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Chapter 1

Chapter 1 - Financial Statements and Business Decisions.docx

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Wilfrid Laurier University
David Scallen

Chapter 1: Financial Statements and Business Decisions - The Nestle Case o Creditors: money lenders, loan for a specific length of time  Hope to gain – interest charged from money that is owed o Investors: individuals who buy small percentages of large corporations; hope to gain: 1) Dividends: a portion of what the company earns in the form of cash payments 2) Difference in amount paid and amount sold at - Financial Activities: when a company exchanges money with its lenders and owners - Investing Activities: when a company buys/ sells property - Business Operations o Suppliers: sells company accessories and material for production o Customers: examples include retail stores (sold through wholesale distributors) - TheAccounting System o Accounting: a system that collects and processes (analyzes, measures and records) financial information about an organization and reports that information to decision makers 1) Internal decision makers: company’s own managers  Continuous detailed information – plan/ manage day-to-day operations of the organization • Managerial or management accounting – developing accounting information for internal decision makers 2) External decision makers: investors (shareholders), bank’s loan officer (use reports produced by the system  Financial accounting: four basic financial statements and related disclosures - Four Basic Financial Statements o Two primary users: Investors (owners) and creditors (lenders)  Rely on all four in their decision to invest o Prepared by for-profit corporations – intended primarily to inform investors, creditors/ other external decision makers o Summarizes financial activity (represented annually, semi-annually or quarterly) * mostly quarterly, end of term 1) Statement of Financial Position (Balance Sheets) o Assets, liabilities and shareholders’equity of an accounting entity at one point in time o ASSETS = LIABILITIES + SHAREHOLDERS’EQUITY o Heading structure: 1) Name of entity – i.e. The Nestle Group 2) Title of statement – i.e. Statement of Financial Position st 3) Date – i.e. at December 31 , 2009 4) Unit of measure – i.e.in millions of Swiss Francs Balance Sheet Definitions: Assets: economic resources controlled by the entity as a result of past business events and from which future economic benefits can be obtained. (LEFT HAND SIDE) - Cash and cash equivalents: amount of cash and short-term deposits in the company’s bank accounts - Trade receivables: amounts owed by customers from prior sales, promise to pays from wholesalers and retailers (this counts as credit) - Inventories: supplies for production, or sale. – i.e. raw material - Prepayments: Rent and insurance paid in advance - Property, plant and equipment: factories and production equipment, land - Investments:Amounts invested in shares of other corporations - Intangible assets: Economic resources that lack physical substance - Other assets:Avariety of assets that are covered in future chapters Liabilities: an entity’s legal obligations that result from past business events, arise primarily from the purchase of goods/services on credit or through cash to finance the business. (RIGHT HAND SIDE) - Trade Payables: amounts owed to suppliers for prior purchases - Short-term borrowings: amounts owed to lenders within one year - Income taxes payable: amount of taxes owed to the government - Accrued liabilities: amounts owed to various suppliers of services - Long-term borrowings: amounts owed on written debt contracts after one year - Provisions: Estimated liabilities whose amounts and timing of payment are not known with certainty - Other Liabilities: a variety of liabilities that are covered in future chapters Shareholders’Equity: amount of financing provided by owners of shares in the business as well as earnings over time. (RIGHT HAND SIDE) - Share capital: amounts invested in the business by shareholders - Retained earnings: past earnings not distributed to shareholders, reinvested into company - Other components: adjustments to assets and liabilities that are explained in future chapters Liquidation: - Creditors and banks look at debts and assets to determine whether a company has the cash to pay/ repay its debts - The sale of assets (by the creditors) may not cover the company’s current debts o Assets are used with the intention of creating more economic growth in the combination of other resources under the legal control of the company. When taken out of context, external parties do not see the same potential. Format: - Assets of international companies usually are ordered from the most liquid (being cash) to the least liquid (such as patents or “intangibles”) - One line after the last of a group, two lines beneath the total of a group 2) The Statement of Comprehensive Income - Reports the change in shareholders’equity during a period from business activities other than investments by s/h or distribution to s/h (excluding exchanges with shareholders) - Income Statement: reports the revenue less the expenses of the accounting period. - Two parts: 1) Accountant’s primary measure of a company’s performance = revenues less expenses = PROFIT 2) Other comprehensive income: income and expense items that are not recognized in the income statement in accordance with International Financial Reporting Standards o Either shown in one statement together or two related statements Revenues – Expenses = PROFIT PROFIT + OTHER COMPREHENSIVE EXPENSES = COMPREHENSIVE INCOME - Revenue: normally reported on the income statement when the goods or services are sold to customers (whether they are paid for or not paid for) o Includes promise to pay, credit, cash, trade receivable (cash in future) o Other income could mean investments or profit from selling property, plant or equipment - Expenses: monetary value of resources the entity used up, or consumed to earn revenues during the period. o Cost of sales: cost of material, wages, portion of cost of buildings, equipment and tools used (depreciation) o Distribution expenses: salaries of sales staff, expenses related to distribution of the company’s products o Marketing and administrative expenses: salaries of marketing and management personnel, promotion of the company’s products through print/ electronic media, rental of office space, insurance, utilities and other general costs of operating the company not directly related to production o R&D expenses: R&D of new products o Other expenses: expenses not included above o Interest expense: reflects the cost of using borrowed funds o Income tax expense o Paid with immediate cash, promise to pay, or an inventory item that has already been paid for. - Profit (net income/ earnings): excess of total revenues over total expenses incurred to generate revenue during a specific period 3) The Statement of Changes in Equity - Shows how income statement and statement of financial position are linked through the r/e section of shareholders’equity - Heading identifies: o Name of entity o Title of statement (i.e. Statement of Changes in Equity For the Year Ended December 31, 2009) o Unit of measure used (i.e. in millions of CHF) - Rest of the layout: o Last period ending balances – i.e. “Balance as of Jan. 1, 2009” o Profit reported on the income statement – “profit for the year” o Dividends declared during the period – i.e. “distribution of dividends” o Issuance of additional share capital during the year – i.e. “decrease in capital” o Adjustments to the balances of specific assets and liabilities – i.e. “other changes, net” o Ending balances reported on the statement of financial position – i.e. “Balance as of Dec. 31, 2009” - Statement reports the way profit, distribution of profit (dividends) and other changes to shareholders’equity affected the company’s financial position in that period. - Retained Earnings: profits earned since creation of company not distributed yet to shareholders as dividends o Profits earned in the year = (+) RE o Declaration of dividends to shareholders = (-) RE - Consists of change in share capital, retained earnings and other components. Equity (beg. of year) + profit of the year + other comprehensive income – dividends +/- other changes (net) = equity (end of year) Beginning R.E. + Profit – Dividends = Ending R.E. 4) The Statement of Cash Flows - Divides company’s cash inflows (receipts) and outflows (payments) into.. 1) Cash flows from operating business o cash flows directly related to earning income o i.e. amount retailers immediately pay Nestle for delivering products. o Includes:  Cash collected from customers  Cash paid to trade suppliers  Cash paid to employees  Cash paid for general and administrative expenses  Cash paid for interest  Cash paid for taxes 2) Investing o Related to the acquisition or sale of company’s productive assets o Includes:  Cash paid to purchase property, plant, and equipmen
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