Week1 2012 Lec

27
(1) Financial Statements, the

Accounting Cycle and Conceptual
Framework
28
Transaction Analysis
CMA Accelerated Program 2012/2013 Lecture Student Weekly File - Week 1
1 of 32 CMA Ontario, 2012
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Review of Transaction Analysis
30
Adjusting Entries Prepaid Expenses
costs are initially recorded as assets and allocated to
expenses of future periods. Examples: prepaid rent and
insurance, ofce supplies, plant and equipment
you start the year with $3,500 of ofce supplies. During
the year you purchase $7,000 of supplies. At the end of
the year, the inventory count reveals that there are
$2,700 of supplies on hand.
on June 1, 20x7 you purchased a two year insurance
policy at a cost of $6,600. The date is December 31,
20x7 and you adjust your accounts annually.
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Adjusting Entries Unearned
Revenues
cash received in advance of service provided -
the unearned revenues are classied as
liabilities until the service is rendered
examples: rent collected in advance,
subscriptions collected in advance, gift
certicates, deposits on special orders
you just opened a health club on April 1, 20x7.
On the rst day you sold 100 one year
memberships at $960 each. What is the
adjusting entry on December 31?
32
Adjusting Entries Accrued
Liabilities
expenses incurred in current period, but for which payment
will occur in future periods
no cash ow on recording, only when paid
examples: payroll, income taxes, interest, electricity
on May 1, 20x7 you took out a 7.5% loan for $250,000.
Interest and principal are payable on May 1, 20x8. It is
now December 31, 20x7 and you prepare nancial
statements annually.
the last payroll was for the two weeks ended Aug 28.
Average daily wages are $3,000/day and you operate 365
days a year. It is now Aug 31 and you prepare monthly
nancial statements.
33
Adjusting Entries Accrued Asset
record revenue and corresponding receivable in
period earned, receive payment in the future
examples: credit sales, rent revenue, interest
receivable
you lend $100,000 to another entity on
October 31, 20x2. The interest rate on the
note is 8%. The note and the interest are
payable on October 31, 20x3. What is the
adjusting entry at December 31, 20x2?
34
Closing the Accounts
all expense and revenue accounts are
temporary accounts - at year end they get
reset to zero; offsetting amount is net income
and gets recorded to retained earnings
dividends are normally debited directly against
the retained earnings account
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Sales Contra Accounts
Sales Sales Discounts
normal early
credit payment
balance discounts
Sales Returns Sales Allowances
merchandise customer
returned keeps
merchandise
but a credit
is given
36
Inventory Systems
perpetual systems: inventory is continually
updated
inventory purchases and sales are recorded
directly in the inventory account
periodic systems: inventory is counted at the
end of each year
inventory purchases are debited to the
Purchases account
cost of goods sold is computed at year end
37
Periodic Systems Inventory
Accounts
Purchases Transportation- I n Purchase Discounts
normal freight early
debit charges payment
balance discount
Purchase Returns Purchase Allowances
merchandise we keep
returned merchandise
but is given
a credit
38
Periodic Systems Calculating
COGS
the purchase account and all contra accounts
are closed out to zero
the inventory account is adjusted to what the
ending balance should be
the amount to balance is equal to cost of goods
sold
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Periodic System - Calculating
COGS Example
Dr. Cr.
Inventory $250,000
Purchases 1,650,000
Transportation-in 18,000
Purchase returns and allowances $25,600
Purchase discounts 5,800
An inventory count at year-end shows that the ending
inventory cost is $285,000. Prepare the journal entry
to record the cost of goods sold.
Problem 1 Financial Statements

The following summarized transactions (in thousands of dollars) occurred during the year
ended December 31, 20x2 for Ruiz Pharmacy, a publicly accountable entity:

a. Merchandise inventory purchased on account was $520.
b. Total sales were $900, of which 80% were on credit.
c. The merchandise inventory as at December 31, 20x2 was $240.
d. Collections from credit customers were $700.
e. The notes receivables are from a major supplier of vitamins. Interest for twelve
months on all notes was collected on May 1. The rate is 12% per annum.
f. The principal on the current notes was collected on May 1, 20x2. The principal on
the remaining notes is payable on May 1, 20x5.

