M2: Financial Accounting & Financial Statements

Question 1

Who uses financial statements?

Answer 1

Any individuals and/or organizations who are somehow invested in the performance of the company. There may be users both inside and outside the organization.

1. Internal users
2. External users

Question 2

Who are internal users of financial statements? Why could they be interested in financial statements?

Answer 2

Internal users: includes management and other employees. They may use the financial statements to assess company performance or to aid in decision making. Employees can care because it can give information about job security and help you see what the companies goals are for the future. Sometimes employees get profit sharing which would also make them concerned about the financial statements. Management could care if their bonus relies on the performance of the company.

Question 3

Who are external users of financial statements? Why could they be interested in financial statements?

Answer 3

External users: investors, banks, suppliers, government agencies or any public interest groups (Ex: environmentalists want to see if companies are acting sustainably). Anyone outside the organization who may use the financial statements to assess company performance or company policies.
Banks: want to make sure you’re going to be able to o pay back loans.
Supplier: want to make sure you can pay for all the supplies they’re sending.
Government: for tax returns.

Question 4

What is a disclosure requirement?

Answer 4

Certain types of companies are required by law to produce financial statements and other types of information. In general, the information a company is required to prepare depends on if it is public or private.

Question 5

What are the disclosure requirements for a public company?

Answer 5

Public companies: public companies are required by law to prepare and publish financial statements, as well as other information.

1. Management Proxy Circular (produced annually)
2. Annual Report.
3. Management Discussion & Analysis (in US)/Annual Information Form (in Canada) .
4. Quarterly Financial Statements (produced each quarter.

Question 6

What are the disclosure requirements for a private company?

Answer 6

Private companies: while they are not legally required to do so, some private corporations may choose to prepare financial statements for information purposes or may be required to do as part of a loan agreement.

Question 7

Why would private companies choose to make financial statements even if they’re not legally required to do so?

Answer 7

To get loans from banks (they check to see if you’re generating enough cash to pay back their loans before they give you one), so managers can see how the company is performing.

Question 8

What is a management proxy circular? When is it produced? What is the purpose?

Answer 8

What is it: Contains information about the owners (major shareholders - who they are), management compensation/perks (benefits and salary of management ex. use of private jet), board of director compensation and responsibilities, and more.

When?: annually

Purpose: The purpose is to provide an agenda and proposals that will be voted on at the annual shareholder meeting. Items to be voted on can include financial statements, auditors, re-election of board of directors and management/board compensation.

Question 9

What is an annual report?

Answer 9

Includes audited financial statements, letter from CEO/chairperson to provide review of accomplishments, progress, challenges ahead, areas of focus, summaries of key financial information, etc.

Question 10

Which of the disclosure requirements is the most important or useful choice for investors and other external users?

Answer 10

• It depends on what investors are looking for
• Disclosure requirements all produced by management, but annual report has a higher level of reliance because it is the only one that is verified by a third party (financial statement needs to be audited).

Question 11

What is Management Discussion & Analysis (in US)/Annual Information Form (in Canada)? When is it produced?

Answer 11

When?: annually
What is it: Contains information about business risks, bad debts (a client is not going to pay you for what they owe you), customer concentration (i.e. required to disclose is one customer makes up over 10% of sales - Risky because If that customer is not doing well they wont be able to pay you), long term goals of the corporation, performance in comparison to prior year goals, etc.

Question 12

What are Quarterly Financial Statements? When are they produced?

Answer 12

Financial statements for a quarter of the year, as well as an update on any outstanding legal proceedings/disputes and updates on compliance with debt agreements. The goal is to provide users with an update on company performance so they don’t need to wait an entire year.
When?: quarterly

Question 13

What are financial statements?

Answer 13

Financial statements are the primary way a company’s financial performance is communicated with owners (shareholders) and other users.

Question 14

What would happen without financial statements (part of the annual report)?

Answer 14

Without financial statements and accounting frameworks, there would be no reliance on the performance of public companies, which would promote fraud & other unethical behaviour.

Question 15

What is the typical financial reporting cycle of a public company with a year end on Dec 31?

Answer 15

1. During the year, accountants record transactions (sale, make a purchase, etc.) using accounting software.
2. Once Dec 31 hits: Accountants (controller) prepare financial statements. They take the data from the accounting system and they organize it to prepare financial statements.
3. At the end of january/february: Financial statements are provided to auditors who perform the audit (is the financial statement accurate? Auditor = third party people who work at public accounting firms perform tests).
4. March 31 (3 months after year end) financial statements are finalized and published.

