WEEK 1
Financial Reporting & FS Video
Demand for and users of Financial Statements
 Business managers
o How effective was the last advertising campaign?
 Employees
o Will I get a raise this year?
 Investors (main user)
o Will the company earn enough income to provide a satisfactory
return?
 Creditors (main user)
o Should I lend money to this business?
 Governments
o How much in taxes does the company owe?
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External decision makers
o Lenders (banks)
o Suppliers
o Investors
o Governments
Internal decision makers
o Board of directors
o Executive management (CEO, CFO)
o Employees
o Functional managers
Statement of Financial Position (SFP)
 Also called the Balance Sheet
 Shows assets, liabilities and shareholders' equity at a given point in time
(December 31)
 Assets = Liabilities + Shareholders' Equity (accounting equation)
Income Statement
 Also called statement of earnings, statement of operations, or profit & loss
 Shows results of the firm's operations over a period of time
Revenues or sales
 Increases in economic benefits earned by selling goods and services in the course
of ordinary business activities
 Not the same as cash receipts
Expenses
 Decreases in economic benefits, incurred in course of ordinary activities (selling
goods and services)
 Not the same as cash disbursements
Non-operating income/expense
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Gains or losses are NOT from ordinary operating activities
Statement of Changes in Equity (Public co)
 This statement provides more detail on the equity section of the SFP
 Usual "buckets" of equity are:
o Share capital (when company issues shares: common or preferred)
o Retained earnings (all earnings over the years less dividends paid)
o AOCI (accumulated Other Comprehensive Income)
o Contributed surplus (may result from stock options or share
repurchases which we may learn about later)
o Non-controlling interests (if subsidiaries of company have partial
owners)
Private companies in Canada
 Are held by private owners and are not traded on a stock exchange
 Not required to follow International Financial Reporting Standards (IFRS) but can
 Usually follow Accounting Standards for Private Enterprises (ASPE)
 Do not have OCI
 Do not have statement of changes in equity or comprehensive income
 Instead have a Statement of Retained Earnings:
Retained Earning beginning of the year X
Add: Profit for the year X
Less: Dividends distributed to the owners (X)
Retained Earnings end of the year XX
o Retained earnings = cumulative net income less dividends or RE, beginning +
net income - dividends
Statement of Cash Flows
 Why cash increases or decreases
 Organized into three types of business activities:
o Operating activities
 All revenues and expenses
o Financing activities
 Issuing shares
 Payment of dividends
 Borrowing (loan)
 Repayment of loan
o Investing activities
 Proceeds from selling land/building/equipment
 Purchase of land/building/equipment
Financial Statement Notes
 Notes are an integral part of the statements
 Under IFRS, notes must be referenced on the face of the statement
Financial Statements Timing
 Statement of Financial Position beginning of period and end of period (one-day)
 Period-of-time statements (12 months)
o Statement of comprehensive income
o Statement of changes in equity
o Statement of cash flows
Forms of Business Organization
Accounting Standards: What is GAAP?
 Generally accepted accounting principles
o Rules that accountants follow to guide financial reporting
o Includes rules and principles that have substantive authority, as well
as broad practices and conventions including professional judgment
o Type of GAAP depends on country and type of organization
IFRS Fundamental Qualitative Characteristics
For information to be useful, it must be
 Relevant
o Makes a difference in a decision
o Has predictive and confirmatory value
o Includes all material information
 Representationally faithful
o Complete
o Neutral - no bias
o Free from material error
Accrual Accounting vs. Cash Basis
 Cash-based accounting records events when cash is received or spent
o This is convenient but does not report the full economic
consequences of transactions in a period
 Accrual accounting provides more complete information of a firm's performance
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o
o
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Recognizes events when main economic impact occurs
Ignore timing of cash transactions
Allows for economic performance to be better assessed (revenue is
recognized in the period earned, regardless of cash payments)
Capitalize and depreciate assets which provide benefits over many
years
The Accounting Equation
 A = L + SE
 Equation must always remain in balance
 If assets increase, then either:
o Liabilities or equity must increase, or
o Another asset must decrease
 Can be expressed in template approach, T-accounts, journal entries
1.1 Statement of Financial Position + Assets
(SFP)
 Also called balance sheet - at a given point in time
 Ex. WestJet
o Total assets = $6.8 billion
o Total liabilities and shareholder's equity = $6.8 billion
Assets
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What the company owns
o Resource controlled by entity
o Result of past event
o Future economic benefits are expected to flow in
Split into current and non-current
o Current - within 1 year
o Non-current - more than 1 year
Using accounting equation
1. Purchase a plane with cash
 Assets (cash) decreases
 Assets (equipment, planes) increases
2. Get bank loan to buy plane
 Assets (planes) increases
 Liabilities (bank loan) increases
3. Purchase inventory with cash
 Assets (cash) decreases
 Assets (inventory) increases
4. Pay back bank loan
 Assets (cash) decreases
 Liabilities (loan) decreases
*transactions that impact both sides, arrows must match
1.2 Liabilities & Shareholders' Equity
Liabilities
 What the company owes
o Present obligation
o Result of past event
o Settlement will result in resource outflow
 Split into current and non-current
 Prefer to finance with debt - leverage
Shareholders' Equity
 What the owners own
o Residual interest in assets after deducting liabilities
o Accounting equation can be rearranged: A - L = SE
 Components:
o Share capital - contributions by shareholders in exchange for shares
o Retained earnings - cumulative net income retained in corporation
(not paid out)
o Other reserves (AOCI, etc.)
