Chapter 8 - Reporting and analyzing receivables

Types of receivables
- Amounts owed to a company by its customers, employees, govt etc, considered
financial assets
- Claims that expected to be collected in cash

Frequently classified as
- Accounting receivables
- Notes receivables → written promises to repay debt.
- A/R and N/R resulting from sales transactions are often referred to as trade
receivables
Other receivables (nontrade receivables) – do not result from the normal operations of the
business
- interest receivable, loans to company officers and advances to employees, sales tax
recoverable, income tax receivable.

Recording AR
- Recorded when service is provided on account (on credit)
- Recorded at the transaction price
- reduced by variable consideration such as expected sales returns and allowances
and by sales discounts.

Subsidiary ledgers
- a group of accounts that share a common characteristic (i.e. they are all receivable
accounts)
- Provides the details that support the total balance for AR in the general ledger
- The signal accounts receivable account in the general ledger is the control account

Accounting for credit losses

- Some ARs become uncollectible. Expected credit losses are debited to an account
called Credit Losses. (Also called bad debt expense)
- Credit loss expense is recognized in the same period that the related sales revenue
is reported

Allowance method
- Estimates the expected credit losses at the end of each period
- Is shown in the ‘allowance for expected credit losses’ (formerly allowance for doubtful
accounts)
- A contra asset account - normally with a credit balance
- Shown below and netted with AR to determine carrying amount
- It is an ESTIMATE

Estimating the allowance

- Most companies use the percentage of receivables basis to determine the allowance
- Either one percentage applied to the entire AR or different percentages applied to AR
that are classified according to the length of time they have been outstanding.
(ageing of accounts receivable)
 - Once the appropriate estimate for
uncollectible accounts is determined, an
adjusting entry can be recorded.
- The amount of credit losses to be
expensed in the period is the difference
between the required balance and the
existing balance in the allowance
account.
- This amount is the credit losses for the
period.

Measuring and recording estimated

uncollectible accounts
- Credit losses are reported in the
statement of income as an operating
expense. The balance in the Allowance
for Expected Credit Losses is deducted from Accounts Receivable in the current
assets section of the statement of financial position: carrying amount

Recording the write-off of an

uncollectible account
- The vice president of
finance authorizes a
write-off of $1250 owed by
V. Dituri

Recording the recovery of an

uncollectible account
- Account previously written off may be collated in the future called a – credit loss
recovery
- Record in two separate entries
- Reverse the write off entry to reinstate the account and record the cash
collection
Account for notes receivable
- Written promise to repay on demand (promissory note)
- A credit instrument that normally requires the payment of interest, extends for the
time periods greater than 30 days
Often used:
- When ppl or company lend or borrow money
- When the amount and the length of credit period exceeds normal limits
- To settle an AR when payment cannot be made within the established credit period

Formula for calculating

interest
For interest-bearing note:

The time factor expresses the # of months in the year that the note is outstanding
(months/12)
For raja 10 000 x 6% x 1/12 = 50

Derecognizing notes receivable

Honoured - collected
- Paid in full at maturity date
- Collection recorded

Dishonoured - not collected

- Not paid at maturity date; note
no longer negotiable
- Balance transferred to AR if
eventual collection expected
- Balance written off to credit
losses if eventual collection is not expected.

Journal entry when a note is dishonoured and collection is not expected

Statement presentation
Statement of financial position
- Short-term receivables reported in the current assets section
- Following cash and trading investments
 - Reported at carrying amount, but must also disclose gross amount of receivables
and the expected credit losses
- Receivables due more than a year are presented SEPARATELY in the non-current
assets section

Statement of income
- Credit losses are reported as an operating expense
- Interest income is reported in the non-operating section as “other income and
expenses”

Evaluating the liquidity of receivables

- Liquidity is measured by how quickly certain assets can be converted into cash

Receivable turnover ratio

- The number of times on average the receivables are collected during the year:
The higher the ratio, the
more liquid the companies
receivables are

Average collection period

- The amount of time that a receivable is outstanding
The lower the average
collection period, the more
liquid comp receivables are.

