chapter 2-accounting critical approach
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critical approach financial accountingTRANSCRIPT
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FINANCIAL ACCOUNTING: A CRITICAL APPROACH
Chapter 2 Financial Statements: A Window on an Entity
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2 Copyright 2010 McGraw-Hill Ryerson Limited
Learning Objectives
LO 1 Identify components of financial statements, understand the info each statement provides, and prepare simple examples
LO 2 Describe the accounting equation
LO 3 Explain the nature of assets, liabilities, owners equity, revenues, and expenses
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Learning Objectives
LO 4 Differentiate between accrual-basis and cash-basis accounting, and prepare simple income statements using each method
LO 5 Use financial statement information to assess the liquidity, risk, and profitability of an entity
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Financial Statements
Balance Sheet Income Statement and Statement of
Comprehensive Income Statement of Changes in Equity or Statement of Retained Earnings Statement of Cash Flows Notes to the Financial Statements
LO 1
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The Balance Sheet
A summary of an entitys financial position at a point in time
Elements: Assets (A), Liabilities (L), Owners Equity (OE)
Information about an entitys financial position can help stakeholders: evaluate its financial health assess its risk predict its future cash flows
LO 1
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Accounting Equation
The accounting equation is the conceptual foundation of accounting Assets (A) Liabilities (L) Owners Equity (OE)
(A = L + OE)
LO 2
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Exercise 2-1 page 63
a. $614,000 b. $425,000 c. $189,000 d. $236,000
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 1 $425,000 ? $189,000
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Exercise 2-1 page 63
a. $614,000 b. $425,000 c. $189,000 d. $236,000 (425,000 189,000)
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 1 $425,000 ? $189,000
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Exercise 2-1 page 63
a. $110,000 b. $1,350,000 c. $730,000 d. $620,000
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 2 ? $730,000 $620,000
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Exercise 2-1 page 63
a. $110,000 b. $1,350,000 c. $730,000 d. $620,000 (730,000 + 620,000)
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 2 ? $730,000 $620,000
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Exercise 2-1 page 63
a. $150,000 b. $50,000 c. $250,000 d. $200,000
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 3 $200,000 50,000 ?
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Exercise 2-1 page 63
a. $150,000 b. $50,000 c. $250,000 d. $200,000 (200,000 50,000)
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 3 $200,000 50,000 ?
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Exercise 2-1 page 63
a. $420,000 b. $770,000 c. $70,000 d. $350,000
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 4 $420,000 ? $350,000
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Exercise 2-1 page 63
a. $420,000 b. $770,000 c. $70,000 d. $350,000 (420,000 350,000)
For each of the following independent situations, fill in the missing amount. Assets = Liabilities + Owners Equity Situation 4 $420,000 ? $350,000
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Assets
According to IFRS, an asset must have the following characteristics: Provide a future benefit to the
entity it must be probable that the entity
will enjoy the benefit Assets are economic resources
available to entity
LO 3
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Assets
Current assets Used up within one year (operating cycle)
Non-current assets Benefits extend beyond one year
LO 3
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Asset Criteria
Result from transaction with another entity Cost can be determined Must provide future benefit Benefit must be reasonably measurable
What are some current assets? Long-term assets?
LO 3
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Question
a. Employees who work for the company b. Research into new products for the
company c. A building owned by the company but
rented out d. Advertising spent on attracting
customers to the company
Which of the following would be considered an asset for accounting purposes?
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Question
a. Employees who work for the company b. Research into new products for the
company c. A building owned by the company but
rented out d. Advertising spent on attracting
customers to the company
Which of the following would be considered an asset for accounting purposes?
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Liabilities
Liabilities are an entitys obligation to pay money or provide goods or services to suppliers, lenders, customers, and government
According to IFRS, a liability must be the result of a past transaction or economic
event require some kind of economic sacrifice to settle
LO 3
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Liabilities
Obligations incurred by entity Not necessarily a legal obligation Current liabilities
Paid or satisfied within one year Non-current liabilities
Paid or satisfied beyond one year
What are some current liabilities? Long-term liabilities?
LO 3
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Question
a. $100,000 non-current liability b. $100,000 current liability c. $90,000 non-current liability d. $10,000 current liability and $90,000
non-current liability
Bass Ltd. borrowed $100,000 from the bank. They will repay $10,000 a year for the next ten years plus 5% interest. How would the loan be initially recorded on Basss balance sheet?
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Answer
a. $100,000 non-current liability b. $100,000 current liability c. $90,000 non-current liability d. $10,000 current liability and $90,000
non-current liability
Bass Ltd. borrowed $100,000 from the bank. They will repay $10,000 a year for the next ten years plus 5% interest. How would the loan be initially recorded on Basss balance sheet?
