ACCT 1235 – Introduction to

Financial Accounting I & II

Chapter 2

A Further Look at Financial Statements

Copyright ©2020 John Wiley & Sons, Inc.

Learning Objectives

LO 1: Identify the sections of a classified statement of

financial position.
LO 2: Identify and calculate ratios for analyzing a
company’s liquidity, solvency, and profitability.
LO 3: Describe the framework for the preparation and
presentation of financial statements.
Classified Statement of Financial Position

• A classified statement of financial position generally

contains the following standard classifications:
Assets Liabilities and Shareholder’s Equity
Currents assets Currents liabilities
Cash Bank indebtedness
Trading investments Accounts payable
Accounting receivable Deferred revenue
Inventory Notes payable
Supplies Current portion of long-term debt
Prepaid expenses Non-current liabilities
Non-current assets Bank loan payable
Long-term investments Shareholder’s equity
Property, plant, and equipment Share capital
Intangible assets Retained earnings
Goodwill
Current Assets
• Assets expected to be converted to cash, sold or used in the
business within one year of the financial statement date or
one operating cycle, whichever is longer
o Operating cycle is the average time it takes to go from cash to
cash in producing revenue
• Usually listed in order of liquidity:
o Reverse order of liquidity also possible
• Examples include cash, trading investments, accounts
receivable, inventory, and prepaid expenses
Non-Current Assets
• Also known as long-term assets
• Assets not expected to be converted to cash, sold or used in
the business within one year of the financial statement date
or one operating cycle
• All assets not considered current
• Examples:
o Long-term investments.
o Property, plant, and equipment.
o Intangible assets and goodwill.
o Other assets
Long-Term Investments
• Multi-year investments in:
o Debt securities: loans, notes, bonds, mortgages
o Equity securities: shares of other companies
• These assets are normally not intended to be sold (and
converted to cash) within one year
Property, Plant, and Equipment
• Tangible assets with relatively long useful lives
• Used in operating a business
• Examples:
o Land
o Buildings, Equipment
o Furniture
o Computers
o Vehicles
• Usually listed in order of permanency
Depreciation (1 of 2)

• Allocation (expense) of the cost of property, plant, and

equipment over their estimated useful lives:
o Companies systematically assign a portion of the cost of
an asset to expense each year
o Under IFRS, this allocation is referred to as depreciation
for property, plant, and equipment, and amortization for
intangible assets
o Under ASPE, amortization is often used instead of
depreciation
Depreciation (2 of 2)

• The cost of long-lived assets with indefinite lives is not

depreciated (e.g. land)
• Accumulated depreciation account shows the total
amount of depreciation recorded to date
o Accumulated depreciation is a contra asset account
• The difference between the cost of the asset and its
accumulated depreciation is referred to as the carrying
amount of the asset
Intangible Assets
• Non-current assets that do not have physical substance
but have significant value
• represent a privilege or a right held by the company
• Examples:
o Patents, copyrights, trademarks, licenses
o Goodwill: excess price paid on acquisition of another
company
• Generate a future value to the company
• Amortized if they do not have an indefinite life
Current Liabilities
• Obligations that are to be paid or settled within the
(longer of the) one year of the financial statement date
or one operating cycle
• Examples:
o Bank indebtedness
o Accounts payable
o Deferred revenue
o Bank loan/notes payable
o Current portion of long-term debt
Non-Current Liabilities
• Obligations expected to be paid or settled after one year
• Examples:
o Bank loan/notes payable
o Lease obligations
o Pension and benefit obligations
o Deferred income tax liabilities
• Usually accompanied by extensive notes to the financial
statements
Shareholders’ Equity
• Share capital:
o Investment of cash (or other assets) in the company by
shareholders in exchange for preferred or common shares
• Retained earnings:
o Cumulative net income kept for use in the company
Using the Financial Statements
• Specific tools can be used to analyze the financial statements
• Ratio analysis expresses the relationships between selected
financial statement data
• Use comparisons to aid in analyses:
o Intracompany comparisons cover two or more periods for the
same company
o Intercompany comparisons between the company and a
competitor
o Industry average comparison based on averages for particular
industries
Liquidity Ratios
• Measure a company’s short-term ability of to pay its
maturing obligations and to meet its unexpected needs
for cash
Working capital = Current assets  Current liabilities
Current assets
Current ratio =
Current liabilities

Higher is generally better

Solvency Ratios
• Measure a company’s ability to survive over a long
period of time:
o The higher the percentage of debt to total assets, the
greater the risk that debts cannot be repaid when they
are due
Total liabilities
Debt to total assets =
Total assets
Lower is generally better
Profitability Ratios
• Measure a company’s operating success of for a given
period of time, usually one year
Income Available to Common Shareholders
Basic Earnings  Loss  Per Share =
Weighted Average Number of Common Shares

Market price Per Share

Price - Earnings Ratio =
Basic Earnings Per Share

Higher is generally better

Using the Financial Statements – Data
Analytics
• Process of analyzing enormous amounts of data to find
patterns, correlations, trends, insights
• Used to enhance decision making, including decisions
impacting financial reporting
Conceptual Framework of Accounting
• Guides decisions about:
o what to present in financial statements
o alternative ways of reporting economic events
o appropriate ways of communicating this information
Conceptual Framework for Financial
Reporting
• Some key items:
o Objective of general-purpose financial reporting
o Qualitative characteristics of useful financial information
o Cost constraint
o Elements of financial statements
o Measurement of the elements of financial statements
Objective of General-Purpose Financial
Reporting
• To provide financial information that is useful to
existing and potential investors, lenders and other
creditors
• Who are making decisions about providing resources to
a company:
o Buying, selling, holding equity and debt
o Providing or settling loans or other credit
• Financial information is provided by general purpose
financial statements
Qualitative Characteristics of
Accounting Information
• Relevance:
o Information has relevance if it makes a difference in
users’ decisions
o May have predictive value and/or confirmatory value
o Materiality is important: will information influence the
decisions of users?
• Faithful representation:
o Information should reflect economic reality
o It must be complete, neutral and free from error
Enhancing Qualities of Useful
Information
• Comparability:
o Users can identify and understand similarities and differences
among items
• Verifiability:
o Independent consensus that information is faithfully
represented
• Timeliness:
o Available before it loses its usefulness in decision-making
• Understandability:
o Classified, characterized and presented clearly and concisely
Cost Constraint
• Ensures that the value of the information provided by
financial reporting is greater than the cost of providing
it
• The benefits of financial reporting should justify the
costs of providing and using it
Going Concern Assumption

• The business will continue operating in the foreseeable

future
• The key assumption – provides a foundation for
accounting and justification for using cost as the value
of certain assets
Elements of Financial Statements
• Assets
• Liabilities
• Equity
• Income
• Expenses
Measurement of the Elements

• Accountants have developed principles that describe

which, when and how the elements of financial
statements should be:
o Recognized
o Measured, and
o Reported
• Known as generally accepted accounting principles
(GAAP)
Generally Accepted Accounting
Principles
• Historical cost:
o Assets and liabilities should be recorded at their cost when
acquired
o Not only at time of purchase, but throughout the life of each
asset and liability
• Fair Value:
o Certain assets and liabilities should be recorded and reported at
fair value
• In choosing between these two, apply the concepts of
relevance and faithful representation
Comparing IFRS and ASPE

Comparing IFRS and ASPE Review

Key Standard Differences International Financial Accounting Standards for

Reporting Standards (IFRS) Private Enterprises (ASPE)
Basic earnings per share Required to present in financial Not required to present in
statements financial statements
Depreciation Uses the term depreciation Uses the term amortization