02 Bergeron7e PPT

PowerPoint
Presentations for
Finance for
Non-Financial Managers:
Seventh Edition
Prepared by
Pierre Bergeron
University of Ottawa
Copyright © 2014 Nelson Education Ltd. 2–1

CHAPTER 2
Accounting and
Financial Statements

Learning Objectives
1. Explain the activities related to bookkeeping.
2. Describe the accounting function and outline the four
financial statements.
3. Examine the contents and the structure of the
statement of income and the statement of
comprehensive income, the statement of changes in
equity, and the statement of financial position.
4. Understand the meaning of analysis in financial
management.
5. Discuss the importance of decision making in financial
management.
6. Analyze the contents and structure of financial
statements prepared for NFP organizations.

Financial Management includes
Bookkeeping
Accounting
Financial Statements

LO 1
Activities Related to 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
LO 1
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
Profit
Debits = Credits
LO 1
The Accounting Cycle
Business Business Activity is Activity is
recorded in transferred to
Transaction Document Journals Ledgers

takes place is prepared
Statement of Financial Position

1. Cash account 3. House
2. VISA 4. Car
Statement of Income
1. Salary 3. Rent
2. Food 4. Clothing

The Trial Balance (Warren Inc. Dec. 31, 2013) LO 1
Debit Credit
SFP
$25,000 ______
SI
$500,000 ______
SFP
20,000 ______
SI
10,000 ______
SI
300,000 ______
SFP
50,000 ______
SCE
135,000 ______
SFP
100,000 ______
SFP
15,000 ______
SI
50,000 ______
SI
25,000 ______
2,000 ______
SFP
SFP
3,000 ______
SFP
200,000 ______
SFP
200,000 ______
SFP
100,000 ______
SFP
20,000 ______
SI
50,000 ______
SFP
500,000 ______
SI
25,000 ______
SFP
100,000 ______
SCE
20,000 ______
SFP
200,000 ______
Total $ 1,325,000 $ 1,325,000

LO 1
Accrued Expenses
Represent a bill that the company still owes during the
current operating year (e.g., wages, rent, bonus,
federal, provincial, or municipal taxes).
December 24 December 31 January 7
An employee works for a

week without being paid
for $800
So, the company owes $800

(liability) to the employee when the
books are closed.

LO 1
Prepaid Expenses
Payments made on accounts for which services have
not yet been provided (e.g., rent, insurance, office
supplies, property taxes).
June 30 December 31 June 30
Pay $4,000 for insurance this

year and show $2,000 as an
expense…
…but, will also show in the closing

statement of financial position an
amount of $2,000 (asset) as a prepaid
expense.
LO 2
Accounting Function and 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.

LO 2
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.
LO 2
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.

LO 3
Financial Statements: Structure & Contents
Statement of Income Statement of Retained Earnings
Revenue Retained earnings (beginning) $900,000

Cost of sales Earnings for the year $100,000
Gross profit $ (20,000)
Less: dividends
Other income/expenses $ 80,000
Retained earnings (ending) $980,000
Profit for the year $100,000
Statement of Financial Position Statement of Cash Flows

• Sources of funds
Assets Equity $80,000
(Where they come from)
• Non- Liabilities $100,000 $25,000 $150,000
current $230,000 Profit CL LT
• Long-term $150,000 • Uses of funds
$25,000 (Where they went)
• Current $25,000 • Current $20,000 $230,000 $25,000
Div. NCA CA
Statement of Income (Operating Performance) LO 3
Revenue
Cost of sales
1 Gross profit
Other income
Distribution costs
Administrative expenses
Finance costs
Total other income and costs
2 Profit before taxes

Income tax expense
3
Profit for the year

LO 3
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
4 Total comprehensive income

LO 3
Warren’s Financial Statements
Warren Inc.
Statement of Income for the Period Ending December 31, 2013
Revenue $500,000
Cost of sales (300,000)
1 Gross profit 200,000
Distribution costs ($50,000)
(50,000)
Cash flow
Administrative expenses
Depreciation (25,000) $ 25,000
Total operating expenses (125,000) 40,000
Operating income (E B I T) 75,000 $ 65,000
Finance costs (10,000)
2 Profit before taxes $75,000
65,000
Income tax expense (25,000) 25,000
3 Profit for the year
$40,000 EBITDA $100,000

