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COMM 321 Midterm NOtes.docx

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COMM 321
Peter Blake

Chapter 1. The Canadian Financial Reporting Environment Objective of Financial Reporting: provide useful fin. Info for decision makers  emphasis on resource allocation decisions (Invest in X company) and  management stewardship (lenders/investors) need to assess managers since they’re managing co. but they’re not ones w/ funds at risk. Management Bias: present biased information that presents company as the best they can (aggressive financial reporting).  Not neutral: may be trying to over/under emphasize positives/negatives. Incentives for Fraudulent Accounting: -compensation tied to fin. performance; common stock price -meeting financial analysts expectations  avoid negative “earnings surprises: -meeting contractual financial ratios – banks (loans); govts (regulators) Need Accting Stds: IFRS (Intl Fin. Reporting Standards) – publicly accountable entities (shares/debt traded publicly) & govt. business enterprises  IASB (International Accounting Standards Board; London based, Int’l members) PE GAPP (Generlly Accepted Accounting Principles) – private co. have option of IFRS or PE GAAP CICA (Canadian Institute of Chartered Accountants) mandated by CBCA (Canada Business Corporation Act)  F/S must be prepared in accordance w/ GAAP as prescribed by the CICA handbook AcSB (Canadian Accounting Standards Board); private co., pension plans, not-for-profit entities US: SEC (adopting IFRS soon, keep deferring); has final authority over standards, NOT FASB  FASB (referred as U.S GAAP; working w/ IASB to IFRS); major standard setting body How Accounting standards set?  Need for std. indentified (new, never happened before, business transaction)  Put on agenda of standard selling body  Board conducts research and analysis  Publishes exposure draft for comment (everyone involved given a copy) 1. Re-exposure if necessary (from comments)  Issues final standard (based on comments and evaluation)  Standards revised if and when necessary (review every 2 years) GAAP Hiearchy (What accountant should consult first) 1. CICA Handbook (Part 1 – IFRS; Part 2- PE GAAP) 2. AcSB / IASB bkgrd info/basis for conclusions 3. AcSB / IASB implementation guidelines 4. Stds. In other jurisdictions (US and FASB) 5. Approved drafts of new standards 6. Exposure Drafts/Research Studies 7. Accting textbooks, journals, studies, articles 8. Industry Practice Sarbanes Oxley (2002)  Stronger independence rules for auditors, audit committee, analysts  F/S must be signed & certified by CEO, CFO  Stronger jail sentences for execs who knowingly commit fraud/misrepresent F/S  Protection for whistleblowers  SEC has power over accounting/auditing standads  Stronger reports on senior exec. stock transactions, off balance sheet Chapter 2. Conceptual Framework Underlying Financial Reporting Conceptual Framework, for setting accounting standards 1. Objectives of Financial Reporting – the “why” ; goals and purposes of accounting 2. Qualitative characteristics of accounting information & Elements of F/S 3. Foundational Princeiples – the “how” implementation Qualitative Characteristics of Useful Financial Information  Fundamental Characteristics o Relevance – makes a diff, has predictive value o Faithful Representation – complete, neutral, free from error or bias  Enhancing Characteristics o Comparability – identify similarities/diff b/w entities; consistency o Verifiability – diff. observers/accountants reach same value o Timeliness – available to decision makers before it loses ability to influence decisions o Understandability – to business users, with reasonable knowledge Tradeoffs – relevance & faithful rep. must be present to ensure info is decision-relevant - If new standard is applied to provide more relevant info., CONSISTENCY will be temp. sacrificed  Constraints o Materiality – if omitting an item could influence/change decisions o Cost versus Benefits – cost of obtaining the info vs. the benefits Elements of Financial Statements Assets, Liabilities, Revenues, Expenses, Gains, Losses Foundational Principles of Financial Reporting Economic Entity Assumption – can identify an entity w/ distinct activities (ie. From business); present most meaningful  usually the consolidated entity rather than the legal entity (TD Sec, wholesale) Control – include all legal entities under common control (equal ability to direct activities) Revenue Recognition and Realization – record rev. when earned (regardless when cash received) Matching – record expenses in same period as related revenues (ex. dep’n; computer to generate revenue for 3 years – expense cost over 3 years of those revenues) Periodicity – fin. info must be presented periodically so assume entity’s activities can be divided into time periods. Shorter time period = more errors Monetary Unit – money is common denominator of economic activity (i.e. ignore CPI, inflation) Going Concern – reporting entity will continue to operate for the foreseeable future (liquidation values ≠F/S Values) Historical Cost – trans’n originally recorded at cost of when took place Fair Value – may be more useful than historical cost for certain assets/liabilities in certain industries  Present fair value (value can be sold at on reporting date) ex. Old Paint company in DT T.O. Mkt value: millions (real estate) Books: thousands ; shareholders would want to know this Full Disclosure – anything that’s relevant to decisions should be disclosed in the F/S Chapter 3. The Accounting Information System A + E + D = L + C + R DR CR The Accounting Cycle  Identification/measurement of transactions and other events  Journalization  Posting (To general ledger, subsidiary ledgers; each account gets a page, running total)  Trial balance preparation (list of accounts and balances at a specific time)  Adjustments (to ensure rev. recognition principle followed, and proper matching occurs)  Adjusted trial balance  Statement Preparation (I/S  R/E  B/S  CF)  Closing (temp. accounts)  Post-closing trial balance (optional)  Reversing Entries (optional) Chapter 4. Reporting Financial Performance PE GAAP – Income Statement IFRS – Statement of Comprehensive Income Objective: Evaluating past financial performance (net income) & be able to predict future financial performance / cash flows  Must separate continuing operations from discontinued operations Within continuing operations (recurring) - Operating section: Sales – COGS (Gross profit) – SG&A Expenses = Operating Income - Non-operating section: Other Incomes & Gains; Other Expenses & Losses - Interest Rev/Exp; Gain/Loss asset/sales - Income Tax Expense (on income from continuing operations only) Within discontinued operations - Income(loss) from operations for period owned (net of tax) - Gain(loss) on disposal (net of tax) - Disc. Ops includes those disposed od & held for sale Extraordinary items (hurricanes) – no more; (other items) – sig. diff from entity’s typical business ops. Change in Accounting Estimates (dep’n extend, etc) – not disclosed separately but is referenced in notes; prior years not adjusted; change is reflected in current year & going forward only Error in Prior Years – opening R/E is adjusted (all comparative figures restated); error explained in notes Change in Accounting Policy – opening R/E is adjusted (all comparative figures restated); change in policy is explained in notes(incl. why) IFRS – Comprehensive Income = Net Income + Other Comprehensive Income (OCI) List includes: - Adjustments on revaluation of PPE (revaluation surplus) - Unrealized gains/losses on available-for-sale securities - Unrealized gains/losses on FX translation of foreign subsidiaries - Actuarial gains/losses on defined benefit pension plans - Changes in fair value of a financial instrument used as a hedge Chapter 5. Financial Position and Cash Flows Chapter 6. Revenue Recognition Earnings Approach & Contract-based Approach Earnings Approach (Completed contract method & percentage of completion method) - In place for IFRS and PE GAAP - Revenue recognized when earned; Performance complete/Collection reasonably assured o Performance achieved: 1. Risks/rewards are transferred; earnings process is substantially complete 2. Price is measurable o Collectability is reasonably assured - Issues: Goods vs. Services Goods – FOB shipping vs FOB destination o FOB shipping – include in earnings before arrives Services 1. Discrete earnings process (car tune-up, tax return prep.) o Earn revenue when finish providing the service Accounting: Use “Completed contract method” All revenue is recorded once contract is complete 2. Continuous earnings process – must perform several activities, usually with interim billings; costs are measured constantly and compared to budget Accounting: Use “% of completion method” to record revenue Revenue recognized = total revenue * % complete less revenue recorded in prior periods % Complete = (Costs incurred to date) / (Costs incurred to date + Estimated costs to complete) Percentage of Completion method GIVEN: 2010 2011 2012 Costs Incurred 3,060,000 6,435,000 9,300,000 Est. Costs to Complete 4,595,000 2,656,000 -0- Progress Billings to Date 4,000,000 6,300,000 11,000,000 Cash Collected to Date 3,500,000 5,000,000 11,000,000 NEED TO CREATE: 2010 2011 2012 Costs Incurred 3,060,000 6,435,000 9,300,000 Est. Costs to Complete 4,595,000 2,656,000 -0- Est. Total Costs 7,655,000 9,091,000 9,300,000 % Complete 39.9739% 70.7843% 100% Revenue to Recognize 4,397,129 (39.97% * 11mil) 7,786,273 11,000,000 Less: Prior years - 4,397,129 7,786,273 Current year Revenue 4,397,129 3,389,144 3,213,727 Costs 3,060,000 3,375,000 2,865,000 Gross Profit 1,337,129 14,144 348,727 Journal Entries for Percentage of Completion (Problem 6-2) 2010 2011 2012 Construction in Process 3,060,000 3,375,000 2,865,000 A/P, RM, Cash, etc 3,060,000 3,375,000 2,865,000 A/R 4,000,000 2,300,000 4,700,000 Billings on C-in-P 4,000,000 2,300,000 4,700,000 Cash 3,500,000 1,500,000 6,000,000 A/R 3,500,000 1,500,000 6,000,000 C-in-P 1,337,129 14,144 348,727 Construction Expenses 3,060,000 3,375,000 2,865,000 Revenues 4,397,129 3,389,144 3,213,727 Billings on C-in-P 11,000,000 C-in-P 11,000,000 Journal Entries Completed Contract Method (First 3 Entries same as % of completion method) 2010 2011 2012 Construction in Process 3,060,000 3,375,000 2,865,000 A/P, RM, Cash, etc 3,060,000 3,375,000 2,865,000 A/R 4,000,000 2,300,000 4,700,000 Billings on C-in-P 4,000,000 2,300,000 4,700,000 Cash
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