WEYGANDT – KIESO - KIMMEL – TRENHOLM – WARREN - NOVAK
ACCOUNTING
PRINCIPLES
VOLUME 2
SEVENTH CANADIAN EDITION
Prepared by:
Debbie Musil, CPA, FCMA
Kwantlen Polytechnic University
CHAPTER 10:
CURRENT LIABILITIES AND
PAYROLL
Current Liabilities & Payroll
•
Determinable (Certain) Current Liabilities
–
–
–
–
–
–
–
•
Uncertain Liabilities
–
–
•
Provisions
Contingencies
Payroll
–
–
–
•
•
Accounts payable
Unearned revenues
Operating line of credit and bank overdraft
Short-term notes payable
Sales taxes
Property taxes
Current maturities of long-term debt
Employee payroll costs
Employer payroll costs
Recording the payroll
Financial Statement Presentation
Payroll Deductions (Appendix 10A)
–
–
Mandatory payroll deductions
Using payroll deduction tables
3
Chapter 10: Current Liabilities and Payroll
LEARNING OBJECTIVES
1. Account for determinable or certain current
liabilities.
2. Account for uncertain liabilities.
3. Determine payroll costs and record payroll
transactions.
4. Prepare the current liabilities section of the
balance sheet.
5. Calculate mandatory payroll deductions
(Appendix 10A).
4
Determinable (Certain)
Current Liabilities
• Obligations that are expected to be settled:
– Within one year of the balance sheet date,
or
– Within normal operating cycle
• Requires existence of a present obligation
• Determinable liabilities have known amount,
payee, due date
5
Accounts Payable
• Often the largest current liability on a
company’s balance sheet
• Entity buys goods from a supplier with the
agreement to pay at a later date
– Accounts Payable (trade payable) usually due
within 30 days
6
Unearned Revenues
• Payment received in advance when customer
order is placed
– Reported as a current liability
• As company provides goods or performs
service, revenue is recognized by reclassifying
amount from Unearned Revenue to Revenue
7
Operating Line of Credit and Bank Overdraft
• Pre-authorized borrowing
– Allows the company to borrow up to a preset limit when
needed
• May require collateral (security)
– Such as current assets, investments, or property, plant, and
equipment
• Used on a short-term basis
• Negative (overdrawn) cash balance is called bank
indebtedness, bank overdraft, or bank advances
8
Short-Term Notes Payable
• Obligations in the form of written promissory notes
• Usually require the borrower to pay interest
• Used instead of accounts payable
– Gives lender proof of obligation in case legal action is
needed to collect
• Issued for varying periods
– If due within one year of the balance sheet date, classified
as current liabilities
9
Short-Term Notes Payable (cont’d)
• Interest is recorded in the period the loan is
outstanding
• At maturity, interest must be updated for two
additional months
10
Short-Term Notes Payable (cont’d)
• Also, at maturity, the face value of the note plus
interest must be repaid
11
Sales Taxes
• Expressed as a percentage of the sales price of goods
sold to customers
• Includes goods and service tax (GST), provincial sales
tax (PST) or a harmonized sales tax (GST and PST
combined into the HST)
• Remitted to government monthly, quarterly or
annually
• Amounts paid by customers for sales tax are not
considered revenue, but are credited to Sales Tax
Payable
12
Property Taxes
• Paid for a calendar year
• Upon receipt of the property tax bill, an expense is recorded for the
months that have passed:
• When paid, expense is recorded for additional months that have passed,
and prepaid is set up for remaining months
• Prepaid is cleared to expense at the end of year
13
Current Maturities of Long-Term Debt
• The portion of long-term debt that is due
within the current year
– Amount not due within current year is disclosed
as a long-term liability
• No adjusting entry is required to recognize the
current portion of long-term debt
– The proper classification is made when the
balance sheet is prepared
14
CHAPTER 10:
LEARNING OBJECTIVES
1. Account for determinable or certain current
liabilities.
2. Account for uncertain liabilities.
3. Determine payroll costs and record payroll
transactions.
4. Prepare the current liabilities section of the
balance sheet.
5. Calculate mandatory payroll deductions
(Appendix 10A).
15
Uncertain Liabilities
• Provision is a liability that exists but the
amount and timing is uncertain
– We owe someone, but not sure how much, when
or even who
• Liability is recognized when:
– Settlement of the liability is likely, and
– Amount of the liability can be reasonably
estimated
16
Product Warranties
• Promises made by seller to buyer to repair or
replace a product if it is defective or does not
perform as intended
• Warranties will lead to future costs for
replacement or repair of defective units
• Cost of warranty is estimated and accrued based
on prior experience
17
Customer Loyalty Programs
and Gift Cards
• Results in an estimated liability:
– Not known if or when rewards will be redeemed
• If redemptions are likely, and can be estimated
based on past experience:
– Record estimated liability as a reduction in
revenue (not an expense)
18
Contingent Liabilities
• Record liability if both conditions are met:
– It is likely (or probable under IFRS) that an obligation
exists, and
– Amount can be reasonably estimated
• If contingent loss is likely, but cannot be reasonably
estimated:
– No liability is recorded
– Disclosed in the notes to the statements
• If contingency is unlikely:
– Still disclosed if event is substantial, otherwise not
disclosed
19
CHAPTER 10:
LEARNING OBJECTIVES
1. Account for determinable or certain current
liabilities.
2. Account for uncertain liabilities.
3. Determine payroll costs and record payroll
transactions.
4. Prepare the current liabilities section of the
balance sheet.
5. Calculate mandatory payroll deductions
(Appendix 10A).
20
Payroll
• More than paying employee salaries and wages
• Companies are required by law:
– To have payroll records for each employee
– To report and remit payroll deductions
– To respect federal and provincial laws
• Two types of payroll costs:
– Employee costs: amounts paid to employees (gross pay) &
amounts paid by employees (payroll deductions)
– Employer costs: amounts paid by employer on behalf of
the employee (employee benefits)
21
Gross Pay (or Earnings)
• The total compensation earned by an
employee
• Consists of:
– Wages = hours worked x hourly rate of pay, or
– Salaries: based on a weekly, biweekly, monthly or
annual rate
– Bonuses
– Commissions
22
Employee Payroll Costs
• The difference between gross pay and the amount actually
received (net pay)
• Mandatory payroll deductions:
– Required by law
– Personal income tax, Canada Pension Plan (CPP) and Employment
Insurance (EI)
– Determined from payroll deduction tables
• Voluntary payroll deductions:
– For charitable causes, retirement, and other purposes
– Should be authorized in writing by the employee
– Do not result in a payroll expense to the employer
23
Employer Payroll Costs
• Amounts an employer is required to pay
– Required by governments:
•
•
•
CPP (matching the employee contribution)
EI (1.4 x the employee contribution)
Workplace health, safety and compensation
– Additional employee benefits:
•
•
Paid absences: sick days, vacation, statutory holidays
Post-employment benefits: to retired employees
• These benefits give rise to liabilities that must be
accrued
24
Recording the Payroll
• Involves:
–
–
–
–
Maintaining payroll records
Recording payroll expenses and liabilities
Paying the payroll, and
Filing and remitting payroll deductions
• Payroll Records
– A separate earnings record is kept for each employee
– Payroll register may be used to accumulate gross earnings,
deductions & net pay by employee for each period
25
Recording Payroll Expenses
and Liabilities
• Employee payroll costs:
• Entry for the employee portion of a payroll
– The company’s expense is equal to total gross pay
– Employee payroll deductions become current
liabilities of the company until remitted
26
Recording Payroll Expenses
and Liabilities (cont’d)
• Employer payroll costs:
– Recorded when the payroll is journalized
– Become current liabilities of the company until
remitted
27
Recording Payment of the Payroll
• Payment of payroll is either by cheque or electronic funds
transfer (EFT)
• Entry to record payment of payroll deductions:
28
CHAPTER 10:
LEARNING OBJECTIVES
1. Account for determinable or certain current
liabilities.
