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FINANCIAL
ACCOUNTING
Fifth Canadian Edition
LIBBY, LIBBY, SHORT, KANAAN, GOWING
Financial Statements
and Business Decisions
Chapter 1
PowerPoint Author:
Robert G. Ducharme, MAcc, CPA, CA
University of Waterloo, School of Accounting and Finance
Copyright © 2014 McGraw-Hill Ryerson Limited
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Understanding the Business
The Players
Investors
Creditors
Managers
1. Purchase materials
and labour
2. Manufacture
product
The
Business
Operations
4. Collect cash from
customers and pay
creditors
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3. Sell products
to customers
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Understanding the Business
Business owners (called investors or shareholders) look
for two sources of possible gain:
Sell
ownership
interest in the
future for more
than they
paid.
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Receive a
portion of the
company’s
earnings in cash
(dividends).
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Business Background
Creditors lend money to a company for a specific length
of time and gain by charging interest on the money
loaned.
Loan
Mel’s
Diner
Interest
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Understanding Business Operations
Manufacturers either make the parts needed to
produce its products or buy the parts from
suppliers.
Manufacturer
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Product
Customer
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The Accounting System
Collects and processes
financial information
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Reports
information
to decision
makers
Managers
(internal
decision
makers)
Investors
and
Creditors
(external
decision
makers)
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The Accounting System
Accounting System
Financial Accounting Reports
Managerial Accounting Reports
Periodic financial statements and
related disclosures
Detailed plans and continuous
performance reports
External Decision Makers
Internal Decision Makers
Investors, creditors,
suppliers, customers, etc.
Managers throughout the
organization
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The Accounting System and Decision Makers
An organized format used by companies
to accumulate the dollar effects of
transactions.
Cash
Inventory
Equipment
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Notes
Payable
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Information Conveyed in Financial Statements
When studying the financial statements you
should focus on these questions:
1. What categories of items (often called elements) are reported
on each of the four statements? (What type of information
does a statement convey, and where can you find it?)
2. What time period (monthly, quarterly, annual) is covered by
the financial statements?
3. How are the elements within a statement related? These
relationships are usually described by an equation that tells
you how the elements fit together.
4. Why is each element important to managers’, owners’ or
creditors’ decisions? (How important is the information to
decision makers?)
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External Financial Reporting


Financial statements are often referred to as having
been prepared using GAAP (Generally Accepted
Accounting Principles)
In Canada, GAAP can be either:




IFRS: International Financial Reporting Standards (IASB)
ASPE: Accounting Standards for Private Enterprise (AcSB)
Companies that trade their securities (debt or equity)
in a public market are required to use IFRS
Those companies that do not meet the above
criteria, have an option of using either IFRS or ASPE
(most will chose ASPE because it is less complex)
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The Four Basic Financial Statements -IFRS
1. STATEMENT OF FINANCIAL POSITION – reports the amount of
assets (resources owned), liabilities (amounts owed), and
shareholders’ equity of an accounting entity at a point in time.
2. STATEMENT OF COMPREHENSIVE INCOME – reports the
revenues less the expenses of the accounting period.
3. STATEMENT OF CHANGES IN EQUITY – reports the way that
profit, distribution of profit (dividends), and other changes to
shareholders’ equity affected the financial position of the company
during the accounting period.
4. STATEMENT OF CASH FLOWS – reports inflows (receipts) and
outflows (payments) of cash during the accounting period in the
categories of operating, investing, and financing.
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The Four Basic Financial Statements-ASPE
1. BALANCE SHEET– reports the amount of assets (resources owned),
liabilities (amounts owed), and shareholders’ equity of an accounting
entity at a point in time.
2. STATEMENT OF INCOME – reports the revenues less the expenses
of the accounting period AND other gains and losses.
3. STATEMENT OF RETAINED EARNINGS – reports the accumulation
of profits that have not been distributed to shareholders, distribution
of profit (dividends) of the company during the accounting period.
4. STATEMENT OF CASH FLOWS – reports inflows (receipts) and
outflows (payments) of cash during the accounting period in the
categories of operating, investing, and financing.
