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Financial Statements Andrew Graham Queens University School of Policy Studies Two Lectures Cash Flows Income Statement S/H Equity Stmt Balance Sheet Comp. Inc. The Road to Financial Statement Enlightenment Should I stop and ask for directions? Warning! All numbers are not the same!

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financial statements

Financial Statements

Andrew Graham

Queens University

School of Policy Studies

Two Lectures

slide2

Cash Flows

Income Statement

S/H Equity Stmt

Balance Sheet

Comp. Inc.

The Road to Financial Statement Enlightenment

Should I stop and ask for directions?

Canadian Public Sector Financial Management

slide3

Warning! All numbers are not the same!

A number must be kept in context with the financial statement where it is presented…

Canadian Public Sector Financial Management

beware of financial vertigo
Beware of Financial Vertigo
  • Easy to get confused with terminology
  • Much of what passes for complexity in financial statements is a terminology issue
  • Sometimes this is counterintuitive – debits and credits as an example
  • Terminology used often has the same meaning, e.g. revenue and income do not mean the same thing

Canadian Public Sector Financial Management

purpose of financial statements
Purpose of Financial Statements
  • To establish the basic rules and assumptions that are used to provide financial information
  • They will tell the accountant and end user what financial items are to be measured and when and how to measure them.

Canadian Public Sector Financial Management

slide6

Source: Public Service Accounting Board, CICA

Canadian Public Sector Financial Management

section 1 the accounting cycle
Section 1The Accounting Cycle

Canadian Public Sector Financial Management

the accounting cycle
The Accounting Cycle

The accounting process is a series of activities that begins with a transaction and ends with the closing of the books. Because this process is repeated each reporting period, it is referred to as the accounting cycle and includes these major steps:

  • Identify the transaction or other recognizable event.
  • Prepare the transaction's source document such as a purchase order or invoice.
  • Analyze and classify the transaction.
  • Record the transaction by making entries in the appropriate journal. Such entries are made in chronological order.

Canadian Public Sector Financial Management

the accounting cycle10
The Accounting Cycle
  • Post general journal entries to the ledger accounts.

The above steps are performed throughout the accounting period as transactions occur or in periodic batch processes. The following steps are performed at the end of the accounting period:

  • Prepare the trial balance to make sure that debits equal credits.
  • Correct any discrepancies in the trial balance. If the columns are not in balance, look for math errors, posting errors, and recording errors. Posting errors include:
        • posting of the wrong amount,
        • omitting a posting,
        • posting in the wrong column, or
        • posting more than once.

Canadian Public Sector Financial Management

the accounting cycle11
The Accounting Cycle
  • Prepare adjusting entries to record accrued, deferred, and estimated amounts.
  • Post adjusting entries to the ledger accounts.
  • Prepare the adjusted trial balance. This step is similar to the preparation of the unadjusted trial balance, but this time the adjusting entries are included. Correct any errors that may be found.
  • Prepare the financial statements.
      • Income statement: prepared from the revenue, expenses, gains, and losses.
      • Balance sheet: prepared from the assets, liabilities, and equity accounts.
      • Cash flow statement: derived from the other financial statements using either the direct or indirect method.

Canadian Public Sector Financial Management

the accounting cycle12
The Accounting Cycle
  • Prepare closing journal entries that close temporary accounts such as revenues, expenses, gains, and losses.
  • Post closing entries to the ledger accounts.

Canadian Public Sector Financial Management

the accounting cycle13
The Accounting Cycle
  • Prepare the after-closing trial balance to make sure that debits equal credits.
  • Prepare reversing journal entries (optional).

Canadian Public Sector Financial Management

section 2 the fundamental accounting equation
Section 2The Fundamental Accounting Equation

Canadian Public Sector Financial Management

the fundamental accounting equation definitions
The Fundamental Accounting Equation - Definitions

The Basic Logic of the Equation: What you have minus what you is what you are worth.

  • Assets = Have
    • Economic resources owned by the organization that are expected to be of benefit to it in the future
    • Rights owed that have a monetary value e.g. right to collect fees
    • Cash. Office supplies, inventory, furniture, land and buildings

Canadian Public Sector Financial Management

the fundamental accounting equation definitions16
The Fundamental Accounting Equation - Definitions

Grouping of assets for presentation on Financial Reports:

  • Very liquid – cash and securities
  • Assets for immediate use - inventory
  • Productive Assets – plant and machinery
  • Accounts receivable
  • Fixed Assets – capital holdings
  • Restricted Assets – non-mission holdings or assets held subject to highly restrictive conditions.

