AFA300 Intermediate Financial Accounting I Course Outline PDF

AFA300 – Intermediate Financial Accounting I: Course Outline Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 1: Sept. 9, 2024 Personal Introduction Recently joined TMU BBA, MBA, PhD (expected Dec. 2024) Re...

AFA300 – Intermediate Financial Accounting I: Course Outline Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 1: Sept. 9, 2024 Personal Introduction Recently joined TMU BBA, MBA, PhD (expected Dec. 2024) Research focus: taxation Wilfrid Laurier University (WLU) in Waterloo, ON Previous courses taught: Taxation I at WLU (i.e., AFA717) o First time teaching intermediate financial accounting In progress: CPA and CFA Course Introduction Prerequisite: AFA 100 – Introductory Financial Accounting Extensive study of financial accounting under International Financial Reporting Standards (IFRS) and Accounting Standards for Private Enterprises (ASPE) Includes case studies to develop technical proficiency and critical thinking through the application of accounting concepts using “The CPA Way” Topics include the conceptual framework for financial reporting, financial statements, revenue and expense recognition, and current assets (e.g., cash, receivables, inventory) Class & Instructor Information Class time: Monday, 8:00 – 11:00 AM (class begins at 8:10 AM) Class location: POD358 Office hours: Mondays, 1:00 PM – 3:00 PM or by appointment Office location: YDI 1066 (1 Dundas Street West, 10th floor) Zoom office hours: by appointment – please email me to arrange Emails should be from your TMU e-mail account o Include “AFA300” in the subject line Course Objectives 1. Understand financial reporting and the conceptual framework 2. Integrate problem solving skills and professional judgement in the application of accounting standards to accounting/economic events (e.g., revenue recognition) 3. Understand the differences between IFRS and ASPE 4. Apply IFRS and ASPE in the preparation, analysis and evaluation of financial statements and disclosures 5. Learn how to communicate in business situations Required Course Text With WileyPLUS: Kieso, Weygandt, Warfield, Weicek, McConomy, Intermediate Accounting, Volume 1, 13th Canadian Edition, 2021, Wiley & Sons. 13th edition is different from the 12th edition – we recommend purchasing the 13th edition Recommended text: CPA Canada Handbook – Accounting (Parts I and II), Chartered Professional Accountants of Canada May be accessed online through TMU libraries: learn.library.torontomu.ca/accounting/standards Other Requirements Calculator: Texas Instruments BA II Plus Financial Calculator Available at the TMU Campus Store and other stores (e.g., Amazon, Best Buy, Staples, Walmart, etc.) No other calculator is permitted Internet access: You may receive emails from the instructor Course will be managed online on D2L Brightspace Homework assignments will be completed online on WileyPLUS Course Grade Breakdown WileyPLUS Homework Assignments 20% In-Class Quizzes 5% In-Person Midterm Exam 25% In-Person Case Test 20% In-Person Final Exam 30% TOTAL 100% WileyPLUS Homework Assignments – 20% 5 assignments: each worth 4% of your final grade For each question, you have 3 attempts – your best score used All students receive the same questions, but with different values Assignment solutions are available after the due date Each assignment will be available for 7 days and due on a Monday, 11:59 PM No make-ups or due date extensions Ungraded version of each assignment (same questions, different values) available for practice immediately after the related graded assignment is due WileyPLUS Homework Assignments – 20% Available Due Tuesday, Sept. 24, Monday, Sept. 30, Assignment 1 12:00 AM 11:59 PM Tuesday, Oct. 1, 12:00 Monday, Oct. 7, 11:59 Assignment 2 AM PM Tuesday, Oct. 15, Monday, Oct. 21, Assignment 3 12:00 AM 11:59 PM Tuesday, Nov. 5, 12:00 Monday, Nov. 11, Assignment 4 AM 11:59 PM Tuesday, Nov. 12, Monday, Nov. 18, Assignment 5 12:00 AM 11:59 PM WileyPLUS Registration 1. Go to: https://login.education.wiley.com/login 2. Sign-up for a WileyPLUS account using your TMU email, or enter your login credentials as a returning student 3. Click: Add Course 4. Enter course section ID: B29592 (or click “I don’t have it” and search “Harjot Mehmi”) 5. Click: Find my course WileyPLUS Registration 6. Click: Next 7. Enter the registration code that came with your WileyPLUS purchase 8. You’re all set! In-Class Quizzes – 5% 5 in-class “pop” quizzes 5 classes will be randomly selected to have each quiz Open-book and collaboration will be allowed Each quiz will be worth 1% of your final grade Quiz responses will be hand-written on scrap paper that you will be provided You will hand in each quiz response during or at the end of class Reasonable attempt will be sufficient to receive full marks In-Person Midterm Exam – 25% Week 7: Monday, Oct. 28 3 hours long, closed book Chapters 0 – 4 Time and location: 8:00 – 11:00 AM, TRS 2-154 (computer room) May include content from class, homework assignments, and/or the textbook Made up of multiple choice as well as short/long- answer questions In-Person Case Test – 20% Saturday, November 23 2:00 – 3:30 PM, TRS 2-154 (computer room) 1.5 hours (90 minutes) long, closed book Chapters 0, 2, 5, and 6 May include content from class, homework assignments, and/or the textbook Respond to the case using “The CPA Way” o Assess situation (identify issue), analyze issue, recommendation, entries, impact In-Person Final Exam – 30% 3 hours long, closed book Cumulative: chapters 0 – 8 Date, time, and location: TBD Final examination period: Dec. 4 – Dec. 15, including weekends May include content from class, homework assignments, and/or the textbook Made up of multiple choice as well as short/long- answer questions Academic Consideration Request (ACR) Available if you experience extenuating circumstances that have a significant impact on your ability to complete the midterm, case test, and/or final exam Examples: physical and mental health issues, traumatic experiences, TMU varsity sports, case competitions, caregiver responsibilities, etc. Do not qualify: vacations, travel, employment, volunteering, extra-curricular activities, lack of internet access, disabilities (please see AAS), etc. Must be submitted within 3 business days of the missed assessment date For more details, visit torontomu.ca/senate/academic_consideration_requests/ Missed Assessments For each missed assessment, you must take the steps mentioned in the course outline: email me, submit ACR, email me again after submmission Missed midterm exam: no make-up – the weight of the midterm exam will be transferred to the final exam (i.e., final exam will be worth 55% of final grade) Missed case test: email me to arrange a make-up case test Missed final exam: email me to arrange a make-up final exam TMU Grading System Definition Letter Grade Grade Point Conversion Range A+ 4.33 90-100 Excellent A 4.00 85-89 A- 3.67 80-84 B+ 3.33 77-79 Good B 3.00 73-76 B- 2.67 70-72 C+ 2.33 67-69 Satisfactory C 2.00 63-66 C- 1.67 60-62 D+ 1.33 57-59 Marginal D 1.00 53-56 D- 0.67 50-52 Unsatisfactory F 0.00 0-49 Chapter 0: Accounting Cycle Review Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 1: Sept. 9, 2024 Financial Accounting Review Questions Will be done in today’s class Will not be posted on D2L o However, I will post review questions/solutions we are not able to cover in class Please follow along Prepaid Expenses Expenses paid in cash before they are used or consumed An asset account is debited (increased) to show the benefit that will be received in the future Cash account is credited (decreased) to show the outflow of cash Examples: prepaid insurance, supplies, advertising, and rent Prepaid expenses expire with the passage of time (e.g., rent and insurance) or through use (e.g., supplies) Deferrals Defer: to postpone or delay Deferrals are revenues or expenses that are recognized at a date later than the date when cash was exchanged 2 types of deferrals: prepaid expenses and unearned revenues o Prepaid expenses: expenses paid in cash before they are used or consumed o Unearned revenues: opposite of prepaid expenses; revenues for which cash is received before the related performance obligation has been met Deferrals Prepaid expenses are deferrals where the expenses are recognized later than the date on which cash was paid Unearned revenues are deferrals where the revenues are recognized later than the date on which cash was received o Unearned revenue on the books of one company is likely to be a prepaid expense on the books of the company that has made the advance cash payment o Potential sources of unearned revenue: rent, subscriptions, airline tickets, etc. o Cash account is debited and unearned revenue (i.e., a liability account) is credited Closing Entries At the end of the accounting period, temporary account balances are moved to a permanent shareholders' equity account – retained earnings (R/E) Companies could close each income statement account directly to R/E o However, this would result in excessive detail in the R/E account Instead, companies close the revenue and expense accounts to another temporary account, Income Summary o Balance in Income Summary is the net income or loss for the accounting period o Income Summary is then closed, which transfers the net income or loss to R/E Dividends When dividends are declared: o Dr. Dividends $XX o Cr. Dividends payable $XX Finally, when dividends are paid: o Dr. Dividends payable $XX o Cr. Cash $XX Dividends: temporary SE account, and must be closed at the end of the period o Dr. Retained earnings $XX o Cr. Dividends $XX Chapter 1: The Canadian Financial Reporting Environment Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 2: Sept. 16, 2024 In-Class Questions CA1.2 Solutions to the above in-class question will be posted on D2L Solutions to the textbook brief exercises have already been posted on D2L Solutions to no other textbook questions will be shared with students If you attempt other textbook questions, and you would like to see the solution, please visit me during my office hours and I can walk you through the solution without necessarily showing it Characteristics of Accounting Accounting measures and communicates financial