Chapter 2: Analyzing Transactions

Question 1

Do All Canadian Companies Use the Same Accounting Standards?

Answer 1

NO

Question 2

All Canadian public companies (which are companies whose shares trade on a Canadian public stock exchange) are required to prepare their financial statements using

Answer 2

International Financial Reporting Standards (IFRS)

public = IFRS

Question 3

Private companies generally follow

Answer 3

Accounting Standards for Private Enterprises (ASPE) (but have the option of using IFRS)

Question 4

Why were common standards of reporting invented?

Answer 4

to minimize the differences in financial reporting across countries and to reduce the need for companies to generate different sets of financial information in each country in which they operate or raise funds.

Question 5

dual-listed companies

Answer 5

Company listed on another public stock exchange (outside of canada perhaps, Toronto-New York)

Question 6

Both IFRS and ASPE focus on the needs of _____ (current and potential) and _____ in determining the financial information that would be useful.

Answer 6

shareholders

creditors

Question 7

Who Sets the Accounting Standards Used in Canada?

Answer 7

The Canadian Accounting Standards Board (AcSB) is the body responsible for developing and establishing the accounting standards used by Canadian companies.
-Both public and private

Question 8

Conceptual framework

Answer 8

an underlying set of objectives and concepts that guide accounting standard- setting bodies in justifying new standards and revising old ones.

Question 9

Useful financial information must be both ______ and ______

Answer 9

Relevant

Representationally faithful

Question 10

Fundamental qualitative characteristics.

Answer 10

Relevance and representational faithfulness (That means that they are essential if financial information is to be considered useful and, without them, the information is useless.)

Question 11

The IASB identified four other qualitative characteristics

enhancing qualitative characteristics

Answer 11

1) comparability,
2) verifiability,
3) timeliness, and
4) understandability.
In other words, on their own they cannot make useless information useful, but they can enhance the usefulness of useful information.

Question 12

Predictive information (Predictive Value)

Answer 12

Information that users can use as the basis for developing expectations about the company’s future.

For example, based on the changes in sales this year, what might next year’s sales be?

Question 13

Confirmatory Information (confirmatory value)

Answer 13

It provides feedback to users on their previous assessments of the company.

For example, analysts may have projected that a company would achieve a certain revenue target, and the actual revenues for that period allow them to assess this.

Question 14

materiality / material

Answer 14

Information is considered to be material if it, or its absence, would impact the decisions of a financial statement user.

Question 15

Material vs immaterial

Answer 15

Material: Information that is critical to user decision-making
Imaterial: information that would not affect the user’s decisions
(Normally, the greater the dollar value of an item, the more material it is considered to be,)

Question 16

To be representationally faithful information, 3 things must occur

Answer 16

it must be complete, neutral, and free from error.

Question 17

Complete

Answer 17

related to providing users with all of the information needed to understand what is being presented in the financial statements, including any necessary explanations

Question 18

Neutral

Answer 18

is unbiased: it is neither optimistic nor overly conservative.

Question 19

Free from error

Answer 19

if it has been determined based on the best information available, using the correct process and with an adequate explanation provided.

Question 20

Comparability

Answer 20

the need for users to be able to compare the financial information of two companies, especially if they are in the same industry, or the need to be able to compare financial information for the same company across multiple periods.

Question 21

Verifiability

Answer 21

achieved if a third party, with sufficient understanding, would arrive at a similar result to that used by the company.

Question 22

Cost Constraint

Answer 22

It recognizes that capturing and reporting financial information is costly for companies.
-the benefits of reporting financial information must exceed the costs of doing so.

Question 23

Two types of qualitative characteristics

Answer 23

Fundamental

Enhancing

Question 24

Accounting standard setters have concluded that the financial information that results from ______ accounting is more useful to users than the information that results from the cash basis.

Answer 24

accrual

Question 25

Accrual basis of accounting.

Answer 25

Under the accrual basis of accounting, transactions are recorded in the period in which they occur, regardless of when the cash related to these transactions flowed into or out of the company.

• the recognition of revenues and expenses is not a function of when the related cash was received or paid. Instead, revenues are recorded when they have been earned, regardless of whether the related cash was received by the company.
• companies should recognize revenues when they have been earned (that is, when the company has satisfied its performance obligations in the contract by providing the goods or services to its customers). Expenses are incurred when there has been a decrease in economic resources, such as a decrease in assets or an increase in liabilities, for the purpose of generating revenues.

Question 26

Cash basis of accounting

Answer 26

Under the cash basis of accounting, transactions are recorded only when the cash is actually received or paid by the company.

• transactions are recorded only when cash flows into or out of the company.
• In other words, revenues would be recorded only when the customer or client pays for the goods or services. Expenses, on the other hand, are recorded only when they are paid for by the company.
• E.G the university would recognize a portion of your tuition payment as revenue in each month of the semester in which it is delivering your courses to you.

