Financial Statements and Business Decisions

• Chapter discusses financial statements and making business decisions.

Learning Objectives

• Identify users of financial statements.
• Identify forms of business organization and business activities.
• Understand the basic accounting equation.
• Understand how a statement of financial position is prepared and used.
• Understand how a statement of earnings is prepared and used.
• Understand how a statement of changes in equity is prepared and used.
• Understand a statement of cash flows and how it is used.
• Describe how management uses financial statements.
• Understand an annual report.
• Understand the role of international accounting standards.
• Understand ethics and legal liability in accounting.

Users of Financial Statements

• Financial statements arise from accounting practices that identify, measure, record, and communicate data regarding a company's business activities, enabling decision-makers to make informed choices.
• Financial statements help different users answer questions and make decisions.

Accounting Information and Questions

• Business managers want to know the effectiveness of advertising campaigns.
• Governments need to know how much in taxes the company owes.
• Employees want to know if they will get a raise this year.
• Creditors need to decide whether to lend money to the business.
• Investors need to know if the will company earn enough income to provide a satisfactory return.
• External Decision Makers include lenders (banks), suppliers, Investors, and Governments.
• Internal Decision Makers include Board of Directors, Executive management (CEO, CFO), Employees and Functional managers

Forms of Business Organization and Activities

• The various businesses include sole proprietorship, partnership, and corporations

Sole Proprietorship

• A sole proprietorship involves an unincorporated business owned by one person.
• Usually small, local businesses like restaurants, photography studios, retail stores, website providers, and professionals adopt the sole proprietorship structure.
• The organizational form is simple to set up and gives the owner (proprietor) control over the business.
• The owner is responsible for the debt of the business.
• Can be formed or dissolved at the wishes of the owner.
• Easily formed, has tax advantages, and is controlled by the owner.
• It may have the disadvantage of personal liability and a limited life.

Partnership

• A partnership is a business owned jointly by two or more individuals or corporations.
• Small businesses and many professional practices of physicians, lawyers, and accountants are often organized as partnerships.
• Relative to sole proprietorships, partnerships provide increased access to financial resources and the individual skills of each of the partners.
• Accounting entities are separate from the partners and the partners are jointly responsible for all the debt of the partnership.
• It is Access to the resources and skills of partners, and has tax advantages.
• It may have the disadvantage of shared control, personal liability and a limited life.
• A partnership is automatically dissolved when any partner leaves the partnership, remaining partners may form a new partnership and continue to operate.

Corporation

• A corporation is organized under the laws of a particular province.
• A corporation is owned by one or more persons called shareholders with ownership interests represented by shares of stock.
• A primary advantage is the ability to raise large amounts of money (capital) by issuing shares of stock.
• The shareholders' legal responsibility for the debt of the business is limited to the amount they invested in the business.
• Shares of stock of a public company listed on a stock exchange can be easily transferred without affecting the corporation.
• The ability of publicly listed corporations make it easier to raise capital.
• Corporations also includes limited liability for owners, and the transferability of the shares.
• One of the disadvantages is the requirements to start a corporation are more complex than for the other forms of business organizations.
• Corporations may pay more taxes than owners of sole proprietorships or partnerships for two reasons: The corporate income tax rate may be greater than the individual income tax rate.
• A corporation's income is taxed twice-at the corporate level as income is earned and at the individual level as earnings are distributed to shareholders, this is know as double taxation.

Business Activities

• Activities fall into three categories: financing, investing, and operating

Financing Activities

• Financing activities include obtaining the funds necessary to begin and operate a business.
• Funds obtained by either issuing shares (equity) or borrowing money (debt).
• Most companies use both types of financing to obtain funds.
• The person to whom the corporation owes money is called a creditor.
• The obligation to repay a creditor is termed a liability.
• Claims of the shareholders are called shareholders' equity.

Investing Activities

• Once a corporation has obtained funds through its financing activities, it buys assets that enable it to operate.
• The purchase (and sale) of the assets that are used in operations (commonly referred to as property, plant, and equipment) are investor activities.

Operating Activities

• Once a corporation has acquired the assets that it needs, it can begin to operate.
• While businesses have different purposes, they generate revenue.
• Revenue is the increase in assets that results from the sale of products or services.
• To earn revenue, a corporation will incur various costs or expenses.
• Expenses are the cost of assets used, or liabilities created, in the operation of the business.
• Comparing revenues to expenses determines the results of a company's operating activities.
• A corporation has earned net income if revenues are greater than expenses.
• A corporation has incurred a net loss if expenses are greater than revenues.