Chapter 9 - Reporting and analyzing long-lived assets (40)

Property plant and equipment
Long lived resources that
- Are controlled by the company, are tangible, used in the operations of a business,
are not intended for sale to customers, Provide economic benefits over many years

Determining costs
Land - cost of land includes purchase price, closing costs (legal fees), additional costs to
prepare land for its intended use (less any proceeds from salvage)
- Land has an unlimited life – therefore not depreciated

Land improvements – the cost of structural additions made to a property (such as paving,
fencing, and sidewalks). These decline in service potential over time
- Recorded separately from land, depreciated over their useful lives
Does not include costs of getting the land ready to use

Buildings – all expenditure related to purchase or construction of a building

- When a building is purchased, such costs include; purchase price, legal fees, cost
required to make building ready for its intended use
- When constructed, its costs are; contract price, architect fees, building permits,
excavation cost, interest cost during construction
Equipment – Costs include; Purchase price, Freight charges, sales tax, or cost of insurance
during transit paid by the purchaser, Assembling, Installing and testing

Expenditure during useful life – after purchase of asset;

Operating expenditures → benefit only the current period, required to maintain asset
in normal operating condition
Capital expenditure → an asset (increases cost of asset), increases life, productivity,
or efficiency

Depreciation
- Systematic allocation of the cost of PPE over the assets useful life.
- Cost allocation, not determining an assets current value.

Factors in Calculating depreciation

Cost – purchase price plus costs required to get the asset ready for use plus estimated asset
retirement costs
Useful life – time period asset is expected to be used or # of units that asset is expected to
produce
Residual value – estimated amount to be received from the disposal at the end of the assets
useful life (how much the fixed asset is worth at the end if its useful life)

Straight Line
- Value is constant for each year
of the assets useful life
- Rate = 100%/5 years = 20%
per year

Diminishing balance
Produces a decreasing annual depreciation expense over anasset’s useful life
- Depreciation is calculated based on the asset’s carrying amount, which
declines each year as accumulated depreciation increases
Annual depreciation
expense is calculated by
multiplying the carrying
amount at the beginning
of the year by the
depreciation rate
- Residual value is
not included in the
calculation

Unit of production
- Expressed in terms of total
units of production or activity
expected from the asset
 - Such as units produced or machine hours worked

Revising depreciation
- Change in estimated useful life or residual, expenditures, impairment
- Accounted for as a change in estimate (in current and future years)

Recording Asset Impairments

- Occurs when carrying amount of asset exceeds its fair value (difference is amount of
loss recorded
- Recorded as a debit to impairment loss and credit to accumulated depreciation
account

Accounting for natural resources

- Long live tangible assets that are consumed physically overtime called wasting
assets
- Called DEPLETION
- UoP method is usually used (production varies from yr 2 yr)
- Reserve values are the fair value of the resource. Impairment will arise if reserve
value < carrying amount

Sale of PPE

Record disposal
- Remove cost of assets
and accumulated
depreciation. Record
proceeds and gain or loss
on disposition

Presentation of long lived assets

- Statement of financial position. Reported as non-current assets under headings:
PPE, Intangible assets, goodwill
Disclose cost and accumulated depreciation of each major class of assets
Disclose depreciation/amortisation methods and useful lives or rates

Statement of Income
- Depreciation expense, amortization expense, gains and losses on disposal, and
impairment losses are included in the operating expenses section
Statement of Cash Flows
- Cash flows from the purchase and sale of long-lived assets are reported in the
investing section

Return on Assets – measures overall profitability

Higher is better

Asset turnover
- Measures how efficiently a company uses its assets

Higher is better

Profit margin revisited

- Together, profit margin and asset turnover explain the return on assets ratio
- Profit Margin x Asset Turnover = Return on Assets

Chapter 10 - Reporting and Analyzing Liabilities (30)

