1 1 Copyright © 2013 McGraw-Hill Ryerson Limited After studying the material in this chapter, you will be able to do the following: LO1 Understand the objectives of general purpose financial reporting and the qualitative characteristics of useful financial information as described in the IFRS conceptual framework LO2 Recognize the basic accounting assumptions that are fundamental to contemporary accounting LO3 Identify components that make up a set of general purpose financial statements, understand the information each statement provides, and prepare simple examples of them Learning Objectives Copyright © 2013 McGraw-Hill Ryerson Limited 1

2 2 Public companies Private companies Government entities – federal, provincial, municipal Not-for-profit organizations Who Prepares Financial Statements? LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 2

3 3 Shareholders Creditors Canada Revenue Agency Competitors Other possible users: ▫Potential investors ▫Franchise owners ▫Employees ▫Regulators Users of Financial Statements LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 3

4 4 Financial statements include: Balance Sheet or Statement of Financial Position 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 Financial Statements LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 4

5 5 General Purpose Financial Statements (GPFS) Intended for all users Prepared in accordance with GAAP: ▫Canadian GAAP, IFRS, Public Sector GAAP, etc. Prepared at least once per year Must be interpreted by user GPFS are intended for no one in particular and for everyone in general General Purpose Financial Statements LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 5

6 6 Materiality is the significance of financial information to stakeholders. ▫Information 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, and all material information should be reported in the financial statements or notes because its absence may affect decision making ▫What information should be considered material? Materiality LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 6

7 7 Balance Sheet - Summary of an entity’s financial position at a point in time Also known as “Statement of Financial Position” Elements: ▫Assets (A) ▫Liabilities (L) ▫Owners’ Equity (OE) The Balance Sheet LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 7

8 8 Preliminary definition of the elements: ▫Assets (A) are economic resources that provide future benefits to an entity ▫Liabilities (L) are an entity’s obligations ▫Owners’ equity (OE) is the investment the owners have made in the entity The Balance Sheet LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 8

9 9 Information about an entity’s financial position can help stakeholders: ▫evaluate its financial health ▫assess its risk ▫predict its future cash flows The Balance Sheet LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 9

10 Copyright © 2013 McGraw-Hill Ryerson Limited The Income Statement LO3 Income Statement - measures an entity’s economic activity over a period of time, such as a year A “How did we do?” statement Shows results for an accounting period (usually 1 yr) ▫Unlike balance sheet (entity’s life) Copyright © 2013 McGraw-Hill Ryerson Limited 10

11 Copyright © 2013 McGraw-Hill Ryerson Limited Revenues - Expenses = Net Income (aka “Bottom line”). 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 The Income Statement LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 11

12 Copyright © 2013 McGraw-Hill Ryerson Limited Economic Consequences 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 The Income Statement LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 12

13 Copyright © 2013 McGraw-Hill Ryerson Limited ABC Company Ltd. Income Statement For Year End Dec. 31, 20xx Revenue xxx - Cost of Goods Sold(xxx) = Gross Margin xxx - Operating Expenses(xxx) = NI Before Income Taxes xxx - Income Taxes(xxx) = Net Income xxx Income Statement - Format LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 13

14 Copyright © 2013 McGraw-Hill Ryerson Limited Statement of Comprehensive Income In the past, certain types of economic events were excluded from the calculation of net income Many of these items went directly to owners’ equity or were not recorded Comprehensive income is an extension of net income Copyright © 2013 McGraw-Hill Ryerson Limited 14 LO3

15 Copyright © 2013 McGraw-Hill Ryerson Limited Statement of Comprehensive Income Current GAAP attempts to capture all transactions and economic events that involve non-owners and that affect equity This measure is called comprehensive income and is calculated as follows: ▫Comprehensive Income = ▫Net income + Other Comprehensive Income (OCI) Copyright © 2013 McGraw-Hill Ryerson Limited 15 LO3

16 Copyright © 2013 McGraw-Hill Ryerson Limited Other Comprehensive Income – includes transactions and economic events that involve non-owners and affect equity but are excluded from the calculation of net income Examples include: Foreign Currency Gains/Losses Unrealized Gains/Losses from Available for Sale Investments Pension Plan Gains/Losses Statement of Comprehensive Income LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 16

17 Copyright © 2013 McGraw-Hill Ryerson Limited Comprehensive Income and the Balance Sheet Comprehensive income also affects the equity section of the balance sheet Other comprehensive income is treated the same way that retained earnings is handled In the equity section of the balance sheet, there is an account called Accumulated Other Comprehensive Income (AOCI) (Note: ASPE does not include OCI or AOCI) Statement of Comprehensive Income LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 17

18 Copyright © 2013 McGraw-Hill Ryerson Limited Companies that follow IFRS must provide a statement of changes in equity This presents the changes in each account in the equity section of the balance sheet during a period Statement of Changes in Equity LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 18

19 Copyright © 2013 McGraw-Hill Ryerson Limited Accounting for Private Enterprises (ASPE) only requires a statement of retained earnings, not a statement of changes in equity Summarizes changes during the period: Opening retained earnings (+) Plus net income for period (-) Less dividends declared (=) Equals ending retained earnings Statement of Retained Earnings LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 19

20 Copyright © 2013 McGraw-Hill Ryerson Limited Statement of Cash Flows Statement of Cash Flows – shows how an entity obtained and used cash during a period ▫Cash is crucial to survival and success of any entity ▫Entities need cash to meet obligations as they come due ▫Cash and Net Income aren’t the same thing because of accrual accounting Copyright © 2013 McGraw-Hill Ryerson Limited 20 LO3

21 Copyright © 2013 McGraw-Hill Ryerson Limited Statement of Cash Flows includes three types of cash flows: 1) Cash from/used in operations ▫Stated on an accrual basis 2) Cash from/used in financing activities ▫From long-term liabilities and directly from investors 3) Cash from/used in investing activities ▫Used to buy capital assets Statement of Cash Flows LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 21

22 Copyright © 2013 McGraw-Hill Ryerson Limited 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 Relationship Among Financial Statements LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 22

23 Copyright © 2013 McGraw-Hill Ryerson Limited Relationship Among Financial Statements The “flow statements” capture the changes between two balance sheets: ▫The statement of cash flows shows how the balance in the cash account on the balance sheet changed from one year to the next ▫2) The statements of income and shareholders’ ▫ equity provide information on changes in the ▫ equity section of the balance sheet from one ▫ year to the next Copyright © 2013 McGraw-Hill Ryerson Limited 23 LO3

24 Copyright © 2013 McGraw-Hill Ryerson Limited Notes to Financial Statements 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 Copyright © 2013 McGraw-Hill Ryerson Limited 24 LO3

25 Copyright © 2013 McGraw-Hill Ryerson Limited Format of general purpose financial statements: ▫No single way to format financial statements ▫Different formats are allowable under IFRS Format of Financial Statements LO3 An example of the balance sheet format suggested by IFRS is seen in Exhibit 2.3 Non-current assets are at the top and current assets at the bottom of the asset side and for liabilities Note: presentation is different when compared to Leon’s balance sheet found in Chapter 2 Copyright © 2013 McGraw-Hill Ryerson Limited 25

26 Copyright © 2013 McGraw-Hill Ryerson Limited Most financial statements follow accounting equation: Assets = Liabilities + Owners’ equity However, accountants can prepare any type of report to satisfy the needs of stakeholders Special Purpose Reports Accounting reports that are prepared to meet the needs of specific stakeholders Normally aren’t publically available Don’t have to be prepared in accordance with any set of standards Format of Financial Statements LO3 Copyright © 2013 McGraw-Hill Ryerson Limited 26