Page 1

After studying this chapter, you should be able to do the following: 1 LEARNING !"E#$I%E& 1 L 1 Recogni'e the infor(ation con)eyed in each of the four basic financial state(ents and how it is used by different decision (a*ers +in)estors, creditors, and (anagers,- p- . 1 L . Identify the role of International /inancial Reporting &tandards +I/R&, in deter(ining the content of financial state(ents- p- 10 1 L 2 Identify the roles of (anagers and auditors in the accounting co((unication process- p- .1 1 L 3 Appreciate the i(portance of ethics, reputation, and legal liability in accounting- p- .3

/ #4& # 5PAN6: Nestl7 &-A%AL4ING AN IN%E&$5EN$ 4&ING /INAN#IAL &$A$E5EN$ IN/ R5A$I N N estl7 &-A-, based in %e)ey, &wit'erland, is the world8s leading nutrition, health, and wellness co(pany- It was founded in 1099 by :enri Nestl7, a phar(acist who de)eloped a baby for(ula that offered a safe and (ore nutritious alternati)e to e;isting breast (il* substitutes for (others who were unable to pro)ide breast (il*People <uic*ly recogni'ed the )alue of the new product after Nestl78s new for(ula sa)ed children8s li)esNestl7 grew o)er the ne;t 3= years and set up factories in the 4nited &tates, !ritain, Ger(any, and &pain- In the 1>.=s, Nestl7 e;panded into new products, with chocolate production beco(ing the co(pany8s second (ost i(portant acti)ity- Nestl7 continued to grow o)er the years through inno)ation and ac<uisition of other co(panies$oday, Nestl7 has an i(pressi)e list of products, including such well?*nown brand na(es as Nestl7, @it@at, Nescaf7, #offee?5ate, &(arties, #heerios, and PerrierNestl7 beca(e a public co(pany in 10A2- Its shares currently trade on the &IB &wiss E;change- Anyone who has in)ested in Nestl7 (ust ha)e ta*en into consideration the )alue of the co(pany8s econo(ic resources, its debts to others, its ability to sell goods for (ore than the cost of producing the(, and its ability to generate the cash necessary to pay its current bills- 5uch of this assess(ent was based on financial infor(ation that Nestl7 pro)ided to in)estors in the for( of financial state(ents4NCER&$ANCING $:E !4&INE&&

$he Players $he success story of Nestl7 began in 1099 when the #o(pany8s founder, :enri Nestl7, by in)esting a (aDor portion of his sa)ings, beca(e the sole owner of the co(pany- As is co((on in new businesses, the founder also functioned as (anager of the business +he wasowner?(anager,Ehen he started the co(pany, :enri Nestl7 needed additional (oney to build (anufacturing facilities and to de)elop the business- &o he borrowed (oney fro( a local ban* and other lenders, or creditors, and used the funds to e;pand the business- :enri Nestl78s leadership in de)eloping the baby for(ula and then e;panding into other (il* products and baby foods helped Nestl7 beco(e the leading international nutrition, health, and wellness co(panyPage . In)estorsFindi)iduals who buy s(all percentages of large corporationsF(a*e their purchases hoping to gain in two ways- $hey hope to recei)e a portion of what the co(pany earns in the for( of cash pay(ents called di)idends, and they hope to e)entually sell their share of the co(pany at a higher price than they paid#reditors lend (oney to a co(pany for a specific length of ti(e- $hey gain by charging interest on the (oney they lend- Ehen Nestl7 e;changes (oney with its lenders and owners, these are called financing acti)ities- Ehen Nestl7 buys or sells property, such as roasting e<uip(ent used in producing coffee products, these are called in)esting acti)ities$he !usiness perations $o understand any co(pany8s financial state(ents, you (ust first understand its operations- As noted, Nestl7 produces and (ar*ets nutrition and health foods for personal consu(ption- Nestl78s products are (anufactured fro( natural ingredients- $o produce the nutrition and health foods for sale, Nestl7 needs raw (aterials such as (il*, cocoa, and cereals- Nestl7 purchases these ingredients and accessories fro( other co(panies, referred to as suppliersNestl7 distributes its (any products through its own distribution networ* throughout the world- It sells its products to retail stores, or custo(ers, through wholesale distributors-

$he Accounting &yste( A## 4N$ING is a syste( that collects and processes +analy'es, (easures, and records, financial infor(ation about an organi'ation and reports that infor(ation to decision (a*ersLi*e all businesses, Nestl7 has an accounting syste( that collects and processes financial infor(ation about an organi'ation and reports that infor(ation to decision (a*ers- Nestl78s (anagers +often called internal decision (a*ers, and parties outside the fir( +often called e;ternal decision (a*ers,, such as the in)estors in Nestl78s shares and the ban*8s loan officer, use reports produced by this syste(- E;hibit 1-1 outlines the two parts of the

accounting syste(- Internal (anagers typically re<uire continuous detailed infor(ation because they (ust plan and (anage the day?to?day operations of the organi'ation- Ce)eloping accounting infor(ation for internal decision (a*ers is called (anagerial or (anage(ent accountingand is the subDect of a separate accounting course$he focus of this te;t is accounting for e;ternal decision (a*ers, called financial accounting, and the four basic financial state(ents and related disclosures that are the output of that syste(L 1Recogni'e the infor(ation con)eyed in each of the four basic financial state(ents and how it is used by different decision (a*ers +in)estors, creditors, and (anagers,Ee begin this process with a brief but co(prehensi)e o)er)iew of the four basic financial state(ents and the people and organi'ations in)ol)ed in their preparation and use- $his o)er)iew pro)ides you with a conte;t in which you can learn the (ore detailed (aterial that is presented in the following chapters- In particular, we focus on how two pri(ary users of the state(ents, in)estors +owners, and creditors +lenders, relied on each of Nestl78s four basic financial state(ents in their decisions to in)est in or lend (oney to Nestl7- Later in the chapter, we discuss a broader range of uses of financial state(ent data in (ar*eting, (anage(ent, hu(an resources, and other business conte;ts-

E;hibit 1-1$he Accounting &yste( and Cecision 5a*ers Page 2 $o understand the way that in)estors and creditors use Nestl78s financial state(ents in their decisions, we (ust first understand what specific infor(ation is presented in the four basic financial state(ents for a co(pany such as Nestl7Ee present (any new business and financial state(ent ter(s in this chapter- Instead of trying to (e(ori'e the definitions of e)ery ter( used in this chapter, focus your attention on learning the general structure and content of the state(ents- &pecifically, you should focus on these <uestions: Ehat categories of ite(s +often called ele(ents, are reported on each of the four state(entsG +Ehat type of infor(ation does a state(ent con)ey, and where can you find itG, :ow are the ele(ents within a state(ent relatedG $hese relationships are usually described by an e<uation that tells you how the ele(ents fit togetherEhy is each ele(ent i(portant to (anagers8, owners8, or creditors8 decisionsG +:ow i(portant is the infor(ation to decision (a*ersG, $he &elf?&tudy Hui''es that occur throughout the chapter will test your ability to answer these <uestionsRe(e(ber that since this chapter is an o)er)iew, each concept discussed in this chapter will be discussed again in #hapters . through IPage 3 RGANIJA$I N / $:E #:AP$ER

$:E / 4R !A&I# /INAN#IAL &$A$E5EN$&: AN %ER%IEE $he four basic financial state(ents include the state(ent of financial position, state(ent of co(prehensi)e inco(e, state(ent of changes in e<uity, and state(ent of cash flows- $hese are the basic state(ents nor(ally prepared by for?profit corporations- $he state(ents are intended pri(arily to infor( in)estors, creditors, and other e;ternal decisions (a*ers- $hey su((ari'e the financial acti)ities of the business- $hey can be prepared at any point in ti(e and can apply to any ti(e span +such as one year, one <uarter, or one (onth,- Li*e (ost co(panies, Nestl7 prepares financial state(ents for in)estors and creditors at the end of each <uarter +*nown as <uarterly

reports, and at the end of the year +*nown as annual reports,$he &tate(ent of /inancial Position1 $he purpose of the state(ent of financial position is to report the financial position +a(ount of assets, liabilities, and shareholders8 e<uity, of an accounting entity at a particular point in ti(e- Ee can learn a lot about what the state(ent of financial position reports Dust by reading the state(ent fro( the top- $he state(ent of financial position of Nestl7 is shown in E;hibit 1-.-

E;hibit 1-.&tate(ent of /inancial Position A &$A$E5EN$ / /INAN#IAL P &I$I N +!ALAN#E &:EE$, reports the financial position +assets, liabilities, and shareholders8 e<uity, of an accounting entity at a point in ti(e&tructure $he heading of the state(ent of financial position identifies four significant ite(s related to the state(ent: na(e of the entityF$he Nestl7 Group title of the state(entF&tate(ent of /inancial Position

specific date of the state(entFAt Cece(ber 21, .==> unit of (easureF+in (illions of &wiss francs,

Page I $he organi'ation for which financial data are to be collected and reported is called an accounting entity- $he accounting entity (ust be precisely defined and is often called the business or the corporation- n the state(ent of financial position, the accounting entity itself, not the business owners, is )iewed as owning the resources it uses and as owing its debtsAn A## 4N$ING EN$I$6 is the organi'ation for which financial data are to be collected$he heading of the state(ent indicates the ti(e di(ension of the report- $he state(ent of financial position is li*e a financial snapshot clearly stating the entity8s financial position at a specific point in ti(eFin this case, Cece(ber 21, .==>Fwhich is stated clearly on the state(ent- /inancial reports are nor(ally deno(inated in the currency of the country in which they are legally re<uired to report their financial results- In this case, Nestl7 reports in &wiss francs +abbre)iated as #:/,- &i(ilarly, #anadian co(panies report in #anadian dollars and 5e;ican co(panies in 5e;ican pesos- Large?si'ed co(panies often report their financial figures in (illionsK that is, they round the last si; digits to the nearest (illion- $he in)entories a(ount of #:/ A,A23 on Nestl78s state(ent of financial position actually (eans #:/ A,A23,===,===Nestl78s state(ent of financial position first lists the co(pany8s assets- Assets are econo(ic resources legally controlled by the entity- Assets are followed by liabilities and shareholders8 e<uity- $hese are the sources of financing or clai(s against the co(pany8s econo(ic resources- /inancing pro)ided by creditors creates a liability/inancing pro)ided by owners creates owners8 e<uity- !ecause Nestl7 is a corporation, its owners8 e<uity is designated shareholders8 e<uity- &ince each asset (ust ha)e a source of financing, a co(pany8s assets (ust, by definition, e<ual the su( of its liabilities and shareholders8 e<uity-. $he basic accounting e<uation, is written as

Page 9 !A&I# A## 4N$ING EH4A$I N Assets L Liabilities M &hareholders8 E<uity

$he basic accounting e<uation shows what we (ean when we refer to a co(pany8s financial position: the econo(ic resources that the co(pany owns and the sources of financing for those resourcesEle(ents Assets are econo(ic resources controlled by the entity as a result of past business e)ents and fro( which future econo(ic benefits can be obtained- Nestl7 lists eight ite(s under the category assets- $he specific ite(s listed as assets on a co(pany8s state(ent of financial position depend on the nature of its operations- $he eight ite(s listed by Nestl7 are the econo(ic resources needed to pro)ide future benefit to Nestl7 through the production and sale of nutrition and health products to its custo(ers- Each of these econo(ic resources is e;pected to pro)ide future benefits to the co(pany- $o prepare for the production process, Nestl7 first neededcash to purchase land on which to build (anufacturing facilities and install production (achinery +plant and e<uip(ent,- Nestl7 needs to ha)e insurance to protect its resources against potential lossesK ad)ance pay(ent of any insurance pre(iu(s ga)e rise to prepay(ents that reflect future econo(ic benefits +i-e-, insurance protection,Nestl7 then began (a*ing its baby food products, which led to the )alue assigned toin)entories- Ehen Nestl7 sells its nutrition and health products to retailers and wholesalers, it often sells the( on credit and recei)es pro(ises to pay called trade recei)ables, which are collected in cash later- As the co(pany grew, it (ade in)est(ents in other co(panies- Nestl7 also owns brands, trade(ar*s, and intellectual property rights- $hese are called intangible assets because they do not ha)e physical e;istence- !ecause of the co(ple;ity of Nestl78s operations, its resources include (any other assets, which are e;plained in future chaptersPage A E)ery asset on the state(ent of financial position is initially (easured at the total cost incurred to ac<uire it&ubse<uent to ac<uisition, assets are reported on the state(ent of financial position at )alues that reflect the benefits the co(pany e;pects to reali'e fro( these assets through use or sale-

Liabilities are the entity8s legal obligations that result fro( past business e)ents- $hey arise pri(arily fro( the purchase of goods or ser)ices on credit and through cash borrowings to finance the business$here are se)en types of liabilities listed on Nestl78s state(ent of financial position- $he trade payables arise fro( the purchase of goods and ser)ices fro( suppliers on credit, without a for(al written contract +or note,- &hort? ter( borrowings represent a(ounts borrowed fro( ban*s and other creditors, to be repaid in the near future- $he inco(e ta;es payablerepresent an a(ount due to the go)ern(ent8s ta; authorities as a result of the co(pany8s profitable operations- $he accrued liabilities are a(ounts owed to suppliers of )arious types of ser)ices, such as rent and utilitiesLong?ter( borrowings result fro( cash borrowings based on for(al written debt contracts with lending institutions such as ban*s- $he pro)isions are esti(ated a(ounts payable in the future, but the e;act a(ount and ti(ing of the pay(ent depends on actual future e)ents- Nestl7 is a )ery large global co(pany that incurs (any other liabilities, which are identified and described in future chapters&hareholders8 e<uity indicates the a(ount of financing pro)ided by owners of shares in the business as well as earnings o)er ti(e- &hareholders8 e<uity arises fro( three sources: +1, share capital, or the in)est(ent of cash and other assets in the business by the owners in e;change for sharesK +., retained earnings, or the a(ount of earnings rein)ested in the business +and thus not distributed to shareholders in the for( of di)idends,K and +2, other co(ponents that essentially reflect the changes in the )alues of assets and liabilities o)er ti(eIn E;hibit 1-., the &hareholders8 E<uity section reports three ite(s- Nestl78s shareholders contributed cash and recei)ed shares of capital in e;change for their contributions- $his is reported as share capital- Nestl78s profit less all di)idends paid to the shareholders since for(ation of the corporation e<ualled #:/ 93,99= and is reported as retained earnings- $otal shareholders8 e<uity is the su( of the proceeds recei)ed on issuing shares to owners, plus the retained earnings, and the )aluation adDust(ents to the co(pany8s assets and liabilities at year?end/INAN#IALANAL6&I&IN$ERPRE$ING A&&E$&, LIA!ILI$IE&, ANC &:ARE: LCER&8 EH4I$6 &$A$E5EN$ / /INAN#IAL P &I$I N N $:E

Assess(ent of Nestl78s assets is i(portant to its creditors and to its owners because assets pro)ide a basis for Dudging whether the co(pany has sufficient resources a)ailable to operate the business- Assets are also i(portant because they could be sold for cash in the e)ent that Nestl7 goes out of business#reditors are interested in Nestl78s debts because of their concern as to whether or not the co(pany has sufficient sources of cash to pay its debt obligations- Nestl78s debts are also rele)ant to its ban*ers8 decisions to lend (oney to the co(pany because e;isting creditors share the ban*ers8 clai(s against Nestl78s assets- Legal ownership of assets re(ains with the creditors to secure Nestl78s repay(ent of debt- If a business does not pay its creditors, the creditors (ay force the sale of assets sufficient to (eet their clai(s- In so(e situations, the sale of assets (ay not co)er the co(pany8s current debts, thus creditors often ta*e a loss- $his is because the assets were ac<uired with the intent of producing benefits in the conte;t of other resources under the legal control of Nestl7- $he assets, when ta*en out of that conte;t, rarely will be seen by e;ternal parties as ha)ing the sa(e potential benefit for the( as the assets had for Nestl7- $hus, creditors (ay not be able to sell the assets for the a(ount of the debtPage 0 Nestl78s shareholders8 e<uity or net worth is i(portant to creditors because, legally, their clai(s for repay(ent of obligations (ust be settled before those of the owners- If Nestl7 goes out of business and its assets are sold, the proceeds of that sale (ust be used to pay bac* creditors before the shareholders recei)e any (oney- &hareholders pro)ide resources for the co(pany to use in future, with no pro(ise of any future repay(ent- $hey are entitled to what is left only after all other clai(s ha)e been settled- $hus, creditors consider shareholders8 e<uity a protecti)e cushion-

A Note on /or(at A few additional for(atting con)entions are worth noting here- Assets (ay be listed on the state(ent of financial position in either increasing or decreasing order of their con)ertibility to cash- &o(e international co(panies, li*e Nestl7, list their assets beginning with the (ost li<uid asset, cash, and ending with the least li<uid assets that are not readily con)ertible to cash, such as patents- In contrast, other co(panies list their least li<uid assets, such as intangibles, first and (ost li<uid assets last- &i(ilarly, liabilities (ay be listed by either increasing or decreasing order of (aturity +due date,- International Accounting &tandard 1 allows co(panies to use either for(at to report their assets and liabilities5ost financial state(ents include the (onetary unit sign +in #anada, the N, beside the first a(ount in a group of ite(s +e-g-, share capital in &hareholders8 e<uity,- Also, it is co((on to place a single underline below the last ite( in a group before a total or subtotal +e-g-, ther assets,- A double underline is also placed below group totals +e-g-, $otal assets,- $he sa(e con)entions are followed in all four basic financial state(ents&EL/?&$4C6 H4IJ 1?1 Nestl78s assets are listed in one section and liabilities andshareholders8 e<uity in another- Notice that the two sections balance, in confor(ity with the basic accounting e<uation- In the following chapters, you will learn that the accounting e<uation is the basic building bloc* for the entire accounting process- 6our tas* here is to )erify that the shareholders8 e<uity of #:/ I2,921 is correct, using the nu(bers for assets and liabilities presented in E;hibit 1-. and the basic accounting e<uation in the for( Assets ? Liabilities L &hareholders8 E<uity Learning which ite(s belong in each of the categories on the state(ent of financial position is an i(portant first step in understanding their (eaning- 5ar* each ite( in the following list as an asset +A,, a liability +L,, or shareholders8 e<uity +&E,, without referring to E;hibit 1-.$rade payables $rade recei)ables #ash &hare capital Property, plant, and e<uip(ent After you co(plete your answers, go online for the solutions&elf?&tudy Hui' 1?1 &olution Page > $he &tate(ent of #o(prehensi)e Inco(e $he &$A$E5EN$ / # 5PRE:EN&I%E IN# 5E reports the change in shareholders8 e<uity, during a period, fro( business acti)ities, e;cluding e;changes with shareholders$he IN# 5E &$A$E5EN$ reports the re)enues less the e;penses of the accounting period&tructure $he state(ent of co(prehensi)e inco(e reports the change in shareholders8 e<uity, during a period, fro( business acti)ities other than in)est(ents by shareholders or distributions to shareholders- It includes all changes in e<uity during a period e;cept those resulting fro( in)est(ents by owners +such as the issuance of shares, and distributions to owners +such as di)idends,- $he state(ent of co(prehensi)e inco(e has two partsIn)entories !an* borrowings Pro)isions Retained earnings

$he first part reports the accountant8s pri(ary (easure of a co(pany8s perfor(ance: re)enues generated less e;penses incurred during the accounting period- Accountants label this (easure of perfor(ance Oprofit-P $he second part reports other co(prehensi)e inco(e, which co(prises inco(e and e;pense ite(s that are not recogni'ed in the inco(e state(ent in accordance with International /inancial Reporting &tandards#o(panies can present all ite(s of inco(e and e;penses either in one state(ent of co(prehensi)e inco(e or in two related state(entsFan inco(e state(ent reporting the re)enues and e;penses that ha)e already affected profit, and a state(ent of co(prehensi)e inco(e reporting inco(e and e;pense ite(s that will affect profit in the future- Ee discuss the inco(e state(ent in this chapter and the state(ent of co(prehensi)e inco(e in #hapters 9 and 1.-

Nestl7 uses the two?state(ent approach- A <uic* reading of Nestl78s inco(e state(ent +E;hibit 1-2, pro)ides an indication about its purpose and content- $he heading of the inco(e state(ent again identifies the na(e of the entity, title of the state(ent, and unit of (easure used in the state(ent- 4nli*e the state(ent of financial position, which reports financial infor(ation as of a certain date, the inco(e state(ent reports infor(ation for aspecified period of ti(e +for the year ended Cece(ber 21, .==>,- $he ti(e period co)ered by the financial state(ents +one year in this case, is called an accounting period-

E;hibit 1-2Inco(e &tate(ent

Page 1= $he A## 4N$ING PERI C is the ti(e period co)ered by the financial state(entsNotice that Nestl78s inco(e state(ent has three (aDor captions: re)enues, e;penses, and profit- $he inco(e state(ent e<uation that describes this relationship is Re)enues ? E;penses L Profit Ele(ents #o(panies earn re)enues fro( the sale of goods or ser)ices to custo(ers +in Nestl78s case, fro( the sale of nutrition and health products,- Re)enues are nor(ally reported on the inco(e state(ent when the goods or ser)ices are sold to custo(ers whether or not they ha)e been paid for- Retail stores such as Eal(art or 5cConald8s often recei)e cash at the ti(e of sale- :owe)er, when Nestl7 sells its nutrition and health products to

wholesale distributors, it recei)es a pro(ise of future pay(ent called a trade recei)able, which is collected in cash at a later date- In either case, the business recogni'es the total of cash and credit sales (ade during a specific accounting period as re)enue for that period- %arious ter(s are used in financial state(ents to describe different sources of re)enue +e-g-, pro)ision of ser)ices, sale of goods, rental of property,- Nestl7 lists two sources: sales re)enue, fro( selling nutrition and health products, and other inco(e fro( its in)est(ents as well as profit fro( selling property, plant, and e<uip(entE;penses represent the (onetary )alue of resources the entity used up, or consu(ed, to earn re)enues during the period- Nestl7 lists se)en ite(s as e;penses on the inco(e state(ent- $he cost of sales +or cost of goods sold, is Nestl78s total cost to produce the nutrition and health products sold to custo(ers during the year- $hese include the costs of ingredients, wages paid to the factory wor*ers, and e)en a portion of the cost of buildings, e<uip(ent, and tools used +called depreciation, to produce the goods that were sold- Cistribution e;penses include a )ariety of e;penses such as the salaries of sales staff and e;penses related to distribution of the co(pany8s products5ar*eting and ad(inistrati)e e;penses include ite(s such as the salaries of (ar*eting and (anage(ent personnel, pro(otion of the co(pany8s products through print and electronic (edia, rental of office space, insurance, utilities, plus other general costs of operating the co(pany not directly related to production- Research and de)elop(ent e;penses relate to the research and de)elop(ent of new products- $heother e;penses consist of a )ariety of e;penses that are not included in the pre)ious categoriesNestl7 also reported interest e;pense, which reflects the cost of using borrowed funds- /inally, as a corporation, Nestl7 (ust pay inco(e ta; to the go)ern(ent- Nestl78s inco(e ta; e;pense for .==> is appro;i(ately 19-I percent of its preta; profitE;penses (ay re<uire i((ediate pay(ent of cash, pay(ent of cash at a future date, or use of so(e other resource, such as an in)entory ite(, that (ay ha)e been paid for in a pre)ious period- /or accounting purposes, the e;pense reported in one accounting period (ay actually be paid for in cash in another accounting periodNe)ertheless, the co(pany recogni'es all e;penses +cash and credit, incurred during a specific accounting period regardless of the ti(ing of the cash pay(ent- /or e;a(ple, let us assu(e that Nestl7 owes #:/ I=,=== in sales co((issions to salespeople who sold nutrition and health ite(s to retailers in Cece(ber .==>, but it did not pay the #:/ I=,=== until "anuary .=1=- In this case, the sales co((issions would be recogni'ed as e;penses for the accounting period ending on Cece(ber 21, .==>, because during Cece(ber .==> the salespeople e;erted the efforts resulting in co((issions for successfully selling the co(pany8s )arious productsPage 11 Profit +also called net inco(e or net earnings, is the e;cess of total re)enues o)er total e;penses incurred to generate re)enue during a specific period- Nestl78s profit for the year (easures its success in selling nutrition and health goods for (ore than it cost to generate those sales- If total e;penses e;ceed total re)enues, a loss is reported- +Losses are nor(ally noted by parentheses around the reported figure-, Ehen re)enues and e;penses are e<ual for the period, the business has operated at brea*e)enEe noted earlier that re)enues are not necessarily the sa(e as collections fro( custo(ers, and e;penses are not necessarily the sa(e as pay(ents to suppliers- As a result, profit nor(ally does not e<ual the net cash generated by operations- $his latter a(ount is reported on the state(ent of cash flows discussed later in the chapter/INAN#IALANAL6&I&ANAL6JING $:E IN# 5E &$A$E5EN$ In)estors and creditors closely (onitor a fir(8s profit because it indicates the fir(8s ability to sell goods and ser)ices for (ore than they cost to produce and deli)er- In)estors buy the co(pany8s shares when they belie)e that profit will i(pro)e and lead to a higher share price- Lenders also rely on future earnings to pro)ide the resources to repay loans- $he details of the state(ent also are i(portant- /or e;a(ple, Nestl7 had to sell #:/ 1=A,910 (illion worth of nutrition and health products to earn #:/ 11,A>2 (illion- If a co(petitor were to lower prices

Dust by 1= percent, forcing Nestl7 to do the sa(e in order to retain its (ar*et share, or if Nestl7 had to triple (ar*et de)elop(ent to catch up to a co(petitor, its profit could be reduced significantly and (ay turn into a loss$hese factors and others help in)estors and creditors esti(ate the co(pany8s future profit based on past infor(ation&EL/?&$4C6 H4IJ 1?. Learning which ite(s belong in each of the inco(e state(ent categories is an i(portant first step in understanding their (eaning- 5ar* each inco(e state(ent ite( in the following list as a re)enue +R, or an e;pense +E,, without referring to E;hibit 1-2#ost of goods sold &elling and ad(inistrati)e

&ales Curing the year .==>, Nestl7 deli)ered nutrition and health products to custo(ers for which the custo(ers paid, or pro(ised to pay in the future, a(ounts totalling #:/ 1=A,910 (illion- Curing the sa(e period, it collected #:/ 11=,=9= (illion in cash fro( its custo(ers- Eithout referring to E;hibit 1-2, indicate which of the two a(ounts will be shown on Nestl78s inco(e state(ent as sales re)enue for .==>- E;plainCuring the year .==>, Nestl7 produced nutrition and health ite(s with a total production cost of #:/ 32,I1I (illion- Curing the sa(e period, itdeli)ered to custo(ers goods that had cost a total of #:/ 3I,.=0 (illion to produce- Eithout referring to E;hibit 1-2, indicate which of the two a(ounts will be shown on Nestl78s inco(e state(ent as cost of goods sold for .==>- E;plainAfter you co(plete your answers, go online for the solutions&elf?&tudy Hui' 1?. &olution Page 1. $he &tate(ent of #hanges in E<uity $he &$A$E5EN$ accounting period/ #:ANGE& IN EH4I$6 reports all changes to shareholders8 e<uity during the

RE$AINEC EARNING& reflect the profits that ha)e been earned since the creation of the co(pany but not distributed yet to shareholders as di)idends-

&tructure Nestl7 prepares a separate state(ent of changes in e<uity, shown in E;hibit 1-3 in a condensed for(at-2 $he heading identifies the na(e of the entity, title of the state(ent, and unit of (easure used- Li*e the inco(e state(ent, the state(ent of changes in e<uity co)ers a specific period of ti(e +the accounting period,, which in this case is one year- $his state(ent reports the way that profit, distribution of profit +di)idends,, and other changes to shareholders8 e<uity affected the co(pany8s financial position during the accounting period- Ee focus on retained earnings in this chapter and discuss the other co(ponents of e<uity in later chaptersProfit earned during the year increases the balance of retained earnings- $he declaration of di)idends to the shareholders decreases retained earnings-3$he retained earnings e<uation that describes these relationships is

!eginning retained earnings M Profit Q Ci)idends L Ending retained earnings Ele(ents $he state(ent begins with Nestl78s balances to share capital, retained earnings, and other e<uity co(ponents at "anuary 1, .==> +the beginning of the accounting period,- $he profit reported on the inco(e state(ent for the current period is added to the beginning balance of retained earnings, and di)idends declared during the year are subtracted fro( this a(ount- Curing .==>, Nestl7 earned #:/ 11,A>2 (illion, as shown in E;hibit 1-2- Also during .==>, Nestl7 declared and paid a total of #:/ I,AA> (illion in di)idends to its shareholders- $he net result is that retained earnings at Cece(ber 21, .==>, +the end of the accounting period, increased by #:/ 9,=13 (illion +L11,A>2 (illion ? I,AA> (illion,, or the portion of the .==> profit rein)ested in the business-

E;hibit 1-3&tate(ent of #hanges in E<uity $he ending retained earnings a(ount of #:/ 93,99= (illion is the sa(e as that reported in E;hibit 1-. on Nestl78s state(ent of financial position- $he ending balances of share capital and other co(ponents are also reported on the state(ent of financial position- $hus, the state(ent of changes in e<uity shows how the inco(e state(ent and the state(ent of financial position are lin*ed through the retained earnings section of shareholders8 e<uityPage 12 /INAN#IALANAL6&I&IN$ERPRE$ING RE$AINEC EARNING& Rein)est(ent of profit, or retained earnings, is an i(portant source of financing for Nestl7, representing o)er one? half of its financing- #reditors closely (onitor a fir(8s retained earnings because the fir(8s policy on di)idend pay(ents to its shareholders affects its ability to repay its debts- E)ery &wiss franc Nestl7 pays to shareholders as a di)idend is not a)ailable for use in paying bac* its debt to creditors- $he re)erse is also trueK e)ery &wiss franc used to repay creditors is una)ailable either for distribution to in)estors as di)idends or for retention and rein)est(ent in the co(pany8s future growth- In)estors e;a(ine retained earnings to deter(ine whether the co(pany is rein)esting a sufficient portion of profit to support future growth&EL/?&$4C6 H4IJ 1?2 Nestl78s retained earnings reflect the way that the profit and distribution of di)idends affected the financial position of the co(pany during the accounting period- In a prior period, Nestl78s financial state(ents reported the following a(ounts: beginning retained earnings, #:/ I.,0.A (illionK total assets, #:/ 1=>,>=0 (illionK

di)idends, #:/ 3,>0. (illionK cost of goods sold, #:/ 3A,22> (illionK and profit, #:/ 1>,=I1 (illion- Eithout referring to E;hibit 1-3, co(pute ending retained earningsAfter you co(plete your answers, go online for the solutions&elf?&tudy Hui' 1?2 &olution

E;hibit 1-I&tate(ent of #ash /lows $he &tate(ent of #ash /lows &tructure Nestl78s state(ent of cash flows, presented in E;hibit 1-I, di)ides Nestl78s cash inflows +receipts, and outflows +pay(ents, into three pri(ary categories of cash flows in a typical business: cash flows fro( operating, in)esting, and financing acti)ities- $he heading identifies the na(e of the entity, title of the state(ent, and unit of (easure used- Li*e the inco(e state(ent, the state(ent of cash flows co)ers a specified period of ti(e +the accounting period,, which in this case is one yearAs discussed earlier in this chapter, reported re)enues do not always e<ual cash collected fro( custo(ers because so(e sales (ay be on credit- Also, e;penses reported on the inco(e state(ent (ay not be e<ual to cash paid out during the period because e;penses (ay be incurred in one period and paid for in another- As a result, profit +re)enues (inus e;penses, doesnot usually e<ual the a(ount of cash recei)ed (inus the a(ount paid during the

period- !ecause the inco(e state(ent does not pro)ide any infor(ation concerning cash flows, accountants prepare the state(ent of cash flows to report inflows and outflows of cash$he &$A$E5EN$ / #A&: /L E& reports cash inflows and outflows that are related to operating, in)esting, and financing acti)ities during the accounting period-

$he state(ent of cash flows e<uation describes the causes of the change in cash reported on the state(ent of financial position fro( the end of the last period to the end of the current period:

Note that each of the three cash flow sources can be either positi)e or negati)eEle(ents #ash flows fro( operating acti)ities are cash flows that are directly related to earning inco(e- /or e;a(ple, when retailers pay Nestl7 for the nutrition and health products it deli)ered to the(, Nestl7 lists the a(ounts collected as cash collected fro( custo(ers- Ehen Nestl7 pays salaries or bills recei)ed for (aterials, it includes the a(ounts in cash paid to e(ployees and trade suppliers-I Page 13 #ash flows fro( in)esting acti)ities include cash flows related to the ac<uisition or sale of the co(pany8s producti)e assets- $his year, Nestl7 had three cash outflows for in)esting acti)ities: purchase of additional property, plant, and e<uip(ent to (eet the growing de(and for its productsK purchase of intangible assetsK and ac<uisition of other businesses- It also recei)ed cash for selling so(e of its businesses and old e<uip(ent#ash flows fro( financing acti)ities are directly related to the financing of the co(pany itself- $hey in)ol)e both receipts and pay(ents of cash to in)estors and creditors- Curing .==>, Nestl7 paid #:/ I,AA> (illion in di)idends to the co(pany8s shareholders as well as #:/ 9,A.1 (illion to buy bac* shares that were pre)iously issued to shareholders- It also paid #/: .,1>= (illion to reduce both short?ter( and long?ter( borrowings, and #:/ 1,AI> (illion to purchase short?ter( in)est(ents- Nestl7 recei)ed #:/ 2,>IA (illion by signing on long? ter( borrowingsPage 1I /INAN#IALANAL6&I&IN$ERPRE$ING $:E &$A$E5EN$ / #A&: /L E& 5any analysts belie)e that the state(ent of cash flows is particularly useful for predicting future cash flows that (ay be a)ailable for pay(ent of debt to creditors and di)idends to in)estors- !an*ers often consider the operating acti)ities section to be the (ost i(portant because it indicates the co(pany8s ability to generate cash fro( sales to (eet its current cash needs- Any a(ount left can be used to repay the ban* debt or e;pand the co(pany&hareholders will in)est in a co(pany if they belie)e that it will e)entually generate (ore cash fro( operations than it uses, so that cash will beco(e a)ailable to pay di)idends and to e;pand- $he in)esting acti)ities section shows that Nestl7 has (ade significant in)est(ents in new (anufacturing capacity, a good sign if de(and continues to increase- $he financing acti)ities section indicates that Nestl7 was able to pay di)idends to

shareholders and repay part of its short?ter( and long?ter( borrowings because it generated cash fro( operating acti)ities&EL/?&$4C6 H4IJ 1?3 Curing the period .==>, Nestl7 deli)ered nutrition and health products to custo(ers that paid, or pro(ised to pay in the future, a(ounts totalling #:/ 1=A,910 (illion- Curing the sa(e period, it collected #:/ 11=,=9= (illion in cash fro( its custo(ers- Eithout referring to E;hibit 1-I, indicate which of the two nu(bers will be shown on Nestl78s state(ent of cash flows for .==>Learning which ite(s belong in each category on the state(ent of cash flows is an i(portant first step in understanding their (eaning- 5ar* each ite( in the following list as a cash flow fro( operating acti)ities + ,, in)esting acti)ities +I,, or financing acti)ities +/,, without referring to E;hibit 1-I- Also place parentheses around the letter only if it is a cash outflowRRRRR #ash paid for di)idends RRRRR #ash paid for interest RRRRR #ash recei)ed fro( ban* borrowings RRRRR #ash paid for ta;es RRRRR #ash paid to purchase property, plant, and e<uip(ent RRRRR #ash collected fro( custo(ers After you co(plete your answers, go online for the solutions&elf?&tudy Hui' 1?3 &olution Relationships a(ong the /our /inancial &tate(ents ur discussion of the four basic financial state(ents focused on the different ele(ents reported on each of the state(ents, how the ele(ents are related through the e<uation for each state(ent, and how the ele(ents are i(portant to the decisions of in)estors, creditors, and other e;ternal users- Ee ha)e also disco)ered how the state(ents, all of which are outputs fro( the sa(e syste(, are related to one another- In particular, we learned that Profit fro( the inco(e state(ent results in an increase in ending retained earnings on the state(ent of changes in e<uityEnding retained earnings fro( the state(ent of changes in e<uity is one of the three co(ponents of shareholders8 e<uity on the state(ent of financial position$he change in cash on the state(ent of cash flows added to the cash balance at the beginning of the year e<uals the balance of cash at the end of the year, which appears on the state(ent of financial position$hus, as e;ternal users, we can thin* of the inco(e state(ent +and the state(ent of co(prehensi)e inco(e, as e;plaining, through the state(ent of changes in e<uity, how the operations of the co(pany changed its financial position during the year- $he state(ent of cash flows e;plains how the operating, in)esting, and financing acti)ities of the co(pany affected the cash balance on the state(ent of financial position during the year- $hese relationships are illustrated in E;hibit 1-9 for Nestl78s financial state(ents-

E;hibit 1-9Relationships a(ong Nestl78s &tate(ents &ource: Nestl7 &-APage 19 /INAN#IALANAL6&I&5ANAGE5EN$ 4&E& / /INAN#IAL &$A$E5EN$& In our discussion of financial analysis thus far, we ha)e focused on the perspecti)es of in)estors and creditors- In addition, (anagers within the fir( often (a*e direct use of financial state(ents- /or e;a(ple, Nestl78s (ar*eting (anagers and credit (anagers use custo(ers8 financial state(ents to decide whether to e;tend credit to the( for their purchases of nutrition and health goods- Nestl78s purchasing (anagers analy'e financial state(ents of suppliers to Dudge whether the suppliers ha)e the resources to (eet Nestl78s de(and for ingredients and in)est in the de)elop(ent of new ingredients- !oth Nestl78s hu(an resource (anagers and the e(ployees8 union use the co(pany8s financial state(ents as a basis for contract negotiations o)er pay rates- $he profit figure e)en ser)es as a basis for co(putinge(ployee bonusesEhen Nestl78s (anagers e;a(ine the financial state(ents of the co(pany8s custo(ers and suppliers, they rely on these state(ents as the best source of financial infor(ation a)ailable to e;ternal users because they do not ha)e access to internal financial infor(ation produced by their custo(ers and their suppliers- :owe)er, when they (a*e internal decisions regarding Nestl78s operations, they rely on (ore detailed financial infor(ation obtained through the co(pany8s (anagerial accounting syste(Page 1A Notes to /inancial &tate(ents At the botto( of each of the four basic financial state(ents you will typically find the following state(ent: O$he notes are an integral part of these financial state(ents-P $his is the accounting e<ui)alent of the nutritional content on pre?pac*aged food- It warns users that failure to read the notes +or footnotes, to these financial state(ents will result in inco(plete *nowledge of the co(pany8s financial health- Notes pro)ide supple(ental infor(ation about the financial condition of a co(pany, without which the financial state(ents cannot be fully understood-

N $E& +/ $N $E&,pro)ide supple(ental infor(ation about the financial condition of a co(pany, without which the financial state(ents cannot be fully understood$here are three basic types of notes- $he first type pro)ides descriptions of the accounting rules applied in the co(pany8s state(ents- $he second presents additional detail about a line on the financial state(ents- /or e;a(ple, Nestl78s in)entory note indicates the costs of raw (aterials and supplies, nutrition and health ite(s that are in the process of being co(pleted, and finished products that are ready for sale to custo(ers- $he third type of note presents additional financial disclosures about ite(s not listed on the state(ents the(sel)es- /or e;a(ple, Nestl7 is e;posed to significant ris*sK the ris*s related to credit and fluctuations in e;change rates are disclosed in a noteEe will discuss (any note disclosures throughout the boo* because understanding their content is critical to understanding the co(pany-9 &u((ary of the /our !asic /inancial &tate(ents Ee learned a lot about the content of the four basic state(ents- E;hibit 1-Asu((ari'es this infor(ation- $a*e a few (inutes to re)iew the infor(ation in the e;hibit before you (o)e on to the ne;t section of the chapter/INAN#IALANAL6&I&CE$ER5INING NE&$LS8& P4R#:A&E PRI#E E)en at this early stage of your study of accounting, we can illustrate part of the process that in)estors (ay use to deter(ine the price they are willing to pay for Nestl7- $he price is decided by considering a )ariety of factors, including the )alue of Nestl78s assets, its debts to others, its ability to sell goods for (ore than their production cost, and its ability to generate the cash necessary to pay its current bills- $hese factors are the subDect (atter of Nestl78s financial state(entsIn general, in)estors use prior years8 financial perfor(ance to (a*e proDections about future perfor(ance- $hey (ay be willing to pay for a fir( that reported high profit in the past if they belie)e it will produce higher profit in the futurene (ethod for esti(ating the )alue of a co(pany that relies on net earnings and growth in earnings is with a priceTearnings ratio +or PTE ratio or PTE (ultiple,- $he PTE ratio (easures the (ultiple of current year8s earnings that in)estors are willing to pay for the co(pany8s shares- A high PTE ratio (eans that in)estors ha)e confidence in the co(pany8s ability to produce higher profits in future yearsPage 10 #o(petitors8 PTE ratios often ser)e as a starting point in analy'ing the price that should be paid for a co(pany or its shares- If we assu(e that other co(panies in the sa(e industry with si(ilar perfor(ance and past growth were selling for 1I ti(es their current year8s earnings, then the price per share could be deter(ined by using the following co(putation:

$he role of net earnings in deter(ining the )alue of a co(pany will be discussed in (ore detail in your corporate finance course and (ore ad)anced courses in financial state(ent analysis-

