FINANCIAL ACCOUNTING
Seventh Canadian Edition
LIBBY, LIBBY, HODGE, KANAAN, STERLING
Financial Statements
and Business Decisions
Chapter 1
PowerPoint Author:
Shannon Butler, CPA, CA, MEd
Carleton University, Sprott School of Business
© 2020 McGraw-Hill Limited
1-1
The Accounting System and Decision Makers
© 2020 McGraw-Hill Limited
1-2
Four Basic Financial Statements: An Overview
 Four financial statements are normally prepared by
profit-making organizations for use by shareholders,
creditors, and other external decision makers.
Statement of financial position: reports the economic
resources it owns and the sources of financing for those
resources.
 Statement of earnings (the main component of the statement
of comprehensive income): reports its ability to sell goods for
more than their cost to acquire and sell.
 Statement of changes in equity: reports additional
contributions from or payments to shareholders, and the
amount of earnings the company reinvested for future growth.
 Statement of cash flows: reports its ability to generate cash
and how it was used.

© 2020 McGraw-Hill Limited
1-3
The Statement of Financial Position
 The purpose of the statement of financial position
(balance sheet) is to report the financial position
(amount of assets, liabilities, and shareholders’ equity) of
an accounting entity at a particular point in time.
 The heading of the statement of financial position
identifies four significant items related to the statement:
Name of the accounting entity
 Title of the statement
 Specific date of the statement
 Unit of measure

© 2020 McGraw-Hill Limited
1-4
The Statement of Financial Position Continued
 The organization for which financial data are to be
collected and reported is called an accounting entity
 Statement of financial position has three major captions:
assets, liabilities, and shareholders’ equity. The basic
accounting equation explains their relationship:
Assets
Economic resources
(e.g., cash,
inventory, buildings)
© 2020 McGraw-Hill Limited
=
Liabilities
Financing from creditors
(e.g., amounts owed to
suppliers, employees,
banks)
+
Shareholders’ Equity
Financing from
shareholders
(e.g., contributed capital,
retained earnings)
1-5
SFP: Elements Part 1
 Assets are economic resources controlled by the entity as
a result of past business events.
 Liabilities and shareholders’ equity are the sources of
financing for the company’s economic resources.
 Liabilities indicate the amount of financing provided by
creditors. They are the company’s debts or obligations.
© 2020 McGraw-Hill Limited
1-6
SFP: Elements Part 2
 Shareholders’ equity indicates the amount of financing
provided by owners of the business and reinvested
earnings.
The investment of cash and other assets in the business by the
shareholders is called contributed capital.
 The amount of earnings (profits) reinvested in the business
(and thus not distributed to shareholders in the form of
dividends) is called retained earnings.