Using the accounting equation
1. Issue common shares
 Assets (cash) increases
 Shareholder's equity increases
2. Issue bonds (liability)
 Assets (cash) increases
 Liabilities increases
3. Record interest expense and interest payable on our bonds as the time passes
 Liabilities increases
 Shareholder's equity decreases
4. Pay all the interest payable to our bond holders
 Assets (cash) decreases
 Liabilities decreases
1.3-i Income Statement
 Also called statement of earnings, or profit & loss
 Shows results of the firm's operations over a period of time
Revenue or sales
 Increases in economic benefits, incurred in course of ordinary activities (selling
goods and services)
 Not the same as cash disbursements
Non-operating income/expense
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Gains or losses are not from ordinary operating activities
1.3-ii Comprehensive Income
Statement of comprehensive income
 Can be its own statement or combined with income statement
 Comprehensive income includes "other comprehensive income" (OCI)
 Starts with net income, adds/deducts certain unrealized gains & losses and other
"non-operating" adjustments allowed by accounting standards
o Ex. foreign currency, hedging, pension
 Comprehensive income = net earnings + OCI
Using the accounting equation
1. Sell plane tickets for flights this period (this month)
 Assets (cash) increases
Shareholders' equity (retained earnings) increases (revenue, net
income)
2. Incur costs for that flight (fuel, salaries, etc.)
 Assets (cash) decreases
 Shareholders' Equity decreases (expenses)
3. Sell plane tickets for a flight next year (next period)
 Assets (cash) increases
 Liabilities increases (have not fulfilled our end of the contract)
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Net income = Revenues - Expenses
o If revenues > expenses, net income is positive and assets will grow
1.4 Statement of Changes in Equity
 Provides more detail on shareholders' equity within the SFP
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Retained earnings = cumulative net income less dividends
o Earned capital
Share capital - contributed by the owners
Private companies in Canada
 Are held by private owners and are not traded on a stock exchange
 Not required to follow International Financial Reporting Standards (IFRS)
 Do not have OCI
 Do not require a statement of changes in equity or a statement of comprehensive
income
 Have statement of retained earnings
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Retained earnings = RE, beginning + net income - dividends
1.5 Statement of Cash Flows
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Operating activities
o Get from net earnings go cash-basis earnings (cash received from
operations)
Investing activities
o Real investments in equipment & LT assets
Financing activities
o Getting $ (+repaying) from equity, debt
Cash and cash equivalents as per SFP
2.1 Accounting Standards - GAAP
 Generally accepted accounting principles
o Rules that accountants follow to guide financial reporting
o Includes rules and principles that have substantive authority, as well
as broad practices and conventions including professional judgment
o Type of GAAP depends on country and type of organization
International Financial Reporting Standards
 Over 140 countries use IFRS
 In Canada, all "publicly accountable" enterprises must use IFRS
 Foreign-based firms operating in the US are allowed to file using IFRS
 US does not use IFRS - they use US GAAP
 IFRS is principles based - broad rules and specific disclosure and reporting
requirements
What GAAP do non-public entities use?
GAAP in Canada
 IFRS
 ASPE - accounting standards for private entities
 ASNPO - accounting standards for not-for-profit entities
 Public sector accounting
How to find which GAAP a company is using?
 Read the independent auditors' report
o Specifies the financial statements they are auditing and which GAAP
they use
 Read Note 1 to the financial statements
2.2 Conceptual Frameworks in Accounting
Why do accountants need a framework?
 To help guide standard setters as they set and revise standards
 To help guide accountants and auditors
What is the objective of IFRS financial statements?
 To provide financial information that is useful to existing and potential investors,
lenders, and other creditors in making decisions
o Buy, sell, hold shares
o Provide loans
 The IFRS conceptual framework has less authority than the IFRS standards
themselves
IFRS Fundamental Qualitative Characteristics
For information to be useful, it must be
 Relevant
o
o
o
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Makes a difference in a decision
Has predictive and confirmatory value
Includes all material information
Representationally faithful
o Complete
o Neutral - no bias
o Free from material error
Materiality - how significant an item is, will it affect a decision?
IFRS Enhancing Qualitative Characteristics
Useful information should also be:
 Comparable
o Information measured and reported in a similar way (company to
company, and year to year)
 Verifiable
o Independent observers agree on treatment
 Timely
o Information is in time to influence decisions
 Understandable
o Present information clearly and concisely
IFRS Conceptual Framework
Assumptions & constraints
 Cost constraint - benefits should exceed costs of reporting financial information
 Going concern - assumption that an entity will continue to operate for the
foreseeable future
US GAAP
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Assumptions
1. Business is separate from its owners
2. A stable currency
3. Time periods used
4. Entity is a going concern
Principles
1. Historical cost: account for assets at original costs, not fair value
 Both IFRS and US are using more fair value reporting (ex.
