January 13, 2022 - The Purpose and Use of
Financial Statements
January 11, 2022 9:28 PM
• Accounting: the information system that identifies and records the economic events of an organization, and then
communicates them to a wide variety of interested users
○ "the language of business"
• There are two broad categories of users:
○
○ Internal users:
▪ Canadian tire store example
□ Store manager - what products to carry/restock
□ Shop manager - are we carrying enough of the right brand? Should we have a sale to reduce inventory
○ External user:
▪ Investors, creditors called Primary users
▪ Others:
□ tax authorities - paying the right tax?
□ Regulatory agencies - playing by the rules?
□ Customers - can they honour warranty?
□ Labour unions - are wages fair?
□ Economic planners - will the company survive?
□ Communities - are they good citizens?
▪ Canadian tire store example
□ Ex. Bank manager - should I extend them more credit? Can they repay the debt they already have?
□ CRA - did they pay the right amount of tax?
• Ethical behaviour:
○ For accounting information to have value, preparers must have high ethical standards:
▪ Actions are legal and responsible
▪ Consider organizations interests
○ Accountants and other professionals have rules or codes of conduct to guide ethical behaviour
○ Companies have rules of conduct
• Forms of business organizations
○ Proprietorship:
▪ Owned by one person
▪ Simple to set up
▪ Owner has control over business
▪ Unlimited liability
○ Partnership:
▪ Similar to proprietorship except owned by more than one person
▪ Formalized in a written agreement
▪ Each partner has unlimited liability
○ Corporation:
▪ Indefinite life
▪ Shareholders enjoy limited liability
▪ May be public or private
□ Depends on whether shares are publicly traded
○ All 3 organizations are reporting entities, but only proprietorship and corporation are taxable entities
• Types of businesses
○ Manufacturing business
▪ What do they do?
□ Start with raw materials
□ Processes it in some way
□ Create finished products
□ Sell the finished products
○ Merchandising business
▪ Example:
□ Have you ever purchased anything from a merchant?
They Buy and resell
□ Some merchants you may be familiar with:
Walmart
Canadian tire
Best Buy
Tim Hortons
Dollarama
Starbucks
○ Service business
▪ What makes a service business different?
▪ What are some types of service businesses?
□ Lawyers
□ Lawn care companies
□ Medical professionals
□ Plumber or electrician
□ Carpenters
□ Handy persons
□ Accountants
• 3 types of business activities
○ Financing activities
▪ Obtaining and repaying funds to finance the operations of the business
▪ Examples - external financing:
□ Borrowing money or repaying loans/debt
□ Selling or repurchasing (retracting) shares (equity)
▪ Examples - internal financing
□ Choose to use "retained earnings" (equity) to reinvest in the business rather than paying dividends
○ Investing activities
▪ Obtaining the resources or assets needed to operate the business for the long term
▪ Examples:
□ Purchase or sale of investments
□ Purchase or sale of long-lived assets such as property, plant, equipment and intangible assets
Operating activities
MOS A and F Page 1
, ○ Operating activities
▪ Operating activities are the main day to day activities of the business
▪ Examples
□ Revenues
□ Expenses
□ Related accounts
Accounts payable, accounts receivable, inventory, etc.
