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
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
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
3. The obligation must require the likely sacrifice of future
economic resources that the firm has little or no discretion
4. The obligation must be measureable with sufficient
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)
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