E;hibit 1-A&u((ary of /our !asic /inancial &tate(ents 1 &o(e co(panies refer to this state(ent as a Obalance sheet,P a title that was co((only used prior to the adoption of I/R& in #anada. A corporation is a business that is incorporated under the federal or pro)incial laws- $he owners are called shareholdersor stoc*holders- wnership is represented by shares of capital that usually can be bought and sold freely- $he corporation operates as a separate legal entity, separate and apart fro( its owners- $he shareholders enDoy li(ited liabilityK they are liable for the debts of the corporation only to the e;tent of their in)est(ents- Appendi; 1A discusses for(s of ownership in (ore detail2 A detailed )ersion of the state(ent of changes in e<uity is discussed in #hapter 93 Retained earnings decrease when e;penses e;ceed re)enues, resulting in a loss- $he co(plete process of declaring and paying di)idends is discussed in a later chapterI Alternati)e ways to present cash flows fro( operating acti)ities are discussed in#hapter I9 $he basic financial state(ents and related notes are part of (ore elaborate docu(ents called annual reports that are produced by public co(panies- Annual reports are nor(ally split into two sections- $he first is non?financial and usually includes a letter to shareholders fro( the chairperson of the co(pany8s board of directors and the chief e;ecuti)e officerK descriptions of the co(pany8s (anage(ent philosophy, products, successes +and occasionally failures,K e;citing prospects and challenges for the futureK as well as beautiful photographs of products, facilities, and personnel$he second section includes the core of the report- $he principal co(ponents of this financial section include su((ari'ed financial data for fi)e or ten years, (anage(ent8s discussion and analysis of the co(pany8s financial condition and results of operations, four financial state(ents and related notes, auditor8s report, recent stoc* price infor(ation, a su((ary of <uarterly financial data, and a list of directors and officers of the co(panyRE&P N&I!ILI$IE& / R $:E A## 4N$ING # 554NI#A$I N PR #E&&L .Identify the role of international financial reporting standards +ifrs, in deter(ining the content of financial state(entsEffecti)e co((unication (eans that the recipient understands what the sender intends to con)ey- /or decision (a*ers to use the infor(ation in Nestl78s financial state(ents effecti)ely, they ha)e to understand what infor(ation each state(ent con)eysPage 1> $hey also need to *now that the a(ounts reported in the state(ents fairly represent what is clai(ed- /inancial

state(ents that do not represent what they clai( to are (eaningless and cannot be used effecti)ely to (a*e decisions- /or e;a(ple, if the state(ent of financial position lists N.,===,=== for a factory that does not e;ist, that part of the state(ent does not con)ey useful infor(ationCecision (a*ers also need to understand the (easure(ent rules applied in co(puting the nu(bers on the state(ents- A swi( coach would ne)er try to e)aluate a swi((er8s ti(e in the O1== freestyleP without first as*ing whether the ti(e was for a race in (etres or in yards- Li*ewise, a decision (a*er should ne)er atte(pt to use accounting infor(ation without first understanding the (easure(ent rules that were used to de)elop the infor(ation- $hese (easure(ent rules are based on International /inancial Reporting &tandards +I/R&,- $hese enco(pass broad principles, specific rules, practices, and con)entions of general application that are used by organi'ations to record transactions and report financial state(ent infor(ation to interested usersIN$ERNA$I NAL /INAN#IAL REP R$ING &$ANCARC& +I/R&, are guidelines for the (easure(ent rules used to de)elop the infor(ation in financial state(entsInternational /inancial Reporting &tandards +I/R&, :ow are Accounting &tandards Ceter(inedG $he accounting syste( that we use today has a long history- Its foundations are nor(ally traced bac* to the wor*s of an Italian (on* and (athe(atician, /r- Luca Pacioli- In 13>3, he described an approach de)eloped by Italian (erchants to account for their acti)ities as owner?(anagers of business )entures- 5any others wrote wor*s on accounting after Pacioli, but prior to 1>22, each co(pany8s (anage(ent largely deter(ined its own financial reporting practices- $hus, little unifor(ity in practice e;isted a(ong co(panies$he &E#4RI$IE& ANC EB#:ANGE # 55I&&I N +&E#, is the 4-&- go)ern(ent agency that deter(ines the financial state(ents that public co(panies (ust pro)ide to shareholders and the (easure(ent rules that they (ust use in producing those state(ents$he N$ARI &E#4RI$IE& # 55I&&I N + &#, is the (ost influential #anadian regulator of the flow of financial infor(ation pro)ided by publicly traded co(panies in #anada/ollowing the dra(atic stoc* (ar*et decline of 1>.>, the &ecurities Act of 1>22 and the &ecurities E;change Act of 1>23 were passed into law by the 4-&- #ongress- $hese acts created the &ecurities and E;change #o((ission +&E#, and ga)e it broad powers to deter(ine the (easure(ent rules for financial state(ents that co(panies (ust pro)ide to shareholders- In #anada, pro)incial securities legislation created securities co((issions, (ost notably the ntario &ecurities #o((ission + &#,, to regulate the flow of financial infor(ation pro)ided by publicly traded co(panies whose shares trade on #anadian stoc* e;changes, such as the $oronto &toc* E;change- &i(ilar to the &E#, the &# plays an influential role in pro(otion, sur)eillance, and enforce(ent of sound accounting practices by publicly traded co(panies- $he &# is one of 12 securities regulators of #anada8s pro)inces and territories- $hese regulators ha)e for(ed the #anadian &ecurities Ad(inistrators, which coordinates and har(oni'es regulation of the #anadian capital (ar*ets a(ong the(&ince their establish(ent, these securities co((issions ha)e wor*ed with organi'ations of professional accountants to establish groups that are gi)en the pri(ary responsibilities to wor* out the detailed rules that beco(e generally accepted accounting principles- $he current #anadian group that has this responsibility is the Accounting &tandards !oard +Ac&!, of the #anadian Institute of #hartered Accountants- $he Ac&! is responsible for establishing standards of accounting and reporting by publicly accountable enterprises, pri)ate enterprises, go)ern(ent organi'ations, and not?for?profit organi'ations- $hese standards or reco((endations, which are published in the #I#A :andboo*, ha)e e;panded o)er ti(e because of the increasing di)ersity and co(ple;ity of business practices- $he &# perfor(s sur)eillance and enforce(ent functions for legal re<uire(ents arising fro( standards in the #I#A :andboo*In "anuary .==9, the Ac&! publici'ed the strategic plan that guided the !oard in carrying out its standard?setting

(andate for the ne;t fi)e years:A Page .= /or public co(panies, the Ac&!8s obDecti)e is to (o)e to a single set of globally accepted high?<uality standards$he Ac&! has concluded that this obDecti)e is best acco(plished by con)erging #anadian GAAP with International /inancial Reporting &tandards +I/R&s, o)er a transitional period- Australia and the European 4nion ha)e already adopted I/R& and other countries ha)e con)ergence progra(s underway- $he Ac&! will de)elop and publish a detailed i(ple(entation plan for achie)ing con)ergence later this year-U $he Ac&! e;pects that the transition period will ta*e appro;i(ately fi)e years, but the precise ti(ing will depend on (any factors, and will be continuously (onitored throughout the process- At the end of that period, #anadian GAAP will cease to e;ist as a separate, distinct basis of financial reporting for public co(panies$he A## 4N$ING &$ANCARC& ! ARC +Ac&!, is the pri)ate?sector body gi)en the pri(ary responsibility to wor* out the detailed rules that beco(e accepted accounting standards$he Ac&! i(ple(ented its plan by re<uiring all publicly accountable enterprises to use I/R& in reporting their financial state(ents for fiscal years +annual accounting periods, that start on or after "anuary 1, .=11- &o(e #anadian co(panies, such as $ho(son Reuters #orporation, adopted I/R& for financial reporting prior to .=11, but the (aDority of public co(panies adopted I/R& in .=11International /inancial Accounting &tandards are produced by the International Accounting &tandards !oard +IA&!,, which is an independent standard?setting board consisting of 1I (e(bers fro( nine countries- $he IA&! co?operates with national accounting standard?setters to achie)e con)ergence in accounting standards around the world-0 $he IA&! initially issued International Accounting &tandards +IA&,- New IA&s are *nown as International /inancial Reporting &tandards$he IN$ERNA$I NAL A## 4N$ING &$ANCARC& ! ARC is an independent standard?setting board that is responsible for the de)elop(ent and publication of International /inancial Reporting &tandards$his boo* focuses on the accounting and financial reporting by publicly accountable enterprises- $he accounting and financial reporting standards used by other types of organi'ations are co)ered in ad)anced accounting courses- Cifferences between the accounting standards applicable to #anadian pri)ate enterprises and #anadian publicly accountable enterprises are highlighted at the end of each chapter5ost (anagers do not need to learn all of the details included in all accounting standards- ur approach is to focus on standards appropriate to an introductory course, which ha)e the greatest effect on the nu(bers presented in financial state(entsEhy Are Accounting &tandards I(portant to 5anagers and E;ternal 4sersG Accounting standards are of great interest to the co(panies that (ust prepare the state(ents and to the readers of these state(ents- I/R& pro)ide guidance to co(panies in selecting the accounting (ethods that best reflect the results of their operations and financial situation- $hese globally accepted accounting standards also pre)ent (anagers fro( deliberately (anipulating and reporting )alues that ser)e their personal interests by using accounting practices not in confor(ity with I/R&- Eidely di)ergent accounting practices reduce the co(parability of financial infor(ation fro( different co(panies operating in the sa(e line of business- I/R& enhances the co(parability by li(iting the nu(ber of acceptable alternati)e accounting (ethods across co(panies and o)er ti(e- /urther(ore, understanding I/R& enables e;ternal users to assess the <uality of the infor(ation presented in the financial state(ents and related notes#o(panies, their (anagers, and their owners are (ost directly affected by the infor(ation presented in the financial state(ents- #o(panies incur the cost of preparing the state(ents and bear the (aDor econo(ic conse<uences of their publication- $hese econo(ic conse<uences include, a(ong others, changes to the selling price of a co(pany8s shares,

changes to the a(ount of bonuses recei)ed by (anage(ent and e(ployees, and loss of co(petiti)e ad)antage o)er other co(paniesPage .1 IN$ERNA$I NALPER&PE#$I%E$:E IN$ERNA$I NAL A## 4N$ING GL !AL # N%ERGEN#E / A## 4N$ING &$ANCARC& &$ANCARC& ! ARC ANC

REAL E RLC EB#ERP$Celoitte IA& Plus Eebsite +www-iasplus-co(,V /inancial accounting standards and disclosure re<uire(ents are set by national regulatory agencies and standard? setting bodies- :owe)er, since .==., the International Accounting &tandards !oard +IA&!, has progressed <uic*ly to fulfill its responsibility to produce International /inancial Reporting &tandards +I/R&,- 5ore than 1== countries ha)e adopted the international standards- #ountries currently re<uiring use of I/R& include All countries in the European 4nion Australia and New Jealand India, :ong @ong, and &outh @orea !ra'il and #hile #hina #anada In the 4nited &tates, the &E# allows foreign co(panies whose shares are traded on 4-&- e;change (ar*ets to use I/R& and is considering allowing the sa(e for do(estic co(panies in the future&ource: Celoitte IA& PL4& websiteRecall that Nestl78s share price can be deter(ined in part based on the profit co(puted in co(pliance with I/R&$his presents the possibility that changes in accounting standards can affect the price buyers are willing to pay for co(panies- E(ployees who recei)e part of their pay based on reaching stated profit targets are directly concerned with any changes in how profit is deter(ined- 5anagers and owners often are concerned that publishing (ore infor(ation in financial state(ents will gi)e away trade secrets to other co(panies that co(pete with the(- As a conse<uence of these and other concerns, changes in accounting standards are acti)ely debated, political lobbying often ta*es place, and the accounting standards that are e)entually issued are often a co(pro(ise a(ong the conflicting wishes of interested parties5anage(ent Responsibility and the Ce(and for Auditing L 2Identify the roles of (anagers and auditors in the accounting co((unication processEho is responsible for the accuracy of the nu(bers in Nestl78s financial state(entsG Pri(ary responsibility lies with (anage(ent, as represented by the highest officer of the co(pany and its highest financial officer->#o(panies ta*e three i(portant steps to assure in)estors that the co(pany8s records are accurate: +1, they de)elop and (aintain a syste( of internal controls o)er both the records and the assets of the co(pany, +., they hire outside independent auditors to attest to the fairness of the state(ent presentations, and +2, they for( a co((ittee of the board of directors to o)ersee the integrity of these two safeguards- $hese responsibilities are often reiterated in a for(al report to (anage(ent or (anage(ent certification in the annual report- $hese three safeguards and a (anage(ent certification are re<uired for all #anadian co(panies with publicly traded shares-

5anagers of co(panies that prepare fraudulent financial state(ents are subDect to cri(inal and ci)il penalties$he REP R$ $ 5ANAGE5EN$ +5ANAGE5EN$ #ER$I/I#A$I N, indicates (anage(ent8s pri(ary responsibility for financial state(ent infor(ation and the steps to ensure the accuracy of the co(pany8s recordsPage .. $hree steps to ensure the accuracy of records:

$he role of the independent auditor is described in (ore detail in the audit report, or report of independent auditors +E;hibit 1-0,- $he audit report describes the auditor8s opinion of the fairness of the financial state(ents, and the e)idence gathered to support that opinion- It is i(portant to note that the (ain difference between the report of (anage(ent and the report of the independent auditors concerns the responsibility for the financial infor(ation included in the co(pany8s annual report- As the report of the independent auditors indicates, the auditor8s responsibility is to e;press an opinion on Nestl78s financial state(ents that ha)e been prepared by its accounting personnel and re)iewed by the audit co((ittee of the board of directors, which assu(es responsibility for the <uality of the content of these financial state(ents-1= $he A4CI$ REP R$ +REP R$ / INCEPENCEN$ A4CI$ R&, describes the auditors8 opinion of the fairness of the financial state(ent presentations and the e)idence gathered to support that opinionIn #anada, an accountant (ay be designated as a #hartered Accountant+#A,, a #ertified General Accountant +#GA,, or a #ertified 5anage(ent Accountant +#5A,- $hese accounting designations are granted by the respecti)e professional accounting organi'ations on co(pletion of specific educational progra(s and e;perience re<uire(ents-11 Professional accountants can offer )arious accounting ser)ices to the public, but only #As and #GAs +in (ost #anadian pro)inces1., are per(itted to issue audit reports of publicly traded co(panies because they ha)e certain responsibilities that e;tend to the general public as well as to the specific business that pays for their ser)icesAn A4CI$ is an e;a(ination of the financial reports to ensure that they represent what they clai( and confor( with International /inancial Reporting &tandardsAn audit in)ol)es the e;a(ination of the financial reports +prepared by the (anage(ent of the co(pany, to ensure that they represent what they clai( and confor( with I/R&- In perfor(ing an audit, the independent auditor e;a(ines the underlying transactions and the accounting (ethods used to account for these transactions-

!ecause of the enor(ous nu(ber of transactions that total billions of dollars each year for a (aDor enterprise, such as Air #anada, the auditor does not e;a(ine each transaction- Rather, professional approaches are used to ascertain beyond reasonable doubt that transactions were (easured and reported properly-12 5any opportunities e;ist for (anagers to intentionally prepare (isleading financial reports- An audit perfor(ed by an independent auditor is the best protection a)ailable to the public- Ehen that protection fails, howe)er, the independent auditor is so(eti(es found liable for losses incurred by those who rely on the state(ents- In this regard, the #anadian Public Accountability !oard was created in .==2 to pro)ide public o)ersight for auditors of public co(panies-

E;hibit 1-0Auditors8 Report Page .3 Ethics, Reputation, and Legal Liability L 3Appreciate the i(portance of ethics, reputation, and legal liability in accountingIf financial state(ents are to be of any )alue to decision (a*ers, users (ust ha)e confidence in the fairness of the infor(ation- $hese users will ha)e greater confidence in the infor(ation if they *now that the people who were associated with auditing the financial state(ents were re<uired to (eet professional standards of ethics and co(petence$he three #anadian professional accounting organi'ations re<uire all of their (e(bers to adhere to professional codes of ethics- $hese broad principles are supported by specific rules go)erning the perfor(ance of audits by (e(bers of these organi'ations- $hese organi'ations stress how i(portant it is for each (e(ber to beha)e in ways that enhance the reputation of the profession by )oluntarily co(plying with codes of ethical conduct- /or e;a(ple, the #anadian Institute of #hartered Accountants places ethical beha)iour and professionalis( as the (ost i(portant of the per)asi)e co(petencies possessed by its (e(bers-13 $he #ertified General Accountants

Association of #anada notes in its #ode of Ethical Principles and Rules of #onduct that an accountant8s actions will ha)e an influence not only on the welfare of society but also on that of the profession- 1I $he &ociety of 5anage(ent Accountants of #anada has also issued a few publications related to ethical conduct, such as #odes of Ethics, Practice and #onduct and I(ple(enting Ethics &trategies within rgani'ations- 19 /ailure to co(ply with professional rules of conduct can result in serious penalties for professional accountants, including rescinding the professional designation of an offending (e(ber- $he potential econo(ic effects of da(age to reputation and (alpractice liability, howe)er, pro)ide e)en stronger incenti)es to abide by professional standards- $hus, the profession recogni'es that its (e(bers8 reputations for ethical conduct and co(petence are their (ost i(portant assets- /inally, recent changes in laws and securities regulation per(it the assess(ent of personal financial penalties on professional accountants who are found guilty of non?co(pliance, and they (ust co(pensate for the financial har( done to others/inancial state(ent fraud is a fairly rare e)ent, due in part to the diligent efforts of practising professional accountants- In fact, (any such frauds are first identified by the fir(8s accounting staff or its e;ternal auditors who ad)ise regulatory authorities of possible wrongdoing- In doing so, these Owhistle blowersP place the interest of the public at large ahead of their own interests and act accordingly- :owe)er, in case of (alpractice, independent auditors (ay be held liable for losses suffered by those who relied on the audited financial state(entsIt is i(portant to note that the )ast (aDority of (anagers and owners do act in an honest and responsible (anner:owe)er, when the top officers in an organi'ation collude to decei)e other parties, they (ay te(porarily succeedIn (any cases, e)en the (ost diligent audit (ay not i((ediately unco)er the results of fraud in)ol)ing collusion of the top officers of a corporation, such as occurred in a nu(ber of well?publici'ed cases such as 6!5 5agne; International Inc- and Li)ent Inc- in #anada, A(erican In)est(ent Group Inc- +AIG, in the 4nited &tates, &ie(ens AG in Ger(any, and Par(alat &-p-A in Italy- :owe)er, those who were in)ol)ed in fraudulent beha)iour were e)entually identified and were sanctioned by the appropriate legal authorities5isrepresentations by (anagers highlight the i(portance of ensuring the integrity of the financial reporting syste( by the public accounting profession- Cisclosure of financial infor(ation that does not confor( to e;isting accounting standards i(poses significant costs on the shareholders, creditors, and e(ployees of co(panies affected by fraudulent acti)ities- Recent refor(s of the accounting profession and the i(position of new go)ern(ent regulations both in #anada and the 4nited &tates (a*e it (ore difficult and costly for co(pany (anagers to engage in fraudulent acti)itiesPage .I A## 4N$ING &$ANCARC&/ R PRI%A$E EN$ERPRI&E $he use of International /inancial Reporting &tandards is re<uired of all #anadian publicly accountable enterprises- :owe)er, corporations that do not ha)e their shares traded on organi'ed e;change (ar*ets and other pri)ate for?profit enterprises +proprietorships and partnerships, are not re<uired to use I/R&- Instead, #anadian pri)ate enterprises (ay prepare their financial state(ents in accordance with a set of #anadian accounting standards that e;cludes inappropriate financial reporting co(ple;ities- 1A

$he Ac&!8s decision to allow #anadian pri)ate enterprises to use accounting standards that de)iate fro( I/R& recogni'es that the infor(ation needs of e;ternal users of the financial state(ents of pri)ate enterprises differ fro( the infor(ation needs of users of the financial state(ents of publicly accountable enterprises- $he (aDor difference between the two types of enterprises is that e;ternal users of the pri)ate enterprise8s financial state(ents do not include the (any indi)idual in)estors that typically purchase shares of publicly accountable enterprises:ence, lenders are often the (aDor e;ternal sta*eholders in pri)ate enterprises and (ay obtain additional infor(ation fro( these co(panies upon re<uest-

$he financial state(ents prepared by both types of co(panies are based on the sa(e conceptual fra(ewor*, but they (ay differ with respect to the details that are reported in the financial state(ents and related notes- /or e;a(ple, the concept of other co(prehensi)e inco(e is not applicable to pri)ate enterprises- :ence, they are not re<uired to prepare a state(ent of co(prehensi)e inco(e or a state(ent of changes in e<uity-

It should be noted that pri)ate enterprises (ay choose to use I/R& for e;ternal reporting- n the other hand, they (ay choose to not follow either I/R& or the accounting standards prescribed for pri)ate enterprises, particularly if they are not dependent on significant e;ternal sources of financing for their operations-

CE5 N&$RA$I N #A&E At the end of (ost chapters, one or (ore de(onstration cases are presented- $hese cases pro)ide an o)er)iew of the pri(ary issues discussed in the chapter- Each de(onstration case is followed by a reco((ended solution- 6ou should read the case carefully and then prepare your own solution before you study the reco((ended solution-$his self?e)aluation is highly reco((ended$he introductory case presented here re)iews the ele(ents reported on the inco(e state(ent and state(ent of financial position and how the ele(ents within each are relatedA!# &er)ice #orporation was organi'ed by Able, !a*er, and #asella on "anuary 1, .=11- n that date, the in)estors e;changed N29,=== cash for all shares of the co(pany- n the sa(e day, the corporation borrowed N1=,=== fro( a local ban* and signed a three?year note, payable on Cece(ber 21, .=12- Interest of 1= percent is payable each Cece(ber 21- n "anuary 1, .=11, the corporation purchased supplies for N.=,=== cash- perations started i((ediatelyAt the end of .=11, the corporation had co(pleted the following additional business transactions +su((ari'ed,: Perfor(ed ser)ices and billed custo(ers for N1==,===, of which N>3,=== was collected by year?end4sed up NI,=== of supplies while rendering ser)icesPaid NI3,=== for other ser)ice e;pensesPaid N1,=== in annual interest e;pense on the note payablePaid N0,=== of inco(e ta;es to #anada Re)enue AgencyRe<uired: #o(plete the following two financial state(ents for .=11 by entering the correct a(ounts- $he suggested solution follows the blan* state(ents-

Page .9 &4GGE&$EC & L4$I N

A Accounting &tandards in #anada: New CirectionsF&trategic Plan, #anadian Institute of #hartered Accountants, .==9,page 10 $he IA&!8s website +www-ifrs-orgV, pro)ides (ore details about the process of producing I/R&> Legally this is enforced by the &# through National Instru(ent I.?1=> ?#ertification of Cisclosure in Issuers8

Annual and Interi( /ilings- #hief e;ecuti)e and chief financial officers (ust sign a legal docu(ent with e)ery financial report filed with the &#- $hat docu(ent certifies that the #E and #/ ha)e designed or super)ised the design of a financial data collection and reporting syste( that will result in financial state(ents free of (aterial (isstate(ent and fraud- $his is an assurance of the <uality of financial infor(ation disclosed by co(panies listed on #anadian stoc* e;changes1= A typical audit report for #anadian public co(panies consists of the auditor8s responsibility and opinion11Refer to the following websites for details of the educational and e;perience re<uire(ents for the respecti)e designations: #hartered Accountant: www-cica-caV #ertified General Accountant:www-cga?canada-orgV #ertified 5anage(ent Accountant:www-c(a?canada-orgV 1.#GAs and #5As ha)e the right to practice public accounting in Huebec if they (eet stringent co(petency criteria- In !ritish #olu(bia, #5As are per(itted to do assurance audits upon successful application to the Audit #ertification !oard12$he Auditing and Assurance &tandards !oard +AA&!, of the #anadian Institute of #hartered Accountants sets standards for auditing of public co(panies- $he AA&! has recently produced new #anadian Auditing &tandards that are essentially the International &tandards on Auditing issued by the International Auditing and Assurance &tandards !oard13 $he 4/E #andidates8 #o(petency 5ap- $he #anadian Institute of #hartered Accountants, $oronto: #anada, .==>, pp- 11W19, accessible through the #I#A8s website: www-cica-caV1I#ode of Ethical Principles and Rules of #onduct- #ertified General Accountants Association of #anada, %ancou)er: #anada, .=1=, accessible through the #GA8s website: www-cga?canada-orgV19$hese publications are accessible through the society8s website: www-c(a?canada-orgV1A Not?for?profit organi'ations and pension plans are subDect to different sets of accounting standards- $he accounting standards applicable to the )arious types of organi'ations are co(piled in different parts of the #I#A :andboo*- Part I of the :andboo* includes I/R&- Part II includes accounting standards for pri)ate enterprises-

Appendi; 1A $ypes of !usiness Entities $his te;tboo* e(phasi'es accounting for profit?(a*ing business entities- $he three (ain types of business entities are sole proprietorship, partnership, and corporation- A sole proprietorship is an unincorporated business owned by one personK it usually is s(all in si'e and is co((on in the ser)ice, retailing, and far(ing industries- ften the owner is the (anager- Legally, the business and the owner are not separate entities- :owe)er, accounting )iews the business as a separate entity that (ust be accounted for separately fro( its ownerA partnership is an unincorporated business owned by two or (ore persons *nown as partners- &o(e partnerships are large in si'e +e-g-, international public accounting fir(s and law fir(s,- $he agree(ents between the owners are specified in a partnership contract that deals with (atters such as di)ision of profit a(ong partners and distribution of resources of the business on ter(ination of its operations- A partnership is not legally separate fro( its owners- Legally, each partner in a general partnership is responsible for the debts of the business +each general partner has unli(ited liability,- $he partnership, howe)er, is a separate business entity to be accounted for separately fro( its se)eral ownersA corporation is a business incorporated federally under the #anada !usiness #orporations Act or pro)incially under si(ilar pro)incial acts- $he owners are called shareholders or stoc*holders- wnership is represented by

shares of capital that usually can be bought and sold freely- Ehen an appro)ed application for incorporation is filed by the organi'ers, a charter is issued by either the federal or the pro)incial go)ern(ent- $his charter gi)es the corporation the right to operate as a legal entity, separate fro( its owners- $he shareholders enDoy li(ited liability&hareholders cannot lose (ore than they paid for their shares- $he corporate charter specifies the types and a(ounts of share capital that can be issued- 5ost pro)inces re<uire a (ini(u( of two shareholders and a (ini(u( a(ount of resources to be contributed at the ti(e of organi'ation- $he shareholders elect a go)erning board of directors, which in turn e(ploys (anagers and e;ercises general super)ision of the corporation-

E;hibit 1->#o(parison of $hree $ypes of !usiness Entities Page .0 5e(bers of the board of directors, e;ecuti)es, and officers of co(panies as well as e(ployees do not enDoy li(ited liability for any da(age caused by their willful wrongdoing- !ecause a corporation is considered a legally separate entity, directors and e;ecuti)es (ay find the(sel)es being sued for da(ages by their for(er e(ployerAccounting also )iews the corporation as a separate business entity that (ust be accounted for separately fro( its ownersIn ter(s of econo(ic i(portance, the corporation is the do(inant for( of business organi'ation in #anada- $his do(inance is caused by the (any ad)antages of the corporate for(: +1, li(ited liability for the shareholders, +., continuity of life, +2, ease in transferring ownership +shares,, and +3, opportunities to raise large a(ounts of (oney by selling shares to a large nu(ber of people- $he pri(ary disad)antages of a corporation are +1, loss of control by shareholders, +., co(ple; reporting procedures for a )ariety of go)ern(ent agencies, and +2, potential for double ta;ation of profit +it is ta;ed when it is earned and again when it is distributed to shareholders as di)idends,- In this te;tboo*, we e(phasi'e the corporate for( of business- Ne)ertheless, the accounting concepts and procedures that we discuss also apply to other types of businesses- $he (ain differences a(ong these three types of entities appear in the e<uity section of the state(ent of financial position&pecific aspects of the three types of business entities are co(pared inE;hibit 1->-

Appendi; 1! E(ploy(ent in the Accounting Profession $oday &ince 1>==, accounting has attained the stature of professions such as law, (edicine, engineering, and architecture- As with all recogni'ed professions, accounting is subDect to professional co(petence re<uire(ents, is dedicated to ser)ice to the public, re<uires a high le)el of acade(ic study, and rests on a co((on body of *nowledge- As indicated earlier, three #anadian accounting designations are a)ailable to an accountant: #A, #GA, and #5A- $hese designations are granted only on co(pletion of re<uire(ents specified by the respecti)e professional organi'ations- Although specific re<uire(ents )ary a(ong the three professional organi'ations, they include a uni)ersity degree with a specified nu(ber of accounting courses, good character, a (ini(u( of two years of rele)ant professional e;perience, and successful co(pletion of a professional e;a(ination- #urrently, all accountants (ust be licensed by the go)ern(ent to engage in professional practice and they (ust (eet ongoing tests of co(petence to retain their licences- &i(ilar accounting designations e;ist in other countries, (ost notably the #ertified Public Accountant +#PA, in the 4nited &tatesAccountants usually are engaged in professional practice or are e(ployed by businesses, go)ern(ent entities, and not?for?profit organi'ations- $he accounting profession is continuously changing- Ehile (any accountants still pro)ide traditional accounting and ta; ser)ices to businesses, indi)idual clients, and go)ern(ent organi'ations, other areas of practice ha)e beco(e increasingly co((on in the accounting profession today- Ce(and for )alue? added accounting ser)ices +e-g-, financial analysis, e)aluation and i(ple(entation of new infor(ation technology and business processes, (anage(ent ad)isory and consulting ser)ices, forensic accounting, and en)iron(ental accounting, is reshaping the nature of educational progra(s that prepare students to beco(e professional accountants-10 Page .> Practice of Public Accounting Although an indi)idual (ay practice public accounting, usually two or (ore indi)iduals organi'e an accounting

fir( in the for( of a partnership +in (any cases, a li(ited liability partnership, or LLP,- Accounting fir(s )ary in si'e fro( a one?person office to regional fir(s, to the O!ig /ourP fir(s +Celoitte X $ouche, Ernst X 6oung, @P5G, and Pricewaterhouse#oopers,, which ha)e hundreds of offices worldwide- Accounting fir(s usually render three types of ser)ices: assurance ser)ices, (anage(ent consulting ser)ices, and ta; ser)icesAssurance &er)ices Assurance ser)ices are independent professional ser)ices that i(pro)e the <uality of infor(ation, or its conte;t, for decision (a*ers- $he (ost i(portant assurance ser)ice perfor(ed by professional accountants in public practice is financial state(ent auditing- $he audit8s purpose is to lend credibility to the financial reportsK that is, to ensure that they fairly represent what they clai(- An audit in)ol)es an e;a(ination of the financial reports +prepared by the (anage(ent of the entity, to ensure that they confor( to I/R&- ther areas of assurance ser)ices include integrity and security of electronic co((erce and reliability of infor(ation syste(s5anage(ent #onsulting &er)ices 5any independent accounting fir(s offer (anage(ent consulting ser)ices$hese ser)ices usually are accounting?based and enco(pass such acti)ities as the design and installation of accounting, data processing, and profit?planning and control +budget, syste(sK financial ad)iceK forecastingK internal controlsK cost?effecti)eness studiesK and operational analysis- $his facet of public accounting practice has grown rapidly- $he percei)ed influence that a)ailability of such ser)ices (ight ha)e on auditor independence has caused large accounting fir(s to dissociate their consulting practice fro( their audit functionPage 2= $a; &er)ices Accountants in public practice usually pro)ide inco(e ta; ser)ices to their clients- $hese ser)ices include both ta; planning as a part of the decision?(a*ing process and the deter(ination of the inco(e ta; liability +reported on the annual inco(e ta; return,- !ecause of the increasing co(ple;ity of pro)incial and federal ta; laws, a high le)el of co(petence is re<uired, which accountants speciali'ing in ta;ation can pro)ide- $he accountant8s in)ol)e(ent in ta; planning often is <uite significant- 5ost (aDor business decisions ha)e significant ta; i(pactsK in fact, ta;?planning considerations often go)ern certain business decisionsE(ploy(ent by rgani'ations 5any accountants, including #As, #GAs, and #5As, are e(ployed by profit?(a*ing, not?for?profit and go)ern(ent organi'ations- An organi'ation, depending on its si'e and co(ple;ity, (ay e(ploy fro( a few to hundreds of accountants- In a business enterprise, the chief financial officer +usually a )ice?president or controller, is a (e(ber of the (anage(ent tea(- $his responsibility usually entails a wide range of (anage(ent, financial, and accounting dutiesIn a business entity, accountants typically are engaged in a wide )ariety of acti)ities, such as general (anage(ent, general accounting, cost accounting, profit planning and control +budgeting,, internal auditing, and co(puteri'ed data processing- A pri(ary function of the accountants in organi'ations is to pro)ide data that are useful for internal (anagerial decision (a*ing and for controlling operations- $he functions of e;ternal reporting, ta; planning, control of assets, and a host of related responsibilities nor(ally are also perfor(ed by accountants in industryE(ploy(ent in the Public and Not?/or?Profit &ectors $he )ast and co(ple; operations of go)ern(ental units, fro( the local to the international le)el, create a need for accountants- $he sa(e holds true for other not?for?profit organi'ations such as charitable organi'ations, hospitals, and uni)ersities- Accountants e(ployed in the public and not?for?profit sectors perfor( functions si(ilar to those perfor(ed by their counterparts in pri)ate organi'ationsA sur)ey of positions occupied by accounting professionals and related salaries is a)ailable at www-accounte(ps-co(V10 Refer to the following website for (ore details about the types of ser)ices and s*ills that should be pro)ided by accountants in the future:www-accounte(ps-co(TEhat#anadianE(ployers&ee*V-

#:AP$ER $A@E?AEA6& Recogni'e the infor(ation con)eyed in each of the four basic financial state(ents and how it is used by different decision (a*ers +in)estors, creditors, and (anagers,- p- . $he state(ent of financial position reports financial )alues for the assets, liabilities, and shareholders8 e<uity at a specific point in ti(e$he state(ent of co(prehensi)e inco(e reports the profit +re)enues (inus e;penses, for a period as well as changes in e<uity during that period, e;cept those resulting fro( e;changes with owners$he state(ent of changes in e<uity reports the way that profit, the distribution of profit +di)idends,, and other changes to shareholders8 e<uity affected the co(pany8s financial position during a specific period$he state(ent of cash flows reports inflows and outflows of cash for a specific period$he state(ents are used by in)estors and creditors to e)aluate different aspects of the fir(8s financial position and perfor(anceIdentify the role of International /inancial Reporting &tandards +I/R&, in deter(ining the content of financial state(ents- p- 10 I/R& are the broad principles, specific rules, and practices used to de)elop and report the infor(ation in financial state(ents- @nowledge of I/R& is necessary to accurately interpret the nu(bers in financial state(entsIdentify the roles of (anagers and auditors in the accounting co((unication process- p- .1 5anage(ent has pri(ary responsibility for the accuracy of a co(pany8s financial infor(ation- Auditors are responsible for e;pressing an opinion on the fairness of the financial state(ent presentations based on their e;a(ination of the reports and records of the co(panyAppreciate the i(portance of ethics, reputation, and legal liability in accounting- p- .3 4sers will ha)e confidence in the accuracy of financial state(ent nu(bers only if the people associated with their preparation and audit ha)e reputations for ethical beha)iour and co(petence- 5anage(ent and auditors can also be held legally liable for fraudulent financial state(ents and (alpracticeIn this chapter, we studied the basic financial state(ents that co((unicate financial infor(ation to e;ternal users#hapters ., 2, 3, andI will pro)ide a (ore detailed loo* at financial state(ents and e;a(ine how to translate data about business transactions into these state(ents- Learning the relationship between business transactions and financial state(ents is the *ey to using financial state(ents in planning and decision (a*ing- #hapter . begins our discussion of how the accounting function collects data about business transactions and processes the data to pro)ide periodic financial state(ents, with e(phasis on the state(ent of financial position- $o acco(plish this purpose, #hapter . discusses *ey accounting concepts, the accounting (odel, transaction analysis, and analytical tools- Ee e;a(ine typical business acti)ities of Nestl7 to de(onstrate the concepts in #hapters ., 2, and 3Page 21 /INCING/INAN#IAL IN/ R5A$I N

@E6 $ER5& Accounting p- .Accounting Entity p- IAccounting Period p- 1=Accounting &tandards !oard +Ac&!, p- 1>Audit p..Audit Report +Report of Independent Auditors,p- ..!asic Accounting E<uationp- 9Inco(e &tate(entp>International Accounting &tandards !oard +IA&!,p- .=International /inancial Reporting &tandards +I/R&,p1>Notes +/ootnotes,p- 1A ntario &ecurities #o((ission + &#,p- 1>Report to 5anage(ent +5anage(ent #ertification,p- .1Retained Earningsp- 1.&ecurities and E;change #o((ission +&E#,p- 1>&tate(ent of #ash /lowsp- 12&tate(ent of #hanges in E<uityp- 1.&tate(ent of #o(prehensi)e Inco(ep- >&tate(ent of /inancial Position +!alance &heet,p- 3

After studying this chapter, you should be able to do the following: . LEARNING !"E#$I%E& . L 1 4nderstand the obDecti)e of financial reporting and the related *ey accounting assu(ptions and principles- p3A . L . Cefine the ele(ents of a classified state(ent of financial position- p- I= 1 L 2 Identify what constitutes a business transaction, and recogni'e co((on account titles used in business- p- I9 1 L 3 Apply transaction analysis to si(ple business transactions in ter(s of the accounting (odel: Assets L Liabilities M &hareholders8 E<uity- p- I0 1 L I Ceter(ine the i(pact of business transactions on the state(ent of financial position by using two basic tools: Dournal entries and $?accounts- p- 92 1 L 9 Prepare a classified state(ent of financial position and analy'e it by using the debt?to?e<uity ratio- p- A1 1 L A Identify in)esting and financing transactions and de(onstrate how they are reported on the state(ent of cash flows- p- A3

/ #4& # 5PAN6: Nestl7 &-AEBPAN&I N &$RA$EG6 IN $:E N4$RI$I N, :EAL$:, ANC EELLNE&& INC4&$R6 N estl7 &-A- +www-nestle-co(,, founded in 1099, produces and (ar*ets a wide assort(ent of nutrition, health, and wellness products, including baby foods, brea*fast cereals, chocolate, coffee, dairy products, ice crea(, bottled water, and pet foods- Its products are sold in o)er 1== countries in the fi)e continentsNestl7 grew rapidly o)er the past 9= years to beco(e the leading food co(pany worldwide, with a total of 33> (anufacturing facilities in 03 countries by Cece(ber 21, .==>, including 1= factories in #anada- $he co(pany has e;ecuted its growth strategy by ac<uiring or in)esting in other co(panies- &ince 1>>0, Nestl7 has in)ested o)er I= billion &wiss francs to grow through ac<uiring other co(panies- $he co(pany8s state(ent of financial position at Cece(ber 21, .==>, co(pared to Cece(ber 21, 1>>0, +in (illions of &wiss francs, highlights its growth:

&ource: Nestl78s annual reports Page 39 $he co(pany8s annual growth in sales and total assets since 1>>0 is highlighted in the graph4NCER&$ANCING $:E !4&INE&& Nutrition, health, and wellness are issues that concern all people- Indi)iduals stri)e to get proper nutrition and be healthy for as long a period as possible- Go)ern(ents also e;ert e)ery effort to help their citi'ens get proper nutrition to be producti)e (e(bers of society- /or this reason, nutrition, health, and wellness ha)e attracted the attention of (any businesses worldwide- A large nu(ber of co(panies ha)e e(erged o)er ti(e to (eet the needs of people see*ing basic nutrition and healthy lifestyles- Nestl7, @raft /oods, #onAgra /oods, &ara Lee, Le Groupe Canone, and #adbury a(ong others capture (ost of the global retail (ar*et for nutrition and health foods and drin*s- $hese and other co(panies co(pete ferociously, with Nestl7 capturing the lion8s share of the global (ar*etNestl7 has been a global food (anufacturing giant since the 1>==s when it had operations on four continents- $he co(pany relies on a strategy of <uality for both its products and its ser)ices, focusing on research and de)elop(ent to bring inno)ati)e products and ser)ices to consu(ers- In .==>, Nestl7 in)ested #:/ . billion in research and de)elop(ent- $he business (odel that has been so successful for Nestl7 rests also on sound scientific e)idence of i(pro)ed nutrition- $he co(pany is proud of its history of both de)eloping reliable suppliers in de)eloping countries and creating a safe (anufacturing setting, sourcing o)er two?thirds of its #:/ .= billion of raw (aterials +(il*, coffee, cocoa, fro( the(- Nestl7 is co((itted to sustainable production, socially responsible business practices, and reducing en)iron(ental pollution and waste$he co(pany8s financial perfor(ance, reported in its audited financial state(ents, helps users to understand how well Nestl7 has i(ple(ented its strategy in the past and to e)aluate future growth potential/inancial state(ents are intended to co((unicate the econo(ic facts, (easured in (onetary units, in a

standardi'ed, for(al way- $herefore, by applying accounting principles consistently, accountants for(ally co((unicate co(parable esti(ates that faithfully represent i(portant econo(ic facts about co(panies li*e Nestl7 and its co(petitors- As e;plained in #hapter 1, financial state(ents include four co(ponents: the state(ent of financial position, the state(ent of co(prehensi)e inco(e, the state(ent of changes in e<uity, and the state(ent of cash flows- In this chapter, we focus on the state(ent of financial position, and we e;a(ine how this financial state(ent co((unicates the results or conse<uences of Nestl78s strategy by answering the following <uestions: Page 3A Ehat type of business acti)ities cause changes in a(ounts reported on the state(ent of financial position fro( one period to the ne;tG :ow do specific acti)ities affect each of these a(ountsG :ow do co(panies *eep trac* of these a(ountsG nce we ha)e answered these <uestions, we will be able to use the infor(ation on the state(ent of financial position to perfor( two *ey analytical tas*s: Analy'e and predict the effects of business decisions on a co(pany8s financial state(ents4se the financial state(ent of other co(panies to identify and e)aluate the acti)ities that (anagers engaged in during a past period- $his is a *ey tas* in financial state(ent analysisIn this chapter, we focus on typical asset ac<uisition acti)ities +often called in)esting acti)ities, in which Nestl7 engages, along with the related financing acti)ities, such as borrowing funds fro( creditors and recei)ing funds fro( in)estors to ac<uire the assets- Ee e;a(ine only those acti)ities that affect a(ounts reported on the state(ent of financial position- perating acti)ities that affect a(ounts reported on both the inco(e state(ent and the state(ent of financial position are co)ered in#hapters 2 and 3- Although these acti)ities are all related, we separate the( initially to aid your understanding- $o begin, let us return to the basic concepts introduced in #hapter 1RGANIJA$I N / $:E #:AP$ER

Appendi; !: $he /or(al Record@eeping &yste( +online,

%ER%IEE / A## 4N$ING # N#EP$&Page 30 L 14nderstand the obDecti)e of financial reporting and the related *ey accounting assu(ptions and principles$he *ey accounting ter(s and concepts we defined in #hapter 1 are part of a theoretical fra(ewor* de)eloped o)er (any years- $he fra(ewor* prescribes the nature, function, and li(itations of both financial accounting and financial state(ents- $he essential ele(ents of this fra(ewor* are e(bodied in the IA&! /ra(ewor* for the Preparation and Presentation of /inancial &tate(ents,1 which identifies concepts that for( the foundation for

financial reporting- $his fra(ewor* is the subDect of a (aDor proDect underta*en Dointly by the IA&! and the /inancial Accounting &tandards !oard +/A&!, of the 4nited &tates-. $his conceptual fra(ewor* is presented in E;hibit .-1 as an o)er)iew, with *ey concepts discussed in the ne;t fi)e chapters- An understanding of the accounting concepts will be helpful as you study because learning and re(e(bering how the accounting process wor*s is (uch easier if you *now why it wor*s a certain way- A clear understanding of these concepts will also help you in future chapters as we e;a(ine (ore co(ple; business acti)ities#oncepts E(phasi'ed in #hapter . $he PRI5AR6 !"E#$I%E / EB$ERNAL /INAN#IAL REP R$ING is to pro)ide useful econo(ic infor(ation about a business to help e;ternal parties (a*e sound financial decisionsbDecti)e of /inancial Reporting $he pri(ary obDecti)e of e;ternal financial reporting is to pro)ide useful econo(ic infor(ation about a business to help e;ternal parties, pri(arily in)estors and creditors, (a*e sound financial decisions in their capacity as capital pro)iders- $he users of accounting infor(ation are identified as decision (a*ers- $hese decision (a*ers include a)erage in)estors, creditors, and e;perts who pro)ide financial ad)ice- $hey are all e;pected to ha)e a reasonable understanding of accounting concepts and procedures +this (ay be one of the reasons why you are studying accounting,- f course, as we discussed in #hapter 1, (any other groups, such as suppliers and custo(ers, also use e;ternal financial state(ents- $o achie)e this obDecti)e, financial reports (ust enable decision (a*ers not only to assess the a(ounts, ti(ing, and uncertainty of future cash inflows and outflows but also to understand the financial )alue of both the assets owned and clai(s against those assets +liabilities and e<uity,All the ele(ents of the financial state(ents in E;hibit .-1 are recogni'ed and reported in accordance with the assu(ptions, principles, and constraints- $he obDecti)e of financial reporting, howe)er, cannot be achie)ed si(ply by reporting any financial )alue for each ele(ent, because the a(ounts (ust also confor( to specific <ualities if they are to be useful to decision (a*ers- $hese <ualities, or <ualitati)e characteristics, appear in the upper part of the e;hibit-

