Module 6, Classified Balance Sheet & Related Disclosures

Key Objective of Financial Statement

To fairly present the entity’s economic resources (assets), obligations (liabilities), equity (share capital, retained earnings), and financial performance (profit, net income).

Focus of Financial Statement Information

• Meet the needs of the financial statement users, such as creditors (i.e., ability to repay debt) and investors (i.e., return on investment).

• Evaluate managers and assist in allocating resources effectively.

Challenges in Applying GAAP

• How to measure wealth.

• How to apply recognition criteria.

• How much information should be disclosed.

Changes in wealth always results from transactions in context with accounting principles…

• Cost.

• Recognition.

• Going concern.

• Timeliness.

• Monetary unit.

• Business entity.

Cost-Benefit Decisions

Application of a materiality policy to avoid unnecessary administrative burden, such as the time and effort required to depreciate a low-cost asset.

To be useful, accounting information should…

• Take into account cost-benefit decisions.

• Include comparable and verifiable information.

• Be presented with clarity and conciseness to meet the understandability principle.

Classified Balance Sheet

A balance sheet in which the assets and liabilities categories are grouped into meaningful and similar categories.

Current Assets

Resources expected to be converted to cash or be consumed within one year or the operating cycle, whichever is longer.

• e.g., Cash, accounts receivable, inventory, pre-paid expenses, etc.

• Often reported in order of their liquidity, before non-current assets.

Non-Current (Long-Term) Assets

Resources that will be useful for more than one year.

• e.g., Land, building, accumulated depreciation, equipment, vehicles, etc.

• Often listed after current assets.

Current Liabilities

Obligations that must be paid within the next twelve months or the next operating cycle, whichever is longer.

• e.g., Accounts payable, current portion of note payable, income taxes payable, etc.

Non-Current (Long-Term) Liabilities

Obligations that do not require repayment for more than one year.

• e.g., Long-term portion of a bank loan or mortgage payable, long-term portion of note payable.

Shareholder’s Equity

Consists of share capital and retained earnings.

Working Capital

A number that represents the company's ability to fund its day-to-day operations and cover short-term obligations, such as payroll and accounts payable.

• Calculated by “current assets - current liabilities”.

Current Ratio

A liquidity ratio that measures a company's ability to pay its short-term obligations with its short-term assets.

• Calculated by “current assets / current liabilities”.

Notes to the Financial Statements

Provides relevant details that are not included in the body of the financial statements.

• Help users understand and analyze the financial statements.

Sections of the Notes to the Financial Statements

• Information regrading nature of operations.

• General information about the business and statement of compliance with accounting standards.

• A summary of various account policies, including…

  • Revenue realization and measurement.

  • Operating expenses recognition.

  • Borrowing costs basis for capitalization or expensed.

  • PPE basis for classification, measurement, and depreciation.

  • Income tax basis.

  • Share capital values.

  • Estimation uncertainty regarding the requirement for judgements, estimates and assumptions.

• Property, plant, and equipment reconciliation schedule of asset classes, additions, disposals, depreciation, and carrying amounts.

• Borrowing schedule with detailed breakdown, including interest rate, how it is scheduled, due date, and payment amounts.

• Share capital detail, including including the classes of shares and the number of shares authorized, issued and outstanding.

Audit

An external examination of a company’s financial statements and its system of internal controls by an independent examiner.

Internal Controls

The processes in place within a company to direct, monitor and measure operations including detection of fraud and error.

• The audit is intended to provide assurances that the financial information is not materially misstated.

Unqualified (Unmodified) Auditor’s Report

Means that the audit determined that the financial statements are truthful.

• This is the type of report that auditors give most often.

• The type of report that most companies expect to receive.

Qualified (Modified) Auditor’s Report

Indicates that the financial statements may or may not be truthful.

• Typically indicates that the auditor isn’t confident about any specific process or transaction, which prevents them from issuing an unqualified or clean report.

• Investors don’t find these type of report opinions acceptable, as they project a negative opinion about a company’s financial status.

Disclaimer of Opinion Auditor’s Report

In which the auditor is distancing themselves from providing any opinion at all related to the financial statements.

• Used if the auditor felt like the company limited their ability to conduct a thorough audit or they couldn’t get satisfactory explanations for their questions).

Adverse Opinion Auditor’s Report

Typically indicates that financial reports contain gross misstatements and have the potential for fraud.

• Is a big red flag.

Auditor’s Report

A report addressed to the Board of Directors, that includes descriptions of the…

• Audited information.

• Management’s responsibilities.

• Auditor’s responsibilities and compliance with audit standards.

• Audit procedures used.

• Auditor’s opinion.

• Also includes conclusion about the adequacy of audit evidence.

Is signed and dated by the auditor.

Management’s Responsibility Report

Report that describes management’s responsibility for the accurate preparation and presentation of financial statements, including the estimates used and maintenance of internal controls.

• The auditor may provide guidance to management regarding aspects of financial statement preparation, but the responsibility for the financial statements ultimately rests with management.