information about economic entities to interested parties Accounting has 2 broad classifications: 1. Financial accounting Includes preparation of financial statements Relevant to internal users (management, employees, etc.) Relevant to external users (investors, creditors, etc.) 2. Managerial accounting Communicates financial information in varied forms (cost-benefit analyses, sales forecasts, etc.) Management uses it to plan, evaluate, control operations Relevant to internal decision-makers Copyright ©2022 John Wiley & Sons, Canada, Ltd. 29 Basic Financial Statements Communicate financial information to external users Major financial statements include: 1. Statement of financial position (i.e., balance sheet) 2. Statement of income/comprehensive income (i.e., income statement or statement of profit/loss or statement of financial performance) 3. Statement of cash flows (i.e., cash flow statement) 4. Statement of changes in equity (IFRS) or statement of retained earnings (ASPE) Note disclosures (e.g., supplementary schedules, management forecasts, news releases, and descriptions of social or environmental impact) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 30 What is at Stake for Each Stakeholder? Stakeholder What is at stake in the financial reporting environment? Investors/creditors Investment/loan Management Reputation, job, bonus, salary, access to capital markets Securities commissions and Reputation, effective and efficient capital marketplace stock exchanges Analysts and credit rating Reputation, profits agencies Auditors Reputation, profits (reporting companies are their clients) Standard setters Reputation Tax authorities Reputation, tax revenue Others Various Copyright ©2022 John Wiley & Sons, Canada, Ltd. 31 Objective of Financial Reporting To provide financial information about the reporting entity that is useful to current and potential decision makers (i.e., decision-usefulness approach) Entity perspective rather than proprietary perspective: o Proprietary perspective: financial reporting should only focus on the needs of shareholders o Entity perspective: companies are separate and distinct from their owners and so, financial reporting should focus on shareholders’ as well as other users’ needs Investors are interested in assessing: 1. Company’s ability to generate net cash inflows 2. Management’s ability to protect and grow capital providers’ investments Copyright ©2022 John Wiley & Sons, Canada, Ltd. 32 Information Asymmetry Information asymmetry: when managers have access to more information than other stakeholders Ideally, all stakeholders should have equal access to all relevant information (i.e., information symmetry) – nice in theory, but it does not work in practice Company must weigh the cost-benefit of sharing information o Benefit: open communication may attract more investors leading to a larger flow of capital, and lower the cost of capital o Cost: could give away proprietary information that could cause profits to fall and hurt the company’s competitive advantage o Therefore, perfect information symmetry does not exist Copyright ©2022 John Wiley & Sons, Canada, Ltd. 33 Information Asymmetry Some reasons for information asymmetry o The efficient markets hypothesis state that market prices reflect all publicly available information. However, capital markets are not fully (informationally) efficient as they do not reflect private or insider information o Individuals may act selfishly at the cost of other market participants (e.g., management may withhold negative information to increase personal bonuses) 2 types problems arising from information asymmetry: 1. Adverse selection: knowing that there is information asymmetry, capital markets may attract the wrong types of companies (e.g., poor investments) 2. Moral Hazard: risk that parties who have information not available to others will act in their own self-interest (e.g., withhold negative info. to boost personal bonus) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 34 Management Bias 2 types of management bias o Aggressive accounting: downplay the negative and focus on the positive (e.g., overstate assets and understate liabilities) o Conservative accounting: downplay the positives and focus on the negatives (e.g., understate assets and overstate liabilities) Reasons managers may engage in aggressive accounting o Management wants to boost their perceived performance o Management compensation may be based on the F/S o Meet analyst expectations to lower cost of capital and access to capital markets o Meeting contractual obligations (e.g., debt covenant) Any bias in financial reporting results in less useful information Copyright ©2022 John Wiley & Sons, Canada, Ltd. 35 Entities Responsible for GAAP Accounting standards help reduce information asymmetry in financial reporting Standard-Setter GAAP Application AcSB: Canadian Accounting Canadian private companies (ASPE) and not-for-profit entities; not- Standards Board for-profit entities in the public sector may have to follow public sector GAAP (responsibility of PSAB) IASB: International Public companies (IFRS); option available for not-for-profit entities Accounting Standards Board and private companies FASB: Financial Accounting For U.S. entities (US GAAP); option available for Canadian public Standards Board companies that are listed on a US stock exchange Security Commissions Not responsible for GAAP, but may require additional disclosures for public companies Copyright ©2022 John Wiley & Sons, Canada, Ltd. 36 CA1.2 – Ethics Case 1. Assess situation: Management wants to report higher net income even if it is not consistent with the new accounting standards. The issue is whether to adopt the accounting standards change earlier than it is required. 2. Analysis: o GAAP must be followed by publicly accountable companies (IFRS) and private companies (ASPE) o Company is not required to implement the new standard until later, but earlier adoption is encouraged as part of the standard’s implementation guidelines CA1.2 – Ethics Case Adopt new standard Adopt new standard 3. Recommendation: Earlier when required earlier GAAP requirement is Provides greater adoption is encouraged and met comparability earlier Receive additional This new standard should be attempted where the time to prepare the may be better for financial statements users of statements costs of doing so do not exceed under the new Impact on net income standard (i.e., should not be a factor information must be for making unbiased the benefits reliable) reporting decisions 4. Entries: N/A 5. Impact: Early adoption will decrease net income. Chapter 2: Conceptual Framework Underlying Financial Reporting Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 2: Sept. 16, 2024 In-Class Questions E2.4, E2.14, E2.15, E2.16, E2.17 Solutions to the above in-class questions will be posted on D2L Solutions to the textbook brief exercises have already been posted on D2L Solutions to no other textbook questions will be shared with students If you attempt other textbook questions, and you would like to see the solution, please visit me during my office hours and I can walk you through the solution without necessarily showing it Development of the Conceptual Framework New framework issued by IASB, effective Jan 1, 2020 Objective of financial reporting: communicate information that is useful to investors, creditors, and other users LO 1 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 41 Fundamental Characteristics of Useful Information 1. Faithful representation: information that is representationally faithful is complete, neutral, and free from error Complete: financial statements include all information needed to portray the underlying events and transactions Neutral: information is factual, truthful, and unbiased, and does not favour one party over another Free from error: information is accurate and reliable Fundamental Characteristics of Useful Information 2. Relevance: to be relevant, information must be capable of making a difference in a decision Has predictive value: helps users make predictions about past, present, and future events (e.g., separating income from continuing operations from discontinued operations may help users predict future income) Has feedback/confirmatory value: helps users confirm or correct previous expectations (e.g., providing information about the value of investments) Is material: information is important enough to influence a decision-maker Materiality How important a piece of information is (i.e., an item’s level of impact on a company’s overall financial operations) Info. is material if its inclusion or omission would influence a decision-maker Quantitative materiality benchmark examples (CAS 320.A8) o 5% of pre-tax income from continuing operations (for-profit entities) o 1% of revenues (not-for profit entities) Qualitative materiality factors: illegal acts, noncompliance with regulations, inadequate or inappropriate description of an accounting policy E2.4 – A, B A: Quantitatively immaterial: the impact is below 5% of net income Qualitatively material: o Bad debt expense and accounts receivable would be understated o Accounts receivable, net income, and retained earnings would be overstated o These misstatements may impact the decisions of users B: Quantitatively material: each item is material in amount and would affect the interpretation of the results for the year E2.4 – C We do not know how significant $10,000 is in relation to Manion’s F/S Expensing all capital equipment under $10,000 could understate PPE, overstate expenses, and understate net income and retained earnings However, since the practice has been followed consistently over several years, the effect on income is likely immaterial E2.4 – D Note payable should be classified as a current liability as it is due in 5 months The incorrect classification affects the current ratio and misleads creditors in making credit decisions Although the amount is small, the motivation in classification as non-current is to improve the current ratio and deceive creditors concerning its liquidity Therefore, it is material Enhancing Characteristics of Useful Information Enhance the usefulness of information that is determined to be relevant and faithfully represented 1. Comparability: achieved when information is measured and reported in a similar way (both company to company and consistently from year to year) 2. Verifiability: achieved when knowledgeable, independent users find similar results 3. Timeliness: achieved when information is available to decision-makers in sufficient time to influence decisions 4. Understandability: achieved when information is of sufficient quality and clarity that it allows reasonably informed users to see its significance Elements of Financial Statements The elements of F/S measure an entity’s performance and financial status: 1. Assets 2. Liabilities 3. Equity 4. Revenues/Income 5. Expenses 6. Gains & Losses Copyright ©2022 John Wiley & Sons, Canada, Ltd. 49 1. Assets An asset has 3 essential characteristics: 1. It represents a present economic resource – a right to use the resource that produces or has potential to produce economic benefits 2. Entity has control over that resource – entity’s ability to decide how to use the asset (through legal ownership or contractual rights) 3. The resource results from a past transaction or event Interesting point: as noted in (1), the conceptual framework defines the asset as the right as opposed to the physical asset. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 50 2. Liabilities A liability has 3 essential characteristics: 1. It represents a present obligation (there is no practical ability to avoid it) 2. The obligation requires the entity to transfer an economic resource 3. The obligation results from a past transaction or event Types of liability obligations: o Contractual (e.g., employment contract to pay employees after work) o Statutory (e.g., fines for illegally polluting) o Constructive – when a company signals that it will accept certain responsibilities (e.g., replanting trees based on a non-legally-required, voluntary corporate policy) o Equitable – arise from moral or ethical considerations (e.g., a company lays off some workers, but helps them find another job) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 51 3. Equity Also known as: net worth Residual interest in an entity that remains after deducting liabilities from assets In business, equity is the ownership interest Normally consists of: 1. Common shares 2. Preferred shares 3. Retained earnings 4. Accumulated other comprehensive income (under IFRS) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 52 4. Revenues/Income ASPE (Revenue) IFRS (Income) Same definition for income and gains: An increases in economic resources, which increases in assets or decreases in result from ordinary operations liabilities, that result in increases to equity (other than contributions from shareholders) Example: A real estate company owns 10 buildings and leases them out. Revenues include the resulting rental income. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 53 5. Expenses ASPE IFRS Same definition for expenses and losses: Decreases in economic resources, which decreases in assets or increases in result from ordinary revenue-generating liabilities, that result in decreases in activities equity Example: A real estate company owns 10 buildings and leases them out. Expenses include heating and property taxes. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 54 6. Gains ASPE IFRS Same definition for income and gains: Increases in equity from an entity’s peripheral increases in assets or decreases in or incidental transactions except liabilities, that result in increases to equity revenues/expenses and owner’s activity (other than contributions from shareholders) Example: A real estate company owns 10 buildings and leases them out. The company’s ordinary revenue-generating activity is renting out buildings, not buying and selling them. Buying and selling buildings would just be incidental transactions. Therefore, any gains on the sale of the buildings would be gains, not revenues. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 55 6. Losses ASPE IFRS Same definition for expenses and losses: Decreases in equity from an entity’s incidental decreases in assets or increases in transactions except revenues/expenses and liabilities, that result in decreases in owner’s activity equity Example: A real estate company owns 10 buildings and leases them out. The company’s ordinary revenue-generating activity is renting out buildings, not buying and selling them. Buying and selling buildings would just be incidental transactions. Therefore, any losses on the sale of the buildings would be losses, not expenses. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 56 Financial Statements ASPE IFRS Statement of financial performance OR Income statement Statement of profit and loss and statement of other comprehensive income Statement of financial position Balance sheet Statement of cash flows Cash flow statement Statement of changes in shareholders’ equity Statement of retained earnings Other comprehensive income (OCI) includes all changes in equity other than net income (NI) and owner’s investments and distributions Comprehensive income = NI + OCI Copyright ©2022 John Wiley & Sons, Canada, Ltd. 57  Foundational Principles Help achieve objective of financial reporting (i.e., communicate useful info.) Help explain which, when, and how financial elements and events should be recognized/derecognized, measured, and Recognition/Derecognition Measurement Presentation/Disclosure presented/disclosed 1. Economic entity assumption 5. Periodicity assumption 10. Full disclosure principle 2. Control 6. Monetary unit assumption 3. Revenue recognition and 7. Going concern assumption realization principles 4. Matching principle 8. Historical cost principle 9. Fair value principle and value in use Copyright ©2022 John Wiley & Sons, Canada, Ltd. 58 1. Economic Entity Assumption Also known as entity concept Means an economic activity can be identified with a particular unit of accountability (e.g., a company, a division, an individual) An economic entity is not always a legal entity o For example, a parent company and its subsidiaries may be separate legal entities (i.e., separate corporations) o Legal entities can be merged into an economic entity for financial reporting purposes to provided more meaningful information (consolidated financial statements) o An economic entity has “control” of the group’s assets and liabilities Copyright ©2022 John Wiley & Sons, Canada, Ltd. 59 2. Control Historically, control existed where the entity held more than 50% of the voting common shares of another entity However, the concept has been changing as business practices have been ASPE changing IFRS Control is the continuing Investor has control over an investee when it has: power to determine 1. Power over the investee strategic decisions without 2. Rights to returns from its involvement with the investee the cooperation of others. 3. Ability to use its power over the investee to affect its own returns Control is assessed through exposure to the risks and rewards of the investee, not just ownership of shares. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 60 3. Revenue Recognition Principle (ASP E) Revenue is recognized when 1. Risks and rewards have passed and/or the earnings process is substantially complete (significant acts have been performed and no continuing involvement) 2. Seller has no continuing involvement in, nor effective control over, the goods sold 3. Revenue is measurable 4. Revenue is collectible (realized or realizable) Revenue is realized when goods or services are exchanged for cash Revenue is realizable when the assets received can be readily converted into cash or claims Copyright to Wiley ©2022 John cash (e.g., & Sons, Canada, accounts Ltd. receivable) 61 3. Revenue Recognition Principle (IFR S) Follows a 5-step approach (IFRS 15): 1. Identify the contract with the customer 2. Identify the performance obligations (transfer distinct goods and/or services) 3. Determine the transaction price 4. Allocate the price to each performance obligation 5. Recognize revenue when each performance obligation is satisfied Copyright ©2022 John Wiley & Sons, Canada, Ltd. 62 4. Matching Principle Dictates that efforts (expenses) should be matched with accomplishments (revenues) Assets such as PPE contribute to the generation of revenues – therefore, these costs should be matched with the revenues they produce Example: Product costs are held in inventory, and then, when revenue (sale) is generated, these costs (cost of goods sold) are recorded PPE costs, which benefit future periods, are matched to future revenues through depreciation However, costs that do not meet the definition of an asset (i.e., Copyright ©2022 John Wiley & Sons, Canada, Ltd. 63 5. Periodicity Assumption Also known as: time period assumption Implies that the economic activity of an entity can be divided into artificial time periods for reporting purposes (e.g., monthly, quarterly, and annual net income) Most commonly used time periods are: 1 month, 1 quarter, and 1 one year The shorter the time period, the more difficult it becomes to determine net income for the period o Month’s results are usually less reliable than a quarter’s results, and a quarter’s results are likely less reliable than a year’s results (because more estimates are needed to accrue costs and revenues when the time Copyright ©2022 John Wiley & Sons, Canada, Ltd. 64 6. Monetary Unit Assumption Assumption that money is the common unit of measure of economic activity This assumption is based on another assumption that quantitative data are useful in communicating economic information and in making rational economic decisions In Canada and the US, the unit of measure (i.e., the dollar) is assumed to remain relatively stable in value (i.e., effects of inflation/deflation are ignored) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 65 7. Going Concern Assumption Assumption that a business will continue to operate in the foreseeable future (i.e., at least 12 more months from the balance sheet date) Although businesses do not last forever, they are expected to last long enough to meet their objectives and commitments Measuring financial statement elements at historical cost would have limited usefulness if liquidation was assumed to be likely