E;hibit .-1/inancial Accounting and ReportingW #onceptual /ra(ewor*#oncepts in red are discussed in #hapter 1 and .- $hose in blac* will be discussed in#hapters 2, 3, and 94sers are (ost interested in infor(ation to assist the( in proDecting the future cash inflows and outflows of a business- /or e;a(ple, creditors and potential creditors need to assess an entity8s ability to pay interest o)er ti(e and repay the initial a(ount borrowed, called the principal- In)estors and potential in)estors want to assess the entity8s ability to pay di)idends in the future- $hey also want to e)aluate how successful the co(pany (ight be in the future, so that as the share price rises, in)estors can then sell their shares for (ore than they paidAccounting Assu(ptions $hree of the four basic assu(ptions that underlie accounting (easure(ent and reporting relate to the state(ent of financial position- $hey were discussed in #hapter 1- 4nder the separate?entity assu(ption, the acti)ities of each business (ust be accounted for as an indi)idual organi'ation that is separate and apart fro( its owners, all other persons, and other entities- &eparation of the owners8 resources +and obligations, fro( those of the business entity is necessary for a proper e)aluation of the entity8s results of operations and its financial position- /or e;a(ple, a building purchased by the owner of a real estate de)elop(ent and (anage(ent

co(pany for personal use should not be (i;ed with buildings owned by the co(pany- 4nder the unit?of?(easure assu(ption, each business entity accounts for and reports its financial results pri(arily in ter(s of the national (onetary unit +dollars in #anada, euros in European union countries, pesos in 5e;ico, etc-,, e)en if the entity has business operations in (any countriesPage 3> $he &EPARA$E?EN$I$6 A&&45P$I N states that business transactions are separate fro( the transactions of the owners$he 4NI$? /?5EA&4RE A&&45P$I N states that accounting infor(ation should be (easured and reported in the national (onetary unit$he use of a specific unit of (easure allows for (eaningful aggregation of financial a(ounts- /urther(ore, accountants assu(e that the unit of (easure has a stable )alue o)er ti(e, e)en though we recogni'e that the price we pay to purchase a specific ite(, such as a candy bar, tends to increase o)er ti(e- Nestl78s state(ent of financial position includes (any assets (easured in &wiss francs fro( the 1>A=s, 1>0=s, and 1>>=s- $he stable (onetary unit assu(ption allows accountants to co(bine different a(ounts, e)en though the purchasing power of the (onetary unit has changed o)er ti(e/or accounting purposes, a business nor(ally is assu(ed to continue operating long enough to carry out its obDecti)es and to (eet contractual co((it(ents- $his continuity assu(ption is so(eti(es called the going? concern assu(ption because we e;pect a business to continue to operate into the foreseeable future- %iolation of this assu(ption (eans that assets and liabilities should be )alued and reported on the state(ent of financial position as if the co(pany were to be li<uidated +i-e-, discontinued, with all assets sold and all debts paid,- In all future chapters, unless indicated otherwise, we assu(e that businesses (eet the continuity assu(ption$he # N$IN4I$6 +G ING?# N#ERN, A&&45P$I N states that businesses are assu(ed to continue to operate into the foreseeable future$he fourth assu(ption, periodicity, pro)ides guidance on (easuring re)enues and e;penses that will be discussed in #hapter 2!asic Accounting Principle $he historical cost principle states that the cash?e<ui)alent cost needed to ac<uire an asset +the historical cost, should be used for initial recognition +recording, of all financial state(ent ele(ents4nder the cost principle, cost is (easured on the date of the transaction as the cash paid plus the current (onetary )alue of all non?cash considerations +any assets, pri)ileges, or rights, also gi)en in the e;change- ne ad)antage of this approach is that (any assets are ac<uired according to legal contracts that clearly state the ac<uisition cost/or e;a(ple, if you trade your co(puter plus cash for a new car, the cost of the new car is e<ual to the cash paid plus the (ar*et )alue of the co(puter- $hus, in (ost cases, cost is relati)ely easy to deter(ine and can be )erified- A disad)antage of this approach is that, subse<uent to the date of ac<uisition, the continued reporting of historical cost on the state(ent of financial position does not reflect any change in (ar*et )alue, usually because (ar*et )alue is a less )erifiable (easure than historical cost$he # &$ PRIN#IPLE re<uires assets to be recorded at the historical cash?e<ui)alent cost, which is cash paid plus the current (onetary )alue of all non?cash considerations also gi)en in the e;change, on the date of the transaction-

Nestl7 owns land that it ac<uired

se)eral years ago and reports it on the state(ent of financial position at historical cost- Although the (ar*et price or econo(ic )alue of the land has risen o)er ti(e, its recorded )alue re(ains unchanged at its original cost because this a(ount is a )erifiable (easure based on an actual e;change that occurred in the past- It would be desirable to show on the state(ent of financial position the land8s current (ar*et )alueK that is, the price at which it could either be sold or replaced instead of its outdated historical cost- :owe)er, the land8s current )alue (ay not be reliable if different real estate appraisers produce different )alues for the sa(e piece of land- Accountants continue, therefore, to rely on historical cost (easures for reporting purposes because they are factual, although they (ay not be useful for specific decision?(a*ing purposes- /urther(ore, as long as Nestl7 re(ains a going concern it is unli*ely to sell the land at its current (ar*et )alue- $he land retains usefulness, often referred to as the asset8s )alue?in?use, to Nestl7- If Nestl7 has no intent to sell the land, then its current (ar*et )alue is not specifically rele)ant to understanding the financial health of the co(pany- $he use of alternati)e (easure(ent bases for asset )aluation will be discussed in #hapter >Page I= Assets, liabilities, and e<uity are the *ey ele(ents of a corporation8s state(ent of financial position, as we learned in #hapter 1- Let us e;a(ine the definitions in (ore detailEle(ents of the #lassified &tate(ent of /inancial Position Assets are econo(ic resources controlled by an entity as a result of past transactions or e)ents and fro( which future econo(ic benefits (ay be obtained- $hese are the resources that the entity has and can use in its future operations- Ehen Nestl7 purchases an asset, it ac<uires the right for future benefits to be deri)ed fro( that asset, as well as any future ris*s and obligations arising fro( control of the asset- E;ternal users of Nestl78s financial state(ents care about its assets because they e(body future financial benefits- /or lenders, Nestl78s assets and their producti)ity are the basis upon which they can generate forecasts about how readily the co(pany can repay its financial obligations- /or Nestl78s shareholders, the increase in the )alue of their in)est(ent will depend in large part on the reali'ed future benefits arising fro( assets under the co(pany8s controlL .Cefine the ele(ents of a classified state(ent of financial positionA&&E$& are econo(ic resources controlled by an entity as a result of past transactions or e)ents and fro( which future econo(ic benefits (ay be obtained$o (a*e financial state(ents (ore useful to in)estors, creditors, and analysts, specific classifications of infor(ation are included on the state(ents- %arious classifications are used in practice, and you should not be confused when you notice slightly different for(ats used by different co(paniesLet us e;plore Nestl78s si(plified state(ent of financial position, presented in E;hibit .-.- /irst, notice the title of the state(ent: #onsolidated &tate(ent of /inancial Position- #onsolidated (eans that the classified ele(ents of Nestl78s state(ent of financial position are co(bined with those of other co(panies under its control +e-g-, Alcon Inc-, :aagen?Ca's &hoppe #o(pany Inc-,-2 /or con)enience, the a(ounts for the )arious ele(ents of the state(ent of financial position are shown in (illions of &wiss francs- $wo a(ounts are shown for each ele(ent: one at Cece(ber 21, .==>, and the other at Cece(ber 21, .==0, one year earlier- $his syste( allows in)estors to co(pare, at a glance, the )alue of each classified ele(ent fro( year to year, and then analy'e these changes to understand whether the co(pany8s financial position has i(pro)ed or deteriorated o)er ti(e-

E;hibit .-.Nestl78s &tate(ent of /inancial Position Nestl78s state(ent of financial position is shown in colu(n or report for(at, with assets listed first, followed by liabilities, and then shareholders8 e<uity- ther co(panies (ay choose an account for(at with the assets listed on the left?hand side and liabilities and shareholders8 e<uity listed on the right- !oth for(ats are standard ways of co((unicating the sa(e infor(ation- Ee now e;plain the )arious ele(ents that appear on Nestl78s state(ent of financial positionE;hibit .-. presents Nestl78s state(ent of financial position, with a(ounts rounded to the nearest (illion &wiss francs- Notice that Nestl78s fiscal year ends on Cece(ber 21- $he choice of year?ends will be discussed in #hapter 3$ypically, the assets of a co(pany include the following: #urrent assets +short?ter(, #ash and cash e<ui)alents

&hort?ter( in)est(ents $rade and other recei)ables Page I. In)entories Prepay(ents +i-e-, e;penses paid in ad)ance of use, ther current assets Non?current assets +long?ter(, Property, plant, and e<uip(ent +at cost less accu(ulated depreciation, In)est(ent in associates /inancial assets Goodwill Intangible assets ther +(iscellaneous, assets Assets are di)ided into two subgroups: current and non?current assets-#urrent assets, also *nown as short?ter( assets, are those econo(ic resources that Nestl7 will typically transfor( into cash or use within the ne;t year or the operating business cycle of the co(pany, whiche)er is longer- Nestl7 lists its assets in order of li<uidity, which (eans how soon they can be transfor(ed into cash- 4nder current assets, cash and cash e<ui)alents +highly li<uid in)est(ents, appear first because they are the (ost li<uid assets- It should be e(phasi'ed that each of the ite(s reported on the state(ent of financial position, such as cash and cash e<ui)alents, is a co(bination of a nu(ber of si(ilar ite(s- Nestl78s cash e<ui)alents consist of ti(e deposits and place(ents in co((ercial paper with original (aturities of three (onths or less- &hort?ter( in)est(ents represent the reported )alues for shares of other co(panies and other financial instru(ents purchased as in)est(ents of e;cess cash#4RREN$ A&&E$& are assets that will be used or turned into cash, nor(ally within one year- In)entory is always considered to be a current asset, regardless of the ti(e needed to produce and sell itAny recei)able represents an a(ount of (oney owed to Nestl7- $rade and other recei)ables consist pri(arily of trade recei)ables, which are a(ounts owed by custo(ers who purchased products and ser)ices on credit- $hese a(ounts are nor(ally collected within one year of the state(ent8s date- Notes recei)able are written pro(ises by custo(ers and others to pay Nestl7 fi;ed a(ounts by specific datesIn)entories refers to goods that +1, are held for sale to custo(ers in the nor(al course of business, or +., are used to produce goods or ser)ices for sale- In)entory is always considered to be a current asset, no (atter how long it ta*es to produce and sell- Nestl78s in)entory would include a )ariety of nutrition and health foods and drin*s not yet sold to distributorsK (il*, cocoa, sugar, and other ingredients purchased but not yet used for production purposesK and partially co(pleted products- Prepay(ents +e-g-, insurance pre(iu(s and rent paid in ad)ance for use of a building, reflect a)ailable benefits +e-g-, (onthly insurance protection, office space, that the co(pany will use within one year- ther current assets, when reported, will include a nu(ber of assets with s(aller balances that are co(bined/INAN#IALANAL6&I&ANAL6&I& / #:ANGE& IN IN%EN$ R6 ANC $RACE RE#EI%A!LE& In)estors analy'e the financial state(ents of a co(pany to decide whether or not to purchase its shares or to lend it (oney- ne i(portant decision factor is how easily a co(pany can access cash to pay both debts to its creditors and di)idends to its shareholders- In a nor(al business cycle, Nestl7 would produce baby foods, brea*fast cereals, chocolate, and coffee products for sale to distributors such as &afeway and Loblaw- $hese products, called in)entories, are stored in warehouses until they are sold- $he faster these products are sold to custo(ers, the faster these assets are transfor(ed into cash- Let8s e;a(ine the co(pany8s ability to access cash, assu(ing for si(plicity that Nestl78s in)entories consist of products held for sale-

Notice the balance of trade recei)ables decreased fro( #:/ 1=,II. (illion at Cece(ber 21, .==0, to #:/ >,3.I (illion at Cece(ber 21, .==>, indicating that the cash collected fro( custo(ers e;ceeded the a(ount of sales on credit- An in)estor would also obser)e that cash and cash e<ui)alents decreased fro( #:/ I,02I (illion at Cece(ber 21, .==0, to #:/ I,0.I (illion at Cece(ber 21, .==>- In)estors would e;a(ine the state(ent of cash flows to gain clearer insight on how e)ents in the past year resulted in the change in cash and cash e<ui)alents +see #hapter I,- /or the (o(ent, this brief analysis would reassure an in)estor that the first two ele(ents reported on the state(ent of financial position are rele)ant to answering an i(portant <uestion about how easily Nestl7 can access cash to pay its debts to creditors and di)idends to shareholdersPage I2 /ollowing the current assets section, Nestl7 reports a nu(ber of non?current assets- $hese assets are considered to be long?ter( because they will be used or turned into cash o)er a period longer than the ne;t year-Property, plant, and e<uip(ent includes all land, buildings, (achinery, and e<uip(ent such as tools, furniture, and other fi;tures that will be used for the production, pac*aging, and storage of Nestl78s foods and drin*s- $hese are also called fi;ed assets or capital assetsFthey ha)e a physical for( you can touch, and therefore each asset is tangibleN N?#4RREN$ A&&E$& are considered to be long ter( because they will be used or turned into cash o)er a period longer than the ne;t yearNestl7 (ay so(eti(es be interested in purchasing shares issued by other corporations for the purpose of e;ercising significant influence o)er their in)esting, financing, and operating decisions- $he in)est(ent in shares to achie)e such an obDecti)e is called in)est(ent in associates- /or e;a(ple, Nestl7 owned about 2= percent of the shares of L8 r7al as at Cece(ber 21, .==>, which allows Nestl78s (anage(ent to influence decisions (ade by L8 r7al- /inancial assets represent in)est(ents in shares or debt instru(ents issued by other co(panies that Nestl7 intends to *eep for longer than one yearGoodwill is an intangible asset that arises when a co(pany purchases another business to control its operating, in)est(ent, and financing decisions- ften, the purchase price of a business e;ceeds the fair (ar*et )alue of all of the identifiable assets owned by the business (inus all of the identifiable liabilities owed to others- Goodwill reflects assets that are not easily identifiable and (easured, such as custo(er confidence, <uality products, reputation for good ser)ice, and financial standing of the ac<uired business- $he a(ount of #:/ .A,I=. (illion that Nestl7 reported at Cece(ber 21, .==>, resulted fro( the ac<uisitions of (any businesses o)er ti(e, particularly its ac<uisition of Ralston Purina in .==1- Intangible assetsha)e no physical substance but ha)e a long life- $hey usually are not ac<uired for resale but are directly related to the operations of the business- Intangible assets include such ite(s as goodwill, franchises, patents, trade(ar*s, and copyrights- $heir )alues arise fro( the legal rights andpri)ileges of ownership, which is recogni'ed if they are purchased fro( e;ternal parties or as a result of internal de)elop(ent- Nestl78s intangibles include brands, intellectual property rights, operating rights, and (anage(ent infor(ation syste(s- Intangible assets, including goodwill, are discussed in (ore detail in #hapter >ther assets, when reported, will include a nu(ber of assets that are co(bined because of their relati)ely s(all )aluesLiabilities are a corporation8s debts and obligations arising fro( past transactions- $hey represent future outflows of assets +(ainly cash, or ser)ices to the creditors that pro)ided the corporation with the resources needed to conduct its business- Ehen the corporation borrows (oney, creditors recei)e not only full pay(ent of the a(ount owed to the(, but also interest on the borrowed a(ountLIA!ILI$IE& are present debts or obligations of the entity that result fro( past transactions, which will be paid with assets or ser)ices$ypically, the liabilities of a co(pany include the following:

#urrent liabilities +short?ter(, $rade payables &hort?ter( borrowings Inco(e ta;es payable Page I3 Accrued liabilities ther current liabilities Non?current liabilities +long?ter(, Long?ter( borrowings Ceferred inco(e ta; liabilities Pro)isions ther liabilities #4RREN$ LIA!ILI$IE& are obligations that will be paid in cash +or other current assets, or satisfied by pro)iding ser)ice within the co(ing yearLi*e assets, liabilities are di)ided into two subgroups: current and non?current- $hey are listed by order of ti(e to (aturity +how soon an obligation (ust be paid,- #urrent liabilities, *nown as short?ter( liabilities, (ust be paid within the ne;t year or operating business cycle of the co(pany, whiche)er is longer- Nor(ally, the cash fro( con)erting current assets is used to pay current liabilities- $he first current liability is trade payables, which represents the total a(ount owed to suppliers of (aterials that Nestl7 used in producing and pac*aging its products for sale- $he second current liability, short?ter( borrowings, represents short?ter( loans fro( ban*s!an* loans are co((on when the co(pany does not ha)e a sufficient a(ount of cash to pay its creditors- $he third liability,inco(e ta;es payable, is si(ply an esti(ate of the a(ount of ta;es Nestl7 is e;pected to pay to ta;ation authorities- Accrued liabilities represent the total a(ount owed to suppliers for )arious types of ser)ices such as payroll, rent, and other obligations- ther current liabilities, when reported, will include a nu(ber of liabilities with relati)ely s(all a(ounts that are co(bined/INAN#IALANAL6&I&ANAL6&I& / #:ANGE IN $RACE PA6A!LE& 4sing both current assets and current liabilities for Nestl7, we can i(pro)e our analysis of the a)ailability of cash to repay debts to creditors and di)idends to shareholders$he co(pany8s current liabilities shows that Nestl7 owes #:/ .,.1A (illion (ore in current liabilities at Cece(ber 21, .==>, than it did at Cece(ber 21, .==0- As in)estors, we would tentati)ely conclude that the co(pany has increased its reliance on suppliers to finance its current assets- :owe)er, in)estors (ust learn far (ore about the business cycle for nutrition and health products, the outloo* for the industry sectors in which Nestl7 operates, and its (ain co(petitors before co(ing to a fir( conclusionAt the beginning of this chapter, we stated that in)estors are (ost interested in rele)ant infor(ation that helps the( predict future cash inflows and outflows- /ro( this )ery preli(inary analysis, in)estors can predict that, because Nestl7 has increased its current liabilities by #:/ .,.1A (illion, a larger a(ount of cash to repay the outstanding debt to creditors is needed ne;t year than in the current yearN N?#4RREN$ LIA!ILI$IE& are a co(pany8s debts that ha)e (aturities e;tending beyond one year fro( the date of the state(ent of financial positionNon?current liabilities are a co(pany8s debts ha)ing (aturities e;tending beyond one year fro( the date of the state(ent of financial position- $hey include long?ter( borrowings fro( ban*s and other lenders, deferred inco(e ta; liabilities that arise fro( te(porary differences between the profit (easured in accordance with I/R& and

ta;able profit that is deter(ined in confor(ity with applicable ta; laws, pro)isions that are esti(ated liabilities characteri'ed by uncertainty about the e;act a(ount to be paid and the ti(ing of the pay(ent, and other liabilities that include a nu(ber of other liabilities- $hese )arious types of non?current liabilities will be co)ered in future chaptersPage II A H4E&$I N / A## 4N$A!ILI$6EN%IR N5EN$AL A## 4N$ING &$ANCARC& LIA!ILI$IE&F$:E GREENING /

/or (any years, co(panies faced growing pressure to esti(ate and disclose en)iron(ental liabilities such as the cleanup of ha'ardous waste- International /inancial Reporting &tandards +I/R&, re<uire publicly accountable enterprises to report their best esti(ate of probable liabilities, including en)iron(ental liabilities, in notes to the financial state(ents- /or e;a(ple, &uncor Energy Inc-, which (ines oil fro( the tar sands of northern Alberta, reported en)iron(ental liabilities e;ceeding N.,000 (illion in its .==> financial state(ents, representing appro;i(ately 0 percent of its total liabilities at Cece(ber 21, .==>- It is esti(ated, howe)er, that a significant percentage of co(panies under?report or fail to report such liabilities, often because of the way disclosure rules are appliedA *ey econo(ic concern for (any #anadian co(panies is how to (anage their resources in an econo(ically sustainable way- Nestl7, li*e (any co(panies, publishes a report on en)iron(ental sustainability, which includes both financial and non?financial perfor(ance indicators that (easure its progress toward (eeting its sustainable de)elop(ent targetsNestl78s (anage(ent belie)es that a business has to create )alue, not only for its shareholders but also for society at large in order to be successful in the long ter(- Nestl78s co(prehensi)e report on en)iron(ental sustainability pro)ides detailed infor(ation about the steps it has ta*en to reduce the i(pact of its acti)ities on the en)iron(ent$he co(pany uses en)iron(ental perfor(ance indicators to (onitor the i(pact of its acti)ities on greenhouse gas e(issions, energy consu(ption, water consu(ption, and waste?water (anage(entNestl7 #anada8s En)iron(ental &ustainability Report for .==0 indicates that its (anage(ent ta*es its en)iron(ental responsibility seriously- $he report illustrates how non?financial infor(ation is rele)ant to e;ternal decision (a*ers&ource: Nestl7 #anada En)iron(ental &ustainability Report .==0- Nestl7 &-A&hareholders8 e<uity +owners8 e<uity or stoc*holders8 e<uity, is the financing pro)ided to the corporation by both its owners and the operations of the business- ne *ey difference between owners and creditors is that creditors are entitled to settle(ent of their legal clai(s on the corporation8s assets before the owners recei)e a penny, e)en if this consu(es all the corporation8s assets- #onse<uently, owners ha)e a residual clai( on the corporation8s assets&:ARE: LCER&8 EH4I$6 + ENER&8 EH4I$6 R &$ #@: LCER&8 EH4I$6, is the financing pro)ided by the owners and the operations of the businesswners in)est +purchase shares, in a co(pany because they e;pect to recei)e two types of cash flow: di)idends, which are a distribution of the corporation8s earnings +a return on shareholders8 in)est(ent,, and gains fro( selling their shares for (ore than they paid +*nown as capital gains,$ypically the shareholders8 e<uity of a corporation includes the following: &hare capital +or capital stoc*,

Retained earnings +accu(ulated earnings that ha)e not been declared as di)idends, ther co(ponents &hare capital reflects the proceeds recei)ed when the corporation issued the shares- ccasionally, shareholders will contribute in e;cess of the a(ount allocated to share capital, such as pre(iu(s on shares issuedK these contributions are called contributed surplus- $he su( of share capital and contributed surplus represents the contributed capital of the corporation- Nestl78s share capital of #:/ 9,.30 (illion has resulted fro( selling shares to in)estors at different points in the co(pany8s history-3 &:ARE #API$AL results fro( owners pro)iding cash +and so(eti(es other assets, to the businessPage I9 5ost co(panies that operate profitably retain part of their earnings for rein)est(ent in their business- $he other part is distributed as di)idends to shareholders- $he annual earnings that are not distributed to shareholders are called retained earnings- Nestl78s retained earnings e<ualled #:/ 93,99= (illion at Cece(ber 21, .==>, and represent the net a(ount of earnings that ha)e not been distributed to shareholders since the co(pany was incorporated in 10A2- Nestl78s growth o)er ti(e has been financed by a substantial rein)est(ent of retained earnings- In addition to share capital and retained earnings, shareholders8 e<uity includes other co(ponents that are e;plained in #hapter 9RE$AINEC EARNING& refers to the accu(ulated earnings of a co(pany that are not distributed to the owners and are rein)ested in the businessNestl7 controls other co(panies and reports all the assets and liabilities of these co(panies on its consolidated state(ent of financial position- !ecause Nestl7 does not own all the )oting shares issued by these co(panies, its shareholders8 e<uity is di)ided between the controlling +parent, and non?controlling +or (inority, shareholders, co((only referred to as non?controlling interestNow that we ha)e re)iewed se)eral of the basic accounting concepts and ter(s, we need to understand the econo(ic acti)ities of a business that result in changes in a(ounts reported in financial state(ents and the process used in generating the financial state(ents1 International Accounting &tandards #o((ittee +1>0>,, /ra(ewor* for the Preparation and Presentation of /inancial &tate(ents- Adopted by the International Accounting &tandards !oard, .==1. /inancial Accounting &tandards !oard, #onceptual /ra(ewor* for /inancial Reporting: $he bDecti)e of /inancial Reporting and Hualitati)e #haracteristics and #onstraints of Cecision?4seful /inancial Reporting Infor(ation, E;posure Craft, 5ay .>, .==02 $he rules for consolidation of financial state(ents are co)ered in ad)anced accounting courses3 In fact, this a(ount consists of #:/ 29I (illion of share capital and #:/ I,002 (illion of pre(iu(s recei)ed fro( shareholders in e;change of issued shares- Ee ha)e co(bined these two a(ounts for si(plicityE:A$ $6PE / !4&INE&& A#$I%I$IE& #A4&E #:ANGE& IN /INAN#IAL &$A$E5EN$ A5 4N$&G L 2Identify what constitutes a business transaction, and recogni'e co((on account titles used in businessNature of !usiness $ransactions Accounting focuses on specific e)ents that ha)e an econo(ic i(pact on the entity- $hose e)ents that are recorded as a part of the accounting process are called transactions- $he first step in translating the results of business e)ents to financial state(ent a(ounts is deter(ining which e)ents to recogni'e as transactionsK only transactions are reflected in the state(ents- As the definitions of assets and liabilities indicate, only econo(ic resources and debts resulting fro( past transactions are recorded on the state(ent of financial position- $ransactions include two types of e)ents: A $RAN&A#$I N is +1, an e;change between a business and one or (ore e;ternal parties to a business or +., a (easurable internal e)ent, such as adDust(ents for the use of assets in operations-

E;ternal e)ents are e;changes of assets, goods, or ser)ices by one party for assets, ser)ices, or pro(ises to pay +liabilities, by one or (ore other parties- E;a(ples include the purchase of a (achine fro( a supplier, the sale of (erchandise to custo(ers, borrowing of cash fro( a ban*, and in)est(ent of cash in the business by the owners$ransactions that affect ele(ents of the state(ent of financial position are discussed in this chapter, and those that affect inco(e state(ent ele(ents will be co)ered in #hapter 2Internal e)ents include certain e)ents that are not e;changes between the business and other parties but ne)ertheless ha)e a direct and (easurable effect on the accounting entity- E;a(ples include using up insurance paid in ad)ance and using buildings and e<uip(ent o)er se)eral years- Accounting for internal e)ents will be discussed in #hapter 3$hroughout this te;tboo*, the word transaction will be used in the broad sense to include both types of e)ents&o(e i(portant e)ents that ha)e an econo(ic i(pact on the co(pany, howe)er, are not reflected in Nestl78s state(ents- In (ost cases, signing a contract is not considered to be a transaction because it in)ol)es only the e;change of pro(ises, not of assets such as cash, goods, ser)ices, or property- /or e;a(ple, assu(e that Nestl7 signs an e(ploy(ent contract with a new regional (anager- /ro( an accounting perspecti)e, no transaction has occurred because no e;change of assets, goods, or ser)ices has been (ade- Each party to the contract has e;changed pro(isesK the (anager agrees to wor* and Nestl7 agrees to pay the (anager for wor* rendered- /or each day the new (anager wor*s, howe)er, the e;change of ser)ices for pay results in a transaction that Nestl7 (ust record- !ecause of their i(portance, long?ter( e(ploy(ent contracts, leases, and other co((it(ents (ay need to be disclosed in notes to the financial state(entsPage IA :ow does the accounting staff at Nestl7 record e;ternal and internal e)ents that cause changes in the a(ounts reported on the co(pany8s state(ent of financial positionG $he recording of transactions has e)ol)ed o)er ti(eAd)ances in co(puter hardware and software technology ha)e pa)ed the way for efficient recording of transactions and instantaneous preparation of financial state(ents- :owe)er, the basic syste( of recording transactions has withstood the test of ti(e and has been in use for (ore than I== years- $he basic tenets of (anual and co(puteri'ed recording syste(s are discussed in this chapter and elaborated on further in #hapters 2 and 3Accounts An A## 4N$ is a standardi'ed for(at that organi'ations use to accu(ulate the (onetary effects of transactions on each financial state(ent ite(An account is a standardi'ed record that organi'ations use to accu(ulate the (onetary effects of transactions on each financial state(ent ite(- $he cu(ulati)e result of all transactions that affect a specific account, or its ending balance, is then reported on the appropriate financial state(ent- $o facilitate the recording of transactions, each co(pany establishes a chart of accounts, a list of accounts and their uni<ue nu(eric codes- $he chart of accounts is organi'ed by financial state(ent ele(ent, with asset accounts listed first +by order of li<uidity,, followed by liabilities +by order of ti(e to (aturity,, shareholders8 e<uity, re)enue, and e;pense accounts in that order- In for(al record*eeping syste(s, including co(puteri'ed accounting syste(s, use of appropriate account nu(bers is essential if the (onetary effects of si(ilar transactions are to be grouped correctly- E;hibit .-2 lists account titles that are <uite co((on and used by (ost co(panies- $his list is helpful when you are co(pleting assign(ents and are unsure of an account titleAssets #ash &hort?ter( in)est(ents Liabilities $rade payables Accrued liabilities &hareholders8 E<uity &hare capital #ontributed surplus Re)enues &ales re)enue /ee re)enue E;penses #ost of sales Eages e;pense

$rade recei)ables Notes recei)able In)entory +to be sold, &upplies Prepay(ents Long?ter( in)est(ents E<uip(ent !uildings Land Intangibles

Notes payable $a;es payable Ceferred re)enue !onds payable

Retained earnings

Interest re)enue Rent re)enue

Rent e;pense Interest e;pense Cepreciation e;pense Ad)ertising e;pense Insurance e;pense Repair e;pense Inco(e ta; e;pense

E;hibit .-2$ypical Account $itles 6ou ha)e probably already noticed so(e patterns in how accounts are na(ed: Accounts with Orecei)ableP in the title are always assets, representing a(ounts owed to the corporation by custo(ers and others, to be collected in the futureAccounts with OpayableP in the title are always liabilities, representing a(ounts owed by the corporation to be paid to others in the future$he account Prepay(ents is an asset since it represents a(ounts paid to others for future benefits, such as future insurance co)erage or rental of propertyE)ery co(pany has a )ariation on this chart of accounts, depending on the nature of its business acti)ities- /or e;a(ple, a s(all lawn care ser)ice (ay ha)e an asset account called Lawn (owing e<uip(ent, but it is unli*ely that the Royal !an* of #anada would need such an account- $hese differences will beco(e (ore apparent as we e;a(ine the state(ents of financial position of )arious co(panies- !ecause each co(pany has a different chart of accounts, you should not try to (e(ori'e a typical chart of accounts-Ehen you prepare ho(ewor* proble(s, you will either be gi)en the co(pany8s account na(es or be e;pected to select appropriate descripti)e na(es, si(ilar to the ones in the preceding lists- nce a na(e is selected for an account, the e;act na(e (ust be used in all transactions that affect that accountPage I0 $he accounts you see in the financial state(ents are actually su((ations +or aggregations, of a nu(ber of specific accounts- /or e;a(ple, Nestl7 *eeps separate accounts for the different foods and drin*s it produces and sells but co(bines the( as In)entories on the state(ent of financial position- E<uip(ent, buildings, and land are also co(bined into an account called Property, plant, and e<uip(ent- &ince our ai( is to understand financial state(ents, we focus on aggregated accounts as presented on the state(entsIN$ERNA$I NALPER&PE#$I%E 4NCER&$ANCING / REIGN /INAN#IAL &$A$E5EN$& $he adoption of International /inancial Reporting &tandards +I/R&, by (any countries has (ade it easier to read foreign co(panies8 financial state(ents- Gla;o&(ith@line, the phar(aceutical giant in the 4nited @ingdo(, prepares its financial state(ents under I/R&- :owe)er, there are still so(e differences in the structure of the state(ents and account titles that (ay cause confusion- /or e;a(ple, (any European co(panies place non? current assets before current assets and list shareholders8 e<uity before liabilities- #o(panies in the 4nited &tates

do not use the ter( Opro)isionP to report esti(ated liabilitiesK they do recogni'e such liabilities, howe)er, under different titles- $he *ey to a)oiding confusion is to pay attention to the subheadings in the financial state(ents and read the notes related to specific financial state(ent ele(ents&EL/?&$4C6 H4IJ .?1 !enetton Group $he following is a list of accounts fro( a recent state(ent of financial position for the Italian co(pany !enetton Group, which sells fashion apparel in o)er 1.= countries- Indicate on the line pro)ided whether each of the following is an asset +A,, liability +L,, or shareholders8 e<uity account +&E,&elf?&tudy Hui' .?1 &olution $rades payable !uildings In)est(ents #urrent portion of long?ter( loans Lease financing %ehicles and aircraft Retained earnings /inancial recei)ables

After you co(plete your answers, )isit #onnect at go online for the solutions: E C $RAN&A#$I N& A//E#$ A## 4N$&G5anagers (a*e business decisions that often result in transactions affecting financial state(ents- /or e;a(ple, the decisions to e;pand the nu(ber of stores, ad)ertise a new product, change an e(ployee benefit pac*age, and in)est e;cess cash would all affect the financial state(ents- &o(eti(es these decisions ha)e unintended conse<uences as well- /or e;a(ple, the decision to purchase additional in)entory for cash in anticipation of a (aDor sales initiati)e will increase in)entory and decrease cash- !ut, if there is no de(and for the additional in)entory, the lower cash balance will also reduce the co(pany8s ability to pay its other obligationsL 3Apply transaction analysis to si(ple business transactions in ter(s of the accounting (odel: Assets L Liabilities M &hareholders8 E<uity!ecause business decisions often in)ol)e an ele(ent of ris*, business (anagers should understand how transactions i(pact the accounts on the financial state(ents- $he process for deter(ining the effects of transactions is called transaction analysisPage I> Principles of $ransaction Analysis $ransaction analysis is the process of studying each transaction to deter(ine its econo(ic effect on the entity in ter(s of the accounting e<uation +A L L M &E, also *nown as the funda(ental accounting (odel,- Ee outline the process in this section of the chapter and create a )isual tool representing the process +the transaction analysis (odel,- $he basic accounting e<uation and two funda(ental concepts are the foundation for this (odel- Recall fro( #hapter 1 that the accounting e<uation for a business that is organi'ed as a corporation is as follows: $RAN&A#$I N ANAL6&I& is the process of studying a transaction to deter(ine its econo(ic effect on the entity in ter(s of the accounting e<uationAssets +A, L Liabilities +L, M &hareholders8 E<uity +&E,

$he two concepts underlying the transaction analysis process follow: E)ery transaction affects at least two accountsK it is critical to correctly identify the accounts affected and the direction of the effect +increase or decrease,$he accounting e<uation (ust re(ain in balance after each transaction&uccess in perfor(ing transaction analysis depends on a clear understanding of how the transaction analysis (odel is constructed, based on these concepts- &tudy this (aterial well- 6ou should not (o)e on to a new concept until you understand and can apply all prior conceptsCual Effects $he idea that e)ery transaction has at least two effects on the basic accounting e<uation is *nown as the dual effects concept-I 5ost transactions with e;ternal parties in)ol)e an e;change by which the business entity both recei)es so(ething and gi)es up so(ething in return- /or e;a(ple, suppose that Nestl7 purchased so(e office supplies for cash- In this e;change, Nestl7 would recei)e supplies +an increase in an asset, and in return would gi)e up cash +a decrease in an asset,-

In analy'ing this transaction, we deter(ined that the accounts affected were office supplies and cash- As we discussed in #hapter 1, howe)er, (ost supplies are purchased on credit +i-e-, (oney is owed to suppliers,- In that case, Nestl7 would engage in two transactions: +1 $he purchase of an asset on credit In the first transaction, Nestl7 would recei)e office supplies +an increase in an asset, a , in return a pro(ise to pay later, called Accounts Payable +an increase in a liability,+. $he e)entual pay(ent In the second transaction, Nestl7 would eli(inate or recei)e bac* its pro(ise to pay +a , the Accounts Payable liability, and would gi)e up cash +a decrease in an asset,-

Page 9= As noted earlier, not all i(portant business e)ents result in a transaction that affects the financial state(ents- 5ost i(portant, signing a contract in)ol)ing the e;change of pro(ises to perfor( a future business transaction does not result in a transaction that is recorded- /or e;a(ple, if Nestl7 sent an order to its paper supplier for (ore paper without (a*ing any pay(ent, and the supplier accepted the order but did not fill it i((ediately, then no transaction has ta*en place for accounting purposes because Nestl7 and the paper supplier ha)e e;changed only pro(ises-9 /ro( the supplier8s perspecti)e, the sa(e holds true- No transaction has ta*en place, so the supplier8s financial state(ents are not affected- As soon as the paper is shipped to Nestl7, howe)er, the supplier gi)es up in)entory in e;change for a pro(ise fro( Nestl7 to pay for the paper it recei)es, and Nestl7 e;changes its pro(ise to pay for the paper it recei)es- !ecause a pro(ise has been e;changed for goods, a transaction has ta*en place, and the financial state(ents of both Nestl7 and the supplier will be affected!alancing the Accounting E<uation $he accounting e<uation (ust re(ain in balance after each transaction- $otal assets +resources, (ust e<ual total liabilities and shareholders8 e<uity +clai(s to resources,- If the correct accounts ha)e been identified and the appropriate direction of the effect on each account has been deter(ined, then the e<uation should re(ain in balance- A syste(atic transaction analysis includes the following steps, in this order: &tep 1: Identify and classify accounts and effects Identify the accounts affected +by their titles,, (a*ing sure that at least two accounts change- As* yourself, what is recei)ed and what is gi)enG #lassify each by type of account- Eas each account an asset +A,, liability +L,, or shareholders8 e<uity +&E,G Ceter(ine the direction of the effect- Cid the account increase YMZ or decrease YQZG &tep .: %erify that the accounting e<uation, A L L M &E, re(ains in balanceAnaly'ing Nestl78s $ransactions $o illustrate the use of the transaction analysis process, let us consider typical Nestl7 transactions that are also co((on to (ost businesses- $his chapter presents transactions affecting accounts reported on the state(ent of financial position- Assu(e that Nestl7 engaged in the following transactions during "anuary .=1=, the (onth

following the state(ent of financial position in E;hibit .-.- $he (onth will end on "anuary 21- /or si(plicity, account titles are based on that state(ent of financial position- Note that all (onetary a(ounts are usually preceded by the sy(bol of the currency used in the e;change transactions +e-g-, N for #anadian dollars, [ for euros, #:/ for &wiss francs,- In the following illustration, all a(ounts are in (illions of &wiss francs, but we o(it including #:/ before the (onetary a(ount, for si(plicityPage 91 +a, Nestl7 issues shares to new in)estors in e;change for 1,2== in cash-

+b, $he co(pany borrows 1,=== fro( its local ban*, signing a note to be paid in two years-

$ransactions +a, and +b, are financing transactions#o(panies that need cash for in)esting purposes +to buy or build additional facilities as part of their plans for growth, often see* funds by selling shares to in)estors, as in transaction +a,, or borrowing fro( creditors, usually ban*s, as in transaction +b,+c, /or e;pansion, Nestl7 opened a new production facility- $he co(pany purchased .,.== of new coffee roasters, counters, refrigerators, and other e<uip(ent, paying 1,I== in cash and signing a note for A==, payable to the e<uip(ent (anufacturer in two years-

Page 9. Notice that (ore than two accounts were affected by transaction +c,$he analysis of transactions +d, through +f, follows- $he effects are listed in the chart at the end of &elf?&tudy

Hui' .?.- &pace is left in the chart for your answers to the <ui', transactions +g, and +h,, that follow transaction +f,+d, Nestl7 lends 3I= to a trade supplier in financial difficulty- $he trade supplier signs notes agreeing to repay the a(ount borrowed in si; (onths-

+e, Nestl7 purchases shares issued by another co(pany as a long?ter( in)est(ent, paying 2,=== in cash- $he nu(ber of shares purchased allows Nestl7 to e;ert significant influence o)er decisions (ade by that co(pany-

+f, Nestl78s board of directors declares cash di)idends of .== for shareholders- $he di)idends are paid i((ediately-

Page 92 &EL/?&$4C6 H4IJ .?. $he (ost effecti)e way to de)elop your transaction analysis s*ills is to practise with (any transactions- Re)iew the analysis in transactions +a, through +f, and co(plete the transaction analysis steps in the chart following the transactions +g, and +h,- Repeat the steps until they beco(e a natural part of your thought process+g, Nestl7 collects 2== cash on notes recei)able fro( the trade supplier- +:int: $hin* about what is recei)ed and what is gi)en-, &tep 1: Identify and classify accounts and effects&tep .: Is the accounting e<uation in balanceG +h, Nestl7 paid 3== on the note owed to the local ban*&tep 1: Identify and classify accounts and effects&tep .: Is the accounting e<uation in balanceG Include these effects on the following chart-

After you co(plete your answers,go onlineV for the solutions&elf?&tudy Hui' .?. &olution +i, Nestl78s board of directors appro)ed the opening of two new production plants at a (eeting in "anuary .=1= and the borrowing of .== fro( the local ban*s to finance the construction of the new plants in /ebruary .=1=4nli*e transactions +a, through +h,, which reflect e;changes between Nestl7 and e;ternal parties, these two decisions of the board of directors are not transactions because no e;changes ha)e ta*en place yet- $he co(pany8s board of directors (ade co((it(ents that will li*ely translate into actions in /ebruary .=1=- &pecific state(ent of financial position accounts will be affected only when the actual e;changes occur in /ebruary .=1=- :owe)er, such co((it(ents will nor(ally be disclosed in a financial state(ent noteI /ro( this concept, accountants ha)e de)eloped what is *nown as the double?entry syste( of record*eeping9 #ontracts of this nature that are li*ely to result in significant future liabilities (ust be noted in the financial state(ents as co((it(ents: E C # 5PANIE& @EEP $RA#@ / A## 4N$ !ALAN#E&GL ICeter(ine the i(pact of business transactions on the state(ent of financial position by using two basic tools: Dournal entries and $?accounts/or (ost organi'ations, recording transaction effects and *eeping trac* of account balances in the (anner Dust presented is i(practical- $o handle the (ultitude of daily transactions that businesses generate, co(panies establish accounting syste(s, usually co(puteri'ed, that follow a cycle- $he accounting cycle, illustrated in E;hibit .-3, highlights the pri(ary acti)ities perfor(ed during the accounting period to analy'e, record, and post transactions- In #hapters . and 2, we will illustrate these acti)itiesduring the period- In #hapter 3, we will co(plete the accounting cycle by discussing and illustrating acti)ities at the end of the period to adDust the records, prepare financial state(ents, and close the accounting records-