Liabilities — present obligations to transfer economic resources as a result of past
transactions. Current and noncurrent

Current liabilities – Expected to be paid within one year of the date on the statement of
financial position. Include:
- bank indebtedness from operating lines of credit, accounts payable & accrued
liabilities (salaries, interest, income tax), refund liabilities, deferred revenue, sales
and property taxes, payroll, notes payable, current portion of bank loans and
mortgages

Sales taxes
- Federal goods and services tax
(GST)
- Provincial Sales Tax (PST or QST)
- Combined into one harmonized
sales tax (HST) in some provinces

Sales Tax Payable

- Divide the cash received by
100% plus the sales tax
percentage
When paid, debit sales tax payable and credit cash

Payroll – salary or wages owed to employees (gross pay)

- Employees gross pay less payroll deductions in known as net pay
Employee Payroll deductions
MANDATORY
- Federal and provincial income
taxes, Canada pension plan,
Employment insurance
VOLUNTARY
- Benefits such as health and
onesion, union duties, charitable donations

Employer Payroll liabilities

- Employers share of CPP and
EI, Workers compensation,
Employee benefits
(compensated absences)

Operating Line of Credit (Credit Facility)

- Pre arranged agreement between a company and a lender to allow the company to
borrow up to a pre-authorized limit whenever required
- To help manage temporary cash shortfalls
- Company repays whatever portion of the borrowed funds it chooses whenever it is
able to
- Interest is charged using a floating interest rate
- When used, results in bank indebtedness; reported in the current liabilities section of
statement of FP

Liabilities w/ Principal due at maturity – a written promise to pay specified amount usually on
a fixed future date

Liabilities w/ instalment payments (one year or more)

- Non current liabilities ex. Bank loans payable, mortgages payable
- Series of periodic payments, called instalments consisting of interest on the unpaid
balance of the loan at the beginning of the period, and repayment of a portion of the
loan principal

Current and Non-current portions

For a loan requiring instalment payments, the principal portion of the loan that will be repaid
during the next year is a current liability - Portion that that will be repaid after the next year is
a non-current liability

Statement of presentation
Current liabilities
- Reported as the first category of liabilities, Can be listed separately on statement of
financial position or detailed in the notes, Normally listed in order in which they are
due
Non-current liabilities
- Typically presented immediately following current liabilities and detail in notes,
Generally measured and reported at amount expected to be paid when due
Solvency ratios
Debt to total assets – indicates the extent to
which a company's assets are financed by
debt. Lower is better

Times Interest Earned – provides an indication of a company’s ability to meet interest

payments as they come due. Higher is better

Chapter 11 - Reporting and Analyzing shareholders equity (50)

The corporate form of organization
- Separate legal entity → separate and distinct from its owners
- May be public or private
- Public: many shareholders, share r publicly traded and held
- Priv: few shareholders, shares are closely held and not traded
Characteristics
- Separate legal existence, Limited liability of shareholders, Transferable ownership
rights, Ability to acquire capital, Continuous life, Corporation management,
Government regulations, Income tax
Advantages listed above
Disadvantages: Increased cost and complexity to follow government regulations, Increased
reporting and disclosure requirements

Share issue considerations

- To raise capital, the corporation sells ownership rights in the form of shares
- Can be divided into different classes – usually referred to as common (ordinary)
shares and preferred shares. Common and preferred shares for share capital
- Ownership rights are specified in articles of incorporation or in by-laws
- Rights in voting, dividends, liquidation
Authorised shares
- Maximum amount of shares corporation allowed to sell, may be limited or unlimited,
not recorded; disclosed only
issued shares
- Number of shares sold
Legal capital
- Share capital cannot be distributed to shareholders, unlike retained earnings, which
can be distributed as dividends

Fair value of shares

- First issue normally through initial public offering (IPO) – share price is set by the
company
- Once issued, shares of publicly held companies trade on organized exchanges