© 2020 McGraw-Hill Limited
1-7
SFP: Format Part 1
 Assets may be listed on the statement of financial
position in either increasing or decreasing order of their
convertibility to cash.
 Most Canadian companies list their assets beginning with
the most-liquid asset, cash, and ending with the leastliquid assets.
 In contrast, many international companies, list their leastliquid assets first and most-liquid assets last.
 Similarly, liabilities may be listed by either increasing or
decreasing order of maturity (due date).
© 2020 McGraw-Hill Limited
1-8
SFP: Format Part 2
 Most financial statements include the monetary unit sign
(in Canada, $) beside the first amount in a group of items
(e.g., the cash amount in the assets).
 It is common to place a single underline below the last
item in a group before a total or subtotal (e.g., Other
assets).
 A double underline is placed below group totals (e.g.,
Total assets).
 The same conventions are followed in all four basic
financial statements.
© 2020 McGraw-Hill Limited
1-9
The Statement of Earnings
 The statement of earnings (also called income
statement, statement of operations, statement of
comprehensive income) reports the accountant’s primary
measure of performance of a business, revenues less
expenses during the accounting period.
 While the term profit is used widely for this measure of
performance, accountants prefer to use the technical
terms net income or net earnings.
© 2020 McGraw-Hill Limited
1-10
The Statement of Earnings Continued
Revenues
Cash and promises
received from delivery
of goods and services
© 2020 McGraw-Hill Limited
−
Expenses
Resources used
to earn the
period’s
revenues
=
Net Earnings
Revenues earned
minus expenses
incurred
1-11
The Statement of Earnings: Elements
 Companies earn revenues from the sale of goods or
services to customers. Revenues normally are amounts
expected to be received for goods or services that have
been delivered to a customer, whether or not the
customer has paid for the goods or services.
 Expenses represent the monetary value of resources the
entity used up, or consumed, to earn revenues during the
period.
 Net earnings (also called the “bottom line”) is the excess
of total revenues over total expenses incurred to
generate revenue during a specific period.
© 2020 McGraw-Hill Limited
1-12
The Statement of Changes in Equity
 The statement of changes in equity reports all changes
to shareholders’ equity during the accounting period.
 This statement reports how net earnings, distribution of
net earnings (dividends), and other changes to
shareholders’ equity affected the company’s financial
position during the accounting period.
Equity, beginning of the period
Plus: Net earnings for the year
Plus: Other comprehensive income
Less: Dividends
Plus/Less: Other changes, net
Equity, end of the period
© 2020 McGraw-Hill Limited
1-13
The Statement of Cash Flows Part 1
 The statement of cash flows divides a companies cash
inflows (receipts) and outflows (payments) into three
primary categories of cash flows in a typical business:
cash flows from operating, investing, and financing
activities.
 The specifics of a complete statement of cash flows are
discussed in Chapter 5.
© 2020 McGraw-Hill Limited
1-14
The Statement of Cash Flows Part 2
 Reported revenues do not always equal cash collected
because some sales may be on credit.
 Expenses reported on the statement of earnings may not
be equal to cash paid out during the period because
expenses may be incurred in one period and paid for in
another.
 Net earnings (revenues minus expenses) does not usually
equal the amount of cash received minus the amount
paid during the period.
 Therefore, because the statement of earnings does not
provide information concerning cash flows, the
statement of cash flows is prepared to report inflows and
outflows of cash.
© 2020 McGraw-Hill Limited
1-15
The Statement of Cash Flows Part 3
 The statement of cash flows equation describes the
causes of the change in cash reported on the statement
of financial position from the end of the last period to the
end of the current period:
+/−
Cash flows from operating activities
+/−
Cash flows from investing activities
+/−
Cash flows from financing activities
Change in cash
© 2020 McGraw-Hill Limited
+
Beginning Cash Balance
=
Ending Cash Balance
1-16
The Statement of Cash Flows: Elements
 Cash flows from operating activities (CFO) are cash flows
that are directly related to generating earnings.
 Cash flows from investing activities (CFI) include cash
flows related to the acquisition or sale of the company’s
property, plant, and equipment, and investments.
 Cash flows from financing activities (CFF) are directly
related to the financing of the company itself. They
involve both receipts and payments of cash from/to
investors and creditors (except for suppliers).
© 2020 McGraw-Hill Limited
1-17
Relationships Among the Statements
1.
2.
3.
Net earnings from the statement of earnings results in
an increase in ending retained earnings on the
statement of changes in equity.
Ending retained earnings from the statement of
changes in equity is one of the three components of
shareholders’ equity on the statement of financial
position.
The change in cash on the statement of cash flows
added to the cash balance at the beginning of the year
equals the balance of cash at the end of the year, which
appears on the statement of financial position.
© 2020 McGraw-Hill Limited
1-18
Relationships Among the Statements: LeNature
© 2020 McGraw-Hill Limited
1-19
Notes to Financial Statements
 Notes provide supplemental information about the
financial condition of a company, without which the
financial statements cannot be fully understood.
 There are three basic types of notes.
1. The first type provides descriptions of the accounting
rules applied in the company’s statements.
2. The second presents additional detail about a line on
the financial statements.
3. The third type of note presents additional financial
disclosures about items not listed on the statements
themselves.
© 2020 McGraw-Hill Limited
1-20
Responsibilities for the Accounting
Communication Process
 Effective communication means that the recipient
understands what the sender intends to convey.
 Understandability is the foundation of effective
communication.
 Decision makers also need to understand
the measurement rules applied in computing the
numbers on the statements.
© 2020 McGraw-Hill Limited
1-21
How are Accounting Standards Determined?
 Our accounting system has a long and distinguished
history. An Italian monk named Luca Pacioli, published
the first elements of double-entry bookkeeping in 1494.
 Prior to 1933, the management teams of most companies
were largely free to choose their own financial reporting
practices.
© 2020 McGraw-Hill Limited
1-22
Accounting Standards Board (AcSB)
 In Canada, the Accounting Standards Board (AcSB) is the
private-sector body given primary responsibility to set
the detailed rules that become accepted accounting
standards.
 The AcSB is responsible for establishing standards of
accounting and reporting by publicly accountable
enterprises, private enterprises, government
organizations, and not-for-profit organizations.
 These standards or recommendations, which are
published in CPA Canada Handbook, have expanded over
time because of the increasing diversity and complexity
of business practices.
© 2020 McGraw-Hill Limited
1-23
International Financial Reporting Standards
 For Canadian publicly accountable enterprises, the AcSB
has determined that they must prepare their financial
statements in accordance with International Financial
Reporting Standards.
 IFRS are a single set of globally accepted high-quality
standards, produced by the International Accounting
Standards Board (IASB), which is an independent
standard-setting board responsible for the development
and publication of IFRS.
 An older set of International Accounting Standards (IAS)
were issued by the Board of the International Accounting
Standards Committee, and they complement the
accounting standards issued by the IASB.
© 2020 McGraw-Hill Limited
1-24
Why Accounting Standards are Important
 Companies, their managers, and their owners are most
directly affected by the information presented in the
financial statements.
 Companies incur the cost of preparing the statements
and bear the major economic consequences of their
publication. These economic consequences include,
among others, the following:
Changes to the selling price of a company’s shares
 Changes to the amount of bonuses received by management
and employees
 The loss of competitive advantage over other companies

