AFM 101 – Chapter #2 Notes
Concepts Emphasized in chapter 2
• The primary objective of external financial reporting is to provide useful economic info about a
business to help external parties, mainly creditors and investors make sound financial
• The users of this accounting info are known as decision makers (including investors,
creditors, and experts who provide financial advice such as brokers) of course others such as
suppliers and customers also use this info.
• To achieve the objective of providing these external parties with useful financial info, financial
reports must enable decision makers to asses the amounts and timing of future cash inflows
and outflows, as well as understand the value of the company’s assets and liabilities.
• The Cost principle requires assets to be recorded at the historical cash-
equivalence cost, which is cash paid plus the current monetary value of all non-
cash items in the exchange on the date of the transaction ex: Nestle owns land
that it acquired years ago and it reports it on the statement of financial position
at historical cost. Although the cost of land may have risen, its recorded value
remain unchanged at its original cost because this amount is recorded and
• 3 of 4 basic accounting assumptions are related to the statement of financial position:
1. The activities of the business are accounted as an individual organization separate from its
2. Separation of the owners resources from those of the company are necessary to get an
accurate measure(proper evaluation) of the company’s financial position.
3. Each business entity reports its financial results in the national monetary unit even if it has
business operations in other countries (dollars in Canada, Euros in Europe)
Basic Accounting Principle
• Accountants rely on this historical cost because it can be tracked back, although it is not very
effective in regard to decision making.
• To make financial statements more useful and accessible to decision makers, specific
classifications of info on the statements.
• Consolidated statements of financial position mean: that the classified sections of Nestle are
combined with the sections of other company’s under its control. (mixes sections with other
• Nestles statement of financial position is shown in a column or report format, with assets
listed first, followed by liabilities, and then shareholders equity.
• Assets – Current Assets ( cash and cash equivalents, short-term investments, accounts
receivables, inventories, prepayments (pre-paid expenses)
• Non-Current Assets – (property, plant and equipment, investment in associates, goodwill, and
• Nestle lists its assets in order of liquidity. • Any receivable mean money owed to nestle(notes or accounts), any payables are money
• Inventories – refers to goods that are held for sale to the customers in the normal
course of business.
• Prepayments – EXPENSES paid in advance, such as rent.
• Investing in associates – is purchasing shares issued by other companies with the purpose
of having significant influence over their investing and financing.
• Financial Assets represent investments in shares of other companies that the firm intends to
keep for longer than a year
• Goodwill – is an intangible asset that arises when a company buys another to controls its
operating, financing and investing decisions. Goodwill reflects assets that are not easily
identifiable and measure such as customer confidence
• Often the purchase price to control its operating and investing
• Often the purchase price of a business far exceeds the fair market value of all its identifiable
assets minus all of its identifiable liabilities, brands and
• Intangible assets: have no physical substance but have a long life. Include: goodwill,
copyrights, patents, and trademarks
• Typically, Liabilities (current) include: trade payables, short term loans, income tax
payables, accrued liabilities and other current liabilities, liabilities that must be paid within a
year or within the accounting period
• Non Current Liabilities (Long term) – long term loans, deferred income tax, provisions that
are inexact about the amount to be paid and when. Liabilities that have maturities beyond a
year or the accounting period. Deferred income tax is a liability recorded on the balance
sheet that results from income already earned and recognized for accounting but NOT
• Accrued Liabilities are liabilities are the total amount owed to suppliers for various services
such as rent, and other obligations.
• One KEY difference between owners and creditors is that CREDITORS are entitled to the
settlement of their legal claims (investments, money) of the company’s assets before
the owner receives a penny! It could be said that owners have residual claim to the
• Owners invest (buy shares) in a company in order to: receive dividends, and to sell their
shares for more than they purchased them for (gain from selling shares, this is called
• TYPICALLY, share holders equity includes: SHARE CAPITAL (OR CAPITAL STOCK,
results from the owner providing cash or other assets to the business), Retained
earnings (accumulated earnings that have not been declared as dividends)
• Share capital + contributed surplus (excess amount of resources contributed by
shareholders) = contributed capital. An alternative definition (funds raised in return for
• Most PROFITABLE companies retain part of their earnings for reinvestment in the business.
• Retained Earnings – refers to the accumulated earnings of a company that aren’t distributed
to the investors (owners) as dividends and are RE-INVESTED in the business.
• SHARE CAPITAL : is the money received from the issuing of shares. Example: company
issues 10,000 shares for $50,000, one would debit cash for 50,000 and credit share
capital for 50,000.
• ONLY 2 things affect Retained Earnings: Dividends (RE go down) and Private or
public contributions (profit goes up retained earnings go up, because net
income is no