Chapter 1: Corporate Financial Reporting Flashcards
What do shareholders, bank, and suppliers use a company’s financial statement for?
to see how the company has performed and what its future prospects might be. Shareholders use them to make informed decisions about things such as whether to sell their shares, hold onto them, or buy more. Creditors use financial statements to assess a company’s ability to service its debts (pay interest and repay principal), while suppliers may use them to determine whether to allow the company to purchase on credit.
Financial Accounting (AKA external financial reporting)
The process by which information on the transactions of an organization is captured, analyzed, and used to report to decision makers outside of the organization’s management team
Creditors
those who have lent money to the organization
Owners of a business aka
Investors
What is the primary purpose of financial accounting information?
is to aid these users in their economic decision-making relative to the organization. Because these users are generally outside of the organization and are not involved in its day-to-day operations, the financial accounting information they receive is often their only “window” into the organization.
Two types of accounting reports
Reports for internal use (managerial accounting - inform decision making
Reports for external use (used for people outside organization) known as financial accounting - help external users make decisions
financial statements
which are management’s reports to the company’s owners that are produced at the end of each accounting period, such as every quarter or every year.
Internal uses of financial statement information
Management
External users of financial statement information
Shareholders, the board of directors, and potential investors
Creditors (for example, financial institutions and suppliers)
Regulators (for example, a stock exchange)
Taxing authorities (for example, the Canada Revenue Agency)
Other corporations, including competitors
Securities (stock) analysts
Credit-rating agencies
Labour unions
Journalists
Shareholders
A company is owned by these people
Private company
Single shareholder owns the company
Public Company
Thousands of shareholders
Board of directors
The board of directors is given the responsibility of overseeing the management team that has been hired to operate the company.
Creditors
Creditors are those who lend money or otherwise extend credit to a company rather than invest in it directly as investors do.
Two major types of creditors
- Financial institutions and other lenders
2. Suppliers, employees, and the various levels of government
Financial institutions
such as banks and credit unions, lend money to companies. They do so seeking to generate a return on these loans in the form of interest.
The other group of creditors includes
suppliers, employees, and various levels of government. These groups often sell goods or provide services prior to receiving payment.
Canada Revenue Agency (CRA)
is the federal taxing authority in Canada and is responsible for federal tax collection. Corporate taxes are primarily based on taxable income, which is calculated based on accounting net income.
Corporations are owned by who?
Shareholders!
There are two main types of corporations
1) public companies (which are also known as publicly traded companies)
2) private companies (which are also known as privately held companies)
the Three Categories of Business Activities
(1) financing activities, (2) investing activities, and (3) operating activities
Financing Activities
obtaining the funding (or financing) needed to purchase the equipment or buildings they need to start operations.
Two ways companies can obtain funding (part of financing activities)
1) Investors (Shares)
2) creditors (taking out loans)
dividends
payments made by a company that distribute a portion of the company’s profits to shareholders
shareholders’ equity.
The funds that flow into the company from issuing shares to its shareholders
retained earnings
Any profits that are kept or retained by the company
Inflows
Borrowing Money
Issuing shares
Outflows
Repaying loan principal
Paying dividends
A company’s investing activities are related to two things:
1) buying and selling property, plant, and equipment
2) buying and selling the shares of other companies
Operating activities (Day to day ongoing activities) CRITICAL TO COMPANY'S LONG RUN SUCCESS
Operating activities are all of the activities associated with developing, producing, marketing, and selling the company’s products and/or services (putting resources of a business into action to generate profit)
Investing Activities
Once a company obtains funds, it must invest them to accomplish its goals. Most companies make both long-term and short-term investments in order to carry out the activities that help them achieve their goals.