Communication of Accounting Information

• Detailed transactions summarized and reported in standardized reports called financial statements to effectively communicate a company's activities to decision-makers.

Financial Statements

• Companies prepare four basic financial statements: The statement of financial position, the statement of comprehensive income, the statement of changes in equity, and the statement of cash flows.
• The statement of financial position reports the resources (assets) owned by a company and the claims against resources (liabilities and shareholders' equity) at a specific point in time.
• The statement of comprehensive income reports how well a company has performed its operations (revenues, expenses, and income) over a period of time.
• statement of changes in equity reports how much of the company's net earnings were retained in the business, dividend distributions to the owners, the dollar amount of shares issued and repurchased, and other changes in equity over a period of time.
• The statement of cash flows reports the sources and uses of a company's cash over a period of time.

Basic Accounting Equation

• Assets = Liabilities + Shareholders' equity
• The basic accounting equation captures two basic features of any company.
• The implication is that what a company owns (assets) must be equal to liabilities and shareholders' equity.

Classified Statement of Financial Position

• The statement of financial position is to report the financial position of a company (its assets, liabilities, and shareholders' equity) at a specific point in time.
• The relationship between the elements of the statement of financial position is given by the basic accounting equation.
• The statement of financial position is organized, or classified, to help users the basic economic similarities and differences between the various items.
• The basic classification of a company's assets is between current and noncurrent items
• Typically, one year is the dividing line between current and noncurrent items.
• The operating cycle of a company is longer than one year, it may be necessary to extend this dividing line beyond one year so that it corresponds to the length of the operating cycle.
• The operating cycle of a company is the average time to take a company to purchase goods, resell goods, and collect the cash from customers.

Current Assets

• Current assets consist of cash and other assets that at are reasonably expected to be converted into cash within one year or one operating cycle, whichever is longer.
• Current assets are listed on the statement of financial position in order of liquidity or nearness to cash.
• Common types of current assets are cash, short-term investments or marketable securities, accounts receivable which provides the right to collect an amount due from customers , inventories which is goods or product held for resale to customers, and other current assets which is a catch-all category that includes items such as prepaid expenses and supplies.

Noncurrent Assets

• Assets that are not classified as current are classified as long-term or noncurrent assets.
• Long-term investments are similar assets to short-term investments except for the duration of holding, include land and buildings not currently used in operations.
• Property, plant, and equipment which are tangible productive assets used in operations, like land, buildings, equipment, and furniture.
• Intangible assets lack physical substance and includes patents, trademarks, copyrights, and goodwill.
• Current Liabilities consist of obligations that will be satisfied, through the payment of cash or by providing goods or services, within one year or the operating cycle, whichever is longer.
• Current liabilities are typically listed in the order in which they will be paid and include accounts payable for an obligation to repay a vendor/supplier for merchandise, salaries payable for an obligation to pay an employee for services performed, unearned revenue for an obligation to deliver goods or perform a service when a company is pre-paid and interest payable for an obligation to pay interest on money that a company has borrowed, as well as income taxes payable for an obligation to pay taxes on income.

Long-Term Liabilities

• Obligations are obligations of the company that will require payment beyond one year or the operating cycle, whichever is longer.
• Loans or notes payable which indicates an obligation to repay borrowed cash at a future date, Bonds payable provides a form of an interest-bearing note payable issued by corporations in an effort to attract a large amount of investors.

Shareholders' Equity

• Shareholders' Equity is the last major classification on a company's statement of financial position Two major Shareholder equities are:
  • Contributed capital represents the owner's contributions of cash and other assets to the company, it includes the common and preferred share of a company
  • Retained earnings represents the accumulated net income of a company that has not been distributed to owners in the form of dividends.