E;hibit .-3$he Accounting #ycle Page 93 Curing the accounting period, transactions that result in e;changes between the co(pany and other e;ternal parties are analy'ed and recorded in thegeneral Dournal in chronological order, and the related accounts are updated in the general ledger- $hese for(al records are based on two )ery i(portant tools used by accountants: Dournal entries and $?accounts- /ro( the standpoint of accounting syste(s design, these analytical tools are (ore efficient (echanis(s for reflecting the effects of transactions and for deter(ining account balances for financial state(ent preparation- As future business (anagers, you should de)elop your understanding and use of these tools in financial analysis- /or those studying accounting, this *nowledge is the foundation for understanding the accounting syste( and future coursewor*- After we e;plain how to perfor( transaction analysis by using these tools, we illustrate their use in financial analysis$he Cirection of $ransaction Effects $he $?A## 4N$ is a tool for su((ari'ing transaction effects for each account, deter(ining balances, and drawing inferences about a co(pany8s acti)itiesCE!I$ (eans the left side of an account#RECI$ (eans the right side of an accountAs we saw earlier, transactions change the balances of assets, liabilities, and shareholders8 e<uity accounts- $o reflect these effects efficiently, we need to structure the transaction analysis (odel in a (anner that shows thedirection of the effects- ne )ery useful tool for su((ari'ing the transaction effects and deter(ining the balances for indi)idual accounts is a $?account, as shown in E;hibit .-I- Notice the following:

E;hibit .-I$ransaction Analysis 5odel Each $?account has two sides: a left side, *nown as the debit side, and a right side, *nown as the credit side$he increase sy(bol, M, is located on the left side of the $ for accounts that appear on the left side of the accounting e<uation, and on the right side of the $ for accounts that are on the right side of the e<uation$he ter( debit +dr, is always written on the left side of each account, and the ter( credit +cr, is always written on the right side/ro( this transaction analysis (odel, we can obser)e the following: Asset accounts increase on the left +debit, side- $hey ha)e debit balances- It would be highly unusual for an asset account, such as in)entories, to ha)e a negati)e +credit, balanceLiabilities and shareholders8 e<uity accounts increase on the right +credit, side, creating credit balances$o re(e(ber which accounts are increased by debit and which accounts are increased by credit, recall that a debit +left, increases asset accounts because assets are on the left side of the accounting e<uation +A L L M &E,&i(ilarly, a credit +right, increases liability and shareholders8 e<uity accounts because they are on the right side of the accounting e<uationPage 9I In su((ary,

In #hapter 2, we will add re)enue and e;pense account effects- 4ntil then, as you are learning to perfor( transaction analysis, you should refer to this (odel often until you can construct it on your own without assistance5any students ha)e trouble with accounting because they forget that the only (eaning for debit is the left side of an account and the only (eaning for credit is the right side of an account- Perhaps so(eone once told you that you were a credit to your school or your fa(ily- As a result, you (ay thin* that credits are good and debits are bad&uch is not the case- "ust re(e(ber that debit is on the left and credit is on the rightIf you ha)e identified the correct accounts and effects through transaction analysis, the accounting e<uation will re(ain in balance- 5oreo)er, the total (onetary )alue of all debits e<uals the total (onetary )alue of all credits in a transaction- /or an e;tra (easure of assurance, add this e<uality chec* +debits L credits, to the transaction analysis processAnalytical $ools $he "ournal Entry In a boo**eeping syste(, transactions are initially recorded in chronological order in a general Dournal +see Appendi; ! atonlineV for a detailed illustration of for(al record*eeping procedures,- After analy'ing the business docu(ents that describe a transaction, the boo**eeper prepares the for(al Dournal entry and enters the effects on the accounts by using debits and credits- $he Dournal entry, then, is an accounting (ethod for e;pressing the effects of a transaction on )arious accounts, using the double?entry boo**eeping syste( e;plained pre)iously- $he Dournal entry for transaction +c, in the Nestl7 illustration is written as follows: Appendi; !: $he /or(al Record@eeping &yste( +online, A " 4RNAL EN$R6 pro)ides a su((ary of a transaction and its effects on )arious accounts, using the double?entry boo**eeping syste(-

Page 99 Notice the following: It is useful to include a date or so(e for( of reference for each transaction- $he debits are written first +on top, with the a(ounts on the left side of the two colu(ns- $he credits are written below the debits and are indented to the right in (anual recordsK the credited a(ounts are written in the right colu(n- $he order of the debited accounts or credited accounts does not (atter, as long as the debits are on top and the credits are on the botto( and indented to the right$otal debits +.,.==, e<ual total credits +1,I== M A==,$hree accounts are affected by this transaction- Any Dournal entry that affects (ore than two accounts is called a co(pound entry- Although this is the only transaction in the preceding illustration that affects (ore than two accounts, (any transactions in subse<uent chapters will re<uire co(pound Dournal entriesRecording e;ternal transactions in the Dournal is based on legal docu(ents that highlight the contractual co((it(ents between Nestl7 and other parties- /or e;a(ple, Nestl7 signed a contract with a (anufacturer to purchase e<uip(ent for .,.==- It issued a che<ue for 1,I== to transfer cash to the (anufacturer and pro(ised to pay A== in two years- #onse<uently, the effects of this transaction are recorded in the Dournal and reflected in Nestl78s financial state(ents- $he e<uip(ent (anufacturer retains legal control of the e<uip(ent until it is fully paid after two years- /or accounting purposes, howe)er, Nestl7 has control of and will use this resource to generate re)enue o)er the ne;t two years- Ehile recording e;ternal transactions in the Dournal re<uires legal docu(ents, so(e legal contracts, such as signing a contract to hire a new e(ployee, are not reflected in the financial state(entsEhile you are learning to perfor( transaction analysis, use the sy(bols A, L, and &E ne;t to each account title, as in the preceding Dournal entry, for all ho(ewor* proble(s- &pecifically identifying accounts as assets +A,, liabilities +L,, or shareholders8 e<uity +&E, clarifies the transaction analysis and (a*es Dournal entries easier to write- /or e;a(ple, if #ash is to be increased, we will write #ash +MA,- $hroughout subse<uent chapters, we include the direction of the effect along with the sy(bol to help you understand the effects of each transaction on the financial state(ents5any students try to (e(ori'e Dournal entries without understanding or using the transaction analysis (odel- $he tas* beco(es increasingly difficult as (ore detailed transactions are presented in subse<uent chapters- In the long run, (e(ori'ing, understanding, and using the transaction analysis (odel presented here will sa)e you ti(e and pre)ent confusion$he $?Account !y the(sel)es, Dournal entries do not pro)ide the balances in accounts- After the Dournal entries ha)e been recorded, the boo**eeper posts +transfers, the (onetary )alues to each account affected by the transaction, to deter(ine the new account balances- In (ost co(puteri'ed accounting syste(s, this happens auto(atically upon recording the Dournal entry-

As a group, the accounts are called a general ledger- In a (anual accounting syste( used by so(e s(all organi'ations, the ledger is often a three?ring binder with a separate page for each account- In a co(puteri'ed syste(, accounts are part of a database and stored on a dis*- &ee E;hibit .-9 for an illustration of a Dournal page and the related #ash ledger page- Note that the cash effects fro( the Dournal entries ha)e been posted to the #ash ledger page- $he three digits under the ORef-P colu(n in the general Dournal are e;a(ples of account codes used in the chart of accounts-

E;hibit .-9Posting $ransaction Effects fro( the "ournal to the Ledger E;hibit .-A shows the $?accounts for the cash and long? ter( borrowings accounts for Nestl7, based on transactions +a, through +h,- Notice that for cash, which is an asset, increases are shown on the left and decreases are on the right side of the $?account/or long?ter( borrowings, howe)er, increases are shown on the right and decreases on the left since notes payable is a liability- &o(e s(all businesses still use handwritten or (anually (aintained accounts in this $?account for(at- #o(puteri'ed syste(s retain the concept but not the for(at of the $?account-

E;hibit .-A$?Accounts Illustrated Page 90 In E;hibit .-A, notice that the ending balance is indicated on the positi)e side with a double underline- $o find the account balances, we can e;press the $?accounts as e<uations:

A word on ter(inology: $he words debit and credit are used as )erbs, nouns, and adDecti)es- /or e;a(ple, we can say that Nestl78s #ash account was debited +)erb, when shares were issued to in)estors, (eaning that the a(ount was entered on the left side of the $? account- r we can say that a credit +noun, was entered on the right side of an account- !orrowings (ay be described as a credit account +adDecti)e,- $hese ter(s will be used instead of left and right throughout the rest of the te;tboo*$he ne;t section illustrates the steps to follow in analy'ing the effects of transactions, recording the effects in Dournal entries, and deter(ining account balances by using $?accounts$ransaction Analysis Illustrated In this section, we will use the (onthly transactions of Nestl7 that were presented earlier to de(onstrate transaction analysis and the use of Dournal entries and $?accounts- Ee analy'e each transaction, chec*ing to (a*e sure that the accounting e<uation re(ains in balance and that debits e<ual credits- $he a(ounts fro( Nestl78s state(ent of financial poisiton at "anuary 1, .=1=, ha)e been inserted as the beginning balances in the $?accounts, located together at the end of the illustration- After re)iewing or preparing each Dournal entry, trace the effects to the appropriate $?accounts by using the transaction letters +a, to +h, as a reference- $he first transaction has been highlighted for you&tudy this illustration carefully, including the e;planations of transaction analysis- #areful study is essential to the understanding of +1, the accounting (odel, +., transaction analysis, +2, the dual effects of each transaction, and +3, the dual?balancing syste(- $he (ost effecti)e way to learn these critical concepts that affect (aterial

throughout the rest of the te;tboo* is to practise, practise, practise+a, Nestl7 issues shares to new in)estors in e;change for 1,2== in cash-

+b, $he co(pany borrows 1,=== fro( its local ban*, signing a note to be paid in two years-

Page 9> +c, /or e;pansion, Nestl7 opened a new production facility- $he co(pany purchased .,.== of new coffee roasters, counters, refrigerators, and other e<uip(ent, paying 1,I== in cash and signing a note for A==, payable to the e<uip(ent (anufacturer in two years-

+d, Nestl7 lends 3I= to a trade supplier in financial difficulty- $he trade supplier signs notes agreeing to repay the a(ount borrowed within si; (onths-

+e, Nestl7 purchases shares issued by another corporation as a long?ter( in)est(ent, paying 2,=== in cash- $he nu(ber of shares purchased allows Nestl7 to e;ert significant influence o)er decisions (ade by that co(pany-

+f, Nestl78s board of directors declares cash di)idends of .== for shareholders- $he di)idends are paid i((ediately-

Page A= &EL/?&$4C6 H4IJ .?2 /or transactions +g, and +h,, fill in the (issing infor(ation, including postings to the $?accounts+g, Nestl7 collects 2== cash fro( the trade supplier-

&elf?&tudy Hui' .? 2 &olution +h, Nestl7 paid 3== on the note owed to the local ban*-

After you co(plete your answers, )isit #onnect at go onlineV for the solutions$he $?accounts that changed during the period because of these transactions are shown below- $he beginning balances are the a(ounts fro( Nestl78s state(ent of financial position at Cece(ber 21, .==>- $he balances of all other accounts re(ained the sa(e-

6ou can )erify that you posted the entries properly by adding the increase side and subtracting the decrease side and then co(paring your answer to the ending balance for each $?account- %isit #onnect at go onlineV to chec* your answersPage A1 /INAN#IALANAL6&I&IN/ERRING !4&INE&& A#$I%I$IE& /R 5 $?A## 4N$& $?accounts are useful pri(arily for instructional and analytical purposes- In (any cases, we will use $?accounts to deter(ine what transactions a co(pany engaged in during a period- /or e;a(ple, the pri(ary transactions affecting trade payables for a period are purchases of assets on account and cash pay(ents to suppliers- If we *now the beginning and ending balances of trade payables and all of the a(ounts that were purchased on credit during a period, we can deter(ine the a(ount of cash paid- A $?account will include the following:

: E I& $:E &$A$E5EN$ / /INAN#IAL P &I$I N PREPAREC ANC ANAL6JECGAs discussed in #hapter 1, a state(ent of financial position is one of the financial state(ents that will be co((unicated to users, especially those e;ternal to the business- It is possible to prepare a classified state(ent of financial position at any point in ti(e fro( the balances in the accountsL 9Prepare a classified state(ent of financial position and analy'e it by using the debt?to?e<uity ratio#lassified &tate(ent of /inancial Position $he state(ent of financial position in E;hibit .-0 was prepared by using the new balances shown in the $? accounts in the preceding Nestl7 illustration +shaded lines in the e;hibit, plus the original balances in the accounts that did not change- It co(pares the account balances at "anuary 21, .=1=, with those at Cece(ber 21, .==>Notice that when (ultiple periods are presented, the (ost recent a(ounts on the state(ent of financial position are usually listed on the leftAt the beginning of the chapter, we presented the changes in Nestl78s total assets fro( 1>>0 to .==>- Ee <uestioned what (ade the accounts change and what the process was for reflecting the changes- Now we can see that the assets ha)e changed again in one (onth, along with liabilities and shareholders8 e<uity, because of the transactions illustrated in this chapter:

E;hibit .-0Nestl78s &tate(ent of /inancial Position Page A.

@E6 RA$I ANAL6&I&$:E CE!$?$ ?EH4I$6 RA$I 4sers of financial infor(ation co(pute a nu(ber of ratios in analy'ing a co(pany8s past perfor(ance and financial condition as input in predicting its future potential- /or e;a(ple, by using the ele(ents and classification in the state(ent of financial position, creditors can assess a co(pany8s ability to pay off its debt, or see what the co(pany8s trend is in ta*ing on (ore debt- $he change in ratios o)er ti(e and how they co(pare to the ratios of the co(pany8s co(petitors pro)ide )aluable infor(ation for users8 decisionsPage A2 Ee introduce here the first of (any ratios that will be presented throughout the rest of this te;tboo*, with a final su((ary of ratio analysis in #hapter 12- In #hapters ., 2, and 3, we present four ratios that pro)ide infor(ation about (anage(ent8s effecti)eness at (anaging debt and e<uity financing +debt?to?e<uity ratio,, controlling re)enues and e;penses +net profit (argin,, and utili'ing assets +total asset turno)er ratio and return on assets,, all for the purpose of enhancing returns to shareholders- $he re(aining chapters discuss other ratios that pro)ide )aluable infor(ation to assess a co(pany8s strategies, strengths, and areas of concernAs we discussed earlier in the chapter, co(panies raise large a(ounts of (oney to ac<uire additional assets by issuing shares to in)estors and borrowing funds fro( creditors- $hese additional assets are used to generate (ore profit- :owe)er, since debt (ust be repaid, ta*ing on increasing a(ounts of debt carries increased ris*- $he debt? to?e<uity ratio pro)ides one (easure for analysts to e;a(ine the co(pany8s financing strategy-

ANAL6$I#AL H4E&$I N \ As an in)estor who (ust decide whether or not to buy shares, it is i(portant to *now how (uch of the co(pany8s assets is financed by creditors and how (uch is financed by owners$he debt?to?e<uity ratio is used to assess the debt capacity of a business- It is co(puted as follows:

$he .==> ratio for Nestl7 is #:/ IA,.0I ] #:/ I2,921 L 1-=A RA$I ANC # 5PARI& N&

IN$ERPRE$A$I N& In General \ $he debt?to?e<uity ratio indicates how (uch debt has been used to finance the co(pany8s ac<uisition of assets, relati)e to e<uity financing that is supplied by shareholders- A high ratio nor(ally suggests that a co(pany relies hea)ily on funds pro)ided by creditors- 5anagers use the ratio to decide whether they should finance any additional ac<uisitions by using debt- #reditors use this ratio to assess the ris* that a co(pany (ay not be able to (eet its financial obligations during a business downturn- In)estors use it to assess the le)el of financial ris* associated with the e;pected cash flows fro( their in)est(ent +di)idends and appreciation in the share )alue,In)estors loo* not only at ratios o)er ti(e for Nestl7, but also at the debt?to?e<uity ratio of co(petitors for co(parison purposes- !oth #onAgra /oods and @raft /oods ha)e higher debt?to?e<uity ratios than Nestl7, suggesting that they ha)e higher financial ris*- As a result, they (ay not be in as good a financial position as Nestl7 to generate the cash necessary to (eet their financial obligations in case of a business downturnA /ew #autions \ $he debt?to?e<uity ratio tells only part of the story with respect to ris*s associated with debt$he ratio is a good indication of debt capacity, but it does not help the in)estor understand whether the co(pany8s operations can support the a(ount of debt that it has- Re(e(ber that debt carries with it the obligation to (a*e cash pay(ents for interest and principal- As a result, (ost in)estors would e)aluate the debt?to?e<uity ratio within the conte;t of the a(ount of cash the co(pany is able to generate fro( operating acti)ities^#onAgra /oods is a top food producer in the 4nited &tates, offering both pac*aged and fro'en foods- $he co(pany (a*es (any leading brands, including :ealthy #hoice, #hef !oyardee, Egg !eaters, :unt8s, r)ille Redenbacher8s, PA5, and !an<uet, a(ong others- @raft /oods is the second largest food co(pany in the world behind Nestl7- It (anufactures and (ar*ets pac*aged food products such as snac*s- Its brands include @raft cheeses and dressings, scar 5ayer (eats, Philadelphia crea( cheese, 5a;well :ouse and "acobs coffee, Nabisco and reo coo*ies- In)estors cannot always co(pare closest co(petitors- !oth Nestl7 and @raft /oods are (uch larger co(panies than #onAgra /oods and (ar*et a wider )ariety of productsPage A3 As you can see, using the rele)ant financial infor(ation fro( financial state(ents to calculate a single ratio is only the first step toward understanding whether a co(pany is healthy enough to (erit your in)est(ent (oney$he real challenges are disco)ering why the ratios ha)e changed o)er ti(e, co(paring the ratios with co(petitors8 ratios, de)eloping a *een understanding of the industry and businesses, and using all this *nowledge to predict the future for a co(pany&EL/?&$4C6 H4IJ .?3 !enetton Group !enetton Group had the following balances on a recent state(ent of financial position +in thousands of Euros,:

LiabilitiesF1,3>.,>29K &hareholders8 e<uityF1,2>0,>2A #o(pute !enetton8s debt?to?e<uity ratio:

Ehat does this tell you about !enetton8s financing strategyG

After you co(plete your answers, #onnect at go onlineV for the solutions&elf?&tudy Hui' .?3 &olution

)isit

/ #4& N#A&: /L E&IN%E&$ING ANC /INAN#ING A#$I%I$IE&

L AIdentify in)esting and financing transactions and how they are reported on the state(ent of cash flows-

Recall fro( #hapter 1 that co(panies report cash inflows and outflows o)er a period in their state(ent of cash flows- $his state(ent di)ides all transactions that affect cash into three categories: operating, in)esting, and financing acti)ities- In)esting and financing acti)ities are co)ered in this chapter whereas operating acti)ities are co)ered in #hapter 2-

$he eight transactions we ha)e analy'ed for Nestl7 included issuing shares, borrowing fro( a ban*, purchasing e<uip(ent, lending to trade suppliers, purchasing shares in other co(panies, declaring and paying di)idends, collecting cash on a note recei)able, and paying down a ban* loan +see E;hibit .->,- All these transactions affected cash- /our of the eight transactions relate to in)est(ent acti)ities and the other four relate to financing acti)ities-

$he first set includes one transaction that increased cash inflow and three transactions that decreased cash- $he collection on notes recei)able increased cash by 2==- n the other hand, the pay(ent of 1,I== in cash for the purchase of e<uip(ent, the short?ter( loan to trade suppliers for 3I=, and the in)est(ent in shares of other

co(panies for 2,=== resulted in a total cash outflow of 3,>I=- $he net change to cash fro( in)est(ent acti)ities is an outflow of 3,9I=-

$he second set of transactions relates to financing acti)ities and includes two transactions that increased cash and two transactions that decreased cash- $he issuance of shares for 1,2== and borrowing 1,=== fro( the ban* increased cash by .,2==- In contrast, pay(ent of di)idends of .== and partial repay(ent on a ban* loan of 3== decreased cash by 9== during the sa(e period- $he net change to cash fro( financing acti)ities is an inflow of 1,A==- In su((ary, the change in the cash balance fro( I,0.I at Cece(ber 21, .==>, to .,0AI at "anuary 21, .=1=, can be e;plained as follows:

Page AI

$he state(ent of cash flows pro)ides infor(ation that not only shows the sources and uses of cash but also helps both in)estors and creditors predict future cash flows for Nestl7 and (a*e appropriate financial decisions- $he pattern of cash flows shown in E;hibit .-> +net cash outflows for in)esting acti)ities and net cash flows fro( financing acti)ities, is typical of Nestl78s past se)eral annual state(ents of cash flows- #o(panies see*ing to e;pand usually report cash outflows for in)esting acti)ities-

E;hibit .->Nestl78s &tate(ent of #ash /lows &EL/?&$4C6 H4IJ .?I Lance Inc- (anufactures and sells snac* products- Indicate whether the following transactions fro( a recent state(ent of cash flows were in)esting +I, or financing +/, acti)ities, and show the direction of the effect on cash +M (eans increases cashK Q (eans decreases cash,: $ransactions 1- Paid di)idends .- &old property 2- &old (ar*etable securities +in)est(ents, 3- Purchased )ending (achines I- Repurchased its own shares After you co(plete your answers, )isit #onnect at go onlineV for the solutions&elf?&tudy Hui' .?I &olution Page A9 &o(e 5isconceptions $ype of Acti)ity +I or Effect on #ash /lows +M or /, Q,

&o(e people confuse boo**eeping with accounting- In effect, they confuse a part of accounting with the whole!oo**eeping in)ol)es the routine, clerical part of accounting and re<uires only (ini(al *nowledge of accountingA boo**eeper (ay record the repetiti)e and unco(plicated transactions in (ost businesses and (ay (aintain the si(ple records of a s(all business- In contrast, the accountant is a highly trained professional, co(petent in the design of infor(ation syste(s, analysis of co(ple; transactions, interpretation of financial data, financial reporting, auditing, ta;ation, and (anage(ent consultingAnother pre)alent (isconception is that all transactions are subDect to precise and obDecti)e (easure(ent, and that the accounting results reported in the financial state(ents are e;actly what happened during that period- In reality, accounting nu(bers are influenced by esti(ates, as subse<uent chapters will illustrate- &o(e people belie)e that financial state(ents report the entity8s (ar*et )alue +including its assets,, but they do not- $o understand and interpret financial state(ents, the user (ust be aware of their li(itations as well as their usefulness- ne should understand what the financial state(ents do and do not try to acco(plish/inally, financial state(ents are often thought to be infle;ible because of their <uantitati)e nature- As you study accounting, you will learn that it re<uires considerable professional Dudg(ent on the part of the accountant to capture the econo(ic essence of co(ple; transactions- Accountants de)elop professional Dudg(ent after years of e;perience in analy'ing business transactions and in applying generally accepted accounting principles in preparing and auditing financial reports- Accounting is sti(ulating intellectuallyK it is not a cut?and?dried subDectIt calls on your intelligence, analytical ability, creati)ity, and Dudg(ent- Accounting is a co((unication process in)ol)ing an audience +users, with a wide di)ersity of *nowledge, interest, and capabilitiesK therefore, it will call on your ability as a co((unicator- $he language of accounting uses concisely written phrases and sy(bols to con)ey infor(ation about the resource flows (easured for specific organi'ations$o understand financial state(ents, you (ust ha)e a certain le)el of *nowledge of the concepts and the (easure(ent procedures used in the accounting process- 6ou should learn what accounting is really li*e and appreciate the reasons for using certain procedures- $his le)el of *nowledge cannot be gained by reading a list of the concepts and a list of the (isconceptions- Neither can a generali'ed discussion of the subDect (atter suffice- A certain a(ount of in)ol)e(ent, pri(arily proble( sol)ing +si(ilar to the re<uire(ent in (athe(atics courses,, is essential in the study of accounting focused on the needs of the user- $herefore, we pro)ide proble(s ai(ed at the desirable *nowledge le)el for the user as well as the preparer of financial state(entsA## 4N$ING &$ANCARC&/ R PRI%A$E EN$ERPRI&E& As noted in #hapter 1, the accounting standards applicable for the reporting of financial infor(ation by pri)ate enterprises (ay differ fro( I/R&, especially the accounting for co(ple; transactions and the e;tent of detail reported in the notes to the financial state(ents- Cifferences in accounting standards (ay lead to different )alues for assets, liabilities, and e<uity that are reported on the state(ent of financial position- Ee will highlight such differences as we co)er specific topics in future chapters- /or e;a(ple, when accounting for inco(e ta;es, pri)ate enterprises (ay use the ta;es payable (ethod, which is a si(pler (ethod than the deferred inco(e ta;es (ethod that is re<uired for publicly accountable enterprises- In that case, the state(ent of financial position would not include the account Ceferred inco(e ta; liabilities- /urther details on accounting for inco(e ta;es are pro)ided in #hapter >Page AA CE5 N&$RA$I N #A&E n April 1, .=11, three a(bitious college students started $errific Lawn 5aintenance #orporation- #o(pleted transactions +su((ari'ed, through April 2=, .=11, for $errific Lawn 5aintenance #orporation follow:

Issued 1,I== shares in e;change for N>,=== cash- Each in)estor recei)ed I== sharesAc<uired ra*es and other hand tools +e<uip(ent, with a list price of N9>= for N9==K paid the hardware store N.== cash and signed a note for the balance with the hardware storerdered three lawn (owers and two edgers fro( B6J Lawn &upply Inc- for N3,===Purchased four acres of land as a future site of a storage garage- Paid cash, NI,===Recei)ed the (owers and edgers that had been ordered, signing a note to pay B6J Lawn &upply in full, in 2= days&old one acre of land to the city for a par*- $he city paid $errific Lawn 5aintenance #orp- N1,.I=, the cost of the land in cashne of the owners borrowed N2,=== fro( a local ban* for personal useRe<uired: &et up $?accounts for cash, e<uip(ent +for hand tools and (owing e<uip(ent,, land, short?ter( notes payable +to e<uip(ent supply co(panies,, and share capital- Indicate beginning balances of N= in the $?accounts- Analy'e each transaction by using the process outlined in the chapter- Prepare Dournal entries in chronological order- Enter the effects of the transactions in the appropriate $?accounts- Identify each a(ount with its letter in the preceding list4se the a(ounts in the $?accounts de)eloped in +1, to prepare a classified state(ent of financial position for $errific Lawn 5aintenance #orporation at April 2=, .=11- &how the account balances for all assets, liabilities, and shareholders8 e<uity- 4se the following transaction analysis (odel:

Prepare the in)esting and financing sections of the state(ent of cash flowsEe strongly reco((end that you prepare your own answers to these re<uire(ents and then chec* your answers with the solution pro)ided below&4GGE&$EC & L4$I N $ransaction analysis, Dournal entries, and $?accounts:

Page A0 +c, $his is not a transactionK no e;change has ta*en place- No accounts are affected-

+g, $his is not a transaction that in)ol)es the co(pany- $he separate?entity assu(ption states that transactions of the owners are separate fro( transactions of the business-

&tate(ent of financial position:

Page A> Notice that the state(ent of financial position presented earlier in the te;t listed assets on the top and liabilities and shareholders8 e<uity on the botto(- It is also acceptable practice to prepare a state(ent of financial position with assets on the left side and liabilities and shareholders8 e<uity on the right side, as in the preceding e;a(pleIn)esting and financing effects of the state(ent of cash flows:

#:AP$ER $A@E?AEA6& 4nderstand the obDecti)e of financial reporting and the related *ey accounting assu(ptions and principles- p- 3A $he pri(ary obDecti)e of e;ternal financial reporting is to pro)ide useful econo(ic infor(ation about a business

to help e;ternal parties, pri(arily in)estors and creditors, (a*e sound financial decisions@ey accounting assu(ptions and principles: &eparate?entity assu(ptionFtransactions of the business are accounted for separately fro( transactions of the owner4nit?of?(easure assu(ptionFfinancial infor(ation is reported in the national (onetary unit#ontinuity +going?concern, assu(ptionFa business is e;pected to continue to operate into the foreseeable future:istorical cost principleFfinancial state(ent ele(ents should be recorded at their cash?e<ui)alent cost on the date of the transactionCefine the ele(ents of a classified state(ent of financial position- p- I= Ele(ents of the state(ent of financial position: AssetsFprobable future econo(ic benefits owned by the entity as a result of past transactionsLiabilitiesFpresent debts or obligations of the entity as a result of past transactions, which will be paid with assets or ser)ices&hareholders8 e<uityFthe financing pro)ided by the owners and the operations of the businessIdentify what constitutes a business transaction, and recogni'e co((on account titles used in business- p- I9 A transaction includes: An e;change between a business and one or (ore e;ternal parties to a businessor A (easurable internal e)ent such as adDust(ents for the use of assets in operationsAn account is a standardi'ed for(at that organi'ations use to accu(ulate the dollar effects of transactions of each financial state(ent ite(- $ypical account titles include the following: Assets: cash, trade recei)ables, in)entory, prepay(ents, and property and e<uip(entLiabilities: trade payables, notes payable, accrued liabilities, and ta;es payable&hareholders8 e<uity: share capital and retained earningsPage 0= Apply transaction analysis to si(ple business transactions in ter(s of the accounting (odel: Assets L Liabilities M&hareholders8 E<uity- p- I0 $o deter(ine the econo(ic effect of a transaction on the entity in ter(s of its accounting e<uation, each transaction is analy'ed as to the accounts +at least two, that are affected- In an e;change, the co(pany recei)es so(ething and gi)es so(ething- If the accounts, direction of the effects, and a(ounts are correctly analy'ed, the accounting e<uation (ust stay in balance- $he transaction analysis (odel is

Ceter(ine the i(pact of business transactions on the state(ent of financial position by using two basic tools: Dournal entries and $?accounts- p- 92 "ournal entries e;press the effects of a transaction on accounts by using the debit?credit fra(ewor*- $he accounts and a(ounts to be debited are listed first- $hen the accounts and a(ounts to be credited are listed below the debits and indented, resulting in debits on the left and credits on the right- A brief description of the transaction is then included for future reference-

$?accounts su((ari'e transaction effects for each account- $hese tools can be used to deter(ine balances and draw inferences about a co(pany8s acti)ities-

Prepare a classified state(ent of financial position and analy'e it by using the debt?to?e<uity ratio- p- A1 #lassified state(ents of financial position are structured as follows: Assets categori'ed as Ocurrent assetsP +those to be used or turned into cash within the year, with in)entory always considered to be a current asset, and non?current assets such as long?ter( in)est(ents, property and e<uip(ent, and intangible assetsLiabilities categori'ed as Ocurrent liabilitiesP +those that will be paid within the ne;t year or the operating cycle, whiche)er is longer, and non?current liabilities&hareholders8 e<uity accounts are listed as share capital first, followed by retained earnings and other co(ponents$he debt?to?e<uity ratio +total liabilities ] shareholders8 e<uity, (easures the relationship between total liabilities and the shareholders8 capital that finance the assets- $he higher the ratio, the (ore debt is used to finance assetsAs the ratio +and thus debt, increases, ris* increasesIdentify in)esting and financing transactions and how they are reported on the state(ent of cash flows- p- A3 A state(ent of cash flows reports the sources and uses of cash for the period by the type of acti)ity that generated the cash flow: operating, in)esting, and financing- In)esting acti)ities are purchasing and selling long?ter( assets, (a*ing loans, and recei)ing pay(ent fro( loans to others- /inancing acti)ities are borrowing and repaying loans to ban*s, issuing and repurchasing shares, and paying di)idendsIn this chapter, we discussed the funda(ental accounting (odel and transaction analysis- "ournal entries and $? accounts were used to record the results of transaction analysis for in)esting and financing decisions that affect specific accounts- In #hapter 2, we continue our detailed loo* at financial state(ents, in particular the inco(e state(ent- $he purpose of#hapter 2 is to build on your *nowledge by discussing concepts for the (easure(ent of re)enues and e;penses and by illustrating transaction analysis for operating decisionsPage 01 @E6 RA$I $he debt?to?e<uity ratio (easures the relationship between total liabilities and the shareholders8 capital that finance the assets- $he higher the ratio, the (ore debt is assu(ed by the co(pany to finance assets- It is co(puted as follows +p- A.,:

/INCING /INAN#IAL IN/ R5A$I N

@E6 $ER5& Accountp- IAAssetsp- I=#ontinuity +Going?#oncern, Assu(ptionp- 3>#ost Principlep- 3>#reditp- 93#urrent Assetsp- I.#urrent Liabilitiesp- I3Cebitp- 93"ournal Entryp- 9ILiabilitiesp- I2Non?current Assetsp- I2Non? current Liabilitiesp- I3Pri(ary bDecti)e of E;ternal /inancial Reportingp- 30Retained Earningsp- I9&eparate? Entity Assu(ptionp- 30&hare #apitalp- II&hareholders8 E<uity + wners8 E<uity or &toc*holders8 E<uity,p- II$? accountp- 93$ransactionp- I9$ransaction Analysisp- I>4nit?of?5easure Assu(ptionp- 3> Page 0. H4E&$I N& Ehat is the pri(ary obDecti)e of financial reporting for e;ternal usersG Cefine the following: Asset #urrent asset Liability #urrent liability &hare capital Retained earnings E;plain what the following principle and assu(ptions (ean in accounting: &eparate?entity assu(ption 4nit?of?(easure assu(ption #ontinuity assu(ption

#ost principle Ehy is it i(portant to ha)e accounting assu(ptionsG :ow is the debt?to?e<uity ratio co(puted and how is it interpretedG /or accounting purposes, what is an accountG E;plain why accounts are used in an accounting syste(G Ehat are the li(itations of using the historical cost principle as a basis for )aluation of assets subse<uent to ac<uisitionG Ehat is the funda(ental accounting (odelG Cefine a business transaction in the broad sense and gi)e e;a(ples of the two different *inds of transactionsE;plain what debit and credit (ean!riefly e;plain what is (eant by transaction analysis- Ehat are the two steps in transaction analysisG Ehat two e<ualities in accounting (ust be (aintained in transaction analysisG Ehat is a Dournal entryG Ehat is a $?accountG Ehat is its purposeG Ehat transactions are classified as in)esting acti)ities in a state(ent of cash flowsG Ehat transactions are classified as financing acti)itiesG Ehat is the difference between a boo**eeper and an accountantG EBER#I&E& E.W1Identifying E)ents as Accounting $ransactions L 2 Ehich of the following e)ents results in an e;change transaction for 8!rien #o(pany +6 for yes and N for no,G

E.W .Identifying Account $itles L 2 $he following are independent situationsA co(pany orders and recei)es 1= personal co(puters for office use for which it signs a note pro(ising to pay N.I,=== within three (onthsA co(pany purchases a new deli)ery truc* that has a list, or stic*er, price of N.3,=== for N.1,=== cashA wo(en8s clothing retailer orders 2= new display stands for N2== each, for future deli)eryA new co(pany is for(ed and sells 1== shares for N1. per share to in)estorsA (anufacturing co(pany signs a contract for the construction of a new warehouse for NI==,===- At the signing, the co(pany writes a che<ue for NI=,=== as a deposit on the future construction-

A publishing fir( purchases the copyright +an intangible asset, to a (anuscript for an introductory accounting te;t fro( the author for N3=,===A (anufacturing fir( pays di)idends of N1==,=== to shareholders in cashA co(pany purchases 3== shares of Eest"et Airlines for NI,=== cashPage 02 A co(pany purchases a piece of land for NI=,=== cash- An appraiser for the buyer )alued the land at NI.,I==A (anufacturing co(pany purchases the patent +an intangible asset, on a new digital satellite syste( for tele)ision reception for NI==,=== cash and a note for N3==,===, payable in one year at an annual interest of 1= percentA local co(pany is a sole proprietorship +one owner,K its owner buys a car for N1=,=== for personal use- Answer fro( the co(pany8s point of )iewA co(pany signs a si;?(onth note for a N1,=== loan on "une 2=, .=11, to be paid bac* on Cece(ber 21, .=11, with 1= percent annual interestA co(pany pays N1,I== principal on its note payableRe<uired: Indicate the appropriate ele(ents on the classified state(ent of financial position +use account titles,, if any, that are affected in each of the preceding e)ents- #onsider what is gi)en and what is recei)edAt what a(ount would you record the truc* in +b,G $he land in +i,G Ehat (easure(ent principle are you applyingG Ehat accounting concepts did you apply for situations +c, and +*,G E.W2#lassifying Accounts and $heir 4sual !alances L 2, I &ingapore Airlines As described in a recent annual report, &ingapore Airlines pro)ides <uality tra)el ser)ices to (any destinations worldwideRe<uired: /or each of the following accounts fro( &ingapore8s recent state(ent of financial position, co(plete the following chart by indicating whether the account is classified as a current asset +#A,, non?current asset +N#A,, current liability +#L,, non?current liability +N#L,, or shareholders8 e<uity +&E,, and whether the account usually has a debit or credit balance-

Account 1- In)est(ent properties .- Retained earnings 2- Notes payable +due in 2 years, 3- Prepay(ents I- Long?ter( in)est(ents 9- &hare capital A- Aircraft, spares, and spare engines 0- $rade and other payables >- &hort?ter( in)est(ents 1=- #urrent ta; payable 11- $rade recei)ables 1.- In)est(ent in associated co(panies 12- #ash and ban* balances 13- In)entories 1I- Land and buildings 19- Ceferred re)enue

&tate(ent of /inancial Position #lassification

Cebit or #redit !alance

E.W3Identifying Effects on Ele(ents of the &tate(ent of /inancial Position L 3 #o(plete the following table by entering either the word increases ordecreases in colu(ns +1, and +.,, and either the word debit or creditin colu(ns +2, and +3,+1, Cebi t Assets Liabilities &hareholders8 e<uity Page 03 E.WICeter(ining /inancial &tate(ent Effects of &e)eral $ransactions _:elp 5e &ol)e It_ %ideo $utorial .?1 L 3 $he following e)ents occurred for /a)ata #o(pany: Recei)ed in)est(ent of N.=,=== cash by organi'ers!orrowed cash fro( a ban* and signed a note for N9,===+., #redit +2, Increases +3, Cecreases

Purchased N1.,=== in landK paid N1,=== in cash and signed a (ortgage note with a local ban* for the balance +due in 1I years,Loaned N2== to an e(ployee who signed a note due in three (onthsPaid the ban* the a(ount borrowed in +b,Purchased N0,=== of e<uip(ent, paying N1,=== in cash and signing a note due to the (anufacturerRe<uired: /or each of the e)ents +a, through +f,, perfor( transaction analysis and indicate the account, a(ount, and direction of the effects +M for increase and Q for decrease, on the accounting e<uation- #hec* that the accounting e<uation re(ains in balance after each transaction- 4se the following headings:

L 3 Ni*e IncE.W9Ceter(ining /inancial &tate(ent Effects of &e)eral $ransactions Ni*e Inc-, with head<uarters in !ea)erton, regon, is one of the world8s leading (anufacturers of athletic shoes and sports apparel- $he following acti)ities occurred during a recent year- $he a(ounts are rounded to (illions of dollarsPurchased additional building for N132-I and e<uip(ent for NA=-2K paid N3I in cash and signed a long?ter( note for the restIssued N.1-1 in additional shares for cashCeclared N11= in di)idendsK paid NA0-0 during the year, with the rest payable in the following year&e)eral Ni*e in)estors sold their own shares to other in)estors on the stoc* e;change for NIIRepaid N2=-. in principal on long?ter( debt obligationsRecei)ed cash for sale of in)est(ents in other co(panies at their cost of N1-3Re<uired: /or each of these e)ents, perfor( transaction analysis and indicate the account, a(ount, and direction of the effects on the accounting e<uation- #hec* that the accounting e<uation re(ains in balance after each transaction4se the following headings:

L I E.WARecording In)esting and /inancing Acti)ities Refer to E.WIRe<uired: /or each of the e)ents in E.WI, prepare Dournal entries, chec*ing that debits e<ual creditsE.W0Recording In)esting and /inancing Acti)ities5 L I Ni*e, IncRefer to E.W9Re<uired: /or each of the e)ents in E.W9, prepare Dournal entries, chec*ing that debits e<ual creditsE;plain your response to E.W9 +d,E.W>Analy'ing the Effects of $ransactions in $?Accounts L I Grady &er)ice #o(pany Inc- was organi'ed by #hris Grady and fi)e other in)estors- $he following e)ents occurred during the year: Recei)ed N92,=== cash fro( the in)estorsK each was issued 1,3== sharesPurchased e<uip(ent for use in the business at a cost of N19,===K one?fourth was paid in cash, and the co(pany signed a note for the balance, payable in si; (onths&igned an agree(ent with a cleaning ser)ice to pay it N.== per wee* for cleaning the corporate officesPage 0I Lent N.,I== to one of the in)estors who signed a note due in si; (onthsIssued shares to additional in)estors who contributed N9,=== in cash and a lot of land )alued at N1I,===-

Paid the a(ount of the note payable in +b,#onor 5ul*een borrowed N1=,=== for personal use fro( a local ban* and signed a note payable in one yearRe<uired: Prepare Dournal entries for each transaction- If an e)ent does not re<uire a Dournal entry, e;plain the reason- 4se the account titles listed in +.,#reate $?accounts for the following accounts: cash, note recei)able, e<uip(ent, land, note payable, and share capital- !eginning balances are 'ero- /or each of the preceding transactions, record the effects of the transaction in the appropriate $?accounts- Include good referencing and totals for each $?account4sing the balances in the $?accounts, fill in the following a(ounts for the accounting e<uation:

E.W1=Inferring In)esting and /inancing $ransactions, and Preparing a &tate(ent of /inancial Position L 3, 9 Curing its first wee* of operations ending "anuary A, .=11, #irba &ports Inc- co(pleted se)en transactions with the dollar effects indicated in the following $?accounts:

Re<uired: Erite a brief e;planation of transactions 1 through A- E;plain any assu(ptions that you (ade#o(pute the ending balance in each account and prepare a classified state(ent of financial position for #irba &ports Inc- on "anuary A, .=11E.W11Inferring In)esting and /inancing $ransactions, and Preparing a &tate(ent of /inancial Position _:elp 5e &ol)e It_ %ideo $utorial .?. L I Curing its first (onth of operations, 5arch .=1., /aye8s /ashions Inc- co(pleted se)en transactions with the dollar effects indicated in the following $?accounts:

Re<uired: Erite a brief e;planation of transactions 1 through A- E;plain any assu(ptions that you (ade#o(pute the ending balance in each account and prepare a classified state(ent of financial position for /aye8s /ashions Inc- at the end of 5arch .=1.Page 09 E.W1.Recording "ournal Entries L I

