Ch.1 + 2 - The Purpose and Use of Financial Statements

Question 1

Two Categories of Users

Answer 1

1. Internal Users
   ex. company officers, managers and directors in different departments.
2. External Users
   ex. investors, lenders, customers, labour unions, tax authorities and regulators.

Question 2

Generally Accepted Accounting Principles (GAAP)

Answer 2

Foundational principles for preparation of financial statements including: (i) broad policies and practices (ii) authoritative rules and procedures.

Publicly Traded: International Financial Reporting Standards (IFRS)
Privately Traded: IFRS or Accounting Standards for Private Enterprises (ASPE)

Proprietorships/Partnerships: typically use ASPE

Question 3

Annual Reports

Answer 3

Public corporations must always produce one yearly.

Contains:
-Financial statements
-Management discussion and analysis (MD&A)
-Auditor’s report
-Notes to financial statements

Question 4

Financial Information: Fundamental Qualitative Characteristics

Answer 4

1. Relevance: influence
   - predictive: future events
   - confirmatory: confirm or correct previous predictions
   - materiality (significant): if its omission can influence
2. Faithful Representation: reflect economic reality
   - complete: nothing omitted
   - neutral: not biased
   - free from material error: accurate description, no error

Question 5

Financial Information: Enhancing Qualitative Characteristics

Answer 5

1. Comparability: users can identify
2. Verifiability: is there a consensus that it accurate
3. Timeliness: available when needed to make a decision
4. Understandability: classified, characterized, and presented clearly and concisely.

Question 6

Financial Information (Cost Constraint and Going Concern Assumption)

Answer 6

Cost Constraint:
-Think about cost-benefit principle and how benefit > cost.

Going Concern Assumption: assumes company will continue to operate in the future. Key assumption which is the foundation for accounting process and justifies that cost for getting an asset.

Question 7

5 Financial Statements

Answer 7

1. Assets
2. Liabilities
3. Shareholders’ Equity
4. Income (ex. Revenues)
5. Expenses

Question 8

Measurement of the Elements of Financial Statements

Answer 8

GAAP: Historical Cost
-Liabilities and assets should be recorded at the price when a cost was incurred from acquiring an asset/liability.

GAAP: Fair Value
-Certain assets and liabilities should be recorded and reported at fair value.

Question 9

Types of Financial Statements

Answer 9

1. Statement of Income
2. Statement of Changes in Equity
3. Statement of Financial Position
4. Statement of Cash Flows

Question 10

Statement of Income

Answer 10

Aka. Income Statement, P&L (Profit & Loss) Statement

Includes: Revenues, Expenses, Income Tax Expense, Net Income (bottom-line)

It reports revenues and expenses for a specific period of time (accounting period can be a fiscal year or interim periods).

Question 11

Statement of Changes in Equity

Answer 11

It reports the changes in each component of shareholders’ equity during an accounting period.

common shares + retained earnings = total equity

Main components:
(i) Share capital - mainly in form of cash ($ contributed by shareholders, may be common and preferred share classes)
(ii) Retained Earnings - aka. Net Income/Net Earnings (net income retained minus dividends paid to shareholders)
(iii) Other shareholders’ accounts

Question 12

Changes in Common Shares vs. Changes in Retained Earnings

Answer 12

Common Shares:
beginning of period + issued (sold) - repurchased = end of period

Retained Earnings:
beginning of period + net income/loss - dividends declared = end of period

Question 13

Statement of Financial Position

Answer 13

It shoes the assets, liabilities, and shareholders’ equity at a specific point in time.

Basic Accounting Equation:

Assets = Liabilities + Shareholders’ Equity

Question 14

Statement of Financial Position: Current Assets

Answer 14

Assets that are expected to be converted into cash or consumed within one year of financial statement date/operating cycle whichever is longer.

Common Types:
-Cash
-Trading Investments
-Accounts Receivable
-Notes Receivable
-Inventory
-Supplies
-Prepaid Expenses

Question 15

Operating Cycle

Answer 15

Average time required to pay cash to obtain products/services and then receive cash from customers for products/services.

Question 16

Statement of Financial Position: Non-Current Assets

Answer 16

Aka. Long-Term Assets

Common Types:
-Long-term investments
-Property, plant, and equipment (PPE)
-Intangible assets (not physical)
-Goodwill

-Tangible assets depreciate over time.
-[Land]
-Buildings
-Equipment
-Furniture
-Computers
-Vehicles

Question 17

Contra Accounts

Answer 17

An account that reduces value of a related account. Every contra account is directly related to the account it reduces.

Question 18

Asset Account & Contra Asset Account

Answer 18

Asset Account: accounts receivable, building, truck.

Contra Asset Account: allowance for doubtful accounts, accumulated depreciation - building, accumulated depreciation - truck.

Question 19

Statement of Financial Position: Current Liabilities

Answer 19

Obligations to be paid or settled within one year of the financial statement.

Common Types:
-Bank indebtedness
-Accounts payable
-Deferred revenue
-Notes payable
-Current portion of long-term debt (CPLTD)

Question 20

Statement of Financial Position: Non-Current Liabilities

Answer 20

aka. long-term liabilities

Common Types:
-Notes payable
-Lease liabilities
-Pension and benefit obligations

Question 21

Statement of Financial Position: Shareholders’ Equity

Answer 21

Residual amount; difference between a company’s assets and liabilities

Common Components:
-Share capital
-Retained earnings

Question 22

Statement of Cash Flows

Answer 22

Reports the effect on cash related to the company’s:
-Operating activities
-Investing activities
-Financing activities