Preparing classified statement

• Preparing a heading with the name of the company and title of the financial statement and the unit of measure.
• List the assets of the company order of their liquidity, add assets and double-underline the total.
• List the liabilities of the assets, order their time to maturity, and add the liabilities and underline total
• List shareholder equity and add components and then continue with the total
• Add any additional information

Financial Position

• Important information about the structure of assets, liabilities, and shareholders' equity can be used to judge a company's financial health.
• The relationship between current assets and current liabilities provides insights into a company's liquidity.
• Two measures of measure of liquidity are working capital and the current ratio.
• Working capital and the current ratio for a company are helpful when they are compared to other companies in the same industry.
• Working capital is a measure of liquidity, computed as Working capital = Current assets – Current liabilities Work capital means companies have current obligations that are expressed a dollar amount
• Current ratio is and compute a current ratio which is a liquidity to allow for any compensation. We need to current assets and current liabilities
• The statement of comprehensive income under IFRS reports the changes that occurred in shareholders' equity over a period from all business activities.
• The statement of earnings reports the results of a company's operations - for a given period. The long term survival of a company has the ability to create wealth that investors will want to be informed of. Past information has information regarding the future statement of earnings provide wealth in companies Statements are usually prepared with revenue and expenses that give us data

Elements of statement

• Revenues is the increase in assets that goes with the product of service
• Which involves the sale of product which involved interest
• Expenses includes a cost of resources over a period of time.
  • We involve the cost of goods that are sold and selling and general administrative Expenses or expenses that will manage the company That's that the cost that leads to products in the business
• Preparing statement that the first one would be the heading which will include the name, the title, the financial statement, the Time period and the unit of measure
• List the revenue of The company start with sales. At with sales revenue
• List all cost of goods sold. List and get to total expenses
• We have to subtract the revenue to get to that income If the revenue is over the expected amount that we have reached. You will total revenues and will eventually reach an income level. We will have to find the right income. And will need to double underline that to indicate the net income The statement of earnings in once a two statements are used in a simple format. Statement of earnings, simple total revenue for total expenses
• We can classify and find useful that we use within Sub totals Gross margin profit equals net sales times the cost of goods sold
• Income and compensation equals cross margin
• Multiple-step

Other revenues or gains

• Interest revenue
• Dividend revenue
• Revenue on investment in shares to other companies
• Gains is a save of property

Other expenses and laws

• The interest expense is what we loan. Which leads the sole to lead or plant Losses may happen doing business
• A company's ability to generate a current account that has current income what does it have, The revenue what it has, the investors. And creators and estimate of the future that of a company That we must get a net profit margin from our profits the income that we are given Net profit/Sales revenue

Statement of Changes in Equity

• Public companies prepare a statement of changes equity which reports how much dividend are made which increased or decreased. And other shareholder actions that effect the company Private companies provide a statement of retained earnings which presents changes

Other contributes can assist in sharing in returns by doing

• Though purchases of common shares. With company they are given. Directly: The company returns the income each year.

• Net income is earned by a company paid out in the form for dividends is call that earnings

• We had stated that the retains earnings must be reviewed

• Steps to review Equity information A- Prepare a heading which must has the name, the title, statements, the time covered and statement of measure B- List the balance of the equity component at the beginning for financial position and earnings

• Earnings must obtained for the statement the dividend and deduction will affect the balance

Cornerstone states for high Tower The first step can be is in the balance

• Additional network and balance

Uses of the Retained Earnings Statement

• Earnings can show the company how to divide and give back money, also to retain the income over the year for shareholders Investors and creditors use this as tool
• If too many payout the company has an issue for hand

Cash flows. They're can be classified in three ways

• Operating expenses is cash that is directed to earnings. Income and collection of balance
• Cash flows for investment . The long statement and that is a purchase

Important Statements

The fourth important statement contains information to gather as well, these will make the statement and show the audience

• It has the ability to assess the credibility with companies that have good cash
• Shareholders that indicate for the company

Relationship among the four financial statements

• Financial state is related to all company
• Shareholders equity
• Companies that have high power and can be used The financial information indicates all statement

Components of the Annual Report

• The annual reports consists of the 4 segments in the user.
• In financial statement it helps expand with numerical and qualitative data Management discuss the financial plan to show favourable and provide trends
• The editor in the form to financial statement that an auditor from the report will provide.

Account are available in all organisation due to the company

• High value skills for all accountants is high skill and provide info by writing
• The communication helps companies to communicate and solve problems
• Members of public accounting firms have skill, that allows them to show competence

Global financial standards

• Global financial statements provides common rules to over the year
• GAAP are created by various organisations through many years
• Canadian commissions work and accountants
• AcSB Canada All public sector companies must do this. When dealing with decision in business one must deal with guidelines. We must follow and respect the code of action to the law.