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Financial Statements

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York University
ACTG 2010
David Stamos

Financial Statements  Compilation of accounting information by an entity  Most common are in form of an annual report by a public corporation for shareholders. These statements are usually referred to as general purpose (may not be suitable for all the varied needs of various users) financial statements. The F/S of Canadian public companies must comply with IFRS.  The F/S of public companies are prepared by management and are audited by an independent accounting firm which expresses an opinion on said F/S as to whether or not the F/S are materially misstated with respect to IFRS. This provides a form of safeguard to limit the self-interested behaviour of managers however considerable flexibility within IFRS still exists as we will see  Can be prepared weekly, monthly, quarterly or yearly 1 Elements of Financial Statements There are 5 components to a financial statement package under ASPE 1. The Balance Sheet 2. The Income Statement 3. The Statement of Retained Earnings or Deficit 4. The Cash Flow Statement 5. Notes to the Financial Statements Under IFRS, basically the same but the names change 1. Statement of Financial Position 2. Statement of Comprehensive Income 3. Statement of Changes in Equity for the Period 4. Statement of Cash Flows for the Period 5. Notes to the Financial Statements 1a. The Balance Sheet (B/S)  Provides information about the financial position of an entity at a SPECIFIC POINT in time. Like a photograph.  B/S shows relationship between the following elements - Assets, Liabilities and Owner’s Equity ASSETS = LIABILITIES + OWNERS EQUITY (OE) This equation must ALWAYS be in balance  ASSETS are economic resources that provide FUTURE BENEFITS to the entity in the course of carrying on its business such as cash, Accounts Receivable, Inventory, Equipment, supplies, buildings, cars, etc. 2 o For bookkeeping purposes, increases in assets are shown as debits. Decreases in assets are shown as credits o Assets on B/S are segregated based on liquidity. Current (<1 year) vs. non-current (> 1 yr) There are 3 criteria for asset recognition: 1. The firm owns or controls the right to use the item 2. This right is a result of a past transaction or exchange 3. The future benefit is measurable with sufficient reliability  LIABILITIES are the OBLIGATIONS of an entity to provide goods or services in the future or to pay debts. Includes bank loans, account payable, mortgage payable, unearned revenue, warranty reserves, etc. o For bookkeeping purposes, increases in liabilities are shown as credits while decreases are shown as debits. o Similar to assets, segregated based on liquidity. Current (<1 yr), vs. non-current (>1 yr). The criteria for liability recognition are as follows: 1. The item represents a present obligation (not intent) 2. The obligation must exist as a result of a past transaction or exchange 3. The obligation must require the likely sacrifice of future economic resources that the firm has little or no discretion to avoid 4. The obligation must be measureable with sufficient reliability 3  OWNERS’ EQUITY (OE) is the INVESTMENT the owners/shareholders have made in the entity. o Similar to liabilities, for bookkeeping purposes, increases in OE are shown as credits while decreases in OE are shown as debits. o OE consists of two components: 1. Direct Investments which are recorded in capital stock account (original capital investment in firm) and 2. Indirect Investments (ie. Retained Earnings) –which is the accumulation of net income or profit of the entity since inception less any dividends (distribution of profits) paid out to shareholders  Thus referring back to the equation A=L+OE we see that the left side shows the economic resources of the firm and the right side shows how these resources were financed (ie. either through debt or equity) In Class: Problem E2-1 from textbook Balance Sheet Ratio Analysis  Working capital = Current Assets-Current liabilities Gives an indication of the liquidity of a company. Liquidity is the entity’s ability to pay its obligations as they come due.  Current Ratio = Current Assets/Current Liabilities Generally the higher the ratio the better – but need to be careful how you interpret 4  Debt/Equity ratio = Liabilities/Shareholder’s Equity Gives a measure of risk and leverage of the firm and
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