" Annual report: the main method that management uses to report the results of the company s activities during the year.

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1 Chapter 1 Overview of Corporate Financial Reporting What is Business? " Business plan to profit from selling a product or service. " Can be an individual or thousands of owners (investors). What is Accounting? " Accounting is an information system in which the underlying economic conditions of organizations and of individuals are recorded, summarized, reported, and understood. " Financial statements: management s reports to the companies owners that summarize how the company performed during a particular period. Also tells users what the company owns, to whom it has obligations (debts), and what is left over after the obligations are satisfied (paid). " Annual report: the main method that management uses to report the results of the company s activities during the year. " In January 1 st, 2011, Canada changed the underlying standards that are used to collect, record, and report accounting information. From Canadian standards to international financial reporting standards (IFRS). Forms of Organization " Profit-seeking entities such as corporations; governing organizations " Service entities such as hospitals and academic institutions " Not-for-profit entities such as charities " We will be concentrating on profit-seeking entities. " Other forms of business include sole proprietorships, partnerships, limited partnerships, and Crown corporations. " In all business organizations, the owners make the initial investment by contributing either cash or property or both. " In sole proprietorships and partnerships, this ownership interest is called the owner s or partners capital. " In a corporation, owners (aka shareholders or stockholders) make similar investment, but their ownership interest is called shareholders capital represented by documents known as shares. Shares are easily transferred between investors

2 Large number of individuals or entities and that are traded on a public stock exchange are called publicly traded corporations. Corporations whos shares are held by a small number of individuals are sometimes called privately held corporations. Shareholders elect board of directors who hires or fires the management. User of Financial Statements " Internal Users Management and the Board of Directors " Use accounting data to make many decisions, such as pricing products, expanding operations, deciding whether to buy or lease equipment, and controlling costs. " They also use other financial data found in managerial accounting. " External Users Shareholders and Potential Investors " Need information that makes it possible to assess how well management has been running the company. " Make decisions about buying more shares are selling some or all of the shares they already own. " Analyze the current share price and compare it with the original price that they paid for the shares. " Consider whether the people currently sitting on the board of directors are doing an adequate job of overseeing the management team they have selected. Creditors " First group: those who sell goods and services to the company and are willing to wait a short period of time for payment, i.e. suppliers, employees. " Second group: financial institution, such as banks, that have loaned money to the company.

3 " Third group: investors who have purchased longterm debt instruments such as corporate bonds from the company. Regulators " Government has regulations for how a business becomes incorporated and for its conduct after incorporation. Taxing Authorities " Parliament, the federal taxing authority in Canada has established the Canada Revenue Agency (CRA) as its collection agency. Other Users " Other companies, security analysts, credit-rating agencies, labour unions, and journalists. Development of Accounting Standards " For Canada, the International Accounting Standards Board (IASB) sets accounting recommendations and standards. These accounting recommendation and standards are in the Canadian Institute of Chartered Accountants (CICA) Handbook and have the force of law in Canada, as they are recognized in both federal and provincial statutes that regulate business corporations. " For United States, the Financial Accounting Standards Board (FASB) sets accounting standards for American corporations. " Qualitative Characteristics and Constraints of Accounting Information Qualitative Characteristics " Understandability " Relevance predictive value or confirmatory value " Reliability faithful representation, substance over form, neutrality, prudence, completeness " Comparability Constraints " Timeliness " Balance between benefits and cost " Balance between qualitative characteristics

4 Business Activities " Financing Activities Financing refers to the activity of obtaining funds (cash) in order to buy major assets, such as the buildings and equipment that almost every business uses. Funds are obtained from two primary sources outside the company: creditors and investors. Creditors expect to be repaid on a timely basis and often charge the business, in form of interest. For the use of their money, goods, or services. Investors invest in the company in the hope that their investment will generate a profit. They earn profits either by receiving dividends (payments of funds from the company to the shareholders) or by selling their shares to another investor. Retained earnings: internal source of new funds for any company is the profit it makes that is not paid out to shareholders in dividends. Typical financing activities: borrowing money, repaying loans, issuing shares, repurchasing shares, paying dividends on shares " Investing Activities Typical investing activities: purchase or sale of property, plant, and equipment; purchase or sale of the shares of other companies " Operating Activities Typical operating activities: sales to customers, collections of amounts owed by customers, purchases of inventory, payments of amounts owed to suppliers, payments of expenses such as wages, rent, and interest, payment of taxes owed to the government. Annual Report " Corporate Profile Describes the company s business activities during the year. Important to understand what kind of business the company is running to know the risks of investing. " Message to Shareholders