Issuing common shares

 - Share capital – the amount that shareholders have paid to the corporation for their
shares
- Shares are usually issued for cash
- Dr. Cash Cr. Common shares
- Shares can be issued in exchange for services or noncash assets
- IFRS: Record at cash equivalent price (ideally the fair value of consideration
received)
- ASPE: Fair value of shares given up or fair value of consideration received
(whichever is more reliable)

Repurchase of common shares

- Repurchased shares are a corporation’s own shares (either common or preferred)
that had been previously issued and later reacquired by the corporation
- Normally retired and cancelled
- Removed from the share capital account
- Can also be held as treasury shares, for future resale, in limited circumstances
- Only in some provinces and foreign jurisdictions

STEPS
1. Remove the cost of shares from share capital account
2. Record the cash paid
3. Record the ‘gain’ or ‘loss’ on repurchase

Repurchase BELOW AVG cost

Repurchase ABOVE AVG cost

Preferred shares
Preferred shares have contractual provisions that give them priority over common shares.
Usually do not have voting rights. Accounting for preferred shares similar to common shares
Dividends
- A pro rata (equal) distribution of a portion of a corporation's retained earnings to its
shareholder
- Cash dividends are most common
- A distribution of cash to shareholders
- Stock dividends may also be issued

Cash dividends
To occur, corporation must:
1. Meet a two part solvency test (CBCA) and,
2. Effect a formal declaration of dividends by board of directors

Three important dates in connection with dividends:

1. Declaration date, record date, payment dare

Declaration date
- Date the board of directors formally authorizes the cash dividend
- Commits the corporation to a binding legal obligation
- Example: declaration on dec 1 of a $0.50 per share quarterly cash dividend on $2
preferred shares
(100000 shares issued x 0.50 = 50,000)

Payment date
- Date dividends are paid to shareholders
- Example: payment date is jan 20

Stock dividends
- Distributed (paid) in shares
- Fair value (on date of declaration) is assigned to the stock dividend shares
Same three dates (declaration date, record date,distribution date) as cash
dividends
- Stock dividend does not change assets, liabilities or total shareholders’ equity
Example:
Assume 50,000 common shares
- Balance of $500,000 in Common Shares account and $300,000 in Retained Earnings
In a 10% stock dividend, 5,000 common shares (50,000 ×10%) would be issued
Amount debited to Dividends Declared account is $75,000(5,000 shares × $15*)
*$15 is the market price (fair value) of the shares on the date of the stock dividend
declaration

Stock dividends effect on shareholders equity

Comparison of dividends and stock splits

Measuring corporate performance

Dividend record:
Payout ratio, dividend yield
Earning performance
Basic earnings per share, return on common shareholders equity

Payout ratio
- Measures the percentage of profit distributed in the form of cash dividends to
common shareholders
 - Higher is better if investor looking for income
- Investors looking for share price appreciation would look for lower payout ratios

Dividend yield
- Measures the profit generated by each
share, based on the market price of the
shares
- Same thing higher and lower for above

Basic earning per share (EPS)

- Measures the income earned by each common share

- Weighted avg number of common shares

- Shares issued during the year x the fraction of the year they are outstanding
Ex. oct 1 = 3/12 months if calendar year used

Calculating

Return on common shareholders equity

- Measures the company’s profitability from the shareholders viewpoint
- How many dollars were earned for each $ invested by common shareholders
- Common shareholders equity = total shareholders equity – legal capital of preferred
shares

HIGHER IS BETTER

Statement of Cash Flows - Chapter 12

Purpose of SOCF
- Helps users assess a company's ability to generate cash from its operating activity
 - How the company received and used other cash flows regarding investing and
financing activities.
- Useful in determining a company's ability to generate future cash flows

Definition of cash/classification of cash flows

- Cash may include cash equivalents – Short-term, highly liquid (easily sold)
investments that have insignificant risk and are readily converted to cash within a
short period of time (usually within three months)
- Cash receipts and payments are classified into three categories
- Operating, investing, and financing activities

