CHAPTER 12: CORPORATIONS AND THEIR FINANCIAL STATEMENTS

CHAPTER 12: CORPORATIONS AND THEIR FINANCIAL STATEMENTS Chapter Overview A. There are five financial statements used by investors to gauge and compare corporate performance: (1) The balance sheet, which shows assets, liabilities, and net worth as of its date. (2) The earnings statement, which shows annual revenues and expenses. (3) The retained-earnings statement, which shows profits accruing in the business. (4) The cash-flow statement, which shows how cash was earned and spent over the course of a year. (5) The annual report, which, in its footnotes, shows details that reveal certain activities of the company that may not be readily apparent through the financial statements. Topic One: The Balance Sheet 1. Overview A. The balance sheet is a snapshot that, in two columns, shows, as of its date: (1) What the company owns (assets). (2) What the company owes (liabilities). (3) Assets minus liabilities (the shareholders' equity or net worth). (a) Shareholder equity is called the book value of the company. It may be more or less than the market value of the shareholders interest. 183

CSC Volume I Study Notes (4) In order for one column to equal the other (i.e., to balance), shareholder equity is added to liabilities, as shown in the balancesheet formula: Total assets = total liabilities + shareholders equity (a) A very simple schematic balance sheet would show: Assets $1,000,000 Liabilities $ 700,000 Shareholders equity 300,000 $1,000,000 $1,000,000 Note: The fictional financial statements in the following pages correspond to the explanations after the statements, starting on page 195. We suggest you remove the statements from this book and then use them side-by-side with the explanations. 184

Chapter 12: Corporations and their Financial Statements Consolidated Balance Sheet of DOA Industries ($000s) as at December 31, 201X ASSETS Current Assets 1 Cash and balances $650 2 Temporary investments 1,500 3 Accounts receivable 875 4 Prepaid expenses 675 5 Income taxes recoverable 440 6 Inventory (merchandise) 6,450 LIABILITIES Current Liabilities 18 Bank advances $1,125 19 Accounts payable 1,965 20 Dividends payable 55 21 Income taxes payable 385 22 Bonds due in one year 875 23 Accrued liabilities 265 7 Total Current Assets 10,590 24 Total Current Liabilities 4,670 8 Miscellaneous Assets Investment in affiliated company 1,875 25 Future Income Taxes 675 26 Non-controlling Interest in Subsidiaries 525 9 Capital Assets 27 Long Term Debt 10 Land 2,225 8% callable debenture due 11 Buildings 3,550 Jan. 31, 2015 5,225 12 Equipment 10,750 Total 16,525 Total Liabilities 11,095 13 Accumulated depreciation (6,650) SHAREHOLDER EQUITY Net value of capital assets 9,875 28 Capital Stock 10% Cum Red. Pfd. ($25 p.v.) 14 Deferred Charges 375 outstanding 50,000 shares 1,250 15 Intangible Assets 29 Common Stock (Authorized 1,500,000; 16 Goodwill 725 outstanding 975,000 shares) 4,875 30 Retained Earnings 4,765 31 Contributed Surplus 685 32 Translation Adjustment 770 33 Total Shareholder Equity 12,345 17 TOTAL ASSETS 23,440 34 TOTAL LIABILITIES and SHAREHOLDER EQUITY 23,440 185

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Chapter 12: Corporations and their Financial Statements Consolidated Earnings Statement of DOA Industries ($000s) as at December 31, 201X OPERATING SECTION 35 Net sales $25,300 36 Cost of goods sold (18,950) 37 Operating income (or gross operating profit) 6,350 38 Depreciation (1,875) 39 General expenses (82) 40 Director s remunerations (375) 41 Net operating profit 4,018 42 Non-Operating Section Income from investments 465 43 Total (Earnings Before Interest and Taxes) 4,483 CREDITORS SECTION 44 Bank interest (1,587) 45 Bond interest (418) 46 Net Income Before Taxes (NIBT) 2,478 OWNERS SECTION Income taxes 47 Current (975) 48 Future (447) 49 Non-controlling (127) 50 Equity income 968 51 Total Net Income Before Extraordinary Items (NEBEI) 1,897 52 Extraordinary items (net of taxes) 221 53 Net Earnings (Deficit) after Extraordinary Items (Net Income) $2,118 187

