1. Finance for Non-Financial Managers, 6th edition
PowerPoint Slides
to accompany
Prepared by
Pierre Bergeron, University of Ottawa
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2. Finance for Non-Financial Managers, 6th edition
CHAPTER 2
ACCOUNTING AND FINANCIAL STATEMENTS
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3. Accounting and Financial Statements
Chapter Objectives
1. Explain the activities related to bookkeeping.
2. Describe the accounting function and give an outline of the four financial statements.
3. Explain the contents and the structure of the statement of income, the statement of changes in equity and the statement of financial position.
4. Explain the meaning of analysis in financial management.
5. Discuss the importance of decision-making in financial management.
6. Draw a comparison between the GAAP and IFRS financial statements’ presentation format.
7. Explain the contents and structure of financial statements prepared for not-for-profit organizations.
Chapter Reference
Chapter 2: Accounting and Financial Statements
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4. Financial Management Includes
Bookkeeping
Accounting
Analysis
Financial Statements
Decision-Making
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5. Copyright © 2011 Nelson Education Limited
1. Bookkeeping
As a rule, when all accounts are closed at the end of an accounting period, the asset and expense accounts have debit balances and the equity, liability and revenue accounts have credit balances.
Debit
Credit
Statement of Financial Position Accounts
Assets
Equity
Liabilities
Debit
Credit
Statement of Income Accounts
Expenses
Revenue
Transfer (profit for the year) is made at the end of the accounting period
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6. The Accounting Equation
Statement of Financial Position
Statement of Income
A = E L
R - E
Debit Increases Decreases Decreases Decreases Increases
Credit Decreases Increases Increases Increases Decreases
Profit for the year
Statement of changes in equity
Ends with the Trial Balance
Debits = Credits
Profit
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7. Copyright © 2011 Nelson Education Limited
The Accounting Cycle
Business
Business
Activity is
recorded in
Activity is
transferred to
Transaction Document
Journals
Ledgers
takes place is prepared
1. Cash account House
2. VISA Car
Statement of Financial Position
1. Salary Rent
2. Food Clothing
Statement of Income
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8. The Trial Balance (Wiley Inc. Dec. 31, 2010)
Debit
Credit
Cash and cash equivalents
Revenue
Prepaid expenses
Finance costs
Cost of sales
Short-term borrowings
Retained earnings (beginning of year)
Trade receivables
Accrued expenses
Distribution costs
Income tax expense
Current income taxes payable
Future income taxes payable (deferred taxes)
Long-term borrowings
Inventories
Trade and other payables
Current portion of long-term debt
Administrative expenses
Non-current assets (at cost)
Depreciation
Accumulated depreciation
Dividends
Share capital
$25,000
SFP
______
$500,000 SI
______
20,000
SFP
10,000 SI
300,000 SI
50,000
SFP
135,000
SCE
100,000
SFP
15,000
SFP
50,000 SI
25,000 SI
2,000
SFP
3,000
SFP
200,000
SFP
200,000
SFP
100,000
SFP
20,000
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SFP
50,000 SI
500,000
SFP SI
25,000
100,000
SFP
20,000
SCE
200,000
SFP
$ 1,325,000
Total
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9. An employee works for a week without being paid for $800
Accrued Expenses
Represent a bill which the company stills owes during the current operating year (i.e., wages, rent, bonus, federal, provincial, or municipal taxes).
Dec. 24
Dec. 31
Jan.7
So, the company owes $800 (liability) to the employee when the books are closed
An employee works for a week without being paid for $800
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10. Prepaid Expenses
Payments made on accounts for which services have not yet been provided (i.e., rent, insurance, office supplies, property taxes).
June 30
December 31
June 30
…but, will also show in the closing statement of financial position an amount of $2,000 (asset) as a prepaid expense.
Pay $4,000 for insurance this year and show $2,000 as an expense…
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11. 2. Financial Statements
To determine the value or wealth of a business, look at the STATEMENT OF FINANCIAL POSITION (also known as the balance sheet) since it gives a reading of its financial position at a given point in time; it’s like a snapshot or an X-Ray.
To determine the flow or wealth of a business, look at the STATEMENT OF INCOME (also known as the earnings statement, the statement of operations and the profit and loss statement) since it shows the infusion of revenue and expenses between two accounting periods.
To determine the accumulated wealth of a business, look at the STATEMENT OF CHANGES IN EQUITY (statement of retained earnings section) since it shows the amount paid to the shareholders and the amount retained in the business.
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12. 3. Financial Statements - Structure and Contents
Statement of Income
Statement of Retained Earnings
Revenue
Cost of sales
Gross profit
Other income/expenses
Profit for the year
Retained earnings (beginning)
Earnings for the year
Less: dividends
Retained earnings (ending)
$900,000
$100,000
$ (20,000)
$ 80,000
$80,000
$25,000
$150,000
$980,000
$100,000
Statement of Financial Position
Statement of Cash Flows
Assets
• Non- current
• Current
Equity
Liabilities
• Long-term
• Current
Sources of funds
(Where they come from)
Uses of funds
(Where they went)
$100,000 $25, $150,000
Profit CL LT
$230,000
$25,000
$20,000 $230, $25,000
Div NCA CA
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13. Statement of Income (Operating Performance)
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Administrative expenses
Finance costs
Total other income and costs
Profit before taxes
Income tax expense
Profit for the year 1 2 3
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14. Statement of Comprehensive Income
Profit for the year
Other comprehensive income/(loss)
Exchange differences on translating foreign operations
Gain or loss on property revaluation
Actual gains (losses) on defined benefit pension plans
Total other comprehensive income/(loss) for the year
Total comprehensive income 4

