Understanding

Financial Accounting
Third Canadian Edition
By Christopher D. Burnley
Prepared by Debbie Musil, FCPA, FCMA

Chapter 1
Overview of Corporate Financial
Reporting
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Learning Objectives (1 of 2)
LO1 – Define financial accounting and understand its
relationship to economic decision-making
LO2 – Identify the main users of financial accounting
information and explain how they use this
information
LO3 – Describe the major forms of business organization and
explain the key distinctions between them

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Learning Objectives (2 of 2)
LO4 – Explain the three categories of business activities and
identify examples of transactions related to each
category
LO5 – Identify and explain the content and reporting
objectives of the four basic financial statements and
the notes to the financial statements

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What Is Financial Accounting?

• Process of capturing, analyzing and reporting

transaction information to financial statement users
• Statement users include:
o Investors
o Creditors
o Management
• Annual report: reports the results of the company’s
activities during the year

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Business Stakeholders
Questions that stakeholders in a business may be asking
Business Stakeholders Potential Questions They May Be Trying to Answer about the Business

Employees, unions Is the business profitable? Will I earn a bonus this year? Can the company afford to
negotiate increased wages? Is the company pension plan in decent shape?
Management How do this year’s sales compare with last year’s? How do they compare with the
budget? Are we maintaining our profit margins on certain product lines? How much do
we owe our employees and suppliers?
Auditors, federal and provincial government Has the company presented its financial information fairly? How does the company’s
departments, legislators financial information compare with the information submitted for taxation or payroll
purposes?
Potential investors, customers What are the long-term prospects for this company? Has the management team done a
reasonable job? Will this company be around to honour its warranties?
Stock analysts, brokers, financial advisors, What are the company’s trends? What are the prospects for this company? How has this
business reporters company performed relative to expectations?
Stock exchange regulators Has the company complied with the financial reporting standards and listing
requirements?
Shareholders, board of directors Has the company generated a sufficient return on our investment? How effectively has
management used the resources at their disposal? Does the company generate enough
income to be able to pay dividends?
Creditors, suppliers, landlords Should we extend credit to this company? Is this a credible and successful company that
we want to attach our brand to? Should we enter into a lease with this company?

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Financial Statement Users
• Internal users:
o Management
• External users:
o Shareholders o Other corporations,
o Board of Directors including competitors
o Potential investors o Security analysts

o Creditors o Credit-rating agencies

o Regulators o Labour unions

o Taxing authorities o Journalists

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Users - Shareholders, the Board of
Directors and Potential Investors
• Includes shareholders, the board of directors and
potential investors
• Shareholders have invested resources in the
company in exchange for a share of its ownership
• Corporations may be either:
o Private companies with a single shareholder
o Public companies with 1000’s of shareholders
requiring a board of directors

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Additional Financial Statement Users

• Additional Financial Statement Users also Include:

• Creditors
o Financial Institutions and other lenders
o Suppliers, employees and various levels of
government
• Regulators
• Taxing Authorities - CRA
• Other Users

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What Is a Corporation?
• Corporations are owned by shareholders who have
provided cash or other assets in exchange for share
certificates
o Called common shares
• Are separate legal entities, distinct from owners
• Two main types:
o Public companies
• Company’s shares are listed on a public stock exchange
o Private companies
• Shares trade privately

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Forms of Business Organization
Key distinctions between the forms of business
Distinguishing Feature Corporation Proprietorship Partnership
Number of owners Can be a single owner or Single owner Multiple owners
multiple owners
Separate legal entity? Yes, shareholders’ No, owner’s No, partners’ personal
personal assets are not personal assets are assets are at risk in the
at risk in the event of at risk in the event event of legal action
legal action against of legal action
company
Owner(s) responsible for Only to extent of Yes Yes
debts of the business? investment
Taxed? Yes, taxed separately No, profits taxed in No, profits taxed in
hands of owner hands of owners
Costs to establish Most expensive Least expensive Moderately expensive
Cost to maintain Most expensive Least expensive Moderately expensive
Must make their financial Yes, on a quarterly and No No
information available annual basis

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Business Activities
The three categories of business activities