Cash disbursements were:

g. To trade creditors, $500.
h. To employees for wages, $193.
i. For miscellaneous expenses such as store rents, advertising, utilities and supplies,
which were all paid in cash, $189.
j. For new equipment acquired on July 1, 20x2, $74.
k. To the insurance company for a new three-year fire insurance policy effective
September 1, 20x2, $36.
l. To the Canada Revenue Agency for income taxes, $19.
m. The board of directors declared cash dividends of $26 on December 15 to be paid
on January 21.

The following adjustments were made on December 31, 20x2:

n. For the interest on the note receivable.
o. For insurance.
p. For depreciation - depreciation expense for 20x2 was $30.
q. Wages earned but unpaid, December 31, 20x2, $15
r. Total income tax expense for 20x2 is $20, computed as 40% of pretax income of
$50.

Required -

1. Post all of the above transactions in T-Accounts.
2. Prepare an income statement, statement of retained earnings and balance sheet for
20x2.
RUIZ PHARMACY

Assets BALANCE SHEET Liabilities & Equity

Cash
Accounts
Receivable

Accounts Payable

B 21 B 100 100 B

Note Receivable -
Current

Wages Payable

B 100 8 B

Accrued Interest
Receivable
Income Taxes
Payable

B 16 4 B

Merchandise
Inventory

Prepaid Insurance

Dividends Payable

B 160 B 3

Note Receivable
Long-Term

Common Stock

B 100 110 B

Equipment
Accumulated
Depreciation

Retained Earnings

B 110 66 B 322 B

Expenses INCOME STATEMENT Revenues

Cost of goods sold Salaries & Wages Sales

Miscellaneous Insurance Interest Revenue

Income Tax Depreciation


Anne Spier has prepared baked goods for resale for several years now. She started a
baking business in her home and has been operating in a rented building with a storefront.
Spier incorporated this business as MAS Inc. on January 1, 20x2, with an initial shares
issue of 1,000 shares of common share for $2,500. Anne Spier is the principal
shareholder of MAS Inc.

Sales have increased 30%, annually since operations began at the present location, and
additional equipment is needed to accommodate expected continued growth. Spier wishes
to purchase some additional baking equipment and to finance the equipment through a
long-term note from a commercial bank. Kelowna Bank & Trust has asked Spier to
submit an income statement for MAS Inc. for the first five months of 20x2 and a balance
sheet as of May 31, 20x2. MAS is a private company and has adopted ASPE.

Spier assembled the following information from the corporation's cash basis records for
use in preparing the financial statements requested by the bank.

1. The bank statement showed the following 20x2 deposits through May 3l.

Sale of common shares $ 2,500
Cash sales 22,770
Rebates from purchases 130
Collections on credit sales 5,320
Bank loan proceeds 2,880
$33,600

2. The following amounts were disbursed through May 31, 20x2.

Baking materials $14,400
Rent 1,800
Salaries and wages 5,500
Maintenance 110
Utilities 4,000
Insurance premium 1,920
Equipment 3,000
Principal and interest payment on bank loan 312
Advertising 424
$31,466

3. Unpaid invoices at May 31, 20x2, were as follows.

Baking materials $ 256
Utilities 270
$ 526

4. Customer records showed uncollected sales of $4,226 at May 31, 20x2.

5. Baking materials costing $1,840 were on hand at May 31, 20x2. There were no
materials in process or finished goods on hand at that date. No materials were on
hand or in process and no finished goods were on hand at January 1, 20x2.

6. The note evidencing the 3-year bank loan is dated January 1, 20x2, and states a
simple interest rate of 10%. The loan requires quarterly payments on April 1, July
1, October 1, and January 1 consisting of equal principal payments plus accrued
interest since the last payment.

7. Anne Spier receives a salary of $750 on the last day of each month. The other
employees had been paid through Friday, May 25, 20x2, and were due an
additional $240 on May 31, 20x2.

8. New display cases and equipment costing $3,000 were purchased on January 2,
20x2, and have an estimated useful life of five years. These are the only fixed
assets currently used in the business. Straight line depreciation is to be used.