2. Account for uncertain liabilities.
3. Determine payroll costs and record payroll
transactions.
4. Prepare the current liabilities section of the
balance sheet.
5. Calculate mandatory payroll deductions
(Appendix 10A).
29
Financial Statement Presentation
• Current liabilities are generally the first category
reported in the liabilities section of the balance sheet
• Each type of current liability is listed separately
• Listed in order of liquidity, usually by maturity date
– Also common to show bank loans, notes payable and
accounts payable first regardless of size
• Terms of operating lines of credit, notes payable, and
other information are disclosed in the notes
30
CHAPTER 10:
LEARNING OBJECTIVES
1. Account for determinable or certain current
liabilities.
2. Account for uncertain liabilities.
3. Determine payroll costs and record payroll
transactions.
4. Prepare the current liabilities section of the
balance sheet.
5. Calculate mandatory payroll deductions
(Appendix 10A).
31
Appendix 10A: Mandatory
Payroll Deductions
• Canada Pension Plan (CPP) contributions:
– Calculated as a percentage of earnings (contribution
rate) over a set minimum (basic exemption) to a
maximum amount of earnings (maximum pensionable
earnings)
– Pro-rated per pay period
• Employment Insurance (EI) contributions:
– Calculated as a percentage of earnings to a maximum
amount (maximum insurable earnings)
– No basic exemption
– Not pro-rated: deducted from pay until maximum is
reached
32
Appendix 10A: Mandatory
Payroll Deductions (cont’d)
• Personal income tax deductions:
– Based on tax rates set by federal and provincial
governments
– Progressive rates: higher percentage rates for
higher income levels
• Complicated calculations:
– Best done using deduction tables or automated
tools provided by the Canada Revenue Agency
33
COPYRIGHT
Copyright © 2016 John Wiley & Sons Canada, Ltd. All
rights reserved. Reproduction or translation of this work
beyond that permitted by Access Copyright (The Canadian
Copyright Licensing Agency) is unlawful. Requests for
further information should be addressed to the
Permissions Department, John Wiley & Sons Canada, Ltd.
The purchaser may make back-up copies for his or her
own use only and not for distribution or resale. The author
and the publisher assume no responsibility for errors,
omissions, or damages caused by the use of these
programs or from the use of the information contained
herein.
Chapter 11
FINANCIAL REPORTING CONCEPTS
Accounting Principles
Eighth Canadian Edition
Weygandt Kieso Kimmel Trenholm Warren Novak
Prepared by Debbie Musil, FCPA, FCMA
Financial Reporting Concepts (1 of 2)
• The conceptual framework of accounting
• The objective of financial reporting
• Elements of financial statements
• Qualitative characteristics of useful financial
information
• Fundamental characteristics
• Enhancing qualitative characteristics and their
application
• Differences under IFRS and ASPE
Copyright ©2019 John Wiley & Sons Canada, Ltd.
2
Financial Reporting Concepts (2 of 2)
• Recognition and measurement criteria
• General, revenue and expense recognition
criteria
• Measurement of elements
• Errors and intentional misstatements
• Foundational Concepts, Assumptions and
Constraints
• Concepts and assumptions
• Constraints
• Summary of conceptual framework
Copyright ©2019 John Wiley & Sons Canada, Ltd.
3
CHAPTER 11: LEARNING OBJECTIVE 1 (1 of 2)
1. Explain the importance of having a conceptual
framework of accounting, and list the key
components.
2. Explain the objective of financial reporting, and
define the elements of the financial
statements.
3. Apply the fundamental and enhancing
qualitative characteristics of the conceptual
framework to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
4
CHAPTER 11: LEARNING OBJECTIVE 1 (2 of 2)
4. Apply the recognition and measurement
criteria of the conceptual framework to
financial reporting situations.
5. Apply the foundational concepts, assumptions
and constraints of the conceptual framework
to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
5
Conceptual Framework of Accounting
• A foundation for accounting:
• Ensures existing standards and practices are
clear and consistent
• Provides guidance in responding to new issues
and developing new standards
• Assists in the application of standards
• Increases users’ understanding and confidence
in financial statements
• Standards built on general principles, not rules
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6
Conceptual Framework 2
• Use professional judgment and framework to
determine appropriate accounting treatment
• Key components of framework:
• 1. Objective of financial reporting and user
needs
• 2. Elements of financial statements
• 3. Qualitative characteristics
• 4. Recognition and measurement criteria
• 5. Foundational concepts, assumptions, and
constraints
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7
CHAPTER 11: LEARNING OBJECTIVE 2 (1 of 2)
1. Explain the importance of having a conceptual
framework of accounting, and list the key
components.
2. Explain the objective of financial reporting, and
define the elements of the financial
statements.
3. Apply the fundamental and enhancing
qualitative characteristics of the conceptual
framework to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
8
CHAPTER 11: LEARNING OBJECTIVE 2 (2 of 2)
4. Apply the recognition and measurement
criteria of the conceptual framework to
financial reporting situations.
5. Apply the foundational concepts, assumptions
and constraints of the conceptual framework
to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
9
Objective of Financial Reporting (1 of 2)
• To provide information that is useful for making
decisions about a business
• To investors and creditors
• To give information about:
• Economic resources (assets) and claims on
those resources (liabilities, equity)
• Changes in resources and claims on them
• Economic performance
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10
Objective of Financial Reporting (2 of 2)
• Enables users to decide whether management
used company resources in the best way
possible
• Referred to as stewardship
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11
Elements of Financial Statements
• Basic categories that are used in financial
statements
• Assets, liabilities, equity, revenues and expenses
• Must be precisely defined and applied in the
same way by all reporting entities
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12
CHAPTER 11: LEARNING OBJECTIVE 3 (1 of 2)
1. Explain the importance of having a conceptual
framework of accounting, and list the key
components.
2. Explain the objective of financial reporting, and
define the elements of the financial
statements.
3. Apply the fundamental and enhancing
qualitative characteristics of the conceptual
framework to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
13
CHAPTER 11: LEARNING OBJECTIVE 3 (2 of 2)
4. Apply the recognition and measurement
criteria of the conceptual framework to
financial reporting situations.
5. Apply the foundational concepts, assumptions
and constraints of the conceptual framework
to financial reporting situations.
