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Chapter 2

COM 270 Chapter Notes - Chapter 2: International Financial Reporting Standards, Income Statement, Accounting Equation

Course Code
COM 270
Graham Chris

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accounting standards: broad guidelines to follow so that info presented in
a company’s financial statement is relatively standardized
-a theoretical framework for the accounting world
-different sets of standards for not-for-profit & public sector entities
(1) International Financial Reporting Standards (IFRS):
accounting standards that must be followed by public reporting entities
(PPEs) & that private companies can adopt if they wish
international standards
(2) Accounting Standards for Private Enterprise (ASPE):
accounting standards that Canadian private companies (SMEs) must
follow, unless they opt to use IFRS
simplified, Canadian standards
-objectives of both IFRS & ASPE is to produce financial reports that are
useful to statement users
conceptual framework: an underlying set of objectives & concepts that
guide accounting standard-setting bodies in justifying new standards &
revising old ones
-helps to create accounting standards that are widely understood & can be
applied by users/preparers
characteristics & constraints of accounting information —
(i) fundamental qualitative characteristics: are essential if financial
information is to be considered useful - w/o them, the info is useless
(a) relevance: must matter to the users’ decision making - can have
either predictive or conformity value, or both:
predictive value: info that the user can use to develop
expectations about the company’s future
conformity value: provides feedback to users on their previous
assessments of the company
materiality: whether or not the absence or presence of info
would impact the decision of a user
-depends on the size of the company
-material: info that is critical to the user
-immaterial: does not have an effect
-assessed from quantitative (measured in $) & qualitative (assessed
in the context) perspectives
(b) representationally faithful: must meet the rules, & represent
events & transactions as they actually took place or are at present
completeness: provides full disclosure to the user with all the
info needed to understand the financial statement
neutrality: unbiased info
freedom from error: financial info has been determined based
on the info available, using the correct process, & with an adequate
explanation provided
-any errors that do exist are immaterial
(ii) enhancing qualitative characteristics: on their own they cannot make
useless info useful, but they can enhance the usefulness of useful info
(a) comparability: the need for users to be able to compare the
financial info of 2 companies, or of the same company across multiple
time periods
(b) verifiability: achieved if a third party could also arrive at a similar
result to that used by the company
(c) timeliness: the newer the info, the more useful & relevant it is
(d) understandability: info is presented as clearly & concisely as
possible, given its complexity
if it isn’t understandable, it simply wont be used
(iii) constraints: capturing & reporting financial info is costly
(a) cost constraint: the benefits of reporting financial info must exceed
the costs of doing so (weight the cost trade-off)
(b) assumptions: assumptions automatically made by accountants
i. stable monetary unit: don’t take inflation into account
ii. ongoing entity: a “going concern” assumption of what sort of
state the company is in
the default assumption is that the company is doing fine
(unless given reason to believe/know otherwise)
iii. separate entity: assume that all business activity is separate from
personal activity
financial statements — there are 4 basic financial statements:
(1) statement of income: calculates the net income of the company
-multi-step statement of income: requires several steps to reach
the company’s profit or loss
each step provides the user with a key piece of info
allows the reader to easily identify gross profits & profits earned
from separate operating activities
groups info into separate groups/steps:
(a) sales revenue: revenues earned by sales
(b) costs of goods sold: manufacturing or purchasing costs
(c) gross profit: difference between revenue & cost of goods
sales revenue - costs of goods sold = gross profit
-allows company to determine the “make or buy
decision - whether or not it is more profitable to make
or buy their products
(d) profit from (continuing) operations: difference
between gross profit & the company’s operating expenses !
(ex. ads, rent, wages)
-used to forecast future costs
gross profit - operating expenses = profit from operations
(e) profits from discontinued operations: operations that
will not be continued the next period
-both include other expenses that are still considered
under management’s control
-used to evaluate/determine management’s bonus
(f) profits before income tax expense: all expenses &
revenues from the company’s non-operating activities
-not under management’s control
(g) net income: the difference between profit before income
tax & income tax expense
profit - income taxes = net income
-overall, totally amount this year
-required for the contents of all other statements
(2) statement of changes in equity - connects the statement of income to the
statement of financial position
-uses last year’s closing balances as this this year’s opening balances
-reflects all the info recorded about:
(a) common shares
(b) retained earnings
dividends declared
(c) total equity - common shares + retained earnings
(3) statement of financial position - based on the accounting equation
-assets & liabilities are listed in liquidity order & are categorized into
current & non-current sections in order to determine the company’s
working capital & assess its ability to meet their obligations coming due
within the next 12 months
total assets must = (total liabilities + shareholders’ equity)
(4) cash flow statement - reports the change in just cash as a result of the
cash inflows & outflows of the 3 categories of business activities:
operating activities - normally expect a net inflow of cash (thus a positive
effect on cash amount)
-info is taken from statement of income, current assets & liabilities
-expect to collect more cash from customers than they spend
generating these sales
investing activities - normally expect a net outflow of cash (thus a negative
effect on cash amount)
-info is taken from non-current assets, PPE
-expect to spend more on purchasing new property, plant &
equipment than they would receive from selling the PPE that they
are finished using
financing activities - normally expect a net inflow of cash (thus a positive
effect on cash amount)
-info is taken from non-current liabilities & shareholders’ equity
-expect to borrow money & issue shares to finance their growth
COM 270 - Chapter 2: Analyzing Transactions & Their Effects on Financial Statements
“Company Name”
Statement of Income
For the year ended (month) (day), (year)
“Company Name”
Statement of Changes in Equity
For the year ended (month) (day), (year)
“Company Name”
Statement of Financial Position
As at (month) (day), (year)
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