AFM 101 Textbook Notes

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Understanding the Business
The Players
Common in new businesses -> the founder = manager of the business (owner-manager)
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Lenders = creditors
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Investors: individuals who buy small percentages of large corporations. They hope to receive a
portion of what the company earns in the form of cash payments (dividends), and they hope to
eventually sell their share of the company at a higher price than they paid.
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Creditors lend money to a company for a specific length of time. They gain by charging interest on
the money they lend.
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Financing activities: exchanging money with lenders and owners
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Investing activities: buying or selling property
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Suppliers: who companies purchase ingredients and accessories from
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Companies sell products to retail stores, customers, or through wholesale distributors.
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Diagram (p.2)
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The Accounting System
Accounting: a system that collects and processes (analyzes, measures, and records) financial
information about an organization and reports that information to decision makers.
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Parties within the firm = internal decision makers (e.g. managers)
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Internal managers typically require continuous detailed information because they must plan and
manage the day-to-day operations of the organization. Developing accounting information for
internal decision makers is called managerial or management accounting.
Parties outside the firm = external decision makers (e.g. creditors, investors, suppliers, customers)
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Accounting for external decision makers is called financial accounting
Exhibit 1.1 (p.3)
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Financial accounting system: periodic financial statements and related disclosures
Managerial accounting system: detailed plans and continuous performance reports
2 primary users of statements: investors (owners) and creditors (lenders)
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The Four Basic Financial Statements: An Overview
The statement of financial position, statement of comprehensive income, statement of changes in
equity, and statement of cash flows
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These basic statements are normally prepared by for-profit corporations. Statements are intended
primarily to inform investors, creditors, and other external decision makers. They summarize the
financial activities of the business. They can be prepared at any point in time and can apply to any
time span.
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Quarterly reports: reports prepared at the end of each quarter
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Annual reports: reports prepared at the end of the year
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The Statement of Financial Position (Balance Sheet)
Reports the financial position (assets, liabilities, and shareholders' equity) of an accounting entity at
a point in time
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Structure
Heading of the statement:
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Name of the entity - The Nestlé Group
Title of the statement - Statement of Financial Position
Specific date of the statement - At December 31, 2009
Unit of measure - (in millions of Swiss francs)
Exhibit 1.2 (p.5)
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Accounting entity: the organization for which financial data are to be collected. It must be precisely
defined and is often called the business or the corporation. On the statement of financial position,
the accounting entity itself, not the business owners, is viewed as owning the resources it uses and
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Chapter 1: Financial Statements and Business Decisions
September-10-12
11:30 AM
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the accounting entity itself, not the business owners, is viewed as owning the resources it uses and
as owing its debts.
a financial snapshot clearly stating the entity's financial position at a specific point in time
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first lists the company's assets, liabilities, and then shareholders' equity. Assets are the sources of
financing or claims against the company's economic resources. Financing provided by creditors
creates a liability. Financing provided by owners creates owners' equity.
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Assets = Liabilities + Shareholders' Equity
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Financial position: the economic resources that the company owns and the sources of financing for
those resources
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Elements
Assets are economic resources controlled by the entity as a result of past business events and from
which future economic benefits can be obtained. Assets can vary depending on the nature of a
company's operations.
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cash,land, plant and equipment, prepayments, inventories, investments
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Trade receivables: selling products on credit and receiving promises to pay (cash is collected later)
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Intangible assets do not have physical existence.
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Every asset on the statement of financial position is initially measured at the total cost incurred to
acquire it. Their values reflect the benefits that the company expects to realize from these assets
through use or sale.
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Liabilities are the entity's legal obligations that result from past business events. They arise primarily
from the purchase of goods or services on credit and through cash borrowings to finance the
business.
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The trade payables arise from the purchase of goods and services from suppliers on credit, without
a formal written contract (or note). Short-term borrowings represent amounts borrowed from
banks and other creditors, to be repaid in the near future. The income taxes payable represent an
amount due to the government's tax authorities as a result of the company's profitable operations.
The accrued liabilities are amounts owed to suppliers of various types of services, such as rent and
utilities.
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Long-term borrowings result from cash borrowings based on formal written debt contracts with
lending institutions such as banks. The provisions are estimated amounts payable in the future, but
the exact amount and timing of the payment depends on actual future events.