marketable securities)
2. Revenue recognition: record revenue when earned, not received in
cash
3. Matching: match expenses to period they contribute to revenue
 Not in IFRS, focus on SFP
4. Full disclosure: disclosure should be enough for decision making
Constraints
1. Objectivity: financial statements are based on objective evidence
2. Materiality: significance of financial items
3. Consistency: use the same accounting choices each period
4. Conservatism: if uncertainty, less favourable solution should be
chosen
 IFRS wants "neutral" information not conservative
5. Cost constraint: benefits should be higher than costs of reporting
WEEK 2
Accounting Cycle - Video 1
This week we will…
 Learn T-Accounts (QT) for recording transactions
o Including normal balances and opening balances (permanent vs
temporary accounts)
 Learn debits, credits and journal entries
 Understand the accounting cycle
o Including chart of accounts, general ledger, general journal, trial
balance, and closing entries
 Make necessary adjusting entries (AJE's)
 Prepare a trial balance and financial statement
T-Account approach (Q-T) derived from the accounting equation
 A = L + SE
 If assets increase, then either:
1. Liabilities or equity must increase, or
2. Another asset must decrease
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Retained earnings:
o Will go up with net income
o Will go down when dividends get paid out
Net income:
o When revenue goes up, net income goes up
o Left down, right up
Expenses and dividends reduce retained earnings
o Opposite signs to liabilities and equity
Permanent & Temporary Accounts
 Statement of financial position (assets and liabilities & equity)
o Permanent accounts - balances $ stay each year
 Income statement (expenses and revenues)
o Balances get reset each Day 1 of new year
 Net income (loss) moves to retained earnings
Record events in T-accounts
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Assets and expenses on the left
Liabilities & shareholders' equity and revenues on the right
Debits & Credits
 Debit is left, credit is right
 Normal balance:
o Assets and expenses - debit normal balance
o Liabilities & equity and revenues - credit normal balance
o Recall that retained earnings is made up of earnings less dividends
What are Journal Entries?
 2 methods (need to know both):
1. T-account method (Q-T) - label your entries
2. Journal "entry" form (written out)
Common Accounts
Chart of Accounts
 List of a company's accounts
 Each account has a code
o If a more complex system is being used, then the code can be more
complicated (so each manager can be responsible for certain
expenditures)
Accounting Structure
Terminology
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Transactions: economic events that we have to account for
Accounts: describing each financial impact within transaction (ex. Inventory, Cash,
etc.)
Journal Entries: go date by date, they impact only certain accounts and they
balance
General Journal: list of journal entries
General Ledger (G/L): entries account by account
Trial Balance: summary list of account balance
General Ledger
 Our full QT accounts are the G/L
 In real life, the G/L is a database with all entries by account
 Does not show other side of the entry
Trial Balance
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Lists accounts and their balances
We need either our full t-accounts G/L or a trial balance in order to prepare
financial statements
At the end - debits & credits are equal (they balance)
Accounting Cycle - Video 2
Accrual Accounting - Adjusting Entries
 Cash-based accounting records events when cash is received or spent
o Convenient but does not report the full economic consequences of
transactions in a period
 Accrual accounting provides better information of a firm's performance
 Adjusting entries are required every time financial statements are prepared
o They do not involve cash, may involve passage of time (interest,
insurance, depreciation)
o Regular entries to adjusting entries to closing entries
Types of Adjusting Entries (do not impact cash)
 Deferrals - when a company needs to recognize a revenue or expense in a period
AFTER cash has bene received or paid (cash first)
o Prepaid expenses (pay up front, expense over time)
o Unearned revenues (get cash before revenue earned)
o Depreciation (pay for equipment, expense over time)
 Accruals - when a company needs to recognize a revenue or expense in a period
BEFORE cash has been received or paid (cash later)
o Accrued expenses (interest payable, wages payable)
o Accrued revenues (interest revenue)
Depreciation - a type of deferral
 Capitalize equipment and other long term assets and depreciate to spread the cost
of the asset over its useful life
 "match" the cost of the asset with revenues it will generate
 Example: $100,000 truck, 3 year life, $25,000 residual value
o 100,000 - 25,000 = 75,000
o 75,000 / 3 = 25,000/year
o Depreciation expense the same over the three years to sell for
$25,000 at the end of 3 year life
Salary or Wages Accrual
Interest Accrual
 Interest is incurred or earned as time passes
Accounting Cycle
1. Normal events
o Generate paper
1. Buy something - get bill
2. Sell something - send invoice
3. Get paid - make deposit
4. Pay someone - write a cheque
2. Adjusting entries (prior to statements being made)
o Things occurring over time - no cash and no paper
3. Closing entries (at year end)
o Transfer this year's revenue, expenses, and dividends
o Reset revenue, expenses, dividends to $0 for the next year
Closing Entries
 Close the revenue and expense accounts at the end of the fiscal period
 Reset balances in all revenue and expense accounts to zero
 Three main steps:
1. Transfer balances in revenue and expense accounts to the income
summary account (a temporary account)
2. Transfer balance in income summary to retained earnings
3. Close dividends to retained earnings
RE end = RE beg + NI - Dividends
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In real life, accounting software covers closing entries
WEEK 3
Revenue: when should it be recognized?
