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(1) Financial Statements, theAccounting Cycle and Conceptual

Framework

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Transaction Analysis

CMA Accelerated Program 2012/2013 Lecture Student Weekly File - Week 1

1 of 32 CMA Ontario, 2012

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Review of Transaction Analysis

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Adjusting Entries Prepaid Expenses costs are initially recorded as assets and allocated to

expenses of future periods. Examples: prepaid rent andinsurance, ofce supplies, plant and equipment

you start the year with $3,500 of ofce supplies. Duringthe year you purchase $7,000 of supplies. At the end ofthe year, the inventory count reveals that there are$2,700 of supplies on hand.

on June 1, 20x7 you purchased a two year insurance

policy at a cost of $6,600. The date is December 31,20x7 and you adjust your accounts annually.



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Adjusting Entries Accrued

Liabilities expenses incurred in current period, but for which payment

will occur in future periods

no cash ow on recording, only when paid examples: payroll, income taxes, interest, electricity on May 1, 20x7 you took out a 7.5% loan for $250,000.

Interest and principal are payable on May 1, 20x8. It isnow December 31, 20x7 and you prepare nancialstatements annually.

the last payroll was for the two weeks ended Aug 28.Average daily wages are $3,000/day and you operate 365days a year. It is now Aug 31 and you prepare monthlynancial statements.



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Adjusting Entries Accrued Asset

record revenue and corresponding receivable inperiod earned, receive payment in the future

examples: credit sales, rent revenue, interestreceivable

you lend $100,000 to another entity onOctober 31, 20x2. The interest rate on thenote is 8%. The note and the interest are

payable on October 31, 20x3. What is theadjusting entry at December 31, 20x2?



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Closing the Accounts

all expense and revenue accounts aretemporary accounts - at year end they getreset to zero; offsetting amount is net incomeand gets recorded to retained earnings

dividends are normally debited directly againstthe retained earnings account

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Sales Contra Accounts

Sales Sales Discounts

normal early

credit payment

balance discounts

Sales Returns Sales Allowances

merchandise customer

returned keeps

merchandisebut a credit

is given



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Inventory Systems

perpetual systems: inventory is continuallyupdated

inventory purchases and sales are recordeddirectly in the inventory account

periodic systems: inventory is counted at theend of each year

inventory purchases are debited to thePurchases account

cost of goods sold is computed at year end

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Periodic Systems Inventory

Accounts

Purchases Transportation- In Purchase Discounts

normal freight early

debit charges payment

balance discount

Purchase Returns Purchase Allowances

merchandise we keep

returned merchandise

but is givena credit



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Periodic Systems Calculating

COGS the purchase account and all contra accounts

are closed out to zero the inventory account is adjusted to what the

ending balance should be the amount to balance is equal to cost of goods

sold

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Periodic System - CalculatingCOGS Example

Dr. Cr.

Inventory $250,000

Purchases 1,650,000

Transportation-in 18,000

Purchase returns and allowances $25,600Purchase discounts 5,800

An inventory count at year-end shows that the endinginventory cost is $285,000. Prepare the journal entryto record the cost of goods sold.



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Problem 1 Financial Statements

The following summarized transactions (in thousands of dollars) occurred during the yearended December 31, 20x2 for Ruiz Pharmacy, a publicly accountable entity:

a. Merchandise inventory purchased on account was $520. b. Total sales were $900, of which 80% were on credit.c. The merchandise inventory as at December 31, 20x2 was $240.d. Collections from credit customers were $700.e. The notes receivables are from a major supplier of vitamins. Interest for twelve

months on all notes was collected on May 1. The rate is 12% per annum.f. The principal on the current notes was collected on May 1, 20x2. The principal on

the remaining notes is payable on May 1, 20x5.

Cash disbursements were:

g. To trade creditors, $500.h. To employees for wages, $193.i. For miscellaneous expenses such as store rents, advertising, utilities and supplies,

which were all paid in cash, $189. j. For new equipment acquired on July 1, 20x2, $74.k. To the insurance company for a new three-year fire insurance policy effective

September 1, 20x2, $36.l. To the Canada Revenue Agency for income taxes, $19.m. The board of directors declared cash dividends of $26 on December 15 to be paid

on January 21.

The following adjustments were made on December 31, 20x2:

n. For the interest on the note receivable.o. For insurance.

p. For depreciation - depreciation expense for 20x2 was $30.q. Wages earned but unpaid, December 31, 20x2, $15r. Total income tax expense for 20x2 is $20, computed as 40% of pretax income of

$50.

