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RSM100Y1 (431)
Chapter 15

RSM100Y1 Chapter 15 Notes

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University of Toronto St. George
Rotman Commerce
Michael Khan

RSM100Y1 Textbook Notes Chapter 15  Accounting: the process of measuring, interpreting, and communicating financial information to support internal and external business decision- making. Users Applications Shareholders, Potential Investors,  To evaluate operations of the firm Creditors  To make investment decisions Management  To plan and control daily and long-range operations Union Officials  To use in contract negotiations Lenders, Suppliers  To evaluate credit ratings Employees  To monitor their firms’ productivity and profitability performance. Business Owners and Board of Directors  To track managers’ progress in operating the organization Government Agencies, Economic  To evaluate tax liabilities Planners, Consumer Groups  To approve new issues of stocks and bonds  Open-book management: a management strategy that believes that allowing employees to view financial information helps them to better understand how their work contributes to the company’s success. o Benefits employees in the end.  Accountants: o Provide important information to help managers deal with the competitive and economic environments. o Help others to understand, predict, and react to technological, regulatory, and social and cultural environments.  I.e. CRA organizes a volunteer program that people can sign up to help others to file their income tax.  All organizations (for- and not-for-profits) perform three basic activities (accounting plays a key role in each): o Financing activities provide necessary funds to start a business and expand it after it begins operating. o Investing activities provide valuable assets that are needed to run a business. o Operating activities focus on selling goods and services, but they also view expenses as important elements of sound financial management.  Brian Hill (CEO of Aritzia) performed these steps and found great success in the Canadian market. o He decided to expand in the US and went to get financing from Berkshire Partners who took a majority stake in the company (didn’t want to take the risk of financing the expansion himself. o The company moved to a vertically integrate model because:  Hill believed they would benefit by cutting out a third-party retailer.  Hill believed Aritzia’s success was due in part because they understood the customers’ needs.  If they are involved at the point of sale, they will have a better feel for those needs.  Accounting professionals can be classified as: o Public Accountants  An accountant who provides accounting services to individuals or business firms for a fee.  Most provide three basic services:  Auditing (examining financial records)  Tax preparation, planning, and related services  Management consulting. o Since they are independent of firms, they can provide unbiased advice about a firm’s financial condition.  Four largest collect almost $4 billion annually. They include:  Deloitte  Ernst & Young  KPMG  PricewaterhouseCoopers  Certain critics believe when a public accountant provides both auditing and management consulting to a single firm, a conflict of interest is created.  This may weaken the confidence in the quality of the financial statements that were audited.  The numerous bankruptcies forced this practice to end.  Legislation has set strict limits on the types of consulting services auditors can provide. o I.e. if an accounting firm audits a company, it cannot provide any other services to that company.  Forced many firms to sell their consulting practices or to created separate companies to handle consulting.  Forensic accountants: focus on uncovering potential fraud in many different organizations.  They investigate below the surface of an organization’s accounting system to find out what actually happened.  They may testify as expert witnesses if a case goes to court.  Recognized accountants include:  Chartered Accountants (CAs) o Canada’s most recognized group of professional accountants. o Must meet provincial requirements for education and experience. o Must successfully complete thorough testing in accounting theory and practice, auditing, law, finance, strategy, and taxation. Need to meet specified  Certified Management Accountant (CMA)  Certified General Accountant (CGA) educational and experience requirements and pass  Certified Fraud Examiner (CFE) certification exams.  Certified Internal Auditor (CIA) o Management Accountants  An accountant who is employed by a business other than a public accounting firm.  They collect and record financial transactions and prepare financial statements that are used by the firm’s managers in decision-making.  They provide timely, relevant, accurate, and concise information that executives can use to operate their firms more effectively and more profitably.  A management accountant should be able to provide the answers to many important questions:  Where is the company going?  