 Usually around delivering product or service, when the customer pays, or when
warranty period expires
 Revenue recognition points
o Varies for different industries
o During production (construction), after production, on delivery, when
cash is received
IFRS 15 - a contract-based (asset-liability) approach
 IFRS 15, revenue from contracts with customers, is a new standard and is the same
as US GAAP
 It says to recognize revenue when:
o Performance is satisfied by transferring a promised good or service
(asset) to a customer
o An asset is transferred when (as) customer obtains control of it
 Steps:
o Identify the contract with a customer
o Identify the performance obligations in the contract
o Determine the transaction price
o Allocate the transaction price to the performance obligations in the
contract
o Recognize revenue when (or as) the entity satisfies a performance
obligation
Revenue recognition example:
 Suppose a car dealership sells a car with a cost of $25,000 for $30,000 in cash. This
sale does not involve any maintenance or warranty services
o Step 1: identify the contract: contract is to buy car for $30,000
o Step 2: identify the performance obligations: only 1 here, deliver new
car
o Step 3: determine the transaction price: $30,000
o Step 4: allocate the price to PO's: not necessary here, only 1
performance obligation
o Step 5: recognize revenue when PO is satisfied: recognize when car is
delivered to customer
Identifying the contract with customers - step 1
 Upon entering into a contract with a customer, a company obtains rights to receive
consideration from the customer and assumes obligations to transfer goods and
services to the customer
o A company does not recognize contract assets or liabilities, nor is a
journal entry performed, until one or both parties perform their
contracted obligations (ie. Deliver or pay)
Identifying separate performance obligations - step 2
 A performance obligation is a promise to provide a product or service
 Promise may be explicit, implicit or possibly based on customary business practice
o Bundle of goods, combination of services, or mixture of both
o Separable (distinct) or combined?
o Does the contract specify repeated delivery of the same good or
service over a period of time (ex. 5,000 tonnes of aluminum over 24
months
Determining the transaction price - step 3
 Transaction price is the amount of consideration (usually $$) that a company
expects to receive from a customer in exchange for transferring goods or services.
Transaction price is usually stated within the contract
 Must consider the following:
o Time value of money - discount if > 1 year
o Non-cash consideration - fair value estimate needed (ie. Trade in)
o Consideration paid or payable to the customer - ex. coupons
o Variable consideration - ex. volume discounts, rebates, incentives
o Example, sales discounts: 2/10 net 30 means if customer pays within
10 days, they get a 2% discount off the price, but if not the total
amount is due in 30 days
Allocating the transaction price to separate performance obligations - step 4
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Transaction prices are allocated to performance obligations based on relative fair
values
o Fair value is what the company could sell the good or service for on a
standalone basis (standalone selling price)
o If this information is not available, best estimates are used
Recognizing revenue when each performance obligation is satisfied - step 5
 A company satisfies its performance obligation when the customer obtains control
of the good or service
 Step 5 is performed for each performance obligation:
o For sale of goods, performance is at a point in time (delivery)
o Performance occurs when control of the good or service is transferred
to the customer. Consider whether the customer:
A. Is obligated to pay for the asset
B. Has legal title to the asset
C. Has taken physical possession
D. Bears the significant risk and rewards of ownership; or
E. Has accepted the asset (IFRS 15 paragraph 38)
Discussion - when do you feel revenue should be recognized in these scenarios? Why?
1. Starbucks sells a $50 gift card in December that will be a gift. The card is not
redeemable until January
2. WestJet sells a plane ticket for $450 and collects the fare in January, for a flight in
February over Spring Break
3. Canada's Wonderland amusement park sells a season pass for 2020 for $1,000 in
September 2019 and collects the cash in September 2019
 What's the performance obligation?
 What's the transaction price?
 When is the performance obligation satisfied?
Revenue recognition for Canadian private companies
 For private companies, recognize revenue when:
o Risks and rewards of ownership have transferred (not control of asset)
An earnings-based approach, ASPE (account standards
for private enterprises)
o Revenue must also be collectable and measurable (returns,
warranties, estimable)
o Usually, risks and rewards transfer when the goods are delivered
What are risks & rewards for Magnotta Winery, a private Canadian company?
o Plant vines
o Maintain vines
o Pick grapes
o Crush grapes
o Ferment
o Bottle
o Ship
o Collect payment
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Other revenue recognition issues
 Right of returns
o Companies must estimate expected returns
o Set up refund liability at time of sale
 Warranties
o Assurance warranty is part of product (no defects)
o Service warranty is a separate performance obligation
 Consignment
o Seller sells a 3rd party's consignor's inventory
o No revenue until sold (ex. used textbooks)
 3rd party sales
o Agents include only commission or fees (expedia)
o Agents get commission for arranging a sale
Statement of Income
 Two main formats:
o Single-step statement
o Multi-step statement
 Companies often use hybrid forms of these approaches, using elements of both
the multi-step and single-step formats in their income statements
Comprehensive Income
 Total change in shareholder's equity from non-owner sources
 Comprehensive income = net income + OCI
 Starts with net income and includes:
o Gains and losses from revaluation of F/S items to fair value
o Gains and losses from changes in foreign exchange rates
Expenses
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Accounting standards allow for expenses to be presented by:
o Function - what functional area of the business the expenses were
related to:
 Cost of sales, administrative activities, selling and
distribution activities, demand creation expense (Nike)
o Or Nature - what the expense actually was, rather than the purpose
for which it was incurred:
 Employee wages, depreciation expenses, cost of goods
sold, advertising expenses, rent expense
Earnings per share (EPS)
 Expresses net income available to common shareholders, on a per-share basis
o Most cited financial measures of a company's performance
o Must be on the face of income statement
o Basic earnings per share (EPS) = (net income - preferred dividends) /
weighted average number of common shares outstanding
WATCH PROBLEM VIDEOS TO PRACTICE
WEEK 4
Cash & Receivables Video 1
What is internal control?
 Internal control consists of the policies and procedures established and maintained
by management to assist in orderly and efficient conduct of business
 Objectives:
1. To improve the effectiveness of management decision making and the
efficiency of business processes
2. To increase the reliability of information (especially financial
reporting)
3. To foster compliance with laws, regulations, and contractual
obligations
How do F/S users know if internal control is working?