Canadian Public Sector Financial Management

the fundamental accounting equation definitions17
The Fundamental Accounting Equation - Definitions
  • Liabilities = Owe
    • Outsider claims which are economic obligations payable to outsiders
    • Outside parties are called creditors

Canadian Public Sector Financial Management

the fundamental accounting equation definitions18
The Fundamental Accounting Equation - Definitions
  • Equity or Capital = Value to Owners = Worth
    • Insider claims to the organization’s assets
    • From a public sector perspective, it reflects the public holdings that remain after transactions – these can be both assets and debts
    • An owner has a claim to the entity’s assets because he or she has invested in the business
    • Amount of an entity’s assets that remain after the liabilities are subtracted
    • Often referred to as net assets

Canadian Public Sector Financial Management

the fundamental accounting equation definitions19
The Fundamental Accounting Equation - Definitions
  • All receivables are assets
  • All payables are liabilities

Canadian Public Sector Financial Management

the fundamental accounting equation definitions20
The Fundamental Accounting Equation - Definitions
  • Capital stock – amount invested in the corporation by its owners
  • Retained Earnings – amount earned by income-producing activities and kept for use in the organization
  • Net Income, Earnings, Profit or Loss – result of taking total revenues and total expenses into account over a specified period

Canadian Public Sector Financial Management

the fundamental accounting equation
The Fundamental Accounting Equation

Assets = Liabilities + Equity

or Assets - Liabilities = Equity

What you own minus what you owe is what you are worth.

Canadian Public Sector Financial Management

slide22

Assets = Liabilities + Equity

What you own - What you owe = What you are worth

The Fundamental Accounting Equation

Claims by

Outsiders

Resources

Sources of Resources

Equation must always be in balance!

Canadian Public Sector Financial Management

components of retained earnings flow chart to better understand financial statements
Components of Retained Earnings: Flow Chart to Better Understand Financial Statements

Revenues of the Period

minus

Expenses for the Period

equals

Net Income (or Net Loss) for the Period

Beginning Balance of Retained Earnings

Ending Balance of Retained Earnings

Dividends for the Period

plus or

minus

minus

equals

Canadian Public Sector Financial Management

section 3 recording financial information
Section 3Recording Financial Information

Canadian Public Sector Financial Management

slide25

Recording Financial Information

  • A financial event is one that affects the fundamental

accounting equation by changing any of its components: Assets = Liabilities + Net Assets

  • A journal is a chronological listing of every financial event

that occurs in an organization.

  • Every type of asset, liability, revenue, or expense is referred to as an account. Organizations may have as many accounts as they need.

Canadian Public Sector Financial Management

recording financial information debits and credits
Recording Financial Information – Debits and Credits
  • Financial events are recorded as a series of debitsand credits
  • Increases in assets are recorded by debits and decreases are recorded by credits.
  • Increases in liabilities and in owner's equity are recorded by credits and decreases are recorded by debits.

Canadian Public Sector Financial Management

recording financial information debits and credits27
Recording Financial Information – Debits and Credits
  • Notice that the debit and credit rules are related to an account's location in the balance sheet. If the account appears on the left-hand side of the balance sheet (asset accounts), increases in the account balance are recorded by left-side entries (debits).
  • If the account appears on the right-hand side of the balance sheet (liability and owner's equity accounts), increases are recorded by right-side entries (credits).

Canadian Public Sector Financial Management

slide28

Debits, Credits and the T-Account

Increases are recorded on one side of the T-account, and decreases are recorded on the other side.

Title of Account

Left or Debit Side

Right or Credit Side

Canadian Public Sector Financial Management

slide30

ASSETS

LIABILITIES

NET ASSETS

Debit for Increase

Credit for Decrease

Debit for Decrease

Credit for Increase

Debit for Decrease

Credit for Increase

Debit and Credit Rules

Debits and credits affect accounts as follows:

A=L+NA

Canadian Public Sector Financial Management

slide31

A Sample Transaction

  • Suppose HOS buys inventory for $2,000. We could just add it to assets. But, that puts the Fundamental Equation out of balance.