What opportunities are in the company’s future?  Will certain situations expose the company to excessive risk?  Does the firm’s information system provide detailed and timely information to all levels of management?  Management accountants often specialize in different aspects of accounting.  Examples: o A cost accountant decides on the costs of goods and services and helps set their prices. o A tax accountant works to minimize a firm’s tax bill and handles its federal and provincial tax returns. o An internal auditor examines the firm’s financial practices to ensure that its records include accurate data and that its operations comply with federal/provincial/local laws/regulations.  A certified management accountant (CMA) has been thoroughly tested and been given certification by the government.  Management accountants are usually involved in the development and enforcement of organizational policies on such items as employee travel.  Since federal regulations for accounting and public reporting have changed, the demand for management accountants has greatly increased (due to the need to adapt). o Government and Not-For-Profit Accountants  They perform professional services similar to the services provided by management accountants.  They are primarily concerned with how efficiently the organizations work to meet their objectives.  Government agencies that employ accountants include:  CRA  Canadian Security Intelligence Service (CSIS)  Province of Manitoba  City of St. John’s  Not-for-profit organizations that employ accountants include:  Churches  Labour unions  Charities  Schools  Hospitals  Universities  The not-for-profit sector is one of the fastest growing segments of accounting practice (donors are interested in how the groups spend the money raised; more accountability).  Generally Accepted Accounting Principles (GAAP): principles that outline the conventions, rules, and procedures for deciding on the acceptable accounting practices at a particular time. o Includes:  International Financial Reporting Standards (IFRS)  Accounting Standards for Private Enterprise (ASPE)  Accounting standards for not-for-profit  Accounting standards for pension plans  Accounting standards for governments o All GAAP’s are based on:  Consistency  All data should be collected and presented in the same manner across all periods (changes must be noted and explained).  Relevance  All information being reported should be appropriate and assist users in evaluating financial information.  Representational faithfulness  Financial information should reflect the substance of the economic activity during the reporting period.  Reliability  The accounting data in financial statements must be dependable and can be verified by an independent party (i.e. an auditor).  Timeliness  The financial information should be made available within a time period that allows the financial information to be useful in decision-making.  Understandability  Financial information must be clearly presented to user.  Verifiability  Other independent and knowledgeable individuals must be able to agree that the financial information is fairly presented.  Comparability  Ensures one firm’s financial statements can be compared with those of similar businesses. o Accounting Standards Board (AcSB): the organization that interprets and modifies GAAP’s in Canada for private and not-for-profit businesses. o Public Sector Accounting Boards (PSAB): the organization responsible for accounting standards for governments.  Canadian public companies are required to use International Financial Reporting Standards (IFRS). o Allow for financial statements to be more easily compared from country to country.  Required because of the increase in worldwide trade.  The idea of a uniform set of global accounting rules is gaining interest because of: o The expansion of the EU. o The signing of cross-national trade agreements (i.e. NAFTA). o The increase in investors buying shares in foreign multinational corporations. o Helps investors make informed decisions.  International Financial Reporting Standards (IFRS): the standards and interpretations adopted by the IASB. o More than 120 countries require, permit the use of, or have a policy working with IFRS (US not included).  International Accounting Standards Board (IASB): the organization that promotes worldwide consistency in financial reporting practices.  A major difference between ASPE and IFRS is: o Under ASPE, firms report, plant, property, and equipment on the balance sheet at the historical cost minus depreciation. o Under IFRS, firms have the option to report plant, property, and equipment on the balance sheet at current market value.  Provides a clearer picture of the real value of a firm’s assets.  Many accounting experts believe that, overall, IFRS is less complicated than traditional GAAP and more transparent.  Financial Accounting Standards Board (FASB): the organization that interprets and modifies GAAPs in the US. o FASB and IASB are currently working on a project to work toward IFRS.  