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The Statement of Financial Position
Typical Account Titles
Assets
Cash
Short-Term Investment
Trade Receivables
Notes Receivable
Inventory (to be sold)
Supplies
Prepaid Expenses
Long-Term Investments
Land
Equipment
Buildings
Intangibles
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Liabilities
Trade Payables
Accrued Liabilities
Notes Payable
Taxes Payable
Deferred Revenue
Bonds Payable
Shareholders’ Equity
Contributed Capital
Retained Earnings
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The Statement of Financial Position
Elements
Assets
Economic resources controlled by the entity as a
result of past business events from which future
economic benefits may be obtained.
Liabilities
Debts or legal obligations of the entity that result
from past business events.
Shareholders’ Equity
Amount of financing provided by owners of the
corporation and from earnings over time.
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The Statement of Financial Position
The Accounting Equation
A = L + SE
(Shareholders’
Equity)
(Assets)
(Liabilities)
Economic
Resources
Sources of Financing for Economic
Resources
Liabilities: From Creditors
Shareholders’ Equity: From Shareholders
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The Statement of Financial Position
SUN-RYPE PRODUCTS LTD.
Statement of Financial Position
At December 31, 2012
(in thousands of Canadian dollars)
ASSETS
Cash
Trade receivables
Inventories
Prepayments
Property, plant, and equipment
Goodwill
Other assets
Total assets
LIABILITIES
Trade payables
Short-term borrowings
Provisions
Long-term borrowings
Other liabilities
Total liabilities
SHAREHOLDERS' EQUITY
Contributed capital
Retained earnings
Other components
Total shareholders' equity
Total
liabilities
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Ryerson
Limited and shareholders' equity
3,727
14,047
29,149
502
42,041
1,061
446
$ 90,973
25,672
3,646
1,687
8,781
4,151
43,937
18,421
28,681
(66)
47,036
$ 90,973
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The Statement of Comprehensive Income
Typical Account Titles
Revenues
Sales Revenue
Fee Revenue
Interest Revenue
Rent Revenue
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Expenses
Cost of Sales
Wages Expense
Rent Expense
Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense
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Statement of Comprehensive Income
SUN-RYPE PRODUCTS LTD.
Statement of Comprehensive Income
For the Year Ended December 31, 2012
(in thousands of Canadian dollars, except for EPS)
Revenues
Net sales
$ 152,795
Expenses
Cost of sales
125,474
Sales and marketing
11,699
Distribution
6,813
General and administrative
5,987
Finance costs
708
Total expenses
150,681
Earnings before income taxes
2,114
Income tax expense
847
Net earnings for the year
$ 1,267
Other comprehensive income (loss)
Foreign currency translation differences
(13)
Total comprehensive income (loss) for the year
$ 1,254
Earnings per share
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$ 2.92
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Statement of Comprehensive Income
Revenues
Earnings from the sale of goods or services.
Revenue is recognized in the period in which
goods and services are sold, not necessarily
the period in which cash is received.
When will the revenue from this transaction be recognized?
$1,000 sale made
on May 25.
May 2015
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X
Cash from sale
collected on June 10.
X
June 2015
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Statement of Comprehensive Income
Revenues
Earnings from the sale of goods or services.
Revenue is recognized in the period in which
goods and services are sold, not necessarily
the period in which cash is received.
When will the revenue from this transaction be recognized?
$1,000 revenue
recognized in May
May 2015
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June 2015
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Statement of Comprehensive Income
Expenses
The dollar amount of resources used up by the entity
to earn revenues during a period.
An expense is recognized in the period in which
goods and services are used, not necessarily
the period in which cash is paid.
When will the expense for this transaction be recognized?
Paid $75 cash on May 11
for newspaper ad.
X
May 2015
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Ad appears
on June 8.
X
June 2015
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Statement of Comprehensive Income
Expenses
The dollar amount of resources used up by the entity
to earn revenues during a period.
An expense is recognized in the period in which
goods and services are used, not necessarily
the period in which cash is paid.
When will the expense for this transaction be recognized?
Advertising expense
recognized in June.