9. Rent was paid for six months in advance on January 2, 20x2.

10. A one-year insurance policy was purchased on January 2, 20x2

11. MAS Inc. is subject to an income tax rate of 20%.

12. Payments and collections pertaining to the unincorporated business through
December 31, 20x1 were not included in the corporation's records, and no cash
was transferred from the unincorporated business to the corporation.

Required -

Using the accrual basis of accounting, prepare for MAS Inc.:
(a) An income statement for the five months ended May 31, 20x2
(b) A balance sheet as of May 31, 20x2.

Morrow Wholesale has kept limited records and has never had an audit until 20x2. As the
senior auditor in charge of the audit, you have been presented with the following
information:
a) Morrow is incorporated and initially sold 11,000 of its common shares for $25 per
share. There have been no other common share transactions.

b) Cash balance in cheque book, December 31,20x1 $ 24,000
Deposits during 20x2:
Cash sales $250,000
Proceeds of $5,000 note issued on July 1 and
bearing interest at 12%, payable annually 5,000
Customer collections 146,000
Proceeds on sale of fully depreciated
equipment (original cost, $20,000) 5,000
$406,000
Cheques written during 20x2:
Purchases of merchandise $180,000
Salaries 10,000
Advertising (to be run in 20x3) 10,000
Miscellaneous expenses 5,500
$205,500
c) Morrow had no outstanding payables at the beginning of 20x2 but owes creditors
$36,000 for unpaid purchases of merchandise on December 31, 20x2.
d) In 20x2 Morrow began selling on a cash-only basis. Receivables at the beginning
of 20x2 totalled $ 155,000. The uncollected receivables were written off as
miscellaneous expenses in 20x2.
e) Morrow's cost of goods sold is 80 percent of sales. The inventory at the beginning
of 20x2 was $80,000.
f) At the beginning of 20x2, equipment with a cost and accumulated depreciation of
$80,000 and $20,000, respectively, was on hand. All equipment is depreciated on
a straight-line basis over ten years with no estimated residual value. The sale of
equipment was made on December 30, 20x2.
g) Retained earnings at the beginning of 20x2 totaled $63,000. During the fourth
quarter of 20x2, a cash dividend of $10,000 was declared and is to be paid in
January 20x3.
h) Morrow's only other asset at the beginning of 20x2 was an investment in
Honeydew common shares. During 20x2 these shares were exchanged for land
and a gain of $4,000 was recognized.
i ) The income tax rate is 30 percent.
j ) At the end of 20x2, sales salaries of $1,600 have accrued but have not been paid.