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Chapter 12: Corporations and their Financial Statements Consolidated Statement of Retained Earnings of DOA Industries ($000s) as at December 31, 201X 54 Balance at beginning of the year $4,189 55 Net income for the year (after extraordinary items) 2,118 56 Dividends $6,307 56a Preferred shares (10% of par value) (125) 56b Common shares ($0.56 per share) (546) 56c Special dividend on common shares (871) 57 Total Retained Earnings $4,765 189

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Chapter 12: Corporations and their Financial Statements Consolidated Statement of Cash Flows of DOA Industries ($000s) as at December 31, 201X 58 Operating Activities 59 Earnings before extraordinary items $1,897 60 Add items not involving cash depreciation 1,875 61 Future Income Taxes 447 62 Non-controlling interest in income of subsidiary 127 companies 63 Equity income affiliated company (968) 64 Net change in operating working capital items (1,480) Cash Flows from Operating Activities 1,898 Financing Activities 65 Proceeds from share issue 0 66 Repayment of long-term debt (875) 67 Borrowing of long-term debt 0 68 Dividends paid (1,542) Cash Flows from Financing Activities (2,417) Investing Activities 69 Acquisition of capital assets (150) 70 Proceeds from disposal of capital assets 221 71 Dividends received from affiliated company 838 Cash Flows from Investing Activities 909 72 Increase in Cash and Temporary Investments 390 73 Cash and Temporary Investments 1,760 beginning of year 74 Cash and Temporary Investments end of year 2,150 Supplemental Information 75 Interest Paid 2,005 76 Income Tax Paid 975 191

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Chapter 12: Corporations and their Financial Statements 2. Classification of Assets on the Balance Sheet A. Assets are categorized as: (1) Current assets (a) Current assets are assets that can be converted into cash in one year or less. They indicate the ability of the company to pay daily operating expenses. i. Current assets appear on the balance sheet in descending order of liquidity, with cash, of course, being most liquid, and followed by: - Temporary investments - Accounts receivable - Prepaid expenses - Income taxes recoverable - Inventory (2) Miscellaneous assets (3) Capital assets (4) Deferred charges (5) Intangible assets (6) Goodwill B. Amortization is a portion of the value of an asset written off against earnings each year. It is similar to depreciation. For example, as equipment wears out, its loss in value is amortized. (Amortization of capital assets is not shown on the DOA statements.) C. Depletion sees a portion of the value of a depleting or reducing asset written off against earnings during each year of the asset s predetermined life. Depletion recognizes how extractive industries such as mining lose their asset base over time; accordingly the assets are called wasting assets. (1) The amount recorded as depreciation each year depends on the method of depreciation used: (a) The straight-line method: where an equal amount of depreciation is charged to each period against the original costs. i. For example: Equipment is bought for $55,000. It will have a useful life of five years and a salvage value of $5,000. 193

CSC Volume I Study Notes Under the straight-line method, the annual charge is [$55,000 $5,000] 5 = $10,000. Thus, $10,000 will be deducted annually as a depreciation charge. (b) The declining balance method where a fixed percentage is charged against the declining balance. i. For example: The same equipment is bought for $55,000. It will have a useful life of five years and a salvage value of $5,000. Under the declining-balance method, the depreciation rate is 100% 5 = 20% x 2 = 40%. Thus, 40% of the value of the equipment will be deducted annually as a depreciation charge. Straight-Line vs. Declining-Balance Depreciation Over a Period of 5 Years Fiscal Year End Straight-Line Depreciation Charge Book Value 1. $10,000 $45,000 ($55,000 $10,000) 2. $10,000 $35,000 ($45,000 $10,000) 3. $10,000 $25,000 ($35,000 $10,000) 4. $10,000 $15,000 ($25,000 $10,000) 5. $10,000 $5,000 ($15,000 $10,000) Declining Balance Depreciation Charge $22,000 ($55,000 x 0.4) $13,200 ($33,000 x 0.4) $7,920 ($19,800 x0.4) $4,752 ($11,880 x0.4) $2,851 ($7,128 x0.4) Book Value $33,000 ($55,000 $22,000) $19,800 ($33,000 $13,200) $11,880 ($19,800 $7,920) $7,128 ($11,880 $4,752) $4,277 ($7,128 $2,851) (c) It is possible for a company to add substantially to its cash and show little or no earnings if it has substantial depreciation charges. (d) Amortization and depletion are non-cash uses of funds. D. The item numbers in the column on the left in the following table correspond to the superscript numbers of assets on the DOA balance sheet. 194