15. Wiley’s Financial Statements
Wiley Inc.
Statement of Income for the Period Ending December 31, 2010
Revenue
Cost of sales
Distribution costs
Administrative expenses
Total operating expenses
Finance costs
Income tax expense
$500,000
(300,000)
200,000
(125,000)
75,000
(10,000)
65,000
(25,000)
$40,000 1
Gross profit
($50,000)
(50,000)
(25,000)
Cash flow
Depreciation
$ 25,000
25,000
$100,000
$ 40,000
Operating income (E B I T)
$ 65,000
$75,000 2
Profit before taxes 3
Profit for the year
EBITDA
Wiley Inc.
Statement of Retained Earnings as at December 31, 2010
Retained earnings (beginning of year) $ 135,000
Earnings for the current year $ 40,000
Dividends (20,000) ,000
Retained earnings (end of year) $ 155,000
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16. Wiley’s Financial Statements
Profit for the year
Other comprehensive income/(loss)
Exchange differences on translating foreign operations
Gain or loss on property revaluation
Actual gains (losses) on defined benefit pension plans
Total other comprehensive income/(loss) for the year
Total comprehensive income
$40,000
---
---
---
---
--- 4
$40,000

17. Wiley’s Financial Statements
Wiley Inc.
Statement of Changes in Equity for the Period Ending December 31
2010
2009
Share capital
Balance at beginning of year
• Common shares issued
• Dividend reinvestment and share purchase plan
• Share issued on exercise of stock options
Balance at end of year
$185,000
15,000
---
$200,000
$180,000
5,000
---
$185,000
Contributed surplus
Balance at beginning of year
• Stock based compensation
• Options exercised
Balance at end of year
---
Retained earnings
Balance at beginning of year
• Earnings for the year
• Dividends paid to shareholders
Balance at end of year
$125,000
20,000
(10,000)
$135,000
40,000
(20,000)
$155,000
Total other comprehensive/(loss) for the year
Balance at beginning of year
• Change in currency translation
• Change in property revaluation
Balance at end of year
---

