FDNACCT Unit 3_Financial Statements_Study Guide.pdf

UNIT 3: FINANCIAL STATEMENTS Financial Statements Definition General purpose reports that provide financial information about the reporting entity’s [business] economic resources [assets], claims against the entity [liabilities and owner’s equity], and changes in those...

UNIT 3: FINANCIAL STATEMENTS Financial Statements Definition General purpose reports that provide financial information about the reporting entity’s [business] economic resources [assets], claims against the entity [liabilities and owner’s equity], and changes in those economic resources and claims [income, expenses, owner’s capital, owner’s drawings] that is useful to primary users in making decisions relating to providing resources to the entity Objective To provide financial information about the reporting entity’s assets, liabilities, equity, income, and expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows to the reporting entity and in assessing management’s stewardship of the entity’s economic resources (includes protecting the company’s assets against price changes and technological changes as well as compliance with laws, regulations, and contracts) Scope Financial information about the reporting entity Reporting Specified period of time period Information about transactions and other events that have occurred after the end of the reporting period is provided if that information is necessary to meet the objective of financial statements Perspective From the perspective of the reporting entity Assumption Going-concern Elements of Financial Statements Conceptual Framework Element Definition or Description Economic resource Asset A present economic resource controlled by the entity as a result of past events An economic resource is a right that has the potential to produce economic benefits Claim Liability A present obligation of the entity to transfer an economic resource as a result of past events Equity The residual interest in the assets of the entity after deducting all its liabilities Changes in Income Increases in assets, or decreases in liabilities, that result in increases in equity, economic resources other than those relating to contributions from holders of equity claims and claims, reflecting Expenses Decreases in assets, or increases in liabilities, that result in decreases in financial performance equity, other than those relating to distributions to holders of equity claims Other changes in - Contributions from holder/s of equity claims, and distributions to them economic resources - Exchanges of assets or liabilities that do not result in increases or decreases and claims in equity 3.1 Statement of Financial Position [Balance Sheet] Definition A position statement that reports the financial condition (financial standing; financial strength) of an entity at the end of the period and presents an organized list of assets, liabilities, and equity Usefulness Provides information useful to assess the entity’s future cash flows, liquidity, and long-term solvency Limitation - The entity's reported book value (assets minus liabilities) will not directly measure the company’s market value (in a public corporation, this is current market price x number of shares issued) - Many assets are measured at their historical costs rather than their fair values - Many aspects of a company may represent valuable resources but are not recorded as assets o Product knowledge o Experienced management team o Trained employees o Loyal customer relationships Forms Report form Account form Assets Assets Liabilities Liabilities Owner's equity Owner's equity 1 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O. Elements ASSETS A present economic resource controlled by the entity as a result of past events Economic resource – the right that has the potential to produce economic benefits Control – the present ability to direct the use of the economic resource and obtain the economic benefits that may flow from it o no other party controls that asset o the right to deploy that asset in its activities o ability to enforce legal rights on that asset Current assets – assets that are expected to be realized (converted to cash) or intended to be sold or to be consumed within the entity’s normal operating cycle* held primarily for the purpose of trading expected to be realized within twelve months after the reporting period cash or cash equivalent unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period *Operating cycle 1 Use cash to acquire inventory ←← – time between the acquisition of ↓ ↑ assets for processing and their 2 Prepare inventory for sale to customers realisation in cash or cash equivalents (Including the production process for manufacturing business) ↓ ↑ * Where a company has no 3 Deliver inventory to customer clearly defined operating cycle, ↓ ↑ the one-year convention is used. 4 Collect cash from customer →→ Current assets are listed according to its liquidity, its nearness to cash. 1. Cash and cash equivalents Cash – cash on hand and in banks that is available for use in the operations of the business Cash equivalents – highly liquid investments that can be quickly converted into cash, not