Chapter 1 Overview of Corporate Financial Reporting
What is Business?
- Business plan to profit from selling a product or service.
- Can be an individual or thousands of owners (investors).
What is Accounting?
- Accounting is an information system in which the underlying economic conditions of
organizations and of individuals are recorded, summarized, reported, and understood.
- Financial statements: managements reports to the companies owners that summarize how
the company performed during a particular period. Also tells users what the company owns,
to whom it has obligations (debts), and what is left over after the obligations are satisfied
- Annual report: the main method that management uses to report the results of the
companys activities during the year.
- In January 1 , 2011, Canada changed the underlying standards that are used to collect,
record, and report accounting information. From Canadian standards to international
financial reporting standards (IFRS).
Forms of Organization
- Profit-seeking entities such as corporations; governing organizations
- Service entities such as hospitals and academic institutions
- Not-for-profit entities such as charities
- We will be concentrating on profit-seeking entities.
- Other forms of business include sole proprietorships, partnerships, limited partnerships, and
- In all business organizations, the owners make the initial investment by contributing either
cash or property or both.
- In sole proprietorships and partnerships, this ownership interest is called the owners or
- In a corporation, owners (aka shareholders or stockholders) make similar investment, but
their ownership interest is called shareholders capital represented by documents known as
Shares are easily transferred between investors
Large number of individuals or entities and that are traded on a public stock exchange
are called publicly traded corporations.
Corporations whos shares are held by a small number of individuals are sometimes
called privately held corporations.
Shareholders elect board of directors who hires or fires the management.
User of Financial Statements
- Internal Users
Management and the Board of Directors
Use accounting data to make many decisions, such as pricing products,
expanding operations, deciding whether to buy or lease equipment, and controlling costs.
They also use other financial data found in managerial accounting.
- External Users
Shareholders and Potential Investors
Need information that makes it possible to assess how well management has
been running the company.
Make decisions about buying more shares are selling some or all of the shares
they already own.
Analyze the current share price and compare it with the original price that they
paid for the shares.
Consider whether the people currently sitting on the board of directors are doing
an adequate job of overseeing the management team they have selected.
First group: those who sell goods and services to the company and are willing to
wait a short period of time for payment, i.e. suppliers, employees.
Second group: financial institution, such as banks, that have loaned money to the
Third group: investors who have purchased long-term debt instruments such as
corporate bonds from the company.
Government has regulations for how a business becomes incorporated and for its
conduct after incorporation.
Parliament, the federal taxing authority in Canada has established the Canada
Revenue Agency (CRA) as its collection agency.
Other companies, security analysts, credit-rating agencies, labour unions, and
Development of Accounting Standards
- For Canada, the International Accounting Standards Board (IASB) sets accounting
recommendations and standards. These accounting recommendation and standards are in
the Canadian Institute of Chartered Accountants (CICA) Handbook and have the force of law
in Canada, as they are recognized in both federal and provincial statutes that regulate
- For United States, the Financial Accounting Standards Board (FASB) sets accounting
standards for American corporations.
- Qualitative Characteristics and Constraints of Accounting Information
Relevance predictive value or confirmatory value
Reliability faithful representation, substance over form, neutrality, prudence,
Balance between benefits and cost
Balance between qualitative characteristics
- Financing Activities
Financing refers to the activity of obtaining funds (cash) in order to buy major assets,
such as the buildings and equipment that almost every business uses.
Funds are obtained from two primary sources outside the company: creditors and
investors. Creditors expect to be repaid on a timely basis and often charge the
business, in form of interest. For the use of their money, goods, or services. Investors
invest in the company in the hope that their investment will generate a profit. They
earn profits either by receiving dividends (payments of funds from the company to
the shareholders) or by selling their shares to another investor.
Retained earnings: internal source of new funds for any company is the profit it makes
that is not paid out to shareholders in dividends.
Typical financing activities: borrowing money, repaying loans, issuing shares,
repurchasing shares, paying dividends on shares
- Investing Activities
Typical investing activities: purchase or sale of property, plant, and equipment;
purchase or sale of the shares of other companies
- Operating Activities
Typical operating activities: sales to customers, collections of amounts owed by
customers, purchases of inventory, payments of amounts owed to suppliers,
payments of expenses such as wages, rent, and interest, payment of taxes owed to
- Corporate Profile
Describes the companys business activities during the year.
Important to understand what kind of business the company is running to know the
risks of investing.
- Message to Shareholders
Brief overview of past events that have affected the company and provides some
insights in the companys future plans.
- Management Discussion and Analysis
Required of all publicly traded companies in Canada and the United States.
Provides an overview of the previous year, a discussion of the risks facing the
company, and some information about future plans.
Includes information about significant events and about sales, profits, and cash flow
during the year.
Focuses on the financial aspects of the business, including pricing, strategies, expenses, earnings, liquidity, environmental and corporate social responsibility,
expansion and future development, taxes, events after the end of the current year,
and executive compensation policies.
- Board of Directors and Management
List of companys board of directors
- Financial Section
Components of the financial section: statement of managements responsibility,
auditors report, financial statements: statement of comprehensive income,
statement of financial position, statement of changes in equity, statement of cash
flows, notes to the financial statements, statement on corporate governance.
STATEMENT OF COMPREHENSIVE INCOME
AKA income statement, the statement of earnings or statement of profit or loss.
Describes the results of the operating activities from the beginning to the end of
the current period.
The results of those activities add up to the net earnings (net income or net
profit/loss), defined as income less expenses. Income is money or resources that
flow into the company as a result of such ordinary activities as sales (aka
revenues) and from gains (selling items for more than their original cost).
Expenses are money or resources that flow out of the company to enable the
inflow of income, such as the cost of the goods that are sold in sale transactions.
Depreciation: recognizing that only a portion of the machine as an expense.
Report of the companys operating performance during the year; it measures the
inflow of revenues and the outflow of expense. (sometimes called flow
Revenue: broken into different types to forecast how the company is doing.
Expenses: Cost of goods sold (or cost of sales, or cost of merchandise sold),
selling expenses (or operating expenses), and administrative expenses. Tax is also
an expense. Earnings per share is the companys net income divided by the
average number of common shares that are outstanding during the year.
STATEMENT OF FINANCIAL POSITION
AKA Balance sheet
Canadian balance sheets will list current assets first.