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Financial Statements
Chapter 1

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Learning Objective 1
Explain why accounting is the language
of business

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The Language of Business?

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The Language of Business!

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The Basic Objective of


Accounting
The basic objective of accounting is to identify and
measure the activities of a business entity in
order to evaluate its performance and to assess its
financial health; then communicate the results to
stakeholders through a set of accounting
reports that contain useful information so as to
help them make rational economic decisions.

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Users of Accounting Information


External to Business

Internal to Business

Investors
Creditors
Government (e.g., CRA and

Management

regulators)
Financial
Non-profit
organizations
Accountin
Customers
g
Suppliers
Employees and employee
unions

Manageri
al
Accountin
g

Back
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Financial Statements
Financial Statements are the business documents
that companies use to report the results of their
activities to various user groups. The system of
accounting produces the following statements:

Income
Statement

Statement of
Retained Earnings

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Balance
Sheet Statement of
Cash Flow

Learning Objective Three


Describe the purpose of each financial
statement and explain the elements of
each one

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The Financial Statements


Question

Financial
Statement

Answer

How well did the


company perform
during the year?

Income
statement

Revenues
Expenses
Net income or (net loss)

Why did the companys Statement of


retained earnings
retained
change during the year? earnings

Beginning retained
earnings
+ Net Income (-Net Loss)
Dividends
Ending retained earnings

What is the companys


financial position at
year-end?

Balance sheet

Assets = Liabilities +
Owners equity

How much cash did the


company generate and
spend during the year?

Statement of
cash flows

Operating cash flows


+/ Investing cash flows
+/ Financing cash flows
Increase(decrease) in cash

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The Income Statement


Also called the Statement of Operations or

Statement of Earnings
Reports two main categories

Revenues and gains


Expenses and losses

Shows the bottom line

Net income or net loss for the period

Net income is the most important item in the


financial statements

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Income Statement
Reports revenue and expenses

These accounts are only reported on the Income


Statement

Shows net income or net loss

If revenues exceed expenses, company has net income


If expenses exceed revenues, company has net loss

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ABC Corporation
Income Statement
Year Ended December 31, 2015

Net sales

$XX,XXX

Other revenue

XX,XXX

Total revenues

XX,XXX

Cost of goods sold

XX,XXX

Gross profit

XX,XXX

Selling, general, and administrative


expenses

XX,XXX

Income from operations

XX,XXX

Interest expense

XX,XXX

Income before income taxes

XX,XXX

Income tax expense

XX,XXX

Net Income

$XX,XXX

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Statement of Retained Earnings


Retained earnings is portion of net income

company has kept over a period of years


Positive balance indicates revenues exceeded
expenses
Accumulated deficit indicates expenses have
exceeded revenues
Net income (or net loss) flows from the Income
Statement to the Statement of Retained Earnings

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Statement of Retained Earnings


Opens with beginning retained earnings balance
Adds net income (or subtracts net loss)

Flows from the Income Statement

Subtracts dividends
Reports ending retained earnings balance

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ABC Corporation
Statement of Retained Earnings
Year Ended December 31, 2015
Retained earnings, December 31,
2014
Plus: Net income
Less: Dividends
Retained earnings, December 31,
2015

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$XX,XXX
XX,XXX
XX,XXX
$XX,XXX

The Balance Sheet


Also called the Statement of Financial Position
Reports

Assets
Liabilities
Stockholders equity

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Balance Sheet
Reports assets, liabilities, and stockholders
equity

These accounts are reported only on the balance sheet

Shows that assets equal sum of liabilities and

stockholders equity
Reports retained earnings which comes from the
statement of retained earnings

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Statement of Financial Position

Assets
Liabilities

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Recognition

(Identification)
Measurement (Valuation)
Disclosure (Classification)

Assets: Recognition
Future benefits

R&D expensing

Rights to future benefits

Human Capital

Quantifiable

Intangibles

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Assets: Measurement
Historical Cost
Market Value

Replacement Cost (Entry Value)


Net Realizable Value (Exit Value)

Present Value of Future Cash Flows

Which Measure?
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Assets: Disclosure
Current Assets

Expected to be converted

Long-term Assets

Will be held longer than

to cash, sold or consumed


one year
in the next year or within
Include
the businesss operating
Property and equipment
cycle
Land
Whichever is longer
Buildings
Include
Computers
Cash and cash
Equipment
equivalents
Intangibles
Short-term investments
Long-term investments
Accounts and notes
receivable
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Inventory
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Liabilities: Recognition

Past transactions
Promise of payment
Quantifiable
Known date

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Liabilities: Measurement
Monetary liabilities: future cash flows or the

present value of future cash flows


Non-Monetary liabilities: the expected cost of
goods and services, or the money received

