Financial
Accounting:
Tools for Business
Decision-Making
Fourth Canadian
Edition
Prepared by:
Peggy Coady
Memorial University of
Newfoundland
&
Catherine Seguin
University of Toronto
Chapter 2
Financial Statements –
Framework, Presentation
and Usage
Conceptual Framework
of Accounting
• Guides choices about
– what to present in financial
statements
– decisions about alternative ways
of reporting economic events
– the selection of appropriate ways
of communicating such
information
Chapter 2
3
Conceptual Framework
of Accounting
• Four main sections
– Objective of financial reporting
– Qualitative characteristics of
accounting information
– Elements of financial statements
– Recognition and measurement
criteria
Chapter 2
4
Objective of Financial
Reporting
• To provide information that is
useful to individuals who are
making investment and credit
decisions
Chapter 2
5
Qualitative
Characteristics
• To be useful for decisionmaking, information should
have these qualitative
characteristics
– Relevance
– Faithful representation
– Comparability
– Understandability
Chapter 2
6
Qualitative Characteristics
of Accounting Information
• Relevance
– Information is relevant if it makes
a difference in a decision. It is
said to have predictive value,
feedback value, and timeliness
• Faithful representation
– Information should reflect
economic reality. It must be
verifiable, neutral, and complete
Chapter 2
7
Qualitative Characteristics
of Accounting Information
• Comparability
– Accounting information can be
compared when companies with
similar circumstances use the
same accounting standards
consistently from year to year
• Understandability
– Average user is assumed to
understand the accounting
information
Chapter 2
8
Discussion Question
Why is a conceptual framework of
accounting important?
Chapter 2
9
Elements of Financial
Statements
•
•
•
•
•
Assets
Liabilities
Equity
Revenues
Expenses
Chapter 2
10
Recognition and
Measurement Criteria
• Accountants need detailed
criteria to help them decide
when and where an item is
included in the financial
statements.
• Includes
– Assumptions
– Principles
– Constraints
Chapter 2
11
Assumptions
•
•
•
•
Monetary unit
Economic entity
Time period
Going concern
Chapter 2
12
Monetary Unit
Assumption
• Only those things that can be
expressed in terms of money
should be included in the
accounting records
• Important presumption is that
the monetary unit remains
stable over time and the effects
of inflation are nominal
Chapter 2
13
Economic Entity
• Every economic entity can be
separately identified and
accounted for
• Personal items relating to
shareholders are not accounted
for by the business
Chapter 2
14
Time Period Assumption
• The economic life of a business
can be divided into artificial
time periods
Chapter 2
15
Going Concern
Assumption
• The business will continue
operating in the foreseeable
future
• Justifies the use of the cost
principle
Chapter 2
16
Generally Accepted
Accounting Principles
• Cost
• Full disclosure
• Revenue recognition (covered
in Chapter 4)
• Matching (covered in Chapter 4)
Chapter 2
17
Cost Principle
• Assets should be recorded at
cost at the time of acquisition
Chapter 2
18
Discussion Question
Which assumption is an important
underpinning of the cost
principle?
Chapter 2
19
Full Disclosure Principle
• Circumstances and events that
make a difference to financial
statement users should be
disclosed
Chapter 2
20
Constraints in
Accounting
• Materiality
– An item is material if it is likely to
influence the decision of a user
• Cost-benefit
– Ensures that the value of the
information is greater than the
cost of providing it
Chapter 2
21
Classified Balance
Sheet
• A classified balance sheet
generally contains the following
standard classifications:
Assets
Liabilities
- Current assets
- Current liabilities
- Long-term investments
- Long-term liabilities
- Property, plant, and equipment
- Intangible assets
Shareholders’ Equity
- Share capital
- Retained earnings
Chapter 2
22
Current Assets
• Assets expected to be
converted to cash or used in
the business within the year
• Listed in order of liquidity
• Examples include cash, shortterm investments, accounts
receivable, inventories and
prepaid expenses
Chapter 2
23
Long-Term Investments
• Investments in the debt or
equity securities of other
corporations
• These assets are normally not
intended to be sold within the
next year
Chapter 2
24
Property, Plant, and
Equipment
• Tangible assets with relatively
long useful lives
• Assets used in operating the
business
• Examples include land, building,
machinery, delivery equipment,
furniture and fixtures
Chapter 2
25
Intangible Assets
• Noncurrent assets that do not
have physical substance and
represent a privilege or a right
• Examples include goodwill,
patents, copyrights,
trademarks, trade names and
licenses
Chapter 2
26
Depreciation
• Allocation of an asset’s full
purchase price to match cost to
revenues over the entire
estimated useful life instead of
expensing full cost in the year of
purchase
• The cost of long-lived assets
with indefinite lives (e.g., land)
is not depreciated
Chapter 2
27
Depreciation
• Accumulated depreciation
account shows the total amount
of depreciation taken to date
• The difference between the cost
of the asset and its
accumulated depreciation is
referred to as the carrying
amount of the asset
Chapter 2
28
CSU CORPORATION
Balance Sheet
December 31, 2009
Assets
Cash
Accounts receivable
Supplies
Equipment
Less: Accumulated depreciation
Total assets
Chapter 2
$ 2,000
4,000
1,800
$24,000
8,000
16,000
$23,800
29
Liabilities
• Current liabilities
– Obligations that are supposed
to be paid within the coming
year
– Examples include accounts
payable, notes payable, interest
payable, etc.
Chapter 2
30
Liabilities
• Long-term liabilities
– Debts expected to be paid after
one year
– Examples include bonds
payable, mortgage payable,
notes payable, lease liabilities,
etc.
Chapter 2
31
Shareholder’s Equity
• Share capital
– Investment of cash (or other
assets) in the business by the
shareholders in exchange for
preferred or common shares
• Retained earnings
– Earnings kept for use in the
business
Chapter 2
32
Discussion Question
What do you think would be the
main asset, liability, and equity
items for a Tim Hortons
franchise?
Chapter 2
33
Financial Ratio
Classifications
• Profitability ratios
– Measure the earnings or
operating success of a company
for a given period of time
Chapter 2
34
Profitability Ratios
Earnings
per share
Priceearnings
ratio
Chapter 2
Net Earnings Available
to Common
Shareholders
=
Weighted Average
Number of Common
Shares
Market Price per
Share
=
Earnings per Share
35
Financial Ratio
Classifications
• Liquidity ratios
– Measure the short-term ability of
the company to pay its maturing
obligations and to meet
unexpected needs for cash
Chapter 2
36
Liquidity Ratios
Working
capital
=
Current assets –
Current liabilities
Current Assets
Current
ratio
Chapter 2
=
Current Liabilities
37
Financial Ratio
Classifications
• Solvency ratios
– Measure the ability of a company
to survive over a long period of
time
Chapter 2
38
Solvency Ratios
Total Liabilities
Debt to
total
assets
=
Free cash
flow
Net cash provided
(used) by operating
activities – Net
=
capital expenditures
- dividends
Chapter 2
Total Assets
39
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