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Chapter 2

Chapter 2 accounting.docx

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ACC 110
Else Grech

Chapter 2 accounting General purpose financial statements - These are financial statements that are made to be used by a wide variety of stakeholders, the opposite of this are special purpose reports which are created to help a single stakeholder in their decision making - Because this statement does not meet all the information needs of stakeholders, the preparer must decide what information must be placed that may be helpful for these stakeholders make their decision Leon’s financial statements; an overview - Consolidated financial statements means that they sum up financial information of more than one company into a set of financial statements, this can only occur if the company owns more than 50% of other companies and intends on providing information to all stakeholders about the company - Financial statements compare two years of a company’s financial performance as this allows stakeholders to determine whether or not a company was able to increase its profits or increase its loss within one fiscal period - Accounting information that cannot be compared to other information isn’t useful to stakeholders - Financial statements report information pertaining to the company’s performance for a year, this 12 month period can be chosen at any date - Dollar amounts in these statements are rounded to the nearest thousands as it does not greatly influence the perspective of investors and makes the financial statement more organized in appearance - Materiality refers to the importance of information to a stakeholder where information is classified as material if its exclusion influences the perspective of stakeholders. - Financial statements must be free from material error and any material error that was identified must be disclosed as mentioned before it can mislead stakeholders into believing what may not be true - Information’s classification as material depends on the stakeholder’s judgment, what they need the information for and who will be using the financial statements The balance sheet - The balance sheet shows the company’ most recent financial position and this information is subject to change after this report was produced and the information from previous years would be different. Stakeholders can use this information to determine the risk in investing in this business, the financial health of the business and determine whether or not they will receive future cash flow in the future - Assets are economic resources that benefit the entity in the long run - Liabilities is the money that is owed to an entity’s financers such as creditors - - Owner’s equity is the sum of cash that was invested into the business - The balance sheet follows the idea of the accounting equation where assets must equal liabilities + owner’s equity - The right side of the equation represents the amount of money earned from financers and owners/shareholders that were used in order to purchase these assets - Creditors are people who money is owed to - Accounts provide additional information about an entity’s financial position - Economic events that are entered into the accounting system take on the form of impacts on the accounting equation in terms of assets, liabilities and owners equity Assets - Under IFRS i) The asset must help the entity generate cash in the near future and it must be likely that the entity that owns this asset will benefit from it ii) The entity must have the right to use the asset to generate cash flow from it iii) Assets are earned as a result of a transaction iv) They can be measured - Entities do not necessarily have to own the asset in order for it qualify as an asset, they must be the one who benefits from it. For instance leasing a piece of land qualifies as an asset for that very reason -missing assets may not be reported on the balance sheet because they may not qualify as an asset, for instance a brand name may not qualify because there is not a lot of certainty that the brand will benefit from its image to consumers. Therefore it is important to realize that the balance sheet does not include all assets of an entity - balance sheet measurements: when assets are gained they are recorded at the amount of money that was paid for them. After acquiring them inventory is recorded at its cost value while capital assets can be either reported at the amount that was paid to acquire them, or the curret market value under IFRS, A/R are valued at the amount that is estimated to be collected from A/R - current assets are assets that expected to be liquidated, used up or sold within a year or an operating cycle. Operating cycle is the time it takes for a return on investment since the day the asset was purchased - noncurrent assets are assets that will not be used up, liquidated or sold within a year Liabilities - Liabilities occurs when the firm is expected to fulfill an obligation or settle a debt I)According to IFRS, a liability is the result of a past transaction or economic event ii)Requires a payment of money to settle the debt - Like assets these are categorized into two groups, current and non-current where current liabilities are those that will be repaid within one year or operating cycle while non current are those that will take more than one year or operating cycle - Non current assets and liabilities are not disclosed on the balance sheet Using balance sheet information to analyze liquidity - Organizing assets and liabilities into current and noncurrent is necessary to determine a company’s liquidity which is the availability of cash or the ability to convert assets into cash to repay debt to creditors - Bankers care about the liquidity of a business as if they are unable to repay their debt then why bother loaning money if you won’t get your money back. For shareholders they would care about the liquidity because if the company is unable to repay their debt how will they continue going on with business, therefore it’s a risky investment as it can go out of business. - Current assets – current liabilities = working capital which can be used to assess the liquidity of an entity where if WC is positive this implies that we have enough assets to repay our debts however if it was negative this would imply that the company has liquidity problems and CL>CA, however this isn’t always the case - The current ratio is the ratio of current assets to current liabilities and is another way of determining working capital where if the ratio is greater than 1, the more assets there are to fulfill the debt of the entity. The opposite applies as well Owner’s equity - Owner’s equity represents the amount shareholders and the owner of the company invest into the company , from the perspective of the accounting equation, this represents the proportion of assets that are financed by investors - Investments are classified into two groups, direct investments occur when shareholders purchase shares of a company while the company receives their money in exchange. This is a direct investment because shareholders give up their own assets for the purpose of financing the entity44 - Indirect investment is when the profit a company earns is not given to shareholders, instead it is used to finance the operations of the business and the decision to do this is made by the board of directors - In the shareholder’s equity section of the balance sheet, the iinvestment into the corporation is divided between common shares, which consist of money used to purchase shares and retained earnings is the total net income a company has earned excluding the dividends that were paid to investors - Dividends are what are repaid to the company’s investors, if the retained earnings of the company is negative it is referred to as a deficit Debt – Equity ratio = liabilities/shareholders equity - This is a balance sheet tool that is used to determine how much of the company is financed between investors and creditors, and to determine the level of risk of investing in this organization - The higher the debt the more risky investments are as debts require timely payments and if those cannot be made the company will not be able to operate or have its assets seized - Interest is the proportion of a loan that accumulates over time and can be seen as the costs of borrowing money, it’s in the form of a percentage usually - Principal is the original
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