o If liquidation of the company is assumed to be likely, use liquidation accounting: state asset values at net realizable value (sales price less costs of disposal) o Under a liquidation approach, theWiley Copyright ©2022 John current versus & Sons, Canada, Ltd. non‐current 66 8. Historical Cost Principle This principle provides guidance on how to measure transactions and balances on the basis of acquisition price (i.e., historical cost) Transactions are measured at the amount of cash (or cash equivalents) exchanged, or the fair value that was ascribed to the transactions when they took place 3 basic assumptions of historical cost: 1. Represents a value at a point in time 2. Results from a reciprocal exchange (i.e. a two-way exchange) 3. Exchange includes an outside arm’s-length party Arm’s length party: not a related party Related party: party that Copyrighthas ©2022ability John Wiley &to Sons,significantly Canada, Ltd. influence the 67 8. Historical Cost Principle Initially, historical cost usually equals fair value Over time, this value may lose its predictive value Calls for subsequent remeasurement o Can be based on different measurement values (e.g., fair value), but that means measurement uncertainty o With no external exchange upon subsequent remeasurement, value may be subjective The trend for subsequent remeasurement is toward a mixed valuation model: primarily historical cost moving to a market valuation model (i.e., fair value) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 68 9. Fair Value Principle The principle that provides guidance on how to measure financial statement elements using the best estimates of market values Fair value definition (IFRS): price that would be received to sell an asset or paid to transfer a liability between market participants at the measurement date Fair value definition (ASPE): price that would be agreed upon in an arm’s length transaction between knowledgeable, willing parties under no compulsion to act Fair value is a market‐based value: looks at how the market would value the item Ignores entity-specific value: an entity‐specific value represents how Copyright ©2022 John Wiley & Sons, Canada, Ltd. 69 Fair Value versus Value in Use Value in use is an entity-specific value (perspective of the entity) o Defined as the present value of future cash flows expected from use of asset Fair value is an exit price: exit price is a selling price, as opposed to an “entry price,” which reflects the entity’s purchase price Copyright ©2022 John Wiley & Sons, Canada, Ltd. 70 9. Fair Value Principle At acquisition, historical cost = fair value Subsequently, with market and economic conditions changing, the 3 values (i.e., historical cost, value in use, and fair value) diverge Fair value (current value, market-based) measures provide more relevant information than historical cost for some assets and liabilities Copyright ©2022 John Wiley & Sons, Canada, Ltd. 71 9. Fair Value Principle Standard setters encourage using fair value: IFRS and ASPE provide an option to use fair value for most financial instruments o Fair value is more relevant for financial instruments because it reflects the current cash equivalent value o Financial instruments are measured at fair value with gains and losses booked to income Some standards under IFRS explicitly allow the use of fair value for some non‐financial assets (e.g., investment properties and PPE) and require it for others (e.g., certain biological assets) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 72 Market-Based versus Entity-Specific Value Fair value is a market-based measure as opposed to an entity- specific value Market-based value o How market participants would value the item in question o More objective and must be applied under IFRS for fair value situations Entity-specific value (value in use) o Present value of the future cash flows expected from the asset o More relevant for operating assets but is subjective Copyright ©2022 John Wiley & Sons, Canada, Ltd. 73 10. Full Disclosure Principle General practice of providing information that is important enough to influence an informed user’s judgement and decisions Recognizes that the nature and amount of information in financial reports comes with trade-offs: o Information should be detailed enough to make a difference to users o Information should be condensed enough to make it understandable Avoid information overload: too much information may result in the user being unable to digest or process it Copyright ©2022 John Wiley & Sons, Canada, Ltd. 74  Foundational Principles Help achieve objective of financial reporting (i.e., communicate useful info.) Help explain which, when, and how financial elements and events should be recognized/derecognized, measured, and Recognition/Derecognition Measurement Presentation/Disclosure presented/disclosed 1. Economic entity assumption 5. Periodicity assumption 10. Full disclosure principle 2. Control 6. Monetary unit assumption 3. Revenue recognition and 7. Going concern assumption realization principles 4. Matching principle 8. Historical cost principle 9. Fair value principle and value in use Copyright ©2022 John Wiley & Sons, Canada, Ltd. 75 E2.14 – 1 Qualitative characteristic violation: faithful representation Element violation: asset Principle violation: matching, historical cost Correct journal entry: Dr. Repairs and maintenance expense $2,500 Cr. Accounts payable $2,500 E2.14 – 2 Qualitative characteristic violation: faithful representation Element violation: revenue Principle violation: revenue recognition Correct journal entry: Dr. Cash $8,000 Cr. Unearned revenue $8,000 E2.14 – 3 Qualitative characteristic violation: faithful representation Element violation: asset Principle violation: none Correct journal entry: Inventory held on consignment is not an economic resource of Trimm; it is an economic resource to Rubber and Rubber has the right to this inventory. No journal entry should be made by Trimm until the sale of the inventory to a third party. E2.14 – 4 Qualitative characteristic violation: faithful representation Element violation: expense Principle violation: matching Correct journal entry: Dr. Prepaid insurance $4,000 Cr. Cash $4,000 E2.15 Please attempt this exercise and compare your response with the solution posted on D2L E2.16 – A Assumption that a business will continue to operate in the foreseeable future (i.e., at least 12 more months from the balance sheet date) Although businesses do not last forever, they are expected to last long enough to meet their objectives and commitments This assumption affects the allocation of costs and revenues among accounting periods, and it is the basis of accrual accounting E2.16 – B I. Equipment: better stated at net realizable value (NRV) instead of historical cost II. Unamortized bond premium: would not be disclosed as there would be no future accounting periods that would allow the business to continue amortizing the premium. Bond would be valued at the amount required to be settled immediately and the entire amount would be presented as currently payable. III. Depreciation expense: would not apply if assets are valued at NRV, instead of historical cost IV. Inventory: better stated at NRV instead of historical cost V. Prepaid insurance: better stated at NRV instead of historical cost E2.17 – A ASPE – Revenue is recognized when: o Risks and rewards have passed and earning process is substantially complete o Vendor has no control over the goods o Revenue is measurable o Collectability is reasonably assured E2.17 – A 1. Recognize revenue when the flight occurs in December 2. If collection can be reasonably assured and an estimate of uncollectible amounts can be made, then recognize revenue at time of sale; otherwise recognize revenue when payment is received 3. Recognize revenue on a per-game basis as each game occurs 4. Recognize revenue when sweater is shipped to the customer E2.17 – B IFRS – Recognize revenue by: 1. Identifying the contract with the customer 2. Identifying the performance obligations 3. Determining the transaction price 4. Allocating the price to each performance obligation 5. Recognizing revenue when each performance obligation is satisfied For 1. to 4., the responses are the same as those for ASPE Chapter 3: Data, Decisions, & Measurement Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 3: Sept. 23, 2024 In-Class Questions E3.1, E3.4, E3.6, E3.7, P3.1 Solutions to the above in-class questions will be posted on D2L Solutions to the textbook brief exercises have already been posted on D2L Solutions to no other textbook questions will be shared with students If you attempt other textbook questions, and you would like to see the solution, please visit me during my office hours and I can walk you through the solution without necessarily showing it Data, Digitization, and Digitalization Technological and innovations are changing the face of the accounting profession Digitization and digitalization have resulted in large amounts of data being available (i.e., big data) o Digitization: process of converting things into machine readable format o Digitalization: transforming processes using new technologies and digital information Copyright ©2022 John Wiley & Sons, Canada, Ltd. 88 Big Data Data having the following 5 attributes/challenges: 1. Volume: How do we handle and store large amounts of data? 2. Velocity: How do we deal with the fast speed at which new data are created? 