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Shareholders' equity indicates the amount of financing provided by owners of shares in the business
and the earnings over time.
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Shareholders' equity arises from 3 sources:
Share capital or the investment of cash and other assets in the business by the owners in exchange
for shares
1.
Retained earnings or the amount of earnings reinvested in the business (not distributed to
shareholders in the form of dividends)
2.
Other components that essentially reflect the changes in the values of assets and liabilities over time
3.
Total shareholders' equity is the sum of the proceeds received on issuing shares to owners, plus the
retained earnings, and the valuation adjustments to the company's assets and liabilities at year-end.
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A Note on Format
Assets may be listed in either increasing or decreasing order of their convertibility of cash. Liabilities
may be listed by either increasing or decreasing order of maturity (due date).
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Most statements include the $ beside the first amount in a group of items. A single underline is
placed below the last item in a group before a total or subtotal. A double underline is placed below
group totals.
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The Statement of Comprehensive Income
Structure
Reports the change in shareholders' equity, during a period, from business activities excluding
exchanges with shareholders. It includes all changes in equity during a period except those resulting
from investments by owners (such as the issuance of shares) and distributions to owners (such as
dividends).
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2 parts:
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Reports the accountant's primary measure of a company's performance (profit): revenues generated
less expenses incurred during the accounting period
1.
Other comprehensive income (income and expense items that are not recognized in the income
2.
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Other comprehensive income (income and expense items that are not recognized in the income
statement in accordance with IFRS)
2.
Income statement: reports the revenues less the expenses of the accounting period
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Items of income and expenses can be presented in 1 or 2 statements -> an income statement
reporting the revenues and expenses that have already affected profit, and a statement of
comprehensive income reporting income and expense items that will affect profit in the future
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Heading: name of the entity, title of the statement, and unit of measure used
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Reports information for a specified period of time (accounting period: time period covered by the
financial statements)
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Revenues - Expenses = Profit
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Elements
Revenues: earned from the sale of goods and services to customers whether or not they have been
paid for
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Expenses: represent the monetary value of resources the entity used up, or consumed, to earn
revenues during the period
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Cost of sales (cost of goods sold): total cost to produce products sold to customers during the year
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Depreciation
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Distribution expenses include a variety of expenses such as the salaries of sales staff and expenses
related to distribution of the company's products. Marketing and administrative expenses include
items such as the salaries of marketing and management personnel, promotion of the company's
products through print and electronic media, rental of office space, insurance, utilities, plus other
general costs of operating the company not directly related to production. Research and
development expenses relate to the research and development of new products. The other
expenses consist of a variety of expenses that are not included in the previous categories.
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Interest expense: reflects the cost of using borrowed funds
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Income tax expense
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Expenses may require immediate payment of cash, payment of cash at a future date, or use of some
other resource, such as an inventory item, that may have been paid for in a previous period. For
accounting purposes, the expense reported in one accounting period may actually be paid for in cash
in another accounting period. Nevertheless, the company recognizes all expenses (cash and credit)
incurred during a specific accounting period regardless of the timing of the cash payment.
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Profit (net income/net earnings):the excess of total revenues over total expenses incurred to
generate revenue during a specific period. (Losses are normally noted by () around the reported
figure.)
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Profit normally does not equal the net cash generated by operations.
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The Statement of Changes in Equity
Structure
Reports all changes to shareholders' equity during the accounting period
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Exhibit 1.4 (p.12)
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Covers a specific period of time (the accounting period)
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Reports the way that profit, distribution of profit (dividends), and other changes to shareholders'
equity affected the company's financial position during the accounting period
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Retained earnings reflect the profits that have been earned since the creation of the company but
not distributed yet to shareholders as dividends. The declaration of dividends to the shareholders
decreases retained earnings.
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Beginning retained earnings + Profit - Dividends = Ending retained earnings
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Elements
Shows how the income statement and the statement of financial position are linked through the
retained earnings section of shareholders' equity
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The Statement of Cash Flows
Structure
Reports cash inflows (receipts) and outflows (payments) that are related to operating, investing, and
financing activities during the accounting period
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Covers a specified period of time (the accounting period)
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Describes the causes of the change in cash reported on the statement of financial position from the
end of the last period to the end of the current period:
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