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14
Fundamental Characteristics of Useful
Financial Information (1 of 2)
• To be useful, information should have two
fundamental qualitative characteristics:
• Relevance
• Faithful Representation
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15
Fundamental Characteristics of Useful
Financial Information (2 of 2)
• Other characteristics enhance the usefulness of
accounting information:
•
•
•
•
Comparability
Verifiability
Timeliness
Understandability
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16
Fundamental Characteristics:
Relevance (1 of 2)
• Accounting information has relevance if it
makes a difference in a decision
• Relevant information has predictive and/or
confirmatory value:
• Predictive value: helps users forecast future
events
• Confirmatory value: confirms or corrects prior
expectations
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17
Fundamental Characteristics:
Relevance (2 of 2)
• Materiality is an important component of
relevance
• An item is material if it will influence a decision
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18
Fundamental Characteristics:
Faithful Representation
• Information must be a faithful representation
of the economic reality of reported events
• Concept known as substance over form
• This is achieved when the information is:
• Complete: includes all necessary information
• Neutral: information is free from bias
• Prudence: managing with care, economy,
frugality
• Free from material error: will not affect
decisions by investors and creditors
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19
Enhancing Qualitative Characteristics:
Comparability
• Comparability: Similar companies use the same
accounting policies
• Consistency: A company uses the same
accounting policies from year to year
• However, accounting policies can change:
• Due to new requirements that have been issued
• When management decides that a difference
policy gives more relevant information
• Accounting changes are disclosed in the
financial statements
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20
Enhancing Qualitative Characteristics:
Verifiability and Timeliness
• Verifiable: assures users that the accounting
information shows the economic reality of a
transaction
• Information is verifiable if two knowledgeable
and independent people agree that it faithfully
represents the economic reality
• Timely: accounting information is provided
when it is still useful for decision-making
• Available to decision makers before it loses its
ability to influence their decisions
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21
Enhancing Qualitative Characteristics:
Understandability
• Information must be understandable to users
for it to be useful
• Enables users to interpret and comprehend the
information provided in the financial
statements
• Users are assumed to have a reasonable
knowledge of:
• Business, economic and financial activities
• Financial reporting
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22
Differences in Qualitative Characteristics
Under IFRS and ASPE (1 of 2)
• ASPE identifies four principal characteristics:
• Understandability – higher status under ASPE
than IFRS
• Relevance – important under both ASPE and
IFRS
• Reliability – considered reliable if it is a faithful
representation
• Comparability – higher status under ASPE than
IFRS
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23
Differences in Qualitative Characteristics
Under IFRS and ASPE (2 of 2)
• ASPE includes conservatism as a component of
reliability
• Similar to the prudence concept for IFRS
• It is anticipated that ASPE will adopt the IFRS
conceptual framework
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24
CHAPTER 11: LEARNING OBJECTIVE 4 (1 of 2)
1. Explain the importance of having a conceptual
framework of accounting, and list the key
components.
2. Explain the objective of financial reporting, and
define the elements of the financial
statements.
3. Apply the fundamental and enhancing
qualitative characteristics of the conceptual
framework to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
25
CHAPTER 11: LEARNING OBJECTIVE 4 (2 of 2)
4. Apply the recognition and measurement
criteria of the conceptual framework to
financial reporting situations.
5. Apply the foundational concepts, assumptions
and constraints of the conceptual framework
to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
26
Recognition & Measurement Criteria (1 of 2)
• Accrual basis of accounting – transactions are
recorded in the period in which the events
occur, rather than when cash is received or paid
• Recognition criteria help determine when items
should be included in financial statements
• Measurement criteria provide guidance on
what amount should be recorded
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27
Recognition & Measurement Criteria (2 of 2)
• An item is usually included in the financial
statements if:
• It meets the definition of an asset, liability,
equity, revenue or expense
• It can be measured, and a reasonable estimate
of the amount can be made
• It meets the fundamental qualitative
characteristics of relevance and faithful
representation
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28
Recognition & Measurement Criteria
Two important concepts underlying the general
recognition criteria:
1. If an asset is going to be recorded it must be probable
that future economic benefit will flow to the business
2. If a liability is going to be recorded it must be
probable that future economic benefit will flow from
the business to settle present obligations
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29
Revenue Recognition Criteria (1 of 2)
• Revenue should be recognized at the same
time that:
• An increase in an asset is recognized, or
• A decrease in a liability is recognized
for profit-generating activities
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30
Revenue Recognition Criteria (2 of 2)
• Two approaches:
• Contract-based approach
• Required for companies that follow IFRS
• Also known as the asset-liability approach
• Earnings approach
• Standard used in ASPE
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31
Revenue Recognition –
Contract Based Approach
• Based on enforceable rights and obligations in a
contract with a customer
• Seller will recognize revenue when promised
goods or services are transferred to customer
•
Performance obligation is complete
• Amount that is recognized reflects consideration
expected to be received in exchange
•
Seller promises to deliver goods or services
(performance obligation) and customer agrees to
pay some amount of consideration in exchange
(enforceable right to receive consideration)
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32
Revenue Recognition – Earnings
Approach: Sale of Goods
• Revenue recognized when all conditions met:
• Performance complete and significant risks and
rewards of ownership have transferred from
seller to buyer
• Seller no longer controls or manages goods
• Revenue can be reliably measured
• Probable increase in economic resources (cash
collected)
• Costs relating to sale can be reliably measured
(critical event)
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33
Revenue Recognition:
Other Situations (1 of 2)
• Right of Return
• If revenue is recognized without consideration
of potential returns, revenue will be overstated
• Under contract-based approach, revenue
recorded at the amount expected to be received
(net amount)
• Under earnings approach, record revenue and
adjust revenue for returns
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34
Revenue Recognition:
Other Situations (2 of 2)
• Warranties
• Accounting is the same under both contractbased and earnings approach
• Assurance warranty: requires a provision for
future warranty costs that may be incurred
• Service warranty: accounted for as a multiple
performance obligation
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35
Expense Recognition Criteria
• Expenses are recognized when there is:
• A decrease in an asset
• An increase in a liability
• Excludes distributions to owners
• Not necessarily when the cash is paid
• Can be a direct association between costs
incurred and revenue earned (matching concept)
• When no direct relationship, another systematic
and rational allocation policy may be used
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36
Measurement of Elements
• Acquired assets are recorded at cost
• Cost is used because it is:
• Relevant: represents the price paid, assets
sacrificed or the commitment made at the date
of acquisition
• A Faithful Representation: objectively
measurable, factual and verifiable
• After acquisition, cost is referred to as historical
cost
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37
Measurement of Elements 2
• Most companies use historical cost model to
report property, plant and equipment
• Under IFRS can choose revaluation model
• Fair value is market value of asset or liability at
reporting date
• Amount of cash expected to be collected when
asset is sold
• For some assets, more relevant to use fair value
Copyright ©2019 John Wiley & Sons Canada, Ltd.