© 2020 McGraw-Hill Limited
1-25
Ethical Conduct
 Ethics are standards of conduct for judging right from
wrong, honest from dishonest behaviour, and fair from
unfair practices.
 Intentional misreporting of financial statements is both
unethical and illegal.
 Many situations are less clear-cut and require that
individuals weigh one moral principle (e.g., honesty)
against another (e.g., loyalty to a friend).
© 2020 McGraw-Hill Limited
1-26
Ethical Conduct Continued
 When facing an ethical dilemma the following three-step
process should be followed:
1. Identify the effects of the decision on both parties,
those who will benefit from the situation (often the
manager or employee involved) and those who will
be harmed (other employees, owners, creditors, the
environment).
2. Identify alternative courses of action.
3. Choose the alternative that you would like to see
reported on the news. That is usually the ethical
choice.
© 2020 McGraw-Hill Limited
1-27
Management Responsibility & the Demand for
Auditing
 Primary responsibility for setting up systems to prevent
and detect unethical behaviour lies with management, as
represented by the highest officer of the company and its
highest financial officer.
 Companies take three important steps to assure investors
that the company’s records are accurate:
1.
2.
3.
They develop and maintain a system of internal controls over
both the records and the assets of the company,
They hire outside independent auditors to attest to the
fairness of the statement presentations, and
They form a committee of the board of directors to oversee
the integrity of these two safeguards.
© 2020 McGraw-Hill Limited
1-28
Management Responsibility & the Demand for
Auditing Continued
© 2020 McGraw-Hill Limited
1-29
Independent Auditor
 The role of the independent auditor is to examine the
financial reports to ensure that they represent what they
claim and conform to generally accepted accounting
principles.
 In performing an audit, the independent auditor
examines the underlying transactions and the accounting
methods used to account for these transactions.
© 2020 McGraw-Hill Limited
1-30
Legal Liability, Professional Conduct, and
Independence
 The Canadian accounting profession requires its members
to adhere to a code of professional conduct and
standards of independence.
 These standards are enforced through a disciplinary
process.
 The provincial CPA institutes all stress how important it is
for each member to behave in ways that enhance the
reputation of the profession through voluntary
compliance.
 In addition, CPA Canada treats professional and ethical
behaviour as the most important of the enabling
competencies possessed by its members.
© 2020 McGraw-Hill Limited
1-31
Appendix 1A: Comparison of Three Types of
Business Entities
Proprietorshi
p
Partnership
Corporation
Number of owners
One owner
Two or more
owners
Many owners
Legal status of entity
Not separate
from that of its
owner
Not separate
from that of its
owners
Separate legal entity
Responsibility of
owners for debts of
business entity
Unlimited legal
liability
Unlimited legal
liability
Owners’ liability
limited to their
investment
Accounting status
© 2020 McGraw-Hill Limited
Each entity is separate from its owners for accounting
purposes
1-32
Appendix 1B: Employment in the Accounting
Profession Today
 Accountants are usually engaged in professional practice
or employed by businesses, government entities, and
not-for-profit organizations.
 Practice of Public Accounting:

Audit or assurance services, management consulting and
advisory services and tax services.
 Employment by Organizations:

External reporting, tax planning, control of assets etc.
 Employment by Public and Not-for-Profit Sectors

Charitable organizations, hospitals and universities.
© 2020 McGraw-Hill Limited
1-33
End of Chapter Summary
 Four basic financial statements:
 The Statement of Financial Position
 The Statement of Comprehensive Income
 The Statement of Changes in Equity
 The Statement of Cash Flows
© 2020 McGraw-Hill Limited
1-34
End of Chapter Summary Continued
 IFRS are the broad principles, specific rules, and practices
used to develop and report the information in financial
statements.
 Knowledge of IFRS is necessary to accurately interpret
the numbers in financial statements.
 Management has primary responsibility for the accuracy
of a company’s financial information.
 Auditors are responsible for expressing an opinion on the
fairness of the financial statement presentations based
on their examination of the reports and records of the
company.
© 2020 McGraw-Hill Limited
1-35