Assets = Liabilities + Net Assets $2,000 = no change + no change

  • In a sense, we have not "paid" for the supplies. Suppose the

seller sent HOS a bill. We would record the full transaction as:

Assets = Liabilities + Net Assets Supplies Accounts Payable

+ $2,000 = + $2,000 + no change

  • To record a financial event, at least two elements of the

fundamental equation must change!

Canadian Public Sector Financial Management

slide32

A One-Sided Change Example

  • Not every financial event (transaction) results in changes to both sides of the fundamental equation. Suppose HOS paid for the inventory in cash. Then the transaction would have

been recorded as follows:Assets = Liabilities + Net Assets Inventory Cash + $2,000 - $2,000 = no change + no change

  • The fundamental equation is still in balance. But, all of the

changes occurred on the left side of the equation.

Canadian Public Sector Financial Management

slide33

Recording Transactions

  • The first step in recording a transaction is determining what has happened and what accounts will be impacted.
  • Suppose near the end of the year, HOS buys a one-year insurance policy for $100 and pays for the policy in cash. Two things have happened:

- Cash has gone down by $100.

- HOS owns a new $100 asset called "prepaid insurance."

  • Here's the way the transaction would be recorded:Assets = Liabilities + Net Assets P/I Cash + $100 - $100 = no change + no change

Canadian Public Sector Financial Management

slide34

Another Example

  • HOS mails a cheque to its bedpan supplier for $2,000 to pay part of the $7,000 it owed them at the start of the year. Two things have happened:

- Cash has gone down by $2,000.

- HOS's accounts payable have decreased by $2,000.

  • Here's the way the transaction would be recorded:Assets = Liabilities + Net Assets Cash = Accounts Payable - $2,000 = - $2,000 + no change

Canadian Public Sector Financial Management

slide35

A Non Transaction

  • HOS signs a binding contract to buy an X-Ray machine that will cost $50,000.
  • This event will not give rise to a journal entry because it does not meet the rules for recognition.

- The value of the transaction is known.

- The timing of the transaction is known.

- But, HOS does not yet own the equipment. There has been no exchange. So HOS does not owe the money. No liability unless we owe the creditor.

Canadian Public Sector Financial Management

slide36
Section 4The Long March Through Financial Statements beginning with the Statement of Financial Position or Balance Sheet

Canadian Public Sector Financial Management

slide37

Balance Sheet

Balance Sheet

Cumulative Transactions

Income Statement

Income Statement

Current Period Transactions

There are only

5

types of accounts in the accounting world

Assets

Liabilities

Equity

Revenue

Expense

Canadian Public Sector Financial Management

slide38

There are only

5

Formal Financial Statements

Balance Sheet

Income Statement

Statement of Cash Flows

Statement of Shareholders’ Equity

Statement of Comprehensive Income

Canadian Public Sector Financial Management

the principal financial statements of an organization

Balance Sheet

Income Statement

Statement of Cash Flows

The Principal Financial Statements of an Organization

All Governed by Accounting Policies of the Organization – an integral part of the financial statements

Canadian Public Sector Financial Management

slide40

Describes where the organization stands at a specific date.

Balance Sheet

Income Statement

Statement of Cash Flows

Canadian Public Sector Financial Management

slide41

Balance Sheet

Depicts the revenue and expenses for a designated period of time.

Income Statement

Statement of Cash Flows

Canadian Public Sector Financial Management

slide42

Balance Sheet

Income Statement

Statement of Cash Flows

Depicts the ways cash has changed during a designated period of time.

Canadian Public Sector Financial Management

slide43

The Balance Sheet

Assets = Liabilities + Equity

The Income Statement

Revenues - Expenses = Net Income

Statement of Cash Flows

Reconciliation of the Change in Cash and Cash Equivalents

Statement of Shareholders’ Equity

Reconciliation of the Changes in the Owners’ Equity Accounts

Statement of Comprehensive Income

Reconciliation of Fair Value Changes and Adjustments

Operating Liabs

Short-term & Long-term Debt

Paid-in Capital + Retained Earnings + Accum. Other Comprehensive Income

Canadian Public Sector Financial Management

statement of financial position or the balance sheet
Statement of Financial Position or The Balance Sheet

The Balance Sheet reports:

Has Today = Owes today + Worth today

A Snapshot in time

Canadian Public Sector Financial Management

slide45

Statement of Financial Position

(The Balance Sheet)

Balance sheets report:

- what an organization owns (Assets),

- what it owes to outsiders (Liabilities), and

- the portion of the organization's assets owned by its owners. Called:

    • Owner's Equity, Partner's Equity, Net Worth, or

Stockholders’ Equity (for-profit organizations).