38
Measurement of Elements 3
Fair Value (1 of 2)
• Current Cost
• Amount of cash or equivalent that would have
to be paid if same or equivalent asset was to be
purchased in current period (replacement cost)
or amount required to settle obligation
currently
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39
Measurement of Elements 3
Fair Value (2 of 2)
• Realizable Value
• Amount that can be reasonably be expected to
be collected or cash expected to be paid to
satisfy liabilities
• Inventory measured in this way
• Present Value
• Present value of future cash inflows or outflows
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40
Errors and Intentional Misstatements
• Revenues and expenses may be misstated by:
•
•
•
•
Recognition in the incorrect accounting period
Misstatement of estimates
Failure to record a revenue or expense
Failure to apply the correct measurement
• Important to analyze transactions carefully to
ensure that accounting principles are applied
correctly and are faithfully represented
Copyright ©2019 John Wiley & Sons Canada, Ltd.
41
CHAPTER 11: LEARNING OBJECTIVE 5 (1 of 2)
1. Explain the importance of having a conceptual
framework of accounting, and list the key
components.
2. Explain the objective of financial reporting, and
define the elements of the financial
statements.
3. Apply the fundamental and enhancing
qualitative characteristics of the conceptual
framework to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
42
CHAPTER 11: LEARNING OBJECTIVE 5 (2 of 2)
4. Apply the recognition and measurement
criteria of the conceptual framework to
financial reporting situations.
5. Apply the foundational concepts, assumptions
and constraints of the conceptual framework
to financial reporting situations.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
43
Foundational Concepts, Assumptions
and Constraints (1 of 4)
• Reporting Entity Concept
• - The accounting for a reporting entity’s
activities must be kept separate and distinct
from those of the activities of its owner and all
other reporting entities
• Going Concern Assumption
• Assumes that a company will continue
operating for the foreseeable future
• Important implications for how financial
information is presented
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44
Foundational Concepts, Assumptions
and Constraints (2 of 4)
• Monetary Unit Concept
• Money is the common denominator of economic
activity
• Prevents recognition of elements that cannot be
quantified (employee morale, customer loyalty)
• Periodicity Concept
• Guides businesses in dividing up their economic
activities into distinct time periods
• Most common periods are months, quarters,
years
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45
Foundational Concepts, Assumptions
and Constraints (3 of 4)
• Full Disclosure Concept
• Requires disclosure of circumstances and events
that make a difference to financial statement
users
• Accomplished through:
• The data in the financial statements
• The notes that accompany the statements
• A summary of significant accounting policies is
usually the first note to the financial statements
Copyright ©2019 John Wiley & Sons Canada, Ltd.
46
Foundational Concepts, Assumptions
and Constraints (4 of 4)
• Cost Constraint
• The value of information should be greater than
the cost of providing it
• Benefits of financial reporting should justify the
costs
• Also known as benefit versus cost constraint
under ASPE
Copyright ©2019 John Wiley & Sons Canada, Ltd.
47
Copyright
Copyright © 2019 John Wiley & Sons Canada, Ltd.
All rights reserved. Reproduction or translation of this work
beyond that permitted by Access Copyright (The Canadian
Copyright Licensing Agency) is unlawful. Requests for further
information should be addressed to the Permissions
Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and not
for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these programs or from the use of the
information contained herein.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
48
Chapter 12
ACCOUNTING FOR PARTNERSHIPS
Accounting Principles
Eighth Canadian Edition
Weygandt Kieso Kimmel Trenholm Warren Novak
Prepared by Debbie Musil, FCPA, FCMA
Accounting for Partnerships
• Partnership form of organization
• Characteristics
• Advantages and disadvantages
• Partnership agreement
• Basic partnership accounting
• Forming a partnership
• Dividing partnership profit or loss
• Partnership financial statements
• Admission and withdrawal of partners
• Liquidation of a partnership
• With or without a capital deficiency
Copyright ©2019 John Wiley & Sons Canada, Ltd.
2
CHAPTER 12: LEARNING OBJECTIVE 1
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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3
Characteristics of Partnerships (1 of 5)
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4
Characteristics of Partnerships (2 of 5)
• Association of individuals
• Usually based on a written agreement
• A legal and accounting entity, but not taxed
• Co-ownership of property
• Assets are jointly owned by partners
Copyright ©2019 John Wiley & Sons Canada, Ltd.
5
Characteristics of Partnerships (3 of 5)
• Division of profit
• Partners determine how profit or loss is to be
divided
• Otherwise shared equally
• Limited life
• Partnership ends when change in ownership
• New partnership can be formed to continue
business
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Characteristics of Partnerships (4 of 5)
• Mutual agency
• Each partner acts for (binds) the partnership
• Unlimited liability
• Each partner is liable for all partnership
liabilities
• Special types of partnerships created to limit
liability
• Limited partnership (LP)
• Limited liability partnership (LLP)
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Characteristics of Partnerships (5 of 5)
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Partnership Agreement (1 of 2)
• Written contract between two or more parties
to form a partnership
• Contains basic information:
• Name and main location of firm
• Purpose of the business
• Date of inception
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Partnership Agreement (2 of 2)
• Specifies relationship of partners:
•
•
•
•
Names and capital contributions of partners
Rights and duties of partners
Basis for sharing profit or loss
Procedures for admission, withdrawal, death of
partner, resolving disputes, liquidation of
partnership
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CHAPTER 12: LEARNING OBJECTIVES 2
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Basic Partnership Accounting:
ASPE Versus IFRS
• Many partnerships are private and therefore
follow ASPE
• Limited Partnerships are often public
enterprises and therefore follow IFRS
• International partnerships must also follow IFRS
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Basic Partnership Accounting:
Forming a Partnership
• Partner’s initial investment is recorded at fair
value of assets contributed
• As at date of transfer into partnership
• Values assigned are agreed to by all partners
• After partnership formed, accounting for
transactions is similar to other types of
business organizations
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CHAPTER 12: LEARNING OBJECTIVES 3
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Basic Partnership Accounting:
Dividing Profit or Loss
• Partnership profit/loss is shared equally
• Unless partnership agreement indicates
otherwise
• Called the profit ratio or profit and loss ratio
• Each partners’ share of profit or loss is
recognized through closing entries
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Partnership Accounting:
Profit and Loss Ratios (1 of 2)
• Typical ratios used to share profit or loss:
• Fixed ratio: a proportion (2:1), percentage
(67%) or fraction (2/3)
• A ratio based on capital balances at beginning
or end of year or on average capital balances
during the year
• Salary and interest allowances to partners,
remainder in a fixed ratio
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Partnership Accounting:
Profit and Loss Ratios (2 of 2)
• Salaries and interest allowances:
• Are allocated first even if greater than profit or
if partnership incurred a loss for the year
• Are NOT expenses of the partnership – only
used to divide profit or loss among the partners
• Are NOT distributions of cash (or other assets) –
drawings by partners are distributions
• Partners are neither employees or creditors
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Partnership Accounting:
Closing Entries (1 of 3)
• Four closing entries for partnership:
1. Close revenue accounts to income summary
2. Close expense accounts to income summary
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Partnership Accounting:
Closing Entries (2 of 3)
• Four closing entries for partnership (continued):
3. Close income summary to partners’ capital
accounts
• If profit:
Dr. Income summary (= total profit)
Cr. Each partner’s capital account (= their
share of profit)
• If loss:
Dr. Each partner’s capital account (= their share
of loss)
Cr. Income summary (= total loss)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Partnership Accounting:
Closing Entries (3 of 3)
• Four closing entries for partnership (continued):
4. Close each partner’s drawings account to their
respective capital accounts