18. Statement of Financial Position (Financial Structure)
Non-Current Assets
Equity
Long-term borrowings
• Capital budgeting
• Financial leverage
• Cost of financing
• Cost of capital
Current Assets
Current Liabilities
Working capital
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19. Wiley’s Financial Statements
Wiley’s Inc.
Statement of Financial Position as at December 31, 2010
Non-current assets
• Accumulated depreciation
$500,000
(100,000) 1
$400,000
Current assets
• Inventories
• Trade receivables
• Prepaid expenses
• Cash and cash equivalents
Total current assets
Total assets
200,000
100,000
20,000
25,000 2
345,000
$745,000
• Share capital
• Retained earnings
Total equity
200,000
155,000 3
355,000
• Long-term borrowings
• Future income taxes payable
Total non-current liabilities
200,000
3,000 4
203,000
Current liabilities
• Trade and other payables
• Short-term borrowings
• Accrued expenses
• Current portion of long-term debt
• Current income taxes payable
Total current liabilities
Total equity and liabilities
100,000
50,000
15,000
20,000
2,000 5
187,000
$745,000
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20. Taxation, Depreciation and Capital Cost Allowance
Corporate tax rate (varies from province to province)
Taxation for small businesses (if taxable profit is less than they benefit from a small business deduction)
Business expenses and deductions
• Operating expenses (i.e., cost of sales, operating
expenses)
• Financing costs (interest on debt)
• Business losses (carried over in future years)
• Capital cost allowance (Canada
Revenue Agency)
$400,000
25%
Depreciation
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21. Depreciation (non-current assets) Amortization (intangible assets)
A $100,000 asset with a 5-year life span.
Revenue $ 200,000
Expenses
Depreciation
Other expenses ,000
Total expenses ,000
Profit before taxes ,000
Income tax expense ,000
Profit for the year ,000
20,000
Add back depreciation ,000
Cash flow $ 30,000
• It is an accounting entry.
• It represents the loss in value of an asset
due to wear and tear.
• The cost of the asset is spread against
revenue; it is more realistic.
• It is sometimes referred to as “reserve
for depreciation” (accumulated).
Goodwill
Patents
Franchise
Trademarks
Legal and architectural fees
Research and development
Amortization (intangible assets)
These costs can also be capitalized and amortized over a period of time (years) just like amortization for capital assets.
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22. CCA and Depreciation CCA @ 50% Depreciation Declining Straight line
1 50% $25,000* $ 20,000
2 50% $37, ,000
3 50% $18, ,000
4 50% $ 9, ,000
5 50% $ 4, ,000
* Income tax regulations allow only half of
the CCA rate during the first year.
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23. Income Statement and P&L Statement
Year 1
Accountant’s worksheet
$300,000
150,000
50,000
75,000
40,000
$35,000
$300,000
150,000
50,000
70,000
80,000
40,000
$40,000
Statement of income
P & L statement
Revenue
Cost of sales
Gross profit
Operating expenses
CCA/Depreciation
Total expenses
Profit before taxes
Taxes - Current (50%)
Future
Profit for the year
$300,000
150,000
50,000
70,000
80,000
40,000
$40,000
25,000
20,000
20,000
37,500
2,500
37,500
2,500
40,000
*The company paid $2,500 less in taxes due to higher CCA rate. Therefore, the company owes this amount to the government in the form of future income taxes payable (it’s like an interest free loan).
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24. Future Income Taxes Payable (Deferred Taxes)
Difference in annual future income 50%
Difference in cumulative future income taxes
20%
Difference between CCA & depreciation
50%
Years
$25,000 $ 20,000 $ 5,000 $ 2, $ 2,500
$37,500 $ 20,000 $17,500 $ 8, $ 11,250
$18,750 $ 20, $ 1, $ $ 10,625
$ 9,375 $ 20, $ 10, $ 5, $ 5,313
$ 4,687 $ 20, $ 15, $ 7,
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25. The Auditor’s Report
Canadian corporate law requires that every limited company appoint an auditor to represent shareholders and report to them annually on the company’s financial statements, expressing an opinion in writing as to their:
fairness, and
consistency.
In Canada, the auditor’s report conventionally has two paragraphs:
1. Scope of the examination (accounting procedures in use and tests
of the accounting records);
2. Auditor’s opinion on the statements indicating that the financial
statements present fairly the financial position of the company in
accordance with Generally Accepted Accounting Principles (GAAP)
applied on a basis consistent with that of the preceding year.
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26. Accounting for Inflation and Changing Values
Need
Question the validity of traditional accounting practices.
Do financial statements prepared according to traditional accounting principles present fairly the financial position of a company in periods of inflation?
Suggested Solutions
Price level accounting
Restating all figures in financial statements in terms of current purchasing power.
Current value accounting
What it would currently cost to acquire an asset with the same capability or capacity as the one presently owned.
Current Canadian Practice
In 1982, the recommendations call for Canadian enterprises whose securities are traded in a public market to disclose in their annual reports supplementary information on the effect of changing prices.
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27. 4. Financial Analysis Horizontal analysis Vertical analysis
Statement of cash flows
Ratio analysis
Break-even analysis
Leverage analysis
Risk analysis
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28. 5. Decision-Making Financing decisions Working capital decisions
Capital budgeting decisions
Growth decisions
Capital structure decisions
Lease or buy decisions
Pricing decisions
Operating budgeting decisions
Valuation decisions
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29. 6. Financial Statements – GAAP versus IFRS
Statement of Income and Statement of Comprehensive Income
Income Statement
Sales revenue
Cost of sales
Gross profit
Operating expenses
Selling expenses
Administrative expenses
Total operating expenses
Operating income (EBIT)
Other income
Other expenses
Extraordinary expenses
Income before taxes
Income taxes
Net income
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Administrative expenses
Finance costs
Total
Profit before taxes
Income tax expense
Profit for the year
Total other comprehensive income/(loss) for the year
Total comprehensive income 1 2 3 4

30. Financial Statements – GAAP versus IFRS
Balance Sheet
Statement of Financial Position
Assets
Current assets
Capital assets
Intangible assets
Total assets
Liabilities
Current liabilities
Long-term debts
Total liabilities
Shareholders’ equity
Total liabilities and equity
Assets
Non-current assets
Intangible assets
Current assets
Total assets
Equity
Liabilities
Non-current liabilities
Current liabilities
Total liabilities
Total equity and liabilities

31. Financial Statements – GAAP versus IFRS
Statement of Changes in Equity
Statement of Changes in Equity
Share capital
• Preferred shares
• Common shares
• Contributed surplus
• Retained earnings
Total shareholders’ equity
Share capital
• Preferred shares
• Common shares
• Contributed surplus
• Retained earnings
• Total other comprehensive
income/(loss) for the year
Total shareholders’ equity

32. 7. Not-For-Profit Organizations
Statement of Operations
Revenue
Less expenses
Equals excess of revenues over expenses
Statement of Changes in Net Assets
Excess (deficiency) or revenue over expenses and net change in investment in capital assets
Statement of Financial Position
Assets minus liabilities equals net assets
Statement of Cash Flows
Operating activities
Financing and investing activities
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