    • Net Assets or Fund Balance (not-for-profit and governments).
  • at a specific point in time.
  • For example, at the end of the organization's Fiscal Year.

Canadian Public Sector Financial Management

slide46

Meals for the Homeless Balance Sheet

Canadian Public Sector Financial Management

slide47

Current and Long-Term Assets

  • Assets on the balance sheet are divided into current or short-term (those that are cash or cash-equivalents or are expected to become cash or will be used up within twelve months) and long-term (those that will not).
  • Short-Term or Current Assets are listed in order of declining liquidity and normally include:

- cash and cash equivalents,

- marketable securities,

- accounts receivable,

- inventory, and

- prepaid expenses (long-term prepaid expenses are called Deferred Charges)

Canadian Public Sector Financial Management

cash and cash equivalents
Cash and Cash Equivalents
  • The ultimate liquid assets
  • Includes all forms of immediately available funds, including bank deposits
  • Always denominated in Canadian funds even if foreign currencies being held

Canadian Public Sector Financial Management

slide49

Marketable Securities

  • Marketable securities include equity and debt instruments that can be bought and sold in public and private markets.
  • The values of marketable securities are reported by governments and not-for-profit organizations at fair market value.
  • If there is any dispute about fair market value, then cost is used to provide a value.

Canadian Public Sector Financial Management

accounts receivable
Accounts Receivable
  • When an organization produces a product, service or obligation for another entity and it is transferred to the entity, the organization acquires the right to collect the money from that entity – this establishes a receivable account
  • An accounts receivable entry is made when this occurs but before the entity pays for it
  • Knowing what the outstanding accounts receivable are for the organization is an important indicator of its anticipated income, the degree to which is it efficiently collecting for its services and the degree to which it is carrying debt that it should collect

Canadian Public Sector Financial Management

inventory
Inventory
  • Inventory is both the finished products held by the organization for sale to an outside buyer and the products used to make the finished product
  • Three kinds of inventory:
    • Raw material inventory
    • Work-in-progress inventory
    • Finished goods inventory

This becomes an accounts receivable when it is sold and cash when the customer pays for it.

Canadian Public Sector Financial Management

pre paid expenses
Pre-paid expenses
  • Financial obligations that the organization has already paid for but not yet received
  • Examples are: insurance, rent, deposits made with suppliers, salary advances
  • They are current assets not because they can be turned into cash, but because the organization will have to use cash to pay for them in the near future and they are generally available for consumption within the twelve month period

Canadian Public Sector Financial Management

current asset cycle a way to think of the relationship of these categories
Current Asset Cycle – a way to think of the relationship of these categories

This is why they are called “Working Assets”

Cash

Accounts

Receivable

Inventory

Canadian Public Sector Financial Management

slide54

Long-Term Assets

Long-Term Assets are generally divided into three categories:

  • Fixed Assets, which include:
      • property (land) usually recorded at cost,
      • plant (buildings) recorded at cost and reported at net book value, and
      • equipment recorded at cost and reported at net book value
  • Investments, and
  • Intangibles

Canadian Public Sector Financial Management

fixed assets
Fixed Assets
  • Productive assets not intended for sale.
  • They will be used over and over again to produce value to the end product of the organizations
  • Commonly include land, buildings, machinery, equipment, furniture, vehicles, etc.
  • Normally reported on Balance Sheet in Net Fixed Asset format: blued at original cost minus an allowance for depreciation

Canadian Public Sector Financial Management

slide56

Net Fixed Asset Determination

  • Recorded at cost when acquired.
  • Reported net of accumulated depreciation on the balance sheet.

Suppose an organization buys a van for $30,000 and expects to use it for five years and sell it for $5,000. Assuming that the van will be used up evenly over the five years, how would its value appear on the balance sheet at the end of two years?