subject to significant risk of changes in value, and must be held for the purpose of ‘meeting short-term cash commitments’ Examples include money market funds, such as: o Investment in treasury bills (short-term debt instruments of government) o Investment in commercial papers (short-term debt instruments of corporations) o Investment in certificate of deposits (short-term debt instruments of banks) 2. Trade and other receivables Trade receivable / Accounts receivable – receivable resulting from a company’s normal trade, that is, providing services or selling goods on account [on credit; on charge account; on open-account credit] Notes receivable – receivable with a written promissory note from another party from a company’s normal trade, usually requiring an additional receipt of explicit interest Other receivables o Advances to employees – advances by the company to employees o Loans receivable – loans given by by the company to individuals and other entities o Accrued income – revenue already earned, but not yet received (recorded as part of adjusting entries at period-end) 3. Inventory – encompass goods that are purchased and held for resale o merchandise purchased by a retailer and held for resale [Merchandise Inventory] o land and other property held for resale raw materials and factory supplies awaiting use in the production process work in progress being produced by the entity finished goods produced 4. Prepaid expense [Deferred expense] – expense paid in advance, thus creating benefits, but not yet used o includes office supplies 2 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O. Non-current assets – residual by definition, an entity shall classify all other assets as non-current. 1. Property, plant, and equipment (PPE) – tangible items that are held for use in the production or supply of goods or services, for rental to others (except for land and building), or for administrative purposes are expected to be used during more than one period o Land o Vehicles o Office equipment o Land improvements o Furniture and o Bearer plants o Building fixtures o Machinery o Fittings Note: There are other non-current assets, but for FDNACCT, only Property, Plant, and Equipment items are discussed. LIABILITIES A present obligation of the entity to transfer an economic resource as a result of past events Obligation – a duty or responsibility that an entity has no practical ability to avoid and owed to another party/parties o person o a group of people / o society at large o another entity a group of entities Transfer an economic resource o pay cash o deliver goods or provide services o exchange economic resources with another party on unfavourable terms (E.g., Forwards; Options) o transfer an economic resource if a specified uncertain future event occurs o Issue a financial instrument if that financial instrument will oblige the entity to transfer an economic recourse Result of past events o the entity has already obtained economic benefits or taken an action o the entity will or may have to transfer an economic resource that it would not otherwise have had to transfer Current liabilities – liabilities that are expected to be settled in the entity’s normal operating cycle are owed primarily for the purpose of trading are due to be settled within twelve months after the reporting period do not have the right at the end of the reporting period to defer settlement of the liability for at least twelve months after the reporting period 1. Trade and other payables Trade payable / Accounts payable – payable resulting from a company’s normal trade, that is, buying assets and goods on account [on credit; on charge account; on open-account credit] Notes payable – payable with a written promise to pay cash at some future date (legal IOUs), usually requiring an additional payment of explicit interest Other payables o Accrued expense – expense already used, but not yet paid (recorded as part of adjusting entries at period-end) 2. Loans payable - current portion – a portion of long-term Loans Payable that is payable within the next year 3. Unearned income [Deferred income] – revenue received in advance, but not yet earned Non-Current liabilities – residual by definition, an entity shall classify all other liabilities that are not current as non- current 1. Loans payable - noncurrent portion – long-term Loans Payable that is not yet due within the next year 2. Long-term notes payable – long-term promissory notes that is not yet due within the next year 3. Mortgage payable – long-term promissory note secured by an asset the title of which is pledged to the lender 3 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O. Deferrals and Accruals Prepaid expense expense paid in advance not yet used ASSET [Deferred expense] Unearned income revenue received in advance not yet earned LIABILITY [Deferred income] paid by providing service Accrued income revenue already earned not yet received ASSET Accrued expense expense already used not yet paid LIABILITY OWNER’S EQUITY The residual interest in the assets of the entity after deducting all its liabilities Owner’s financial interest or net worth in a business Assets – Liabilities = Owner’s Equity