5 Senior executive Brief overview of past events that have affected the company and provides some insights in the company s future plans. " Management Discussion and Analysis Required of all publicly traded companies in Canada and the United States. Provides an overview of the previous year, a discussion of the risks facing the company, and some information about future plans. Includes information about significant events and about sales, profits, and cash flow during the year. Focuses on the financial aspects of the business, including pricing, strategies, expenses, earnings, liquidity, environmental and corporate social responsibility, expansion and future development, taxes, events after the end of the current year, and executive compensation policies. " Board of Directors and Management List of company s board of directors " Financial Section Components of the financial section: statement of management s responsibility, auditor s report, financial statements: statement of comprehensive income, statement of financial position, statement of changes in equity, statement of cash flows, notes to the financial statements, statement on corporate governance. STATEMENT OF COMPREHENSIVE INCOME " AKA income statement, the statement of earnings or statement of profit or loss. " Describes the results of the operating activities from the beginning to the end of the current period. " The results of those activities add up to the net earnings (net income or net profit/loss), defined as income less expenses. Income is money or resources that flow into the company as a result of such ordinary activities as sales (aka revenues) and from gains (selling items for more than their original cost). Expenses are money or resources that flow out of the company to enable the inflow of

6 income, such as the cost of the goods that are sold in sale transactions. l Depreciation: recognizing that only a portion of the machine as an expense. " Report of the company s operating performance during the year; it measures the inflow of revenues and the outflow of expense. (sometimes called flow statement) " Revenue: broken into different types to forecast how the company is doing. " Expenses: Cost of goods sold (or cost of sales, or cost of merchandise sold), selling expenses (or operating expenses), and administrative expenses. Tax is also an expense. Earnings per share is the company s net income divided by the average number of common shares that are outstanding during the year. STATEMENT OF FINANCIAL POSITION l AKA Balance sheet " Canadian balance sheets will list current assets first. " Canadian balance sheets will list current liabilities, then long-term liabilities, then equity. " Assets: something of value that the company either owns or has the right to use. (a present economic resource to which the entity has a right or other access that others do not have). # Liquid funds: Cash, short term investments, accounts receivable, other receivables, prepaid expenses, and stock-in-trade (often called inventories) # Deferred tax receivables, long-term receivables # Buildings and land, equipment, tools, fixtures and fittings (often called fixed assets) # Brands, customer relationships, leasehold rights and goodwill (often called intangible assets) " Classified balance sheet will specify whether assets and liabilities are current or non-current. " Liquidity: how quickly the company can turn the asset into cash or will use the cash to settle (pay)

7 an outstanding liability. Non-current assets are the least liquid because they will be used over a long time period and will not be quickly turned into cash. " Liabilities: amounts that the company owes to others. (page 29) " Shareholders Equity: note the listings for share capital, reserves, retained earnings, and profit for the year. " Basic accounting equation: ASSETS = LIABILITIES + EQUITY " Net assets ( assets value less the liabilities) " Market value: the price at which the shares trade in the stock market. This value can be very different from book value of shareholders equity because accounting records are not necessarily based on market values or expectations. " The higher the proportion of debt to equity, the greater the financial risk facing the company. (no expanding, and using shareholders equity to finance their activities) " Shareholders equity is usually composed of at least two accounts: share capital and retained earnings. # Share capital: aka capital stock, records the amount that the investors originally paid (invested) for the shares that the company issued. # Retained earnings: keeps track of the company s earnings less any amounts that the company pays to the shareholders in dividends. STATEMENT OF CASH FLOWS " Cash flow statement: measures the inflows and outflows of cash during a specific time period.