LO 3
Profit for the year $40,000
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 ---
4 Total comprehensive income $40,000

LO 3
Warren Inc.
Statement of Changes in Equity for the Period Ending December 31
2013 2012
Share capital
Balance at beginning of year $185,000 $180,000
• Common shares issued 15,000 5,000
• Dividend reinvestment and share purchase plan --- ---
• Share issued on exercise of stock options --- ---
Balance at end of year $200,000 $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 $135,000 $125,000
• Earnings for the year 40,000 20,000
• Dividends paid to shareholders (20,000) (10,000)
Balance at end of year $155,000 $135,000
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
Statement of Financial Position LO 3
(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

LO 3
Warren’s Inc.
Statement of Financial Position as at December 31, 2013
Non-current assets $500,000
1
• Accumulated depreciation (100,000) $400,000
Current assets
• Inventories 200,000
• Trade receivables 100,000
2 • Prepaid expenses 20,000
• Cash and cash equivalents 25,000
Total current assets 345,000
Total assets $745,000
• Share capital 200,000

3 • Retained earnings 155,000
Total equity 355,000
• Long-term borrowings 200,000

4 • Future income taxes payable 3,000
Total non-current liabilities 203,000
Current liabilities
• Trade and other payables 100,000
• Short-term borrowings 50,000
5 • Accrued expenses 15,000
• Current portion of long-term debt 20,000
• Current income taxes payable 2,000
Total current liabilities 187,000
Total equity and liabilities $745,000

LO 3
Taxation, Depreciation, and CCA
1. Corporate tax rate (varies from province to
province)
2. Taxation for small businesses (if taxable profit is
less than $400,000 they benefit from a 25%
small business deduction)
3. 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) Depreciation

LO 3
Depreciation
Depreciation (non-current assets)
A $100,000 asset with a 5-year life span.
Revenue $ 200,000
Expenses
Depreciation 20,000
Other expenses 160,000 • Is an accounting entry
Total expenses 180,000 • Represents the loss in value of an asset
Profit before taxes 20,000 due to wear and tear
Income tax expense 10,000 • Cost of the asset is spread against
Profit for the year 10,000 revenue; it is more realistic

Add back depreciation 20,000 • Sometimes referred to as “reserve
Cash flow $ 30,000 for depreciation” (accumulated)
• Goodwill Amortization (intangible assets)

• Patents
• Franchise
• Trademarks These costs can also be capitalized and
• Legal and architectural fees amortized over a period of time (years)
• Research and development just like depreciation for capital assets.

LO 3
CCA and Depreciation
CCA @ 50% Depreciation
Declining Straight line
1 $100,000 @ 50% $25,000* $
20,000
2 75,000 @ 50% $37,500 20,000
3 37,500 @ 50% $18,750 20,000
4 18,750 @ 50% $ 9,375 20,000
5 9,375 @ 50% $ 4,687 20,000

* Income tax regulations allow only half of
the CCA rate during the first year.

Income Statement and P&L Statement LO 3
Year 1 Accountant’s Statement of P&L

worksheet income statement
Revenue $300,000 $300,000 $300,000
Cost of sales 150,000 150,000 150,000
Gross profit 150,000 150,000 150,000
Operating expenses 50,000 50,000 50,000
CCA/Depreciation 25,000 20,000 20,000
Total expenses 75,000 70,000 70,000
Profit before taxes 75,000 80,000 80,000
Taxes - Current (50%) 37,500 37,500 40,000
Future 2,500 2,500
40,000 40,000 40,000
Profit for the year $35,000 $40,000 $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).
Future Income Taxes Payable
LO 3
(Deferred Taxes)
Difference in Difference in
Depreciation Difference annual future cumulative
CCA @ @ 20% between CCA income taxes @ future
Years 50% & depreciation 50% income taxes
1 $25,000 $ 20,000 $ 5,000 $ 2,500 $
2,500
2 $37,500 $ 20,000 $17,500 $ 8,750 $