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CHAPTER 12: LEARNING OBJECTIVES 4
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Partnership Financial Statements:
Statement of Partners’ Equity
• The equity statement for a partnership is the
statement of partners' equity
• Explains changes in each partner’s capital account
and in total partnership equity during the year
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Partnership Financial Statements:
Balance Sheet
• Capital balances of each partner are shown on
the balance sheet in section called partners’
equity:
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CHAPTER 12: LEARNING OBJECTIVES 5
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
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Admission of a Partner
• Causes the legal dissolution of the existing
partnership and the beginning of a new
partnership
• A new partner may be admitted either by:
• Purchasing the interest of one or more existing
partners
• Investing assets in the partnership
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Admission of a Partner:
Purchase of a Partner’s Interest
• A personal transaction between one or more
existing partners and the new partner
• Consideration exchanged is personal property
of the partners involved and not property of the
partnership
• In the partnership, only the transfer of the
partnership interest is recorded:
• Existing partners’ equity is decreased by the
amount of equity given to the new partner
• New partner’s equity is increased by same
amount
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Admission of a Partner:
Investment of Assets in Partnership (1 of 2)
• A transaction between the new partner and the
partnership:
• Partnership receives assets from new partner in
exchange for an interest in the partnership
• Both net assets and total partners’ equity of
the partnership will increase
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Admission of a Partner:
Investment of Assets in Partnership (2 of 2)
• Complications occur when new partner’s
investment differs from the capital equity
acquired:
• The difference is considered a bonus either to
the existing (old) partners or to the new partner
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Admission of a Partner:
Bonus to Existing (Old) Partners
• Bonus to old partners may be necessary:
• Fair value of partnership assets may be greater
than their carrying value
• Goodwill may exist that has not been recorded
• Bonus to old partners occurs when:
• New partner’s investment > capital account
credit on the date of admission
• Amount of bonus = difference
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Admission of a Partner:
Bonus to New Partner
• Bonus to new partner may be necessary:
• New partner has resources or attributes that
the partnership wants (cash, expertise)
• Carrying amount of partnership assets is greater
than their fair value
• Bonus to new partner occurs when:
• New partner’s investment < capital account
credit on the date of admission to partnership
• Amount of bonus = difference
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Admission of a Partner:
Determining Amount of Bonus (1 of 2)
1. Determine the total capital of partnership
• = Capital of old partnership + new partner’s
investment
2. Determine new partner’s capital credit
• = Total capital determined above × new
partner’s ownership interest
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Admission of a Partner:
Determining Amount of Bonus (2 of 2)
3. Determine the amount of the bonus
• = New partner’s investment ± new partner’s
capital credit
• If investment > capital credit: bonus to old
partners
• If investment < capital credit: bonus to new
partner
4. Allocate the bonus to/from old partners
• Based on income ratios of old partners
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Admission of a Partner:
Example Calculation of Bonus
• Old partners’ capital balance = $120,000
• Peart $72,000 and Huang $48,000
• Old partners’ profit ratios:
• Peart 60% and Huang 40%
• Trent purchases 25% share:
• Scenario 1: for $80,000
• Scenario 2: for $20,000
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Admission of a Partner:
Bonus Calculation – Scenario 1
1. Total capital of new partnership:
• $120,000 + $80,000 = $200,000
2. New partner’s capital credit:
• $200,000 × 25% = $50,000
3. Amount of bonus to old partners:
• $80,000 − $50,000 = $30,000
4. Allocation of bonus to old partners
• To Peart: $30,000 × 60% = $18,000
• To Huang: $30,000 × 40% = $12,000
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Admission of a Partner:
Bonus Calculation – Scenario 2
1. Total capital of new partnership:
• $120,000 + $20,000 = $140,000
2. New partner’s capital credit:
• $140,000 × 25% = $35,000
3. Amount of bonus to new partner:
• $20,000 − $35,000 = $(15,000)
4. Allocate bonus from old partners:
• From Peart: $15,000 × 60% = $9,000
• From Huang: $15,000 × 40% = $6,000
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CHAPTER 12: LEARNING OBJECTIVES 6
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Withdrawal of a Partner
• Voluntary withdrawal: Partner sells their equity
in the firm
• Involuntary withdrawal: Partner reaches
mandatory retirement age, dies or is expelled
• Withdrawal may be accomplished by:
• Payment from remaining partners’ personal
assets
• Payment from partnership assets
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Withdrawal of a Partner: Payment from
Partners’ Personal Assets (1 of 2)
• A personal transaction between partners
• Payment is from remaining partners’ personal
assets
• Partnership assets are not involved and total
capital of partnership does not change
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Withdrawal of a Partner: Payment from
Partners’ Personal Assets (2 of 2)
• In the partnership, only the transfer of the
partnership interest is recorded:
• Departing partner’s equity is eliminated
• Remaining partners’ equity increased by same
amount
• Amount is split between remaining parties on
same basis as they paid departing party
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Withdrawal of a Partner:
Payment from Partnership Assets (1 of 2)
• A transaction between the withdrawing partner
and the partnership:
• Partnership pays assets in exchange for the
withdrawing partner’s interest in the
partnership
• Both net assets and total partners’ equity of
the partnership will decrease
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Withdrawal of a Partner:
Payment from Partnership Assets (2 of 2)
• Complications occur when amount paid differs
from withdrawing partner’s capital balance:
• The difference is considered a bonus either to
the departing partner or to the remaining
partners
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Withdrawal of a Partner:
Bonus to Withdrawing Partner (1 of 2)
• Bonus to withdrawing partner may be
necessary:
• Fair value of partnership assets may be greater
than their carrying amount
• Goodwill may exist that has not been recorded
• Remaining partners wish to remove partner
from firm
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Withdrawal of a Partner:
Bonus to Withdrawing Partner (2 of 2)
• Bonus to withdrawing partner occurs when:
• Payment to departing partner > departing
partner’s capital balance on the date of
departure
• Amount of bonus = difference
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Withdrawal of a Partner:
Bonus to Remaining Partners
• Bonus to remaining partners may be necessary:
• Recorded assets are overvalued
• Partnership has a poor earnings record
• Partner wishes to leave partnership
• Bonus to remaining partners occurs when:
• Payment to departing partner < departing
partner’s capital balance on departure date
• Amount of bonus = difference
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Withdrawal of a Partner:
Determining Amount of Bonus
1. Determine the amount of the bonus
• = Payment from partnership to departing
partner ± departing partner’s capital balance
• If payment > capital balance: bonus to departing
partner
• If payment < capital balance: bonus to
remaining partners
2. Allocate payment of bonus to remaining
partners based on their profit ratios
• Amount allocated to each remaining partner =
bonus × profit ratio for each partner
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Withdrawal of a Partner:
Example Calculation of Bonus
• Partners’ capital balance:
Roman $50,000
Sand $30,000
Terk $20,000
• Partners’ profit ratio:
Roman, Sand, Terk: 3:2:1
• Terk retires and is paid:
Scenario 1: $25,000
Scenario 2: $16,000
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Withdrawal of a Partner:
Bonus Calculation (1 of 2)
Scenario 1:
1. Amount of bonus to departing partner:
• $25,000 - $20,000 = $5,000
2. Allocate payment of bonus by remaining
partners:
• From Roman: $5,000 × 3/5 = $3,000
• From Sand: $5,000 × 2/5 = $2,000
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Withdrawal of a Partner:
Bonus Calculation (2 of 2)
Scenario 2:
1. Amount of bonus to remaining partners:
• $16,000 − $20,000 = $(4,000)
2. Allocate payment of bonus to remaining
partners:
• To Roman: $4,000 × 3/5 = $2,400
• To Sand: $4,000 × 2/5 = $1,600
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CHAPTER 12: LEARNING OBJECTIVES 7
1. Describe the characteristics of the partnership
form of business organization.