Operating activities
- Related to a company’s principal income-producing activities
- Activities relate to cash effects of transactions that create revenues and expenses
that enter into determination of net income
- Includes relevant non cash current assets and current liabilities on the statement of
financial position, where the related account is a statement of income account
Investing Activities
- Related to the acquisition and disposal of non-current assets
- Purchasing and disposing of:
- Long-lived assets and investments not held for trading
- Generally includes non-current asset items (e.g., long-lived investments, property,
plant, and equipment) on the statement of financial position
Financing activities
- Related to changes in a company’s debt and equity,including:
- Obtaining cash from issuing debt and repaying the amounts borrowed
- Obtaining cash from selling common and preferred shares and paying
dividends
- Generally includes non-current liabilities, and shareholders' equity

Significant non-cash activities

- If it does not affect cash, Do Not report in statement of cash flows
- Report in separate note to the financial statements
Examples
- Issue of shares to purchase assets or to reduce liabilities
- Conversion of debt into equity
- Exchange of property, plant, and equipment
- The acquisition of assets by directly assuming related liabilities
FORMAT
Preparing the STOF
- Prepare operating, then investing, then finance activities section
- Complete the statement of cash flows

Operating activities
- Determine the net cash provided (used) by operating activities by converting net
income from an accrual basis to a cash basis
- Conversion may be done by either the indirect method or the direct method
- Companies prefer the indirect method bc it's easier to prepare, reveals less
information to competitors
Preparing using indirect method
- Start with Net Income and add or deduct items not affecting cash to arrive at net cash
provided (used) by operating activities

SUMMARY OF ADJUSTMENTS TO DETERMINE NET CASH PROVIDED (USED) BY

OPERATING ACTIVITIES – indirect method
 Net
cash provided (used) by operating activities – indirect method

Prepare the investing activities section

- Measure cash flows relating to non-current asset accounts;long-term investments;
property, plant and equipment;intangible assets
- Reported the same under both direct and indirect methods
- Asset acquisitions are uses of cash; disposals are sources of cash (for the proceeds
of disposition)
- Depreciation expense is a noncash charge
Prepare the financing activities section
- Determine the net cash provided (used) by financing activities by analyzing changes
in non-current liability and equity accounts
- Changes to notes, loans and mortgages, and bonds payable are analyzed to
determine cause of change
- Analyze share capital and retained earnings accounts for changes and their cause
- Profit is reported in the operating activities section

Complete the statement of cash flows

- Complete the statement of cash flows by combining the operating, investing and
financing activities sections
- Determine increase (decrease) in cash for the period
- Ensure ending cash balance agrees to that reported on statement of financial
position
- Identify any non cash disclosures
Using cash flows to evaluate a company
- Four phases: introductory, growth, maturity and decline can help in the understanding
of a company’s cash flow from its operating, investing and financing activities

Free cash flow

- Measures discretionary cash flow remaining from operating activities available to use
to expand operations, reduce debt, go after new opportunities, or pay additional
dividends, among other alternatives
Net cash provided (used) by operating activities – net capital expenditures – dividends paid
Higher is better

Prepare the operating activities section of a SOCF using direct method

- However, whereas indirect method adjusts total net income, direct method adjusts
each individual revenue and expense item in the statement of income
Cash receipts from customers
- The relationship between cash receipts from customers,revenues from sales, and
changes in accounts receivable and deferred revenue is:

If other cash receipts (interest), these must be adjusted for any receivables amounts as was
done above
Cash payments to suppliers
The relationship between cash payments to suppliers,cost of goods sold, changes in
inventory, and changes in accounts payable is:

Cash payments for other operating expenses

The relationship between cash payments for operating expenses, changes in prepaid
expenses, and changes in liabilities relating to other operating expenses is:

Cash payments for income tax

The relationship between cash payments for income tax, income tax expense, and changes
in income tax payable is:

A similar calculation would be made for cash payments for interest

Summary of Adjustments to DetermineNet Cash Provided (Used) by Operating Activities –

Direct Method
Using direct method ^