Chapter 1

The Purpose and Use of Financial

Statements

Financial Accounting: Tools for

Business Decision-Making
Ninth Canadian Edition

Kimmel; Weygandt; Mitchell; Trenholm; Irvine; Burnley

Prepared by Debbie Musil, FCPA, FCMA
Learning Objectives
LO 1: Identify the uses and users of accounting.
LO 2: Describe the primary forms of business
organization.
LO 3: Explain the three main types of business activity.
LO 4: Describe the purpose and content of each of the
financial statements.

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Learning Objective 1
Identify the uses and users of accounting
information.

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The Purpose and Use of Financial
Statements (1 of 2)
• Uses and Users of Accounting
o Internal and external users
o Ethics in financial reporting
o Data analytics

• Forms of Business Organization

o Proprietorships, partnerships and corporations
o Generally accepted accounting principles for business organizations

• Types of Business Activity

o Financing, Investing and operating activities
o Summary of business activities

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The Purpose and Use of Financial
Statements (2 of 2)
• Financial Statements
o The financial statements
o North West’s financial statements
o Elements of the annual report

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Uses and Users of Accounting
• Accounting identifies and records the economic events
of an organization and communicates to interested
users
• There are two broad categories of users
o Internal users
o External users

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Users of Financial Information
• Internal users
o Manage companies, not-for-profit, & government
organizations
o Company officers, managers and directors in finance,
marketing, human resources, production and other
functional areas
• External users
o Do not work for the company. This includes:
• Investors, lenders, and other creditors
• Customers, employees, labour unions
• Taxing authorities and regulators
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Discussion Question 1
Identify the internal and external users of financial
information for a local hospital.

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Ethics in Financial Reporting
• For accounting information to have value, preparers
must have high ethical standards
o Actions are legal and responsible and
o Consider organization’s interests

• Accountants, other professionals, and most companies

have rules or codes of conduct to guide ethical
behavior

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Discussion Question 2
What are some ethical issues that might exist for financial
information in a local hospital?

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Data Analytics
• Involves analyzing data, using software and statistics, to
draw inferences
• Use of data analytics is becoming increasingly common
• Four most common types of data analytics:
o What happened? (descriptive)
o Why did it happen? (diagnostic)
o What is likely to happen? (predictive)
o What should we do about it? (prescriptive)

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Learning Objective 2
Describe the primary forms of business organization.

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Forms of Business Organizations: 1.
Proprietorship
• Owned by one person (proprietor)
• Simple to set up
• Owner has control over business
• Limited life
• Unlimited liability
• Income tax paid by owner

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Forms of Business Organizations: 2.
Partnership
• Similar to proprietorship except owned by more than
one person
• Formalized in a written agreement
• Limited life
• Each partner has unlimited liability
• Income tax paid by individual partners

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Forms of Business Organizations: 3.
Corporations
• Separate legal entity owned by shareholders (owners of
shares)
• Indefinite life
• Ease of raising capital
• Shareholders enjoy limited liability
• Corporation pays income tax
• May be public or private:
o Public if shares are publicly traded
o Private if shares are not available to the general public

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Generally Accepted Accounting Principles
(GAAP) for Business Organizations
• Accounting rules and practices for the preparation of
financial statements
• Different for publicly-traded and private corporations
o Publicly-traded corporations use International Financial
Reporting Standards (IFRS)
o Private corporations may use IFRS or Accounting Standards for
Private Enterprises (ASPE)
• Proprietorships and partnerships generally follow A SPE for
external reporting
o Not required to follow any particular standards for internal use

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Learning Objective 3
Explain the three main types of business activity.

