FINANCIAL STATEMENTS

For the sale of a business that includes real property, the buyer should receive, review, and be satisfied with the following:

1. an income statement showing the revenue and expenses of the business for a period of 12 months ending not more than 120 days before the signing of the agreement;

2. the balance sheet of the business; and

3. a statement containing a list of all fixtures, goods, chattels, rights, and other assets relating to or connected with the business that are not included in the transaction.

Sale of a Business: Is a Real Estate Licence Needed?

• No: If a business does not hold real estate assets.

• Yes: If a business is sold as separate assets, and these include a real estate component (sale or lease of real property, including assignment of a lease).

• Yes: If a business holding real estate is a corporation and is sold with a 100% purchase of all shares.

• No: If a business holding real estate is a corporation, but is sold with less than 100% purchase of all shares – this is considered a securities trade, not a trade in real estate (and may require registration under the Securities Act)

Notes and Comments

-explanatory notes: indicate the actual accounting methods used by the entity and disclose additional information related to what is presented in the financial statements

Balance Sheet (or Statement of Financial Position)

-shows the assets (items of value) owned by the enterprise, as well as how these assets have been financed.

-two sources of financing for the acquisition of assets: creditors and owners

-An entity acquires assets either by borrowing the money from creditors (debt financing) or by using the money provided by the owners for the enterprise (equity).

-The liabilities of an entity are the items that are owed by the enterprise to others outside the business, and represent the equity that the creditors have in the enterprise

-total of the assets of a business enterprise must equal the total of its sources of capital.

ASSETS = LIABILITIES + OWNER’S EQUITY

-companies reporting under the International Financial Reporting Standards (IFRS) have the option of revaluing their property, plant, and equipment to its fair market value periodically.

Balance Sheet Classifications - Current Assets

-the entity’s cash and other assets that are expected to be converted within one year or its normal operating cycle

-listed in order of liquidity (the items that are most readily converted into cash are listed first.)

-Marketable securities: temporary investments of a business enterprise in the securities of another entity; to be classified as current assets:

◦ the investment must be readily convertible into cash; and

◦ management must not intend to keep the investment for more than one year.

-If the market value of temporary investments is readily available, the investment should be revalued to market value each time the financial statements are prepared, with the revaluation gain or loss being treated as revenue or an expense for the period.

-Accounts receivable: amounts due from customers for the sale of goods or rendering of services for which cash has not been received.

-Inventories: items that are held for resale to customers and supplies used in the business.

-Prepaid expenses: services or rights to services for which cash has been paid but the services have not yet been consumed.

-A balance sheet does not show the value of a business

-the current market price of the assets could be significantly more or less than the figures on the balance sheet.

Balance Sheet Classifications - Non-Current Assets

-assets that will not be sold or consumed within one year or the normal operating cycle of the business

-include investments that management has no intention of selling within a year, as well as property, plant, and equipment.

-the matching principle dictates that we cannot charge off or expense the cost of these assets in any single year; we must allocate the cost of these assets over the years in which the benefit is derived through the use of depreciation expense

-net book value of non-current assets = original cost - all the depreciation that has accumulated to date.

Balance Sheet Classifications - Current Liabilities

-liabilities that the enterprise expects to pay off within one year

-include accounts payable, wages payable, income taxes payable, interest payable, and property taxes payable.

-Accounts payable: amounts owed by the business enterprise to suppliers of goods and/or services that have already been received but not yet paid for in cash.

-Wages payable: wages owed to employees.

-Income taxes payable: amount of income taxes owed.

-Tenants’ deposits: amounts paid in advance by the tenants for security purposes

-Current portion of long-term debt: any portion of the principal balance of long-term debt that will be payable within one year of the balance sheet date.

-Property taxes payable; taxes that have accrued but have not yet been paid in cash.

Balance Sheet Classifications - Non-Current Liabilities

-liabilities that the enterprise does not expect to pay off within one year

-most common of these, from a real estate viewpoint, is a mortgage.

Income Statement (Revenue and Expense or Profit and Loss Statement)

-can be for any period of time – a month, a quarter, six months, or a year.

-general format: Revenue – Expenses = Net Income

-the reduction in principal is not considered to be an expense. However, the interest portion of the payment is considered an expense and is deducted from revenue

-Land is not a depreciable asset so no depreciation is calculated on this item.

-neither partnerships nor proprietorships pay income taxes; When Joe is completing his personal income tax return, he will have to include the taxable income from his rental business.

Revenue

Some common types include:

• Sales revenue: revenue realized from the sale of goods

• Interest revenue: revenue realized from lending money or placing money in a bank account

• Service revenue: revenue realized from the rendering of services such as those services rendered by a physician, accountant, or real estate licensee

• Rent revenue: revenue realized from the renting or leasing of space the business owns

Expenses

-cost of items or services consumed in order to produce revenue

-net income: the amount by which revenues exceed expenses in any given time period

-net loss for the reverse

-common ones include:

• interest expense

• property taxes

• cost of goods sold

• depreciation

Cost of Goods Sold

-the cost of the goods is not deducted from revenue on the income statement until they are actually sold

-To treat the cost of these goods as an expense before they are sold would violate the matching principle

-This type of expense would not be present in a service enterprise

Depreciation (or Amortization) Expense

-For depreciable assets (i.e., assets that are used up over a period of time through wear and tear), depreciation expense is the method used by accountants in financial statements to allocate the cost of the asset over time.

-Examples of depreciable assets are buildings and equipment. Land is not considered to be a depreciable asset

-several methods; simplest and most common method is the straight-line method:

→ an estimate is made at the time an asset is purchased (i.e., its acquisition date) of how many years the asset will be of economic benefit to the enterprise; for how many years will the asset be beneficial to the enterprise in contributing to revenue?

→ salvage value: an estimate of the amount that can be realized from the sale of the asset at the end of its useful life

→ The economic life of a building is determined through consultation with experts who can estimate how long a building will last, considering its use.

-depreciation expense = (cost of the asset - estimated salvage value) / the estimated number of years the asset will be of use

-will be recorded each year as long as the asset is being used to generate revenues.

-depreciation expense is an accounting concept following the matching principle – and is applicable only in the firm’s financial reports.

-Canada Revenue Agency (CRA) will only recognize depreciation as a tax deduction if it is calculated using the capital cost allowance (CCA) in determining taxable income.

Owner’s Equity and Retained Earnings

-At year-end, the amount of the net income or net loss on the income statement is transferred to the owner’s equity account in the balance sheet

-In the case of a proprietorship or partnership, the amount of net income would increase the capital account of the proprietor or partners

-In a corporation, the net income or net loss is transferred to the retained earnings account.

-ASSETS – LIABILITIES = OWNER’S EQUITY

-if the net assets (assets minus liabilities) of a business enterprise have increased from the beginning of one fiscal period to the end of the fiscal period, the owner’s equity must have increased as well (even if the owners of the enterprise have made compensating withdrawals of their equity during this period).

-goodwill: an intangible asset, accounting for the difference between the purchase price of a business and the market value of its net assets

Cash flow statement

-provides information that an owner, investor, lender, or creditor would like to determine, such as the amount of cash available for distribution to debt and equity holders, and the amount available to make loan payments.

-first step: to identify and measure both cash inflows from each source and cash outflows for each use

- it specifically shows how and why the cash position has changed, which can be a crucial element in business success (and in some cases, business survival).