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The Purpose and Use of

Financial Statements
Chapter 1

Who uses accounting information?
• Accounting identifies and records the economic
events of an organization and communicates this
information to interested users.
• Two broad categories of users
 Internal
» Managers, employees, etc.

 External
» Investors, creditors, CRA, customers, etc.


Financial or Managerial?
• External users
• Rigid rules
• Historical perspective
• Aggregate information
• Quantitative

• Internal users
• Flexible format
• Future perspective
• Detailed information
• Quantitative and
qualitative information

Legal Forms of Businesses
• Sole proprietorship
 Owned by one person
• Partnership
 Owned by more than one person but not
• Corporation
 Separate legal entity having ownership held by
 May be a public or private corporation
 May be a for-profit or a not-for-profit

Types of Business Activities
• Financing
 Obtaining (and repaying) funds to finance the
operations of the business.
 Usually long-term liabilities or
shareholders’/owners’ equity are related to
financing (debt or equity).
• Investing
 Obtaining the resources or assets needed to
operate the business for the long term.
 Usually long-term assets (investments or
property, plant & equipment)
• Operating
 The main day-to-day activities of the business
 Usually current assets and current liabilities
(cash, AR, AP, etc)

Financial Statements
• Balance Sheet (also called Statement of Financial
 Assets, Liabilities and Shareholders’ Equity as at a
specific point in time.
• Income Statement (also called Statement of Earnings)
 Results of operations (revenue and expenses) for a
specific period of time.
• Statement of Cash Flows
 How a company obtained cash and how cash was
used for specific period of time.
• Statement of Retained Earnings (also called
Statement of Changes in Equity for IFRS companies)
 Changes in each component of equity for a specific
period of time.

Income Statement
• Revenues
 Arise from the sale of a product or service.
• Expenses
 Costs of assets consumed or services used to
generate revenues.
• Net earnings (loss) = Revenues minus expenses
• For a period of time
• Measures gains and losses


Statement of Retained Earnings
• Shows the changes in retained earnings for the
• Cumulative profit (earnings) retained in the
• Less dividends paid to shareholders


Statement of Changes in Equity
• For IFRS companies only.
• Shows the changes in each component of
shareholders’ equity for the period
• Share capital:
 Amounts contributed by shareholders
 May have common and preferred classes
• Retained earnings / deficit:
 Cumulative profit (earnings) retained in the
 Less dividends paid to shareholders

Balance Sheet
• Assets:
 Resources owned by a business
• Liabilities:
 Obligations of the business
• Shareholders’ equity:
 Share capital and retained earnings


Balance Sheet

• Assets= Liabilities + Owners’ Equity
• At a Point in Time

Statement of Cash Flows
• Details all cash inflows and outflows
• Operating Activities
 Transactions that create revenues and expenses.
• Investing Activities
 Acquiring the resources that are needed to run the
• Financing Activities
 Collecting the necessary funds to support the
• For a period of time
• Shows net increase or decrease in cash for the period

Other Annual Report Components
• Annual report
 Publicly traded companies must give their
shareholders an annual report each year.
 Contains financial and non-financial
information about the company.
• Footnotes
• Management discussion & analysis
• Independent auditors’ report


Generally Accepted
Accounting Principles (GAAP)
• Rules and practices for the preparation of
financial statements.
• Different for publicly-traded and private
 Publicly-traded corporations use International
Financial Reporting Standards (IFRS).
 Private corporations may use IFRS or
Accounting Standards for Private Enterprises
• Proprietorships and partnerships do not have to
use IFRS or ASPE as statements are prepared for
internal users only.

In class 1.1


In class 1.2