Understanding
Financial Accounting
Third Canadian Edition
By Christopher D. Burnley
Prepared by Debbie Musil, FCPA, FCMA
Chapter 1
Overview of Corporate Financial
Reporting
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Learning Objectives (1 of 2)
LO1 – Define financial accounting and understand its
relationship to economic decision-making
LO2 – Identify the main users of financial accounting
information and explain how they use this
information
LO3 – Describe the major forms of business organization and
explain the key distinctions between them
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Learning Objectives (2 of 2)
LO4 – Explain the three categories of business activities and
identify examples of transactions related to each
category
LO5 – Identify and explain the content and reporting
objectives of the four basic financial statements and
the notes to the financial statements
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What Is Financial Accounting?
• Process of capturing, analyzing and reporting
transaction information to financial statement users
• Statement users include:
o
o
o
Investors
Creditors
Management
• Annual report: reports the results of the company’s
activities during the year
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Business Stakeholders
Questions that stakeholders in a business may be asking
Business Stakeholders
Potential Questions They May Be Trying to Answer about the Business
Employees, unions
Is the business profitable? Will I earn a bonus this year? Can the company afford to
negotiate increased wages? Is the company pension plan in decent shape?
Management
How do this year’s sales compare with last year’s? How do they compare with the
budget? Are we maintaining our profit margins on certain product lines? How much do
we owe our employees and suppliers?
Auditors, federal and provincial government
departments, legislators
Has the company presented its financial information fairly? How does the company’s
financial information compare with the information submitted for taxation or payroll
purposes?
Potential investors, customers
What are the long-term prospects for this company? Has the management team done a
reasonable job? Will this company be around to honour its warranties?
Stock analysts, brokers, financial advisors,
business reporters
What are the company’s trends? What are the prospects for this company? How has this
company performed relative to expectations?
Stock exchange regulators
Has the company complied with the financial reporting standards and listing
requirements?
Shareholders, board of directors
Has the company generated a sufficient return on our investment? How effectively has
management used the resources at their disposal? Does the company generate enough
income to be able to pay dividends?
Creditors, suppliers, landlords
Should we extend credit to this company? Is this a credible and successful company that
we want to attach our brand to? Should we enter into a lease with this company?
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Financial Statement Users
• Internal users:
o
Management
• External users:
o
o
o
o
o
o
Shareholders
Board of Directors
Potential investors
Creditors
Regulators
Taxing authorities
o
o
o
o
o
Other corporations,
including competitors
Security analysts
Credit-rating agencies
Labour unions
Journalists
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Users - Shareholders, the Board of
Directors and Potential Investors
• Includes shareholders, the board of directors and
potential investors
• Shareholders have invested resources in the
company in exchange for a share of its ownership
• Corporations may be either:
o
o
Private companies with a single shareholder
Public companies with 1000’s of shareholders
requiring a board of directors
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Additional Financial Statement Users
• Additional Financial Statement Users also Include:
• Creditors
o
o
Financial Institutions and other lenders
Suppliers, employees and various levels of
government
• Regulators
• Taxing Authorities - CRA
• Other Users
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What Is a Corporation?
•
Corporations are owned by shareholders who have
provided cash or other assets in exchange for share
certificates
o
•
•
Called common shares
Are separate legal entities, distinct from owners
Two main types:
o Public companies
• Company’s shares are listed on a public stock exchange
o
Private companies
• Shares trade privately
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Forms of Business Organization
Key distinctions between the forms of business
Distinguishing Feature
Corporation
Proprietorship
Partnership
Number of owners
Can be a single owner or
multiple owners
Single owner
Multiple owners
Separate legal entity?
Yes, shareholders’
personal assets are not
at risk in the event of
legal action against
company
No, owner’s
personal assets are
at risk in the event
of legal action
No, partners’ personal
assets are at risk in the
event of legal action
Owner(s) responsible for
debts of the business?
Only to extent of
investment
Yes
Yes
Taxed?