• Financial statements
○ Financial statements: the business documents that companies use to report the results of their activities to various
user groups
○ The system of accounting produces the following statements:
▪
▪ They change name under different law things, but have very similar uses
▪
○ Income statements
▪ Reports the results of operations for a specific period of time
▪ Revenues:
□ Arise from the sale of a product or service in the regular course of operations
▪ Expenses:
□ Costs of assets consumed or services used to generate revenues
▪ Gains and losses:
□ Extra income or expenses arising from one time (or unusual) events that are not in the regular course of
operations
▪ Net earnings or net profit (loss):
□ Revenues + gains - expenses - losses
○ Statement of retained earnings
▪ Shows the changes in each component of shareholders equity for the period
▪ Share capital:
□ Amounts contributed by shareholders
□ May have common and preferred classes
▪ Retained earnings/deficit:
□ Cumulative profit retained in the company
□ Less dividends paid to shareholders
Ignore book reference to comprehensive income
○ Balance sheet
▪ Assets: Resources owned by a business
▪ Liabilities: Obligations of the business
▪ Shareholders' equity: Share capital and retained earnings
▪ Accounting equation:
□ Assets = liabilities + equity
○ Cash flow statement
▪ Reports the cash receipts and payments for a specific period of time
▪ Changes in cash should be categorized as one of the following activities:
□ Operating - operations and changes in current assets and liabilities
□ Investing - changes in long term assets
□ Financing - changes in long term liabilities and equity
• Accounting equation
○ Assets = liabilities + equity
○ Economic resources = claims on economic resources
○ Assets: the economic resources of a business that are expected to produce a benefit in the future
○ Liabilities: “outsider claims” or economic obligations payable to outsiders
○ Shareholders (owners') equity: represents the “insider claims” of a business
○ For a corporation, shareholders' equity is divided into two main categories:
▪ Share capital
▪ Retained earnings
▪
• Components of retained earnings
○
• Annual report
MOS A and F Page 2
, • Annual report
○ Publicly traded companies must prepare an annual report each year
○ Includes financial and nonfinancial information about the company
▪ Financial: management discussion and analysis ("MD&A") statement of management responsibility, auditors'
report, financial statements and notes
□ management discussion and analysis ("MD&A"): managements explanation of the financial information
and the significance of said information
□ 5 key elements that should be included:
Company's vision, core businesses, strategy
Key performance drivers
Capital and other resources
Historical and prospective results
risks
▪ Nonfinancial: company's mission and goals, products, people
• Generally accepted accounting principles (GAAP)
○ Rules and practices for the preparation of financial statements
○ Different for publicly traded and private corporations:
▪ Publicly traded corporations use International Financial Reporting Standards (IFRS)
▪ Private corporations may use IFRS or Accounting Standards for Private Enterprises (ASPE)
○ Proprietorships and partnerships do not have to use IFRS or ASPE as statements are usually prepared for internal users
only
MOS A and F Page 3
Financial Statements
January 11, 2022 9:28 PM
• Accounting: the information system that identifies and records the economic events of an organization, and then
communicates them to a wide variety of interested users
○ "the language of business"
• There are two broad categories of users:
○
○ Internal users:
▪ Canadian tire store example
□ Store manager - what products to carry/restock
□ Shop manager - are we carrying enough of the right brand? Should we have a sale to reduce inventory
○ External user:
▪ Investors, creditors called Primary users
▪ Others:
□ tax authorities - paying the right tax?
□ Regulatory agencies - playing by the rules?
□ Customers - can they honour warranty?
□ Labour unions - are wages fair?
□ Economic planners - will the company survive?
□ Communities - are they good citizens?
▪ Canadian tire store example
□ Ex. Bank manager - should I extend them more credit? Can they repay the debt they already have?
□ CRA - did they pay the right amount of tax?
• Ethical behaviour:
○ For accounting information to have value, preparers must have high ethical standards:
▪ Actions are legal and responsible
▪ Consider organizations interests
○ Accountants and other professionals have rules or codes of conduct to guide ethical behaviour
○ Companies have rules of conduct
• Forms of business organizations
○ Proprietorship:
▪ Owned by one person
▪ Simple to set up
▪ Owner has control over business
▪ Unlimited liability
○ Partnership:
▪ Similar to proprietorship except owned by more than one person
▪ Formalized in a written agreement
▪ Each partner has unlimited liability
○ Corporation:
▪ Indefinite life
▪ Shareholders enjoy limited liability
▪ May be public or private
□ Depends on whether shares are publicly traded
○ All 3 organizations are reporting entities, but only proprietorship and corporation are taxable entities
• Types of businesses
○ Manufacturing business
▪ What do they do?
□ Start with raw materials
□ Processes it in some way
□ Create finished products
□ Sell the finished products
○ Merchandising business
▪ Example:
□ Have you ever purchased anything from a merchant?