Required -

1. Post all of the above transactions in T-Accounts.2. Prepare an income statement, statement of retained earnings and balance sheet for

20x2.



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3. Unpaid invoices at May 31, 20x2, were as follows.

Baking materials $ 256Utilities 270

$ 526

4. Customer records showed uncollected sales of $4,226 at May 31, 20x2.

5. Baking materials costing $1,840 were on hand at May 31, 20x2. There were nomaterials in process or finished goods on hand at that date. No materials were onhand or in process and no finished goods were on hand at January 1, 20x2.

6. The note evidencing the 3-year bank loan is dated January 1, 20x2, and states asimple interest rate of 10%. The loan requires quarterly payments on April 1, July1, October 1, and January 1 consisting of equal principal payments plus accruedinterest since the last payment.

7. Anne Spier receives a salary of $750 on the last day of each month. The otheremployees had been paid through Friday, May 25, 20x2, and were due anadditional $240 on May 31, 20x2.

8. New display cases and equipment costing $3,000 were purchased on January 2,20x2, and have an estimated useful life of five years. These are the only fixedassets currently used in the business. Straight line depreciation is to be used.

9. Rent was paid for six months in advance on January 2, 20x2.

10. A one-year insurance policy was purchased on January 2, 20x2

11. MAS Inc. is subject to an income tax rate of 20%.

12. Payments and collections pertaining to the unincorporated business throughDecember 31, 20x1 were not included in the corporation's records, and no cashwas transferred from the unincorporated business to the corporation.

Required -

Using the accrual basis of accounting, prepare for MAS Inc.:

(a) An income statement for the five months ended May 31, 20x2(b) A balance sheet as of May 31, 20x2.



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Problem 3 Financial Statements

Morrow Wholesale has kept limited records and has never had an audit until 20x2. As thesenior auditor in charge of the audit, you have been presented with the followinginformation:

a) Morrow is incorporated and initially sold 11,000 of its common shares for $25 pershare. There have been no other common share transactions.

b) Cash balance in cheque book, December 31,20x1 $ 24,000Deposits during 20x2:

Cash sales $250,000Proceeds of $5,000 note issued on July 1 and

bearing interest at 12%, payable annually 5,000Customer collections 146,000Proceeds on sale of fully depreciated

equipment (original cost, $20,000) 5,000

$406,000Cheques written during 20x2:Purchases of merchandise $180,000Salaries 10,000Advertising (to be run in 20x3) 10,000Miscellaneous expenses 5,500

$205,500c) Morrow had no outstanding payables at the beginning of 20x2 but owes creditors

$36,000 for unpaid purchases of merchandise on December 31, 20x2.d) In 20x2 Morrow began selling on a cash-only basis. Receivables at the beginning

of 20x2 totalled $ 155,000. The uncollected receivables were written off as

miscellaneous expenses in 20x2.e) Morrow's cost of goods sold is 80 percent of sales. The inventory at the beginning

of 20x2 was $80,000.f) At the beginning of 20x2, equipment with a cost and accumulated depreciation of

$80,000 and $20,000, respectively, was on hand. All equipment is depreciated ona straight-line basis over ten years with no estimated residual value. The sale ofequipment was made on December 30, 20x2.

g) Retained earnings at the beginning of 20x2 totaled $63,000. During the fourthquarter of 20x2, a cash dividend of $10,000 was declared and is to be paid inJanuary 20x3.

h) Morrow's only other asset at the beginning of 20x2 was an investment in

Honeydew common shares. During 20x2 these shares were exchanged for landand a gain of $4,000 was recognized.i ) The income tax rate is 30 percent.

j ) At the end of 20x2, sales salaries of $1,600 have accrued but have not been paid.

Prepare an income statement for the year ended December 31, 20x2, and a balance sheetat December 31, 20x2, for Morrow Wholesale. Morrow Wholesale is a private companyand has adopted ASPE.



