Chapter 1 Financial Accounting UBC

Financial Accounting

The process by which information on the transactions of an organization is captured, analyzed, and used to report to decision makers outsideof the organization's management team

Financial Statement Users

Investors who have invested in the organization, and creditors who have lent money to the organization

Managerial Accounting

Information needed to develop forward looking budgets

Shareholders

Owners of the company

Board of Directors

Represents the interests of the shareholders and has the responsibility of overseeing the management team hired to operate the company

Two major groups of creditors

1. Financial institutions and other lenders

2. Suppliers, employees, and various levels of government

Corporate bonds

Ways that large companies enter into long term borrowing arrangements

Three categories of business activities

Financing activities, investing activities, operating activities

Financing activities

Funding needed to purchase equipment, initial purchase of goods, paying a landlord - obtained primarily from investors and creditors

What do shareholders hope for?

Receiving dividends to appreciate their capital

Shareholders' Equity

Funds that flow into the company from its shareholders

Retained Earnings

Money that is kept by company and not sent to shareholders

Typical Financing Activities

Inflows: borrowing money, issuing shares

Outflows: repaying loan principal, paying dividends

Typical Investing Activity

Inflows: proceeds from the sale of property, plant, and equipment - proceeds from the sale of shares of other companies

Outflows: purchase of property, plant, equipment, investing in other companies

Typical Operating Activity

Inflows: sales to customers, collections of amounts owed by customers

Outflows: purchases of inventory, payments of amounts owed to suppliers, payments of expenses such as wages rent and interest, payment of taxes owed to the government

Statement of Income

Measure the company's performance by the results of its operating activities

for a month, quarter, year

Profit: income - expenses

Income VS Gains

Gains are special cases of selling something for more than you bought it for, income is your regular profit

Statement of income is also knows as the

Statement of operations

Statement of earnings

Statement of loss

Consolidated financial statement

Includes the financial information for the main or parent company plus the financial information of all other companies that is controlled (subsidiary companies)

Comparative information

Provide results of current period and preceding period so users can assess the changes from the previous period

Earnings per Share

The company's net income divided by the average number of common shares that are outstanding (owned by shareholders of the company) that year

Common Statement of Income Items

- sales revenue

- other income

- cost of goods sold

- selling, general, and administrative expense

- depreciation expense

- interest expense

- income tax expense

Other income

Various types of revenues or income to the company other than sales, including interest or rental income

Cost of goods sold

The cost of the inventory that was sold during the period

Selling, general, and administrative expense

The total amount of other expenses (such as salaries and rent) during the period that do not fit into another category

Interest expense

The amount of interest incurred on the company's debt during the year

Income tax expense

The taxes levied on the company's profits during the year

Statement of changes in shareholders' equity is also known as..

statement of shareholders' equity, statement of changes in equity, statement of equity

What does the statement of changes in shareholders' equity provide?

It provides details on how each component of shareholders; equity changed during the period

- ex explain changes to each class of shares issued by the company

What is the equation for retained earnings?

Opening retained earnings + net income - dividends declared = ending retained earnings

What are the two components of shareholders' equity?

share capital and retained earnings

What is share capital?

Share capital represents the shares issued by the company - usually an amount equal to what the company received from investors on the initial issuance of the shares

What are retained earnings?

Earnings that have not been paid out as dividends.

What is the statement of financial position?

Balance sheet! shows a company's finances at a snapshot in time

Features of the balance sheet/statement of financial position

- presents information in order of liquidity

- current items: will be received within 12 months of year end

- working capital: the difference between a company's current assets and current liabilities

The Accounting Equation

Assets = liabilities + shareholders' equity

The components of an asset

1. It is a resource controlled by an entity

2. The company expects future economic benefits from the use or sale of the resource

3. The event that gave the company control of the resource has already happened

Common assets

- cash

- short term investments

- accounts receivable

- inventory

- prepaid expenses and deposits

- property, plant, and equipment

- intangible assets

- goodwill

Short-term Investments

short term investments in the shares of other companies

Accounts receivable

amounts owed to the company by its customers as a result of credit sales

Inventory

Goods held for resale to customers

Prepaid expenses and deposits

Amounts that have been paid by the company but the underlying service has not yet been used. Ex. insurance premiums or rent paid in advance

Property, plant, equipment

Land, buildings, equipment, vehicles, and so on that the company purchases to use to generate revenues in the future, they are not purchased to resell

Intangible assets

Licenses, patents, trademarks, copyrights, computer software, and other assets that lack physical form. Acquired to generate revenue in the future.

Goodwill

A premium that has been paid on the acquisition of another company related to factors such as management expertise and corporate reputation that will result in higher future earnings.

What are the characteristics of a liability?

1. it is a present obligation of the entity

2. the company expects to settle it through an outflow of resources that represent future economic benefits

3. the obligation results from an event/payment that has already happened`

What are some common liabilities?

- bank indebtedness

- accounts payable

- deferred revenue

- dividends payable

- accrued liabilities

- income taxes payable

- notes payable

- long-term debt

- deferred income taxes

Bank indebtedness

Amounts owed to the bank on short-term credit

Accounts payable

Amounts owed to suppliers from the purchase of goods on credit

Deferred revenue (unearned revenue)

Amounts owed to customers for advance payments until the related goods or services have been provided, eg. rent paid in advance

Dividends payable

Amounts owed to shareholders for dividends that have been declared by the board of directors

Accrued Liabilities

Amounts owed related to expenses that are not yet due, such as interest or warranty expense

Income taxes payable

Amounts owed to taxing authorities.

Notes payable

Amounts owed to a creditor (bank or supplier) that are represented by a formal agreement called a note. Notes payable usually have an interest component, whereas accounts payable do not.

Long-term debt

Amounts owed to creditors due beyond one year

Deferred income taxes

Amounts representing probable future taxes the company will have to pay

Shareholders' Equity

capture's the ampunt of the company's shareholders' interest in the assets of the company - the amount of assets that would remain if the company's liabilities were settles

The Accounting Equation

Assets - Liabilities = Shareholders' Equity

What is the reporting objective of the statement of cash flows?

The statement of cash flows presents the flows of cash related to the three categories of business activities - enables financial statement users to assess the company's inflows and outflows of cash so they can see where the cash came from and how it was used

What are operating activities?

Operating activities include all inflows and outflows of cash related to the sale of goods and services - the activities the company provides in its normal operations

What are financing activities?

Financing activities are transactions that either resulted from new funds being received from investors or creditors or from the return of funds to these two groups.

What are investing activities?

Investing activities often involve the purchase and sale of long term assets such as property, plant, and equipment, and investments in other companies

What type of information is in the notes to a company's financial statements?

Management gives more detail about specific items such as the various types of inventory held by the company and details on its long-term assets.