!5E Group, head<uartered in 5unich, Ger(any, (anufactures se)eral auto(oti)e brands, including !5E, 5INI, and Rolls?Royce- /inancial infor(ation is reported in euros +[,, using International /inancial Reporting &tandards as applicable to the European 4nion- $he following transactions were adapted fro( the annual report of the !5E GroupK a(ounts are in (illions of eurosCeclared [I2. in di)idends to be paid ne;t (onthIssued additional shares for [139 cashPaid [31> in di)idends declared in prior (onths!orrowed [2,>I9 and signed a 1. percent note due in two yearsLent [.A to trade suppliers who signed notes to repay the loans in three (onthsPurchased e<uip(ent for [1.,0>=, paying [>,0A= in cash and signing a note for the balancePurchased in)est(ents for [.,9I3 cashRe<uired: Prepare Dournal entries for each transaction- !e sure to use good referencing and categori'e each account as an asset +A,, liability +L,, or shareholders8 e<uity +&E,- If a transaction does not re<uire a Dournal entry, e;plain the reason-

E.W12Recording "ournal Entries L I Philippine Long Cistance $elephone #o(pany

Philippine Long Cistance $elephone #o(pany is the leading teleco((unications pro)ider in the Philippines- $he (onetary unit is the Philippine peso +,- $he following e)ents were adapted fro( a recent annual report- A(ounts are in (illions of pesosCeclared 2A,=23 in di)idends to be paid ne;t (onthrdered 93= in e<uip(entPaid 2A,=23 in di)idends pre)iously declared in +a,Issued additional shares for 1,.A= in cash&old land at its cost for cash, .22Recei)ed the e<uip(ent ordered in transaction +b,, paying 1.= in cash and signing a note for the balancePurchased short?ter( in)est(ents for 2,3IA in cashPaid 12,2AI in principal on long?ter( debtRe<uired: Prepare Dournal entries for each transaction- !e sure to use good referencing, and categori'e each account as an asset +A,, liability +L,, or shareholders8 e<uity +&E,- If a transaction does not re<uire a Dournal entry, e;plain the reasonE.W13Analy'ing the Effects of $ransactions by 4sing $?Accounts, Preparing a &tate(ent of /inancial Position, and Interpreting the Cebt?to?E<uity Ratio as a 5anager of the #o(pany L I, 9

5assi(o #o(pany has been operating for one year +.=1=,- 6ou are a (e(ber of the (anage(ent tea( in)estigating e;pansion ideas, all of which will re<uire borrowing funds fro( ban*s- At the start of .=11, 5assi(o8s $?account balances were as follows:

Page 0A

Re<uired: 4sing the data fro( these $?accounts, co(plete the accounting e<uation on "anuary 1, .=11:

Enter in the $?accounts the following transactions that occurred in .=11: +a, +b, +c, +d, +e, +f, Paid one?half of the principal on the long?ter( note payable&old N1,=== of the in)est(ents for N1,=== cashPaid in full the principal on the short?ter( notes payable&old one?half of the property and e<uip(ent for N.,=== in cash!orrowed N.,=== fro( the ban* and signed a note pro(ising to pay the principal and interest at an annual rate of 1= percent in three yearsPaid NI== in di)idends to shareholders-

#o(pute ending balances in the $?accounts to co(plete the state(ent of financial position on Cece(ber 21, .=11:

4sing the ending balances in the $?accounts, prepare a classified state(ent of financial position at Cece(ber 21, .=11, in good for(#alculate the debt?to?e<uity ratio at Cece(ber 21, .=11- If the industry a)erage for the debt?to?e<uity ratio is 1-==, what does your co(putation suggest to you about 5assi(o #o(panyG Eould you support e;pansion by borrowingG Ehy or why notG E.W1IE;plaining the Effects of $ransactions on &pecific Accounts by 4sing $?Accounts L I :ea)ey and Lo)as /urniture Repair &er)ice, a co(pany with two shareholders, began operations on "une 1, .=11$he following $?accounts indicate the acti)ities for the (onth of "une-

Re<uired: E;plain transactions +a, through +f,, which resulted in the entries in the $?accounts- $hat is, what acti)ity (ade the account increase or decreaseG E.W19Inferring $ypical In)esting and /inancing Acti)ities in Accounts L I $he following $?accounts indicate the effects of nor(al business transactions:

Re<uired: Cescribe the typical in)esting and financing transactions that affect each $?account- $hat is, what econo(ic e)ents (ade these accounts increase or decreaseG /or each $?account, co(pute the (issing a(ountsE.W1AIdentifying In)esting and /inancing Acti)ities Affecting #ash /lows L A $he /or'ani Group Ltd-

$he /or'ani Group Ltd- +/GL, is #anada8s largest sporting goods retailer, with o)er 22= co(pany? owned stores under the /or'ani8s, &port #he*, #oast 5ountain &ports, &port 5art, National &ports, Athletes Eorld, and :oc*ey E;perts banners- /GL also boasts about .2= franchised stores under the &port E;perts, At(osphere, Intersport, Ne)ada !ob8s Golf, /itness &ource, Pegasus, &2, Econosports, and $ech &hop na(es- $he stores sell na(e?brand and pri)ate?label sports e<uip(ent, footwear, and apparel- $he following are se)eral of /GL8s in)esting and financing acti)ities that were reflected in a recent annual state(ent of cash flowsPage 00 Principal repay(ent of long?ter( debtPurchase of in)est(entsIssuance of sharesAddition to capital assets +property, plant, and e<uip(ent,Issuance of long?ter( debtRepurchase of sharesCisposal of other assetsRe<uired: /or each of these, indicate whether the acti)ity is in)esting +I, or financing +/, and the direction of the effect on cash flows +M L increases cashK Q L decreases cash,E.W10Preparing the In)esting and /inancing &ection of the &tate(ent of #ash /lows L A

:ilton :otels #orporation

:ilton :otels #orporation constructs, operates, and franchises do(estic and international hotel and hotel?casino properties- Infor(ation fro( the co(pany8s recent annual state(ent of cash flows indicates the following in)esting and financing acti)ities during that year +si(plified,: Pay(ent of debt principal Purchase of in)est(ents &ale of property +assu(e sold at cost, Issuance of shares Purchase and reno)ation of properties Additional borrowing fro( ban*s Receipt of principal pay(ent on a note recei)able Re<uired: Prepare the in)esting and financing sections of the state(ent of cash flows for :ilton hotels- Assu(e that the co(pany8s year?end is Cece(ber 21, .=11E.W1>/inding /inancial Infor(ation as a Potential In)estor L 2, 9, A N .3 12> .2= 9= 2A= >>. 1.I

6ou are considering in)esting the cash you inherited fro( your grandfather in )arious co(pany shares6ou ha)e recei)ed the annual reports of se)eral (aDor co(paniesRe<uired: /or each of the following, indicate where you would locate the infor(ation in an annual report- +:int: $he infor(ation (ay be in (ore than one location-, $otal current assetsPrincipal a(ount of debt repaid during the year&u((ary of significant accounting policies#ash recei)ed fro( sales of non?current assetsA(ount of di)idends paid during the year&hort?ter( obligations-

Cate of the state(ent of financial positionPR !LE5& P.W1Identifying Accounts on a #lassified &tate(ent of /inancial Position and $heir Nor(al Cebit or #redit !alances +AP.W1, L 1, 2 $otal, &-A$otal, &-A- is a large, international, publicly traded integrated oil and gas co(pany that e;plores, produces, refines, (ar*ets, and supplies crude oil and petroleu( products- It is a (aDor actor in the che(icals business, and has operations in (ore than 12= countries on fi)e continents- $he following are se)eral of the accounts that appeared on the co(pany8s recent state(ent of financial position-

Account

&tate(ent of /inancial Position #lassification

Cebit or #redit !alance

1.23I9A0>1=111.12131I19-

#ash and cash e<ui)alents Ceferred inco(e ta; liabilities Retained earnings 5aterials and supplies Prepay(ents &hare capital Patents +an intangible asset, $rade and other payables Accrued liabilities Ceferred re)enue #urrent financial assets In)est(ent in associates $rade recei)ables #rude oil products and (erchandise Land and buildings Pro)isions +short?ter(, Page 0>

Re<uired: /or each account, indicate how it nor(ally should be categori'ed on a classified state(ent of financial position4se #A for current asset, N#A for non?current asset, #L for current liability, N#L for non?current liability, and &E for shareholders8 e<uity- Also indicate whether the account nor(ally has a debit or credit balanceP.W.Ceter(ining /inancial &tate(ent Effects of %arious $ransactions+AP.W., L 2, 3 Lester8s :o(e :ealthcare &er)ices was organi'ed on "anuary 1, .=11, by four friends- Each organi'er in)ested N1=,=== in the co(pany and, in turn, was issued 0,=== shares- $o date, they are the only shareholders- Curing the first (onth +"anuary .=11,, the co(pany co(pleted the following si; transactions: #ollected a total of N3=,=== fro( the organi'ers and, in turn, issued the shares-

Purchased a building for N9I,===, e<uip(ent for N19,===, and three acres of land for N1.,===K paid N12,=== in cash, and signed a 1= percent (ortgage for the balance payable to the local ban* in 1I years- +:int: /i)e different accounts are affected-, ne shareholder reported to the co(pany that he sold I== shares to another shareholder for a cash consideration of NI,===Purchased short?ter( in)est(ents for N2,=== cash&old one acre of land costing N3,=== to another co(pany for N3,=== cashLoaned one of the shareholders NI,=== for (o)ing costs, in e;change for a signed note due in one yearRe<uired: Eas Lester8s :o(e :ealthcare &er)ices organi'ed as a sole proprietorship, a partnership, or a corporationG E;plain the basis for your answerCuring the first (onth, the records of the co(pany were inade<uate- 6ou were as*ed to prepare a su((ary of the preceding transactions- $o de)elop a <uic* assess(ent of the transaction effects on Lester8s :o(e :ealthcare &er)ices, you ha)e decided to co(plete the tabulation that follows and to use plus +M, for increases and (inus +Q, for decreases for each account- $he first transaction is used as an e;a(ple-

Page >= Cid you include all the transactions in the tabulationG If not, which one did you e;clude and whyG !ased only on the co(pleted tabulation, pro)ide the following a(ounts at "anuary 21, .=11 +show co(putations,: $otal assets $otal liabilities $otal shareholders8 e<uity #ash balance $otal current assets #o(pute the debt?to?e<uity ratio at "anuary 21, .=11- Ehat does this suggest about the co(panyG P.W2Recording $ransactions in $?Accounts, Preparing a &tate(ent of /inancial Position, and E)aluating the Cebt? to?E<uity Ratio +AP.W2, E;cel $e(plate L 9 InDection Plastics #o(pany has been operating for records reflected the following: #ash In)est(ents +short?ter(, $rade recei)ables In)entories Notes recei)able +long? ter(, three years- At Cece(ber 21, .=11, the accounting N2,=== 1I,=== .,=== A,=== 30,===

N.1,=== Intangibles .,=== $rade payables 2,=== Accrued liabilities .3,=== &hort?ter( borrowings 1,=== Notes payable +long? ter(,

E<uip(ent /actory building

30,=== &hare capital >=,=== Retained earnings

>=,=== 2=,===

Curing the year .=1., the following su((ari'ed transactions were co(pleted: Purchased e<uip(ent that cost N10,===K paid N9,=== cash and signed a one?year note for the balanceIssued .,=== additional shares for N1.,=== cashLent NA,=== to a supplier who signed a two?year notePurchased short?ter( in)est(ents for N>,=== in cashPaid NI,=== on the note in transaction +a,!orrowed N1.,=== cash on Cece(ber 21, .=1., fro( a local ban* and signed a note, payable "une 2=, .=12Purchased a patent +an intangible asset, for N2,=== cash!uilt an addition to the factory for N.I,===K paid N>,=== in cash and signed a three?year note for the balance:ired a new president at the end of the year- $he contract was for N0I,=== per year plus options to purchase co(pany shares at a set price based on co(pany perfor(anceReturned defecti)e e<uip(ent to the (anufacturer, recei)ing a cash refund of N1,===Re<uired: #reate $?accounts for each of the accounts on the state(ent of financial position and enter the balances at the end of .=11 as beginning balances for .=1.Record each of the transactions for .=1. in $?accounts +including referencing, and deter(ine the ending balancesE;plain your response to transaction +i,Prepare a classified state(ent of financial position at Cece(ber 21, .=1.#o(pute the debt?to?e<uity ratio at Cece(ber 21, .=1.- Ehat does this ratio suggest about InDection Plastics #o(panyG Page >1 P.W3Identifying Effects of $ransactions on the &tate(ent of #ash /lows+AP.W3, L A Refer to P.W2Re<uired: 4sing the transactions +a, through +D, in P.W2, indicate whether each transaction is an in)esting +I, or financing +/, acti)ity for the year and the direction of the effect on cash flows +M for increase and Q for decrease,- If there is no effect on cash flows, write NEP.WIRecording $ransactions, Preparing "ournal Entries, Posting to $?Accounts, Preparing a &tate(ent of /inancial Position, and E)aluating the Cebt?to?E<uity Ratio +AP.WI, E;cel $e(plate L I, 9 !ayer AG !ayer AG, with head<uarters in Le)er*usen, Ger(any, is an international, research?based group of co(panies acti)e in health, agriculture, poly(ers, and che(icals- Popular products include !ayer Aspirin, Al*a?&elt'er, and ne?A?Cay )ita(ins- $he following is !ayer8s +si(plified, state(ent of financial position as at "une 2=, .==>:

Page >. Assu(e that the following transactions occurred in the second half of .==>: Issued additional shares for [1,.== in cash!orrowed [2,>I. fro( ban*s due in two yearsCeclared and paid [>I2 in di)idends to shareholdersPurchased additional intangibles for [3I cashPurchased property, plant, and e<uip(entK paid [.,93A in cash and [I,31= with additional long?ter( ban* loansAc<uired additional in)est(entsK paid [19= in cashLent [.I= to an associated co(pany that signed a si;?(onth note&old in)est(ents costing [11I for the sa(e a(ount in cashRe<uired: Prepare a Dournal entry for each transaction-

#reate $?accounts for each financial state(ent account and include the "une 2=, .==>, balances- Post each Dournal entry to the appropriate $?accountsPrepare a state(ent of financial position for !ayer based on the $?account ending balances at Cece(ber 21, .==>#o(pute !ayer8s debt?to?e<uity ratio at Cece(ber 21, .==>- Ehat does this suggest about the co(panyG P.W9Preparing the In)esting and /inancing &ections of a &tate(ent of #ash /lows +AP.W9, L A !ayer AG Refer to P.WIRe<uired: !ased on the transactions that occurred in .==>, prepare the in)esting and financing sections of the state(ent of cash flows of !ayer for the second half of .==>P.WA4sing /inancial Reports: Preparing a #lassified &tate(ent of /inancial Position and Analy'ing the Cebt?to? E<uity Ratio +AP.WA, L 9 $he accounts below, in alphabetical order, are for !ig !urgers Inc- +a(ounts are in thousands of #urrent Prior 6ear 6ear Accounts and notes recei)able Accounts payable Accrued liabilities #ash and e<ui)alents #urrent (aturities of long?ter( debt Intangible assets, net In)entories NA>I-> 90>-3 .,233-. 3,.9=-3 9I0-A 1,>I=-A 13A-= NA3I-I A13-2 .,133= 1,2A>0 09.-. 1,0.02 13A-I adapted fro( a recent state(ent of financial position dollars,: #urrent Prior 6ear 6ear Long?ter( debt Notes payable +short ter(, ther long?ter( liabilities ther non?current assets Prepaid e;penses and other current assets Property and e<uip(ent, net Retained earnings N0,>2A3 I33-= 1,09>-= 1,.3I-= 939-3 .=,1=0= 1.,221> .,013-. N0,2IA2 F 1,AI0-. 1,220-3 I0I-= .=,>=21 11,>>0->

In)est(ents in and ad)ances to 1,=2I-3 1,1=>- &hare capital .,.=.-9 affiliates > Re<uired: #onstruct, in good for(, a classified state(ent of financial position +with two years reported, for !ig !urgers Inc#o(pute the co(pany8s debt?to?e<uity ratio at the end of the current year- :ow do you interpret this ratio for !ig !urgersG Page >2 P.W0Preparing "ournal Entries, 4sing $?Accounts, Preparing a &tate(ent of /inancial Position, and E)aluating the Cebt?to?E<uity Ratio o)er $i(e as a !an* Loan fficer +AP.W0, L I, 9 At the beginning of year .=1., Lee Celi)ery applied to your ban* for a N1==,=== loan to e;pand #o(pany Inc-, which was organi'ed in .=11, the business- $he )ice?president of the ban* as*ed

you to re)iew the infor(ation and (a*e a reco((endation on lending the funds- $he following transactions occurred during year .=11 +the co(pany8s first year of operations,: Recei)ed cash fro( the organi'ers, N3=,===Purchased land for N1.,=== and signed a one?year note +at a 1= percent annual interest rate,!ought two used deli)ery truc*s for operating purposes at the start of the year at a cost of N1=,=== eachK paid N.,=== cash and signed a pro(issory note for the balance, payable o)er the ne;t three years +at an annual interest rate of 11 percent,&old one?fourth of the land for N2,=== to !ir*ins 5o)ing, which pro(ised to pay in si; (onthsPaid N.,=== cash to a truc* repair shop for a new (otor for one of the truc*s- +:int: Increase the account you used to record the purchase of the truc*s since the usefulness of the truc* has been i(pro)ed-, $raded the other truc* and N9,=== cash for a new one- $he old truc*8s fair )alue is N1=,===&hareholder "onah Lee paid N..,=== cash for a )acant lot +land, for his personal use#ollected the a(ount of the note due fro( !ir*ins 5o)ing in +d,Paid one?third of the principal of the note due for the deli)ery truc*s in +c,Re<uired: &et up appropriate $?accounts with beginning balances of N= for cash, short?ter( notes recei)able, land, e<uip(ent, short?ter( notes payable, long?ter( notes payable, and share capital- 4sing the $?accounts, record the effects of these transactions on Lee Celi)ery #o(panyPrepare a classified state(ent of financial position for Lee Celi)ery #o(pany at the end of .=11- #o(pute the debt?to?e<uity ratio at that dateEhat reco((endation would you (a*e to the ban*8s )ice?president about lending the (oney to Lee Celi)ery #o(panyG At the end of the ne;t two years, Lee Celi)ery #o(pany reported the following a(ounts on its state(ents of financial position-

#o(pute the co(pany8s debt?to?e<uity ratio for .=1. and .=12- Ehat is the trend and what does this suggest about the co(panyG AL$ERNA$E PR !LE5& AP.W1Identifying Accounts on a #lassified &tate(ent of /inancial Position and $heir Nor(al Cebit or #redit !alances +P.W1, L I, 9 #elestica IncAccording to a recent annual report of #elestica Inc-, the co(pany is a O*ey player in the new technology?dri)en global econo(y-P $he co(pany pro)ides a broad range of ser)ices, including Odesign, prototyping, asse(bly, testing, product assurance, supply chain (anage(ent, worldwide distribution, and after?sales ser)ice-P $he following are se)eral of the accounts fro( a recent state(ent of financial position:

+1, $rade accounts recei)able +., &hort?ter( borrowings +2, &hare capital +A, Property, plant, and e<uip(ent +0, Retained earnings +>, $rade accounts payable +1=, #ash and short?ter( in)est(ents

+3, Long?ter( debt +I, Prepaid e;penses and other assets +9, Intangible assets +11, Accrued liabilities +1., ther long?ter( liabilities +12, In)entories +13, Inco(e ta;es payable Page >3

Re<uired: Indicate how each account nor(ally should be categori'ed on a classified state(ent of financial position- 4se #A for current asset, N#A for non?current asset, #L for current liability, N#L for non?current liability, and &E for shareholders8 e<uity- Also indicate whether the account nor(ally has a debit or credit balanceAP.W.Ceter(ining /inancial &tate(ent Effects of %arious $ransactions and Interpreting the Cebt?to?E<uity Ratio +P.W., L 2, 3 @adou( Incorporated is a s(all (anufacturing co(pany that (a*es (odel trains to sell to toy stores- It has a s(all ser)ice depart(ent that repairs custo(ers8 trains for a fee- $he co(pany has been in business for fi)e years- At the end of the (ost recent year, .=1=, the accounting records reflected total assets of NI==,=== +cash, N1.=,===K buildings, N21=,===K e<uip(ent, NA=,===, and total liabilities of N.==,=== +short?ter( notes payable, N13=,===K long?ter( notes payable, N9=,===,, and total shareholders8 e<uity of N2==,=== +share capital, N..=,===K retained earnings, N0=,===,- Curing the current year, .=11, the following su((ari'ed transactions were co(pleted: Issued 1=,=== shares for N1==,=== cash!orrowed N1.=,=== cash fro( the ban* and signed a 1=?year, 1. percent note!uilt an addition onto the factory for N.==,=== and paid cash to the contractorPurchased e<uip(ent for N2=,===, paying N2,=== in cash and signing a note due in si; (onths for the balancePurchased N0I,=== in long?ter( in)est(entsReturned a defecti)e piece of the e<uip(ent purchased in transaction +d,K recei)ed a reduction of N2,=== on the note payablePaid N1.,=== of the principal due on the note in +b,Purchased a deli)ery truc* +e<uip(ent, for N1=,===K paid NI,=== cash and signed a short?ter( note for the re(ainderLoaned N.,=== cash to the co(pany president, Je*i @adou(, who signed a note pro(ising to pay the a(ount and annual interest at the rate of 1= percent within one yearA shareholder sold so(e of her shares in @adou( Incorporated to her neighbour for NI,===Recei)ed N.I= cash fro( 5r- @adou( on the note due, transaction +i,Re<uired: Prepare a su((ary of the preceding transactions- $o de)elop a <uic* assess(ent of the transaction effects on @adou( Incorporated, you ha)e decided to co(plete the tabulation that follows and to use plus +M, for increases and (inus +Q, for decreases for each account- $he first transaction is used as an e;a(ple-

Cid you include all transactions in the tabulationG If not, which one did you e;clude and whyG

!ased on beginning balances plus the co(pleted tabulation, calculate the following a(ounts at the end of .=11 +show co(putations,: $otal assets $otal liabilities $otal shareholders8 e<uity #ash balance $otal current assets #o(pute the co(pany8s debt?to?e<uity ratio at the end of the year- Ehat does this ratio suggest to you about @adou( IncorporatedG Page >I AP.W2Recording $ransactions in $?Accounts, Preparing a &tate(ent of /inancial Position, and E)aluating the Cebt?to?E<uity Ratio +P.W2, L I, 9 Gildan Acti)ewear Gildan Acti)ewear Inc- speciali'es in (anufacturing following is adapted fro( a recent state(ent of on Cece(ber 21, .==0,- Collars are in thousands#ash and cash e<ui)alents N1.,2IA and selling $?shirts, sport shirts, and fleece- $he financial position +assu(e that the fiscal year ends Accounts payable and accrued liabilities ther current liabilities Long?ter( debt ther long?ter( liabilities &hare capital Retained earnings ther co(ponents of e<uity I,99>

Accounts recei)able In)entories Prepaid e;penses and other current assets Property, plant, and e<uip(ent, net Intangible assets ther assets

...,1I0 219,1A. 1=,312 329,I19 I>,>I3 33,II9

I=,102 3>,330 23,3>2 0>,2AA 90>,>0= 2.,>A9

Assu(e that the following transactions occurred in the first <uarter ended 5arch 21, .==>: Recei)ed N92= on sale of intangiblesPaid N1.,23= in principal on long?ter( debtPurchased N2,3== in non?current in)est(ents for cash&old e<uip(ent at its cost for N3,=.= cashPurchased additional intangibles for N.,>0= cashIssued additional shares for N1,=.= in cashPurchased property, plant, and e<uip(entK paid N1,02= in cash and N>,3== with additional long?ter( ban* loans&old other assets at cost for N21= cashCeclared and paid N2== in di)idends to shareholdersRe<uired: #reate $?accounts for each of the accounts on the state(ent of financial positionK enter the balances at Cece(ber 21, .==0Record each of the transactions for the first <uarter ended 5arch 21, .==>, in the $?accounts +including referencing, and deter(ine the ending balancesPrepare a classified state(ent of financial position at 5arch 21, .==>-

#o(pute the debt?to?e<uity ratio at 5arch 21, .==>- Ehat does this suggest about Gildan Acti)ewearG AP.W3Identifying Effects of $ransactions on the &tate(ent of #ash /lows +P.W3, L A Gildan Acti)ewear Refer to AP.W2Re<uired: 4sing the transactions +a, through +i, in AP.W2, indicate whether each transaction is an in)esting +I, or financing +/, acti)ity for the year and the direction of the effect on cash flows +M for increase and Q for decrease,- Indicate no effect on cash flows related to in)esting or financing with NEAP.WIRecording $ransactions, Preparing "ournal Entries, Posting to $?Accounts, Preparing a &tate(ent of /inancial Position, and E)aluating the Cebt?to?E<uity Ratio +P.WI, E;cel $e(plate L I, 9 Cell IncCell Inc- is a leading global pro)ider of co(puter products and ser)ices for both the consu(er and enterprise (ar*ets- Cell offers a full line of des*top and noteboo* P#s, networ* ser)ers, wor*stations, storage syste(s, printers, handheld co(puters, digital (usic players, L#C and plas(a tele)isions, and proDectors$he following is Cell8s +si(plified, state(ent of financial position fro( a recent year:

Page >9 Assu(e that the following transactions +in (illions of dollars, occurred in the re(ainder of fiscal year .=1= +ending on /ebruary ., .=1=,: Issued additional shares for N.== in cash!orrowed N2= fro( ban*sK due in two yearsPurchased additional in)est(ents for N12,=== cashK one?fifth were long ter( and the rest were short ter(Purchased property, plant, and e<uip(entK paid N0AI in cash and N1,31= with additional long?ter( ban* loansLent N.I= to associated co(panies that signed a si;?(onth note&old short?ter( in)est(ents costing N1=,=== for N1=,=== cashRe<uired: Prepare a Dournal entry for each transaction#reate $?accounts for each ite( on the state(ent of financial position and include the "anuary 2=, .==>, balances-

Post each Dournal entry to the appropriate $?accountsPrepare a state(ent of financial position for Cell based on the $?account ending balances at /ebruary ., .=1=#o(pute Cell8s debt?to?e<uity ratio for fiscal year .=1=- Ehat does this suggest about the co(panyG Page >A AP.W9Preparing the In)esting and /inancing &ections of a &tate(ent of #ash /lows +P.W9, L A Cell IncRefer to AP.WIRe<uired: !ased on the transactions that occurred in fiscal year .=1=, prepare the in)esting and financing sections of the Cell8s state(ent of cash flows for that yearAP.WA4sing /inancial Reports: Preparing a #lassified &tate(ent of /inancial Position and Analy'ing the Cebt?to? E<uity Ratio +P.WA, L A Canier Leather $he accounts below, in alphabetical order, are adapted fro( Canier Leather Inc-8s recent state(ent of financial position +a(ounts in thousands of dollars,: #urrent 6ear Prior 6ear #urrent 6ear Prior 6ear Accounts payable and accrued liabilities Accounts recei)able #ash Inco(e ta;es payable In)entories Non?current liabilities N0,1A= I>3 .1,1>2 ?=? .>,>A= .=,.I0 N>,2II 9.9 ..,IA9 >I. .>,302 10,.AI ther non?current assets NI,I>9 Prepaid e;penses and other current assets Property and e<uip(ent, net Retained earnings &hare capital N9,2>>

9>0 .I,213 2.,.13 ..,A.2

1,0>3 .0,0>1 29,>=. .3,20I

Re<uired: Prepare, in good for(, a classified state(ent of financial position +with two years reported, for Canier Leather Inc- Assu(e the current year ends on "une 2=, .=1=Page >0 #o(pute the co(pany8s debt?to?e<uity ratio for the current year- :ow do you interpret this ratio for Canier LeatherG AP.W0Analy'ing the Effects of $ransactions by 4sing $?Accounts, Preparing a &tate(ent of /inancial Position, and Interpreting the Cebt?to?E<uity Ratio as a !an* Loan fficer +P.W0, L I, 9 #hu Celi)ery #o(pany Inc- was organi'ed in .=1=$he following transactions occurred during year .=1=: Recei)ed N3=,=== cash fro( organi'ers in e;change for shares in the new co(panyPurchased land for N1.,===, signing a one?year note +ignore interest,!ought two used deli)ery truc*s for operating purposes at the start of the year at a cost of N1=,=== eachK paid N3,=== cash and signed a note due in three years for the rest +ignore interest,&old one?fourth of the land for N2,=== to Pablo 5o)ing, which signed a si;?(onth note-

Paid N1,=== cash to a truc* repair shop for a new (otor for one of the truc*s- +:int: Increase the account you used to record the purchase of the truc*s since the producti)e life of the truc* has been i(pro)ed-, &hareholder "ingbi #hu paid N.A,9== fro( her personal sa)ings to purchase a )acant lot +land, for her personal useRe<uired: &et up appropriate $?accounts with beginning balances of 'ero for cash, short?ter( note recei)able, land, e<uip(ent, short?ter( notes payable, long?ter( notes payable, and share capital- 4sing the $?accounts, record the effects of these transactions by #hu Celi)ery #o(panyPrepare a classified state(ent of financial position for #hu Celi)ery #o(pany at Cece(ber 21, .=1=At the end of the ne;t two years, #hu Celi)ery #o(pany reported the following a(ounts on its state(ents of financial position: End of .=1. Assets Liabilities &hareholders8 E<uity N1.=,=,=== A=,=== I=,=== End of .=11 N>=,=== 3=,=== I=,===

#o(pute the co(pany8s debt?to?e<uity ratio for .=11 and .=1.- Ehat is the trend and what does this suggest about the co(panyG At the beginning of year .=12, #hu Celi)ery #o(pany applied to your ban* for a N1==,=== loan to e;pand the business- $he )ice?president of the ban* as*ed you to re)iew the infor(ation and (a*e a reco((endation on lending the funds based solely on the results of the debt?to?e<uity ratio- Ehat reco((endation would you (a*e to the ban*8s )ice?president about lending the (oney to #hu Celi)ery #o(panyG #A&E& ANC PR "E#$& /INCING ANC IN$ERPRE$ING /INAN#IAL IN/ R5A$I N #P.W1 /inding /inancial Infor(ation L 1, ., 2, 3, A #adbury Plc Refer to the financial state(ents and the acco(panying notes of #adbury plc, a)ailable onlineVAnnual Reports of #adbury plc Re<uired: Is the co(pany a corporation, a partnership, or a proprietorshipG :ow do you *nowG 4se the co(pany8s state(ent of financial position to deter(ine the a(ounts in the accounting e<uation +A L L M &E,$he co(pany shows on the state(ent of financial position that in)entories are reported at `A9A (illion- Coes this a(ount represent the e;pected selling priceG Ehy or why notG Ehat is the co(pany8s fiscal year?endG Ehere did you find the e;act dateG Ehat are the co(pany8s non?current liabilitiesG #o(pute the co(pany8s debt?to?e<uity ratio and e;plain its (eaning:ow (uch cash did the co(pany spend on purchasing property, plant, and e<uip(ent each year +capital e;penditures,G Ehere did you find the infor(ationG #P.W. #o(paring #o(panies

L 2, A #adbury Plc %s- $he Nestl7 Group Refer to the financial state(ents and the acco(panying notes of #adbury plc, a)ailable onlineV, and of $he Nestl7 Group, gi)en inAppendi; A- Nestl7 uses the &wiss franc +#:/, in preparing its financial state(ents, whereas #adbury reports its financial infor(ation by using the pound sterling +`,- 4se the e;change rates indicated in re<uire(ents 1 and . below to con)ert the pounds sterling into &wiss francs so you can co(pare the specific financial state(ent ele(ents for both co(paniesAnnual Reports of #adbury plc Re<uired: Ehich co(pany is larger in ter(s of total assetsG $he e;change rate between the two currencies was `1 L #:/ 1-I2 at Cece(ber 21, .==0#o(pute the debt?to?e<uity ratio for both co(panies- Ehich co(pany is assu(ing (ore ris*G Ehy do you thin* thatG In the (ost recent year, what were the net cash flows +i-e-, the increases in cash (inus the decreases in cash, related to the buying and selling of in)est(ents for each co(panyG :ow (uch did each co(pany pay in di)idends for the (ost recent yearG Ehat account title does each co(pany use to report any land, buildings, and e<uip(ent it (ay ha)eG /INAN#IAL REP R$ING ANC ANAL6&I& #A&E& #P.W2 !roadening /inancial Research &*ills: Locating /inancial Infor(ation on the &ECAR Catabase L 9 $he &ecurities #o((issions regulate co(panies that issue shares on the stoc* (ar*et- $hey recei)e financial reports fro( public co(panies electronically under a syste( called &ECAR +&yste( for Electronic Cocu(ent Analysis and Retrie)al,- 4sing the Internet, anyone (ay search the database for the reports that ha)e been filed- A si(ilar syste( is a)ailable for retrie)al of financial infor(ation about 4-&public co(panies- It is *nown as ECGAR +Electronic Cata Gathering and Retrie)al &er)ice,Page >> 4sing your Eeb browser, access the &ECAR database atwww-sedar-co(V- $o search the database, select aEnglish,8 then a#o(pany Profiles8K clic* on the letter $ to get a list of all co(pany na(es that start with $- &elect $ho(son Reuters #orporation +$R#,, and then clic* on O%iew this co(pany8s public docu(entsP at the lower left corner of the ne;t screenRe<uired: Loo* at &ECAR filings by clic*ing on the interi( financial state(entsFEnglish- $hen locate the state(ent of financial positionEhat was the a(ount of $R#8s total assets at the end of the (ost recent <uarter reportedG Cid long?ter( debt increase or decrease for the <uarterG #o(pute the debt?to?e<uity ratio- Ehat does this suggest about the co(panyG Loo* at the O&tate(ent of #ash /lowsP in the interi( reportEhat a(ount did $R# spend on capital e;penditures for the (ost recent <uarter reportedG Ehat was the total a(ount of cash flows fro( +used in, financing acti)ities for the (ost recent <uarter reportedG #P.W3 Interpreting the /inancial Press L 2, 3

$he Cece(ber .., .==2, edition of !usiness Eee* (aga'ine includes an article titled OIs Eilbur Ross #ra'yGP 6ou can access the article onlineVRe<uired: Read the article and then answer the following <uestions: Ehat is distressed in)esting according to the articleG 5r- Ross usually beco(es a bondholder but often swaps debt with e<uity- Ehy is this ris*ierG According to the article, what (a*es 5r- Ross successful +i-e-, what is his approach and attitude toward in)esting,G #P.WI 4sing /inancial Reports: E)aluating the Reliability of a &tate(ent of /inancial Position L 1, . !etsey "ordan as*ed a local ban* for a NI=,=== loan to e;pand her s(all co(pany- $he ban* as*ed !etsey to sub(it a financial state(ent of the business to supple(ent the loan application- !etsey prepared the following state(ent of financial position-

Re<uired: $he state(ent of financial position has se)eral flaws- :owe)er, there is at least one (aDor deficiency- Identify it and e;plain its significanceAs a ban* (anager, would you lend the co(pany (oneyG E;plainPage 1== #P.W9 4sing /inancial Reports: Analy'ing the &tate(ent of /inancial Position L 9 &(iley #orp- and $sang Inc- were organi'ed in business- $he state(ents of financial position of the .==I- !oth co(panies operate in the sa(e line of two co(panies at Cece(ber 21, .=11, are as

follows:

Re<uired: Eric /rechette wants to in)est in one of these two co(panies by purchasing all of its shares- As a financial ad)iser to 5r- /rechette, which co(pany would you select as an in)est(entG Pro)ide Dustification for your selectionEach co(pany applied to Ce)elop(ent !an* for a loan of N.=,===, payable in four (onths- As a ban* loan officer, would you lend each co(pany the re<uested a(ountG E;plain#RI$I#AL $:IN@ING #A&E& #P.WA 5a*ing a Cecision as a /inancial Analyst: Preparing and Analy'ing a &tate(ent of /inancial Position L 1, ., 9

6our best friend fro( ho(e writes you a letter about an in)est(ent opportunity that has co(e her way- A co(pany is raising (oney by issuing shares and wants her to in)est N.=,=== +her recent inheritance fro( her great?aunt8s estate,- 6our friend has ne)er in)ested in a co(pany before and, *nowing that you are a financial analyst, as*s that you loo* o)er the state(ent of financial position and send her so(e ad)iceAn unaudited state(ent of financial position, in only (oderately good for(, is enclosed with the letter:

E;cel $e(plate Page 1=1 $here is only one footnote, and it states that the building was purchased for N9I,===, has been a(orti'ed by NI,=== on the boo*s, and still carries a (ortgage +shown in the liability section,- $he

footnote further states that, in the opinion of the co(pany president, the building is Oeasily worth N>0,===-P Re<uired: Craft a new state(ent of financial position for your friend, correcting any errors you note- +If any of the account balances need to be corrected, you (ay need to adDust the balance of retained earnings correspondingly-, If no errors or o(issions e;ist, state soErite a letter to your friend e;plaining the changes you (ade to the state(ent of financial position, if any, and offer your co((ents on the co(pany8s apparent financial condition based only on this infor(ation- &uggest other infor(ation your friend (ight want to re)iew before co(ing to a final decision on whether to in)est#P.W0 5anipulating of /inancial &tate(ents: Ethical #onsiderations L 2 $echnology N 5otion is a publicly traded co(pany that is facing financial difficulties- $o sur)i)e, the co(pany needs large new ban* loans- As the chief financial officer of the co(pany, you approached se)eral ban*s, but each has as*ed for your audited financial state(ents for .=11, the (ost recent fiscal year- 6ou called for a (eeting with other corporate officers to discuss how the financial state(ents could be i(pro)ed- $he suggestions (ade by your colleagues include the following: Ee owe N.= (illion to our suppliers- Ee could show half this a(ount as a liability on our state(ent of financial position and report the other half as share capital- $his will i(pro)e our financial positionEe own land that is worth at least N0 (illion in today8s (ar*et, but it cost us only N2 (illion when we bought itEhy not show the land at N0 (illion on the co(pany8s state(ent of financial position, which increases both the total assets and shareholders8 e<uity by NI (illionG Ee owe /irstRate &oftware N. (illion, due in 2= days- I can as* their chief financial officer to let us delay the pay(ent of this debt for a year, and our co(pany could sign hi( a note that pays 0 percent interestRe<uired: E)aluate each of these three proposals to i(pro)e $echnology N 5otion8s financial state(ents by considering both accounting and ethical issues#P.W> E)aluating an Ethical Cile((a: Analy'ing 5anage(ent Incenti)es L 2 Nortel Networ*s #orporation Nortel Networ*s #orporation +Nortel,, based in !ra(pton, ntario, is a global supplier of networ*ing solutions and ser)ices- In .==I, the co(pany released the findings of an independent re)iew as a result of continuing proble(s with its accounting- $he re)iew re)ealed that three for(er co(pany e;ecuti)es, the chief e;ecuti)e officer, the chief financial officer, and the controller, used accounting practices that increased reported earnings fro( late .==. to (id?.==2- $hrough Nortel8s internal in)estigation, se)eral proble(s had beco(e *nown, not the least of which was N>== (illion of inappropriately reported liabilities and appro;i(ately N.I= (illion of o)erstated profit- $his (attered to the e;ecuti)es who recei)ed a bonus if inco(e before ta; e;ceeded specific le)elsIn April .==3, Nortel issued a news release announcing the appoint(ent of its new chief e;ecuti)e officer +#E , 5r- Eillia( wens, and the ter(ination of its pre)ious #E , for cause- $he pre)ious #E resigned his position on April .0 and fro( the co(pany8s board of directors on 5ay .1, .==3- Neither the chair(an of the board of directors nor the new #E would co((ent on the ter(ination- A (onth earlier the chief financial officer and the controller had been placed on paid lea)e of absence and they too were fired- A day later, the 4-&- &ecurities and E;change #o((ission announced that it was in)estigating Nortel, and then the ntario &ecurities #o((ission launched its own in)estigation- !ut the worst was yet to co(eIn 5ay .==3, a 4-&- federal grand Dury subpoenaed Nortel for accounting records and other docu(ents prepared

for the pre)ious four years during which the pre)ious #E , an accountant, had ser)ed as chief financial officer- A few days later the ntario Public &er)ice E(ployees 4nion Pension $rust filed a class action lawsuit to reco)er losses arising fro( its in)est(ent in Nortel shares between April .==2 and .==I, based on fraudulent financial infor(ation- !y August .==3, the Royal #anadian 5ounted Police began a #anadian cri(inal in)estigation into the for(er #E 8s acti)ities- $he cost to Nortel has been o)er N.-3 billion in cash awarded to the ntario pension fund in April .==I and the co(pany sued the for(er #E to reco)er this (oney fro( hi( personally- Pursuant to the independent re)iew, 1. senior e;ecuti)es agreed to repay a total of N0-9 (illion in bonuses they recei)ed fro( the co(pany in the pastRe<uired: Page 1=. Cescribe the parties that were har(ed or helped by this fraudE;plain how greed (ay ha)e contributed to this fraudEhy do you thin* the independent auditors failed to catch the fraudG /INAN#IAL REP R$ING ANC ANAL6&I& $EA5 PR "E#$ #P.W1= $ea( ProDect: Analy'ing of &tate(ent of /inancial Position and Ratios L 2, A

As a tea(, select an industry to analy'e- A list of co(panies classified by industry can be obtained by accessingwww-fpinfo(art-caV and then choosing O#o(panies by IndustryP- 6ou can also find a list of industries and co(panies within each industry )ia http:TTca-finance-yahoo-co(Tin)estingV- A list of industries can be obtained by clic*ing on Annual Reports under $oolsEach group (e(ber should ac<uire the annual report for a different publicly traded co(pany in the industry+Library files, the &ECAR ser)ice at www-sedar-co(V, or the co(pany8s website are good sources-, Re<uired: Each tea( (e(ber should write a short report answering the following <uestions about his or her selected co(pany- Ciscuss any patterns that you as a tea( obser)e- $hen, as a tea(, write a short report co(paring and contrasting your co(panies/or the (ost recent year, what are the top three asset accounts by si'eG Ehat percentage is each of total assetsG +#alculated as Asset A ] $otal Assets, Ehat are the (aDor in)esting and financing acti)ities +by dollar si'e, for the (ost recent yearG +Loo* at the state(ent of cash flows-, Ratio Analysis Ehat does the debt?to?e<uity ratio (easure in generalG #o(pute the debt?to?e<uity ratio for the last three years- +6ou (ay find prior years8 infor(ation in the section in the annual report called O&elected /inancial Infor(ation,P or search for prior years8 annual reports-, Ehat do your results suggest about the co(panyG If a)ailable, find the industry ratio for the (ost recent year, co(pare it to your results, and discuss why you belie)e your co(pany differs or is si(ilar to the industry ratio-

Page 1=2

After studying this chapter, you should be able to do the following: 2 LEARNING !"E#$I%E& 2 L 1 Cescribe a typical business operating cycle and e;plain the necessity for the periodicity assu(ption- p- 1=3 2 L . E;plain how business acti)ities affect the ele(ents of the inco(e state(ent- p- 1=9 1 L 2 E;plain the accrual basis of accounting and apply the re)enue principle and the (atching process to (easure profit- p- 11= 1 L 3 Apply transaction analysis to e;a(ine and record the effects of operating acti)ities on the financial state(ents- p- 11A 1 L I Prepare an inco(e state(ent and understand the difference between profit and cash flow fro( operations- p1.. . L 9 #o(pute and interpret the total asset turno)er ratio and the return on assets ratio- p- 1.9