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Financial Statements

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Components of FinancialStatements

IAS 1 states that a complete set of nancial statementscomprises of the following:

(a) a statement of nancial position as at the end ofthe period,

(b) a statement of comprehensive income for theperiod,

(c) a statement of changes in equity for the period,(d) a statement of cash ows for the period (e) a set of notes, which provide a summary of the

entity's signicant accounting policies along withother explanatory information



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Statement of Comprehensive

Income (Income Statement) IAS1 requires the presentation of expenses

using a classication based on either thenature of expenses or their function within theentity, whichever provides information that isreliable and most relevant

the chosen analysis does not need to be shownon the face of the income statement - it can

be detailed in the notes

the choice depends on historical and industryfactors and the nature of the entity

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Income Statement - cont

d analysis of expenses by nature - i.e.

depreciation, purchases of materials, transportcosts, employee benets and advertising costs

analysis of expenses by function - i.e. cost ofsales, cost of distribution and administrativeactivities



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Income Statement - Minimum Disclosures

revenues cost of goods sold nance costs share of prot or loss of associates and joint ventures

accounted for using the equity method tax expense discontinued operations: prot or loss + re-measurement

to FV less costs to sell prot or loss

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The Statement of Changes inShareholders

Equity



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The Statement of Financial Position

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Statement of Financial Position -

General

ordering by liquidity is required if it providesinformation that is reliable and more relevant

no offsetting (netting out) is allowed order or format is not prescribed, only

recommended

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Current Assets a current asset is dened as follows:

it is expected to be realized in, or is intended for sale orconsumption in, the entity s normal operating cycle

it is held primarily for the purpose of being traded

it is expected to be realized within 12 months, or

it is cash or a cash equivalent. cash, marketable securities, accounts receivable, inventory,

prepaids valuation: lower of cost or market (market dened as NRV);

except marketable securities which are valued at market



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Noncurrent assets dened by what they are not: they are not

current assets long-term investments tangible capital assets: land, buildings and

equipment accumulated depreciation account is a

contra account intangible capital assets

amortization reduces the asset account

valuation: cost or revaluation models, subjectto impairment test

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Liabilities a liability is classied as current when it satises any of

the following criteria: it is expected to be settled in the entity s normal

operating cycle, it is held primarily for the purpose of being traded, it is due to be settled within 12 months, or

the entity does not have an unconditional right todefer settlement of the liability for at least 12months

accounts payable, bank indebtedness, dividends payable,returnable deposits, unearned revenues, sales taxes,employee related liabilities



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Long-term liabilities long-term debt and lease obligations deferred credits:

pension liability

deferred income taxes

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Accounting Standards in Canada publicly accountable entities follow IFRS private enterprises can chose between

Accounting Standards for Private Enterprises(ASPE) or IFRS

non-prot organizations follow accountingstandards for non-prot organizations

pension plans follow their own accountingstandards

these comprise Parts I, II, III and IV of theCICA Handbook respectively



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ASPE Differences the Statement of Financial Position is called a Balance Sheet the order of the Balance Sheet is traditional: current assets

before noncurrent assets; current liabilities, then noncurrentliabilities followed by shareholders equity

there is no statement of comprehensive income, just an incomestatement (no other comprehensive income in ASPE)

a statement of changes in shareholders equity is not required;a statement of changes in retained earnings is required instead

format of the income statement is unspecied; the standardsrequire minimum disclosures



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Conceptual Framework

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What is a Conceptual Framework a conceptual framework is a statement of generally

accepted theoretical principles which form the frame ofreference for a particular eld of inquiry

these theoretical principles provide the basis for boththe development of new reporting practices and theevaluation of existing ones

a conceptual framework will form the theoretical basisfor determining which events should be accounted for,

how they should be measured, and how they should becommunicated to the user



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Users and their Information Needs conceptual framework focuses on current and potential

creditors and shareholders - these need information tohelp them assess the prospects for future net cashinows to an entity

primary users are considered those who do nototherwise have access to internal information andneed to rely on general purpose statements

nancial statements are not primarily directed to otheruser groups such as regulators and members of thepublic

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Objectives of Financial Reporting to provide information about the nancial position, performance and

changes in nancial position of an entity that is useful to users inmaking economic decisions, including:

the evaluation of the ability of the entity to generate cashand the timing and certainty of this generation,

information about the economic resources controlled by theentity,

information about the nancial structure of the entity, information about liquidity and solvency of the entity, information about the performance and the variability of

performance of the entity, particularly its protability, and

information about changes in the nancial position of theentity. to show the results of the stewardship of management, dened as

how efciently and effectively the entity s management and boardhave discharged their responsibilities to use the entity sresources .