Yes, taxed separately
No, profits taxed in
hands of owner
No, profits taxed in
hands of owners
Costs to establish
Most expensive
Least expensive
Moderately expensive
Cost to maintain
Most expensive
Least expensive
Moderately expensive
Must make their financial
information available
Yes, on a quarterly and
annual basis
No
No
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Business Activities
The three categories of business activities
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Financing Activities
•
A company’s financing comes from two sources:
o
o
•
Investors, through issuance of shares
Creditors, through taking out loans or making purchases
on credit
Typical Financing Activities:
o
Cash Inflows:
• Taking out a loan (borrowing money)
• Issuing Shares
o
Cash Outflows:
• Repaying loan principal
• Paying dividends on shares
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Investing Activities
•
Investing activities include:
o
o
•
Buying and selling of property, plant, and equipment
(PP&E)
Buying and selling the shares of other companies
Typical Investing Activities:
o
Cash Inflows:
• Sale proceeds from PP&E
• Sale proceeds from shares of other companies
o
Cash Outflows:
• Purchase of PP&E
• Purchase of shares of other companies
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Operating Activities
• Operating activities are related to the company’s
revenues and expenses and fall into two general
categories:
o
Cash Inflows:
• Sales to and collections from customers
o
Cash Outflows:
• Payment of business expenses
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Financial Reporting
The components of the Financial Statements include:
• Statement of Income
• Statement of Changes in Equity
• Statement of Financial Position
• Statement of Cash Flows
• Notes to the Financial Statements
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Statement of Income
• Presents the results of a company’s operating
activities for a month, quarter or year
• Revenues – Expenses = Profit (Net Income)
• Common items
o
o
o
o
o
Sales revenues
Other income
Cost of goods sold
Selling, general, and administrative expenses
Depreciation/(amortization), interest, and income tax
expenses
• Incudes an earnings per share disclosure
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Statement of Changes in Equity
• Provides detail on how each component of
shareholders’ equity has changed during the period
• The two major components of shareholders’ equity
include:
o
o
Share Capital
Retained Earnings
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Statement of Financial Position
• Presents financial status of the company at a
particular point in time
• Also known as the balance sheet
• Lists what is owned (assets) and what is owed
(liabilities), measuring net worth (shareholders’
equity)
• The Accounting Equation:
Assets = Liabilities + Shareholders’ Equity
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Liquidity
• Assets and liabilities are classified on the statement
of financial position into current and non-current
categories and are listed in order of liquidity
• Liquidity: how quickly something will be received,
realized, consumed, settled or paid
• A common measure of liquidity is working capital
Working Capital = Current Assets-Current Liabilities
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Assets
• Characteristics:
o
o
o
It is an economic resource controlled by an entity
The company expects future economic benefits from
the use or the sale of the resource
The event that gave the company the control of the
economic resource has already happened
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Assets - Examples
• Examples
o
o
o
o
o
o
o
o
o
Cash
Short-term (temporary) investments
Accounts receivable
Inventory
Prepaid expenses
Property, Plant and Equipment
Right-of-Use Assets
Intangible Assets
Goodwill
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Liabilities
• Characteristics:
o
o
o
It is a present obligation of the entity
The company expects to settle it through an outflow
of economic resources
The obligation results from an event that has already
happened
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Liabilities - Examples
• Examples
o
o
o
o
o
Bank indebtedness
Accounts payable
Deferred Revenue
Notes payable
Dividends payable
o
o
o
o
o
Accrued liabilities
Taxes payable
Long-term debt
Lease Liabilities
Deferred income taxes
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Shareholders’ Equity
• Value of the shareholders’ interest in the assets of
the company
• Often referred to as the net assets of the company
o
This is the amount of assets that would remain after
all of the company’s liabilities were settled
• Usually composed of at least two accounts:
o
o
Share capital
Retained earnings
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Accounting Equation Rearranged
Assets – Liabilities = Shareholders’ Equity
(Net Assets)
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Share Capital
• Represents the shares that have been issued by the
company
• Usually stated at an amount equal to what was
originally paid by investors for the shares
• Market value of the shares is the price the shares are
trading at on the stock market
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Retained Earnings
• The earnings of the company (as measured on the
Income Statement) that have been kept (retained)
and not paid out in the form of dividends
Retained Earnings = Opening Retained Earnings
+ Net Income
– Dividends Declared
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Statement of Cash Flows
• Presents inflows and outflows of cash during a
specific period of time
o
Cash Flow from Operating Activities
• All inflows & outflows related to the company’s sale of
goods or services
o
Cash Flow from Investing Activities
• Inflows and outflows related to the purchase and sale
of long-term assets
o
Cash Flow from Financing Activities
• Transactions that either generate new funds from
investors/creditors or return funds to
investors/creditors
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Notes to the Financial Statements
• More detail about specific referenced items
• Includes the Summary of Accounting Policies
• Includes information about various segments of the
company
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Copyright
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