 Management must certify each quarter that its internal control over financial
reporting (ICFR) is effective
o National Instrument 52-109 certification of disclosure in issuers'
annual and interim filings (Canada)
o Sarbanes oxley act (SOX) 404 (US)
 How does management design and test whether ICFR are working? They use the
COSO Internal Control Framework
COSO Internal Control - Integrated Framework
 COSO 2013 framework has become the basis for evaluating ICFR (internal control
over financial reporting)
COSO principles of effective internal control
 Control environment (FYI only)
1. Demonstrates commitment to integrity and ethical values
2. Exercises oversight responsibility
3. Establishes structure, authority, and responsibility
4. Demonstrates commitment to competence
5. Enforces accountability
 Risk assessment
1. Specifies suitable objectives
2. Identifies and analyzes risk
3. Assesses fraud risk
4. Identifies and analyzes significant change
 Control activities
1. Selects and develops control activities
2. Selects and develops general controls over technology
3. Deploys through policies and procedures
 Information & communication
1. Uses relevant information
2. Communicates internally
3. Communicates externally
 Monitoring activities
1. Conducts ongoing and/or separate evaluations
2. Evaluates and communicates deficiencies
Cash
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Cash is a current asset on the SFP (balance sheet)
o Unless its use is restricted in some way
 Legally binding fund for bond retirement
 Cash set aside for employee benefits or replacement of
equipment
o Includes currency on hand, petty cash and funds on deposit in banks
o Money held in foreign banks is converted to Canadian dollars as of the
SFP date (gain or loss on foreign currency valuation)
Cash & cash equivalents
 Cash equivalents are:
o Liquid assets - easily sold (within 90 days)
o With insignificant risk of changes in value (shares are too risky)
o Convertible into a known amount of cash)
 Bank overdrafts are when cash is negative (overdraft; line of credit)
 Cash equivalents = liquid assets without risk, convertible into known cash - bank
overdrafts
Internal control as applies to cash
 A good internal control system over cash includes:
o Physical controls: securely store cash in locked safes, point-of-scale
(POS) terminals, and make regular bank deposits
o Assignment of responsibilities: ensure point-of-sale staff sign in during
shift and reconcile cash to sales at end of shift
o Separation (segregation) of duties: one person receives and handles
cash, another is authorized to sign cheques, and a third records cash
in and out in the accounting records. Duties are separated
o Independent verification: manager checks the bank reconciliation
each month; manager checks cashiers' cash-outs and returns
o Documentation: use of pre-numbered cheques, sales receipts, pointof-sale system reports
Internal controls over cash
 Cash is highly susceptible to theft
 Common internal control procedures
o Separate the handling of cash from access to accounting records to
that no single employee covers all aspects of a business transaction
 Segregation of duties (authorization, recording, custody)
o Separate approval of expenditures from the signing of cheques
o Make all payments by cheques/EFT and not cash
o Store cash in a locked safe; deposit to bank regularly
Bank reconciliation - a personal example
Bank reconciliation
 Must agree the bank's understanding of our cash position to our internal
accounting system
 Differences may be:
o Deposits in transit (outstanding deposits)
o Uncashed cheques (outstanding cheques)
Both valid timing differences, don't adjust! Time will
clear these
Unrecorded deposits or EFT's
Unrecorded bank charges
Errors by us or by the bank
 Need a journal entry to fix (unless a bank error, then
need a call to bank)
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o
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Bank reconciliation - format
Understanding debits and credits
Bank (your cash account is a
liability to the bank)
Cheque
Deposit
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Debit (decrease)
General ledger (GL) (cash is
an asset to the company)
Credit (decrease)
Credit (increase)
Debit (increase)
Bank and GL have opposite Dr/Cr balances (a source of confusion to many nonaccountants)
Accounts receivable (A/R)
 Also known as trade receivables
 When a firm allows its customers to pay later, but revenue recognition criteria are
met
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Other receivables include loans to employees, interest receivable, taxes receivable
Valuing accounts receivable
 How do we value A/R on the SFP?
o At the amount we expect will be collected
 NRV - net realizable value
Will be less than 100% (usually)
Need to estimate the uncollectable amount
Some companies don't estimate uncollectible amounts. They just write off A/R
when it is deemed uncollectible. This is called the direct write-off method and it is
not GAAP. When might it be used?
o Why is direct write-off not conceptually correct?
 The sales with A/R probably happened last year
 Write-offs do not usually happen until a lot of time has
passed
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
Cash & Receivables Video 2
What is the allowance for doubtful accounts and why do we use it?
 Allowance for doubtful accounts, AFDA, is a contra account connected to accounts
receivable (A/R)
o Has the opposite +/- sign as A/R
o Net A/R = A/R less AFDA
 Why do we use an allowance account and not adjust A/R directly?
o We want to retain original customer A/R data
o With an ERP or accounting software, A/R is a sub-ledger so it's not
possible to reduce A/R without adjusting a customer account
o AFDA is a general allowance made as a % of A/R or sales. We don’t
know which specific accounts will be uncollectable
Accounts receivable and allowance (ADFA)
Using the allowance account
1. Estimate amount which will not be collected (2 methods)
2. Increase allowance for doubtful accounts and bad debt expense for uncollectable
estimates, each FS reporting date
3. When true uncollectable accounts are known, write off by reducing allowance &
reducing accounts receivable. Estimates are coming true!