2. Account for the formation of a partnership.
3. Allocate and record profit or loss to partners.
4. Prepare partnership financial statements.
5. Account for the admission of a partner.
6. Account for the withdrawal of a partner.
7. Account for the liquidation of a partnership.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Liquidation of a Partnership
• Liquidation ends the business
• Steps in liquidating a partnership:
1. Sell non-cash assets for cash
2. Allocate any gain or loss from sale (on
realization) to partners’ capital accounts based
on profit and loss ratios
3. Pay partnership liabilities in cash
4. Distribute remaining cash to partners based on
their capital balances (not their profit ratios)
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Liquidation of a Partnership:
No Capital Deficiency
• Capital deficiency: if one or more partners’
capital account is in a debit balance
• If no capital deficiency:
• Remaining cash after all assets sold and
liabilities paid is distributed to partners
• Distribution is based on partners’ capital
balances
• Since this is the final distribution to partners all
accounts will have zero balances afterwards
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Liquidation of Partnership:
Capital Deficiency
• Capital deficiency may be caused by:
• Recurring losses
• Excessive drawings by one or more partners
• Losses from sale of assets during liquidation
• Partners having a capital deficiency
immediately before final distribution:
• May or may not be able to pay the deficiency
from personal funds
• This will affect the amount of funds available for
distribution to other partners
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Liquidation of Partnership:
Payment of Capital Deficiency
• Partnership has a legally enforceable claim
against partners with a capital deficiency
• If partner repays deficiency to partnership:
• Amount repaid is added to cash available for
distribution
• Total cash after repayment is distributed to
partners with credit balances in their capital
accounts
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Liquidation of Partnership:
Nonpayment of Deficiency
• If partner does not repay deficiency to
partnership:
• Amount of deficiency is considered a loss
• Loss is allocated between partners with credit
balances based on their profit ratios
• Allocation of loss will affect remaining partners
capital accounts
• Final distribution of remaining cash is to
partners with credit balances in capital accounts
Copyright ©2019 John Wiley & Sons Canada, Ltd.
54
Copyright
Copyright © 2019 John Wiley & Sons Canada, Ltd.
All rights reserved. Reproduction or translation of this work
beyond that permitted by Access Copyright (The Canadian
Copyright Licensing Agency) is unlawful. Requests for further
information should be addressed to the Permissions
Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and not
for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these programs or from the use of the
information contained herein.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
55
Chapter 13
INTRODUCTION TO CORPORATIONS
Accounting Principles
Eighth Canadian Edition
Weygandt Kieso Kimmel Trenholm Warren Novak
Prepared by Debbie Musil, FCPA, FCMA
Introduction to Corporations
• The corporate form of organization
• Characteristics
• Operating a corporation
• Share capital
• Issuing shares
• Preferred shares
• Retained earnings
• Corporate income statements
• Cash dividends
• Reporting retained earnings
• Statement presentation and analysis
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 1 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
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CHAPTER 13: LEARNING OBJECTIVE 1 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ equity section of the
balance sheet and calculate return on equity.
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The Corporate Form of Organization
• A legal entity separate from its owners (known
as shareholders)
• Classified by purpose and ownership:
• Purpose: for profit or not-for-profit
• Ownership:
• Public corporation: shares are available for
purchase on an organized securities market
• Private corporation: shares are held by a few
individuals and are not traded
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Characteristics of a Corporation (1 of 3)
• Separate legal existence from its owners
• Acts under its own name
• Owners do not bind the corporation
• Limited liability of shareholders
• Limited to the amount of their investment
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Characteristics of a Corporation (2 of 3)
• Transferable ownership rights
• Shares may be bought and sold
• No effect on operating activities of corporation
• Ability to acquire capital
• Can raise capital by issuing shares
• May be difficult for closely-held corporations
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Characteristics of a Corporation (3 of 3)
• Continuous and unlimited life
• Unaffected by change in ownership
• Government regulations
• Specific laws that govern operations of
corporations
• Income tax
• Taxed as a separate entity
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Forming a Corporation (1 of 2)
• Can incorporate federally or provincially
• Done by filing articles of incorporation (the
company’s “constitution”):
• Provides information such as :
• Name and purpose of company
• Number of shares and kinds of shares to be
authorized
• Location of corporation’s head office
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Forming a Corporation (2 of 2)
• By-laws: internal rules and policies
• Organization costs:
• Costs of forming a corporation
• Must be expensed when incurred
Copyright ©2019 John Wiley & Sons Canada, Ltd.