3. Variety: Data come in many forms and need to be sorted and cleaned before being used 4. Variability: How do we accommodate constantly changing data? Copyright ©2022 John Wiley & Sons, Canada, Ltd. 89 Analysis versus Analytics Recent move from data analysis to data analytics Study of data sets, using special software and systems, to make deductions about the information that they possess Involves increased amounts of diverse data Involves more sophisticated tools and technologies (e.g., Excel and Power BI) including artificial intelligence (AI) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 90 Types of Analytics 1. Descriptive analytics: examines historical data to answer questions o Provides most basic value and insights o Example: examining past sales figures 2. Diagnostic analytics: identifies patterns and relationships in historical data o Example: examining why sales went up or down by mapping to economic data Copyright ©2022 John Wiley & Sons, Canada, Ltd. 91 Types of Analytics 3. Predictive analytics: uses statistics, AI, and other techniques to predict future trends o Example: likelihood of sales trends continuing given what is happening in the economy 4. Prescriptive analytics: applies rules and models to determine next steps and decisions o Provides highest level of value and insights o Example: determining how a downward sales trend can be reversed Copyright ©2022 John Wiley & Sons, Canada, Ltd. 92 Measuring Financial Statement Elements Determining an item’s fair value is straightforward when market prices are available (e.g., at exchange transaction) However, when a market price is not available, accountants must rely on valuation models to develop a fair value estimate. o Initial measurement: usually fair value o Subsequent valuation: valuation techniques may need to be used Many items are measured by historical cost (e.g., PPE and inventory), but many are based on fair value (e.g., certain financial instruments) Some items are measured based on both: they have attributes of historical cost and current value Copyright ©2022 John Wiley & Sons, Canada, Ltd. 93 Measurement Categorizations Cost-based Measures Hybrid Measures Current Value Measures Property, plant and equipment Impaired PP&E measured Financial instruments carried at cost or net book at recoverable amount: carried at fair value value (ASPE 3061 and IAS 16) higher of the value in use (ASPE 3856 and IFRS 9) and fair value less costs of disposal (IAS 36) Financial instruments (e.g., Inventory measured at the Biological assets (IAS 41) bonds payable) carried at cost lower of cost and net and agricultural or amortized cost (straight-line realizable value (ASPE inventories (ASPE 3041) or effective interest) (ASPE 3031 and IAS 2) 3856 & IFRS 9) Inventory using various cost Impaired notes receivable Investment properties flow assumptions such as measured at best estimate (option to measure at weighted average and FIFO of revised cash flows fair value under IAS 40) (ASPE 3031 and IAS 2) discounted at historical discount Copyright ©2022 Johnrate Wiley &(IFRS 9) Ltd. Sons, Canada, 94 Valuation Techniques 2 common techniques to measure fair value when no market price: Income models (e.g., discounted cash flows): convert future amounts (e.g., future cash flows) to current amounts (to adjust for time value of money) Market models (e.g., earnings multiples): use prices and other information from identical or similar market transactions Copyright ©2022 John Wiley & Sons, Canada, Ltd. 95 2 Approaches to Discounted Cash Flows Traditional discounted cash flow approach o Stream of cash flows is discounted o Discount rate is adjusted to reflect the riskiness of the cash flows o Best used when cash flows are fairly certain (e.g., fixed interest and principal payments) o Example: a company determining the value of a note receivable, would adjust the discount rate for the credit risk posed by the party that is paying the cash flows Expected cash flow approach o Stream of cash flows is discounted o Discount rate is risk-free rate,John Copyright ©2022 andWileycash flowsLtd.are adjusted for risk using & Sons, Canada, 96 Expected Cash Flow Approach Copyright ©2022 John Wiley & Sons, Canada, Ltd. 97 Expected Cash Flow Approach Copyright ©2022 John Wiley & Sons, Canada, Ltd. 98 Present Value Concepts Time value concepts are used by accountants when preparing financial statements under IFRS and ASPE Value of $1 today is not equal to the value of $1 tomorrow (i.e., inflation) Money today can be invested, and interest can be earned over time The more risk involved in the investment, the higher the interest rate Macroeconomic factors also affect interest rates (e.g., prime Copyright ©2022 John Wiley & Sons, Canada, Ltd. 99 Present Value Variables When money is borrowed or invested, interest (i.e., return) is usually earned The amount of interest (and therefore, FV) is a function of 3 variables: o Principal (P): amount borrowed or invested o Interest rate (I): percentage of outstanding principal; stated as an annual rate; also called nominal, stated or coupon rate o Number of time periods (N): # of portions of a year the principal is outstanding 3 factors increase the dollar amount of interest (and therefore, FV): o The larger the principal Copyright ©2022 John Wiley & Sons, Canada, Ltd. 100 Present Value Concepts: Calculating Interest Simple interest: return on the principal for 1 time period [Interest = p × i] Compound interest (i.e., interest on interest and principal): interest not only on the principal but also on the interest earned to date (if interest is added to the principal) o Interest in period 1: [p × i ] o Interest in period 2: [(p + interest from period one) × i ] Copyright ©2022 John Wiley & Sons, Canada, Ltd. 101 Present Value Concepts: Calculations The initial principal, invested at the beginning of Year 1, is the present value (PV) of the investment The value of the investment at the end of the term is the future value (FV) of the investment Different tools for calculating present value: 1. Present value formulas 2. Present value tables 3. Financial calculators (e.g., Texas Instruments BA II Plus) 4. Excel functions (e.g., FV, PV, PMT, etc.) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 102 PV of a Single Future Amount Assume you want to invest a sum of money at 5% to have $1,000 at the end of 1 year The amount that you would need to invest today is called the present value (PV) of $1,000 discounted for 1 year at 5% $952.38 × 1.05 = $1,000.00 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 103 PV of a Single Future Amount: Using a Formula Assume you want to invest a Future Value(FV) sum of money at 5% to have Present Value(PV)= (1+i)n $1,000 at the end of 1 year $1,000 PV = The amount that you need 1+5% 1 to invest today is the PV of $1,000 = $1,000 discounted for 1 year 1.05 =$952.38 at 5% Copyright ©2022 John Wiley & Sons, Canada, Ltd. 104 PV of a Single Future Amount: Using a PV Table Assume you want to invest a sum of money at 5% to have $1,000 at the end of 1 year The amount you would invest today is the PV of $1,000 discounted for 1 year atPresent 5% Value (PV) = $1,000 × 0.95238* = $952.38 * PV factor from the “Present value of 1” Table A.2 (Appendix A) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 105 PV of a Single Future Amount: Using a Financial Calculator Assume you want to invest a sum of money at 5% to have $1,000 at the end of 1 year Amount that you would invest today is the PV of $1,000 discounted for 1 PV =at year Present 5% ? Value I = Interest Rate 5% PV = $952.38 N = Number of 1 Periods FV = Future Value $1,000 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 106 PV of a Single Future Amount: Using Excel AssumeFunctions you want to invest a sum of money at 5% to have $1,000 at the end of 1 year Amount that you would invest today is the PV of $1,000 discounted for 1 year at 5% PV function: returns the PV of an investment (i.e., amount that a Syntax: PV(rate,nper,pmt,fv,type) series of future payments is worth now)  Rate: interest rate per period. In this case, 5% or 0.05.  Nper: total number of payment periods in an investment. In this case, 1.  Pmt: payment made each period; entered as a negative number. In this case, none.  FV: future value; usually entered as a negative number. In this case, -1,000.  Type: payment at beginning of period = 1; payment at the end of the period = 0. In this case, 0. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 107 PV of a Series of Future Cash Flows (Annuities) Assume you will pay $1,000 cash annually for 3 years (at the end of the year) Discount rate is 4% PV = $2,775 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 108 Present Value of an Annuity: Using a Formula Assume you will pay $1,000 cash annually for 3 years (at the end of the year) Discount rate is 4% PV = $2,775 Future Value(FV) Present Value(PV)  n 1+i $1,000 $1,000 $1,000    1 4%1 1 4%2 1 4%3 $961.54  $924.56  $889.00 $2,775.10 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 109 Present Value of an Annuity: Using a PV Table Assume you will pay $1,000 cash annually for 3 years (at the end of the year) Discount rate is 4% Appendix A: Table A.2 PV = $2,775 FV × PV Factor = PV (4%) $1,000 (1 year × 0.96154 = $961.54 away) $1,000 (2 years × 0.92455 = $924.55 away) $1,000 (3 years ×John Copyright ©2022 0.88900 Wiley & Sons, Canada, Ltd.= $889.00 110 PV of an Annuity: Using a Financial Calculator Assume you will pay $1,000 cash annually for 3 years (at the end of the year) Discount rate is 4% PV = $2,775 PV = Present ? Value I = Interest Rate 4% PV = $2,775.09 N = Number of 3 Periods PMT = Payment - $1,000 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 111 PV of an Annuity: Using Excel Functions Assume you will pay $1,000 cash annually for 3 years (at the end of the year) Discount rate is 4% PV function: returns the PV of an investment (i.e., amount that a series of future payments is worth now) Syntax: PV(rate,nper,pmt,fv,type)  Rate: interest rate per period. In this case, 4% or 0.04.  Nper: total number of payment periods in an investment. In this case, 3.  Pmt: payment made each period; entered as a negative number. In this case, -$1,000.  FV: future value; usually entered as a negative number. In this case, $0.  Type: payment at beginning of period = 1; payment at the end of the period = 0. In this case, 0. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 112 E3.1 – A & D Amount of cash flows: Dividends have been received in the past, but management will have to consider if dividends are expected to continue and in what amount. Timing of cash flows: Since cash flows need to be discounted to a present value, it is relevant to consider when the cash is expected to be received. Risk involved in the cash flows: Hoda will need to consider the discount rate to be used in calculating the present value and whether that discount rate needs to be a risk-adjusted rate, or if the cash flows will be adjusted for risk of uncertainty. E3.1 – B PV of annual cash flows = $336,989 o N=5 o I / Y = 6% / 1 = 6% o PMT = $80,000 PV of sales proceeds = $747,258 o N=5 o I / Y = 6% / 1 = 6% o PMT = $1,000,000 Fair value = $336,989 + $747,258 = $1,084,247 E3.1 – C Risk-adjusted annual cash flows = 80% × $80,000 + 20% × $50,000 = $74,000 PV of annual cash flows = $329,435 o N=5 o I / Y = 4% / 1 = 4% o PMT = -$74,000 PV of sales proceed = $821,927 o N=5 o I / Y = 4% / 1 = 4% o PMT = -$1,000,000 Fair value = $329,435 + $821,927 = $1,151,362 E3.4 – A Use “RATE” function in Excel and enter “1” for “guess” Assume end of period payment, unless stated otherwise PV = $100,000 (enter “-100000” in Excel) FV = $123,210 PMT = $0 N=2 I / Y = I / 1 = 11.00% E3.4 – B Use “PV” function in Excel Assume end of period payment, unless stated otherwise FV = $120,000 (enter “-120000” in Excel) PMT = $0 N=2 I / Y = I / 1 = 11.00% PV = $97,395 E3.6 Which building yields the lowest net cost PV? Building A: PV = $600,000 Building B: o Beginning of year payments (“type” = 1 in Excel) o N = 25 o I / Y = 12% / 1 = 12% o PMT = -$69,000 o FV = $0 o PV = $606,118 E3.6 Building C: o End of year payments (“type” = 0 in Excel) o N = 25 o I / Y = 12% / 1 = 12% o PMT = $7,000 o FV $0 o PV = -$54,902 o Total PV = $650,000 - $54,902 = $595,098 Since Building C has lowest net cost PV, locate to Building C E3.7 – A What is the PV (i.e., selling price) of the bonds? PV of periodic coupon payments: o Assume end of period payments (“type” = 0 in Excel) o I / Y = 10% / 2 = 5% o N = 14 × 2 = 28 o PMT = -$2,000,000 × (11% / 2) = -$110,000 o FV = $0 o PV (i.e., selling price) = $510,187 E3.7 – A What is the PV (i.e., selling price) of the bonds? PV of bonds face value: o Assume end of period payment (“type” = 0 in Excel) o I / Y = 10% / 2 = 5% o N = 14 × 2 = 28 o PMT = $0 o FV = $2,000,000 o PV (i.e., selling price) = $1,638,794 PV (i.e., selling price) of the bonds = $510,187 + $1,638,794 = $2,148,981 E3.7 – B & C B: Basis of measurement is amortized cost (cost-based measure) C: No measurement uncertainty – amount and timing of cash flows are fixed along with the rate of interest as stated in the bond agreement P3.1 – A Forgiveness of first 3 payments affects the transaction price of the leased asset Time value of money must be considered in the delayed start of payments Interest accrues starting from June 1, 2023 on the lease obligation and must be recognized each month as an expense (although the cash flows of the monthly payments are delayed 3 months and start on September 30, 2023) P3.1 – B What is the PV of the lease obligation as at September 1, 2023? o End of period payments (“type” = 0 in Excel) o I / Y = 6% / 12 = 0.5% o N = 21 o PMT = -$3,000 o FV = $0 o PV = $59,664 P3.1 – B What is the PV of the lease obligation as at June 1, 2023? o End of period payments (“type” = 0 in Excel) o I / Y = 6% / 12 = 0.5% o N=3 o PMT = $0 o FV = $59,664 o PV = $58,778 P3.1 – C & D C: Interest accrual as at June 30, 2023 = $58,778 × 6% / 12 = $294 D: No measurement uncertainty needs to be disclosed – the amount and timing of cash flows are fixed and the rate of interest is stated in the lease Chapter 4: Reporting Financial Performance Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 4: Sept. 30, 2024 In-Class Quiz #1 – Chapter 2 Identify the appropriate qualitative characteristic for each of the items below: 1. Neutrality is an ingredient of this fundamental quality of accounting information 2. Predictive value is an ingredient of this fundamental quality of information 3. The characteristic being employed when companies in the same industry are using the same accounting policies 4. Requires a high degree of consensus among individuals on a given measurement In-Class Quiz #1 – Chapter 2 Identify the appropriate qualitative characteristic for each of the items below: 1. Representational faithfulness 2. Relevance 3. Comparability 4. Verifiability 5. Timeliness In-Class Questions E4.16, P4.1, P4.2, P4.3, P4.7 Solutions to the above in-class questions will be posted on D2L Solutions to the textbook brief exercises have already been posted on D2L Solutions to no other textbook questions will be shared with students If you attempt other textbook questions, and you would like to see the solution, please visit me during my office hours and I can walk you through the solution without necessarily showing it Statement of Financial Performance Report that measures success of a company’s operations over a specific time period ASPE: known as an income statement o Includes revenues, expenses, gains, losses, and net income IFRS: income can be reported in a statement of financial performance or in 2 separate statements – statement of profit or loss and statement of comprehensive income o Statement of financial performance: includes revenues, expenses, gains, losses, net income, other comprehensive income, and comprehensive income o Statement of profit Copyright or loss: includes ©2022 John Wiley & revenues, Sons, Canada, Ltd. expenses, gains, losses, 131 Other Comprehensive Income (OCI) OCI is made up of unrealized gains and losses on certain securities, foreign exchange gains or losses, and other gains and losses as defined by IFRS. OCI = comprehensive income less net income o Comprehensive income = net income + OCI OCI is closed to an equity account on the S FP called Accumulated Other Comprehensive Income (AOCI) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 132 Communicating Information About Performance Investors and creditors can use the information in the income statement to Evaluate past performance and profitability (e.g., compare the company’s performance with that of its competitors) Provide a basis for predicting future performance (however, past success does not necessarily mean future success) Help assess the risk of not achieving future net cash inflows by looking at relationships between the various components of income o For example, segregating recurring income from (continuing operations) from nonrecurring income sources (discontinued operations) is useful because operations are usually the primary way to generate revenue. Thus, results from continuing operations usually have greater Copyright ©2022 John Wiley & Sons, Canada, Ltd. 133 Quality of Earnings How well reported earnings reflects the sustainability of earnings and business fundamentals without bias o For example, net income from continuing operations is viewed as higher quality than net income from discontinued operations since continued operations are more sustainable Characteristics of High-Quality Earnings: 1. Content: Unbiased. objectively determined, reflects economic reality, reflects primary earnings from on-going core activities, closely tied to cash flows from operations 2. Presentation: Transparent (does not disguise or mislead) and understandable Copyright ©2022 John Wiley & Sons, Canada, Ltd. 134 Quality of Earnings/Information The income statement has the following shortcomings: Items that cannot be measured reliably are not reported in the income statement o For example, contingent gains cannot be recorded in income, because there is uncertainty about whether the gains will ever be realized. Numbers are affected by accounting methods used (e.g., method of depreciation) Income measurement involves the use of estimates (e.g., estimate asset’s useful life) Financial reporting contains bias (sometimes due to financial reporting pressures) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 135 GAAP is not always optimal Earnings Management Usually used to boost current-year earnings by reducing future-year earnings, but can also be used to decrease current-year earnings to boost future-year earnings Decreases quality of earnings (i.e., not sustainable and is biased) Targeting earnings levels and then working backward to meet those targets by: o Selection of specific accounting policies​(e.g., slower asset depreciation) o Use of aggressive assumptions/estimates (e.g., valuation of investments) o Unnecessary transactions Used by companies to meet Copyright investors ©2022 expectations John Wiley & Sons, Canada, Ltd. 136 Types of Income Net income: Revenues less expenses (including gains and losses other than those defined under IFRS as OCI) Comprehensive income: net income plus OCI Operating income: ongoing revenues less expenses Measure of regular income before any irregular items such as gains/losses, discontinued operations, and OCI Supports the view that irregular items do not reflect future earnings power as they are nonrecurring and including one-time items (e.g., write-offs and restructuring charges) reduces the income measure’s predictive value Copyright ©2022 John Wiley & Sons, Canada, Ltd. 137 Other Comprehensive Income (OCI) OCI is made up of unrealized gains and losses on certain securities, foreign exchange gains or losses, and other gains and losses as defined by IFRS. OCI = comprehensive income less net income o Comprehensive income = net income + OCI OCI is closed to an equity account on the S FP called Accumulated Other Comprehensive Income (AOCI) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 138 Discontinued Operations Operations that include separate components of an enterprise that has been sold, abandoned, shut down, disposed of, or formally planned for disposal (i.e., classified as held for sale) Component of an enterprise: part of an entity being disposed of where its operations, cash flows, and financial elements are distinguishable from the rest of the entity o Must generate its own net cash flows (i.e., cash-generating unit) o Must operate as a separate unit with its own assets, liabilities, and cash flows o Generally a major line of business or a geographical area Discontinued operations are presented separately, net of tax, on the Copyright ©2022 John Wiley & Sons, Canada, Ltd. 139 statement of financial performance and on the statement of cash Assets Held for Sale If a component is not yet disposed of, it can be presented as discontinued operations if it is considered held for sale Must be a formal for disposal of the assets to be considered as held for sale Assets are “held for sale” if they meet all criteria 1. Authorized plan to sell exists 2. Asset available for immediate sale in its current state 3. Active search for a buyer 4. Sale is probable within a year 5. Asset is reasonably priced and