/ #4& # 5PAN6: Nestl7 &-A- //ERING PR C4#$& $AIL REC $ #LIEN$&8 NEEC& N estl7 +www-nestle-co(, is the leading pro)ider worldwide of nutrition, health, and wellness products- $o achie)e its tre(endous success, Nestl7 had to produce food ite(s and be)erages that cater to the needs of a wide )ariety of custo(ers with different cultural bac*grounds, tastes, social status, and financial (eans- Nestl78s growth and enhanced perfor(ance hinge on a O3 b 3 b 3 road(apP: four co(petiti)e ad)antages, four growth dri)ers, and four strategic pillars-1 Its four co(petiti)e ad)antages are an un(atched product and brand portfolio consisting of global brands, such as Nestl7 and @it@at, as well as local brands sold in specific (ar*etsK an un(atched research and de)elop(ent capabilityK an un(atched geographic presence, with (ore than 3I= factories in 03 countriesK and an e(phasis on people, culture, )alues, and openness to di)ersityNestl78s four growth dri)ers co(prise its focus on nutritional and health benefits across the entire product portfolio, popularly positioned products that sell predo(inantly in e(erging (ar*ets, out?of?ho(e foods, and pre(iu(isationFthe production and (ar*eting of pre(iu( and lu;ury products that appeal to a specific class of custo(ers$he four co(petiti)e ad)antages and four growth dri)ers are co(ple(ented by Nestl78s four strategic pillars, which include inno)ation and reno)ation of products to pro)ide superior <uality and taste for healthier and lighter eating, operational efficiency that ensures the offering of <uality products at co(petiti)e cost, consu(er co((unication that is essential to build the co(pany8s brands and highlight the nutritional and health benefits of its products, and product ubi<uityK that is, a)ailability of Nestl78s products Owhene)er, where)er, howe)er,P

through an e;tensi)e and di)ersified distribution networ* that includes con)enience stores, gas stations, large depart(ent stores as well as the InternetPage 1=3 In #anada, Nestl7 e(ploys appro;i(ately 2,I== people in .1 (anufacturing, sales, and distribution sites across the country, with sales e;ceeding .-1 billion #anadian dollars annually4NCER&$ANCING $:E !4&INE&& $o beco(e the leading nutrition, health, and wellness co(pany worldwide, Nestl78s e;ecuti)es de)elop strategies, plans, and (easurable indicators of progress toward their goals- In de)eloping operating and growth strategies, co(panies such as Nestl7 plan their co(panywide operations in ter(s of the ele(ents of the inco(e state(ent +specific re)enues and e;penses,- $hese strategies are (ost often disclosed in the (anage(ent discussion and analysis section of the annual report/inancial analysts de)elop their own set of e;pectations about Nestl78s future perfor(ance- $he published inco(e state(ent pro)ides the pri(ary basis for co(paring analysts8 proDections to the actual results of operations- Ee discuss these co(parisons and the stoc* (ar*et8s reactions to Nestl78s results throughout this chapter as we learn about inco(e recognition and (easure(ent- $o understand how business plans and the results of operations are reflected on the inco(e state(ent, we need to answer the following <uestions: :ow do business acti)ities affect the inco(e state(entG :ow are these acti)ities recogni'ed and (easuredG :ow are these acti)ities reported on the inco(e state(entG In this chapter, we focus on Nestl78s operating acti)ities, which include sales of baby foods, brea*fast cereals, chocolate, coffee, dairy products, ice crea(, bottled water, and pet foods to )arious wholesalers that distribute its products to retail outlets- $he results of these acti)ities are reported on the inco(e state(ent1 Nestl78s 5anage(ent Report .==> includes a detailed discussion of its 3 b 3 b 3 road(ap- It can be found on the Nestl7 website, http:TTwww-nestle-co(RGANIJA$I N / $:E #:AP$ER

Appendi; !: $he /or(al Record@eeping &yste( +online,

: E C !4&INE&& A#$I%I$IE& A//E#$ $:E IN# 5E &$A$E5EN$G$he perating #ycle $he long?ter( obDecti)e for any business is to turn cash into (ore cash- /or co(panies to stay in business, this e;cess cash (ust be generated fro( operations +i-e-, fro( the acti)ities for which the business was established,, not fro( borrowing (oney or selling non?current assetsL 1Cescribe a typical business operating cycle and e;plain the necessity for the periodicity assu(ption#o(panies ac<uire in)entory and the ser)ices of e(ployees, and then sell in)entory or ser)ices to custo(ers- $he length of ti(e between the pay(ent of cash to suppliers of in)entory and to e(ployees and the collection of cash fro( custo(ers +*nown as the operating, or cash?to?cash, cycle, depends on the nature of the businessPage 1=I $he operating cycle for Nestl7 is relati)ely short- It spends cash to purchase ingredients used in the preparation and pac*aging of its (any products according to its own blends and recipesK sells these products through distribution channels that reach consu(ers at ho(e, wor*, and playK and then collects cash fro( custo(ers- In so(e co(panies, in)entory is paid for well before it is sold- $oys ORP 4s, for e;a(ple, builds its in)entory for (onths prior to the year?end holiday season- It borrows funds fro( ban*s to pay for the in)entory and repays the loans with interest when cash is recei)ed fro( custo(ers- In other co(panies, cash is recei)ed fro( custo(ers well after a sale ta*es place- /or e;a(ple, car dealerships often sell cars o)er ti(e, with (onthly pay(ents fro( custo(ers due o)er se)eral years- #o(panies atte(pt to shorten the operating cycle by creating incenti)es to encourage custo(ers to buy sooner or pay faster in order to i(pro)e the co(pany8s cash flows$he PERA$ING +#A&:?$ ?#A&:, #6#LE is the ti(e it ta*es for a co(pany to pay cash to suppliers, sell goods and ser)ices to custo(ers, and collect cash fro( custo(ers-

/INAN#IALANAL6&I&&: R$?$ER5 CE!$ /INAN#ING ANC $:E PERA$ING #6#LE $he ti(ing of the cash outflows and inflows shown in the illustration abo)e indicates that (any businesses (ust

pay suppliers and e(ployees before they recei)e cash fro( custo(ers, causing the( to see* short?ter( financingEhen the co(panies recei)e cash fro( custo(ers, they pay off the liability- In addition, if a co(pany plans to growFsay, to sell twice as (any goods as in the prior periodFit (ay not ha)e collected enough cash fro( the prior period8s custo(ers to purchase the <uantity of in)entory needed in the ne;t period- &ources of financing include suppliers and financial institutions +ban*s and co((ercial credit co(panies,Page 1=9 5anagers *now that reducing the ti(e needed to turn cash into (ore cash +i-e-, shortening the operating cycle, (eans higher profits and faster growth- Eith the e;cess cash, (anagers (ay purchase additional in)entory or other assets for growth, repay debt, or distribute it to owners$he PERI CI#I$6 A&&45P$I N (eans that the long life of a co(pany can be reported in shorter periods4ntil a co(pany ceases acti)ities, the operating cycle is repeated continuously- :owe)er, decision (a*ers re<uire periodic infor(ation about the financial condition and perfor(ance of a business- $o (easure inco(e for a specific period of ti(e, accountants follow the periodicity assu(ption, which assu(es that the long life of a co(pany can be reported in shorter ti(e periods, such as (onths, <uarters, and years-. $wo types of issues arise in reporting periodic inco(e to users: Recognition issues: Ehen should the effects of operating acti)ities be recogni'ed +recorded,G 5easure(ent issues: Ehat a(ounts should be recogni'edG L .E;plain how business acti)ities affect the ele(ents of the inco(e state(ent!efore we e;a(ine the rules accountants follow as they resol)e these issues, let us re)iew the ele(ents of financial state(ents that are affected by operating acti)itiesEle(ents of the Inco(e &tate(ent E;hibit 2-1 shows a recent inco(e state(ent for Nestl7- It has (ultiple subtotals, such as operating profit and profit before interest and ta;es- $his(ultiple step for(at is )ery

E;hibit 2-1Inco(e &tate(ent Page 1=A co((on- #lassification of the )arious inco(e state(ent ite(s helps financial state(ent users assess the co(pany8s operating perfor(ance and predict its future profitability$he inco(e state(ent includes three (aDor sections: Results of continuing operations Results of discontinued operations Profit +the su( of 1 and ., Earnings per share All co(panies report infor(ation for sections 1 and 2, while so(e co(panies report infor(ation in section ., depending upon their particular circu(stances- $he botto( line, profit, is the su( of sections 1 and .- /irst, we will focus on the (ost co((on and (ost rele)ant section, continuing operations#ontinuing perations $his section of the inco(e state(ent presents the results of continuing operations- As we discuss the ele(ents of the inco(e state(ent, it is useful to refer to the conceptual fra(ewor* outlined in E;hibit .-1perating Re)enues Increases in assets or settle(ent of liabilities fro( ongoing operations of the business are defined as re)enues- perating re)enues result fro( the sale of goods or ser)ices- Nestl7 earns re)enue when it sells goods and renders ser)ices to custo(ers- It recogni'es re)enue in the inco(e state(ent when the significant ris*s and rewards of ownership ha)e been transferred to the buyer, which is (ainly upon ship(ent- Ehen

re)enues are earned, assets, usually cash or trade recei)ables, often increase- &o(eti(es, a co(pany recei)es cash in e;change for a pro(ise to pro)ide goods or ser)ices in the future- At that point, re)enue is not earned, but a liability account, deferred re)enue, is created- Ehen the co(pany pro)ides the pro(ised goods or ser)ices to the custo(er, re)enue is recogni'ed and the liability is settledRE%EN4E& are increases in assets or settle(ents of liabilities fro( ongoing operationsLi*e (ost co(panies, Nestl7 generates re)enues fro( a )ariety of sources- Its operating acti)ities are grouped into si; (ain seg(ents: powdered and li<uid be)erages, (il* products and ice crea(, prepared dishes and coo*ing aids, confectionary, pet care, and phar(aceutical products- $he first two, Nestl78s (ost i(portant seg(ents, together account for II percent of its re)enuesperating E;penses &o(e students confuse the ter(s e;pendituresand e;penses- An e;penditure is any outflow of cash for any purpose, whether to buy e<uip(ent, pay off a ban* loan, or pay e(ployees their wages- An e;pense is (ore narrowly definedK it results when an asset, such as e<uip(ent or supplies, is used to generate re)enue during a period, or when an a(ount is incurred to generate re)enues during a period, such as using electricity, e)en if the a(ount will be paid in the future- $herefore, not all e;penditures are e;penses, and e;penses are necessary to generate re)enues- E;penses are decreases in assets or increases in liabilities fro( ongoing operations and are incurred to generate re)enues during the period-

Nestl7 pays e(ployees who sell its products and pro)ide ser)ices to clients, uses electricity to operate e<uip(ent and light facilities, ad)ertises the goods it sells, and uses a wide )ariety of supplies in its production processesEithout incurring these e;penses, Nestl7 could not generate re)enuesAlthough so(e of the e;penses (ay result fro( e;penditures of cash at the ti(e they are incurred, so(e (ay be incurred after cash was paid in the past, and other e;penses (ay be incurred before cash is paid in the future- Ehen an e;pense occurs, assets such as supplies in)entory decrease +are used up, or liabilities such as salaries payable or utilities payable increaseEBPEN&E& are decreases in assets or increases in liabilities to generate re)enues during the period$he following are Nestl78s pri(ary operating e;penses: #ost of goods sold is the cost of products sold to custo(ers- /or e;a(ple, when Nestl7 purchases coffee beans fro( suppliers located in different countries, it pays for i(port duties, transport, and handling, in addition to the purchase price- All these costs are included in the cost of the asset Oin)entories-P As in)entories are used to produce and pac*age the roasted and ground coffee beans, they beco(e an e;pense, called cost of goods sold- In co(panies with a (anufacturing or (erchandising focus, the cost of goods sold +also called cost of sales, is usually the (ost significant e;pense- $he cost of goods sold for Nestl7 is #:/ 3I,.=0 (illion and represents about 3. percent of the re)enues for .==>- $he difference between sales re)enues and cost of goods sold is *nown as gross profit or gross (arginPage 1=0 perating e;penses are the usual e;penses, other than cost of goods sold, that are incurred in operating a business

during a specific accounting period- $he e;penses reported will depend on the nature of the co(pany8s operationsInternational Accounting &tandard 1 re<uires co(panies to classify their e;penses either by functionFsuch as (ar*eting and pro(otion, distribution, and ad(inistrati)eFor by nature of the e;pense- #lassification by nature includes the three (ain costs of production: (aterials, labour, and property and e<uip(ent useGR && PR /I$ + R GR && 5ARGIN, is net sales less cost of goods soldNestl7, li*e (ost co(panies, classifies its e;penses by function-2Cistribution e;penses include a )ariety of e;penses related to the distribution of the co(pany8s products to its custo(ers, such as the wages earned by distribution personnel and depreciation of deli)ery )ehicles-5ar*eting and ad(inistrati)e e;penses include, for e;a(ple, the salaries of (ar*eting personnel and those who support the sales effort such as legal counsel, accountants, and co(puter technicians- $hey (ay also include pro(otion of the co(pany8s products through )arious print and electronic (edia, rental of office space, insurance, utilities, plus other general operating e;penses not directly related to production- Research and de)elop(ent e;penses relate to the research and de)elop(ent of new products- Another subtotal, operating profit, also called profit fro( operations, is co(puted by subtracting operating e;penses fro( gross profitPERA$ING PR /I$ +profit fro( operations, e<uals net sales less cost of goods sold and other operating e;pensesNon?operating Ite(s Not all acti)ities affecting an inco(e state(ent are central to continuing operations- Any re)enues, e;penses, gains, or losses that result fro( these other acti)ities are not included as part of operating profit, but are instead categori'ed as other inco(e or e;penses- /or e;a(ple, using e;cess cash to purchase shares in other co(panies is an in)esting acti)ity for Nestl7, not a central operation- :owe)er, any interest or di)idends earned on the in)est(ent is called in)est(ent inco(e +orfinance inco(e,- Li*ewise, borrowing (oney is a financing acti)ity- :owe)er, the cost of using that (oney is called interest e;pense- E;cept for financial institutions, incurring interest e;pense or earning in)est(ent inco(e are notthe central operations of (ost businesses, including Nestl7- Ee say that these are peripheral +nor(al but not central, transactions-

#o(panies so(eti(es sell property, plant, and e<uip(ent occasionally and replace the( with new assets to (oderni'e their facilities- &elling land for (ore than the original purchase price results in a gain, not in re)enue, because the sale of land is not a central operating focus for the business- $he gain results in an increase in assets or decrease in liabilities fro( a peripheral transaction- &i(ilarly, losses are decreases in assets or increases in liabilities fro( peripheral transactions- /or e;a(ple, in .==0, Nestl7 sold part of its in)est(ent in other businesses, particularly Alcon, and reali'ed a gain of #:/ >,.=0 (illion- &ince the sale of this

in)est(ent is not central to Nestl78s ongoing operations, the gain is reported as a co(ponent of other inco(e on the co(pany8s inco(e state(ent for fiscal year .==0- ther non?operating ite(s include losses due to i(pair(ent of assets, restructuring costs, and litigation settle(ents- /or Nestl7, the (onetary effects of all non?operating ite(s are reported on its .==> inco(e state(ent in four su((ary a(ounts +in (illions,: other inco(e, I=>K other e;penses, 1,.20K finance e;pense, A>3K and finance inco(e, 1A>- Note 3 to Nestl78s financial state(ents discloses details of the other inco(e and other e;pense ite(sGAIN& are increases in assets or decreases in liabilities fro( peripheral transactionsL &&E& are decreases in assets or increases in liabilities fro( peripheral transactions-

Page 1=> $he non?operating ite(s that are subDect to inco(e ta;es are added or subtracted fro( operating profit to obtain profit before inco(e ta;es, also called preta; profitInco(e $a; E;pense Inco(e ta; e;pense is the last e;pense listed on the inco(e state(ent- All for?profit corporations are re<uired to co(pute inco(e ta;es owed to federal, pro)incial, and foreign go)ern(ents- Inco(e ta; e;pense is calculated as a percentage of profit before inco(e ta;es, reflecting the difference between inco(e, which includes re)enues and gains, and e;penses and lossesK it is deter(ined by using applicable ta; ratesNestl78s effecti)e ta; rate in .==> was .2 percent +inco(e ta; e;pense 3 profit before inco(e ta;es,- $his indicates that for e)ery &wiss franc of profit that Nestl7 (ade in .==>, the co(pany incurred a ta; e;pense of #:/ =-.2PR /I$ !E/ RE IN# 5E $ABE& +preta; profit, e<uals re)enues (inus all e;penses e;cept inco(e ta; e;penseCiscontinued perations #o(panies (ay dispose of a (aDor line of business or a geographical area of operations during the accounting period, or decide to discontinue a specific operation in the near future- Ehen the decision is (ade to discontinue a (aDor co(ponent of a business, the profit or loss fro( that co(ponent, as well as any gain or loss on subse<uent disposal, are disclosed separately on the inco(e state(ent as discontinued operations!ecause of their non?recurring nature, the financial results of discontinued operations are not useful in predicting

future recurring profitsK hence, they are presented separately fro( the results of continuing operations- In .==>, Nestl78s disposal of businesses resulted in a loss of .0, as reported in Note 3 abo)eNon?controlling Interests Nestl7 has in)ested in (any businesses by purchasing a (aDority, or in (any cases, all of the shares issued by these co(panies- Purchase of all or a (aDority of other co(panies8 shares allows Nestl7 to control their operating, in)esting, and financing decisions- Ehen Nestl7 owns a (aDority of the shares of another co(pany, it beco(es a controlling shareholder- $he other shareholders are then *nown as non?controlling +or (inority, shareholders and entitled to a proportionate share of the profit of the co(pany in which they in)ested:ence, non?controlling interests refers to the portion of the consolidated profit that does not belong to Nestl7 but to the non?controlling shareholders-3 Page 11= Earnings per &hare #orporations are re<uired to disclose earnings per share on the inco(e state(ent or in the notes to the financial state(ents- $his ratio is widely used in e)aluating the operating perfor(ance and profitability of a co(pany- $o co(pute earnings per share, profit is di)ided by the weighted a)erage nu(ber of shares outstanding during the period- $he calculation of the deno(inator is co(ple; and is presented in ad)anced accounting coursesNestl78s earnings per share decreased significantly fro( .==0 to .==>- Although this appears to be bad news, in)estors would want to chec* the historical trend of earnings per share for a period of fi)e years- 5ore i(portantly, in)estors need to co(pare Nestl78s perfor(ance to its co(petitors during the sa(e period- /inally, it should be noted that o)erreliance on this ratio for in)est(ent decisions can lead to inad)isable decisionsIN$ERNA$I NALPER&PE#$I%ECI//EREN#E& IN A## 4N$& IN / REIGN /INAN#IAL &$A$E5EN$& Ee learned in #hapters 1 and . that foreign co(panies establish their own accounting and reporting rules, with (any adopting the International /inancial Reporting &tandards- $he result is that foreign co(panies often use account titles different fro( #anadian co(panies- /or e;a(ple, the co(panies Gla;o&(ith@line +a 4-@phar(aceutical co(pany, and 4nile)er +a 4-@- and Netherlands?based co(pany supplying food, ho(e, and personal care products such as :ell(an8s (ayonnaise, Co)e soap, and Popsicle treats, use the ter( Oturno)erP to refer to sales re)enue- $hese two co(panies use I/R& for reporting purposes- n the other hand, 4-&- co(panies, which do not follow I/R&, use Oinco(e fro( in)est(entsP for finance inco(e and Ointerest e;penseP for finance e;pense- $he *ey to a)oiding confusion is reading the notes related to specific financial state(ent ele(ents. In addition to the audited annual state(ents, (ost businesses prepare <uarterly financial state(ents +also *nown as interi( reports co)ering a three?(onth period, for e;ternal users- $he securities co((issions re<uire publicly accountable enterprises to do so2 /urther discussion of classification of e;penses by nature is pro)ided in #hapter 93 Intercorporate in)est(ent is a co(ple; topic that is co)ered in ad)anced accounting courses-

: E ARE PERA$ING A#$I%I$IE& RE# GNIJEC ANC 5EA&4RECG #A&: !A&I& A## 4N$ING

records re)enues when cash is recei)ed and e;penses when cash is paid6ou probably deter(ine your personal financial position by the balance in your ban* account- 6our financial perfor(ance is (easured as the difference between your account balance at the end of the period and the balance at the beginning of the period +i-e-, whether you end up with (ore or less cash,- If you ha)e a higher account balance, cash receipts e;ceeded cash disburse(ents for the period- 5any local retailers, (edical offices, and other s(all businesses use cash basis accounting, in which re)enues are recorded when cash is recei)ed and e;penses are recorded when cash is paid, regardless of when the re)enues are earned or the e;penses incurred- $his basis is often <uite ade<uate for these organi'ations that usually do not ha)e to report to e;ternal usersAccrual Accounting Profit (easured on a cash basis can be (isleading- /or e;a(ple, a co(pany using a cash basis can report higher profit in one period si(ply because +1, a custo(er paid cash in ad)ance of recei)ing a good or ser)ice or +., the co(pany postponed the pay(ent of utility bills until the ne;t period- In the first case, the co(pany has not perfor(ed the ser)ice or deli)ered the pro(ised goods to earn re)enue- In the second case, the co(pany has already used gas, electricity, and phone ser)ice to generate re)enues +creating an e;pense,, but the e;pense is not recorded because pay(ent occurs in the ne;t periodL 2E;plain the accrual basis of accounting and apply the re)enue principle and (atching process to (easure profit/inancial state(ents created under cash basis accounting nor(ally postpone or accelerate recognition of re)enues and e;penses long before or after goods and ser)ices are produced and deli)ered- $hey also do not necessarily reflect all assets and liabilities of a co(pany on a particular date- /or these reasons, cash basis financial state(ents are not )ery useful to e;ternal decision (a*ers- $herefore, I/R& re<uire accrual basis accounting for financial reporting purposesA##R4AL !A&I& A## 4N$ING records re)enues when earned and e;penses when incurred, regardless of the ti(ing of cash receipts or pay(entsPage 111 In accrual basis accounting, re)enues and e;penses are recogni'ed when the transaction that causes the( occurs, not necessarily when cash is recei)ed or paid- Re)enues are recogni'ed when they are earned and e;penses when they are incurred- $he re)enue principle and the(atching process deter(ine when re)enues and e;penses are to be recorded under accrual basis accounting-

$he Re)enue Principle #o(panies engage in a series of e)ents that lead to the recognition of re)enue/or e;a(ple, after purchasing the raw (aterials, such as (il*, cocoa, and coffee, Nestl7 places the( into a production process that cul(inates in finished products, including #offee?5ate, Nido, &(arties, @it@at, Nescaf7, Nes<ui*, and (any other products- $he finished products are then stored in the co(pany8s warehouses and (ar*eted to consu(ers through )arious (edia before they are sold to custo(ers for either cash or on credit- Each acti)ity +purchase of raw (aterials, production, pro(otion, sale, and collection fro( custo(ers, contributes to the recognition of re)enue- It is difficult, howe)er, to esti(ate and recogni'e the )alue each acti)ity adds to the a(ount e)entually recogni'ed as re)enue- Instead, accountants atte(pt to identify the (ost critical e)ent that leads to a flow of future benefits to Nestl7 fro( all these acti)ities-

$he RE%EN4E PRIN#IPLE states that re)enues are recogni'ed when the significant ris*s and rewards are transferred to the buyer, it is probable that future econo(ic benefits will flow to the entity, and the benefits and the costs associated with the transaction can be (easured reliably$o guard against identification of critical e)ents that (ay fa)our earlier recognition of re)enue, and increase in profit, the following conditions (ust be satisfied, as per the re)enue principle, to deter(ine the point in ti(e when re)enue fro( the sale of goods should be recogni'edI: $he entity has transferred to the buyer the significant ris*s and rewards of ownership of the goods- In (ost cases, the transfer of the ris*s and rewards of ownership coincides with the transfer of the legal title or the passing of possession to the buyer$he entity retains neither continuing (anagerial in)ol)e(ent to the degree usually associated with ownership nor effecti)e control o)er the goods sold- If the entity retains significant ris*s of ownership, the transaction is not a sale and re)enue is not recogni'ed- An entity (ay retain a significant ris* of ownership in a nu(ber of ways- /or e;a(ple, if the buyer has the right to rescind the purchase for a reason specified in the sales contract and the entity is uncertain about the probability of return, then re)enue cannot be recogni'ed at the point of sale$he a(ount of re)enue can be (easured reliably- $here are no uncertainties as to the a(ount to be collectedIt is probable that the econo(ic benefits associated with the transaction will flow to the entity- $he consideration recei)ed for the sale of goods is either cash or the custo(er8s pro(ise to pay cash in the future- /or cash sales, collection is not an issue since it is recei)ed on the date of the e;change- /or sales on credit, the co(pany re)iews the custo(er8s ability to pay- If the custo(er is considered creditworthy, collecting cash fro( the custo(er is reasonably li*ely$he costs incurred or to be incurred in respect of the transaction can be (easured reliably- #o(panies that pro)ide ser)ice after sale (ay incur additional costs related to the sale transaction- In general, the costs to be incurred after the ship(ent of the goods can nor(ally be (easured reliably when the other conditions for the recognition of re)enue ha)e been satisfied- :owe)er, re)enue cannot be recogni'ed when the e;penses cannot be (easured reliablyIf any of the pre)ious conditions is not (et, re)enue nor(ally is notrecogni'ed and should not be recorded- /or (ost businesses, these conditions are (et at the point of deli)ery of goods or ser)ices-9 Page 11. #o(panies usually disclose their re)enue recognition practices in a note to the financial state(ents- $he following e;cerpt fro( Nestl78s note describes how it recogni'es its re)enue:

E;hibit 2-. shows e;cerpts fro( the re)enue recognition policies used by other co(panies that offer different types of products and ser)ices- Note that the point in ti(e when re)enue should be recogni'ed depends on the

nature of the products sold and ser)ices pro)ided by the co(pany-

E;hibit 2-.$i(ing of Re)enue Recognition Page 112 Although businesses e;pect to recei)e cash in e;change for their goods and ser)ices at the ti(e of deli)ery, the ti(ing of cash receipts fro( custo(ers does not dictate when businesses report re)enues- Instead, the *ey to deter(ining when to report re)enues is whether or not the business has done what it pro(ised to do- $hus, cash can be recei)ed +1, before the goods or ser)ices are deli)ered, +., at the sa(e ti(e as the goods or ser)ices are deli)ered, or +2, after the goods or ser)ices are deli)ered, as shown in E;hibit 2-2-

E;hibit 2-2Recording Re)enues )ersus #ash Receipts &EL/?&$4C6 H4IJ 2?1 $his self?study <ui' allows you to practise applying the re)enue principle under accrual accounting- Ee reco((end that you refer bac* to there)enue recognition criteria presented earlier as you answer each <uestion#o(plete this <ui' now to (a*e sure you can apply this principle- $he following transactions are sa(ples of typical (onthly operating acti)ities of Nestl7-

Indicate the account titles that are affected and the type of account for each +A for asset, L for liability, and R for re)enue,Identify the a(ount of re)enue that is recogni'ed in "anuary, the re)enue that has been earned in Cece(ber, and the re)enue that will be earned in future periods +deferred re)enue,#o(pute the re)enue recogni'ed in "anuary and co(pare it to the a(ount of cash recei)ed in "anuaryEhich a(ountFre)enue recogni'ed in "anuary or cash recei)ed in "anuaryFis a better (easure of Nestl78s operating perfor(anceG E;plainRefer to Nestl78s inco(e state(ent presented in E;hibit 2-1 on page 1=9for account titles- Note: All a(ounts are in (illions of &wiss francsPage 113

&elf?&tudy Hui' 2?1 &olution

A H4E&$I N / A## 4N$A!ILI$65ANAGE5EN$8& IN#EN$I%E& $ PRIN#IPLE

%I LA$E $:E RE%EN4E

$he decisions of in)estors in the stoc* (ar*et are based on e;pectations of future earnings- Ehen co(panies announce <uarterly and annual earnings infor(ation, in)estors e)aluate how well the co(pany (et e;pectations and adDust their in)esting decisions accordingly- #o(panies that fail to (eet e;pectations often e;perience a decline in the stoc* price- $hus, (anagers are (oti)ated to produce earnings results that (eet or e;ceed e;pectations, to bolster stoc* prices- &ince (any e;ecuti)es are gi)en options to purchase co(pany shares as part of their co(pensation, greed (ay lead so(e (anagers to (a*e unethical accounting and reporting decisions, often

in)ol)ing falsifying re)enues and e;penses, as described in the April 1, .==., issue of #anadian !usiness- $he article includes two re)enue?related frauds in)ol)ing Li)ent Inc- and 6!5 5agne; International Inc$he #o(pany Li)ent IncEhat the #o(pany8s 5anage(ent Cid

5anage(ent has been accused by the &ecurities and E;change #o((ission and the ntario &ecurities #o((ission of using false in)oices and *ic*bac*s, filing false infor(ation, and in its earnings-

6!5 5agne; International Inc-

$he co(pany was in)estigated by the ntario &ecurities #o((ission for o)erstating sales b creating fictitious custo(er lists- At the sa(e ti(e, laundered (oney poured into the co(pan Russian gangsters- $he co(pany went ban*rupt in 1>>0Page 11I

$he &#8s in)estigation of 6!5 resulted in i(posing penalties, totalling N1-. (illion, on two bro*erage fir(s and fi)e co(pany officials- $he co(pany officials were ordered to resign fro( their positions and were banned fro( holding such positions at other co(panies for periods of three to fi)e years-

Li)ent8s co?founders Garth Crabins*y and 5yron Gottlieb were found guilty for fraudulent financial reporting and con)icted for their white?collar cri(e- $hey were sentenced to se)en and si; years of prison, respecti)ely, al(ost 11 years after the fraud was initially reported by the co(pany8s chief financial officer-

&ources: "ohn Gray, O:o(e?grown accounting scandals,P #anadian !usiness, April 1, .==.K Peter /it'patric*, O &# hands down 6!5 penalties,P National Post, "uly 2, .==2, /P1, 0K and "ohn Gray, OE;it, stage left,P #anadian !usiness, &epte(ber 13, .==>$he 5atching Process $he 5A$#:ING PR #E&& re<uires that e;penses be recorded when incurred in earning re)enue$he (atching process re<uires that when the period8s re)enues are properly recogni'ed according to the re)enue principle, all of the resources consu(ed in earning those re)enues should be recorded in that sa(e period, a (atching of costs with benefits- $hus, e;penses are recorded in the sa(e period as the related re)enues- $he costs of generating re)enue include e;penses incurred such as the following: &alaries to e(ployees who wor*ed during the period +salaries e;pense,4tilities for the electricity used during the period +utilities e;pense,5il*, cocoa, sugar, and other ingredients used to produce nutrition and health foods that are sold during the period +cost of goods sold,/acilities rented during the period +rent e;pense,4se of buildings and e<uip(ent for production purposes during the period +depreciation e;pense,&o(e of these e;penses are (atched directly to sales re)enue, such as the cost of goods sold and sales co((issions- ther e;penses, such as utilities, rent of facilities, insurance, and interest, (ay not be identifiable with specific sources of re)enue but need to be incurred in order to generate re)enue during the periodAs with re)enues and cash receipts, e;penses are recorded as incurred,regardless of when cash is paid- #ash (ay

be paid before, during, or after an e;pense is incurred, as shown in E;hibit 2-3- An entry will be (ade on the date the e;pense is incurred and another one on the date of the cash pay(ent, if at different ti(es&EL/?&$4C6 H4IJ 2?. $his self?study <ui' allows you to practise applying the (atching processunder accrual accounting- It is i(portant to co(plete this <ui' now to (a*e sure you can apply this process$he following transactions are sa(ples of typical (onthly operating acti)ities of Nestl7Indicate the account titles that are affected and the type of account for each +A for asset, L for liability, and E for e;pense,If an e;pense is to be recogni'ed in "anuary, indicate the a(ount- If an e;pense is not to be recogni'ed in "anuary, indicate why#o(pute the a(ount of e;penses recogni'ed in "anuary and co(pare this a(ount to the cash paid in "anuaryRefer to Nestl78s inco(e state(ent presented in E;hibit 2-1 on page 1=>for account titlesNote: All a(ounts are in (illions of &wiss francsPage 119

After you co(plete your answers, go online for the solutions&elf?&tudy Hui' 2?. &olution

E;hibit 2-3Recording E;penses )ersus #ash Pay(ents Page 11A /INAN#IALANAL6&I&&$ #@ 5AR@E$ REA#$I N& $ A## 4N$ING ANN 4N#E5EN$& &toc* (ar*et analysts and in)estors use accounting infor(ation to (a*e in)est(ent decisions- $he stoc* (ar*et, which is based on in)estors8 e;pectations about future co(pany perfor(ance, often reacts negati)ely when a co(pany does not (eet pre)iously specified operating results- A co(pany can e;perience difficulty e)en if it does not report a loss- Any une;pected de)iation of actual perfor(ance fro( the operating plan, such as lower than e;pected <uarterly earnings, needs to be e;plainedn /ebruary 1>, .=1=, Nestl7 announced the results of its fiscal year .==> ending Cece(ber 21, .==>- n the day of the announce(ent, the price per share closed at #:/ 3.-A=, an increase of #:/ 1-.I o)er the closing price on the pre)ious day-^ Nestl78s annual results showed a decrease of earnings per share +EP&, fro( #:/ 3-0A for .==0 to #:/ .->. for .==>- Profit for .==> included, howe)er, a non?operating gain of #:/ >-. billion +#:/ .-30 per share, for the sale of Nestl78s in)est(ent in Alcon- E;cluding this gain, the EP& for .==0 would ha)e been #:/ .-2>- $his suggests that Nestl7 i(pro)ed on its operating perfor(ance during .==>- $he increase in share price suggests that the reported EP& figure is higher than in)estors8 e;pectations$his is a clear e;a(ple of how e;ternal users reacted to the infor(ation- Accounting infor(ation has a per)asi)e effect on all for(s of corporate decision (a*ing, as well as on the econo(ic decisions that in)estors and creditors (a*e^Nestl7 website- "une .3, .=1=- http:TTwww-nestle-co(TIn)estorsVL 3Apply transaction analysis to e;a(ine and record the effects of operating acti)ities on the financial state(entsI International Accounting &tandards !oard, .==>- International Accounting &tandard 10 c Re)enue, paragraph 139 /urther discussion of the application of the re)enue principle to special circu(stances is pro)ided in #hapter A$:E EBPANCEC $RAN&A#$I N ANAL6&I& 5 CELNow that we ha)e seen the )ariety of business acti)ities affecting the inco(e state(ent and how they are (easured, we need to deter(ine how these business

acti)ities are recorded in the accounting syste( and reflected in the financial state(ents- #hapter . co)ered in)esting and financing acti)ities affecting assets, liabilities, and share capital- Ee now e;pand the transaction analysis (odel presented in that chapter to include operating acti)ities-

$ransaction Analysis Rules $he co(plete transaction (odel presented in E;hibit 2-I includes all fi)e ele(ents: assets, liabilities, shareholders8 e<uity, re)enues, and e;penses- Recall that the retained earnings account is the accu(ulation of all past re)enues and e;penses (inus any profit distributed as di)idends to shareholders +i-e-, earnings not retained in the business,- Retained earnings increase when profit is reali'ed and decrease when a loss occurs$hese relationships a(ong financial state(ent ele(ents are su((ari'ed in the upper part of E;hibit 2-I!efore illustrating the use of the e;panded transaction analysis (odel, we want to e(phasi'e the following: Re)enues increase profit, thus increasing retained earnings and shareholders8 e<uity, which therefore ha)e credit balancesE;penses decrease profit, thus decreasing retained earnings and shareholders8 e<uity- $herefore, e;penses ha)e debit balances +opposite of the balance in retained earnings,K that is, to increase an e;pense, you debit it, which decreases profit and retained earnings- 6ou are adding to the e;penses when you debit the accountPage 110 Ehen re)enues e;ceed e;penses, the co(pany reports profit, increasing retained earnings and shareholders8 e<uity- :owe)er, when e;penses e;ceed re)enues, a loss results that decreases retained earnings and thus shareholders8 e<uity-

E;hibit 2-IE;panded $ransaction Analysis 5odel Ehen constructing and using the

transaction analysis (odel, we (aintain the direction rule and the debit?credit fra(ewor* described in #hapter .: All accounts can increase or decrease, although re)enues and e;penses tend to increase throughout a period- /or accounts on the left side of the accounting e<uation, the increase sy(bol, 1, is written on the left side of the $? account- /or accounts on the right side of the accounting e<uation, the increase sy(bol, 1, is written on the right side of the $?accountCebits +dr, are written on the left side of each $?account and credits +cr, are written on the rightE)ery transaction affects at least two accountsAs indicated in #hapter ., a syste(atic transaction analysis includes the following steps: Page 11> &ince re)enues are defined as increases in assets or settle(ent of liabilities fro( ongoing operations of the business, then, by definition, the recording of re)enue results in either increasing an asset or decreasing a liability- In li*e (anner, when recording an e;pense, an asset is decreased or a liability is increased6ou should refer to the e;panded transaction analysis (odel until you can construct it on your own without assistance- &tudy the following illustration carefully to (a*e sure that you understand the i(pact of operating acti)ities on both the state(ent of financial position and the inco(e state(entAnaly'ing Nestl78s $ransactions Now we build on Nestl78s state(ent of financial position presented at the end of #hapter .- It included the effects of the in)esting and financing transactions that occurred during the accounting period- Ee analy'e, record, and post to the $?accounts the effects of this chapter8s operating acti)ities that also occurred during the accounting cycle- In #hapter 3, we will co(plete the accounting cycle with the acti)ities at the end of the period +"anuary 21,All a(ounts are in (illions of &wiss francs, and the effects are posted to the appropriate $?accounts at the end of the illustrationNestl7 sold (il* products and be)erages to custo(ers for 2,I.= in cash- $he cost of these sales was 1,>9=- +Note: $his re<uires two entries, one for the re)enue earned and one for the e;pense incurred in generating the re)enue-,

Recall that re)enues are recogni'ed when Nestl7 sells goods and renders ser)ices regardless of the ti(ing of cash receipts, and e;penses are recogni'ed when incurred regardless of the ti(ing of cash pay(ents- $o highlight the difference between accrual basis accounting and cash basis accounting, we show in the (argin the net effect of each transaction on profit and on cashNestl7 sold coffee products to retail outlets for 2,=.=K .,=.= was recei)ed in cash and the rest was due fro( the outlets- $he cost of products sold was 1,3==-

Page 1.= Nestl7 recei)ed 23I fro( custo(ers, including AI for sales (ade in Cece(ber and the rest fro( "anuary sales-

Nestl7 signed contracts with new clients and recei)ed I== cash- $he co(pany earned 3== i((ediately by perfor(ing ser)ices for these clientsK the rest will be earned o)er the ne;t se)eral (onths-

Nestl7 paid A3= in ad)ance for the following: 19= for insurance for the ne;t four (onths, 3I= for rent of warehousing facilities for the ne;t three (onths, and 12= for ad)ertising in /ebruary-

Nestl7 paid A21 for utilities, repairs, and fuel for deli)ery )ehicles, all considered distribution e;penses-

Page 1.1 Nestl7 ordered and recei)ed .,>== in supplies in)entoriesK >== was paid in cash and the rest was on account with suppliers-

Nestl7 paid 1,2I= in cash to e(ployees for wor* in "anuary: 3== to personnel associated with distribution acti)ities and >I= for e(ployees in the corporate head<uarters, considered as ad(inistrati)e e;penses-

&EL/?&$4C6 H4IJ 2?2 /or transactions +i, through +*,, fill in the (issing infor(ation- !e sure to post Dournal entries to the $?accounts in E;hibit 2-9+i, Nestl7 recei)ed 9I= in cash: I= in interest earned on notes recei)able and 9== in pay(ents (ade on notes recei)able fro( custo(ers-

Page 1.. +*, Nestl7 sold land for 2I=- $he cost of the land is I=&elf?&tudy Hui' 2?2 &olution

E;hibit 2-9 shows the $?accounts that changed during the period because of transactions +a, through +*,- $he balances of all other accounts re(ained the sa(e- $he a(ounts fro( Nestl78s state(ent of financial position at the end of #hapter . ha)e been included as the beginning balances in E;hibit 2-9 for assets, liabilities, and shareholders8 e<uity accounts- n the other hand, inco(e state(ent accounts ha)e 'ero beginning balances so that the effects of transactions affecting re)enue and e;pense accounts can be accu(ulated o)er the period6ou can )erify that you posted the entries for transactions +i, through +*, properly by adding the increase side and subtracting the decrease side, and then co(paring your answer to the ending balance gi)en in each of the $? accounts-

: E I& $:E IN# 5E &$A$E5EN$ PREPAREC ANC ANAL6JECGL IPrepare an inco(e state(ent and understand the difference between profit and cash flow fro( operations!ased on the "anuary transactions that ha)e Dust been posted in the $?accounts, we can now prepare an inco(e state(ent reflecting the operating acti)ities for "anuary-

E;hibit 2-9$?Accounts $he beginning balances of financial state(ent accounts are ta*en fro( E;hibit .-0Page 1.2 $his inco(e state(ent is not yet adDusted for all re)enues earned or e;penses incurred in "anuary- /or e;a(ple, $he prepay(ents account includes rent and insurance co)ering "anuary, and future (onths, but the e;penses are not yet recorded for the a(ounts used in "anuary- $his is true of the e<uip(ent used during the (onth as well4ntil adDusted, assets are o)erstated and e;penses are understatedEe ha)e not calculated inco(e ta;es for the a(ount incurred in "anuary and owed within the ne;t <uarter- $hus, both e;penses and liabilities are understatedPage 1.3 #hapter 3 will describe the adDust(ent process to update the accounting records- After the adDust(ents are (ade, the a(ount of inco(e ta; e;pense will be deter(ined and the state(ents will reflect I/R& following accrual basis accounting/INAN#IALANAL6&I&REP R$ING 5 RE CE$AILEC /INAN#IAL IN/ R5A$I N IN $:E N $E& 5any co(panies, especially )ery large ones, operate in (ore than one geographic area- $hese co(panies are often called (ultinationals- A consolidated inco(e state(ent that is based on aggregated data (ay not pro)e as useful to in)estors see*ing to assess possible ris*s and returns fro( co(panies operating in foreign (ar*ets- $his

is also true if a co(pany operates in (ore than a single business- /or e;a(ple, a (anufacturing operation in a &outh A(erican country suffering fro( political unrest is ris*ier than a (anufacturing facility located in ntario$herefore, (any co(panies pro)ide additional infor(ation about geographic and business seg(ents in notes to the financial state(ents- An e;cerpt fro( Nestl78s .==> financial state(ents pro)ides infor(ation on its geographic seg(ents:

/ #4& N#A&: /L E& PERA$ING A#$I%I$IE& In #hapter ., we presented Nestl78s state(ent of cash flows for the in)esting and financing acti)ities for the (onth- Recall that in)esting acti)ities relate pri(arily to transactions affecting non?current assets- /inancing acti)ities are those fro( ban* borrowings, issuance of shares, and di)idend pay(ents to shareholders- In this chapter, we focus on cash flows fro( operating acti)ities, which essentially reflects cash basis accounting- $his section of the state(ent of cash flows reports cash fro( operating sources, pri(arily custo(ers, and cash tosuppliers and others in)ol)ed in operations- $he accounts (ost often associated with operating acti)ities are current assets, such as trade recei)ables, in)entories, and prepay(ents, and current liabilities, such as trade payables, salaries payable, and deferred re)enuePage 1.I Ee present the cash flows fro( operating acti)ities section of the state(ent of cash flows by using the direct (ethod W cash receipts and cash disburse(ents- :owe)er, (ost co(panies report cash fro( operations by using the indirect (ethod that will be discussed in#hapter I and later chapters-

Ehen a transaction affects cash, it is included on the state(ent of cash flows- Ehen a transaction does not affect

cash, such as when ac<uiring a building with a long?ter( (ortgage note payable or selling goods on account to custo(ers, it is not included on the state(ent- If you see cash in a transaction, it will be reflected on the state(ent of cash flows- $herefore, when preparing the cash flows fro( operating acti)ities section of the state(ent of cash flows by using the direct (ethod, the easiest way is to loo* at the acti)ities in the cash $?account-

perating acti)ities contributed .,213 in cash during "anuary- $his a(ount represents the increase in the cash account +I,I2> ? .,0AI,, e;cluding the cash recei)ed fro( the sale of land +2I=,, which is an in)esting acti)ity$his cash basis profit is different fro( the operating profit of 1,01> that is based on accrual accounting- Note that the gain of 2== on the sale of land is not included because it resulted fro( an in)esting, not an operating, transaction- $he difference between these two a(ounts is due to the fact that re)enue is recogni'ed when earned, regardless of when cash is recei)ed, and e;penses are recogni'ed when incurred, regardless of when cash is paidEe presented abo)e, in the (argin, the effects of each operating transaction on both profit and cash- If you co(pute the net effect of all transactions on profit, you will get .,11>, the sa(e profit figure that appears in the inco(e state(ent- 6ou should not be surprised by this result because the inco(e state(ent reflects the net effects of all operating transactions during a period- &i(ilarly, the net effect of the sa(e operating transactions on cash is .,213, which e<uals the net cash flow fro( operating acti)ities on the state(ent of cash flows$o re(ain in business in the long run, co(panies (ust generate positi)e cash flows fro( operations- #ash is needed to pay suppliers and e(ployees- Ehen cash fro( operations is negati)e o)er a period of ti(e, the only other ways to obtain the necessary funds are to +1, sell non?current assets, which reduces future producti)ityK +., borrow fro( creditors, at increasing rates of interest as ris* of default risesK or +2, issue additional shares, where in)estor e;pectations about poor future perfor(ance dri)es the stoc* price down- $here are clearly li(its on how (any of these acti)ities a co(pany can underta*ePage 1.9 Nestl7 has reali'ed positi)e operating cash flows o)er the fi)e?year period .==IW.==>, as shown below/urther(ore, the cash flow fro( operations e;ceeded profit in four of these fi)e years- In .==0, Nestl78s sale of in)est(ents in other businesses resulted in a gain of >,.=0- If this one?ti(e gain is ignored, then Nestl78s profit would be slightly lower than its operating cash flows for .==>- $he e;cess of operating cash flows o)er profit represents a prudent way of reporting re)enues and e;penses that builds analysts8 confidence as to the reliability of the reported profit (easures-

.==I #ash flow fro( operations Profit 1=,.= I 0,I10

.==9 11,9A 9 >,03>

.==A 12,32 > 11,20.