10
Ownership Rights of Shareholders
• Ownership rights are in the form of shares
• Can be divided into different classes
• As stated in the articles of incorporation
• Each class has rights and privileges
• Usually referred to as common and preferred
shares
• Shareholders have rights:
• To vote on certain matters
• To dividends: the distribution of profit
• To remaining assets in a liquidation
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Corporation Management
• Shareholders manage the corporation indirectly
through the Board of Directors that they elect
• The board:
• Decides on the corporation’s operating policies
• Selects officers (such as the Chief Executive
Officer or CEO) to execute policy and perform
daily management functions
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Distribution of Profit
• Profit can either be reinvested in the company
or distributed to shareholders as dividends
• Dividend:
• Pro-rata distribution of a portion of
corporation’s retained earnings to shareholders
• Pro-rata: based on the proportion of shares
owned
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 2 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 2 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the
balance sheet and calculate return on equity.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Share Issue Considerations (1 of 2)
• Authorized share capital
• Total number of each class of shares company is
allowed to sell
• Many companies have unlimited number of
shares
• Issue of shares
• Issued directly to investors or through an
investment dealer
• First public sale is called an initial public offering
(IPO)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Share Issue Considerations (2 of 2)
• Market value of shares
• Once issued, shares trade on a secondary
market
• Prices determined by buyers and sellers and
other external factors
• Legal capital
• Share capital is legal capital and cannot be
distributed to shareholders
• Retained earnings are earned capital and can be
distributed as dividends
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Common Shares: Issuing Shares
• Shares are usually issued for cash:
• Dr. Cash
Cr. Common shares
• Shares can be issued in exchange for services or
noncash assets
• Recorded at fair value of goods/services received:
• Dr. Service or asset (e.g. Legal Fees Expense)
Cr. Common shares
• Under IFRS, if fair value of goods/services not
measurable, use fair value of shares given in
exchange
• Under ASPE, value transaction at amount that can
be more reliably measured
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Preferred Shares
• Priority over common shares for dividends and
assets in the event of liquidation of the
company
• Entries to record issue and reacquisition of
preferred shares similar to entries for common
shares
• Transactions for each class of share is recorded
in a separate account
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19
Dividend Preference
• Preferred shareholders have a right to
dividends before common shareholders
• Cumulative preferred shares have a right to
current year’s dividends and any prior years’
dividends owing before dividends are paid on
common shares
• Any unpaid dividends (in arrears) are not
considered a liability
• No obligation to pay until dividend is declared
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Convertible Preferred Shares
• Provide option to exchange preferred shares to
common shares at a specified ratio
• Conversion is recorded by transferring cost
from Preferred Shares to Common Shares
account
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21
Redeemable and Retractable Preferred
Shares
• Corporation (redeemable) or the shareholder
(retractable) can redeem the shares at specified
future dates and prices
• Similar to debt: offers a repayment of the
principal
• Considered a financial instrument
• These preferred shares usually reported in the
liabilities section of the balance sheet
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 3 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 3 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the
balance sheet and calculate return on equity.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Retained Earnings
• The cumulative total of profit less losses and
less declared dividends since incorporation
• Represents part of shareholder’s claim on total
assets of a corporation
• Not a claim on any specific asset (including
cash)
• Two major components:
• Profit
• Dividends: cash distributions to owners
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Corporate Income Statements (1 of 2)
• Income statement for corporations are similar
to proprietorship or partnership statements
• One major difference is income taxes
• Since corporation is a separate legal entity
• Affects income statement (income tax expense)
and balance sheet (income tax payable or
receivable)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Corporate Income Statements (2 of 2)
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CHAPTER 13: LEARNING OBJECTIVE 4 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 4 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the
balance sheet and calculate return on equity.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Dividends
• Common types of dividends
• Cash dividends
•
Distribution of cash on a pro rata basis to
shareholder
• Stock dividends
- Distribution of corporation’s own shares to
shareholders (normally common shares)
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Cash Dividends (1 of 2)
• To pay dividends, a corporation must:
• Have enough retained earnings and cash
• Maintain legal capital
• Declare a dividend payable
• Declaration date:
• Board of directors formally declares dividend
• Commits corporation to a legal obligation
• Declaration is recorded:
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Cash Dividends (2 of 2)
• Record date:
• Ownership of shares is determined
• Shareholders of record on this date will receive
dividend
• No journal entry required
• Payment date:
• Dividend is paid to shareholders and recorded:
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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Preferred Share Cash Dividends
• Main difference between common share cash
dividends occurs when preferred shares are
cumulative
• Dividends in arrears are not considered a
liability
• No obligation to pay dividend until board of
directors declares
• Amount of dividends in arrears should be
disclosed in notes to financial statements
Copyright ©2019 John Wiley & Sons Canada, Ltd.
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CHAPTER 13: LEARNING OBJECTIVE 5 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
34
CHAPTER 13: LEARNING OBJECTIVE 5 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the
balance sheet and calculate return on equity.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
35
Statement of Retained Earnings
• Shows the changes in retained earnings during
the year
• Required under ASPE
• Transactions that affect retained earnings:
• Earning a profit (incurring a loss)
• Declaring cash and stock dividends
• Other transactions
Copyright ©2019 John Wiley & Sons Canada, Ltd.
36
Sample Statement of Retained Earnings
Copyright ©2019 John Wiley & Sons Canada, Ltd.
37
Closing Entries for a Corporation
• All temporary accounts must be closed at the
end of the accounting period
• Balance in Retained Earnings must be updated
Copyright ©2019 John Wiley & Sons Canada, Ltd.
38
CHAPTER 13: LEARNING OBJECTIVE 6 (1 of 2)
1. Identify and discuss characteristics of the
corporate form of organization.
2. Explain share capital and demonstrate the
accounting for the issuance of common and
preferred shares.
3. Prepare a corporate income statement.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
39
CHAPTER 13: LEARNING OBJECTIVE 6 (2 of 2)
4. Explain and demonstrate the accounting for
cash dividends.
5. Prepare a statement of retained earnings and
closing entries for a corporation.
6. Prepare the shareholders’ section of the
balance sheet and calculate return on equity.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
40
Shareholders’ Equity on the Balance
Sheet
• Contributed Capital: total amount contributed
by shareholders
• Share capital: preferred and common shares
• Contributed surplus: amounts contributed from
acquiring and retiring shares
• Retained Earnings: cumulative profit (or loss)
since incorporation that has been retained
• Annual profit (loss) is added (deducted)
• Dividends declared are deducted
Copyright ©2019 John Wiley & Sons Canada, Ltd.
41
Sample Shareholders’ Equity Section
Copyright ©2019 John Wiley & Sons Canada, Ltd.
42
Return on Equity
• Also called return on investment
• Considered to be the most important measure
of a firm’s profitability
• It evaluates how many dollars are earned for
each dollar invested by shareholders
Copyright ©2019 John Wiley & Sons Canada, Ltd.
43
Copyright
Copyright © 2019 John Wiley & Sons Canada, Ltd.
All rights reserved. Reproduction or translation of this work
beyond that permitted by Access Copyright (The Canadian
Copyright Licensing Agency) is unlawful. Requests for further
information should be addressed to the Permissions
Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and not
for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these programs or from the use of the
information contained herein.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
44
Chapter 14
Corporations: Additional
Topics and IFRS
Accounting Principles
Eighth Canadian Edition
Weygandt Kieso Kimmel Trenholm Warren Novak
Prepared by Debbie Musil, FCPA, FCMA
Corporations: Additional
Topics and IFRS (1 of 2)
• Additional Share Transactions
• Stock dividends and splits
• Reacquisition of shares
• Comprehensive Income
• Continuing and discontinued operations
• Other comprehensive income
• Accounting Changes
• Changes in accounting policies and estimates
• Correction of prior period errors
Copyright ©2019 John Wiley & Sons Canada, Ltd.
2
Corporations: Additional
Topics and IFRS (2 of 2)
• Reporting Changes in Shareholders’ Equity
• Summary of transactions
• Statement of changes in shareholders’ equity
• Analyzing Shareholders’ Equity
• Earnings performance; Dividend record
Copyright ©2019 John Wiley & Sons Canada, Ltd.
3
CHAPTER 14: LEARNING OBJECTIVE 1
(1 of 2)
1. Explain how to account for stock dividends and
splits, and compare their financial impact.
2. Explain how to account for the reacquisition of
shares.
3. Prepare an income statement showing
continuing and discontinued operations, and
prepare a statement of comprehensive income.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
4
CHAPTER 14: LEARNING OBJECTIVE 1
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
5
Stock Dividends
• Distribution of corporation’s own shares to its
shareholders
• Distributed (paid) in shares instead of cash
• Does not change assets or shareholders’ equity
• Decreases retained earnings and increases
share capital by the same amount
• Total amount is therefore unchanged
Copyright ©2019 John Wiley & Sons Canada, Ltd.
