Chapter 1 Flashcards
The Purpose and Use of Financial Statements
Accounting
Information system that identifies and records the economic events of an organization, then communicates them to a wide variety of interested users.
Internal users
Users of accounting information with access to a company’s internal accounting information, including company officers, managers, and directors.
External users
Users of accounting information that are not involved in managing the organization and do not have access to accounting information other than which is publicly available. Includes investors, lenders, and other creditors.
Investors
Users of accounting information that have an ownership interest (debt/equity securities) in the organization.
Lenders
Users of accounting information, including bankers, that extend credit to borrowers.
Creditors
Users of accounting information, including suppliers, that grant credit (sell on account) to a customer.
Proprietorship (and its characteristics)
Business owned by one person:
- Easy to set-up;
- Minimal start-up capital required;
- Owner holds unlimited liability (personally liable);
- Limited life;
- Income is taxed on the owner’s personal income tax return.
Reporting entity concept
Concept that economic activity that can be identified with a particular company must be kept separate and distinct from the activities of the owner(s) and of all other economic entities.
Applies to all primary forms of business organizations.
Partnership (and its characteristics)
Business owned by more than one person:
- Partners bring unique skills, and economic resources;
- Formalized in a written partnership agreement;
- Each partner has unlimited liability;
- Income is taxed on each partner’s personal income tax return.
Corporation (and its characteristics)
Company organized as a separate legal entity. Shares are evidence of ownership:
- Shareholders have limited liability;
- Ownership rights are transferable;
- Great ability to acquire capital, through selling shares;
- Indefinite life;
- Shareholders elect a Board of Directors, who “manage” the corporation;
- Government regulations, reporting and disclosure requirements take effect;
- Income tax is payed as separate legal entity (Corporate income tax rate < Individual income tax rate).
Public corporation
Corporation whose shares are publicly traded on a stock exchange. Follow IFRS accounting standards.
Private corporation
Corporation whose shares are not traded on a public stock exchange. Usually have few shareholders. Follow ASPE (or IFRS) accounting standards.
Generally Accepted Accounting Principles (GAAP)
A general guide, having substantial authoritative support, that describes how economic events should be recorded and reported for financial reporting purposes.
Publicly-traded corporations must use IFRS, while private corporations use ASPE (most likely) or IFRS.
Financing activities
Activities that report the cash effects of debt or equity financing. These include:
1 - Borrowing/Repaying cash from (to) lenders;
2 - Issuing/reacquiring shares or paying dividends to investors.
Share capital
Shares representing the ownership interest in a corporation. Includes common shares and preferred shares.
Dividends
The distribution of retained earnings from a corporation to its shareholders, normally in the form of cash.
Liabilities
The debts and obligations of a business. Liabilities are claims of lenders and other creditors on the assets of a business.
Investing activities
Activities that report the cash effects of purchasing and disposing of long-lived assets such as property, plant, and equipment, and investments not held for trading.
Assets
The resources owned or controlled by a business that are expected to provide future economic benefits.
Operating activities
Activities that result from day-to-day operations. They report the cash effects of transactions that create revenues (income) and expenses.
Income (aka revenue)
The increase in economic benefits that result from the normal operating activities of a business, such as the sale of a product or provision of a service.
Expenses
The decreases in economic benefits that result from the costs of assets consumed or services used in ongoing operations to generate revenue.
Net income (aka profit, or net earnings)
Why are financial statement users interested in net income?
The amount by which revenues exceed expenses.
Net Income = Revenues - Expenses
Historical net income helps predict future income, ability to repay, and performance (for growth, debt repayment, share price, dividend payment)
Loss (aka net loss)
The amount by which expenses are more than revenues. The opposite of net income.
Fiscal year
An accounting period that is one year long.
Income statement
A financial statement that presents the revenues and expenses and resulting net income or loss of a company for a specific period of time.
Statement of changes in equity
Why do users care?
A financial statement that summarizes the changes in total shareholders’ equity, as well as each component of shareholders’ equity, for a specific period of time.
Users evaluate the use of equity for financing purposes (dividend payment, issue of shares)
Shareholder’s equity
The shareholders’ claim on total assets, represented by the investments of the shareholders (share capital) and undistributed earnings (retained earnings) generated by the company.
Retained earnings
The amount of accumulated net income (less net losses, if any) from prior and current periods, that has been retained and reinvested in the corporation for future use, and not distributed to shareholders as dividends.
Deficit
A negative balance in retained earnings, resulting from cumulative net losses > cumulative net income.
Statement of financial position (aka the balance sheet)
Why do users care?
A financial statement that reports the assets, liabilities and shareholders’ equity at a specific date.
External users use the SFP to determine the likelihood of being repaid, by analyzing the nature of the assets and liabilities.
Internal users use the SFP to determine whether inventory was adequate, whether there was sufficient cash on hand. They also analyze the proportion of debt/equity financing.
Accounting equation
Assets = Liabilities + Shareholders’ Equity.
Statement of cash flows
A financial statement that provides information about the cash inflows (receipts) and outflows (payments) for a specific period of time.