Chapter 12: Corporations and their Financial Statements Item Explanation no. 1 Cash available. 2 Stocks and bonds that can be easily sold for cash. 3 Accounts receivable: money due to the company for goods or services provided, less allowance for doubtful accounts (e.g., the estimated amount that is unlikely to be collected from customers who fail to pay their bills). 4 Prepaid expenses: claims for services that have been paid but for which the benefit has not been fully received (e.g., car insurance, rent that has been paid in advance). 5 Income taxes recoverable: government tax refunds. 6 Inventories or goods in stock: items used to provide the product or service. Three different calculations can be used to value inventories: - Average cost values all inventory on an individual basis and averages the total. - FIFO (first-in-first-out). Inventory is valued from oldest to newest. Oldest inventory is used first, because these costs are lower (due to increasing prices). Company profits will accordingly be higher. - LIFO (last-in-first-out). Inventory is valued from newest to oldest and the newest inventory is used first. The higher cost of this inventory is reflected in lower company profits. 7 The total of all current assets. 8 Miscellaneous Assets These assets do not fall within the other categories of assets. For example, they can include: - Cash surrender value of life insurance. - Funds due from directors, officers, employees, etc. - Long-term investments. - Investments or advances to subsidiary and affiliated companies. DOA Industries has invested $1,875,000 in another company. This appears as a miscellaneous asset on the balance sheet and on the earnings statement under the heading of Equity Income. 9 Capital Assets (property, plant, and equipment) Capital assets are used to produce goods and services for sale; they include land, buildings, and machinery. Except for land, capital assets are depreciated (amortized) each year. See notes on depreciation/amortization below. Capital assets are shown on the balance sheet at original cost less accumulated depreciation; this is called their net book value or net carrying amount. 195

CSC Volume I Study Notes 10 Land 11 Buildings 12 Machinery, tools, and equipment. 13 On the balance sheet, one figure shows the accumulated balances for all depreciation and depletion, and it is deducted from the capital assets. The notes to the financial statements provide the proper breakdown. 3. Capitalized Charges (Not Shown on DOA Statements) A. Capitalized charges record expenditures such as leases or interest costs as assets rather than expenses, in order to spread an expense over more than one accounting period. B. A capitalized lease is a lease that finances the acquisition of an asset is considered an asset that is recorded at fair market value. The lessee assumes liability for the asset as if it had been purchased outright. (1) The liability is recorded as the present value of future lease payments. (2) The leased item is recorded at its net carrying amount (cost less accumulated amortization) on the asset side of the balance sheet. Its cost is a liability, recorded as the present value of future lease payments. C. Capitalized interest is recorded by some companies (particularly those active in exploration or construction) capitalize interest costs to align expenses, such as interest costs, with revenues. (1) The cost of interest is either added to the cost of the asset, and then expensed in subsequent periods once the asset commences operation, or it is deferred (see item 14 below). 14 Deferred Charges (2) Deferred charges represent payments a company makes for which benefits will extend over a period of years. (3) Example of a deferred charge: An exploration company discovers a silver mine worth $20 million that has a life expectancy of 20 years. The cost of discovering and putting the mine into operation (e.g., prospecting, land filing charges, etc.) are $1 million. The $1 million is not expensed in one year but is amortized over the 196

Chapter 12: Corporations and their Financial Statements life of the asset, in this case, 20 years. (4) The value of deferred assets appears as an asset on the balance sheet. (5) Another example of a deferred charge: the expenses incurred when issuing a bond that is not going to be repaid until 15 years after issue. The expenses incurred for issuing the bond (e.g., prospectus, legal, and filing fees) are amortized over the life of the bond. Coupons are a liability. 15 Intangible Assets Intangible assets (also called miscellaneous assets or other assets) include patents, 16 Goodwill 17 Total Assets copyrights, and leaseholds. They are recorded at fair value or at an amortized value. Intangible assets contribute, or can contribute, to the earning power of a company, but are not assets that can be easily valued. Intangible assets with a specified lifetime (e.g., a copyright for 50 years) are amortized over that period. Intangible assets with perpetual value (e.g., a patent) are recorded at fair value, but this may be reduced if it appears their value is no longer accurate. Goodwill represents the positive relationship between a company and its customers or the value of the management team to a buyer of the company. Goodwill is shown on combined balance sheets as an excess of the amount paid for shares over their net asset value. Example of goodwill: $2 million was paid over and above the book value of a clothing store because of its prime location. The $2 million would be listed as goodwill and written off over a period of time. The value of goodwill and intangible assets should be proven annually. The total of all assets of the company. 4. Classification of Liabilities A. Liabilities are categorized as: (1) Current liabilities that must be repaid within one year. They include: (a) (b) (c) (d) (e) Bank advances. Accounts payable. Dividends owed. Income taxes owed. First mortgage bonds. (2) Future income taxes. (3) Non-controlling interest in subsidiaries. 197