actively marketed 6. Changes to the plan are unlikely Copyright ©2022 John Wiley & Sons, Canada, Ltd. 140 Assets Held for Sale: Measurement & Presentation Remeasured at “lower of carrying amount and fair value less cost to sell” If the value of an asset that has been written down later increases, the gain can be recognized only up to the amount of the original loss Depreciation is not recognized on held for sale assets Presented separately on balance sheet o Under ASPE, held for sale assets retain original classification as current or non-current o Under IFRS, held for sale assets are generally classified as current Copyright ©2022 John Wiley & Sons, Canada, Ltd. 141 Presentation of Discontinued Operations Income/loss from discontinued operations could broken up into multiple line items (as above), or shown as a single-line item, with the details in the notes The assets of the discontinued operations would be shown separately on the statement of financial position Copyright ©2022 John Wiley & Sons, Canada, Ltd. 142 Ordinary versus Peripheral Activities What is the difference between revenues/expenses and gains/losses? Revenues/expenses: arise from ordinary activities – everyday business activities or frequent activities o Example: When McDonald’s sells a burger, the selling price is revenue Gains/losses: arise from peripheral activities – not everyday business activities or infrequent activities o Example: When McDonald’s sells a deep fryer machine, any excess of the selling price over the book value is a gain Copyright ©2022 John Wiley & Sons, Canada, Ltd. 143 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 144 Single-Step Income Statement Simplified income statement that lists all income first followed by all expenses Only 2 groups of items: revenues (including gains) less expenses (including losses) Single-step: single subtraction needed to arrive at net income before discontinued operations Income tax is reported after income/loss from continuing operations, but before income/loss from discontinued operations Advantage: presentation is simple Disadvantages: oversimplification and less detail Copyright ©2022 John Wiley & Sons, Canada, Ltd. 145 Single-Step Income Statement: Presentation 1. Continuing operations: revenues/expenses and gains/losses from continuing operations a) Revenues/gains b) Expenses/losses c) Income taxes 2. Discontinued operations: income/losses from discontinued operations plus gains/losses resulting from the disposition of a part of the business (net of taxes) 3. OCI (IFRS only) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 146 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 147 Multiple-Step Income Statement Separates operating transactions and non-operating transactions and matches the relevant expenses with their related revenues Highlights intermediate components to facilitate ratio analyses: o Gross profit margins o Operating earnings Separate disclosure helps users recognize that incidental or irregular activities are unlikely to continue at the same level (enhances predictive value). Copyright ©2022 John Wiley & Sons, Canada, Ltd. 148 Multiple-Step Income Statement: Presentation 1. Continuing operations a) Operating section i. Revenues ii. COGS iii. Selling expenses iv. Administrative or general expenses b) Non-operating section i. Other revenues and gains ii. Other expenses and losses c) Income taxes 2. Discontinued operations 3. OCI (IFRS only) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 149 Multiple-Step Income Statement: Operating Section 1. Continuing Operations a. Operating section: revenues and expenses related to the main operations i. Revenues: presents sales, discounts, allowances, returns, etc. to arrive at sale revenue ii. COGS: cost of goods sold to produce the sales iii. Selling expenses: expenses to make sales (e.g., salaries, travel, advertising, etc.) iv. Administrative or general expenses: expenses for general administration (e.g., legal costs, insurance, office supplies, etc.) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 150 Multiple-Step Income Statement: Operating Section 1. Continuing Operations b. Non-Operating section: revenues and expenses related to secondary operations as well as gains and losses that are infrequent i. Other revenues and gains: revenues and gains (net of expenses) from non-operating transactions ii. Other expenses and losses: expenses and losses from non-operating transactions c. Income taxes: income taxes on income from continuing operations Copyright ©2022 John Wiley & Sons, Canada, Ltd. 151 Multiple-Step Income Statement: Operating Section 2. Discontinued Operations: income/losses from discontinued operations plus gains/losses resulting from the disposition of a part of the business (net of taxes) 3. OCI (IFRS only): Other gains/losses that are not required by IFRS to be included in net income (net of taxes) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 152 Earnings Per Share (E P S) Key indicator of a company’s performance Measures the number of dollars earned per common share Based on net income, not comprehensive income Does not report the dollars paid (or to be paid) to shareholders as dividends Income available to common shareholders* EPS Weighted average number of common shares outstanding *Income available to common shareholders = Net income − Preferred Dividends Copyright ©2022 John Wiley & Sons, Canada, Ltd. 153 EPS Presentation Public companies are required to disclose EPS on the face of the income statement Company that reports discontinued operations must also report EPS for income before discontinued operations and for income from discontinued operations (either on the face of the income statement or in the notes) EPS is less relevant for private companies (shares are closely held), so companies following ASPE are not required to disclose EPS Copyright ©2022 John Wiley & Sons, Canada, Ltd. 154 Statement of Retained Earnings (ASP E) Reconciles the R/E balance from the beginning to the end of the period Net income is closed out to retained earnings at the end of the period The statement of retained earnings shows accumulated income (or deficit if losses) and how much has been paid out as dividends Other variables that affect retained earnings o Retrospective changes in accounting policies o Retrospective corrections of errors o Changes in accounting estimates are accounted for prospectively (in the income statement, Copyright ©2022 not the John Wiley statement & Sons, Canada, Ltd. of retained earnings) 155 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 156 Statement of Changes in Equity (IFRS) Reconciles the R/E, common shares, and each of the other shareholders’ equity account balances from the beginning to the end of the period Reports the changes in each shareholders’ equity account and in total shareholders’ equity during the year, including comprehensive income, net income, and OCI Must also report the effects of retrospective application for each equity component Must also disclose an analysis of OCI by item (in the statement or the notes) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 157 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 158 Presentation of Shareholders’ Equity in the Statement of Financial Position Copyright ©2022 John Wiley & Sons, Canada, Ltd. 159 E4.16 – A E4.16 – B P4.1 – A & B A. Earnings management: targeting earnings levels and then working backward to meet those targets o Usually used to boost current-year earnings by reducing future-year earnings, but can also be used to decrease current-year earnings to boost future-year earnings o Decreases quality of earnings (i.e., not sustainable and is biased) B. Effect of the proposed accounting: assuming the same financials for 2023 and 2024 o 2023: Warranty expense is increased (from $5,000 to $8,000) and net income is decreased (from $38,000 to $35,000) o 2024: Warranty expense is decreased Copyright ©2022 (from John Wiley & Sons, Canada, $5,000 Ltd. to $2,000) and net162 P4.1 – C & D C. Do not change the warranty expense to change earnings – report the underlying economic reality: $5,000 warranty expense and $38,000 net income D. If a larger warranty expense is reported, with full disclosure of the warranty accrual, an investor should see through the company’s attempts to mask the underlying economic reality that the growth trend in income may not be maintained o Investor may view the company’s larger warranty accrual as earnings management o Investor may be wary of the company’s accounting practices and quality of earnings Copyright ©2022 John Wiley & Sons, Canada, Ltd. 163 P4.2 Please attempt this problem and compare your response with the solution posted on D2L Copyright ©2022 John Wiley & Sons, Canada, Ltd. 164 P4.3 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 165 P4.3 Copyright ©2022 John Wiley & Sons, Canada, Ltd. 166 P4.7 – Weaknesses in classification and 1. Salesdisclosure taxes have been erroneously added to gross sales revenue. Failure to deduct these taxes directly from customer billings results is a deceptive inflation of revenue. 2. Purchase discounts should not be treated as revenue. A purchase discount is a reduction of the cost of purchases. The discount should reduce the cost of goods purchased. 3. Recoveries of accounts written off in prior years should be credited to allowance for doubtful accounts unless the direct write-off method was used in accounting for bad debt expense, in which case the recovery would offset the current year’s bad debt expense. o Debit A/R and credit AFDA, then debit cash and credit AR Copyright ©2022 John Wiley & Sons, Canada, Ltd. 167 P4.7 – Weaknesses in classification and disclosure 4. Freight out is a selling expense and is therefore, reported correctly. However, freight in is a cost of transporting raw materials or goods to the business for resale, and therefore, a part of COGS. 5. Loss on discontinued styles: should not be treated as an unusual item because it is a part of the main business. It should be reported as an operating expense. 6. Loss on disposal of FV-NI investments should be presented as a separate component of income from operations. As the company appears to trade investments frequently, the loss should not be labelled as unusual. 