May 2015
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June 2015
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Statement of Changes in Equity
Equity, beginning of the period
Plus: Net earnings for the year
Plus: Other comprehensive income
Less: Dividends
Plus/Less: Other changes, net
Equity, end of the period
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Statement of Changes in Equity
SUN-RYPE PRODUCTS LTD.
Statement of Changes in Equity
For the Year Ended December 31, 2012
(in thousands of Canadian dollars)
Contributed Retained
Other
Capital
Earnings Components
Balance as at Jan. 1, 2012
Net earnings for the year
Other comprehensive income (loss)
Repurchase and cancellation of shares
Distribution of dividends
Balance as at Dec. 1, 2012
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$ 18,518
$ 27,914
1,267
($ 53)
(13)
(97)
$ 18,421
(500)
$ 28,681
($ 66)
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Statement of Cash Flows
Because
revenues reported
do not always equal
cash collected. . .
. . . and expenses
reported do not
always equal
cash paid . . .
Net earnings are
usually not equal
to the change
in cash for
the period.
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Statement of Cash Flows
SUN-RYPE PRODUCTS LTD.
Statement of Cash Flows
For the Year Ended December 31, 2012
(in thousands of Canadian dollars)
Operating activities
Cash collected from customers
Cash paid to trade suppliers
Cash paid for operating expenses
Cash paid for interest
Cash received for taxes (income tax refund)
Net cash flow from operating activities
Investing Activities
Cash paid to purchase property, plant,
and equipment
Net cash flow used for investing activities
Financing Activities
Cash received from borrowings
Repayment of borrowings
Repurchase of own shares
Cash paid for dividends
Net cash provided by financing activities
Net increase in cash during the year
Cash at beginning of year
Effect of exchange rate changes on cash
Cash at end of year
$
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152,181
(111,202)
(23,907)
(826)
1,690
17,936
(1,418)
(1,418)
1,502
(14,264)
(97)
(500)
(13,359)
3,159
571
(3)
3,727
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Relationships Among the Statements
1.
Net earnings from the income statement
results in an increase in ending retained
earnings on the statement of changes in
equity.
Income Statement
Revenues
$ 152,795
151,518
Expenses
Net earnings $ 1,267
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Statement of Changes in Equity
Beginning retained earnings $ 27,914
Net earnings
1,267
Dividends
(500)
Ending retained earnings
$ 28,681
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Relationships Among the Statements
2.
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.
Statement of Changes in Equity
Retained
Earnings
Beginning retained earnings
$ 27,914
Net earnings
1,267
Dividends
(500)
Ending retained earnings
$ 28,681
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Statement of Financial Position
Cash
Other assets
Total assets
Liabilities
Contributed capital
Retained earnings
Other equity components
Total liabilities and equity
$
3,727
87,246
$ 90,973
$ 43,937
18,421
28,681
(66)
$ 90,973
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Relationships Among the Statements
3.
The change in cash on the statement of
cash flows is added to the beginning-of-year
balance in cash to arrive at end-of-year cash
on the statement of financial position.
Statement of Cash Flows
Cash flows from operating activities
Cash flows from investing activities
$ 17,933
(1,418)
Cash flows from financing activities
Change in cash
Beginning cash balance
Ending cash balance
(13,359)
$ 3,156
571
$ 3,727
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Statement of Financial Position
Cash
$ 3,727
Other assets
87,246
Total assets
Liabilities
Contributed capital
Retained earnings
Other equity components
Total liabilities and equity
$ 90,973
$ 43,937
18,421
28,681
(66)
$ 90,973
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Notes
All financial statements should be accompanied by
notes which provide the reader with supplemental
information about the financial condition and
results of operations of the company.

Three types . . .
Describe accounting rules applied.
Present additional detail about an item on the
financial statements.
Provide additional information about an item not on
the financial statements.
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Management Uses of Financial Statements
Marketing managers and credit managers use
customers’ financial statements to decide
whether to extend credit.
Purchasing managers use suppliers’ financial
statements to decide whether suppliers have the
resources to meet the demand for products.
Employees’ union and human resource
managers use the company’s financial
statements as a basis for contract negotiations
over pay rates.