Question 27

template approach / synoptic approach

Answer 27

Initially, we will use the accounting equation as the framework for our transaction analysis and recording.
-the most basic of accounting systems

Question 28

Accounting Equation

Answer 28

Assets=Liabilities+Shareholders’ Equity

Question 29

Types of assets

Answer 29

A/R: Accounts receivable
Inv: Invententory
Prepaid ins: prepaid insurance
Equip: Equipment

Question 30

Types of liabilities

Answer 30

A/P: accounts payable
Interest payable
Bank Loan Payable

Question 31

Shareholders Equity (S/H equity)

Answer 31

Common shares

Retained earnings

Question 32

Three basic rules When recording transactions within the template,

Answer 32

1. Every transaction must affect at least two accounts.
2. The accounting equation must remain in balance with each transaction; that is, assets must constantly equal the sum of liabilities and shareholders’ equity.
3. Nothing can be recorded in the Retained Earnings account without an explanation of the nature of that transaction being recorded in the final column, stating whether it is due to a revenue, an expense, or a dividend declared.

Question 33

Retained Earnings account is a “bridge” between the financial statements.

Answer 33

“R” for revenues (which will increase retained earnings)
“E” for expenses (which will decrease retained earnings)
“DD” for dividends declared (which also decrease retained earnings)

Question 34

Incorporation

Answer 34

The process of organizing a business as a separate legal entity having ownership divided into transferable shares held by shareholders

Question 35

purchasing on account (also known as a credit purchase)

Answer 35

Pay at a later date

Question 36

Cost of goods sold

Answer 36

the inventory that has been provided to the client and has become an expense

Question 37

When analyzing transactions involving the sale of goods

Answer 37

Part 1 accounts for the sales revenue and cash/accounts receivable.
Part 2 accounts for the inventory that has become cost of goods sold.

Question 38

To depreciate property, plant, and equipment, we need to know four things:

Answer 38

1. the pattern in which the asset’s economic benefits will be consumed
2. the asset’s cost
3. the asset’s estimated residual value
4. the asset’s estimated useful life

Question 39

depreciation

Answer 39

The allocation of the cost of capital to expense over their estimated useful life

Question 40

estimated residual value

Answer 40

The amount the company estimates it may be able to recover from the disposal of the asset when the company is finished using it

Question 41

estimated useful life.

Answer 41

The period of time a company estimates an asset will be used to help generate revenue

Question 42

straight-line depreciation

Answer 42

A method of calculating depreciation in which the amount of expense for each period is found by dividing an assets depreciable amount (equal to cost less estimated residual value) by its estimated useful life

Question 43

Straight line depreciation formula

Answer 43

Original cost-Estimated residual Value / estimated useful life

Question 44

What Are the Limitations of the Accounting Equation Template Approach?

Answer 44

-One of the main limitations of the template method is the number of columns that can be included within the template.
-Another significant limitation of the template method is the lack of specific revenue, expense, and dividends declared accounts.
-

Question 45

Classified statement of financial position.

Answer 45

A classified balance sheet is a financial statement that reports asset, liability, and equity accounts in meaningful subcategories for readers’ ease of use. In other words, it breaks down each of the balance sheet accounts into smaller categories to create a more useful and meaningful report.

Question 46

carrying amount is also known as the net book value

Answer 46

It represents the portion of the equipment’s cost that has yet to be expensed.

Question 47

Operating activities

Answer 47

normally expected to result in a net inflow of cash (and therefore have a positive effect on cash) because companies would be expected to collect more cash from customers than they spend to generate these sales. This may not be the case for new businesses.

Question 48

Investing activities

Answer 48

normally expected to result in a net outflow of cash (and therefore have a negative effect on cash) because companies would be expected to spend more purchasing new property, plant, and equipment than they would receive from selling the property, plant, and equipment that they have finished using.

Question 49

Financing activities

Answer 49

normally expected to result in a net inflow of cash (and therefore have a positive effect on cash) for new companies because they are generally borrowing and issuing shares to finance their growth. Mature companies may not fit this pattern because they are often able to finance new assets through operating activities, while returning some profits to shareholders as dividends or repaying debt.

Question 50

Ratio analysis uses

Answer 50

can be used to assess things such as profitability, the effectiveness of management, and the company’s ability to meet debt obligations.

Question 51

profitability ratios.

Answer 51

Profitability ratios are usually constructed by comparing some measure of the company’s profit (net income or earnings) with the amount invested, or by comparing the profit with the company’s revenues.

Net income / revenue

Question 52

profit margin ratio

Answer 52

calculated by dividing the company’s profit (or net income) by the revenues that produced the profit.
(Profit Margin=Net Income/Sales Revenue)

EX: 7,400/34,000=0.217or 21.7%

Question 53

Return on equity ratio

Answer 53

compares the profit (or net income) earned relative to the amount invested by the shareholders (represented by the total shareholders’ equity)
(Return on Equity=Net Income/Average Total Shareholders’ Equity)
EX: 7,400/257,000* =0.0288 or 2.88%

This measure shows that in the month of January, SCL’s shareholders earned a 2.88% return on their investment in the company. It also means that during its first month of operations, the company earned profit at the rate of $0.0288 for each $1.00 that was invested by the owners.

Question 54

Return on assets

Answer 54

It is calculated by dividing the company’s profit (or net income) by its average total assets.
(Return on Assets=Net Income/Average Total Assets)

Question 55

Simple terms: Cash basis

Answer 55

Revenues recorded when cash is received

Expenses recorded when cash is paid

Question 56

Simple terms; Accrual basis

Answer 56

Revenues recorded when they are earned (i.e service is performed)
Expenses recorded when they are incurred (phone bill came in december, did not pay until January)