11,250
3 $18,750 $ 20,000 - $ 1,250 -$ 625 $

10,625
4 $ 9,375 $ 20,000 - $ 10,625 - $ 5,312 $ 5,313
5 $ 4,687 $ 20,000 - $ 15,313 - $ 7,656 -----

LO 3
The Auditor’s Report
• Canadian corporate law requires:

– 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
LO 3
The Auditor’s Report
• In Canada, the auditor’s report 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.
LO 3
Accounting for Inflation and Changing Values
A. 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?
B. Suggested Solutions
1. Price level accounting
Restating all figures in financial statements in terms of current
purchasing power.
2. Current value accounting
What it would currently cost to acquire an asset with the same
capability or capacity as the one presently owned.
C. 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.
LO 4
Financial Analysis
• Horizontal analysis
• Vertical analysis
• Statement of cash flows

• Ratio analysis
• Break-even analysis
• Leverage analysis
• Risk analysis

LO 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
LO 6
Not-For-Profit (NFP) 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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Copyright © 2014 Nelson Education Ltd. 2–1

Copyright © 2014 Nelson Education Ltd. 2–2

Copyright © 2014 Nelson Education Ltd. 2–3

Copyright © 2014 Nelson Education Ltd. 2–4

Transfer (profit for the year) is made at

Statement of Financial Position Statement of Income

Debit Increases Decreases Decreases Decreases Increases

Credit Decreases Increases Increases Increases Decreases

Profit for the year

Transaction Document Journals Ledgers

Statement of Financial Position

Copyright © 2014 Nelson Education Ltd. 2–7

Total $ 1,325,000 $ 1,325,000

Copyright © 2014 Nelson Education Ltd. 2–8

December 24 December 31 January 7

An employee works for a

So, the company owes $800

Copyright © 2014 Nelson Education Ltd. 2–9

June 30 December 31 June 30

Pay $4,000 for insurance this

…but, will also show in the closing

To determine the value or wealth of a business,

Copyright © 2014 Nelson Education Ltd. 2–11

To determine the flow or wealth of a

To determine the accumulated wealth of a

Copyright © 2014 Nelson Education Ltd. 2–13

Revenue Retained earnings (beginning) $900,000

Statement of Financial Position Statement of Cash Flows

2 Profit before taxes

Copyright © 2014 Nelson Education Ltd. 2–15

Profit for the year

Other comprehensive income/(loss)

4 Total comprehensive income

Copyright © 2014 Nelson Education Ltd. 2–16

Copyright © 2014 Nelson Education Ltd. 2–17

Profit for the year $40,000

Other comprehensive income/(loss) ---

4 Total comprehensive income $40,000

Copyright © 2014 Nelson Education Ltd. 2–18

• Capital budgeting • Financial leverage

Current Assets Current Liabilities

Copyright © 2014 Nelson Education Ltd. 2–20

Total assets $745,000

• Share capital 200,000

• Long-term borrowings 200,000

Copyright © 2014 Nelson Education Ltd. 2–21

Copyright © 2014 Nelson Education Ltd. 2–22

Profit for the year 10,000 revenue; it is more realistic

• Goodwill Amortization (intangible assets)

Copyright © 2014 Nelson Education Ltd. 2–23

2 75,000 @ 50% $37,500 20,000

3 37,500 @ 50% $18,750 20,000

4 18,750 @ 50% $ 9,375 20,000

5 9,375 @ 50% $ 4,687 20,000

Copyright © 2014 Nelson Education Ltd. 2–24

Year 1 Accountant’s Statement of P&L

2 $37,500 $ 20,000 $17,500 $ 8,750 $

3 $18,750 $ 20,000 - $ 1,250 -$ 625 $

4 $ 9,375 $ 20,000 - $ 10,625 - $ 5,312 $ 5,313

5 $ 4,687 $ 20,000 - $ 15,313 - $ 7,656 -----

• Canadian corporate law requires:

• In Canada, the auditor’s report has two