Canadian Public Sector Financial Management

slide57

Record the Van at Cost = $30,000

Subtract two years of depreciation

[($30,000 - $5,000 salvage)/5 yr life] x 2 = $10,000

Net Book Value =

$30,000 cost - $10,000 Accumulated Depreciation = $20,000

A Net Book Value Example

Canadian Public Sector Financial Management

slide58

Fixed Assets on the Balance Sheet

All three values - cost, accumulated

depreciation, and net book value are shown.

Museum A Museum B

Are these two museums really similar or different?

Canadian Public Sector Financial Management

slide59

Recognizing Asset Transactions

  • Financial events are recorded at the time of Recognition
  • Asset transactions are recognized when:

- they are owned by the organization,

- they have a monetary value,

- that monetary value can be objectively determined.

Canadian Public Sector Financial Management

recognizing asset transactions
Recognizing Asset Transactions
  • Which of the following should be recognized as assets?
    • the amount due on a bill sent to a client?
    • an overhead projector?
    • a fundraising mailing list developed in an organization?

Canadian Public Sector Financial Management

can intangible assets appear on a balance sheet
Can Intangible Assets Appear on a Balance Sheet?
  • What are intangible assets? An asset that has no substance or physical properties. Intangible assets include goodwill, patent rights, permits, copyrights and licenses.
  • How are they assets? An intangible is any event that creates or modifies perceptions of the future behavior, value or relevance, of the organization but that are seen as usable assets that can be converted into (ultimately) cash.

Canadian Public Sector Financial Management

can intangible assets appear on a balance sheet62
Can Intangible Assets Appear on a Balance Sheet?
  • Intangibles, intangible assets, knowledge assets and intellectual capital are more or less synonyms. All are widely used – intangibles specifically in the accounting literature, knowledge assets by economists and intellectual capital predominantly in the management literature.
  • Intangibles create future value. All intangibles are future-oriented. (Because of this they are ignored by traditional accounting systems – conservatism concept, materiality concept).
  • Rule of quantification – slippery slope of quantification
  • Good will and knowledge assets………

Canadian Public Sector Financial Management

slide63

ASSETS

LIABILITIES & NET ASSETS

Current Assets

Liabilities

Cash

$ 1,000

Current Liabilities

Marketable Securities

3,000

Wages Payable (Accrued Expenses)

$ 2,000

Accounts Receivable, Net

55,000

Accounts Payable

2,000

Inventory

2,000

Notes Payable

6,000

Prepaid Expenses

1,000

Current Portion – Mortgage

4,000

Total Current Assets

$62,000

Total Current Liabilities

$ 14,000

Long-Term Assets

Long-Term Liabilities

Fixed Assets

Mortgage Payable

$ 12,000

Property

$ 40,000

Total Long-Term Liabilities

$ 12,000

Equipment, Net

35,000

Investments

8,000

TOTAL LIABILITIES

$ 26,000

Total Long-Term Assets

$ 83,000

NET ASSETS

119,000

TOTAL ASSETS

$145,000

TOTAL LIABILITIES & NET ASSETS

$145,000

Meals for the Homeless

Balance Sheet

Canadian Public Sector Financial Management

slide64

Liabilities

  • Liabilities are economic obligations of the organization such as money that it owes to lenders, suppliers, employees, etc.
  • Like assets, liabilities are categorized as short term and long term depending on when they are due for payment.
  • Can be categorized and groups for presentation on the balance sheets by:
      • To whom the debt is owned and
      • Whether the debt is payable within the year

Canadian Public Sector Financial Management

short term or current liabilities
Short-term or current liabilities
  • Generally consist of:
    • specific "payables" which are typically due within a specified period, usually the current fiscal year, e.g. wages or salary payable
    • Generally have the following groupings:
      • Accounts payable to suppliers
      • Accrued expenses owed to employees and other for services
      • Current debt owed to lenders
      • Taxes owed

Canadian Public Sector Financial Management

accrued expenses wage payable
Accrued Expenses – Wage Payable
  • Monetary obligations similar to accounts payable
  • Some flexibility on how these categories are used
  • Generally accrued expenses involve financial obligation within the organization
  • Therefore, this often records salary earned but not yet paid, interest due but not yet paid on bank debt, pension buy-outs, outstanding training costs

Canadian Public Sector Financial Management

accounts payable
Accounts Payable
  • Bills, generally to other organization for material sand equipment bought on credit, that must soon be paid
  • When it receives materials, the organization can either pay for them immediately with case or wait and let what is owed become an account payable
    • notes payable – i.e., short-term loans, and that portion of long-term debt which is due during the coming year.