.==0 1=,A9 2 1>,=I 1

.==> 1A,>2 3 11,A>2

&EL/?&$4C6 H4IJ 2?3 #anadian $ire #orporation Li(ited #anadian $ire #orporation Li(ited is a leading hard goods retailer with (ore than 3== stores across #anada- $he transactions below are ta*en fro( a recent annual state(ent of cash flows- Indicate whether the transaction affected cash flow as an operating + ,, in)esting +I,, or financing +/, acti)ity, and indicate the direction of the effect on cash +1 for increasesK ? for decreases,: &elf?&tudy Hui' 2?3 &olution $ransactions 1- Cistribution to shareholders .- Receipt of cash fro( custo(ers 2- Additions to property 3- Pay(ent of inco(e ta;es I- Pay(ent of cash to suppliers 9- Repay(ent of long?ter( borrowings A- Receipt of interest on in)est(ents 0- Long?ter( borrowings >- Issuance of shares 1=- Pay(ent of interest on borrowings 11- Pay(ent of cash to e(ployees 1.- &ale of property After you co(plete your answers, go online for the solutions@E6 RA$I ANAL6&I& Ee now introduce two ratios to assess (anagers8 use of assets in total to i(pro)e profits- $hese two ratios focus on the use of assets to generate re)enue and profit, respecti)ely- As we will see in other chapters, si(ilar analysis on the use of specific types of assets pro)ides additional infor(ation for decision (a*ersL 9#o(pute and interpret the total asset turno)er ratio and the return on assets ratio$ype of Acti)ity + , I, Effect on #ash /lows +M or or /, Q,

$ $AL A&&E$ $4RN %ER RA$I ANAL6$I#AL H4E&$I N \ :ow effecti)e is (anage(ent in generating sales fro( assets +resources,G RA$I ANC # 5PARI& N& \ $he total asset turno)er ratio is useful in answering this <uestion- It is co(puted as follows:

^ A)erage $otal Assets I +!eginning total assets 1 Ending total assets, ] . Page 1.A $he .==> ratio for Nestl7 is

IN$ERPRE$A$I N& In General \ $he total asset turno)er ratio (easures the sales generated fro( the use of assets- A high asset turno)er signifies efficient (anage(ent of assetsK a low asset turno)er ratio signifies less efficient (anage(ent- A co(pany8s products and business strategy contribute significantly to its asset turno)er ratio- :owe)er, when co(petitors are si(ilar, (anage(ent8s ability to control the fir(8s assets is )ital in deter(ining its success&tronger financial perfor(ance i(pro)es the assets turno)er ratio-

#reditors and security analysts use this ratio to assess a co(pany8s effecti)eness at controlling current and non?current assets- In a well?

run business, creditors e;pect the ratio to fluctuate because of seasonal upswings and downturns- /or e;a(ple, as in)entory is built up prior to a high?sales season, co(panies need to borrow funds- $he asset turno)er ratio declines with this increase in assets- E)entually, the season8s high sales pro)ide the cash needed to repay the loans$he asset turno)er ratio then rises with the increased sales/ocus #o(pany Analysis \ Nestl78s total asset turno)er ratio was stable fro( .==A to .==>, suggesting that (anage(ent (aintained its effecti)eness in using assets to generate sales- Nestl78s .==> total asset turno)er ratio is higher than @raft /oods8 ratio but on par with #onAgra8s ratio- $he (ain reason for the @raft /oods8 lower ratio is the relati)ely larger a(ount of intangible assets reported on its state(ent of financial position- @raft /oods8 intangible assets represent 93 percent of its total assets, whereas the intangible assets of Nestl7 and #onAgra /oods represent 2= percent and 20 percent of their total assets, respecti)ely- $hese intangible assets result (ainly fro( ac<uisition of other businesses, and they differ fro( assets li*e e<uip(ent and in)entories in ter(s of their contribution to generating sales for the periodA /ew #autions \ $he total asset turno)er ratio (ay decrease because of seasonal fluctuation, but a declining ratio (ay also be caused by changes in corporate policies leading to a rising le)el of assets- E;a(ples include rela;ing credit policies for new custo(ers or reducing collection efforts in trade recei)ables- A detailed analysis of the changes in the *ey co(ponents of assets is needed to deter(ine the causes of a change in the asset turno)er ratio and thus in (anage(ent8s decisions- Re(e(ber that any one ratio is not sufficient as a basis for in)est(ent decisionsRE$4RN N A&&E$& +R A, ANAL6$I#AL H4E&$I N \ :ow well has (anage(ent used the total in)ested capital pro)ided by debtholders and shareholders during the periodG RA$I ANC # 5PARI& N& \ Analysts refer to the rate of return on assets +R A, as a useful (easure in addressing this issue- It is co(puted as follows:

!oth the total asset turno)er ratio and the return on assets (easure (anage(ent8s effecti)eness in utili'ing the co(pany8s resources: the first in generating re)enue during the period, the second in generating after?ta; return on the use of assets$he return on assets ta*es into consideration the resources contributed by both shareholders and creditors- /or this reason, the return to shareholders or profit is aug(ented by the return to creditors, which is interest e;penseInterest e;pense is (easured net of inco(e ta; because it represents the net cost of the funds pro)ided by the creditors to the corporation- $he returns to both shareholders and creditors are (easured net of ta; in the nu(erator of this ratioPage 1.0 $he .==> ratio for Nestl7 is

1As disclosed in Note I to Nestl78s financial state(ents.$his illustration assu(es a corporate ta; rate of .I percent-

IN$ERPRE$A$I N& In General \ R A (easures how (uch the fir( earned fro( the use of its assets- It is the broadest (easure of profitability and (anage(ent effecti)eness, independent of financing strategy- R A allows in)estors to co(pare (anage(ent8s in)est(ent perfor(ance against alternati)e in)est(ent options- /ir(s with higher R A are doing a better Dob of selecting new in)est(ents, all other things being e<ual- #o(pany (anagers often co(pute the (easure on a di)ision?by?di)ision basis and use it to e)aluate di)ision (anagers8 relati)e perfor(ance-

/ocus #o(pany Analysis \ Nestl7 appears to ha)e done well in fiscal year .==0 co(pared with both .==A and .==>- E;a(ination of the co(pany8s inco(e state(ent shown in E;hibit 2-1 indicates a significant a(ount of other inco(e in .==0, which includes a gain of #:/ >,.=0 (illion on the sale of its in)est(ent in Alcon- If we e;clude this one?ti(e gain fro( profit, then Nestl78s R A for .==0 would drop to >-9 percent- Nestl7 achie)ed a higher R A than both #onAgra /oods and @raft /oods- E;a(ination of the state(ents of financial position of #onAgra /oods and @raft /oods indicates that their assets include a proportionally higher a(ount of goodwill than Nestl7- !ecause goodwill is not an operational asset that generates re)enue and profit in the sa(e way as food?processing e<uip(ent, its e;clusion fro( total assets would increase the R As for both #onAgra /oods and @raft /oods, bringing their ratios closer to Nestl78sA /ew #autions \ Effecti)e analysis of R A re<uires an understanding of why R A differs fro( prior le)els and fro( the R A of the co(pany8s co(petitors- Analysis of the differences in R A o)er ti(e and across co(panies can be facilitated by a deco(position of this ratio into two other ratios, as shown later in #hapter 12&EL/?&$4C6 H4IJ 2?I

&ears #anada &ears #anada is one of the biggest #anadian retailers- It operates a large nu(ber of depart(ent stores that sell ho(e fashions, appliances, apparel, ho(e electronics, and garden products- It also sells (erchandise online&elected infor(ation about the co(pany8s resources and operations are presented below +a(ounts in (illions of #anadian dollars,&elf?&tudy Hui' 2?I &olution .==> $otal assets $otal re)enue Net earnings +Profit, Interest e;pense $a; rate .==0 .==A .==9 .==I .==3

N2,3=3- N2,.93- N2,==1- N2,=>2- N2,1> N3,.9 0 A A 2 > . I,.==-9 I,A22-. 9,2.9-3 I,>2.-0 9,.20 9,.2= .23-A .I-. 2.d .00-9 1= 21d 2=9-= 1.-A 22d 1I.-9 AA1 1.> II

30 30-> Page 1.>

29d .=d 2.d

Re<uired: #o(plete the following table by co(puting the total asset turno)er ratio and the return on assets ratio for .==9 and .==I.== .== .== .== .== > 0 A 9 I $otal asset turno)er ratio 1-I9 1-02 .-=0 Return on assets +R A, =-=0 =-=> =-1= $he return on assets for .==I is relati)ely high co(pared with those of later years- Ehat is the (ost li*ely e;planation for this high ratioG Ehat conclusion can you draw fro( these ratios about the co(pany8s effecti)eness in (anaging the econo(ic resources under its controlG After you co(plete your answers, go online for the solutionsA## 4N$ING &$ANCARC&/ R PRI%A$E IN$ERPRI&E& $he accounting concepts and procedures co)ered in this chapter are e<ually applicable to #anadian pri)ate enterprisesCE5 N&$RA$I N #A&E $his case is a continuation of the $errific Lawn 5aintenance #orporation introduced in #hapter .- $he co(pany was established with supplies, property, and e<uip(ent purchased ready for business- $he state(ent of financial position at April 2=, .=11, based on in)esting and financing acti)ities is as follows:

$he following co(pleted acti)ities occurred during April .=11: Purchased and used gasoline for (owers and edgers, paying N>= in cash at a local gas stationIn early April, recei)ed fro( the city N1,9== cash in ad)ance for lawn (aintenance ser)ice for April through "uly +N3== each (onth,- $he entire a(ount was recorded as deferred re)enueIn early April, purchased insurance costing N2== co)ering si; (onths, April through &epte(ber- $he entire pay(ent was recorded as prepay(ent5owed lawns for residential custo(ers who are billed e)ery two wee*s- A total of NI,.== of ser)ice was billed in AprilResidential custo(ers paid N2,I== on their accountsPaid wages e)ery two wee*s- $otal cash paid in April was N2,>==Recei)ed a bill for N2.= fro( the local gas station for additional gasoline purchased on account and used in AprilPaid N1== on trade payablesPage 12= Re<uired: n a separate sheet of paper, set up $?accounts for cash, trade recei)ables, e<uip(ent, land, prepay(ents, trade payables, deferred re)enue, notes payable, share capital, retained earnings, (owing re)enue, fuel e;pense, and wages e;pense- !eginning balances for asset, liability and e<uity accounts should be ta*en fro( the preceding state(ent of financial position- !eginning balances for operating accounts are N=- Indicate these balances on the $?accountsAnaly'e each transaction using the steps outlined in #hapter .- Please refer to the e;panded transaction analysis (odel presented in this chaptern a separate sheet of paper, prepare Dournal entries to record the transactions abo)e in chronological order and indicate their effects on the accounting (odel +Assets I Liabilities 1 &hareholders8 E<uity, as well as their effects on profit and cash- %erify that the accounting e<uation is in balanceEnter the effects of each transaction in the appropriate $?accounts- Identify each a(ount with its letter in the list of acti)ities#o(pute balances in each of the $?accountsEe strongly reco((end that you prepare your own answers to these re<uire(ents and then chec* your answers with the following solution&4GGE&$EC & L4$I N

"ournal entries, effects on accounting e<uation, e<uality chec*s, and $?accounts:

Page 121 $?Accounts $he beginning balances of the state(ent of financial position accounts are ta*en fro( the solutions to the de(onstration case in #hapter . +pp- AAWA0,-

#:AP$ER $A@E?AEA6& Cescribe a typical business operating cycle and e;plain the necessity for the periodicity assu(ption- p- 1=3 perating cycleFthe cash?to?cash cycle is the ti(e it ta*es to purchase goods or ser)ices fro( suppliers, sell the goods or ser)ices to custo(ers, and collect cash fro( custo(ersPeriodicity assu(ptionFto (easure and report financial infor(ation periodically, we assu(e that the long life of the co(pany can be cut into shorter periodsE;plain how business acti)ities affect the ele(ents of the inco(e state(ent-p- 1=9 Ele(ents on the classified inco(e state(ent: Re)enuesFincreases in assets or settle(ents of liabilities fro( ongoing operationsE;pensesFdecreases in assets or increases in liabilities fro( ongoing operationsGainsFincreases in assets or settle(ents of liabilities fro( peripheral acti)itiesLossesFdecreases in assets or increases in liabilities fro( peripheral acti)itiesE;plain the accrual basis of accounting and apply the re)enue principle and (atching process to (easure profit- p- 11= Ehen applying accrual accounting concepts, re)enues are recogni'ed +recorded, when earned and e;penses are recogni'ed when incurred to generate the re)enuesRe)enue principleFrecogni'e re)enues when the earnings process is co(plete or nearly co(plete, an e;change has ta*en place, and collection is probable5atching processFrecogni'e e;penses when incurred in earning re)enueApply transaction analysis to e;a(ine and record the effects of operating acti)ities on the financial state(ents- p11A $he e;panded transaction analysis (odel includes re)enues and e;penses:

Prepare an inco(e state(ent and understand the difference between profit and cash flow fro( operations-p- 1.. $he inco(e state(ent reports the re)enues generated during the period and the related e;penses- Profit is the difference between re)enues and e;penses, whereas cash flow fro( operations e<uals the difference between cash receipts and cash pay(ents related to operations- Profit differs fro( cash flow fro( operations because the re)enue principle and (atching process result in the recognition of re)enues and related e;penses that are independent of the ti(ing of cash receipts and pay(ents#o(pute and interpret the total asset turno)er ratio and the return on assets ratio- p- 1.9 Page 122 $he total asset turno)er ratio +&ales 3 A)erage total assets, (easures the sales generated fro( the use of assets$he higher the ratio, the (ore efficient the co(pany is at (anaging assets- $he return on assets +R A, ratio (easures how (uch the co(pany earned fro( the use of assets- It pro)ides infor(ation on profitability and (anage(ent8s effecti)eness in utili'ing assets- An increasing ratio o)er ti(e suggests increased efficiency- R A is co(puted as the su( of profit and interest e;pense +net of ta;, di)ided by a)erage total assetsIn this chapter, we discussed the operating cycle and accounting concepts rele)ant to inco(e deter(ination: periodicity assu(ption, definitions for the inco(e state(ent ele(ents +re)enues, e;penses, gains, and losses,, the re)enue principle, and the (atching process- $hese accounting principles are defined in accordance with the accrual basis of accounting, which re<uires re)enues to be recorded when earned and e;penses to be recorded when incurred in generating re)enues during the period- Ee e;panded the transaction analysis (odel introduced in #hapter . by adding re)enues and e;penses- In#hapter 3, we discuss the acti)ities at the end of the accounting period: adDust(ent process, preparation of adDusted financial state(ents, and closing process@E6 RA$I & $he total asset turno)er ratio (easures the sales generated fro( the use of assets- A high ratio suggests that the co(pany is (anaging its assets +resources used to generate re)enues, efficiently- It is co(puted as follows + p1.9,:

$he return on assets ratio (easures how (uch the co(pany earned fro( the use of assets during the period- A high ratio suggests that the co(pany is (anaging its assets efficiently- It is co(puted as follows +p- 1.A,:

^+!eginning $otal Assets 1 Ending $otal Assets, ] .

/INCING/INAN#IAL IN/ R5A$I N

Page 123 @E6 $ER5& Accrual !asis Accountingp11=#ash !asis Accountingp11=E;pensesp1=AGainsp1=0Gross Profit +Gross 5argin,p1=0Profit before Inco(e $a;esp- 1=>Lossesp- 1=05atching Processp- 11I perating #ycle +#ash?to?#ash,p1=I perating Profitp- 1=0Periodicity Assu(ptionp- 1=9Profit !efore Inco(e $a;esp- 1=>Re)enuesp1=ARe)enue Principlep- 111 H4E&$I N& Assu(e that you ha)e Dust opened a s(all gift store that speciali'es in gift ite(s i(ported fro( the /ar EastE;plain the typical business operating cycle for your storeE;plain what the periodicity assu(ption (eans in accountingIndicate the inco(e state(ent e<uation and define each ele(entE;plain the difference between re)enues and gainse;penses and lossesCefine accrual accounting and contrast it with cash basis accountingEhat conditions nor(ally (ust be (et for re)enue to be recogni'ed under the accrual basis of accountingG E;plain the (atching processE;plain why shareholders8 e<uity is increased by re)enues and decreased by e;pensesE;plain why re)enues are recorded as credits and e;penses as debits#o(plete the following (atri; by entering either debit or credit in each cell: Ite( Re)enues E;penses Gains Losses #o(plete the following (atri; by entering either increase or decreasein each cell: Ite( Re)enues Cebit #redit Increase Cecrease

E;penses Gains Losses Identify whether each of the following transactions results in a cash flow effect fro( operating, in)esting, or financing acti)ities, and indicate the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write OnoneP: $ransaction #ash paid to suppliers &ale of goods on account #ash recei)ed fro( custo(ers Purchase of in)est(ents for cash #ash paid for interest Issuance of shares for cash &tate the e<uation for the total asset turno)er ratio, and e;plain how it is interpreted&tate the e<uation for the return on assets ratio, and e;plain how it is interpretedPage 12I EBER#I&E& L 1 E2W1Inferring Inco(e &tate(ent %alues &upply the (issing dollar a(ounts for the .=11 inco(e state(ent of 4lti(ate &tyle #o(pany for each of the following independent cases: perating, In)esting, or /inancing Effect Cirection of the Effect

#ase A &ales re)enue &elling e;pense #ost of goods sold Inco(e ta; e;pense Gross profit Profit before inco(e ta; Ad(inistrati)e e;pense Profit L . E2W.Preparing an Inco(e &tate(ent N>== G G G 3== .== 1I= 1A=

#ase ! NA== 1I= 20= 2= G >= G G

#ase # N31= 0= G .= G G 9= I=

#ase C NG 3== I== 3= G 1>= 1== G

#ase E NG .I= 21= 2= 33= G 0= 0=

$he following data were ta*en fro( the records of %illage #orporation at Cece(ber 21, .=11: &ales re)enue Gross profit &elling +distribution, e;pense Ad(inistrati)e e;pense Profit before inco(e ta; Inco(e ta; rate Nu(ber of shares outstanding NA=,=== .3,I== 0,=== G 1=,=== 2=d 3,===

Re<uired: Prepare a co(plete inco(e state(ent for the co(pany +showing both gross profit and profit fro( operations,&how all co(putations- +:int: &et up the side captions starting with sales re)enue and ending with earnings per shareK use the a(ounts and percentages gi)en to infer (issing )alues-, L 2 E2W2Reporting #ash !asis )ersus Accrual !asis Profit _:elp 5e &ol)e It_ %ideo $utorial 2?1 5ostert 5usic #o(pany had the following transactions in 5arch: &old instru(ents to custo(ers for N1=,===K recei)ed N3,=== in cash and the rest on accountCeter(ined that the cost of the instru(ents sold was NA,===Purchased N3,=== of new instru(ents in)entoryK paid N.,=== in cash and the rest on accountPaid N9== in wages for the (onthRecei)ed a N.== bill for utilities that will be paid in AprilRecei)ed N1,=== fro( custo(ers as deposits on orders of new instru(ents to be sold to custo(ers in April#o(plete the following state(ents:

Page 129 Coes cash basis or accrual basis of

accounting pro)ide a better indication of the operating perfor(ance of 5ostert 5usic #o(pany in 5archG E;plainL ., 2

E2W3Identifying Re)enues Re)enues are nor(ally recogni'ed when the entity has transferred to the buyer the significant ris*s and rewards of ownership of the goods, it retains neither continuing (anagerial in)ol)e(ent to the degree usually associated with ownership nor effecti)e control o)er the goods, it is probable that future econo(ic benefits will flow to the co(pany, and the benefits fro( and costs associated with the transaction can be (easured reliably- $he a(ount recorded is the cash?e<ui)alent sales price- $he following e)ents and transactions occurr1ed in &epte(ber .=11: A custo(er orders and recei)es 1= personal co(puters fro( Gateway .===K the custo(er pro(ises to pay N.=,=== within three (onths- Answer fro( Gateway8s standpoint&a( &hell Codge sells a truc* with a list, or stic*er, price of N.3,=== for N.1,=== cash$he :udson8s !ay #o(pany orders 1,=== (en8s shirts fro( Gildan Acti)ewear Inc- at N10 each for future deli)ery- $he ter(s re<uire pay(ent in full within 2= days of deli)ery- Answer fro( Gildan8s standpointGildan Acti)ewear co(pletes production of the shirts described in +c, and deli)ers the order- Answer fro( Gildan8s standpointGildan recei)es pay(ent fro( the :udson8s !ay #o(pany for the order described in +c,- Answer fro( Gildan8s standpointA custo(er purchases a tic*et fro( Eest"et for N32I cash to tra)el the following "anuary- Answer fro( Eest"et8s standpointGeneral 5otors issues N.9 (illion in new shares:all #onstruction #o(pany signs a contract with a custo(er for the construction of a new NI==,=== warehouseAt the signing, :all recei)es a che<ue for NI=,=== as a deposit on the future construction- Answer fro( :all8s standpointn &epte(ber 1, .=11, a ban* lends N1=,=== to a co(pany- $he loan carries a 1. percent annual interest rate, and the principal and interest are due in a lu(p su( on August 21, .=1.- Answer fro( the ban*8s standpointA popular s*i (aga'ine co(pany recei)es a total of N1,0== fro( subscribers on &epte(ber 2=, the last day of its fiscal year- $he subscriptions begin in the ne;t fiscal year- Answer fro( the (aga'ine co(pany8s standpoint&ears #anada, a retail store, sells a N1== la(p to a custo(er who charges the sale on his store credit card- Answer fro( the standpoint of &ears-

Re<uired: /or each of the &epte(ber transactions, Indicate the account titles that are affected and the type of each account +A for asset, L for liability, &E for shareholders8 e<uity, and R for re)enue,If re)enue is to be recogni'ed in &epte(ber, indicate the a(ount- If re)enue is not to be recogni'ed in &epte(ber, indicate which of the re)enue recognition criteria are not (et4se the following headings in structuring your solution: L ., 2

E2WIIdentifying E;penses Re)enues are nor(ally recogni'ed when goods or ser)ices ha)e been pro)ided and pay(ent or pro(ise of pay(ent has been recei)ed- E;pense recognition is guided by an atte(pt to (atch the costs associated with the generation of those re)enues to the sa(e ti(e period- $he following e)ents and transactions occurred in "anuary .=11: Gateway .=== pays its co(puter ser)ice technicians N0I,=== in salary for the two wee*s ended "anuary A- Answer fro( Gateway8s standpoint$urner #onstruction #o(pany pays N3,I== in wor*ers8 co(pensation insurance for the first three (onths of the yearPage 12A 5cGraw?:ill Ryerson Li(ited uses N1,.== worth of electricity and natural gas in its head<uarters building for which it has not yet been billedGildan Acti)ewear Inc- co(pletes production of I== (en8s shirts ordered by !on $on Cepart(ent &tore at a cost of N> each and deli)ers the order- Answer fro( Gildan8s standpoint$he ca(pus boo*store recei)es I== accounting te;tboo*s at a cost of NA= each- $he ter(s indicate that pay(ent is due within 2= days of deli)eryCuring the last wee* of "anuary, the ca(pus boo*store sold 3I= accounting te;tboo*s recei)ed in +e, at a sales price of N1== each&a( &hell Codge pays its salespeople N2,I== in co((issions related to Cece(ber auto(obile sales- Answer fro( &a( &hell Codge8s standpoint-

n "anuary 21, &a( &hell Codge deter(ines that it will pay its salespeople N3,.== in co((issions related to "anuary sales- $he pay(ent will be (ade in early /ebruary- Answer fro( &a( &hell Codge8s standpointA new grill is installed at a 5cConald8s restaurant- n the sa(e day, pay(ent of N13,=== is (ade in cashn "anuary 1, .=11, #arousel 5all had Danitorial supplies costing N1,=== in storage- An additional N9== worth of supplies was purchased during "anuary- At the end of "anuary, N>== worth of Danitorial supplies re(ained in storageA #oncordia 4ni)ersity e(ployee wor*s eight hours, at N1I per hour, on "anuary 21K howe)er, payday is not until /ebruary 2- Answer fro( the uni)ersity8s point of )iewEang #o(pany paid N2,9== for a fire insurance policy on "anuary .- $he policy co)ers the current (onth and the ne;t 11 (onths- Answer fro( Eang8s point of )iewA(ber Incorporated has its deli)ery )an repaired in "anuary for N.0= and charges the a(ount on accountJiegler #o(pany, a far( e<uip(ent co(pany, recei)es its phone bill at the end of "anuary for N.2= for "anuary calls- $he bill has not been paid to date&pina #o(pany recei)es and pays in "anuary a N.,1== in)oice fro( a consulting fir( for ser)ices recei)ed in "anuary/elicetti8s $a;i #o(pany pays a N9== in)oice fro( a consulting fir( for ser)ices recei)ed and recorded in Accounts Payable in Cece(berRe<uired: /or each of the "anuary transactions, Indicate the account titles that are affected and the type of each account +A for asset, L for liability, &E for shareholders8 e<uity, and E for e;pense,If an e;pense is to be recogni'ed in "anuary, indicate the a(ount- If an e;pense is not to be recogni'ed in "anuary, indicate why4se the following headings in structuring your solution:

L ., 2, I

E2W9Identifying Re)enues and E;penses

!ob8s !owling Inc- operates se)eral bowling centres for ga(es and e<uip(ent sales- $he transactions on the following page occurred in "uly .=11Re<uired: /or each transaction, indicate in the appropriate colu(n the account titles that are affected and the type of account +A for asset, L for liability, R for re)enue, and E for e;pense,, and the a(ount of cash recei)ed or paidIf a re)enue or e;pense is to be recogni'ed in "uly, indicate the a(ount- If a re)enue or e;pense is not to be recogni'ed in "uly, indicate whyE;plain why the difference between re)enues and e;penses is not e<ual to the net cash flow during "uly .=11-

Page 120 L 2 E2WA$i(ing of Re)enue Recognition 5odern E<uip(ent #orp- (anufactures special?purpose (achines for use in the (ining industry- In late April, the co(pany recei)ed an order fro( @ross 5ining #o(pany +@5#, for a special?purpose (achine to be deli)ered in two (onths- $he specific e)ents related to the production of this (achine are shown belowApril @5# placed an order for a special?purpose (achine to be (anufactured and deli)ered in two

.> 5ay 2 5ay 3 5ay 1. 5ay 12 5ay 13 5ay 1I 5ay 19 "une 19 "une 1> "une .I Re<uired:

(onthsRaw (aterials and co(ponents are ordered so that the (achine can be (anufacturedRecei)ed written confir(ation of the order fro( @5#5anufacture of the (achine is co(pleted$he (achine is shipped to @5#@5# recei)ed the (achineRecei)ed written confir(ation that the (achine was deli)ered to @5#An in)oice was sent to @5#@5# recei)es free after?sales ser)ice for the (achineA che<ue recei)ed fro( @5# in full pay(ent$he che<ue is cleared by the ban*-

Ehen should 5odern E<uip(ent #orp- recogni'e re)enue fro( the sale of the (achineG E;plainL 3 E2W0Ceter(ining the /inancial &tate(ent Effects of perating Acti)ities !ob8s !owling Inc- operates se)eral bowling centres +for ga(es and e<uip(ent sales,- /or each of the following transactions, co(plete the tabulation, indicating the a(ount and effect +1 for increase and . for decrease, of each transaction- +Re(e(ber that A L L M &E, R ? E L P, and P affects &E through retained earnings-, Erite NE if there is no effect- $he first transaction is pro)ided as an e;a(ple-

Page 12> L 3 E2W>Preparing an Inco(e &tate(ent Refer to the transactions in E2W0 +including the e;a(ple, and prepare an inco(e state(ent for !ob8s !owling Incfor the (onth of "uly .=11- 4se an inco(e ta; rate of 3= percentL 3

E2W1=Ceter(ining /inancial &tate(ent Effects of $he following transactions occurred during a recent year: Issued shares to organi'ers for cash +e;a(ple,!orrowed cash fro( the local ban*Purchased e<uip(ent on creditEarned re)enueK collected cashIncurred e;penses, on creditEarned re)enue, on creditPaid cash on account-

%arious $ransactions

Incurred e;pensesK paid cashEarned re)enueK collected three?fourths in cash and the rest on creditE;perienced theft of N1== cashCeclared and paid cash di)idends#ollected cash fro( custo(ers on accountIncurred e;pensesK paid four?fifths in cash and the rest on creditPaid inco(e ta; e;pense for the periodRe<uired: #o(plete the tabulation below for each of the transactions, indicating the effect +1 for increase and . for decrease, of each transaction- +Re(e(ber that A L L M &E, R M E L P, and P affects &E through retained earnings-, Erite NE if there is no effect- $he first transaction is pro)ided as an e;a(ple-

L 3 No*ia #orporation

E2W11Ceter(ining /inancial &tate(ent Effects of

%arious $ransactions

No*ia #orporation designs, de)elops, (anufactures, (ar*ets, and sells a wide range of teleco((unications software and hardware, including cell phones- No*ia also offers networ* security, peripherals, and ser)ice and support progra(s- $he following transactions occurred during a recent year- Euros are in (illionsIssued [I2 in shares to in)estors +e;a(ple,Purchased on account [2=,I92 of additional in)entory of raw (aterials used in asse(bling its (obile teleco((unication de)icesPaid [23 on long?ter( notesPage 13= &old [I=,A1= of products to custo(ers on accountK the cost of the products sold was [ 22,22ACeclared and paid cash di)idends of [.,=30-

Purchased [00> of additional property, plant, and e<uip(ent for cashIncurred [3,20= in selling e;penses with two?thirds paid in cash and the rest on accountEarned [2I2 interest on in)est(entsK recei)ed >= percent in cashIncurred [10I in interest e;pense +not yet paid,Re<uired: #o(plete the tabulation below for each of the transactions, indicating the effect +1 for increase and . for decrease, of each transaction- +Re(e(ber that A L L M &E, R M E L P, and P affects &E through retained earnings-, Erite NE if there is no effect- $he first transaction is pro)ided as an e;a(ple-

L 3 &ysco E2W1.Recording "ournal Entries &ysco, for(ed in 1>9>, is the largest 4-&- (ar*eter and distributor of food ser)ice products, ser)ing nearly .I=,=== restaurants, hotels, schools, hospitals, and other institutions- $he following su((ari'ed transactions are typical of those that occurred in a recent year: !orrowed N0= (illion fro( a ban*, signing a short?ter( notePro)ided N2A-I billion in ser)ice to custo(ers during the year, with N2.-3 billion on account and the rest recei)ed in cashPurchased plant and e<uip(ent for NI1I-> (illion in cashPurchased N.>-. billion in)entory on accountPaid N.-2 billion in salaries during the yearRecei)ed N29-3 billion on account paid by custo(ersPurchased and used fuel of N92A (illion in deli)ery )ehicles during the year +paid for in cash,Ceclared and paid N3>A-3 (illion in di)idends for the yearPaid N.9-. billion cash on trade payablesIncurred N3A (illion in utility usage during the yearK paid N2= (illion in cash and the rest on accountRe<uired:

Prepare a Dournal entry to record each of the transactions- Ceter(ine whether the accounting e<uation re(ains in balance and debits e<ual credits after each entryL 3 Research In 5otion E2W12Recording "ournal Entries Research In 5otion +RI5, designs, (anufactures, and (ar*ets wireless de)ices to (eet the co((unication needs of its global (ar*et- $he co(pany sells its !lac*!erry products to custo(ers in 9= countries around the worldRI5 also pro)ides co((unications ser)ers to custo(ers who need secure internal wireless co((unications- $he following hypothetical Cece(ber transactions are typical of those that occur each (onth +in thousands of dollars,: !orrowed N9== fro( the ban* on Cece(ber 1 with a si;?(onth note at 0 percent annual interest to finance its operations- $he principal and interest are due on the (aturity datePurchased legal software for corporate use for N2= cash on Cece(ber 1- $he software8s useful life is esti(ated at two years with 'ero residual )aluePurchased and recei)ed N1=,=== of raw (aterials for use in asse(bling its wireless productsIncurred N.,.== in routine selling e;penses for !lac*!erry#losed a contract of N0,3== to be filled in "anuary and recei)ed cash in full pay(ent&old products in Cece(ber for N1==,=== in cashPage 131 &old products on account in Cece(ber for N0A,===Recei)ed a N.,=== deposit fro( a custo(er in 5e;ico for deli)ery of wireless products in "anuaryPaid half of the a(ount of the transaction in +c,Recei)ed N9=,=== on account fro( the custo(ers in +g,Paid N1I,=== in wages to (anufacturing e(ployees for the (onth of Cece(berRe<uired: Prepare a Dournal entry to record each transaction- +Re(e(ber to chec* that debits e<ual credits and that the accounting e<uation is in balance after each transaction-, &how the effects +direction and a(ount, of each transaction on profit and cashAssu(e that RI5 had a N1.,=== balance in trade recei)ables at the beginning of the year- Ceter(ine the ending

balance in the trade recei)ables account- &how your wor* in $?account for(atL 3 E2W13Recording "ournal Entries Rowland X &ons Air $ransport &er)ice Inc- has been in operation for three years- $he following transactions occurred in /ebruary: /ebruar y 1 . 3 A 1= 13 10 .I .A Re<uired: Prepare a Dournal entry to record each transaction- !e sure to categori'e each account as an asset +A,, liability +L,, shareholders8 e<uity +&E,, re)enue +R,, or e;pense +E,&how the effects +direction and a(ount, of each transaction on profit and cashL 2, 3, I, 9 E2W1IAnaly'ing the Effects of $ransactions in $?Accounts, and #o(puting #ash !asis )ersus Accrual !asis Profit &brocchi8s Piano Rebuilding #o(pany has been operating for one year +.=1=,- At the start of .=11, its inco(e state(ent accounts had 'ero balances and the account balances on its state(ent of financial position were as follows: #ash $rade recei)ables &upplies N1=,=== I=,=== .,3== $rade payables Ceferred re)enue +deposits, Note payable +due in three years, &hare capital Retained earnings N19,=== 9,3== 0=,=== Paid N1,>== for rent of hangar space in /ebruaryPurchased fuel costing N3I= on account for the ne;t flight to EinnipegRecei)ed custo(er pay(ent of N>I= to ship se)eral ite(s to 5ontreal ne;t (onth/lew cargo fro( ttawa to Ed(ontonK the custo(er paid N1,.3= for the air transportPaid pilot N3,=== in wages for flying in "anuaryPaid N9== for an ad)ertise(ent in the local paper, to run on /ebruary 1>/lew cargo for two custo(ers fro( Regina to #algary for N1,0==K one custo(er paid NI== cash and the other as*ed to be billedPurchased spare parts for the planes costing N1,2I= on accountCeclared a N1,2== cash di)idend to be paid in 5arch-

E<uip(ent Land

19,=== 1.,===

19,=== 29,===

!uilding

93,===

Re<uired: #reate $?accounts for the accounts reported on the state(ent of financial position and for these additional accounts: rebuilding fees re)enue, rent re)enue, wages e;pense, and utilities e;pense- Enter the beginning balancesEnter the following "anuary .=11 transactions in the $?accounts, using the letter of each transaction as the reference: Recei)ed a NI== deposit fro( a custo(er who wanted her piano rebuiltRented a part of the building to a bicycle repair shopK recei)ed NI== for rent in "anuaryCeli)ered 1= rebuilt pianos to custo(ers who paid N19,=== in cashPage 13. Recei)ed N0,=== fro( custo(ers as pay(ent on their accountsRecei)ed an electric and gas utility bill for N3.= to be paid in /ebruaryrdered N0== in suppliesPaid N1,>== on account to suppliersRecei)ed fro( the ho(e of 5s- &brocchi, the (aDor shareholder, an N0I= tool +e<uip(ent, to use in the businessPaid N0,I== in wages to e(ployees for wor* in "anuaryCeclared and paid a cash di)idend of N2,===Recei)ed and paid for the supplies ordered in +f,4sing the data fro( the $?accounts, calculate the a(ounts for the following on "anuary 21, .=11: Re)enues, N . E;penses, N L Profit, N Assets, N L Liabilities, N M &hareholders8 E<uity, N #alculate the co(pany8s profit for "anuary by using the cash basis of accounting- Ehy does this differ fro( the accrual basis profit in +2, abo)eG #alculate the return on assets ratio for "anuary .=11- If the co(pany had a return on assets ratio of 11 percent in Cece(ber .=1= and 1= percent in No)e(ber .=1=, what does your co(putation suggest to you about &brocchi8s

Piano Rebuilding #o(panyG Ehat would you state in your reportG L 3

E2W19Analy'ing the Effects of $ransactions on the Refer to E2W1IRe<uired:

&tate(ent of #ash /lows

4se the following chart to identify whether each of the transactions in E2W1I results in a cash flow effect fro( operating + ,, in)esting +I,, or financing +/, acti)ities, and indicate the direction and the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write Onone-P $he first transaction is pro)ided as an e;a(ple-

L 3 E2W1APreparing an Inco(e &tate(ent and a Partial &tate(ent of #ash /lows Refer to E2W1IRe<uired: 4se the ending balances in the $?accounts in E2W1I to prepare the following: An inco(e state(ent for "anuary .=11, in good for($he operating acti)ities section of the state(ent of cash flows for "anuary .=11, in good for(E;plain the difference between the profit and the cash flow fro( operating acti)ities co(puted in +1,L 3 E2W10Analy'ing the Effects of $ransactions in $?Accounts @aren Gorewit and Pat Nally had been operating a catering business, $ra)elling Gour(et, for se)eral years- In 5arch .=1., the partners were planning to e;pand by opening a retail sales shop and decided to for( the business as a corporation called $ra)elling Gour(et Inc- $he following transactions occurred in 5arch .=1.: Recei)ed N1=,=== cash fro( each of the two shareholders to for( the corporation, in addition to N.,=== in trade recei)ables, NI,2== in e<uip(ent, a )an +e<uip(ent, appraised at a fair (ar*et )alue of N13,I==, and N1,.== in suppliesPurchased a )acant store in a good location for N9=,=== with a N1.,=== cash down pay(ent and a (ortgage fro(

a local ban* for the re(ainder!orrowed N.I,=== fro( the local ban* on a 1= percent, one?year notePurchased for cash, and used food and paper products costing N0,02=5ade and sold food at the retail store for N1=,>== in cash#atered four parties in 5arch for N2,.==K N.,=== was billed, and the rest was recei)ed in cashRecei)ed a N2.= telephone bill for 5arch to be paid in AprilPaid N213 for gas to use the )an in 5archPage 132 Paid NI,=0= for wages of e(ployees who wor*ed in 5archPaid a N2== di)idend fro( the corporation to each ownerPaid N1I,=== to purchase e<uip(ent +refrigerated display cases, cabinets, tables, and chairs,, and N>,0A= to reno)ate and decorate the new store +added to the cost of the building,Re<uired: &et up appropriate $?accounts for cash, trade recei)ables, supplies, e<uip(ent, building, trade payables, note payable, (ortgage payable, share capital, retained earnings, food sales re)enue, catering sales re)enue, cost of food and paper products, utilities e;pense, wages e;pense, and gasoline e;penseRecord in the $?accounts the effects of each transaction for $ra)elling Gour(et Inc-, in 5arch- Identify the a(ounts with the letters, starting with +a,&how the effects +direction and a(ount, of each transaction on profit and cashL 3

E2W1>Analy'ing the Effects of $ransactions on the Refer to E2W10Re<uired:

&tate(ent of #ash /lows

4se the following chart to identify whether each of the transactions in E2W10 results in a cash flow effect fro( operating + ,, in)esting +I,, or financing +/, acti)ities, and indicate the direction and the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write Onone-P $he first transaction is pro)ided as an

e;a(ple-

L 3 E2W.=Preparing an Inco(e &tate(ent and a Partial &tate(ent of #ash /lows Refer to E2W10Re<uired: 4se the ending balances in the $?accounts in E2W10 to prepare the following: An inco(e state(ent for 5arch .=1., in good for($he operating acti)ities section of the state(ent of cash flows for 5arch .=1., in good for(E;plain the difference between the profit and the cash flow fro( operating acti)ities co(puted in +1,L ., 2, 3 E2W.1Inferring perating $ransactions and Preparing an Inco(e &tate(ent and a &tate(ent of /inancial Position _:elp 5e &ol)e It_ %ideo $utorial 2?. @iernan @ite #o(pany +a corporation, sells and repairs *ites fro( (anufacturers around the world- Its stores are located in rented space in (alls and shopping centres- Curing its first (onth of operations ended April 2=, .=1., @iernan @ite #o(pany co(pleted eight transactions with the dollar effects indicated in the following schedule:

Page 133 Re<uired: Erite a brief e;planation of transactions +a, through +h,- E;plain any assu(ptions that you (ade#o(pute the ending balance in each account and prepare an inco(e state(ent for the co(pany for April .=1. and a classified state(ent of financial position as at April 2=, .=1.L 9

E2W..#o(puting and E;plaining the $otal Asset $urno)er Ratio $he following data are fro( annual reports of "ustin8s "ewellery #o(pany:

#o(pute "ustin8s total asset turno)er ratio and its return on assets for .=1= and .=11- Ehat do these results suggest to you about "ustin8s "ewellery #o(panyG L 3, 9

E2W.2Analy'ing the Effects of $ransactions by $urno)er Ratio as a /inancial Analyst

4sing $?Accounts and Interpreting the $otal Asset

Internet 5ar*eting Inc- +I5I,, which has been operating for three years, pro)ides (ar*eting consulting ser)ices worldwide for dot?co( co(panies- 6ou are a financial analyst assigned to report on the effecti)eness of I5I8s (anage(ent tea( at (anaging its assets- At the start of .=11 +its fourth year,, I5I8s $?account balances were as follows- Collars are in thousands-

Page 13I Re<uired: 4sing the data fro( these $?accounts, co(plete the accounting e<uation on "anuary 1, .=11Assets,N Liabilities, N &hareholders8 E<uity, N L M

Enter the following .=11 transactions in the $?accounts: Recei)ed NA,A== cash fro( clients on account-

Pro)ided NA=,=== in ser)ices to clientsK recei)ed NI=,=== in cash and the rest on accountRecei)ed NI== in inco(e on in)est(entsPaid N.=,=== in wages, N.1,0== in tra)el, N1.,=== rent, and N.,=== on trade payablesRecei)ed a utility bill for N1,2== for the current (onthPaid N9== in di)idends to shareholdersRecei)ed N.,=== in cash fro( clients in ad)ance of ser)ices that I5I will pro)ide ne;t year#o(pute ending balances in the $?accounts to deter(ine the (issing a(ounts on Cece(ber 21, .=11: Re)enues, N . E;penses, N L Profit, N Assets, N I Liabilities, N 1 &hareholders8 E<uity, N #alculate the total asset turno)er ratio for .=11- If the co(pany had an asset turno)er ratio of .-== in .=1= and of 1-0= in .==>, what does your co(putation suggest to you about I5IG Ehat would you state in your reportG L 3 E2W.3Inferring $ransactions and #o(puting Effects by 4sing $?Accounts A recent annual report of a leading business and financial news co(pany included the following accounts- Collars are in (illions-

Re<uired: Cescribe the typical transactions that affect each $?account +i-e-, the econo(ic e)ents that occur to (a*e these accounts increase and decrease,#o(pute the (issing a(ounts for each $?accountL 9

E2W.I#o(puting and Interpreting the $otal Asset

$urno)er Ratio and the Return on Assets Ratio

!ianca #orp- and 4'(a Inc- operate in the sa(e industry- $he co(panies8 total assets, re)enue, and profit for the years .=1=W.=12 are pro)ided below- All a(ounts are in thousands of dollars!ianca #orp$otal assets Re)enue Profit Interest e;pense, net of ta; 4'(a Inc$otal assets Re)enue Profit Interest e;pense, net of ta; Re<uired: #o(pute the total asset turno)er ratio and the return on assets ratio for each co(pany for each of the years .=11, .=1., and .=12!ased on the two sets of ratios that you co(puted, which co(pany was (ore efficient in (anaging its assets during the .=1=W.=12 periodG E;plainPage 139 PR !LE5& L 3 P2W1Recording Non?<uantitati)e "ournal Entries +AP2W1, $he following list includes a series of accounts for :eiss #orporation, which has been operating for three years$hese accounts are listed and nu(bered for identification, and followed by a series of transactions- /or each transaction, indicate the account+s, that should be debited and credited by entering the appropriate account nu(ber+s, to the right of each transaction- If no Dournal entry is needed, use nu(ber 19- $he first transaction is used as an e;a(pleN 9I,=== 1I=,=== 3,0== 3== N 9=,=== 1I3,=== I,=== I== N I=,=== 133,=== 2,0== 3== N 3=,=== 12=,=== .I,=== 2== .=12 N 3=,=== 12=,=== .I,=== 1,=== .=1. N I=,=== 133,=== 2,0== 0== .=11 N 9=,=== 1I3,=== I,=== A== .=1= N 9I,=== 1I=,=== 3,0== 0==

L 3 P2W.Recording "ournal Entries +AP2W., #had Polo)ic* organi'ed a new co(pany, #ollege#aps Inc$he co(pany operates a s(all store in an area (all and speciali'es in baseball?type caps with logos printed on the(#had, who is ne)er without a cap, belie)es that his target (ar*et is college students- 6ou ha)e been hired to record the transactions occurring in the first two wee*s of operations5a Issued 1,=== shares for N2I per sharey1 5a !orrowed N3=,=== fro( the ban* to pro)ide additional funding to begin operations- $he interest rate y1 is 1= percent annuallyK principal and interest are due in .3 (onths5a Paid N1,.== for the current (onth8s rent and another N1,.== for ne;t (onth8s renty1 5a Paid N1,0== for a one?year fire insurance policy +recorded as a prepaid e;pense,y1 5a Purchased furniture and fi;tures for the store for N10,=== on account- $he a(ount is due within 2= y2 days5a Purchased a supply of 4ni)ersity of Eaterloo, 6or* 4ni)ersity, and &aint 5ary8s 4ni)ersity baseball y3 caps for the store for N.,1== cash5a Placed ad)ertise(ents in local college newspapers for a total of N29= cashyI 5a y> &old caps totalling NI==, half of which was charged on account- $he cost of the caps sold was N.I=5a 5ade full pay(ent for the furniture and fi;tures purchased on account on 5ay 2y 1= 5a Recei)ed N1== fro( a custo(er on accounty 13 Page 13A

Re<uired: Prepare a Dournal entry to record each of the transactions- !e sure to categori'e each account as an asset +A,, liability +L,, shareholders8 e<uity +&E,, re)enue +R,, or e;pense +E,#o(plete the tabulation below for each of the transactions, indicating the effect +1 for increase and . for decrease, of each transaction- Erite NE if there is no effect- $he first transaction is pro)ided as an e;a(ple- +Re(e(ber that A L L M &E, R ? E L P, and P affects &E through retained earnings-,

L 3, I P2W2Analy'ing the Effects of $ransactions by 4sing $?Accounts, Preparing an Inco(e &tate(ent, E)aluating the $otal Asset $urno)er Ratio and the Return on Assets as a 5anager+AP2W2, E;cel $e(plate Paula Abboud, a connoisseur of fine chocolate, opened Paula8s Passions Inc- in #ollegetown on /ebruary 1, .=11$he shop speciali'es in a selection of gour(et chocolate candies and a line of gour(et ice crea(- 6ou ha)e been hired as (anager- 6our duties include (aintaining the store8s financial records- $he following transactions occurred in /ebruary .=11, the first (onth of operations: Recei)ed contributions of N1I,=== in total fro( four shareholders to for( the corporationPaid store rent for three (onths at N0== per (onth +recorded as prepay(ent,Purchased supplies for N3== cashPurchased on account and recei)ed candy for NI,===, due in 9= daysbtained a N1=,=== loan at the ban* and signed a note at 1. percent annual interest- $he principal and interest are due in a lu(p su( in two years4sed the (oney fro( +e, to purchase a co(puter for N.,=== +for record*eeping and in)entory trac*ing,- $he rest was used to buy furniture and fi;tures for the storePlaced a grand?opening ad)ertise(ent in the local paper for N3.I cash5ade sales on %alentine8s Cay totalling N1,0==K N1,I.I was in cash and the rest on accounts- $he cost of the candy sold was N1,===5ade a NI== pay(ent on trade payablesIncurred and paid e(ployee wages of NI1=#ollected trade recei)ables of NI= fro( custo(ers5ade a repair on one of the display cases for N123 cash5ade cash sales of N.,9== during the rest of the (onth- $he cost of the goods sold was N1,3==Incurred interest e;pense of N3==, payable in the futureRe<uired: &et up appropriate $?accounts for cash, trade recei)ables, supplies, (erchandise in)entory, prepaid rent, e<uip(ent, furniture and fi;tures, trade payables, notes payable, interest payable, share capital, sales re)enue, cost of sales, ad)ertising e;pense, wages e;pense, repair e;pense, and interest e;pense- All accounts begin with 'ero balancesRecord in the $?accounts the effects of each transaction for Paula8s Passions in /ebruary, referencing each transaction in the accounts with the transaction letter- &how the ending balances in the $?accountsPrepare an inco(e state(ent for /ebruary .=11Erite a short (e(o to Paula offering your opinion on the results of operations during the first (onth of businessAfter three years in business, you are being e)aluated for a pro(otion- ne (easure is how efficiently you (anaged the assets of the business- $he following data are a)ailable:

.=12^ $otal assets $otal liabilities $otal shareholders8 e<uity $otal sales Profit N0=,=== 3I,=== 2I,=== 0I,=== .=,===

.=1. N3I,=== .=,=== .I,=== AI,=== 1=,===

.=11 N2I,=== 1I,=== .=,=== I=,=== 3,===

^At the end of .=12, Paula decided to open a second store, re<uiring loans and in)entory purchases prior to the opening in early .=13Page 130 #o(pute the total asset turno)er ratio and the return on assets for .=1. and .=12 and e)aluate the results- Co you thin* you should be pro(otedG EhyG $he co(pany is subDect to an inco(e ta; rate of 2= percentL 3 P2W3Analy'ing the Effects of $ransactions on the &tate(ent of #ash /lows +AP2W3, Refer to P2W2Re<uired: 4se the following chart to identify whether each of the transactions in P2W2 results in a cash flow effect fro( operating + ,, in)esting +I,, or financing +/, acti)ities, and indicate the direction and the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write Onone-P $he first transaction is pro)ided as an e;a(ple-

L 3, I #anada Post P2WIAnaly'ing the Effects of $ransactions by 4sing $?Accounts, Preparing /inancial &tate(ents, and E)aluating the $otal Asset $urno)er and Return on Assets Ratios +AP2WI, E;cel $e(plate $he following are se)eral Cece(ber 21, .==0, account balances +in (illions of dollars, fro( a recent annual report of #anada Post #orporation, followed by se)eral typical transactions- $he corporation8s )ision is described in the annual report as follows: #anada Post will be a world leader in pro)iding inno)ati)e physical and electronic deli)ery solutions, creating )alue for our custo(ers, e(ployees, and all #anadiansAccount Non?current assets $rade payables Prepay(ents Accrued liabilities Long?ter( borrowings Ceferred re)enues !alance N.,=23 39> A1 I=> A3 .=2 Account E<uity of #anada Recei)ables ther non?current assets #ash In)est(ents +long?ter(, ther non?current !alance N1,I22 I0. 1,223 9=I >9I .,0=2

liabilities $hese accounts ha)e nor(al debit or credit balances, but are not necessarily in good order- $he following hypothetical transactions +in (illions of dollars, occurred the ne;t (onth +fro( "anuary 1, .==>, to "anuary 21, .==>,: Pro)ided deli)ery ser)ice to custo(ers, recei)ing NA.= in trade recei)ables and N9= in cashPurchased new e<uip(ent costing N019K signed a long?ter( notePaid NA3 cash to rent e<uip(ent, with N93 for rental this (onth and the rest for rent for the first few days in /ebruary&pent N2>9 cash to (aintain and repair facilities and e<uip(ent during the (onth#ollected N9I. fro( custo(ers on account!orrowed N>= by signing a long?ter( notePaid e(ployees N20= during the (onthPurchased for cash and used N3> in suppliesPaid N103 on trade payablePage 13> rdered NA. in spare parts and suppliesRe<uired: &et up $?accounts for the preceding list and enter the respecti)e balances- +6ou will need additional $?accounts for inco(e state(ent accounts-, /or each transaction, record the effects in the $?accounts- Label each by using the letter of the transaction#o(pute ending balances&how the effects +direction and a(ount, of each transaction on profit and cashPrepare in good for( an inco(e state(ent for "anuary .==>Prepare in good for( a classified state(ent of financial position as at "anuary 21, .==>Prepare the operating acti)ities section of the state(ent of cash flows for "anuary .==>, and e;plain the difference between the cash flow fro( operating acti)ities and the profit co(puted in +3,#o(pute the co(pany8s total asset turno)er ratio and its return on assets ratio- Ehat do these ratios suggest to you about #anada PostG Assu(e that the long?ter( note of N>= was signed on "anuary 21, and that interest has not accrued yetL 3, 9 Apple #o(puter P2W9Ceter(ining and Interpreting the Effects of $ransactions on Inco(e &tate(ent #ategories and Return on Assets +AP2W9, Apple #o(puter populari'ed both the personal co(puter and the easy?to?use graphic interface- $oday it co(petes against (any co(panies that rely on Intel (icroprocessors and the Eindows operating syste(- $he co(pany8s inco(e state(ent for a recent year is presented below +in (illions of 4-&- dollars,-

Re<uired: Assu(e that the following hypothetical additional transactions occurred during the fiscal year- #o(plete the

following tabulation, indicating the sign of the effect of each additional transaction +1 for increase, . for decrease, and NE for no effect,- #onsider each ite( independently and ignore inco(e ta;esRecorded sales on account of NA== and related cost of goods sold of N3AIIncurred additional research and de)elop(ent e;pense of N1==, which was paid in cashIssued additional co((on shares for N2I= cashCeclared and paid di)idends of N>=$ransaction abcdL I, 9!arric* Gold Eest "et Airlines Le Groupe "ean #outu Gross Profit perating Profit +Loss, Return on Assets

Page 1I= P2WA#o(puting and Analy'ing the $otal Asset +AP2WA, E;cel $e(plate $urno)er Ratio and the Return on Assets Ratio

A su((ary of selected historical results is presented below for three #anadian co(panies: !arric* Gold, Eest"et Airlines, and Le Groupe "ean #outu- Each of these co(panies has grown in si'e o)er ti(e by ac<uiring assets and in)esting in other co(panies- +A(ounts are in (illions of dollars-, .==0 !arric* Gold $otal assets $otal re)enue Profit Interest e;pense, net of ta; perating cash flow Eest"et Airlines $otal assets $otal re)enue Profit +loss, Interest e;pense, net of ta; perating cash flow Le Groupe "ean #outu $otal assets $otal re)enue 1,>3> 1,9A9 .,22A 12,.9I I,I>1 11,132 I,9>I >,91A 1,233 2,=32 1,A.2 3,=I. 2,.A> .,I3> 1A0 I2 391 .,>03 .,1.A 1>2 IA I31 .,A.A 1,AA3 11I 3> 229 .,.12 1,2>2 .3 2> .3A 1,0AA 1,=I0 +1A, 22 133 1,3AA 093 91 10 1>. N.3,191 A,>12 A0I 19 .,.=9 N.1,>I1 9,22. 1,11> 0I 1,A2. N.1,2A2 I,92= 1,I=9 >I .,1.. N9,09. .,2I= 3=1 I A.9 N9,.0A 1,>2. .30 13 I=> NI,2I0 .,=2I .== 13 I1> .==A .==9 .==I .==3 .==2

Profit +loss, Interest e;pense, net of ta; perating cash flow

+.I1, 3 139

192 1>I 1>.

1=3 132 19I

1=3 112 ...

122 11 109

193 1I .13

Re<uired: #o(plete the following table by co(puting the total asset turno)er ratio and the return on assets ratio for each co(pany for each of the years .==A and .==0.==0 !arric* Gold $otal asset turno)er ratio Return on assets +R A, Eest"et Airlines $otal asset turno)er ratio Return on assets +R A, Le Groupe "ean #outu $otal asset turno)er ratio Return on assets +R A, 1->0 =-=33 .-A2 =-=9. 1->0 =-=>3 =-A. =-=99 =-90 =-=21 =-92 =-=1 =-3= =-112 =-29 =-=9. =-22 =-=3I .==A .==9 .==I .==3

!ased on the co(puted ratios, ran* these co(panies fro( (ost successful to least successful in i(ple(enting their growth strategies and effecti)ely utili'ing their assetsEhich of these three co(panies appears to be in the best position at the end of .==0 to pay off its short?ter( liabilitiesG Ehat additional infor(ation would help you pro)ide a (ore definite answer to this re<uire(entG E;plainL 3, 9 #edar /air P2W0Recording "ournal Entries and Identifying Effects on the $otal Assets $urno)er Ratio E;cel $e(plate #edar /air, L- P- +Li(ited Partnership,, is one of the largest a(use(ent par* operators in the world, owning 11 a(use(ent par*s, fi)e outdoor water par*s, and one indoor water par*- Par*s in the 4nited &tates include #edar Point in hioK %alleyfair near 5inneapolisT&t- PaulK Corney Par* and Eildwater @ingdo( near Allentown, Pennsyl)aniaK Eorlds of /unT ceans of /un in @ansas #ityK and Great A(erica in &anta #lara, #alifornia- It also operates #anada8s Eonderland, near $oronto- $he following are su((ari'ed transactions si(ilar to those that occurred in a recent year +a(ounts in thousands of dollars,: Page 1I1 Guests at the par*s paid NI99,.99 cash in ad(issions$he pri(ary operating e;penses +such as e(ployee wages, utilities, and repairs and (aintenance, for the year were N310,II=, with N2>0,IA3 paid in cash and the rest on accountInterest paid on long?ter( borrowings was N1.>,I91$he par*s sell food and (erchandise and operate ga(es- $he cash recei)ed during the year for these co(bined acti)ities was N2II,>1A$he cost of products sold during the year was N>=,9.9#edar /air purchased and built additional buildings, rides, and e<uip(ent during the year, paying N02,301 in cash$he (ost significant assets for the co(pany are land, buildings, rides, and e<uip(ent- $herefore, a large e;pense for #edar /air is depreciation e;pense +related to the using of these assets to generate re)enues during the year,-

$he a(ount for the year was N1.3,I== +credit accu(ulated depreciation,Guests (ay stay at acco((odations owned by the co(pany at the par*s- Curing the year, acco((odations re)enue was NA3,=3>K NA2,91. was paid by the guests in cash and the rest was on account#edar /air paid N1A,3I= on notes payable$he co(pany purchased N>.,2.9 in food and (erchandise in)entory for the year, paying N>=,I20 in cash and the rest on account$he selling, general, and ad(inistrati)e e;penses +such as the president8s salary and ad)ertising for the par*s, those not classified as operating e;penses, for the year were N121,00.K N12=,I2> was paid in cash and the rest was on account#edar /air paid N9,3I. on trade payables during the yearRe<uired: Prepare a Dournal entry to record each of these transactions- 4se the letter of each transaction as its reference&how the effects +direction and a(ount, of each transaction on profit and cashIndicate the direction of the effect +increase, decrease, or no effect, of each of the transactions +a, through +l, on the total asset turno)er ratio, and pro)ide an e;planation for your answer- #edar /air8s total asset turno)er ratio was =-I9 in the pre)ious year- /or e;a(ple, transaction+a, increases the ratio- !oth sales and total assets would increase- &ince the ratio is less than 1-=, the increase in sales +the nu(erator, is proportionally higher than the increase in total assets +the deno(inator,L 9 P2W>Analy'ing the Effects of $ransactions on the &tate(ent of #ash /lows Refer to P2W0, and use the following chart to identify whether each transaction in P2W0 results in a cash flow effect fro( operating + ,, in)esting +I,, or financing +/, acti)ities, and indicate the direction and a(ount of the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write Onone-P $he first transaction is pro)ided as an e;a(ple$ransaction perating, In)esting, or /inancing Effect Cirection and A(ount of the Effect MI99,.99 Page 1I. AL$ERNA$E PR !LE5& L 3 AP2W1Recording Non?<uantitati)e "ournal Entries +P2W1, $he following is a series of accounts for rti' X rti' Incorporated, which has been operating for two years- $he accounts are listed and nu(bered for identification, followed by a series of transactions- /or each transaction, indicate the account+s, that should be debited and credited by entering the appropriate account nu(ber+s, to the right of each transaction- If no Dournal entry is needed, write OnoneP after the transaction- $he first transaction is gi)en as an e;a(ple-

+a,

L 3 AP2W.Recording "ournal Entries +P2W., Rhonda !ennett is the president of &er)icePro Inc-, a co(pany that pro)ides te(porary e(ployees for not? for?profit co(panies&er)icePro has been operating for fi)e yearsK its re)enues are increasing with each passing year6ou ha)e been hired to help Rhonda in analy'ing the following transactions for the first two wee*s of April: Apr . Purchased office supplies for NI== on accountil 2 Recei)ed the telephone bill for N.3II !illed 4nited Eay N1,>I= for te(porary ser)ices pro)ided0 Paid N.I= for supplies purchased and recorded on account last period0 Placed an ad)ertise(ent in the local paper for N3== cash> Purchased a new co(puter for the office costing N.,2== cash1= Paid e(ployee wages of N1,.==- f this a(ount, N.== had been earned and recorded in the prior periodRecei)ed N1,=== on account fro( 4nited EayPurchased land as the site of a future office for N1=,===- Paid N.,=== down and signed a note payable for the balance- $he note is due in fi)e years and has an annual interest rate of 1= percentIssued .,=== additional shares for N3= per share in anticipation of building a new office!illed /a(ily X #hildren8s &er)ice N.,=== for ser)ices renderedPage 1I2 Re<uired: Prepare a Dournal entry to record each of the transactions- !e sure to categori'e each account as an asset +A,, liability +L,, shareholders8 e<uity +&E,, re)enue +R,, or e;pense +E,#o(plete the tabulation below for each of the transactions, indicating the effect +1 for increase and . for decrease, of each transaction- Erite NE if there is no effect- $he first transaction is pro)ided as an e;a(ple- +Re(e(ber that A L L M &E, R ? E L P, and P affects &E through retained earnings-,

11 1. 12 13

L 3, 9 AP2W2Analy'ing the Effects of $ransactions by 4sing $?Accounts, Preparing an Inco(e &tate(ent, E)aluating the $otal Asset $urno)er Ratio and the Return on Assets as a 5anager +P2W2, Green &tables Inc- was established on April 1, .=11- $he co(pany pro)ides stables, care for ani(als, and grounds for riding and showing horses- 6ou ha)e been hired as the new assistant controller- $he following transactions for April .=11 are pro)ided for your re)iew: Recei)ed contributions fro( fi)e in)estors of NAI,=== in cash +N1I,=== each,, a barn )alued at N1==,===, and land )alued at NAI,===- Each in)estor recei)ed I,=== shares!uilt a s(all barn for NI=,===- $he co(pany paid half the a(ount in cash and signed a three?year note payable for the balance on April 1, .=11Pro)ided ani(al care ser)ices, all on credit, for N1I,.9=Rented stables to custo(ers who cared for their own ani(als, and recei)ed cash pay(ent of N19,2==Recei)ed fro( a custo(er N1,0== to board her horse in April, 5ay, and "une +record as deferred re)enue,Purchased straw +a supply in)entory, on account for N3,92=Paid N03= in cash for water utilities e;pense incurred in the (onthPaid N1,A== on trade payables for pre)ious purchasesRecei)ed N2,=== fro( custo(ers on trade recei)ablesPaid NI,9== in wages to e(ployees who wor*ed during the (onthPurchased a one?year insurance policy for N1,0== at the end of the (onthRecei)ed an electric utility bill for N.,12= for usage in AprilK the bill will be paid ne;t (onthPaid NI== cash di)idend to each of the in)estors at the end of the (onthRe<uired: &et up appropriate $?accounts- All accounts begin with 'ero balancesRecord in the $?accounts the effects of each transaction for Green &tables in April, referencing each transaction in the accounts with the transaction letter- &how the ending balances in the $?accountsPrepare an inco(e state(ent at the end of April .=11, as well as a classified state(ent of financial position as at April 2=, .=11Erite a short (e(o to the fi)e owners, offering your opinion on the results of operations during the first (onth of businessPage 1I3 After three years in business, you are being e)aluated for a pro(otion to chief financial officerhow efficiently you (anaged the assets of the business- $he following data are a)ailable: .=12^ $otal assets $otal liabilities $otal shareholders8 e<uity $otal sales Profit N30=,=== 1.I,=== 2II,=== 3I=,=== I=,=== .=1. N2.=,=== .0,=== .>.,=== 3==,=== 2=,=== .=11 N2==,=== 2=,=== .A=,=== 29=,=== +1=,===, ne (easure is

^At the end of .=1., Green &tables decided to build an indoor riding arena for gi)ing lessons year?round- $he co(pany borrowed construction funds fro( a local ban* and the arena was opened in early .=13#o(pute the total asset turno)er ratio and the return on assets for .=1. and .=12 and e)aluate the results- Co you thin* you should be pro(otedG EhyG Ignore interest on the long?ter( note related to +b,-

L 3 AP2W3Analy'ing the Effects of $ransactions on the &tate(ent of #ash /lows +P2W3, Refer to AP2W2Re<uired: 4se the following chart to identify whether each of the transactions in AP2W2 results in a cash flow effect fro( operating + ,, in)esting +I,, or financing +/, acti)ities, and indicate the direction and the effect on cash +1 for increase and . for decrease,- If there is no cash flow effect, write Onone-P $he first transaction is pro)ided as an e;a(ple$ransaction perating, In)esting, or /inancing Effect / Cirection and A(ount of the Effect MAI,===

+a, L 3, I, 9 Gildan Acti)ewear

AP2WIAnaly'ing the Effects of $ransactions by 4sing $?Accounts, Preparing /inancial &tate(ents, and E)aluating the $otal Asset $urno)er and Return on Assets Ratios +P2WI, $he following are the su((ary account balances fro( a recent state(ent of financial position of Gildan Acti)ewear- $he accounts are followed by a list of hypothetical transactions for the (onth of "anuary .=11- $he following accounts are shown in (illions of dollars#ash N 92I .,..> 1,I=2 II1 .,I10 $rade payables N1,0..

Long?ter( borrowings $rade recei)ables In)entories Ceferred inco(e ta;es +credit, Property and e<uip(ent, net

Inco(e ta; payable Prepay(ents Retained earnings ther non?current assets

2== 19 3,.99 1,1.9

1=,AI>

&hare capital

2,3II

$he accounts ha)e nor(al debit or credit balances, but they are not necessarily listed in good orderPurchased new e<uip(ent costing N1I= (illion by issuing long?ter( debtRecei)ed N>== (illion on trade recei)ablesRecei)ed and paid the telephone bills for N1 (illionEarned NI== (illion in sales to custo(ers on accountK the cost of sales was N2== (illionPaid e(ployees N1== (illion for wages earned in "anuaryPaid half of the inco(e ta;es payablePurchased in)entory for N.2 (illion on accountPrepaid rent for /ebruary for a warehouse for N1. (illionPaid N1= (illion of long?ter( borrowings and N1 (illion in interest on the debtPurchased a patent +an intangible asset, for N0 (illion cashPage 1II Re<uired: &et up $?accounts for the preceding list and enter the respecti)e balances- +6ou will need additional $?accounts for

inco(e state(ent accounts-, /or each transaction, record the effects in the $?accounts- Label each by using the letter of the transaction#o(pute ending balances&how the effects +direction and a(ount, of each transaction on profit and cashPrepare in good for( an inco(e state(ent for the (onth of "anuary .=11 and a classified state(ent of financial position as at "anuary 21, .=11Prepare the operating acti)ities section of the state(ent of cash flows for "anuary .=11, and e;plain the difference between the cash flow fro( operating acti)ities and the profit co(puted in +2,#o(pute the co(pany8s total asset turno)er ratio- Ehat does this ratio suggest to you about Gildan Acti)ewearG L 3, 9 !arnes X Noble IncAP2W9Ceter(ining and Interpreting the Effects of $ransactions on Inco(e &tate(ent #ategories and Return on Assets +P2W9, !arnes X Noble Inc- re)olutioni'ed boo*selling by (a*ing its stores public spaces and co((unity institutions where custo(ers (ay browse, find a boo*, rela; o)er a cup of coffee, tal* with authors, and Doin discussion groups- $oday it is fighting increasing co(petition not only fro( traditional sources but also fro( online boo*sellers- Presented here is a recent inco(e state(ent +in (illions,-

Re<uired: Assu(e that the following hypothetical additional transactions occurred during the fiscal year: +a, recorded and recei)ed interest inco(e of N13, +b, purchased N>I of additional in)entory on open account, +c, recorded and paid additional ad)ertising e;pense of N1>, and +d, issued additional co((on shares for N>= cash#o(plete the following tabulation, indicating the sign of the effect of each additional transaction +1 for increase, . for decrease, and NE for no effect,- Assu(e that the co(pany8s return on assets is less than 1 prior to these transactions- #onsider each ite( independently and ignore inco(e ta;es$ransaction abcdL I, 9 Gildan Acti)ewear Research In 5otion Andrew Peller perating Profit +Loss, Profi t Return on Assets

AP2WA#o(puting and Analy'ing the $otal Asset $urno)er Ratio and the Return on Assets Ratio +P2WA, E;cel $e(plate A su((ary of selected historical results is presented on the following page for three #anadian co(panies: Gildan Acti)ewear, Research In 5otion, and Andrew Peller- Each of these co(panies has grown in si'e o)er ti(e by ac<uiring assets and in)esting in other co(panies- +A(ounts are in (illions of dollars-,

.==0 Gildan Acti)ewear $otal assets $otal re)enue Profit Interest e;pense, net of ta; Research In 5otion $otal assets $otal re)enue Profit Interest e;pense, net of ta; Andrew Peller $otal assets $otal re)enue Profit Interest e;pense, net of ta; .9= .2A 11 3 I,I11 3,>13 1,.>3 =-2 N1,1=. 1,.I= 13I I-0

.==A

.==9

.==I

.==3

N0AI >93 12= 2->

NA.2 AA2 1=A .-I

NI>0 9I3 09 2-A

N30> I22 9= I-1

2,=0> .,2=3 92. =-.

.,21. .,=99 20. =-2

.,9.A 1,2I= .12 =-2

1,>2A I>I I2 =-.

.2> ..0 > 3 Page 1I9

... .1. 9 2

19. 190 0 .

139 1I9 > .

Re<uired: #o(plete the following table by co(puting the total asset turno)er ratio and the return on assets ratio for each co(pany for each of the years .==A and .==0.==0 Gildan Acti)ewear $otal asset turno)er ratio Return on assets +R A, Research In 5otion $otal asset turno)er ratio Return on assets +R A, Andrew Peller $otal asset turno)er ratio 1-1= 1-=> =-03 =-1II =-I> =-=>2 1-1A =-199 1-.= =-19I .==A .==9 .==I

Return on assets +R A,

=-=3A

=-=9I

!ased on the co(puted ratios, ran* these co(panies fro( (ost successful to least successful in i(ple(enting their growth strategies and effecti)ely utili'ing their assets to generate re)enue and profitAssu(e that you are interested in in)esting in one of these three co(panies, which co(pany would you chooseG Erite a brief report to Dustify your choice#A&E& ANC PR "E#$& /INCING ANC IN$ERPRE$ING /INAN#IAL IN/ R5A$I N L ., 3, 9 #adbury #P2W1/inding /inancial Infor(ation Refer to the financial state(ents and the acco(panying notes of #adbury plc, a)ailable onlineRe<uired: &tate the a(ount of the largest e;pense on the .==0 inco(e state(ent and describe the transaction represented by the e;pensePrepare the Dournal entry for interest e;pense for the year ended Cece(ber 21, .==0 +for this <uestion, assu(e that the a(ount has not yet been paid,Page 1IA Assu(ing that all net sales are on credit, how (uch cash did #adbury collect fro( custo(ersG +:int: 4se a $? account of trade recei)ables to infer collections-, Cescribe and contrast the purpose of an inco(e state(ent )ersus a state(ent of financial position#o(pute the co(pany8s total asset turno)er ratio and its return on assets for .==0- E;plain their (eaningL ., 2, I #adbury %s- Nestl7 #P2W.#o(paring #o(panies Annual Reports of #adbury plc Refer to the financial state(ents and the acco(panying notes of the Nestl7 Group gi)en in Appendi; A, and of #adbury plc, a)ailable onlineRe<uired: Ehat title does each co(pany call its inco(e state(entG E;plain what the ter( consolidated (eansEhich co(pany had higher profit at the end of its fiscal yearG^ #o(pute the total asset turno)er ratio and the return on assets for each co(pany for the (ost recent year- Ehich co(pany is utili'ing assets (ore effecti)ely to generate sales and profitG E;plain:ow (uch cash was pro)ided by operating acti)ities by each co(pany during the (ost recent yearG Ehat was the percentage change in operating cash flows for each co(pany during the (ost recent yearG +:int: Percentage change I Y#urrent year a(ount . Prior year a(ountZ ] Prior year a(ount-, :ow (uch did each co(pany pay in inco(e ta;es during the last fiscal year reported in the financial state(entsG Ehere did you find this infor(ationG Ehat seg(ents does #adbury report in the notesG Ehat does Nestl7 report about seg(entsG L 9 Nestl7

#P2W2#o(paring a #o(pany o)er $i(e Refer to the annual report for the Nestl7 Group in Appendi; ARe<uired: #o(pute the total asset turno)er ratio for fiscal years .==A and .==0- $he co(pany had #:/ 1=1,0=I (illion in total assets at Cece(ber 21, .==9In #hapter ., we discussed the debt?to?e<uity ratio- #o(pute this ratio for fiscal years .==A and .==0Ehat do your results fro( the trends in the two ratios suggest to you about Nestl7G ^$he a)erage e;change rate between the two currencies during .==0 was `1L #:/ 1->>/INAN#IAL REP R$ING ANC ANAL6&I& #A&E& L 2 !usiness Eee* #P2W3Interpreting the /inancial Press $he ctober 3, .==3, edition of !usiness Eee* presented an article titled O/u''y Nu(bersP on issues related to accrual accounting and its wea*nesses that ha)e led so(e corporate e;ecuti)es to (anipulate esti(ates in their fa)our, so(eti(es fraudulently- 6ou can access the article onlineRe<uired: Read the article and then answer the following <uestions: Ehat is accrual accountingG Ehat does the article8s title O/u''y Nu(bersP (eanG Ehat does the article suggest about the refor(s adopted by the 4-&- #ongress and the &E#G #RI$I#AL $:IN@ING #A&E& L 2, 9 #P2WI5a*ing a Cecision as a !an* Loan fficer: Analy'ing and Restating /inancial &tate(ents $hat :a)e 5aDor Ceficiencies +A #hallenging #ase, $o( 5artine' started and operated a s(all boat repair ser)ice co(pany during .=1.- :e is interested in obtaining a N1==,=== loan fro( your ban* to build a dry doc* to store boats for custo(ers in the winter (onths- At the end of the year, he prepared the following state(ents based on infor(ation stored in a large filing cabinet:

Page 1I0 $he following is a su((ary of co(pleted transactions: Recei)ed the following contributions to the business fro( the

owner when it was started in e;change for 1,=== shares in the new co(pany: !uilding $ools and e<uip(ent N.1,=== Land N.=,=== 1A,=== #ash 1,===

Earned ser)ice fees during .=1. of N0A,===K of the cash collected, N.=,=== was for deposits fro( custo(ers on wor* to be done by 5artine' during .=12Recei)ed the cash di)idends on shares of A!# Industrial purchased by $o( 5artine' as a personal in)est(ent si; years earlierIncurred e;penses during .=1., N91,===Ceter(ined a(ount of supplies on hand +unused, at the end of .=1., NA==Re<uired: Cid 5artine' prepare the inco(e state(ent on a cash basis or an accrual basisG E;plain how you can tell- Ehich basis should be usedG E;plain whyReconstruct the correct entries under accrual accounting principles and post the effects to $?accountsPrepare an accrual?based inco(e state(ent for .=1. and a state(ent of financial position at the end of .=1.E;plain +using footnotes, the reason for each change that you (a*e to the inco(e state(entEhat additional infor(ation would assist you in for(ulating your decision regarding the loan to 5r- 5artine'G !ased on the re)ised state(ents and additional infor(ation needed, write a letter to 5r- 5artine' e;plaining your decision at this ti(e regarding the loanL 2 #P2W9Proper 5easure(ent of Profit Paula 5anola*os purchased La /oret Inc-, a ba*ery, fro( Gianni /iori- $he purchase agree(ent included a pro)ision that re<uired Paula to pay Gianni .I percent of the ba*ery8s profit in each of the ne;t fi)e years- $he agree(ent stated that the ba*ery8s profit would be (easured in a Ofair and reasonable (anner,P but did not state that it would be (easured in accordance with the applicable financial reporting standards- Neither Paula nor Gianni were fa(iliar with accounting conceptsPage 1I> In (easuring profit, Paula used the following accounting policies: Re)enue was recogni'ed when cash was recei)ed fro( custo(ers- !ecause of the nature of the business, (ost custo(ers paid in cash, but a few custo(ers purchased (erchandise on account and were allowed to pay in 2= daysPaula set her annual salary at N9=,===, which Gianni has agreed was reasonable- &he also paid N2=,=== per year to her spouse and to each of her two teenage children- $hese fa(ily (e(bers did not wor* in the business on a regular basis, but they did help during busy periodsEee*ly e;penditures for eggs, (il*, flour, and other supplies were charged directly to supplies e;pense, as were the wee*ly groceries for Paula8s fa(ily$he ba*ery had (odern ba*ing e<uip(ent )alued at NI=,=== at the ti(e Paula purchased the co(pany- $he inco(e state(ent for the first year included a NI=,=== e<uip(ent e;pense related to these assetsInco(e ta;es e;pense included the a(ount paid by the corporation +which was co(puted correctly,, as well as the personal inco(e ta;es paid by )arious (e(bers of Paula8s fa(ily on the salaries they earned for wor*ing in the businessGianni was disappointed, howe)er, when Paula reported profit for the first year that was far below his e;pectations-

Re<uired: Ciscuss the fairness and reasonableness of Paula8s accounting policies- Identify the accounting principle or assu(ption that (ay ha)e been )iolatedCo you thin* that the net cash flow fro( operations +cash receipts (inus cash pay(ents, is higher or lower than the profit reported by PaulaG E;plainEhat ad)ice would you gi)e Gianni to ensure that the ba*ery8s profit would be (easured properly in future yearsG L 2 #P2WAE)aluating an Ethical Cile((a 5i*e @ru* is the (anager of a %ancou)er regional office for an insurance co(pany- As the regional (anager, his co(pensation pac*age co(prises a base salary, co((issions, and a bonus when the region sells new policies in e;cess of its <uota- 5i*e has been under enor(ous pressure lately, ste((ing largely fro( two factors- /irst, he is e;periencing a (ounting personal debt because of a fa(ily (e(ber8s illness- &econd, co(pounding his worries, the region8s sales of new policies ha)e dipped below the nor(al <uota for the first ti(e in years6ou ha)e been wor*ing for 5i*e for two years, and li*e e)eryone else in the office, you consider yourself luc*y to wor* for such a supporti)e boss- 6ou also feel great sy(pathy for his personal proble(s o)er the last few (onths- In your position as accountant for the regional office, you are only too aware of the drop in new policy sales and the i(pact this will ha)e on the (anager8s bonus- Ehile you are wor*ing late at year?end, 5i*e stops by your office5i*e as*s you to change the (anner in which you ha)e accounted for a new property insurance policy for a large local business- A che<ue for the pre(iu(, substantial in a(ount, ca(e in the (ail on Cece(ber 21, the last day of the reporting year- $he pre(iu( co)ers a period beginning on "anuary I- 6ou deposited the che<ue and correctly debited cash and credited a deferred re)enue account- 5i*e says, O:ey, we ha)e the (oney this year, so why not count the re)enue this yearG I ne)er did understand why you accountants are so pic*y about these things anywayI8d li*e you to change the way you ha)e recorded the transaction- I want you to credit a re)enue account- And anyway, I8)e done fa)ours for you in the past, and I a( as*ing for such a s(all thing in return-P Eith that, he lea)es for the dayRe<uired: :ow should you handle this situationG Ehat are the ethical i(plications of 5i*e8s re<uestG Eho are the parties who would be helped or har(ed if you co(plied with the re<uestG If you fail to co(ply with his re<uest, how will you e;plain your position to hi( in the (orningG Page 19= /INAN#IAL REP R$ING ANC ANAL6&I& $EA5 PR "E#$ L ., 2, I, 9 #P2W0$ea( ProDect: Analy'ing Inco(e &tate(ents and Ratios As a tea(, select an industry to analy'e- A list of co(panies classified by industry can be obtained by accessingwww-fpinfo(art-caV and then choosing O#o(panies by Industry-P 6ou can also find a list of industries and co(panies with each industry )iahttp:TTca-finance-yahoo-co(Tin)estingV +clic* on OAnnual ReportsP under O$oolsP,Each tea( (e(ber should ac<uire the annual report for a different publicly traded co(pany in the industry+Library files, the &ECAR ser)ice atwww-sedar-co(V, or the co(pany8s website are good sources-, Re<uired:

n an indi)idual basis, each tea( (e(ber should write a short report that answers the following <uestions about the selected co(pany- Ciscuss any patterns across the co(panies that you as a tea( obser)e- $hen, as a tea(, write a short report co(paring and contrasting your co(panies/or the (ost recent year, what isTare the (aDor re)enue account+s,G Ehat percentage is each to total operating re)enuesG +#o(puted as Re)enue A ] $otal re)enues-, /or the (ost recent year, what isTare the (aDor e;pense account+s,G Ehat percentage is each to total operating e;pensesG +#o(puted as E;pense A ] $otal e;penses-, Ratio Analysis Ehat do the total asset turno)er and the return on assets ratios (easure in generalG #o(pute these ratios for the last three yearsEhat do your results suggest about the co(panyG If a)ailable, find the industry ratio for the (ost recent year, co(pare it with your results, and discuss why you belie)e your co(pany differs or is si(ilar to the industry ratioCescribe the co(pany8s re)enue recognition policy, if reported- +4sually found in note . to the financial state(ents titled &ignificant Accounting Policies-, $he percentage of cash fro( operating acti)ities to profit (easures how liberal +i-e-, speeding up re)enue recognition or delaying e;pense recognition, or conser)ati)e +i-e-, ta*ing care not to record re)enues too early or e;penses too late, a co(pany8s (anage(ent is in choosing a(ong )arious re)enue and e;pense recognition policies- A ratio abo)e 1-= suggests (ore conser)ati)e policies and below 1-=, (ore liberal policies- #o(pute the percentage for the last three years- Ehat do your results suggest about the co(pany8s choice of accounting policiesG