Prepare an income statement for the year ended December 31, 20x2, and a balance sheet
at December 31, 20x2, for Morrow Wholesale. Morrow Wholesale is a private company
and has adopted ASPE.
40
Financial Statements
41
Components of Financial
Statements
IAS 1 states that a complete set of nancial statements
comprises of the following:
(a) a statement of nancial position as at the end of
the period,
(b) a statement of comprehensive income for the
period,
(c) a statement of changes in equity for the period,
(d) a statement of cash ows for the period
(e) a set of notes, which provide a summary of the
entity's signicant accounting policies along with
other explanatory information
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Statement of Comprehensive
Income (Income Statement)
IAS1 requires the presentation of expenses
using a classication based on either the
nature of expenses or their function within the
entity, whichever provides information that is
reliable and most relevant
the chosen analysis does not need to be shown
on the face of the income statement - it can
be detailed in the notes
the choice depends on historical and industry
factors and the nature of the entity
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Income Statement - contd
analysis of expenses by nature - i.e.
depreciation, purchases of materials, transport
costs, employee benets and advertising costs
analysis of expenses by function - i.e. cost of
sales, cost of distribution and administrative
activities
44
45
46
Income Statement - Minimum Disclosures
revenues
cost of goods sold
nance costs
share of prot or loss of associates and joint ventures
accounted for using the equity method
tax expense
discontinued operations: prot or loss + re-measurement
to FV less costs to sell
prot or loss
47
The Statement of Changes in
Shareholders Equity
48
The Statement of Financial Position
49
50
Statement of Financial Position -
General
ordering by liquidity is required if it provides
information that is reliable and more relevant
no offsetting (netting out) is allowed
order or format is not prescribed, only
recommended
51
Current Assets
a current asset is dened as follows:
it is expected to be realized in, or is intended for sale or
consumption in, the entitys normal operating cycle
it is held primarily for the purpose of being traded
it is expected to be realized within 12 months, or
it is cash or a cash equivalent.
cash, marketable securities, accounts receivable, inventory,
prepaids
valuation: lower of cost or market (market dened as NRV);
except marketable securities which are valued at market
52
Noncurrent assets
dened by what they are not: they are not
current assets
long-term investments
tangible capital assets: land, buildings and
equipment
accumulated depreciation account is a
contra account
intangible capital assets
amortization reduces the asset account
valuation: cost or revaluation models, subject
to impairment test
53
Liabilities
a liability is classied as current when it satises any of
the following criteria:
it is expected to be settled in the entitys normal
operating cycle,
it is held primarily for the purpose of being traded,
it is due to be settled within 12 months, or
the entity does not have an unconditional right to
defer settlement of the liability for at least 12
months
accounts payable, bank indebtedness, dividends payable,
returnable deposits, unearned revenues, sales taxes,
employee related liabilities
54
Long-term liabilities
long-term debt and lease obligations
deferred credits:
pension liability
deferred income taxes
55
Accounting Standards in Canada
publicly accountable entities follow IFRS
private enterprises can chose between
Accounting Standards for Private Enterprises
(ASPE) or IFRS
non-prot organizations follow accounting
standards for non-prot organizations
pension plans follow their own accounting
standards
these comprise Parts I, II, III and IV of the
CICA Handbook respectively
56
ASPE Differences
the Statement of Financial Position is called a Balance Sheet
the order of the Balance Sheet is traditional: current assets
before noncurrent assets; current liabilities, then noncurrent
liabilities followed by shareholders equity
there is no statement of comprehensive income, just an income
statement (no other comprehensive income in ASPE)
a statement of changes in shareholders equity is not required;
a statement of changes in retained earnings is required instead
format of the income statement is unspecied; the standards
require minimum disclosures
57
Conceptual Framework
58
What is a Conceptual Framework
a conceptual framework is a statement of generally
accepted theoretical principles which form the frame of
reference for a particular eld of inquiry
these theoretical principles provide the basis for both
the development of new reporting practices and the
evaluation of existing ones
a conceptual framework will form the theoretical basis
for determining which events should be accounted for,
how they should be measured, and how they should be
communicated to the user
59
Users and their Information Needs
conceptual framework focuses on current and potential
creditors and shareholders - these need information to
help them assess the prospects for future net cash
inows to an entity
primary users are considered those who do not
otherwise have access to internal information and
need to rely on general purpose statements
nancial statements are not primarily directed to other
user groups such as regulators and members of the
public
60
Objectives of Financial Reporting
to provide information about the nancial position, performance and
changes in nancial position of an entity that is useful to users in
making economic decisions, including:
the evaluation of the ability of the entity to generate cash
and the timing and certainty of this generation,
information about the economic resources controlled by the
entity,
information about the nancial structure of the entity,
information about liquidity and solvency of the entity,
information about the performance and the variability of
performance of the entity, particularly its protability, and
information about changes in the nancial position of the
entity.
to show the results of the stewardship of management, dened as
how efciently and effectively the entitys management and board
have discharged their responsibilities to use the entitys
resources.
61
Underlying Assumptions
accrual basis - the effects of transactions and other