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Owners Equity
Owners equity: the amount owners have invested in an
entity represents the amount of the assets
financed by the owners Terms
Shareholders equity (corporation) Partners equity (partnership) Proprietors equity (proprietorship)
LO 3
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The Income Statement
Results for an accounting period Unlike balance sheet
Revenues minus expenses Net income (Bottom line)
What are some examples of revenue? What are some examples of expenses?
LO 1
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The Income Statement
Measures an entitys economic activity over a period of time, such as a year
Uses for an income statement are: evaluating the performance of an entity and its
management predicting future earnings and cash flows estimating the value of an entity determining the amount of tax that must be paid
LO 1
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The Income Statement
The income statement can have significant economic consequences for entities and their stakeholders including: stock prices often change when a company
announces its net income managers bonuses are often based on net income net income is used to determine income taxes the selling price of a business can be based on net
income
LO 1
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Format of Income Statement
Revenue xxx - Cost of Goods Sold (xxx) = Gross Margin xxx - Operating Expenses (xxx) = NI Before Income Taxes xxx - Income Taxes (xxx) = Net Income xxx
LO 1
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Question
a. $240,000 b. $400,000 c. $1,800,000 d. $3, 200,000
Lennox. Ltd. reported sales of $5,000,000, cost of goods sold of $3,200,000, operating expenses of $1,400,000 and income tax expense of $160,000 for the year. What was their net income for the year?
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Answer
a. $240,000 b. $400,000 c. $1,800,000 d. $3, 200,000 (5,000,000 3,200,000 1,400,000 160,000)
Lennox. Ltd. reported sales of $5,000,000, cost of goods sold of $3,200,000, operating expenses of $1,400,000 and income tax expense of $160,000 for the year. What was their net income for the year?
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Exercise 2-19 page 67
Complete together with the class Prepare an income statement. What is the net income? What is Sussexs gross margin for 2013? What is Sussexs gross margin percentage for 2013?
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Exercise 2-10 page 65
Complete together with the class
Prepare a balance sheet
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The Statement of Comprehensive Income
Current GAAP attempts to capture all transactions and economic events that involve non-owners and that affect equity
Net income + Other comprehensive income (OCI) = Comprehensive income
LO 1
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The Statement of Comprehensive Income
Comprehensive income also affects the equity section of the balance sheet
In the equity section of the balance sheet, there is an account called Accumulated Other Comprehensive Income (AOCI)
LO 1
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Statement of Shareholders Equity
Companies that follow IFRS must provide a statement of shareholders equity
Presents the changes in each account in the equity section of the balance sheet during a period
LO 1
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Statement of Retained Earnings
Canadian GAAP for private companies only requires a statement of retained earnings
Summarizes changes during the period Opening retained earnings + net income for period - dividends declared = ending retained earnings
LO 1
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Statement of Cash Flows
Cash from/used in operations
Cash from/used in financing activities
From long-term liabilities and directly from investors
Cash from/used in investing activities
Used to buy capital assets
LO 1
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The Relationship Among Financial Statements
The individual financial statements are closely related
Many transactions and economic events involve both the Income Statement and the Balance Sheet, and any transaction that involves cash is included in the Statement of cash flows
LO 1
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Notes to Financial Statements
The notes to the financial statements Expand and explain the information in the
statements Explain the accounting policies Provide additional information that may help
stakeholders assess an entity
LO 1
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Format of Financial Statements
Format of general purpose financial statements No single way to format financial statements
An example of the balance sheet format suggested by IFRS is seen in Exhibit 2.5
Notice that in contrast to the Leons balance sheet Non-current assets are at the top of the asset side and
current assets at the bottom On the liabilities and equity side, equity is at the top, followed
by non-current liabilities, and then current liabilities
LO 1
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Cash Basis
Revenue recorded when receive cash
Expenses recorded when pay cash
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Accrual Basis
Revenue Economic benefit earned from providing goods
or services Represents an increase in owners equity Expenses Economic sacrifices or costs made to earn
revenues Using up an asset or incurring a liability
LO 3
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Analysis
Liquidity - the availability of cash or the ability to convert assets to cash to meet obligations important to creditors who are expecting to be paid
Liquidity measure: Working capital
Current assets minus current liabilities
LO 5
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Analysis
Debt-to-equity ratio: Liabilities
Shareholders equity
A measure of how an entity is financed - the higher the ratio, the more debt an entity is using relative to equity
LO 5
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Analysis
Using the income statement to assess performance
Gross margin = sales cost of sales
Gross margin % = Gross margin Sales
LO 5
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Materiality
Materiality is the significance of financial information to stakeholders Info. is material if its omission or misstatement
affects the judgment of the users of the financial statements
Financial statements should be free of material misstatements or errors, & all material info should be reported in the financial statements or notes because its absence may affect decision making
LO 1
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Accounting Equation (Revisited)
The income statement is part of the owners equity section of the balance sheet
A = L + (OE beginning + Revenue Expenses of the period-Dividends)
OR A = L + (OE beginning + Net Income-Dividends)
LO 2