CSC Volume I Study Notes (4) Long-term debt. B. In volume 2 of this course you will learn about the financial ratios that are used as indicators of the financial health of a company. (1) One of the basic financial ratios is the debt/equity ratio (total debt total assets = the debt ratio) that shows whether debt exceeds assets. (2) Debt is not the same as liabilities, and this distinction is important in order for the ratio to be completed correctly. (3) Debt is money borrowed that must be repaid, such as a bond. Liabilities are money owed, such as for services rendered. C. The item numbers in the column on the left in the following table correspond to the superscript numbers on the DOA balance sheet. Item No. Current Liabilities 18 Bank advances (short-term loans) 19 Accounts payable (unpaid bills) 20 Dividends declared but not paid 21 Tax liabilities can be one of the largest items on the balance sheet. 22 The principal on bonds and debentures due within one year 23 Other current accrued liabilities, which can include salaries payable, bank or bond interest payable, pension payments, property taxes, etc. 24 Total Current Liabilities The total of all current liabilities. 25 Future Income Taxes This figure represents the difference between the book value of an asset or liability and its value for tax purposes. This difference arises because the amortization of its capital assets is calculated according to the Canadian Institute of Chartered Accounts guidelines and according to the rules pertaining to capital cost allowances by income-tax regulations. 26 Non-controlling Interest in Subsidiary Companies (Minority Interest) When a company owns more than 50% of a subsidiary company, its financial statements will be consolidated, with 100% of the assets and liabilities for the parent and subsidiaries combined into one statement. The portion that is not owned by the parent is known as a non-controlling interest. 198

Chapter 12: Corporations and their Financial Statements The non-controlling interest on the DOA Balance Sheet is $525,000. This means that, if DOA paid 72% for another company valued at $1,875,000, the portion it did not own would be 28% or $525,000. D. Other Liabilities (not shown on DOA Statements) may include: (1) Provisions for predicted future expenses (e.g., from a pending lawsuit). (2) Deferred revenue, when payment is received for goods and services that have not been provided. (a) Example: A customer pays a lump sum to a landscaper in December for services to be provided monthly until the following November. The lump sum is recorded as income on the earnings statement. As services are provided each month, the deferred revenue of the landscaper is reduced. (b) In theory, deferred income is reduced as the goods and services are provided; however, in reality, the liability is usually reduced annually. 27 Long-term Debt Long-term debt is the debt of a company that is due, usually in instalments, over a period of years or as a future lump-sum payment. Whatever portion of the long-term debt that is due within one year is classified as current debt. Long-term debt includes: Mortgages. Bonds and debentures. Details of the debt, including collateral, interest rate, maturity date and sinking-fund provisions, must be provided. E. Shareholders' Equity (1) This is the amount shareholders have at risk. (2) The following chart shows what constitutes shareholder equity. 28-29 Share Capital Share capital (item 28) and common shares (item 29) is the amount of money paid for shares when they were issued (i.e., the permanent capital of the company). 199

CSC Volume I Study Notes Its value is not related to the current market price of the outstanding shares. It does not change unless new shares are issued or shares are bought back. 30 Retained Earnings The retained earnings are the profits available for reinvestment after expenses including dividends have been paid. If the company has a loss in a given year, it is deducted from the retained earnings. 31 Contributed Surplus Contributed surplus comes from sources that are not earnings (e.g., selling stock above the par value of the shares. If a stock is sold for $5 more than its par value, the par value goes into the capital stock account and the $5 goes into the contributed surplus account. 32 Foreign Currency Translation Adjustment These are adjustments due to exchange rate fluctuations that appear on the consolidated financial statements of a parent company that owns a foreign subsidiary. 33 Total Shareholders Equity This is the total of items 28 to 32. 34 Total Liabilities and Shareholders Equity Remember: Key Equation of the Balance Sheet: Total assets = total liabilities + shareholders equity Topic Two: The Earnings Statement 1. Overview. A. Also called the Income Statement or Profit and Loss Statement. B. It is differentiated from the Balance Sheet because it shows revenues and expenses over the course of a year. C. The earnings statement shows the company s earning power and cash flow, and therefore, the company s strength and stability. D. Net earnings are earnings (profit) after taxes from which dividends may 200

