest it) to invest in the business instead of paying dividends (money paid annually by a company, according to the value of shares, to shareholders) 2. Investing: Obtaining the resources necessary to operate a business long term (buying the stuff they need to run the business) a. Examples: purchase or sale of investments/assets 2. Operating: the main day-to-day activities done by a business a. Examples: Revenues, expenses, book keeping Financial Statements: essentially are the business documents used by businesses to record and track the results of their activities to various interested parties. The system of accounting produces the follow set of documents: Under IFRS (International Financial Reporting Standards

Under ASPE (Accounting Standards for Private Enterprises)

1.

Statement of Income

1.

Balance Sheet (not temporary accounts)

Statement of Changes in

1.

Income Statement

Statement of Financial

1.

Cash Flow Statement

Statement of Cash Flows

1.

1. Equity 1. Position 1.

Statement of Retained Earnings (Dividends are reported here as well)

MOS 1023, Western University

1. Statement of Income: reports the results of operations for a specific period of time (shows whether or not a company made a profit in a allotment of time). Reports Revenues & Expenses to show how successful a company was over a period of time. a. Revenues: come from the sale of a product or service in regular course of operations (not from irregular events) b. Expenses: cost of assets attained/services used to generate revenue c. Gains & loses: a surplus of income or expenses caused by one-time (irregular) events (Gains = random event causing attainment of money (a random grant from the government)(Loses = Irregular event causing a loss of money (such as a natural disaster destroying the office) d. Net earnings or Net profit (loss): Revenues + gains - expenses - losses 2. Statement of Changes in Equity: Shows the changes in each component of shareholders' equity (includes: share capital; and retained earnings), as well as total equity for a period. a. Share Capital: amounts contributed by shareholders b. Retained Earnings/Deficit (keep or lose): Cumulative profit retained in the company (the profit left over after all dividends and other expenses are paid, is a running total (continues to add up each year)) 3. Statement of Financial Position: Balance Sheet (indicates whether the company relies more on debt or shareholders' equity to finance its assets). This statement presents a picture of what the company owns (assets), what it owes (liabilities), and its net worth (shareholders' equity) at a specific point in time. a. Assets: resources owned by a business (coffee machines owned by Starbucks) b. Liabilities: obligations/responsibilities of the business (debts to be repaid) c. Shareholders' Equity: Share capital and Retained earnings 2. Statement of Cash Flows: "Cash is King". Reports the cash receipts and payments for a short period of time. Shows where a company obtained cash, and how it was used over a period of time. Changes in cash will be categorized as one of the following: a. Operating (operating activities result from transactions that create revenues and expenses) i. Could also be described as activities the company performs to generate profits b. Investing (investing activities involve the purchase or sale of long-lived resources such as property, plant, and equipment that a company needs to operate and the purchase or sale of investments in long-term securities) c. Financing (financing activities involve borrowing/repaying long-term debt from/to lenders and issuing shares or distributing dividends to shareholders) Relationships Between the Statements: 1. The statement of changes in equity depends, in part, on the results of the income statement (retained earnings are affected by profit) 2. The statement of financial position and statement of changes in equity are interrelated because the ending balances of each component of shareholders' equity (common shares and retained earnings) as well as the total shareholders' equity at the end of the month reported on the statement of changes in equity is reported in the shareholders' equity section of the statement of financial position

MOS 1023, Western University

3. The statement of cash flows & the statement of financial position are also interrelated. The ending amount of cash shown on the statement of cash flows agrees with the amount of cash shown in the assets section of the statement of financial position . ~Additional information is reported in notes to the financial statements that are cross referenced to the 4 statements. The Accounting Equation:

Shareholder's Equity: is essentially a company's Net Worth and is divided into two categories: 1. Share Capital: all the money invested in a company by its shareholders 2. Retained Earnings: refers to the percentage of earnings not paid out as dividends but rather retains by company to be reinvested Components of Retained Earnings:

MOS 1023, Western University

Annual Report: must be prepared by all Publicly traded companies annually. Report includes financial/nonfinancial information about the company such as:  Financial: management discussion and analysis statement of management responsibility, auditor's report, financial statements and notes  Nonfinancial: company's goals/mission, products, and employees Management Discussion and Analysis (MD&A): management's explanation of the financial information and its significance. The five key elements included: 1. Company's vision, core business, and strategy 2. Key performance drivers 3. Capital and other resources 4. Historical and prospective results 5. Risks Generally Accepted Accounting Principles (GAAP): rules and practices for the preparation of financial statements  Differs between Public & Private companies: o Publicly traded companies: use IFRS (Refer to above) o Private companies: may use IFRS or ASPE (Refer to above) o Proprietorships & Partnerships do not necessarily have to use IFRS or ASPE as statements are prepared for internal users only

MOS 1023, Western University...