Textbook Notes (368,986)
Canada (162,320)
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MGFB10H3 (19)
Chapter 3

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Sultan Ahmed

Chapter 3: Financial Statements 3.1 Accounting Principles  Accounting is simply an organized way of summarizing all of a firm’s transactions and presenting them in such a way that external users can understand the firm’s affairs  Auditors simply attest to whether or not the financial statements fairly represent the firm’s financial position according to generally accepted accounting principles  In the past US GAAP and Canadian GAAP were significantly different but the differences are becoming less important due to the Free Trade agreement and because many Canadian firms now list their securities on US and Canadian stock exchanges and have to file their takes using both Canadian and US GAAP 3.2 Organizing a Firm’s Transactions Bookkeeping  Bookkeeping is different from accounting o Bookkeeper manages all the transactions in a firm while the accountant uses them to create the firm’s financial statements by applying GAAP  In bookkeeping, there is double entry accounting (debits must equal credits)  Liquidity: the ease w/ which assets and liabilities are converted to cash Accounting Conventions: The Basic Principles  The most basic principles of GAAP are: o The Entity Concept: accounting is done for an economic entity o he Going Concern Principle o A Period of Analysis (e.g. yr end balance sheet) o A monetary value o Matching principle  Most important principle. Leads into accrual accounting  Expenses and revenue must match the period even if the cash components of the transaction occur in other periods o Revenue Recognition  The major conventions of GAAP are (“CDMPS”): o Consistency: the firm shouldn’t constantly switch b/w different conventions even if they are acceptable w/i GAAP o Disclosure: the statements should “fully and fairly” disclose the firm’s position  “full disclosure” all material data that might be of significance to a reasonably intelligent user should be disclosed  Objectivity, consistency and conformity to GAAP are aspects of full disclosure o Materiality: everything that someone could reasonably rely on is disclosed o Procedures: assets are on the left, liabilities and equity are on the right; when multiple yrs are shown, assets are at the top and liabilities and equity are below o Standards: in Canada, this is the CICA handbook 3.3 Preparing Accounting Statements  Income statement: the firm’s financial statement showing the sales, expenses and net profit for a given period Tax Statements  Two tax accounts: taxes payable and deferred taxes  Corporations are allowed to present one set of accounts to the CRA (tax authorities) and another to the investing public  Depreciation/ Amortization: the reduction in value of an asset over time o Many different ways to calculate depreciation. Most common way: straight-line o For tax purposes, the govt allows a special form of depreciation which in Canada is called capital and cost allowance (CCA) o Deferred income taxes: Depreciation $ used in financial statements—CCA depreciation  This amount doesn’t need to be owed to the government. It’s the result of the accountant’s judgment Cash Flow Statements  Cash Flow statement: a summary of a firm’s cash receipts and disbursements over a specified period (tracks the flow of hard cash throughout the firm)  Two ways to calculate the cash flow statement: 1. Examining the changes in the balance sheet accounts (e.g. can estimate the sources of cash from increases in liabilities and decreases in assets) 2. Adding back non-cash items to net income (e.g. depreciation and deferred income taxes)  Traditional cash flow: net income plus non-cash expenses such as depreciation and deferred income taxes  Working Capital= Current Assets—Current Liabilities  Called working capital b/c it represents short term investments that turn over are constantly working  Cash flow from operations (CFO): the result of subtracting the increase in net working capital from traditional cash flow 1. Brings to light any increases in receivables and inventory so the analyst can ask why people aren’t paying for their sales and why inventory is increasing 2. If sales are constant and yet the increase in net working capital is significant, it is one sign that the firm’s net income numbers might be aggressive  Cash flow from investing= capital expenditures (capex)  Free cash flow: the result of subtracting capital expenditures from cash flow from operations 1. used to see whether a company is generating or using cash 2. focuses on the financing of the firm: if firm is using cash, money must be raised from somewhere 3.4 Tim Hortons Inc. Accounting Statements 3.5 The Canadian Tax System Corporate Taxes  There are similarities and differences b/w the way CRA files income tax returns for corporations and for investors o Differences: 1. different methods are used to calculate amortization expense 2. the treatment of investment income and expenses  CCA i
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