Recall, A/R net = A/R - allowance
Estimating uncollectables - two methods
 Percentage of sales (income statement approach):
o Bad debts expense = x% of credit sales
o Determine what the expense should be for the period. Matches with
sales
o Easy and can be used at quarter end, but does not measure NPV of
asset
 Percentage of receivables or aging method (balance sheet approach)
o Bad debts expense = x% of aged accounts receivable
o Determine what the allowance (AFDA) should be, and plug bad debt
expense in order for AFD to be measured correctly
o Conceptually better (primacy of asset measurement in IFRS)
Estimating Uncollectables - How to
1. Aging of accounts receivable
 At year end, detail length of time all receivables have been
outstanding
 Using past experience, estimate % of each category that will likely be
uncollectable
 Increase allowance to this amount
2. Percentage of sales
 At the end of each year, estimate % of bad debts based on past year's
credit sales
 Add this amount to the allowance account
Aging analysis
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
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Step 1: prepare aging analysis using information from the A/R subledger
Step 2: apply historical rates for each age grouping. (note how rates increase with
age of A/R)
Step 3: total the amounts determined for each age grouping; the total is the
required allowance for doubtful accounts
Allowance method journal entries
Allowance method T-accounts
Reporting receivables
 Show accounts receivable and its contra account "allowance for doubtful accounts"
on the balance sheet as a current asset (usually just net shown on balance sheet
and details in note)
Notes receivable
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Written promise (promissory note) to repay, so stronger legal claim to assets than
accounts receivable
A credit instrument that:
 Requires the payment of interest
 Extends for time periods greater than 30 days
Often accepted from higher-risk customers or those who need to extend payment
of an account receivable
The amount lent is the principal
Interest - principal x annual interest rate x fraction of one year
Asset management for receivables
F/S analysis - liquidity
 Liquidity - the ability to convert assets into cash to pay liabilities
 2 measures of liquidity introduced:
WEEK 5
Inventory Video 1
 Assets held for sale in the ordinary course of business
 Goods on hand for the retailer
 Materials, WIP, and finished goods for manufacturer
 Includes purchase costs less discounts, includes shipping & other costs to bring
product to location
Inventory, transportation costs
 Shipping terms can be either:
o F.O.B. shipping point: ownership of the inventory passes from the
seller to the buyer at the shipping point, and the buyer normally pays
the transportation costs, termed as freight-in
o F.O.B. destination: ownership of the inventory passes when the goods
are delivered to the buyer, and the seller is usually responsible for
paying the transportation costs, freight-out
o F.O.B. is short for free on board
Manufacturing sector
 Important for financial analyzing this sector
 Service sector
o Little inventory except for work-in-process
 Retail sector
o Inventory of merchandise for sale
 Manufacturing sector has 3 types of inventory (at least):
o Raw material inventory - unused parts or inputs
o Work-in-process inventory - incomplete goods
o Finished goods inventory - unsold products
Accounting for manufacturing costs
 All manufacturing costs become expenses only when the product is finally sold
 Production costs are an asset until they are sold. At the time, they become an
expense
 3 types of inventory:
o Raw material inventory
o Work-in-process inventory
o Finished goods inventory
 To cost of goods sold
Cost of goods sold (COGS) equation
 Beginning inventory + purchases = COGS + ending inventory
 Beginning inventory + purchases = cost of goods available for sale
Two methods of tracking inventory
 Periodic method
o Does not keep continual track of inventories and COGS
o Physical inventory count determines ending inventory quantity
o Keep track of goods bought in a purchases account
o Calculate cost of goods sold
o COGS = beg inv + purchases - ending inv
 Perpetual method
o
o
o
o
Continuously updates inventory account as goods are bought,
returned, or sold
UPCs and scanning
Can see inventory quantity and COGS from accounting records
Physical inventory counts still performed to confirm quantities
Periodic inventory records

Purchases is a temporary account that gets closed to zero
Cost of goods sold model in periodic system
 In a periodic system, an adjusting entry is needed to:
o Clear out purchases to zero
o Update the inventory G/L balance to actual
o Record COGS for the year
Perpetual inventory records
Cost of goods sold model in perpetual system
 In a perpetual system, the only adjusting entry needed is to record any shrinkage.
COGS has already been recorded
Inventory Video 2
Methods of allocating costs between inventory (SFP) and COGS (I/S)
 Which units are sold? Which units remain on hand?