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Liabilities: Disclosure
Current Liabilities

Long-term Liabilities

Debts payable in the next

year or within the


businesss operating cycle
Include
Current maturities of
long-term debt
Accounts payable
Income taxes payable
Accrued expenses
payable

Debts payable more than

one year from balance


sheet date
Include
Long-term notes
payable
Bonds payable

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Stockholders Equity on the


Balance Sheet
Represents stockholders ownership of the

business assets
Represents residual interest in assets after all
liabilities are settled
Consists of:

(Common stock
Contributed surplus.. Chapter 11
(Retained earnings
Accumulated other comprehensive income (loss)

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The Statement of Cash Flows


Measures cash receipts and cash payments
Fourth required financial statement
Categorizes into three types of activities:

Operating
Investing
Financing

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Statement of Cash Flows


Reports cash flows from operating, investing, and
financing activities

Results in an increase or decrease

Shows whether cash increased or decreased

during the year


Reports ending cash as shown on the balance
sheet

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Cash Flow Categories


Operating activities

Cash receipts and payments from selling goods and


services

Investing activities

Purchasing & selling long-term assets

Financing activities

Issuing stock, paying dividends, borrowing, and


repayment of borrowed funds

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Learning Objective Four


Explain the relationships among the
financial statements

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Income
Statement
Statement of
Retained
Earnings

Balance Sheet

Statement of
Cash Flows
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Relationships between Financial


Statements
Income Statement
Year Ended December 31, 2015

Revenues

$XX,XXX

Expenses

(XX,XXX)

Net income

$XX,XXX

Statement of Retained Earnings


Year Ended December 31, 2015

Beginning retained earnings


Net income

$XX,XXX
XX,XXX

Cash dividends

(XX,XXX)

Ending retained earnings


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$XX,XXX

Statement of Retained Earnings


Year Ended December 31, 2015

Beginning retained earnings


Net income

$XX,XXX
XX,XXX

Cash dividends

(XX,XXX)

Ending retained earnings

$XX,XXX

Balance Sheet
December 31, 2015

Assets

$XX,XXX

Liabilities

$XX,XXX

Stockholders equity:
Common stock

$XX,XXX

Retained earnings
Total liabilities
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XX,XXX

and equity
Copyright 2015 Pearson Canada Inc.

$XX,XXX

Balance Sheet
December 31, 2015
Assets

$XX,XXX

Liabilities

$XX,XXX

Stockholders equity:
Common stock

$XX,XXX

Retained earnings

XX,XXX

Total liabilities and equity

$XX,XXX

Statement of Cash Flows


Year Ended December 31, 2015
Cash flows from operating activities

$XX,XXX

Cash flows from investing activities

XX,XXX

Cash flows from financing activities

XX,XXX

Net cash flows

XX,XXX

Cash balance, December 31, 2011

XX,XXX

Cash balance, December 31, 2012


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$XX,XXX
Copyright 2015 Pearson Canada Inc.

Cash from
the Asset
section of
the
Balance
Sheet
equals
ending
Cash on
the
Statement
of Cash
Flows

Learning Objective Two


Explain accountings conceptual
framework and underlying assumptions

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How Accounting Standards Are


Set
Accountants follow professional guidelines.

he rules that govern accounting are called GAA


(generally accepted accounting principles).

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GAAP
CICA Handbook: official source of GAAP;
sanctioned by federal and
provincial governments
and the Canadian Securities Administrators

Accounting Standards Board (AcSB)


Public Sector Accounting Standards Board
Emerging Issues Committee (EIC)
International Accounting Standards Board (IASB)
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International Financial Reporting


Standards (IFRS)

As commerce becomes more global and


accounting more complex, the existence
of different GAAP in countries made
comparisons between companies almost
impossible.

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International Financial Reporting


Standards (IFRS)
As a result, the International Accounting
Standards Board (IASB) was set up in 2001 to
issue International Financial Reporting Standards
(IFRS). These are being adopted in Canada (and
around the world) as generally accepted
accounting principles.

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Accountings Conceptual
Framework

How do accountants formulate the standards?

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Objective

To provide financial information that is useful to existing investors,


lenders, and other creditors in making decisions about providing
resources to that entity

Fundamental
Qualitative
Characteristics

Relevance
(includes materiality)

Comparability

Verifiability

Faithful representation

Timeliness

Enhancing
Qualitative
Characteristics
Constraints

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Cost
Financial Reporting
Standards
Copyright 2015 Pearson Canada Inc.

Understandabili
ty

Assumptions & Principles


Entity assumption

A business is a separate economic unit

Continuity (going- concern) assumption

Entity will continue to exist indefinitely

Historical cost principle

Assets recorded at purchase price

Stable monetary unit assumption

Dollars purchasing power is stable over time

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