Investing and Financing Decisions and the Statement of Financial Position

CHP 2: Investing and Financing Decisions and the Statement of Financial Position

Tuesday, September 18, 2018

11:35 AM

OVERVIEW OF THE CHAPTER:

[pic 1]

• The main OBJECTIVE of financial reporting to provide internal uses such as investors, lenders and creditors with useful financial information so they  can make decisions about providing money to the company

• Financial statements must allow them to look at the assets and claims against those assets

Conceptual Framework:

Qualitative characteristics of useful accounting information:

• Objective is to provide financial information to decision makers such as internal users (creditors, investors, lenders etc)

To be useful- must be relevant and honest

Qualitative Characteristics: what makes financial information useful and what should it have ot be useful

Two fundamental qualitative characteristics- relevance and faithful representation

• Supported by 4 enhancing qualitative characteristics: comparability, verifiability, timeliness and understandability

1. Relevance: relevant information

1. Predictive value of the statement of earnings if non reoccurring things are presented separately on the multi step statement of earnings
2. Confirmatory value, if it conforms or changes priod expectations based on previous evaluations

1. Faithful representation: reflecting the substance of the underlying transactions

1. Ex: overstating the amount of revenue on the statement of earnings- lack of faithful representation
2. Transaction effects should not result in favouring one group of users over others
3. If the transaction represents a purchase transactions then accountants must classify it as a purchase
4. Keywords: Complete and neutral

Enhancing characterisitics:

1. Comparibility: enhanced when similar accouting mentods have beeen applied

1. Enables users to idenitfy the similarities and differences between two financial statements produced by two different companeis
2. Enhaced if consistent information is made avaible by using the same accounting emthods over time
3. Changes in accounting methods reduce comparibility

1. Verifiability: indpendant acocuntants must agree on the nature and amunt of transaction

1. Historical piece recorded at the value it was purchased for ; not for what it was sold for
2. The cost of acuqisition Is based on the purchase price and related costs that result from actual exchanges between the two parties

1. Timeliness: information not presented in time loses its relevance because it cannot be used anymore to make the decision

1. Enhances predictive and conformatory values
2. As time passes, the relevance of making deciisons goes down

1. Understandability: information cannot be used if its not udnerstood properly

1. Assuming that users fo the accountign information have basic business information
2. Presentation of the information ehnaces its value

1. Constraints of Accountign Measurement: accurate interpretation of financial statements equires tha the readers are aware of the restrictions/constraints of the measurement

1. Cost:

1. Cost constraint says that information should only be produced if the benefits increase decision making and exceed the cost of providing the information
2. Improtant to determien whether new information hsould be produced to users

1. Prudence (cautious): special care should be taken to avoid

1. Overstating asets and revenues
2. Understanding liabilites and expenses

1. Example: creditors interested in how secure their investment will be if the company goes into debts

1. Not concerned about if the company will do well or not
2. Show assets at historical cost but reduce the amount when current vlaues are lower to satisfy creditors

Recognition and Measurement Concepts

3 concepts/assumptions:

1. Separate entity assumption: activities of the busienss must be cslculated seperately than the acivities of the owner

• Personal use items should not be recorded on financial statement

1. Stable monetary unit assumption: accountign information shoild be measured and reported in th enatual monetary unit or currency of canada- dollars

• No adjustments in purchsing power (inflation)

1. Continuity (going concern) assumption: assume that busiensses will continue to operate in the future

• Violation means that assets and liabilties shuld be valued and reported on the statement of financial potiison as if the company was to be liquidated

1. Mixed attribute measurement model: measuring the elements of the statement of financial position

1. Historical cost principle: Most elements recorded at cash equivalent on the date of the transaction

• Assets recorded at the cash paid for and the monetary value of all non cash considerations
• Advanatage: many assets are acquired because they are stated at the auqisition cost

Elements of the Classified Statement of Financial Position

Assets: economic resourcees that can benefit the company in the future

• For shareholders, for their value of investment to increase, it depends on the future benefits from the assets of the company

Current Assets:

• Economic resources that wil tranform into cash or use within the next year or next business cycle

• Cash: most liquid asset
• Short term investments: shares purchased as investments of excess cash
• Recievable: (accounts recievables, trade recievbales)

• Normlly collected within a year
• Amounts owed by customers who purchased prodcuts on credit

• Inventories: goods that are either held for sale to customers or used to produce goods and services for sale

• Doesn’t matter how long it takes to produce, it is always a current asset

• Prepaid exenses: benefits that the company will use within a year

Non Current Assets

• Long term because will be sued or turned into cash over a longer period than one year
• Also called fixed assets or capital assets- if they have a physical form - tangible

• Property, plant and equipment- land, buildings, machine, tools
• Recievables or long term investents
• Goodwill- intangible asset- when company purchases another busness to control its operating, investing and financial deciisons

• Purchase price of a business esxceeds the vlaue of assets- liabilites
• Reflects assets are not easily measured

• Intangible assets: no physical substance but have a long life

• Not acuqired for resale
• Value arises from legal rights and privileges of ownership

• Valuable intangible assets such as trademarks, patents and copyrights that are developed inside a company (not purchased) are reported on the statement of financial position

Liabilities: present debts or obligations that come from past transaction and will be paid with assets or services

• Represent future outflows of assets or services to the creditors that provided the company with resoruces
• When a company borrows money, creditors reciev full payment with interest

Current Liabilities:  

• Short term loans that will be paid within the comign year by giving cash, goods or current assets

• Normally current assets are converted into cash to pay

Non Current Liabilties

• Comanys obliggations not classified as short term and will take longer to pay off

• Include long term debt from bansk and lenders

• Provisions: estimated liabilties with the exact amoutn and time to be paid
• Other liabilities: number of other liabilties

• SHAREHOLDERS EQUITY: financing provided to business by owners and operations of business

• Main difference between shareholders and creditors: creditors can claim the assets of the shareholders and receive all the money owed by the company even if they take all the comapnys assets

• Shareholders invest in the company ebcause they receive money in 2 types of cash flows

• Dividends: distribution of corporatiosn earning (return on shareholders investment)
• Gains from selling investment for more than they paid (Capita gains)

Typically, the shareholders’ equity of a corporation includes the following:

1. Contributed capital

1. Retained earnings (accumulated earnings that have not been declared as dividends)
2. Other components

Financing provided by shareholders is called CONTIRBUTED CAPITAL