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Responsibilities for the Accounting
Communication Process
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Effective communication means that
the recipient understands what the
sender intends to convey.
Decision makers need to understand
accounting measurement rules.
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Responsibilities for the Accounting
Communication Process
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The Rules
International
Financial
Reporting
Standards
(IFRS)
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How are IFRS and Generally Accepted
Accounting Principles Determined?
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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.
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Generally Accepted Accounting Principles
Securities Act of 1933
Securities and Exchange Act of 1934
The Securities and Exchange Commission (SEC)
has been given broad powers to determine
measurement rules for financial statements in the U.S.
The Ontario Securities Commission (OSC)
has been given broad powers to determine
measurement rules for financial statements in Canada.
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Generally Accepted Accounting Principles
The OSC has worked closely with the
accounting profession to
work out the detailed rules that have
become known as GAAP.
Currently, the Accounting Standards Board (AcSB)
is recognized as the body to formulate GAAP in Canada.
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Generally Accepted Accounting Principles
Companies incur the cost of preparing
the financial statements and bear the
following economic consequences . . .
 Effects on the selling price of shares.
 Effects on the amount of bonuses
received by managers and other employees.
 Loss of competitive information to other
companies.
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International Perspective
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International Financial Reporting Standards
Since 2002, there has been substantial movement toward the
adoption of International Financial Reporting Standards (IFRS)
issued by the International Accounting Standards Board (IASB).
Examples of jurisdictions currently requiring the use of IFRS include:
• All countries in the European Union
• Australia and New Zealand
• Hong Kong, China, India, Malaysia, and South Korea
• Israel and Turkey
• Argentina, Brazil and Chile
• Canada and Mexico
In the United States, the Securities and Exchange Commission (SEC)
now allows foreign companies whose shares are traded in the U.S. to
use IFRS and is considering allowing the same for domestic companies
in the future.
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Management Responsibility and the Demand
for Auditing
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To ensure the accuracy of the company’s
financial information, management:
 Maintains a system of controls.
 Hires outside independent auditors.
 Forms a committee of the board of directors to
review these two safeguards.
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Independent Auditors
 Auditors
express an opinion
as to the fairness of the
financial statements.
 Independent auditors have
responsibilities that extend
to the general public.
 The CPAB issues detailed
auditing standards that
auditors must follow.
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Overall, I believe
these financial
statements are
fairly stated.
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Independent Auditors
An audit involves . . .
 Examining the financial reports to
ensure compliance with GAAP.
 Examining the underlying
transactions incorporated into the
financial statements.
 Expressing an opinion as to the
fairness of presentation of financial
information.
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Accounting Designations
Chartered Professional Accountant = CPA
(newly amalgamated organization of many provincial CA,
CMA, and CGA organizations effective January 1, 2013)
Chartered Accountant = CA
Certified Management Accountant = CMA
Certified General Accountant = CGA
Certified Public Accountant = CPA*
(* in USA)
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Ethics, Reputation, and Legal Liability
The Chartered Professional Accountants of
Canada (CPA) and the Canadian Institute of
Chartered Accountants (CA) require that all
members adhere to a professional code of
ethics. The other accounting professions
have similar requirements.
Code of
Ethics
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Ethics, Reputation, and Legal Liability
A CPA’s reputation for honesty and
competence is his/her most important asset.
Like physicians, CPAs, CAs, CMAs, and CGAs
have liability for malpractice.
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Appendix 1A: Types of Business Entities
Sole Proprietorship: owned by a single individual.
Partnership: owned by two or more individuals.
Corporation: ownership represented by shares of stock.
Advantages of a Corporation
 Limited liability
 Continuity of life
 Ease of transfer of ownership
 Opportunity to raise large amounts of money
Disadvantage of a Corporation
 Double taxation
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Appendix 1B: Employment in the Accounting
Profession Today
Professional
Designations
CPA
CA
CMA
CGA
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Career Opportunities
Public Accounting
 Audit and Assurance Services
 Management Consulting Services
 Tax Services
Employment by Organizations
 Internal accounting
 External reporting
 Tax planning
 Various other functions
Employment in the Public and Notfor-Profit Sector
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End of Chapter 1
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