Chapter 12: Corporations and their Financial Statements be paid to the shareholders. 2. Structure of the Earnings Statement. A. There are four broad sections to the statement: (1) Operating section: Operating income is the income a company receives for selling its core products or services. (2) Non-operating section: Non-operating income is income that is not directly derived from normal operations. Examples include interest from investments or royalties from a patent. (3) Creditors section: This section outlines what a company pays as interest owed to its creditors. (4) Owners section: This section shows how a company distributes its income to its shareholders. B. The names of these four sections would not normally appear on the earnings statement. 201

CSC Volume I Study Notes THE EARNINGS STATEMENT Item no. Explanation Operating Section The operating section can include: 35 Operating income received: net sales (or net revenue) is gross sales less deductions (e.g., excise tax, returns, discounts). The net sales figure is a key indicator of a company s financial position. 36 Expenses incurred to obtain income: cost of goods sold is manufacturing cost or inventory cost. 37 Gross operating profit is: net sales less cost of goods sold. This figure can be used to compare success at producing profits among companies in the same field. Gross operating profit margin is a percentage of net sales. The GP of DOA Industries is $6,350,000. The margin is 25.1% ($6,350 $25,300 [net sales] x 100%). 3. Operating Expenses. A. Once gross operating profit is known, the following operating expenses are deducted. Many companies call these their overhead costs. 38 Depreciation, amortization, and depletion for the year. Remember, these items are non-cash items, (i.e., no cash actually left the company to pay these expenses). 39 Selling, general, and administrative expenses (e.g., office expense, commissions) 40 Contributions to employee s pensions, legal fees, directors remuneration, etc. 41 Net operating Profit (or Loss) Gross profit operating expenses = net operating profit.. 42 Non-Operating Section Income received that is not directly related to the main operation of company (e.g., rent, interest, investments, etc.). Keeping operating and non-operating income separate on the earnings statement gives a truer picture of the earning power of a company. For example, if DOA was in the business of selling shoes and had an office building in which it rented out excess space, the rents received would not be part of their normal operations but would still be considered part of their income for the business. 202

Chapter 12: Corporations and their Financial Statements This item is excluded from sales when calculating ratios for comparison. 43 Total Operating + non-operating income = earnings before interest and taxes or EBIT. The EBIT for DOA Industries is $4,483,000. The net operating income margin is 17.72% ($4,483 $25,300 [net sales] x 100%). Creditors Section Often referred to as fixed charges because the amount of interest that must be paid to debt holders is known and is a required payment. The creditors section includes: 44 Interest paid to the bank (e.g., for a line of credit). 45 Interest paid to bond holders. 46 Total net income less fixed charges is the net income before taxes or NIBT. Owners Section A company s shareholders are its owners. 47 The current portion of income taxes on the statement is that amount that must be submitted to the CRA. 48 The future portion of income taxes is the difference between taxes owed and submitted due to accounting rules. 49 Non-controlling As explained earlier, the non-controlling interest appears on the financial statements of the investing company (i.e., the parent) and represents that portion of the consolidated assets or earnings of the subsidiary that is not owned by the parent. 50 Equity Income Equity income (sometimes called equity earnings or earnings from subsidiaries) calculated by the equity accounting method is shown when the parent company owns between 20% and 50% of the subsidiary and each company produces its own financial statements. The cost method for calculating equity income is used when ownership is less than 20%. The value of the ownership (including equity income that accumulated over the years and is retained in the subsidiary company) will be realized if and when the subsidiary is sold. Equity income is a non-cash source of funds and is deducted when calculating some ratios. An equity loss is incurred if a subsidiary reports a loss. 51 Net Income Before Extraordinary Items (Also called NIBEI) For DOA Industries, the amount is $1,897,000 and the net profit margin is 7.5% ($1,897 $25,300 [net sales] x 100%). 203