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Underlying Assumptions

accrual basis - the effects of transactions and otherevents are recognized when they occur (and not as cash,or its equivalent, is received or paid) and they arerecorded in the accounting records and reported in thenancial statements of the periods to which they relate.

going concern - the nancial statements are normallyprepared on the assumption that an entity is a goingconcern and will continue in operation for theforeseeable future.

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Qualitative characteristics ofuseful nancial information

fundamental qualitative characteristics: relevance (predictive and conrmatory value,

materiality)

faithful representation (complete, neutraland free from error)

enhancing qualitative characteristics:

comparability, veriability, timeliness andunderstandability the cost constraint



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Relevance information is relevant if it is capable of

making a difference in the decisions made byusers by helping them evaluate past, presentor future events (predictive value) orconrming, or correcting, their past evaluations(conrmatory role)

secondary characteristic: materiality

information is material if its omission ormisstatement could inuence the economicdecisions of users taken on the basis of thenancial statements.

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Faithful Representation to be useful, nancial information must faithfully

represent the phenomena that it purports to represent three characteristics of faithful representation:

completeness - all information necessary for a userto understand the phenomenon being depicted,including all necessary descriptions andexplanations

neutrality - no bias in the selection orpresentation of nancial information. Financialstatements are not neutral if, by the selection or

presentation of information, they inuence themaking of a decision or judgment in order toachieve a predetermined result or outcome.

free from material error



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Enhancing Qualitative

Characteristics comparability - accounting information is comparable

with previous periods (interperiod comparability orconsistency) and comparable to other rms operating inthe same industry (interrm comparability)

veriability - different knowledgeable and independentobservers could reach consensus, although notnecessarily complete agreement, that a particulardepiction is a faithful representation

timeliness - having information available to decisionmakers in time to be capable of inuencing theirdecisions

understandability - nancial statements must be readilyunderstandable by users. Users are assumed to have areasonable knowledge of business and economic activitiesand accounting and a willingness to study the informationwith reasonable diligence

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Elements of Financial Statements Asset - a resource controlled by the entity as a result

of past events and from which future economic benetsare expected to ow to the entity

Liability is dened as a present obligation of the entityarising from past events, the settlement of which isexpected to result in an outow from the entity ofresources embodying economic benets

Equity is dened as the residual interest in the assets of

the entity after deducting all its liabilities.



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Elements of Financial Statements - cont d

income is dened as increases in economicbenets during the accounting period in theform of inows or enhancements of assets ordecreases of liabilities that result in increasesin equity, other than those relating tocontributions from equity participants.

income = revenues + gains revenue arises in the course of the ordinary

activities of an entity

gains represent other items that meet thedenition of income and may, or may not,arise in the course of the ordinary activitiesof an entity

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Elements of Financial Statements - cont

d Expenses are dened as decreases in economic

benets during the accounting period in theform of outows or depletions of assets orincurrence s of liabilities that result indecreases in equity, other than those relatingto distributions to equity participants.

Capital maintenance adjustments - therevaluation or restatement of assets andliabilities gives rise to increases or decreases inequity. While these increases or decreasesmeet the denition of income and expenses,they are not included in the income statement.



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Measurement Basis - cont

d Realizable (settlement) value - assets are

carried at the amount of cash or cashequivalents that could currently be obtained byselling the asset in an orderly disposal.Liabilities are carried at their settlementvalues; that is, the undiscounted amounts ofcash or cash equivalents expected to be paid tosatisfy the liabilities in the normal course of

business.

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Measurement Basis - cont

d Present value - assets are carried at the

present discounted value of the future netcash inows that the item is expected togenerate in the normal course of business.Liabilities are carried at the present discountedvalue of the future net cash outows that areexpected to be required to settle the liabilities

in the normal course of business.



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ASPEs Conceptual Framework 1. Understandability

2. Relevance: predictive value feedback value,timeliness

3. Reliability: representational faithfulness,veriability, neutrality, conservatism

4. Comparability



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Week 1

Homework File

Suggested study plan for this week:

Primary List Secondary List

1. Review what we did in class on Saturday.

2. Financial StatementsMCQ, Problems 1, 2, 3, 4, 5 Problems 6, 7, 8, 9, 10, 11

3. If you have time and have not done so already, work through the FinancialAccounting Review Manual - especially chapter 1.

4. Prepare the Week 1 Quiz

* Problem numbers refer to the problems with solutions located in the course materials.


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