Canadian Public Sector Financial Management

notes payable current portion of debt
Notes Payable/Current Portion of Debt
  • Short-term obligations that are payable in a year or less
  • Brings in long-term obligations, but only the amount to be spent within the year to discharge it

Canadian Public Sector Financial Management

slide69

Long-Term Liabilities

  • Long-Term Liabilities included in Liabilities section is the current portion of the long-term liability that would have to be paid in the next 12 months:

- Long-Term Debt,

      • Capital Leases
      • Long-Term Unsecured Loans
      • Mortgages
      • Bonds Payable

- Pension Liabilities, and

- Contingent Liabilities.

Canadian Public Sector Financial Management

slide70

Amortizing Long-Term Debt

  • Suppose that Meals buys a delivery van for $32,000.
  • It finances $25,000 of the purchase price with a five-year loan at 8% interest per annum.
  • The loan calls for annual payments (in arrears) of $6,261.41.
  • How much of each year's payment would be interest?
  • What would be the amounts shown on the Balance Sheet at the end of year 3?

Canadian Public Sector Financial Management

amortizing long term debt
Amortizing Long-Term Debt

End of Year 3 Bal. Sheet: Short-term Liability $5,368; Long-term Liability $5,798.

How was the $6,261.41 calculated?

Canadian Public Sector Financial Management

slide72

Liability Recognition

  • Liabilities are recognized when:
    • they are legally owed,
    • have to be paid, and
    • the amount to be paid can be objectively
    • measured.
  • Which of the following should be recognized as a liability?
    • a bill received from a vendor?
    • wages that are due to a worker?
    • a $5 million lawsuit filed against an organization?

Canadian Public Sector Financial Management

slide73

Net Asset Categories

  • The amount of total assets minus total liabilities equals equity. Because equity is equal to the net difference between assets and liabilities, it is also called net assets.
  • Both ‘net worth’ and ‘book value’ hold the same meaning as ‘net assets’ and ‘shareholder value’
  • The net worth of an organization represents the sum of the organization's earnings from inception plus any paid-in capital (in for-profits) less any payments that have been made to the organization's owners. Also call Capital Stock
  • Retained earnings: money that is held after all liabilities have been discharged and not used for assets – can also be negative value, i.e. debt

Canadian Public Sector Financial Management

net asset categories
Net Asset Categories
  • In not-for-profit organizations, net worth is called "Net Assets" and is broken down into three categories.
    • Unrestricted Net Assets, which have not been restricted by donors (also cumulative profits appear here).
    • Temporarily Restricted Net Assets, the use of which has been restricted by donors.
    • Permanently Restricted Net Assets, which are restricted in perpetuity.

Canadian Public Sector Financial Management

slide75

Balance Sheet with Net Asset Categories

Canadian Public Sector Financial Management

section 5 generating a balance sheet
Section 5Generating a Balance Sheet

Canadian Public Sector Financial Management

slide77

Generating a Balance Sheet

  • Generating a balance sheet involves:
    • Beginning with the starting balance sheet,
    • Recording all of the transactions for the period,
    • Adding the impact of the transactions to the starting balance sheet,
    • Formatting the resulting balance sheet accounts into the balance sheet reporting format.

Canadian Public Sector Financial Management

slide78

The Starting Balance Sheet

Canadian Public Sector Financial Management

slide79

Transactions Work Sheet

ASSETS LIABILITIES & NA

Canadian Public Sector Financial Management

slide80

The Ending Balance Sheet

Canadian Public Sector Financial Management

slide81

Section 6The Income Statement or Statement of Operations (Also called Activity Statement, Statement of Revenues and Expenses, or Profit and Loss (P&L) Statement)

Canadian Public Sector Financial Management

what is an income statement
What is an Income Statement?
  • Reports on cash movements in the organization
  • Statement of cash movement for a specific period of time, usually a quarter, month or year – a specified period of time.
  • Unlike a Balance Sheet which is a snapshot of a specific day

