Financial Accounting: Tools for Business

Decision-Making
Seventh Canadian Edition
Kimmel Weygandt Kieso Trenholm Irvine Burnley

Chapter 2

A Further Look at Financial Statements

Learning Objectives
LO 1: Identify the sections of a classified statement of
financial position.
LO 2: Identify and calculate ratios for analyzing a
company’s liquidity, solvency, and profitability.
LO 3: Describe the framework for the preparation and
presentation of financial statements.

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Classified Statement of Financial Position
• A classified statement of financial position generally
contains the following standard classifications:
Assets Liabilities and Shareholder’s Equity
Currents assets Currents liabilities
Cash Bank indebtedness
Held for trading investments Accounts payable
Accounting receivable Unearned revenue
Inventory Notes payable
Supplies Current maturities of long-term debt
Prepaid expenses Non-current liabilities
Non-current assets Bank loan payable
Long-term investments Shareholder’s equity
Property, plant, and equipment Share capital
Intangible assets Retained earnings
Goodwill

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Current Assets
• Assets expected to be converted to cash, sold or used
in the business within one year or one operating cycle,
whichever is longer
o Operating cycle is the average time it takes to go from cash
to cash in producing revenue
• Usually listed in order of liquidity:
o Reverse order of liquidity also possible
• Examples include cash, held-for-trading investments,
accounts receivable, inventory, and prepaid expenses

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Non-Current Assets
• Assets not expected to be converted to cash, sold or
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used in the business within one year or one operating

cycle
• All assets not considered current
• Examples:
o Long-term investments.
o Property, plant, and equipment.
o Intangible assets and goodwill.
o Other assets

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Long-Term Investments
• Multi-year investments in:
o Debt securities: loans, notes, bonds, mortgages
o Equity securities: shares of other companies
• These assets are normally not intended to be sold
(and converted to cash) within one year

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Property, Plant, and Equipment
• Tangible assets with relatively long useful lives
• Used in operating the business
• Examples:
o Land
o Buildings, Equipment
o Furniture
o Computers
o Vehicles
• Usually listed in order of permanency

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Depreciation (1 of 2)
• Allocation (expense) of the cost of property, plant, and
equipment over their estimated useful lives:
o Companies systematically assign a portion of the cost of an
asset to expense each year
o Under IFRS, this allocation is referred to as depreciation for begin underline end underline

property, plant, and equipment, and amortization for intangible

begin underline end underline

assets
o Under ASPE, amortization is often used instead of
depreciation

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Depreciation (2 of 2)
• The cost of long-lived assets with indefinite lives is not
depreciated (e.g. land)
• Accumulated depreciation account shows the total
amount of depreciation taken to date
• The difference between the cost of the asset and its
accumulated depreciation is referred to as the carrying
amount of the asset
o Accumulated depreciation is a contra asset account

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Intangible Assets
• Non-current assets that do not have physical substance
and represent a privilege or a right held by the company
• Examples:
o Patents, copyrights, trademarks, licenses
o Goodwill: excess price paid on acquisition of another company
• Generate a future value to the company
• Amortized if they do not have an indefinite life

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Current Liabilities
• Obligations that are to be paid or settled within the
(longer of the) coming year or one operating cycle
• Examples:
o Bank indebtedness
o Accounts payable
o Unearned revenue
o Bank loan/notes payable
o Current maturities of long-term debt

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Non-Current Liabilities
• Debts expected to be paid or settled after one year
• Examples:
o Bank loan/notes payable
o Lease obligations
o Pension and benefit obligations
o Deferred income tax liabilities
• Usually accompanied by extensive notes to the financial
statements

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Shareholders’ Equity
• Share capital:
o Investment of cash (or other assets) in the company by
shareholders in exchange for preferred or common shares
• Retained earnings:
o Cumulative net income kept for use in the company

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Discussion Question 1
What do you think would be the main asset, liability,
and equity items for a Tim Hortons franchise?