events are recognized when they occur (and not as cash,
or its equivalent, is received or paid) and they are
recorded in the accounting records and reported in the
nancial statements of the periods to which they relate.
going concern - the nancial statements are normally
prepared on the assumption that an entity is a going
concern and will continue in operation for the
foreseeable future.
62
Qualitative characteristics of
useful nancial information
fundamental qualitative characteristics:
relevance (predictive and conrmatory value,
materiality)
faithful representation (complete, neutral
and free from error)
enhancing qualitative characteristics:
comparability, veriability, timeliness and
understandability
the cost constraint
63
Relevance
information is relevant if it is capable of
making a difference in the decisions made by
users by helping them evaluate past, present
or future events (predictive value) or
conrming, or correcting, their past evaluations
(conrmatory role)
secondary characteristic: materiality
information is material if its omission or
misstatement could inuence the economic
decisions of users taken on the basis of the
nancial statements.
64
Faithful Representation
to be useful, nancial information must faithfully
represent the phenomena that it purports to represent
three characteristics of faithful representation:
completeness - all information necessary for a user
to understand the phenomenon being depicted,
including all necessary descriptions and
explanations
neutrality - no bias in the selection or
presentation of nancial information. Financial
statements are not neutral if, by the selection or
presentation of information, they inuence the
making of a decision or judgment in order to
achieve a predetermined result or outcome.
free from material error
65
Enhancing Qualitative
Characteristics
comparability - accounting information is comparable
with previous periods (interperiod comparability or
consistency) and comparable to other rms operating in
the same industry (interrm comparability)
veriability - different knowledgeable and independent
observers could reach consensus, although not
necessarily complete agreement, that a particular
depiction is a faithful representation
timeliness - having information available to decision
makers in time to be capable of inuencing their
decisions
understandability - nancial statements must be readily
understandable by users. Users are assumed to have a
reasonable knowledge of business and economic activities
and accounting and a willingness to study the information
with reasonable diligence
66
Elements of Financial Statements
Asset - a resource controlled by the entity as a result
of past events and from which future economic benets
are expected to ow to the entity
Liability is dened as a present obligation of the entity
arising from past events, the settlement of which is
expected to result in an outow from the entity of
resources embodying economic benets
Equity is dened as the residual interest in the assets of
the entity after deducting all its liabilities.
67
Elements of Financial Statements - contd
income is dened as increases in economic
benets during the accounting period in the
form of inows or enhancements of assets or
decreases of liabilities that result in increases
in equity, other than those relating to
contributions from equity participants.
income = revenues + gains
revenue arises in the course of the ordinary
activities of an entity
gains represent other items that meet the
denition of income and may, or may not,
arise in the course of the ordinary activities
of an entity
68
Elements of Financial Statements - contd
Expenses are dened as decreases in economic
benets during the accounting period in the
form of outows or depletions of assets or
incurrences of liabilities that result in
decreases in equity, other than those relating
to distributions to equity participants.
Capital maintenance adjustments - the
revaluation or restatement of assets and
liabilities gives rise to increases or decreases in
equity. While these increases or decreases
meet the denition of income and expenses,
they are not included in the income statement.
69
Measurement Basis
Historical cost - assets are recorded at the
amount of cash or cash equivalents paid or the
fair value of the consideration given to acquire
them at the time of their acquisition. Liabilities
are recorded at the amount of proceeds
received in exchange for the obligation, or in
some circumstances (for example, income
taxes), at the amounts of cash or cash
equivalents expected to be paid to satisfy the
liability in the normal course of business.
70
Measurement Basis - contd
Current Cost - assets are carried at the
amount of cash or cash equivalents that would
have to be paid if the same or an equivalent
asset was acquired currently. Liabilities are
carried at the undiscounted amount of cash or
cash equivalents that would be required to
settle the obligation currently.
71
Realizable (settlement) value - assets are
carried at the amount of cash or cash
equivalents that could currently be obtained by
selling the asset in an orderly disposal.
Liabilities are carried at their settlement
values; that is, the undiscounted amounts of
cash or cash equivalents expected to be paid to
satisfy the liabilities in the normal course of
business.
72
Present value - assets are carried at the
present discounted value of the future net
cash inows that the item is expected to
generate in the normal course of business.
Liabilities are carried at the present discounted
value of the future net cash outows that are
expected to be required to settle the liabilities
in the normal course of business.
73
ASPEs Conceptual Framework
1. Understandability
2. Relevance: predictive value feedback value,
timeliness
3. Reliability: representational faithfulness,
veriability, neutrality, conservatism
4. Comparability
Week 1
Homework File

Suggested study plan for this week:

Primary List Secondary List

1. Review what we did in class on Saturday.

2. Financial Statements
MCQ, Problems 1, 2, 3, 4, 5 Problems 6, 7, 8, 9, 10, 11

3. If you have time and have not done so already, work through the Financial
Accounting Review Manual - especially chapter 1.

4. Prepare the Week 1 Quiz

* Problem numbers refer to the problems with solutions located in the course materials.


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(1) Financial Statements, the

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