 Methods:
1. Specific identification
 Used when: high value, not interchangeable
2. Cost flow assumptions (formula)
 Weighted average - used when units are
indistinguishable
 First-in, first-out (FIFO) - sell oldest units first
 Last-in, first-out (LIFO) - sell newest units first
 LIFO is not allowed in Canada for tax or F/S
3. Retail method
 Used when: constant markup
Inventory cost flow assumptions
 Ending inventory and COGS will differ, depending on which cost flow assumption is
used
Example company - FIFO
Example company - LIFO
Example company - weighted average - periodic
Example company - weighted average - perpetual
 Weighted average, perpetual system requires more calculations
 Also called the moving average since before each sale, you need to recalculate the
average cost of the inventory on hand
Inventory alternatives
 All are acceptable under GAAP so choose the method which best matches physical
flow of inventory
 Recall, LIFO is not allowed for reporting to the CRA or under IFRS but is allowed
under US GAAP
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Impact of cost flow assumptions on earnings & inventory, if prices are rising:
o LIFO
 Inventory values low (not reflective of recent cost)
 Cost of goods sold will be higher
 Lower net income since COGS is higher
o FIFO
 Inventory at recent cost, so high quality valuation
 Cost of goods sold will be lower
 Higher net income since COGS is lower
COGS = beg inv + purchases - end inv
So beg inv + purchases = COGS + end inv
LIFO required disclosure in US
 US companies who use LIFO must disclose how much cost to replace current
inventory exceed their carrying values on the SFP
 LIFO results in higher COGS, lower income and lower taxes (when prices rise)
 Earnings management is easy with LIFO, just produce less and sell old inventory
Inventory valuation
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
Important as influences both assets (SFP) and earnings (COGS)
Most inventory is valued using a cost-based system at "lower of cost and net
realizable value" or LC&NRV. Historically known as lower of cost of or market"
o Inventory is initially recorded at cost
o Inventory is valued at the lower of cost and net realizable value
(LC&NRV)
o Net realizable value (NRV) is the estimated selling price less the
estimated costs to complete and sell
o If inventory's NRV becomes lower than cost, then an inventory writedown is needed (inventory goes down, expense (usually COGS) goes
up)
Determining lower cost and NRV
 Cost and NRV should be compared on an item-by-item basis
Inventory errors
 If the inventory count is wrong, or if purchases are recorded incorrectly, then COGS
will be wrong too
If inventory is:
Overstated
Understated
Cost of goods sold
Understated
Overstated
Gross profit
Overstated
Understated
Net income
Overstated
Understated
Retained earnings Overstated
Understated
 Beginning inventory + purchases = COGS + ending inventory
Common ratios for inventory
 Inventory turnover:
o Cost of goods sold / average inventory
 Where average inventory = (beg inv + end inv)/2
o Measures number of times on average inventory was sold during the
period
 Gross margin ratio:
o Gross margin / sales
 Where GM = sales - COGS

Average days in inventory:
o 365 / inventory turnover
WEEK 6
Long-Term Assets Video 1
Property, Plant & Equipment (PPE)
 Major characteristics of PPE:
1. Acquired and held for use in operations and not for resale
2. Long-term in nature and usually subject to depreciation
3. Possess physical substance (tangible)
 Examples: land, building, equipment, and natural resource properties
 Also called capital assets, fixed assets, or long-lived assets
Initial costs to capitalize as a PPE asset:
 All costs required to acquire or self-construct the asset
o Purchase price less discounts, plus shipping, import duty & nonrefundable taxes
 And costs to prepare it for its intended use (installation, testing, training)
 And any dismantling or site restoration costs
 Professional judgement required!
 Examples:
o Land - title search, legal feels, demolition of old structure
o Building - construction permits, architectural design, construction
costs, interest on construction loans during construction (prior to use)
 Interest on loans that could have been avoided gets
capitalized
o Equipment - sales taxes, transportation and delivery, installation and
testing
Basket purchase (bundle or lump-sum purchase)
 When a company purchases multiple assets for one sale price
o Allocate the purchase price using the assets' relative fair value at time
of purchase
o
Allocated costs add up in total to purchase price
Capitalization vs Expense

A capitalization limit (cap limit) establishes a $ limit, below which all purchased
assets will be expensed. (cost/benefit)
Replacements versus repairs
 Companies incur expenditures related to existing assets
o Issue is whether the additional subsequent expenditures have future
benefit
 Expense expenditures that would normally be considered repairs and maintenance
to maintain asset in operating condition
o Example: oil change on engine
 Capitalize replacements of significant asset components
o Example: engine overhaul
ASPE (Canadian private enterprise) requirements
 IFRS has replacement/repair classification whereas
 ASPE refers to betterment/maintenance classification:
o Expenditures that enhance the quality or quantity of output are
betterments
 Betterments are capitalized (can simply add to asset's
carrying value)
o If capitalization requirement is not met, expense as repairs &
maintenance
Depreciation
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Systematic (yet arbitrary) process of cost allocation
o Spreads the cost of PPE over its economic useful life
o Why establish a systematic way to spread costs? Why not let
management choose expense each year?
 Financial information is more comparable, reliable for
investors
Depreciation matches costs to the benefit period
o Does NOT attempt to value the assets (what PPE is worth today)
Depreciation is synonymous with depletion and amortization
o
o
o

Depreciation - tangible human-made assets
Depletion - tangible natural resources
Amortization - intangible assets
Land is NOT depreciated, its useful life is infinite
Depreciation - key estimates
 Useful life: how long will we use this asset?
 Residual value: amount expected to be currently obtainable from the disposal of
the asset (less disposal costs)
o Residual value often ignored - simpler, may be immaterial
o Not used in declining balance method rate calculation (but, don't
depreciate past residual value, using declining balance method)
 Pattern of depreciation: what best reflects how the economic benefits are used?