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Three Types of Business Activities
• All businesses are involved in three types of activities:
• Financing
• Investing
• Operating

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Financing Activities
• Obtaining (and repaying) funds to finance the
operations of the business
• Examples:
o Issuing (selling) or repurchasing shares (equity financing)
o Borrowing money or repaying loans (debt financing)

• Forms of debt
o Bank indebtedness, bank loan payable, long-term debt
such as mortgages payable, bonds payable, finance lease
obligations

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Investing Activities
• Purchase or sale of long-lived assets needed to operate
the company
• Examples
o Purchase or sale of long-lived assets such as property,
plant and equipment and intangible assets
o Purchase or sale of investments, such as shares or debt
securities of other companies

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Operating Activities
• Operating activities are the main day-to-day activities
of the business
• Examples
o Sources of income (revenue and income)
o Expenses
o Related accounts such as accounts receivable and
accounts payable

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Discussion Question 3
What are the potential operating, investing, and financing
activities for a retail company? Would your answer differ
for a service company?

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Learning Objective 4
Describe the purpose and content of each of the financial
statements.

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Financial Statements (1 of 2)
• Statement of income
o Reports revenues and expenses for a specific period of
time
• Statement of changes in equity
o Reports the changes in each component of shareholders’
equity during a period of time
• Statement of financial position
o Shows the assets, liabilities and shareholders’ equity at a
specific point in time

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Financial Statements (2 of 2)
• Statement of cash flows
o Shows, for a specific period of time, how company
obtained cash and how that cash was used
• Order of preparation of statements

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Statement of Income
• Revenues
o Arise from the sale of products or services
o Result in an inflow of assets

• Expenses
o Costs of assets consumed or services used to generate
revenues
• Net Income (loss) = Revenues − Expenses

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Statement of Income - Example

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Statement of Changes in Equity (1 of 2)
• Shows the changes in each component of
shareholders’ equity for the period
• Share capital
o Amounts contributed by shareholders
o May include common and preferred share classes

• Retained earnings /deficit

o Cumulative net income retained in the corporation LESS
any dividends paid to shareholders
• Other shareholders’ accounts

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Statement of Changes in Equity (2 of 2)
Changes in common shares

Changes in retained earnings

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Statement of Changes in Equity -
Example

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Statement of Financial Position
• Assets
o Resources owned or controlled by a business
• Liabilities
o Claims of lenders and other creditors
• Shareholders’ equity
o Claims of shareholders
• Accounting equation
o Assets = Liabilities + Shareholders’ Equity

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Statement of Financial Position -
Example (1 of 2)

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Statement of Financial Position -
Example (2 of 2)

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Statement of Cash Flows
• Reports the effect on cash related to the company’s
o Operating activities
o Investing activities
o Financing activities

• Shows net increase or decrease in cash for the period

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Statement of Cash Flows - Example

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Relationships Between Statements
• The statements are interrelated
o Results from some statements are used as data in other
statements
• Examples
o Net income from statement of income is reported in
statement of changes in equity
o Ending balances of each shareholders’ equity account is
reported in both statements of financial position and changes
in equity
o Statement of cash flows is related to statement of financial
position
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Annual Report
• Public corporations must produce an annual report
each year, which contains:
o Financial statements
o Statement of management’s responsibility for the
statements
o Management discussion and analysis
o Auditor’s report
o Notes to financial statements
o Historical summary of the key financial ratios and
indicators
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Review of IFRS and ASPE
Key Standard International Financial
Differences Reporting Standards (IFRS)
Accounting Standards Publicly traded corporations
must use IFRS; private
corporations normally use ASPE,
but can choose to use I FRS
Statement of changes in A statement of changes in equity
equity vs. statement of must be presented that shows
retained earnings the changes in all components of
shareholder’s equity (for
example, share capital and
retained earnings).
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Accounting Standards for Private
Enterprises (ASPE)
Private corporations normally use A SPE,
but can choose to use I FRS. Once the
choice is made, it must be applied
consistently. Proprietorships and
partnerships generally follow A SPE.
A statement of retained earnings is
presented that shows the change in
only one component of shareholder’s
equity retained earnings.
38
Copyright

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