Sarbanes-Oxley Act (SOX): made in response to accounting fraud. o Public Company Accounting Oversight Board: created by the SOX.  Consists of five members who have the power to set audit standards and to investigate and approve the accounting firms that certify the books of publicly traded firms. o All Canadian companies that have publicly traded stock or debt on a U.S. stock exchange must comply with SOX. o Bill 198 is the Canadian equivalent.  Both SOX and Bill 198 have added to the reporting requirement for publicly traded companies. o I.e. senior executives (including the CEO and CFO), must personally certify that the financial information reported by the company is correct.  Since it is very expensive for firms to meet GAAP standards and requirements of SOX and Bill 198 (i.e. audits can cost millions in a year), Canada has multiple sets of standards to help smaller businesses.  Corruption of Foreign Public Officials (CFPO) Act: a federal law that prohibits Canadian citizens and companies from bribing foreign officials to win or continue business. o Later extended to make foreign officials subject to penalties if they cause similar corrupt practices to occur within Canada or its territories.  Accounting deals with a firm’s financial transactions with its employees, customers, suppliers, owners, and with bakers and various government agencies.  Prompt payment of bills keeps the firm’s credit rating high and helps its future ability to earn a profit.  Accounting cycle: the set of activities involved in converting information and individual transactions into financial statements (done by accountants).  The activities involved in the accounting cycle are: o Record  Transactions are recorded, usually electronically, in chronological order in books called journals, along with a brief explanation for each entry. o Classify  Journal entries are transferred, or posted, usually electronically, to individual accounts kept in a ledger.  All entries involving cash are brought together in the ledger’s cash account.  All entries involving sales are recorded in the ledger’s sale account. o Summarize  All accounts in the ledger are summarized at the end of the accounting period, and financial statements are prepared from these account summaries.  Computers have simplified the accounting cycle, making it both faster and easier. o I.e. POS terminals in retail stores perform several functions each time they record sales.  They recall product prices from a computer system’s memory and keep inventory count.  They also do the data entry functions that were once entered manually.  Accounting software programs are used widely, and allow a do-it-once approach: a single sales entry is automatically converted into a journal entry, which is stored until needed. o Decision-makers can then instantly access up-to-date financial statements and financial ratios.  Some accounting software programs (i.e. QuickBooks and Simply Accounting) have been designed specifically for entrepreneurs and small businesses. o Other software programs (i.e. products from Oracle and SAP) often need more sophisticated systems so are used by larger firms.  New programs can handle all of a company’s accounting information for every country where it operates. o I.e. foreign languages, currencies, and financial, legal, and tax requirements of each nation where the firm does business.  Several software producers offer Web-based accounting products designed for small and medium-sized businesses. o Allow for access of information anywhere through the Web.  Three fundamental terms in the accounting equation: o Assets  Asset: anything with future benefit owned or controlled by a firm.  Includes:  Land  Buildings  Supplies  Cash  Accounts Receivable  Marketable Securities  Assets can either be:  Tangible (most common assets) o For example buildings, equipment and inventories.  Intangible (possibly the most important) o For example patents and trademarks. o They are especially important for such companies as computer software firms, biotechnology companies, and pharmaceutical companies. o Johnson & Johnson reported +$31 billion in intangible assets ($95 billion in total assets). o Liabilities  Liability: a claim against a firm’s assets by creditors.  Includes:  Accounts Payable  Notes Payable  Long-term Debt  Wages Payable Wages/salaries owed to  Accrued Wages employees. o Owners’ Equity  Owners’ equity: the funds that owners invest in the business plus any profits not paid to owners in the form of cash dividends.  In the case of a corporation, OE is the claims of the shareholders.  A strong OE position is often used as evidence of a firm’s financial strength and stability.  Accounting equation (accounting identity): the relationship that should reflect a firm’s financial position at any time; assets should always equal the sum of liabilities and OE.  The right side also represents the business’s financial structure (since financing comes from either creditors/owners).  Double-entry bookkeeping: the process used to reco
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