1 1101 – Chapter 1 Class Notes – Friday Sept 10th Lecture Outline – Note to student: we will elaborate on these notes in class. You should download and add to the document as we proceed through class. Topic 1: Internal versus external users, form of business and GAAP. (Pages 1-1 to 1-8) Financial accounting is focused on preparing financial statements for external users to help these users make decisions. Preparers must act ethically. Examples of external users and what they are deciding: #1 -Investors/shareholders/potential shareholders – The decision here is whether to invest in the company (BUY, HOLD, SELL – for the shares) #2 - Lenders such a bank – The decision to be made here is whether to provide a loan (financing) to the organization. The banker/other lender would want to see good cash flow because that indicates an ability for the organization to make interest payments and to pay back the loan. #3 - Insurance companies or other suppliers of goods/services – Suppliers of goods and services would decide whether or not to sell to the organization, and, if so, what credit terms may be warranted. #4 - Unions – To help them negotiate for employee groups. 2 1101 – Chapter 1 Class Notes – Friday Sept 10th For example – the unions representatives for Dal faculty may try to support wage increases by using strong revenue numbers from Dal’s financial statements #5 - Government – example – Canada Revenue Agency (CRA) – CRA is Canada’s taxing authority. CRA uses financial statements to assess whether the entity is complying with tax laws and paying what is owed on time. Conflict exists!! Preparers of the financial statements (chief financial officer and his/her team of accountants). They prepare the F/S for the external users to base their decisions on. There can be bias in financial statement preparation – to please the users and make them grant loan/invest/…. To reduce/mitigate the risk of a preparer of financial statements creating false or misleading information: 1. Codes of conduct in place at organization that employees are expected to follow. External codes of conduct and professional standards exist for Chartered Professional Accountants (CPAs). 2. KEY element – is an external audit report. This is an opinion provided by an independent firm.(common audit firms: KPMG, Ernst and Young, Grant Thornton, etc). Publicly company – REQUIRED to get an annual audit opinion or the shares are delisted. 3 1101 – Chapter 1 Class Notes – Friday Sept 10th Forms of Business Sole Proprietorships, partnerships – these are NOT incorporated. Means there is no separate legal entity. Corporations – a separate legal entity is formed. Parties contribute cash (or other assets) in exchange for share ownership in the corporation. Owners are separate from the corporation. GAAP = Generally Accepted Accounting Principles In Canada, generally 2 forms of GAAP IFRS (International Financial Reporting Standards) – REQUIRED for publicly traded company. Optional for others – some private companies would still choose to use IFRS. versus ASPE (Accounting Standards for Private Enterprises) – simpler standards, easier to prepare F/S using ASPE versus IFRS. Topic 2: Financial statements (pages 1-13 to 1-25). We will consider the 4 financial statements prepared for external reporting purposes. a. Income Statement 4 1101 – Chapter 1 Class Notes – Friday Sept 10th Shows income earned by a company for a period of time. See Illustration 1.6 on page 15. What information is shown on this statement for Sierra Corp (a marketing agency)? The income statement reports revenues and expenses for a period of time. This results in a total net income (or, if expenses are greater than revenues we have a net loss). Net income is also called profits or net profit. Therefore, the income statement is known for providing information to users on “profitability”. Users may be interested in trends in profitability. What was net income in 2021 versus 2020 versus 2019. b. Statement of changes in equity. Illustration 1.9 on page 16. What is shown on this statement? Two accounts that we need to know: Common shares – this represents what the shareholders paid for the shares. Cumulative net income and loss of the firm less dividends declared. *dividends are the distributions to shareholders. c. Statement of Financial Position (Balance Sheet) ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY Assets – liabilities = shareholders’ equity. Let’s look at Illustration 1.11. 5 1101 – Chapter 1 Class Notes – Friday Sept 10th What information is shown on this statement for Sierra Corp? We can see assets reported such as cash, A/R, supplies and equipment. We can see that Sierra owes money (liabilities) to its employees and to the bank (interest payable). And the ending balances for common shares and retained earnings are reported as well. NOTE: The balance sheet DOES balance. What might external users be deciding based on this information? d. Cash Flow Statement Let’s look at Illustration 1.12 on page 19. What information is shown on this statement for Sierra Corp? Shows the user the cash being paid and the cash being collected. What might external users be deciding based on this information? Does entity have the cash to make loan payments, pay dividends, etc. Stating the obvious – Cash is very important. In class: Problem 1.7A (from textbook). We will work on this together.