They Buy and resell
□ Some merchants you may be familiar with:
Walmart
Canadian tire
Best Buy
Tim Hortons
Dollarama
Starbucks
○ Service business
▪ What makes a service business different?
▪ What are some types of service businesses?
□ Lawyers
□ Lawn care companies
□ Medical professionals
□ Plumber or electrician
□ Carpenters
□ Handy persons
□ Accountants
• 3 types of business activities
○ Financing activities
▪ Obtaining and repaying funds to finance the operations of the business
▪ Examples - external financing:
□ Borrowing money or repaying loans/debt
□ Selling or repurchasing (retracting) shares (equity)
▪ Examples - internal financing
□ Choose to use "retained earnings" (equity) to reinvest in the business rather than paying dividends
○ Investing activities
▪ Obtaining the resources or assets needed to operate the business for the long term
▪ Examples:
□ Purchase or sale of investments
□ Purchase or sale of long-lived assets such as property, plant, equipment and intangible assets
Operating activities
MOS A and F Page 1
, ○ Operating activities
▪ Operating activities are the main day to day activities of the business
▪ Examples
□ Revenues
□ Expenses
□ Related accounts
Accounts payable, accounts receivable, inventory, etc.
• Financial statements
○ Financial statements: the business documents that companies use to report the results of their activities to various
user groups
○ The system of accounting produces the following statements:
▪
▪ They change name under different law things, but have very similar uses
▪
○ Income statements
▪ Reports the results of operations for a specific period of time
▪ Revenues:
□ Arise from the sale of a product or service in the regular course of operations
▪ Expenses:
□ Costs of assets consumed or services used to generate revenues
▪ Gains and losses:
□ Extra income or expenses arising from one time (or unusual) events that are not in the regular course of
operations
▪ Net earnings or net profit (loss):
□ Revenues + gains - expenses - losses
○ Statement of retained earnings
▪ Shows the changes in each component of shareholders equity for the period
▪ Share capital:
□ Amounts contributed by shareholders
□ May have common and preferred classes
▪ Retained earnings/deficit:
□ Cumulative profit retained in the company
□ Less dividends paid to shareholders
Ignore book reference to comprehensive income
○ Balance sheet
▪ Assets: Resources owned by a business
▪ Liabilities: Obligations of the business
▪ Shareholders' equity: Share capital and retained earnings
▪ Accounting equation:
□ Assets = liabilities + equity
○ Cash flow statement
▪ Reports the cash receipts and payments for a specific period of time
▪ Changes in cash should be categorized as one of the following activities:
□ Operating - operations and changes in current assets and liabilities
□ Investing - changes in long term assets
□ Financing - changes in long term liabilities and equity
• Accounting equation
○ Assets = liabilities + equity
○ Economic resources = claims on economic resources
○ Assets: the economic resources of a business that are expected to produce a benefit in the future
○ Liabilities: “outsider claims” or economic obligations payable to outsiders
○ Shareholders (owners') equity: represents the “insider claims” of a business
○ For a corporation, shareholders' equity is divided into two main categories:
▪ Share capital
▪ Retained earnings
▪
• Components of retained earnings
○
• Annual report
MOS A and F Page 2
, • Annual report
○ Publicly traded companies must prepare an annual report each year
○ Includes financial and nonfinancial information about the company
▪ Financial: management discussion and analysis ("MD&A") statement of management responsibility, auditors'
report, financial statements and notes
□ management discussion and analysis ("MD&A"): managements explanation of the financial information
and the significance of said information
□ 5 key elements that should be included:
Company's vision, core businesses, strategy
Key performance drivers
Capital and other resources
Historical and prospective results
risks
▪ Nonfinancial: company's mission and goals, products, people
• Generally accepted accounting principles (GAAP)
○ Rules and practices for the preparation of financial statements
○ Different for publicly traded and private corporations:
▪ Publicly traded corporations use International Financial Reporting Standards (IFRS)
▪ Private corporations may use IFRS or Accounting Standards for Private Enterprises (ASPE)
○ Proprietorships and partnerships do not have to use IFRS or ASPE as statements are usually prepared for internal users
only
MOS A and F Page 3