A company’s operating activities are related to the company’s revenues and expenses, which fall into two basic categories:
1) inflows from sales to and collections from customers
2) outflows related to payment of the expenses of the business
Components of the Financial Statements
Statement of income (accrual) Statement of changes in equity (accrual) Statement of financial position (Balance Sheet) (accrual) Statement of cash flows Notes to the financial statements
The objective of the statement of income
is to measure the company’s performance by the results of its operating activities for a month, a quarter, or a year (revenues - expenses = net income)
Profit = Revenue - expenses
KNOW THIS BABY
Profit is also known as
Net income, net earnings, or earnings
Income, aka Revenue
defined as increases in economic benefits, but this is more commonly thought of as the money or other resources that flow into the company as a result of its ordinary activities, such as sales of goods and services.
Expenses
defined as decreases in economic benefits, but are more commonly thought of as the money or other resources that flow out of the company in the course of generating revenues.
consolidated financial statement
consolidates the financial information for the main or parent company plus the financial information of all the other companies that it controls (known as the subsidiary companies
comparative information
the results of both the current period and preceding period
Gross profit aka gross margin
It is equal to the difference between the revenue received from the sale of the goods and the amount these goods cost the seller
statement of changes in equity
provides details on how each component of shareholders’ equity changed during the period
share capital and retained earnings
the earnings or income that have been “retained” by the company and reinvested into the business
Retained earnings =
Opening balance + net income - dividends declared + Shares issued
Statement of financial position (aka Balance sheet)
The term financial position indicates that this statement presents the company’s financial status at a particular point in time (usually end of accounting period). Shows the assets and liabilities
Liquidity
refers to how soon something will be received, realized, or consumed, or else settled or paid
Current items
Current items are those that will be received, realized, or consumed, or else settled or paid within 12 months from the year end.
Non-current items
Those that are non-current will not be received, realized, consumed, or settled or paid within 12 months from the year end.
Working Capital =
Current Assets−Current Liabilities
The Accounting Equation
Assets = liabilities + shareholder’s equity (this is part of statement of financial position)
Characteristics of an Asset
- It is a resource controlled by an entity.
- The company expects future economic benefits from the use or sale of the resource.
- The event that gave the company control of the resource has already happened.
Liabilities
A simple definition of liabilities might be amounts that the company owes to others. (They are also known as debt and obligations.)
Characteristics of a Liability
- It is a present obligation of the entity.
- The company expects to settle it through an outflow of resources that represent future economic benefits.
- The obligation results from an event that has already happened.
Shareholders’ Equity
Shareholders’ equity is often referred to as the net assets of the company. This is the amount of assets that would remain after all of the company’s liabilities were settled.
The Accounting Equation (Rearranged)
Assets−Liabilities=Shareholders’ Equity (Net Assets)
market value,
we mean the price at which the shares are trading in the stock market.
statement of cash flows (sometimes called the cash flow statement)
presents the flows of cash related to the three categories of business activities
Subsections of the Statement of Cash Flows
Cash flow from operating activities
Cash flow from financing activities
Cash flow from investing activities
notes to the 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.
By including additional explanations in notes rather than in the financial statements, management keeps the company’s statements simple and uncluttered
only four main financing activities
two inflows (proceeds from issuing shares and from taking out a loan) and two outflows (paying dividends and repaying loan principal).
Remember that there are only four main investing activities
two inflows (proceeds from selling long-term assets, like equipment, or the shares of other companies) and two outflows (purchasing long-term assets, like equipment, and the shares of other companies).
Debt financing
When a company borrows money
Equity financing
When a company sell shares in exchange for cash
Forward-looking budgets are examples of
Internal reports that accounting provides to internal users.
Items on the statement of income
Sales revenue Other income Cost of goods sold Selling, general, and administrative expense Depreciation expense Interest expense Income tax expense Interest revenue from short-term investment
Items found on Statement of financial position (balance sheet)
Cash Short-term investments Accounts receivable Inventory Prepaid Expense and deposit Non-current assets Property, plant, and equipment Intangible assets Goodwill Bank indebtedness Accounts payable Dividends payable Income tax payable Notes payable Long-term debt Deferred income taxes Common shares Wages payable Retained earnings
Net income =
Revenue - expenses
