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CHAPTER 2:A FURTHER LOOK AT FINANCIAL STATEMENTSFINANCIAL ACCOUNTINGTools for Business Decision-MakingKIMMEL WEYGANDT KIESO TRENHOLM IRVINESO 1: Identify the sections of a classified statement of financial position.SO 2: Identify and calculate ratios for analyzing a companys liquidity, solvency, and profitability.SO 3: Describe the framework for the preparation and presentation of financial statements.

STUDY OBJECTIVESClassified Statement of Financial PositionA classified statement of financial position generally contains the following standard classifications:AssetsLiabilities and Shareholders Equity- Current assets- Current liabilities Investments- Non-current liabilities Property, plant & equipment- Shareholders equity- Intangible assets- Share capital Goodwill- Retained earningsCurrent AssetsAssets expected to be converted to cash or used in the business within one year or one operating cycle, whichever is longerOperating cycle is the average time it takes to go from cash to cash in producing revenueUsually listed in order of liquidity:Reverse order of liquidity also possibleExamples include cash, short-term (trading) investments, accounts receivable, merchandise inventory, and prepaid expensesNon-Current AssetsAssets not expected to be converted to cash or used in the business within one year or one operating cycleAll assets not considered currentExamples:InvestmentsProperty, plant, and equipmentIntangible assets and goodwillOther assetsLong-Term InvestmentsMulti-year investments in:Debt securities: loans, notes, bonds, mortgagesEquity securities: shares of other companiesThese assets are normally not intended to be sold (and converted to cash) within one yearProperty, Plant, and EquipmentTangible assets with relatively long useful livesUsed in operating the businessExamples:LandBuildingsEquipmentFurnitureUsually listed in order of permanencyDepreciationAllocation of the cost of property, plant, and equipment over their estimated useful lives:Companies systematically assign a portion of the cost of an asset to expense each yearUnder IFRS, this allocation is referred to as depreciation for property, plant, and equipment, and amortization for intangible assetsUnder ASPE, amortization is often used instead of depreciationDepreciation (continued)The cost of long-lived assets with indefinite lives is not depreciated (e.g. land) Accumulated depreciation account shows the total amount of depreciation taken to dateThe difference between the cost of the asset and its accumulated depreciation is referred to as the carrying amount of the assetIntangible AssetsNon-current assets that do not have physical substance and represent a privilege or a right held by the companyExamples: Patents, copyrights, trademarks, licensesGoodwill: excess price paid on acquisition of another companyGenerate a future value to the companyAmortized if they do not have an indefinite lifeCurrent LiabilitiesObligations that are to be paid within the (longer of the) coming year or one operating cycleExamples:Bank indebtednessAccounts payableUnearned revenueBank loan/notes payableCurrent maturities of long-term debt

Non-Current LiabilitiesDebts expected to be paid or settled after one yearExamples:Bank loan/notes payableLease obligationsPension and benefit obligationsDeferred income tax liabilitiesUsually accompanied by extensive notes to the financial statementsShareholders EquityShare capital:Investment of cash (or other assets) in the company by shareholders in exchange for preferred or common sharesRetained earnings:Cumulative profits kept for use in the company

Discussion QuestionWhat do you think would be the main asset, liability, and equity items for a Tim Hortons franchise?

Using the Financial StatementsSpecific tools can be used to analyze the financial statementsRatio analysis expresses the relationships between selected financial statement dataUse comparisons to aid in analyses:Intracompany comparisons cover two or more years for the same companyIntercompany comparisons between the company and a competitorIndustry average comparison based on averages for particular industriesLiquidity RatiosMeasure a companys short-term ability of to pay its maturing obligations and to meet its unexpected needs for cashWorking capital=Current assets Current liabilitiesCurrent ratio=Current assetsCurrent liabilitiesHigher is generally betterSolvency RatiosMeasure a companys ability to survive over a long period of time:The higher the percentage of debt to total assets, the greater the risk that debts cannot be repaid when they are dueDebt to total assets=Total liabilitiesTotal assetsLower is generally betterProfitability RatiosMeasure a companys operating success of for a given period of time

Earnings per share=Profit available to common shareholdersWeighted average number of common sharesPrice-earnings ratio=Market price per shareEarnings per shareHigher is generally betterConceptual Framework of AccountingGuides decisions about:what to present in financial statementsalternative ways of reporting economic eventsappropriate ways of communicating this informationConceptual Framework for Financial ReportingFive main sections:Objective of financial reportingQualitative characteristics of useful financial informationUnderlying assumptionsElements of financial statementsMeasurement of the elements of financial statementsDiscussion QuestionWhy is a conceptual framework of accounting important?

Objective of Financial ReportingTo provide financial information that is useful to existing and potential investors, lenders and other creditorsWho are making decisions about providing resources to a company:Buying, selling, holding equity and debt Providing or settling loans or other creditFinancial information is provided by general purpose financial statementsQualitative Characteristics of Accounting InformationRelevance:Information has relevance if it makes a difference in users decisionsMay have predictive value and/or confirmatory valueMateriality is important: will information influence the decisions of users? Faithful representation:Information should reflect economic realityIt must be complete, verifiable and free from material errorEnhancing Qualities of Useful InformationComparability:Users can identify and understand similarities and differences among itemsVerifiability:Independent consensus that information is faithfully representedTimeliness:Available before it loses its usefulness in decision-makingUnderstandability:Classified, characterized and presented clearly and conciselyCost ConstraintEnsures that the value of the information provided by financial reporting is greater than the cost of providing itThe benefits of financial reporting should justify the costs of providing and using itGoing Concern AssumptionThe business will continue operating in the foreseeable futureThe key assumption provides a foundation for accountingProvides justification for using cost as the value of certain assetsElements of Financial StatementsAssetsLiabilitiesEquityRevenuesExpensesMeasurement of the ElementsAccountants have developed principles that describe when and how the elements of financial statements should be:RecognizedMeasured, andReportedKnown as generally accepted accounting principlesGenerally Accepted Accounting PrinciplesHistorical cost:Assets and liabilities should be recorded at their cost when acquiredNot only at time of purchase, but throughout the life of each asset and liabilityFair value:Certain assets and liabilities should be recorded and reported at fair valueIn choosing between these two, apply the concepts of relevance and representational faithfulnessComparing IFRS and ASPE

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