BASIC ACCOUNTING EQUATION Resources = Claims on resources Assets = Liabilities + Owner’s Equity A = L + OE 3.2 Statement of Financial Performance Statement of Profit & Loss [Income Statement; Statement of Operations] Definition A change statement that summarizes the profit-generating transactions that changes the owner’s equity for the period and reports an entity’s financial performance, that is, its net profit or net loss, for the period Usefulness Provides information useful to assess the entity’s profitability, return on owner’s investment, its operations and various functions and predicting future expenses and cash outflows Statement of Other Comprehensive Income Definition A change statement that summarizes the items of income and expenses that are not recognized in the Statement of Profit or Loss (E.g., reclassifications) Statement of Comprehensive Income = Statement of Profit & Loss + Statement of Other Comprehensive Income Forms Nature of expense method Classifies expenses within profit or loss according to their nature Function of expense method Classifies expenses by their function within the entity o Cost of sales – cost of providing service / cost of goods sold o Distribution costs – expenses related to selling and distributing the goods to the customers o Administrative costs – expenses related to the general administration of the business o Finance costs – interest expense Elements INCOME Earnings of an entity Inflow of resources resulting from services provided or goods sold to customers Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims o Service income / Professional fees – revenue from services provided to clients o Sales – revenue from sale of goods to customers o Other income – revenue from sources other than the main line of business § Interest income § Income from investments § Rent income § Gain on sale of PPE item § Commissions income 4 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O. EXPENSES Outflow of resources incurred for generating income Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to distributions to holders of equity claims o Delivery expense o Employee benefits o Insurance expense o Taxes & licenses expense o Interest expense o Transportation & travel expense o Marketing expense o Utilities expense (advertising, promotion) o Miscellaneous expenses / o Office supplies expense Other expenses / Sundry expenses o Professional fees o Bad debts expense* (accounting, audit, legal) o Doubtful debts expense* o Rent expense o Depreciation expense* o Repair & maintenance expense *recorded as part of adjusting entries at o Representation & entertainment expense period-end o Salaries & wages expense 3.3 Statement of Changes in Owner’s Equity Definition A change statement that discloses the events that caused the owner’s equity to change for the period Usefulness Provides information useful to understand the transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners Items affecting equity Income and expenses Contributions [investment] by owner Owner’s capital – financial investment of the owner o Cash o Other assets § Recorded at its fair market value at the time of investment Distributions to [withdrawal by] owner Owner’s drawings – temporary withdrawal of the profit of the business --- Capital Capital / Owner’s capital – financial investment of the owner Capital employed – the long-term source of financing, which includes both the capital of the owner and non-current liabilities Working capital – refers to net current assets (Current assets minus Current liabilities) Capital expenditures – expenditures for purchase of non-current assets Capital budgeting – the process of investment appraisal --- EXPANDED ACCOUNTING EQUATION Resources = Claims on resources Owner’s Equity Assets = Liabilities + Changes Drawings Capital Expenses Income 5 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O. 3.4 Statement of Cash Flows Definition A change statement disclosing the events that caused cash to change for the period Usefulness Provides information useful to assess the entity’s ability to generate cash and cash equivalents and to utilize those cash flows To be discussed in detail in Unit 4.9. 3.5 Preparing financial statements with accompanying notes (service business) Notes to Financial Statements The notes shall: present information about the basis of preparation of the financial statements and the specific accounting policies used disclose the information required by IFRSs that is not presented elsewhere in the financial statements provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding of any of them --------------------------------------------------------------------------------------------------------------------------------------------------- REFERENCES IFRS Foundation (2003, December). IAS 10 - Events after the Reporting Period IFRS Foundation (2018, March). Conceptual Framework for Financial Reporting. IFRS Foundation (2024, April). IFRS 18 - Presentation and Disclosure in Financial Statements. Spiceland, Sepe, Thomas, Tan, Low, Low (2019), Intermediate Accounting Global Edition (2nd Edition), McGraw- Hill Education (Asia). 6 | FDNACCT / AY2024-2025_Term 1 Trinidad, Editha O.