RSM219H1 Chapter 2 Notes

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University of Toronto St. George
Rotman Commerce
Alexander Edwards- Universityof Toronto( St.George)

RSM219H1 Textbook Notes Chapter 2: A Further Look at Financial Statements Assets Liabilities Currents assets Current liabilities Investments Non-current liabilities Property, plant, and equipment Shareholders’ equity Intangible assets Share capital Goodwill Retained earnings  Current assets: are assets that are expected to be converted into cash (sold or used up) within one year of the company’s financial statement date or its operating cycle (whichever is longer).  Operating cycle: the average time it takes to go from cash to cash in producing revenue. o Can exceed one year depending on the type of business.  Common types of current assets: o Cash o Short-term investments (trading investments)  Investments in debt securities (i.e. bonds of another company) or equity securities (i.e. shares of another company) that are held in hopes of generating interest income and/or gains from profitable resale in the near term. o Accounts receivable  Amounts owed to the company by customers who purchased products/services on account. o Accrued receivables  Amounts owed to the company for interest, sales tax, rent, and like items. o Notes receivable (including loans receivable)  Amounts owed to the company by customers or others that are supports by a written promise to repay. o Merchandise inventory  Goods held for sale to customers.  Can include finished and unfinished goods. o Supplies  Consumable items like office supplies and cleaning supplies. o Prepaid expenses  The cost of things like rent and insurance paid in advance of use.  Current because they are unused benefits available for use during the year.  North American companies normally list current assets in order of liquidity while some international companies list current assets in the reverse order.  Cash equivalents: very liquid investments in debt securities that can be easily converted into cash.  Non-current assets: assets not expected to be converted into cash (sold or used up) by the business within one year of the financial statement date or its operating cycle.  Common types of non-current assets: o [Long-term] investments  Include:  Multi-year investments in debt securities that management intends to hold to earn interest.  Equity securities of other companies that management plans to hold for many years to generate investment revenue or for strategic reasons. o Property, plant, and equipment  Tangible assets of a long-lived nature that are being used to operate the business.  They are listed on the balance sheet in their order of permanency (i.e. longest life).  Revaluation model: recording these assets at fair value rather than at cost.  Depreciation: allocating a portion of the cost of these assets to expense each year of their useful lives (except land which is assumed to have an indefinite life).  Accumulated depreciation: the amount of depreciation take so far over the life of the asset it relates to.  Contra asset account: an account that is offset against (reduces) an asset account on the balance sheet.  Carrying amount (book value): cost – accumulated depreciation. o Intangible assets and goodwill  Assets that do not have physical substance and that represent a privilege or a right granted to, or held by, a company.  I.e. patents, copyrights, franchises etc.  Intangible assets can be grouped into assets with:  Definite lives o Their cost is allocated over the future periods and this is called amortization under IFRS.  Indefinite lives o Their cost is not allocated over the future periods.  Goodwill = the difference between the price paid for the acquisition of a company and the fair value of the assets acquired in the acquisition. o Other assets  Can include:  Non-current receivables  Deferred tax assets  Properties held for sale  Current liabilities: obligations that are to be paid or settled within one year of the company’s statement date or its operating cycle (whichever is longer).  Common current liabilities: o Bank indebtedness  A short-term loan from a bank (usually resulting from a credit line). o Accounts payable  Amounts owed by the company to suppliers for purchases made on account. o Accrued liabilities  Amounts owed by the company for salaries, interest, sales tax, rent, income tax etc. o Notes payable (including bank loans payable)  Amounts owed, often to banks but also to suppliers or others, that are supported by a written promise to repay. o Current maturities of long-term debt  The portion of a non-current or long-term loan that is repayable in the current year.  Remainder is classified as a non-current liability.  Non-current (long-term) liabilities: obligations that are expected to be paid or settled after one year.  Common non-current liabilities: o Notes payable (including bank loans payable, mortgages payable, bonds payable)  Mortgages payable have property pledged as security for the loan. o Lease obligations  Amounts to be paid in the future on long-term rental contracts used for equipment or other property. o Pension and benefit obligations  Amounts companies owe past and current employees for retirement benefits. o Deferred income tax liabilities  Income tax that is expected to be payable in a later year or years when a company prepares its future corporate income return.  Non-current liabilities are generally accompanied by notes to the financial statements revealing further information about each item (i.e. maturity date).  There is no generally prescribed order for reporting non-current liabilities.  Shareholders’ equity is divided into: o Share capital  If only one class of shares are issued, the name is common shares. o Retained earnings  The cumulative profits that have been retained for use in a company.  Ratio analysis expresses the relationships between selected items of financial statement data.  Three types of ratios are: o Liquidity ratios  Measure a company’s short-term ability to pay its maturing obligations and to meet unexpected needs for cash.  Liquidity: a company’s ability to pay obligations that are expected to become due within the next year.  Include:  Working capital = current assets – current liabilities o If > 0, a greater likelihood exists that the company will be able to pay its liabilities. o If < 0, the company may need to borrow money to pay short-term creditors.  Current ratio = o It show how much a company has in current assets for every $1 in current liabilities.  I.e. 2:1 means $2 in current assets for every $1 in current liabilities. o A higher current ratio of company A than company B does not mean A is better off.  A may have more current assets tied up in items such as inventory and uncollectable receivables while B may have more in cash. o Solvency ratios  Measure a company’s ability to survive over a long period of time.  Solvency: a company’s ability to pay interest as it comes due and to repay the face value of debt at maturity.  Insolvent: when a company is unable to pay its debts.  Include:  Debt to total assets = o Measures the percent of assets that are financed by lenders and other creditors.  I.e. a ratio of 55% means 55 cents of every dollar that the company invested in assets came from lenders and other creditors. o Debt is riskier than equity as debt has to be repaid at specific points in time whereas equity does not.  Free cash flow = income from operating activities – capital expenditures - dividends o Profitability ratios  Measure a company’s operating success for a given period of time.  Include:  Earnings per share (EPS) = o Measures the profit earned on each common share. o If no preferred shares have been issued, than he profit available to common shareholders is the same as the profit repo
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