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Financing Activities
• A company’s financing comes from two sources:
o Investors, through issuance of shares
o Creditors, through taking out loans or making purchases
on credit
• Typical Financing Activities:
o Cash Inflows:
• Taking out a loan (borrowing money)
• Issuing Shares
o Cash Outflows:
• Repaying loan principal
• Paying dividends on shares
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Investing Activities
• Investing activities include:
o Buying and selling of property, plant, and equipment
(PP&E)
o Buying and selling the shares of other companies
• Typical Investing Activities:
o Cash Inflows:
• Sale proceeds from PP&E
• Sale proceeds from shares of other companies
o Cash Outflows:
• Purchase of PP&E
• Purchase of shares of other companies

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Operating Activities

• Operating activities are related to the company’s

revenues and expenses and fall into two general
categories:
o Cash Inflows:
• Sales to and collections from customers
o Cash Outflows:
• Payment of business expenses

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Financial Reporting
The components of the Financial Statements include:
• Statement of Income
• Statement of Changes in Equity
• Statement of Financial Position
• Statement of Cash Flows
• Notes to the Financial Statements

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Statement of Income
• Presents the results of a company’s operating
activities for a month, quarter or year
• Revenues – Expenses = Profit (Net Income)
• Common items
o Sales revenues
o Other income
o Cost of goods sold
o Selling, general, and administrative expenses
o Depreciation/(amortization), interest, and income tax
expenses
• Incudes an earnings per share disclosure
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Statement of Changes in Equity

• Provides detail on how each component of

shareholders’ equity has changed during the period
• The two major components of shareholders’ equity
include:
o Share Capital
o Retained Earnings

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Statement of Financial Position

• Presents financial status of the company at a

particular point in time
• Also known as the balance sheet
• Lists what is owned (assets) and what is owed
(liabilities), measuring net worth (shareholders’
equity)
• The Accounting Equation:
Assets = Liabilities + Shareholders’ Equity

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Liquidity

• Assets and liabilities are classified on the statement

of financial position into current and non-current
categories and are listed in order of liquidity
• Liquidity: how quickly something will be received,
realized, consumed, settled or paid
• A common measure of liquidity is working capital
Working Capital = Current Assets-Current Liabilities

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Assets

• Characteristics:
o It is an economic resource controlled by an entity
o The company expects future economic benefits from
the use or the sale of the resource
o The event that gave the company the control of the
economic resource has already happened

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Assets - Examples
• Examples
o Cash
o Short-term (temporary) investments
o Accounts receivable
o Inventory
o Prepaid expenses
o Property, Plant and Equipment
o Right-of-Use Assets
o Intangible Assets
o Goodwill
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Liabilities

• Characteristics:
o It is a present obligation of the entity
o The company expects to settle it through an outflow
of economic resources
o The obligation results from an event that has already
happened

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Liabilities - Examples

• Examples
o Bank indebtedness o Accrued liabilities
o Accounts payable o Taxes payable
o Deferred Revenue o Long-term debt
o Notes payable o Lease Liabilities
o Dividends payable o Deferred income taxes

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Shareholders’ Equity

• Value of the shareholders’ interest in the assets of

the company
• Often referred to as the net assets of the company
o This is the amount of assets that would remain after
all of the company’s liabilities were settled
• Usually composed of at least two accounts:
o Share capital
o Retained earnings

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Accounting Equation Rearranged

Assets – Liabilities = Shareholders’ Equity

(Net Assets)

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Share Capital

• Represents the shares that have been issued by the

company
• Usually stated at an amount equal to what was
originally paid by investors for the shares
• Market value of the shares is the price the shares are
trading at on the stock market

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Retained Earnings

• The earnings of the company (as measured on the

Income Statement) that have been kept (retained)
and not paid out in the form of dividends

Retained Earnings = Opening Retained Earnings

+ Net Income
– Dividends Declared

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Statement of Cash Flows
• Presents inflows and outflows of cash during a
specific period of time
o Cash Flow from Operating Activities
• All inflows & outflows related to the company’s sale of
goods or services
o Cash Flow from Investing Activities
• Inflows and outflows related to the purchase and sale
of long-term assets
o Cash Flow from Financing Activities
• Transactions that either generate new funds from
investors/creditors or return funds to
investors/creditors
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Notes to the Financial Statements

• More detail about specific referenced items

• Includes the Summary of Accounting Policies
• Includes information about various segments of the
company

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Copyright
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