Question 16

What is the financial reporting cycle of a private company?

Answer 16

For a private company, there is no legal requirement to issue financial statements so the 3 month deadline does not apply and financial statements are often issued later in year (sometimes up to 6 months after the year end).

Question 17

What are accounting standards? What are the three common sets of accounting standards in North America?

Answer 17

As we’ve seen, users need financial statements for different purposes. In order to provide information that is consistent and comparable, accountants are required to use a set of specific rules, called accounting standards, to prepare financial statements.

1. International Financial Reporting Standards (IFRS).
2. US Generally Accepted Accounting Principles (US GAAP).
3. Accounting Standards for Private Enterprises (ASPE).

Question 18

Which accounting standards can private companies use in Canada?

Answer 18

Canadian private companies can choose between IFRS and ASPE.

Question 19

What are the two main sections of accounting standards?

Answer 19

1. Conceptual framework.

2. Detailed standards relating to specific statements or transactions.

Question 20

What key points fall under conceptual framework?

Answer 20

1. Assumptions underlying financial reporting
2. Characteristics of financial reporting information
3. Basic accounting principles
4. Financial reporting constraints

Question 21

(conceptual framework) What are the assumptions underlying financial reporting? Explain them.

Answer 21

1. Separate Entity: Due to the fact that a corporation is a separate legal entity with a limited liability, the financial statements should only include information about the corporation and its performance. doesn’t include the shareholders personal income.
2. Unit of Measure:
   States that we should use units of money to present financial information.
3. Accounting Period: States that financial statements should be prepared on a periodic and timely basis to provide information that will be useful to shareholders. Generally on a yearly basis with quarterly updates.
4. Going Concern:
   Assumes that the corporation will continue to operate for the foreseeable future. (Ex: If my assumption is that they will go bankrupt, the financial statements change because it changes how you account for things ex: you have to sell everything tmr because company will go bankrupt. Cant say your assets will be good for the next 10 years.)

Question 22

(conceptual framework) What are the characteristics of financial reporting? Explain them.

Answer 22

1. Relevance:
   Defined as information that is capable of making an impact when the user is making a decision. For example, does the information help predict future events or confirm previous predictions?
2. Reliability:
   The information presented in the financial statements should be reliable, which means that it is verifiable by someone independent. Information should also be neutral/unbiased.
3. Consistency:
   Companies should follow consistent accounting policies from one period to the next to aid with comparability.
4. Comparability:
   Information should be comparable between different companies or for the same company over different periods.
   Only knowing how a company is doing by itself is not useful if you can’t compare it to other companies and also compare to information of past years to see if the company is improving.

Question 23

(conceptual framework) What are the accounting principles of financial reporting?

Answer 23

1. Historical cost
2. Revenue principle
3. Matching principle

Question 24

What is historical cost (from accounting principles)?

Answer 24

When a company purchases an asset, they will record it on their financial statements for the amount paid (includes any cost to get the asset ready to use). If the fair market value subsequently increases, we don’t increase the value on the financial statements. This is because we consider the amount paid to be more reliable than an estimate of fair market value.
Ex: Even if the value of the building is increasing over time, I’m still going to show what i originally purchased it for. This is more reliable.

Question 25

What is revenue principle (from accounting principles)?

Answer 25

Revenues from sales will be recognized as income in the financial statements only when it has been earned AND when collection is reasonably assured. Earned can be either when the legal title of goods has been transferred or, in the case of service revenue, the service has been rendered.
Ex: going to a concert. The company selling the tickets is getting cash right away. The company can only say they have revenue at the time when they earned the revenue, not when they got the cash. they can only say they made the sale when the service was performed.
Also, to record a sale you have to be sure you will be able to collect the cash from the sale if the client is paying later.

Question 26

What is matching principle (from accounting principles)?

Answer 26

Similar to the revenue principle, the matching principle determines when expenses should be deducted in the financial statements. This depends on the type of expenses:

• When possible, expenses should be recognized when related revenues are recognized. For example, when goods have been shipped, revenue will be recognized, so the cost of those goods should also be deducted in the financial statements.
• Expenses that will have benefits over time, such as depreciation and insurance, should be recognized over the period of the expected benefit.
• Other expenses that don’t have any future benefits should be deducted when the cost is incurred. (ex: marketing).

