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Chapter 2

Chapter 2 BU227.docx

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Wilfrid Laurier University
Carolyn Mac Tavish

BU227 Chapter 2 – Investing and Financing Decisions and the Week 2 Statement of Financial Position Overview of Accounting Concepts -The primary objective of external financial reporting is to provide useful economic information about a business to help external parties, primarily investors and creditors, make sound financial decisions in their capacity as capital providers -he users of accounting information are identified as decision makers -Investors and potential investors want to assess the entities ability to pay dividends in the future -Three of the our basic assumptions that underlie accounting measurement and reporting relate to the statement of financial position -Under the separate-entity assumption, the activities of each business must be accounted for as an individual organization that is spate and apart from its owners, all other persons, and other entities -Under the unit-of-measurement assumption, each business entity accounts for and reports its financial results primarily in terms of the national monetary unit, even is the entity has business operations in many countries -We assume that businesses meet the continuity assumption -The historical cost principle sates that the cash equivalent cost needed to acquire an asset should be used for initial recognition (recording) of all financial statement elements -Under the cost principle, cost is measured on the date of the transaction as the cash paid plus the current monetary value of a non-cash considerations -One advantage of this approach is that many assets are acquired according to legal contracts that clearly state the acquisition cost -A disadvantage of this approach is that, subsequent to the date of acquisition, the continued reporting of historical cost on the statement of financial position does not reflect any change in market value, usually because market values is a less verifiable measure than historical cost -Unit of measure assumptions – states that accounting information should be measured and reported in the national monetary unit -Continuity assumption – states that businesses are assumed to continue to operate into the foreseeable future -Cost principle – requires assets to be 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 Cash Paid + Market Value of Computer = Historical Cost of New Car Elements of the Classified Statement of Financial Position -Asses are economic resources controlled by an entity as a result of past transactions or events and from which future economic benefits may be obtained -Consolidated means that the classified elements are combined with those of other companies under its control -Column ore report format lists assets first, followed by liabilities, and shareholder`s equity -Some companies choose an account format with the assets listed on the left-hand side and liabilities and shareholder equity listed on the right -Both communicate the same information -Typically the assets of a company include the following: 1. Current assets (short term) – cash and cash equivalents, short-term investments, trade and other receivables, inventories, prepayments, other current assets 2. Non-current assets (long-term) – property, plant, and equipment (at cost less accumulated BU227 Chapter 2 – Investing and Financing Decisions and the Week 2 Statement of Financial Position depreciation), investment in associates, financial assets, goodwill, intangible assets, other assets -Current assets are typically transformed into cash within the next year -Assets are listed in order of liquidity – how fast it can be turned into cash -Trade receivables are amounts owed by customers who purchase goods on credit -Notes receivable are written promises by customers to pay fixed amount by specific dates -Long term assets are used or turned into cash over a period longer than the next year -Financial assets represent investments in shares of debt instruments issues by other companies that are intended to be kept for longer than one year -Goodwill is an intangible asset that arises when a company purchases another business to control its operating, investment, and financing decisions -Goodwill reflects assets that are not easily identifiable and measured such as consumer confidence -Intangible assets are not acquired or resale but are directly related to the operations of the business -Liabilities represent outflows of assets -Typically the liabilities of a company include the following: -Current liabilities (Short-term) – trade payables, short-term borrowings, income taxes payable, accrued liabilities, other current liabilities -Non-current liabilities (long-term) – long-term borrowings, deferred income tax liabilities, provisions, other liabilities -Liabilities are listed by order of time to maturity – how soon an obligation must be paid -Trade payables – the total amount owed to suppliers of materials -Short-term borrowings – short-term loans from banks -Accrued liabilities – total amount owed to suppliers for various types of services such as payroll, rent, etc. -Provisions – estimated liabilities characterized by uncertainty about the exact amount to be paid and the timing of the payment -Owners invest in a company because they expect to receive two types of cash flow: dividends, and capital gains (selling share for more than was purchased) -Typically, the shareholder’s equity of a corporation includes the following: -Share capital (or capital stock) -Retained earnings (accumulated earnings that have not been declared as dividends) -Other components -Share capital – res
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