CSC Volume I Study Notes 52 Extraordinary Items (Gains or Losses) These are gains or losses that are not part of the normal business operations and are not expected to recur with any frequency (e.g., losses because of an earthquake). Due to their ability to distort earnings or losses, they are stated on the earnings statement after all other revenue and expense items have been accounted for. 53 Net Earnings (Deficit) After Extraordinary Items The amount of income available for transfer as retained earnings and distribution via dividends. Topic Three: The Retained Earnings Statements 1. Overview. A. The retained earnings sheet shows the profits that have not been paid to shareholders as dividends but rather have been left in the business year after year. B. A reserve represents funds not available for distribution to shareholders. C. The retained earnings statement is the link between the earnings statement and balance sheet: the profit/loss for the year, as indicated on the earnings statement is added to or subtracted from the retained earnings from previous years. This amount (less any reserve amount) is transferred to the shareholders equity section of the balance sheet. Item No. Explanation 54 Balance at the beginning of the fiscal year. At beginning of the year, the retained earnings were $4,189,000. This would have been shown on the balance sheet for the previous year in the common shareholder s equity section. 55 Net income for the fiscal year (after extraordinary items) The company made $2,118,000 in net income after extraordinary items. Even though they had an extraordinary item of $221,000, that money still belongs to the company. If the company had not paid any dividends this year, it would have retained earnings of $6,307,000 ($4,189,000 + $2,118,000). 204

Chapter 12: Corporations and their Financial Statements 56 Dividends The company did pay out a total of $1,542,000 in dividends to its preferred and common shareholders, leaving it with retained earnings of $4,765,000 ($6,307,000 - $1,542,000). This is the figure on the balance sheet in the common shareholders section. 57 Total Retained Earnings The amount of earnings left in the business year after year. Topic Four: The Cash Flow Statement 1. Overview A. The cash flow statement shows how a company produces cash and spends cash over a year. (1) Cash on a cash flow statement includes cash in bank accounts, net of short-term borrowing, and temporary investments. B. The cash flow statement indicates the financial position of the company: specifically its ability to pay any debts, generate funds internally, and distribute dividends to its shareholders. (1) It is a good tool for investors to compare the financial situation of a company over a number of years. Item No. Explanation 58-64 Operating Activities Everyday activities of the company that generate sales or expenses. Determined as income before extraordinary items + non-cash items such as future taxes, depreciation, and non-controlling interest) equity income The net change in operating working capital items (e.g., accounts receivables, inventories, accrued liability, etc.) are added or deducted. 65-68 Financing Activities These activities affect the capital structure of the company (i.e., the level of debt and equity it has on its balance sheet). The capital structure of a company shows how much debt (bonds and debentures) and equity (common and preferred shares) the company has outstanding. 205

CSC Volume I Study Notes Cash flows in to the company when shares are issued and cash flows out of the company when debt is repaid. 69-71 Investing Activities These costs are investments made in the company itself (i.e., capital assets) or in other companies (i.e., dividends received). DOA paid out $150,000 to purchase capital assets. This was in order to purchase fixed assets such as machinery needed to run their business. They also received $221,000 from the sale of capital assets. This could have been from the sale of stock it owned in other companies. 72-74 Change in Cash Flow At the end of the cash flow statement there is a summary of the cash flows of operating, investing, and financing activities. The summary shows the increase (or decrease) in cash for the fiscal year. Ideally, it shows a positive cash flow. If it does not, the reason for the negative cash flow must be determined. 75-76 Supplemental Information Income taxes and interest paid must be in the cash flow statement. Topic Five: The Annual Report 1. Footnotes to the Financial Statements. A. Notes to the financial statements explain essential information that cannot be easily summarized in the actual statements (e.g., accounting policies, more details about share capital, etc.) B. The footnotes often detail company information by operation and location. 2. The Auditor s Report. A. Canadian corporate law requires limited companies to have an auditor who represents shareholders and reports to them annually. B. The auditor s report outlines the responsibilities of management and the auditor, and how the audit was conducted and gives the auditor s opinion concerning the financial statements. 206

Chapter 12: Corporations and their Financial Statements 3. Accounting Standards A. Financial statements are prepared based on the Generally Accepted Accounting Principles (GAAP) which allows a company some flexibility in reflecting its particular type of operation. B. In 2011, the GAAP will be replaced with International Financial Reporting Standards (IFRS). C. The CSA, CICA, and OFSI have created the Canadian Public Accountability Board (CPAB) to review and examine the audit procedures of accounting firms to ensure the independence of auditors and the increased transparency of the audit procedure. 207