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Chapter 2

Chapter 2 - Investing and Financing Decisions and the Statement of Financial Position.docx

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Wilfrid Laurier University
David Scallen

Chapter 2: Investing/Financing Decisions & Statement of Financial Position - Financial statements are intended to communicate the economic facts, measured in monetary units, in a standardized, formal way Objective of Fin.Acc: - Primary objective of ext. fin/acc: provide useful econ info about a business to help ext parties make sound financial decision - Users of acc. info are decision makers (i.e. average investors, creditors, and experts who provide financial advice) Accounting Assumptions: - Separate-entity assumption: business transactions are separate from the transactions of the owners o i.e. building purchased by owner for recreational use does not count as a cost or asset of the business - Unit of MeasureAssumption: accounting info should be measured and reported in the national monetary unit o i.e. US branches in India would still be recording in USD - Stable Monetary UnitAssumption: allows accountants to combine different amounts, even though the purchasing power of the monetary unit has changed over time. - Continuity (going concern) assumption: businesses are assumed to continue to operate into the foreseeable future o Failure to do so means company’s assets and liabilities are valued/ reported as liquidated (all assets sold, all debts paid) BasicAccounting Principle - Historical Cost Principle: assets recorded at the historical cash-equivalent cost, which is cash paid plus the current monetary value of all non-cash considerations also given in the exchange, on the date of the transaction o i.e. $15000 in cash + laptop worth $2000 = a car worth $17000 example - Advantage: many assets are acquired according to legal contracts that clearly state the acquisition cost – easy to determine, can be verified - Disadvantage: change in market value not recorded – because market value is less verifiable than historical value o Current market value not relevant if land is asset-in-use/ no interest in selling it Classified (Consolidated) Statement of Financial Position - Increase in the value of shareholders’investment will depend largely on realized future benefits arising from company’s assets - Consolidated: financial position is combined with those of other companies under its control - Two columns are shown: current and previous year o Allows investors to see change over time – predict improvement or deterioration - Content: - What is on a CSFP? o Heading:  Name – i.e. THE NESTLE GROUP  Type of statement – i.e. Consolidated Statement of Financial Position st  Period recorded – i.e. as at December 31  Currency – i.e. (in millions of Swiss francs) o Assets: listed by liquidity  Current assets: assets that used or turned into cash under one year • Cash and cash equivalents: amount of cash and short-term deposits in the company’s bank accounts • Short-term investments: excess cash invested in financial instruments • Trade receivables: amounts owed to customers from prior sales, purchased on credit – normally collected under a year • Notes receivable: amounts to be received from others on specific dates • Inventories: supplies for production, or sale. (inventory is always considered current asset, regardless of time needed to produce and sell it). Refers to goods that are... 1) Held on sale to customers in the normal course of business 2) Used to produce g/s for sale • Prepayments: rent and insurance paid in advance • Other current assets: a variety of assets that are covered in future chapters (i.e. number of assets with smaller balances that are combined)  Non-current assets: considered to be long-term because they will be used or turned in cash in over a year • Property, plant & equipment: factories and production equipment – aka. “fixed” or “capital” assets because they are tangible • Investments in associates: amounts invested in shares of associated corporations • Financial assets: amounts invested in term deposits and securities of other corporations • Goodwill: intangible asset that arises when a company purchases another business to control its operating, investment and financing decisions (price of purchase > fair market value of business) o GW reflects assets like quality, customer service, reputation • Intangible assets: economic resources that lack physical substance, legal rights and privileges of company • Other assets: a variety of assets that are covered in future chapters o Liabilities and Equity: debts/ obligations of the entity that result from past transactions, which will be paid with assets or services; listed by order of maturity (how soon it must be paid)  Current liabilities – paid with cash, other current assets or services within year or business cycle, whichever is longer • 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 • Other current liabilities: a variety of liabilities that are covered in future chapters  Non-current liabilities • Long-term borrowings: amounts owed on written debt contracts after one year • Deferred income tax liabilities: amount of taxes deferred to future periods • 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 o Equity: financing provided by owners and the operations of the business. Owners purchase shares in other companies to receive two types of cash flows 1) Dividends – distribution of corporation’s earnings 2) Capital gains – selling shares for more than they paid  Share capital: amounts invested in the business by shareholders • Contributed surplus: The amount of money that a company earns from sources other than its profits, such as when a company issues and sells shares at a price greater than their par value. • Share capital + contributed surplus = contributed capital  Retained earnings: past earnings not distributed to shareholders, reinvested into company  Other components: adjustments to assets and liabilities that are explained in future chapters  Total equity attributable to shareholders of the parent – bolded, listed after the three items above.  Non-controlling interests: equity of other corporations not controlled by parent company What BusinessActivities Cause Changes in Financial StatementAmounts? - Nature of Business Transactions: o Transactions: a) An exchange between a business and one/more external parties to a business b) Measurable internal event (i.e. adjustments for the use of assets in operations) o Two types of transactions 1) External Events  Exchanges of assets, goods, or services by one party for assets, services or promises to pay (liabilities) by
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