7. Loss on disposal of warehouse: this item may be presented Copyright ©2022 John Wiley & Sons, Canada, Ltd. 168 P4.7 – Weaknesses in classification and disclosure 8. Tax reassessments for 2022 and 2021: the company may wish to show this as a separate line item within income tax expense for greater transparency. 9. The income statement is missing income tax as an expense. 10.Income before unusual items should instead be labelled income from operations. Copyright ©2022 John Wiley & Sons, Canada, Ltd. 169 Chapter 5: Financial Position & Cash Flows Harjot Mehmi Email: [email protected] Office: YDI 1066 (1 Dundas St W) Office Hours: Mondays, 1 – 3 PM AFA300 – Section 011 Week 5: Oct. 7, 2024 In-Class Quiz #2 – Chapter 3 HQ Ltd. purchased a used truck from Auto Sales Inc. HQ paid a $4,000 down payment and signed a note that calls for 36 payments of $1,033.34 at the end of each month The stated rate of interest in the note is 4% What is the purchase price of the used truck? In-Class Quiz #2 – Chapter 3 What is the purchase price of the used truck? o End of period payments (“type” = 0 in Excel) o I / Y = 4% / 12 = 0.3333% o N = 36 o PMT = $1,033.34 o FV = $0 o PV = $35,000 o Purchase price = $35,000 + $4,000 = $39,000 In-Class Questions P5.3, P5.6, P5.7, P5.12 Solutions to the above in-class questions will be posted on D2L Solutions to the textbook brief exercises have already been posted on D2L Solutions to no other textbook questions will be shared with students If you attempt other textbook questions, and you would like to see the solution, please visit me during my office hours and I can walk you through the solution without necessarily showing it Statement of Financial Position (SFP) Known as the balance sheet under ASPE Financial statement that shows a company’s financial condition at a specific date Provides information to users: o For calculating rates of return on invested assets (e.g., ROA and ROIC) o For evaluating the capital structure (e.g., long-term debt to assets ratio) o On liquidity (amount of time until an asset is converted to cash – current/quick ratio) o On solvency (ability to pay debts and related interest)  For example, higher long‐term debt to assets ratio indicates higher risk of insolvency o About financial flexibility (ability to respond to unexpected needs and Copyright ©2022 John Wiley & Sons, Canada, Ltd. 174 SFP: Classes 1. Assets: Present economic resources controlled by an entity as a result of past transactions or events with the potential to produce economic benefits 2. Liabilities: present duty that obligates the entity to transfer an economic resource, arising from past transactions or events and which cannot be avoided 3. Equity: residual interest the assets after deducting liabilities (i.e., net assets) SFP generally shows classes in the above order, although IFRS allows the order to be reversedCopyright ©2022 John Wiley & Sons, Canada, Ltd. 175 SFP: Elements Assets Liabilities and Equity Current assets Current liabilities Long-term investments Long-term debt Property, plant, and Shareholders’ equity equipment o Capital shares Intangible assets o Contributed surplus Other assets o Retained earnings o Accumulated OCI Copyright ©2022 John Wiley & Sons, Canada, Ltd. 176 Current Assets Generally presented in order of liquidity (e.g., cash, short-term investments, receivables, inventory, and prepaid items) Current assets are cash and other assets to be realized: o Within 1 year from the SFP date, or o Within the normal operating cycle, whichever is longer The operating cycle is the time between the acquisition of assets and the realization of cash. Cash is realized through sales of the related product. The cycle Copyright begins©2022 with cash John Wiley &and Sons, then Canada, Ltd. 177 Current Assets – Cash Includes cash and cash equivalents: Cash, demand deposits, short- term highly liquid investments readily convertible into cash o Have none to insignificant risk of dropping in value Any restrictions to availability of cash items must be disclosed and may affect whether those items are presented as current How much cash should a company hold? o Need enough cash to settle its current liabilities in a timely manner o However, cash generally does not contribute to net income, and therefore, too much cash could have a large opportunity cost Copyright ©2022 John Wiley & Sons, Canada, Ltd. 178 Current Assets – Short-Term Investments Investments in debt and equity securities are presented separately from other assets Considered short-term if expected to be sold within 12 month of the SFP date or if held for trading purposes Valued at cost/amortized cost or fair value Companies with excess cash often have significant amounts of short- term investments (instead of having cash sit idle as non-interest‐ bearing cash) In addition, the way a company does business can result in more investments o For instance, insurance companies Copyright ©2022 John Wiley have large & Sons, Canada, Ltd.amounts of investments. 179 Current Assets – Receivables Amounts should be reported separately based on the nature of their origin: o Ordinary trade accounts o Amounts owing by related parties (related party: party that has ability to significantly influence the policies of the other) o Other unusual items Uncollectible amounts should be accrued (AFDA and bad debt expense) Accounts receivable valued at net realizable value (A/R less AFDA) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 180 Current Assets – Inventories Inventories assets that are: o Held for sale in the ordinary course of business o In the process of production for such sale, or o Materials or supplies to be consumed in production or in the rendering of service Valued at lower of cost and net realizable value (NRV; selling price less selling costs) Inventory cost formula (i.e., FIFO, weighted average, or specific identification) must be disclosed For a manufacturer, the stage of the inventories’ completion must all be indicated (i.e., raw materials, work-in-progress, or finished goods) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 181 Current Assets – Prepaid Expenses Expenses paid in cash before the related benefits are received Benefits will be received within 1 year or operating cycle (whichever is longer) o Recall: The operating cycle is the time between acquisition of assets and the realization of cash. Cash is realized through sales of the related product. The cycle begins with cash and then moves through inventory, production, and receivables, and back to cash. Prepaid expenses are reported at the amount of the unexpired or unconsumed cost Prepaid expenses expire with the passage of time (e.g., rent and insurance) or throughCopyright use ©2022 (e.g., supplies) John Wiley & Sons, Canada, Ltd. 182 Long-Term Investments Presented just below current assets in a separate section called “Investments” Investments that will be held for an extended period Include: o Debt securities (e.g., bonds, long-term notes, and loans receivable) o Equity securities (e.g., significant influence investments, subsidiaries, other equities) o Other investments (e.g., sinking funds, tangible assets held as investment such as land) Valuation options: fair value, amortized cost, and equity method (chapter 9 - AFA400) Copyright ©2022 John Wiley & Sons, Canada, Ltd. 183 Property, Plant, and Equipment (PPE) Physical (tangible) assets used in on-going business operations to generate income Long-term in nature: used in multiple reporting periods Examples: land, buildings, machinery, furniture, wasting resources (e.g., minerals and oil and gas properties) Generally reported at cost or amortized cost IFRS allows option for valuation at fair value (using revaluation or fair value method) PPE assets are depreciable (e.g., buildings) or depletable (e.g., minerals, oil reserves) o However, land is not depreciable Copyright ©2022 John Wiley & Sons, Canada, Ltd. 184 Intangible Assets & Goodwill Non-physical capital assets with greater uncertainty regarding future benefits E.g., patents, copyrights, franchises, trademarks, trade names, and secret processes Initially recorded at cost, and tested for impairment Intangible assets are grouped into 2 categories: o Those with finite life: amortized over useful life and tested for impairment o Those with indefinite life – not amortized, but is tested for impairment Goodwill: asset representing future benefits that arise from a business combination Copyright ©2022 John Wiley & Sons, Canada, Ltd. 185 o Not amortized, but is tested for impairment Other Assets Assets that are not included in any other category and usually individually immaterial Listed below intangibles and goodwill on the SFP Examples: o Intangible assets o Non-current receivables o Assets in special funds o Land held for speculation o Deferred income tax assets (known as future income tax assets under ASPE) Copyright ©2022 John Wiley & Sons, Canada, Ltd. Sufficient information must be disclosed to inform users of the 186 Current Liabilities Obligations due within 1 year from the SFP date or within the operating cycle, whichever is longer o Recall: The operating cycle is the time between acquisition of assets and the realization of cash. Cash is realized through sales of the related product. The cycle begins with cash and then moves through inventory, production, and receivables, and back to cash. Examples: o Payables resulting from acquisitions of goods and services o Collections received in advance of delivery of goods or services (i.e., unearned revenue) o Short-term financing payable on demand (e.g., bank overdraft) Accounts payable normally listed first; however, current liabilities are Copyright ©2022 John Wiley & Sons, Canada, Ltd. 187 Long-Term Liabilities Long-term obligations are those not reasonably expected to be liquidated within the normal operating cycle 3 types: o From specific financing situations (e.g., issuance of bonds, long‐term notes payable) o From ordinary enterprise operations (e.g., pension obligations, unearned revenues) o Depending on the occurrence of future events (e.g., service or product warranties) The portion due within the next year must be reported as a current liability Copyright ©2022 John Wiley & Sons, Canada, Ltd. 188 Shareholders’ Equity Also known as