Canadian Public Sector Financial Management

what is an income statement83
What is an Income Statement?
  • Linkage is that the net income for this year as shown on an Income Statement is added to Retained Earnings on the Balance Sheet to show increase/decrease in Net Assets as a result of this year’s income
  • Therefore, the Income Statement shows for a period all the transactions taken by the organization to either increase assets or decrease liabilities on the Balance Sheet
  • Key tool in financial control and budgetary management: used to inform of current financial situation, identify surplus/deficits, measure performance

Canadian Public Sector Financial Management

basic income statement formula
Basic Income Statement Formula

Revenues – Expenses = Net Income (Net Loss)

Canadian Public Sector Financial Management

slide85

Meals for the Homeless

Activity Statement

Canadian Public Sector Financial Management

the income statement revenues and support
The Income Statement: Revenues and Support
  • represent inflows that the organization has received or is entitled to receive.
  • result in an inflow of Assets to the organization and an increase in Net Assets.

Canadian Public Sector Financial Management

the income statement revenues and support87
The Income Statement: Revenues and Support
  • Revenues are generally the result of an exchange for goods and services that the organization has provided or budgetary decisions that a government makes
  • Support is the result of gifts, grants, and other contributions to the organization.
  • Category of other income from fees or non-tax income streams

Canadian Public Sector Financial Management

slide88

Expenses and Net Income

  • Expenses represent the recognition of the use of an asset to generate revenue and support or otherwise carry on the operations of the entity which result in an outflow of assets and a decrease in Net Assets.
  • Net Income is the difference between revenues and support and expenses.

Canadian Public Sector Financial Management

expenses and net income
Expenses and Net Income
  • Profits are an excess of revenues over expenses. Also called a surplus or increase in net assets.
  • Losses are an excess of expenses over revenues. Also called a deficit or decrease in net assets.

Canadian Public Sector Financial Management

cost vs expense
Cost vs. Expense
  • Cost describes how money is spent to build inventories or add to plant or capacity
  • Expense is any other operating expenditure.
  • Note: An expenditure can be either a cost or an expense. Expenditure simply means the use of cash to pay for an item purchased.

Canadian Public Sector Financial Management

slide91

Recognizing Revenue and Support

  • Revenue is recognized if:

- the goods or services have been provided,

    • - the amount to be collected can be objectively measured,
    • - there is a reasonable likelihood of collection.
  • Support is recognized if:

- all of the conditions of the gift have been met,

- the value of the pledge can be objectively measured, and

- there is a reasonable likelihood of collection.

Canadian Public Sector Financial Management

slide92

Recognizing Expenses

  • Expense Recognition depends on the type of expense:

- Product costs are those directly connected to providing goods and services. They are recognized based on the matching principle, which holds that expenses should be recorded in the same period as the revenue they were used to generate.

- Period Costs, like rent, are those related to the passage of time. They are recognized in the time period they are incurred.

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Expired and Unexpired Costs

  • Suppose Meals bought 100 canned hams at a cost of $1,000 in March. At acquisition, Meals would recognize the hams as an asset (Inventory). They are also an unexpired cost.
  • If they paid for the hams in cash, Cash would go down by $1,000. Otherwise Accounts Payable increases $1,000.
  • In May, Meals used 50 of the hams to produce meals.

- At use, the hams become an expense (expired cost) of $500 (50 hams * $10 per ham = $500), and the value of the asset (Inventory) is reduced by $500.

  • This is a Product Cost. The inventory becomes an expense as used to provide service.

Canadian Public Sector Financial Management

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Inventory Expense

  • Inventory expenses represent the cost of using supplies to operate an organization. Inventory expense and the ending inventory value are calculated using the following relationship:

Beginning Inventory + Purchases - Consumption = Ending

5 + 10 - 13 = 2

Canadian Public Sector Financial Management

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Deferred Revenue

  • Deferred or unearned revenues arise when an organization is paid in advance for goods or services. Deferred usually long term, Unearned usually short term.

- Why is deferred revenue a liability to an organization?

  • A museum sells a five-year membership for $250.
    • How much of the $250 should be recorded as deferred revenue?
    • How much of the $250 would the museum recognize as revenue during the first year of the membership?