o Same each year (uniform) - straight line method
o Decreasing/diminishing
o Fluctuating
 If management's best estimates are wrong - no problem, will change them going
forward
Depreciation methods
1. Straight-line method
 Simple to use
 Assumes:
 Constant usage over life
 Repair costs same each year
 Depreciation = (cost - residual value)/useful life
2. Diminishing balance method
 Can match assets' productivity to cost
 More depreciation in earlier years when asset has greatest benefit
 Depreciation = carrying value x diminishing balance rate
 Where:
 Carrying value = (cost - accumulated depreciation)
 Aka Net Book Value
3. Units of production
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Only appropriate where usage is not a function of time
Can be hard to estimate total number of units over life of asset
Depreciation per unit = (cost - residual value)/total life in units
Keep in mind
 In straight-line and units of production methods, deduct residual value in
calculation
o Depreciable amount is depreciated under straight line and units of
production
o Depreciable amount = cost - residual value
 In diminishing balance method, do NOT deduct residual value
o Apply % to carrying value
o Stop depreciating when net book value reaches residual value
Matching revenues and depreciation
Straight-line and diminishing (declining balance) methods
 Assume:
o $40,000 machine, $4,000 residual value, 5 year life
 Straight-line depreciation = ($40,000 - $4,000) / 5 = $7,200
 Straight-line rate = 100%/5 = 0.2 = 20%
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Declining balance - ignore residual value
At 35% rate:
o $40,000 x 0.35 = $14,000
o Carrying value = $40,000 - $14,000 = $26,000
o In year 2, take carrying value ($26,000) multiply by 35%
Total expense in year 5 = amortization of $2,499 + loss on retirement of $641*
Units of production method
 Assume: we purchased an extrusion machine which can extrude 1,000,000 metres
of plastic molding
 Cost of machine = $400,000; residual value = $50,000
 Depreciation per metre
o (cost - residual value)/total units
o ($400,000 - $50,000) / 1,000,000 metres
o $350,000 / 1,000,000
o $0.35 per metre
Long-Term Assets Video 2
Other depreciation considerations
 Need to have a policy regarding partial-year depreciation for assets acquired or
disposed of during the year
o Depreciate to the nearest month (let’s assume for our class)
 Depreciation expense for partial period = annual depreciation expense x (# of full
months/12)
o

Full or half year in year of acquisition (this is what CRA does for tax purposes)
and/or disposal (CRA has none in year of disposal)
Need to separately depreciate significant components of PPE asset (but
components can be grouped if same useful life and depreciation methods)
Example company - straight line
 Cost = $200,000, life = 5 years, residual value = $25,000
o Straight-line per year = ($200,000 - $25,000)/5 = $35,000
o Straight-line rate = 100%/5 = 0.2 = 20%
Example company - double-declining balance
 Cost = $200,000, life = 5 years, residual value = $25,000
o Straight-line rate = 100%/5 = 0.2 = 20%
o Double-declining rate = 20% x 2 = 0.4 = 40%

Cannot have depreciation too high that makes carrying value lower than residual
value (year 5)
Impairment
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
Impairment is a permanent decline in the future benefit of an asset
Companies search for indicators of impairment annually, and if impairment exists,
an entry is made
o
Loss from impairment
xxx
Accumulated impairment loss
xxx
 In reality, impairment is often credited to accumulated
depreciation out of simplicity
Retirement or sale of PPE
 Steps:
1. Catch up on depreciation to month of sale
2. Record cash received if sold (if any)
3. Remove original cost from asset account
4. Remove accumulated depreciation for the asset retired/sold

Example: sell equipment with carrying amount of $25,000 for $23,5000 cash
proceeds
1. Loss of $1,500
2. Loss on sale = cash proceeds - carrying value

Example: sell equipment with carrying amount of $25,000 for $31,000 cash
o Gain on sale of $6,500 (cash proceeds - carrying value)
Revaluation model for PPE under IFRS
 So far, we have covered the cost model, on SFP at (cost-depreciation)
 IFRS also allows the revaluation model, where write-up's allowed
Intangible assets
 An identifiable non-monetary asset without physical substance
o Recall, to be an asset, must also provide future benefits & be
controlled by entity
1. Lack of physical substance
o Tangible portion is incidental to the value of the item (ie, patent
certificate, computer program)
2. Non-monetary nature
o Some assets that lack physical substance are not intangible assets
o Assets may be financial in nature and non intangibles (ie, accounts
receivable, bond investments)
3. Identifiability
o Able to distinguish and separate from other items (ie could sell it)
o Hold legal rights to this asset
Intangible assets - types
Common types:
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Copyright - on intellectual property
o Up to life of author + 50 years
Franchise - run an outlet
o Life of the agreement
Trademark - on a symbol or name
o 15 years, can be renewed indefinitely
Brand names
o Indefinite life
Research and development costs
o Expense research costs as incurred - uncertain benefits
o Capitalize development (applied research) costs - prototypes
 If costs are identifiable and firm has ability/intention to
market product in near future
Amortization of intangible assets
 Intangibles with finite useful lives
o Allocate (amortize) cost over useful life to match cost to benefits
 Useful life is the lesser of legal life and economic life
o Amortization = cost/estimated useful life
 No residual value
o Example - a patent (20 year legal life)
 Intangibles with indefinite useful lives
o No reasonable basis for specifying the period over which to allocate
the cost
o So must annually evaluate asset for impairment
o Example - a registered trademark in Canada can be renewed
indefinitely (15-year increments)
Goodwill
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Goodwill is the difference between the purchase cost of a business and the fair
value of identifiable assets net of liabilities
o Goodwill is distinct from other intangible assets
 Because goodwill is not identifiable. It is a residual
(leftover) amount
o Goodwill is a separate type of asset
o It is tested for impairment, not amortized
Goodwill only arises from the purchase of a business
o Companies that have never acquired another business cannot have
goodwill
Economic goodwill (excellent customer service, social responsibility, branding, etc.)
is NOT accounting goodwill
IFRS says internally generated goodwill shall not be recognized as an asset
Financial Statement Analysis
 Average age %
o

How much have PPE assets been depreciated?
Average age
o

How many years has PPE been used?
Fixed asset turnover
o
How effectively can they generate sales based on investment in PPE