Question 27

What is depreciation?

Answer 27

An expense that will be expensed over the time they will be useful. Ex: if i buy a building for 1 million. I expense a portion of a million over the years that it will be useful .

Question 28

(conceptual framework) What are the constraints of financial reporting?

Answer 28

1. Materiality: there is some flexibility in how “small” amounts of money are recorded, if the amount of money in question is non material, a company can use more professional judgement or can leave an error uncorrected. Materiality is defined as an amount that would impact the users decision, which is different for each company.(Ex: I’m a shareholder of apple. Apple expenses ONE computer all in one year instead of over 5 years. They won’t care because the cost of one computer doesn’t make an impact on the billions of dollars on Apple’s financial statement. It’s different for every company.)
2. Cost-benefit: there is an understanding that accounting information should only be produced to the extent that the cost of developing the information does not exceed its benefit to the user. While there is a certain amount of flexibility, this does not meet that companies can omit important information because it is “too expensive” to prepare (Ex: providing the salary of every single individual employee).

Question 29

What counts as costs to develop information?

Answer 29

1. Cost to collect info
2. Cost to publish info
3. Cost to audit
4. Potential legal costs

Question 30

What is something that is “missing” from an auditors report?

Answer 30

They’re not promising the financial statements they audited are perfect. They’re just promising its free of any material (big) mistakes.

Question 31

What are the elements that MUST be included in a financial statement?

Answer 31

1. Income Statement (also referred to as Statement of Comprehensive Income)
2. Balance Sheet (also referred to as Statement of Financial Position)
3. Statement of Changes in Equity
4. Cash Flow Statement (also referred to as Statement of Cash Flows)
5. Notes to the financial statements

Question 32

What is the purpose of a balance sheet?

Answer 32

The purpose of the balance sheet is to present, on a specific date, the assets (resources) owned by the company, the liabilities owed to creditors/suppliers and the equity of the company.

Question 33

What is included in a balance sheet? explain.

What is the relationship between the components?

Answer 33

1. Assets: tangible or intangible resources that will provide future economic benefits (cash, buildings, fixed assets, etc).
2. Liabilities: financial obligations or commitments
3. Equity: amount investors contributed to the company, as well as any accumulated undistributed profits.

All resources must have a source (i.e. no company gets cash for free), the relationship between these components is as follows:
Assets = Liabilities + Owners/Shareholders Equity

Question 34

What is the purpose of an income statement?

Answer 34

The purpose of the income statement is to show, for a specific period of time, the income generated by the business.

Question 35

What is included in an income statement? explain.

Answer 35

1. Revenues: summarizes the revenues from selling goods/services for the defined period.
2. Revenues: summarizes the expenses incurred during the defined period.
3. Gross profit: the difference between the revenues and the cost of goods sold, expenses that relate directly to the production of revenues (ex. inventory & transportation costs).
4. Profit: the difference between the revenues and expenses will be the profit or net income of the business for that period. (AFTER all expenses are paid).

Question 36

What is the purpose of a statement of changes in equity?

Answer 36

The purpose of the statement of changes in equity is to summarize, for a specific period of time, the transactions that impact the owners equity accounts. (Ex: Paying dividends, sell more shares, buy back more shares. Interactions between company and shareholders).

Question 37

What is included in a statement of changes in equity? explain.

Answer 37

1. Common or preferred stock: shows the value of shares issued/redeemed during the period.
2. Retained earnings: shows the income of the period and any dividends declared during the period.
3. Other sections may also apply to the company depending on the equity structure but these would be covered in a more advanced accounting course.

Question 38

What is the purpose of a cash flow statement?

Answer 38

The purpose of the cash flow statement is to show, for a specific period of time, from where company received cash and how it was spent.

Question 39

What is included in a cash flow statement? Explain.

Answer 39

1. Operating cash flows: details the cash received from day to day operations (i.e. sales) and spent on recurring expenses (i.e. inventory, wages, etc.).
2. Investing cash flows: details the cash received from sale of business assets (ex. buildings, equipment, etc.) and the cash spend on the purchase of these assets.
3. Financing cash flows: details the cash received from and paid to investors or creditors (ex. receiving/repaying bank loans or issuing/repurchasing shares).

Question 40

look at the elements of a financial statement in exercise 1 of lecture 6.

Answer 40

go look bitch.

Question 41

Redo the activity.

Answer 41

Go redo it now ugly.