Canadian Public Sector Financial Management

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Where the Income Statement and Balance Sheet Meet

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Reflecting the Change in Net Assets

on the Balance Sheet

Net income is reported as a change in net assets on the

balance sheet.

Activity Statement

Balance Sheet

Canadian Public Sector Financial Management

Finkler: Financial Management For Public, Health, And Not-For-Profit Organizations © Prentice Hall Publishing 2001

section 7 cash flow statements
Section 7Cash Flow Statements

Canadian Public Sector Financial Management

the cash flow statement
The Cash Flow Statement
  • The Cash Flow Statement shows:
    • Cash on hand at the start of the period
    • Cash received in the period
    • Cash spent in the period
    • Cash on hand at the end of the period

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There are only

5

Sections on the Cash Flow Statement

  • Change in Cash & Cash Equivalents
  • Net Income Line
  • Cash Generated by Operating Activities
  • Cash Generated by Investing Activities
  • Cash Generated by Financing Activities

Canadian Public Sector Financial Management

the cash flow statement101
The Cash Flow Statement
  • Why does an organization need both an operating statement and a cash flow statement?
    • Cash flow statements provide vital budget to plan information in purely cash terms
    • Cash flow information gives you information on your budgetary flexibilities and also on the actual cash performance versus the predicted one for cash/budget management purposes
  • Why is it important to know the sources and uses of cash flow?
    • This will depend on the nature of the organization – less so with single source (budget funds) of cash

Canadian Public Sector Financial Management

the cash flow statement102
The Cash Flow Statement
  • Isn't knowing if cash increased or decreased enough?
    • No, source and availability are important

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The Cash Flow Statement

Start with Change in Net Assets [i.e., net income] as a first approximation of cash

flow, and then make adjustments. Why isn't this good enough? Why are the other adjustments needed?

Assets = Liabilities + Net Assets

 Assets = Liabilities + Net Assets

 Cash + Other Assets = Liabilities + Net Assets

 Cash = Liabilities + Net Assets Other Assets

The Cash Flow Statement is equal to the change in the other balance sheet accounts.

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The first estimate of cash flow from operations is the change in

net assets.

Example: Assume This Activity Statement for Meals

Revenue

Clients 5,000

City 35,000

Donations 20,000

Total Revenue $60,000

Expense

Food $20,000

Labor 25,000

Depreciation 10,000

Total Expenses $55,000

Increase in Net Assets $ 5,000

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Adjusting the Increase in Net Assets to Cash Flow

  • The Increase in Net Assets is an approximation of cash flow. Adjustments are needed to arrive at true cash flow.
  • The first adjustment is for "Expenses not requiring cash" such as depreciation or amortization. Why doesn't depreciation require cash?
  • The remainder of the adjustments to operating cash flow are for changes in balance sheet accounts related to operations.

Canadian Public Sector Financial Management

adjusting the increase in net assets to cash flow
Adjusting the Increase in Net Assets to Cash Flow
  • Why subtract an increase in Accounts Receivable? The increase in net assets includes all revenue.
  • What if A/R increases? Was all revenue collected in cash? If not, then how would you have to adjust the Change in Net Assets to make it a closer measure of cash flow?

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The Statement of Cash Flows

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The Statement of Cash Flows, continued

Canadian Public Sector Financial Management

the cash flow statement109
The Cash Flow Statement
  • Cash flows relating to investment and financing activities are listed separately.
  • The method shown was the indirect method. The direct method is easier, just requiring a listing of all cash inflows and outflows (could be taken from transactions worksheet cash column). But indirect method provides more information.

Canadian Public Sector Financial Management

how to cook the books
How to Cook the Books
  • There is fraud and there is distortion possible in all this. So too is creative accounting.
  • So much relies upon issues such as recognition rules, when expenses and expenditures are actually recognized

Canadian Public Sector Financial Management

how to cook the books111
How to Cook the Books
  • Some common means to cook the books:
      • Padding revenue expectations
      • Accelerating and decelerating expenditures flows
      • Improperly lowering costs
      • Assuming ‘efficiencies’ planned will be achieved
      • Not accruing liabilities
      • Flipping lower valued assets for higher ones
      • Shifting expenses between periods and years
      • Accelerating depreciation rates

Canadian Public Sector Financial Management

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Are we having fun yet?

Canadian Public Sector Financial Management