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Using the Financial Statements
• Specific tools can be used to analyze the financial
statements
• Ratio analysis expresses the relationships between
selected financial statement data
• Use comparisons to aid in analyses:
o Intracompany comparisons cover two or more periods for the
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same company
o Intercompany comparisons between the company and a
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competitor
o Industry average comparison based on averages for particular
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industries
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Liquidity Ratios
• Measure a company’s short-term ability of to pay its
maturing obligations and to meet its unexpected needs
for cash

Working capital = Current assets  Current liabilities

Current assets
Current ratio =
Current liabilities
Higher is generally betters

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Solvency Ratios
• Measure a company’s ability to survive over a long
period of time:
o The higher the percentage of debt to total assets, the greater
the risk that debts cannot be repaid when they are due

Total liabilities
Debt to total assets =
Total assets

Lower is generally better

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Profitability Ratios
• Measure a company’s operating success of for a given
period of time
Profit available to common
shareholders
Basic earnings per share =
Weighted average number of
common shares

Market price per share

Price-earnings ratio =
Basic earnings per share

Higher is generally better

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Conceptual Framework of Accounting
• Guides decisions about:
o what to present in financial statements
o alternative ways of reporting economic events
o appropriate ways of communicating this information

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Conceptual Framework for Financial
Reporting
• Five main sections:
o Objective of financial reporting
o Qualitative characteristics of useful financial
information
o Underlying assumption
o Elements of financial statements
o Measurement of the elements of financial statements

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Discussion Question 2
Why is a conceptual framework of accounting important?

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Objective of Financial Reporting
• To provide financial information that is useful to
existing and potential investors, lenders and other
creditors
• Who are making decisions about providing resources
to a company:
o Buying, selling, holding equity and debt
o Providing or settling loans or other credit
• Financial information is provided by general purpose
financial statements

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Qualitative Characteristics of Accounting
Information
• Relevance:
o Information has relevance if it makes a difference in users’
decisions
o May have predictive value and/or confirmatory value
o Materiality is important: will information influence the
decisions of users?
• Faithful representation:
o Information should reflect economic reality
o It must be complete, neutral and free from error

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Enhancing Qualities of Useful Information
• Comparability:
o Users can identify and understand similarities and differences
among items
• Verifiability:
o Independent consensus that information is faithfully
represented
• Timeliness:
o Available before it loses its usefulness in decision-making
• Understandability:
o Classified, characterized and presented clearly and concisely

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Cost Constraint
• Ensures that the value of the information provided by
financial reporting is greater than the cost of providing
it
• The benefits of financial reporting should justify the
costs of providing and using it

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Going Concern Assumption
• The business will continue operating in the foreseeable
future
• The key assumption – provides a foundation for
accounting
• Provides justification for using cost as the value of
certain assets

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Elements of Financial Statements
• Assets
• Liabilities
• Equity
• Income
• Expenses

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Measurement of the Elements
• Accountants have developed principles that describe
which, when and how the elements of financial
statements should be:
o Recognized
o Measured, and
o Reported
• Known as generally accepted accounting principles
(GAAP)

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Generally Accepted Accounting Principles
• Historical cost:
o Assets and liabilities should be recorded at their cost when
acquired
o Not only at time of purchase, but throughout the life of each
asset and liability
• Current Value:
o Certain assets and liabilities should be recorded and reported
at current value
• In choosing between these two, apply the concepts of begin underline

relevance and representational faithfulness

end underline begin underline end underline

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Comparing IFRS and ASPE
Comparing IFRS and ASPE Review
Key Standard Differences International Accounting Standards for
Financial Reporting Private Enterprises (ASPE)
Standards (IFRS)
Basic earnings per share Required to present in Not required to present in
financial statements financial statements
Conceptual framework for Still under development Same general framework
financial reporting currently under development by
international and U.S. standard
setters anticipated to be applied to
private enterprises when complete

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Copyright
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