6
Stock Dividends: Purpose and Benefits
• Satisfies shareholders' dividend expectations
without spending cash
• Increases marketability of corporation’s shares
• Increasing number of shares will cause market
price to decrease and make shares more
affordable
• Emphasizes that a portion of shareholders’
equity has been permanently reinvested in the
business
•
Therefore unavailable for cash dividends
Copyright ©2019 John Wiley & Sons Canada, Ltd.
7
Entries for Stock Dividends
• Declaration date:
• Record date: no entry required
• Distribution date:
Copyright ©2019 John Wiley & Sons Canada, Ltd.
8
Stock Splits
• Involves the issue of additional shares to
shareholders
• Similar to a stock dividend
• Increases the marketability of shares by
lowering market price per share
• Effect on share price is generally inversely
proportional to size of split
• Does not affect shareholders’ equity
• Therefore no entries are required
Copyright ©2019 John Wiley & Sons Canada, Ltd.
9
Comparison of Dividends and Stock
Splits
• Cash dividends reduce assets and shareholders’
equity (retained earnings)
• Stock dividends increase share capital and
decrease retained earnings
• Stock splits have no effect (but do increase
number of shares issued)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
10
CHAPTER 14: LEARNING OBJECTIVE 2
(1 of 2)
1. Explain how to account for stock dividends and
splits, and compare their financial impact.
2. Explain how to account for the reacquisition of
shares.
3. Prepare an income statement showing
continuing and discontinued operations, and
prepare a statement of comprehensive income.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
11
CHAPTER 14: LEARNING OBJECTIVE 2
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
12
Common Shares:
Reacquisition of Shares (1 of 2)
• Companies can reacquire their shares from
shareholders in order to:
• Increase trading on securities markets (to
hopefully increase share value)
• Increase earnings per share
• Buy out hostile shareholders
• Have shares available for compensation or
other uses
• Reacquired shares are retired and cancelled (in
most jurisdictions)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
13
Common Shares:
Reacquisition of Shares (2 of 2)
• Steps to record a reacquisition:
• Remove dollar amount of shares from share
capital account
• Based on average per share amount (must be
calculated)
• Record cash paid for the shares
• Record any difference on reacquisition in
shareholders’ equity
Copyright ©2019 John Wiley & Sons Canada, Ltd.
14
Reacquisition of Shares:
Below Average per Share Amount
• If shares reacquired at a price < average per
share amount:
• Difference is an excess on reacquisition
• This excess is credited to a shareholders’ equity
account for the contributed capital from the
reacquisition:
Copyright ©2019 John Wiley & Sons Canada, Ltd.
15
Reacquisition of Shares:
Above Average per Share Amount
• If shares reacquired at a price > average per share
amount:
• Difference is a deficiency on reacquisition
• Additional cost of shares is first debited to
contributed capital from previous reacquisitions (if
any)
• Remaining difference is debited to Retained Earnings:
Copyright ©2019 John Wiley & Sons Canada, Ltd.
16
CHAPTER 14: LEARNING OBJECTIVE 3
(1 of 2)
1. Explain how to account for stock dividends and
splits, and compare their financial impact.
2. Explain how to account for the reacquisition of
shares.
3. Prepare an income statement showing
continuing and discontinued operations, and
prepare a statement of comprehensive income.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
17
CHAPTER 14: LEARNING OBJECTIVE 3
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
18
Discontinued Operations (1 of 2)
• Disposal or reclassification to “held for sale” of
a component of an entity
• A separate major business line or geographic
area
• Reported separately on income statement
• Includes allocation of income tax expense or
savings (called intraperiod tax allocation)
• Profit (loss) from discontinued operations and
gain (loss) from disposal
Copyright ©2019 John Wiley & Sons Canada, Ltd.
19
Discontinued Operations (2 of 2)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
20
Comprehensive Income
• Additional statement required under IFRS
• All-inclusive format or as a separate statement
• No “other comprehensive income” under ASPE
• Includes all changes in shareholders’ equity
except from sale/repurchase of shares and
dividend transactions
Copyright ©2019 John Wiley & Sons Canada, Ltd.
21
CHAPTER 14: LEARNING OBJECTIVE 4
(1 of 2)
1. Explain how to account for stock dividends and
splits, and compare their financial impact.
2. Explain how to account for the reacquisition of
shares.
3. Prepare an income statement showing
continuing and discontinued operations, and
prepare a statement of comprehensive income.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
22
CHAPTER 14: LEARNING OBJECTIVE 4
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
23
Change in Accounting Estimates
• Estimates of future conditions and events are
often made in accounting
• For example, bad debt expense or warranty
expense
• These estimates may need to be changed due
to:
• A change in circumstances
• New information becoming available
• The new estimate is used from now on
(prospective application)
• Do not go back and change prior periods
Copyright ©2019 John Wiley & Sons Canada, Ltd.
24
Change in Accounting Policy
• Occurs when the policy used in current year is
different that that used in prior year
• Only occurs when change:
• Is required by new IFRS or ASPE guidance
• Provides more reliable and relevant information
• Retrospective application required (prior years
restated) unless not practical to do so
Copyright ©2019 John Wiley & Sons Canada, Ltd.
25
Correction of Prior Period Errors (1 of 2)
• When a material error is discovered after the
financial statements have been issued
• Correction is made directly to Retained
Earnings (retrospective restatement)
• Since effect of error is now located there (all
revenues and expenses have been closed to
retained earnings)
• Net of any income tax effect
Copyright ©2019 John Wiley & Sons Canada, Ltd.
26
Correction of Prior Period Errors (2 of 2)
• Example: overstatement of interest expense
• Understatement of profit (now retained
earnings), and income tax payable
Copyright ©2019 John Wiley & Sons Canada, Ltd.
27
Presentation of Corrections of Prior
Period Errors
• Correction is added to (or deducted from)
opening balance of retained earnings, net of
income tax effect
• Financial statements of prior years are restated
to reflect the change
• Details of the change and its impact disclosed
in a note to the financial statements
Copyright ©2019 John Wiley & Sons Canada, Ltd.
28
CHAPTER 14: LEARNING OBJECTIVE 5
(1 of 2)
1. Explain how to account for stock dividends and
splits, and compare their financial impact.
2. Explain how to account for the reacquisition of
shares.
3. Prepare an income statement showing
continuing and discontinued operations, and
prepare a statement of comprehensive income.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
29
CHAPTER 14: LEARNING OBJECTIVE 5
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
30
Statement of Changes in Shareholders’
Equity
• Required for companies following IFRS
• Shows changes in shareholders’ equity during
year
• Including Contributed Capital, Retained Earnings,
Accumulated Other Comprehensive Income
• Companies following ASPE:
• Continue to use a Statement of Retained Earnings
• Other changes are reported in notes to the
statements
Copyright ©2019 John Wiley & Sons Canada, Ltd.
31
Summary of Shareholders’ Equity
Transactions
Copyright ©2019 John Wiley & Sons Canada, Ltd.
32
CHAPTER 14: LEARNING OBJECTIVE 6
(1 of 2)
1. Explain the different types of accounting
changes and account for the correction of a
prior period error.
2. Prepare a statement of changes in
shareholders’ equity.
3. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
33
CHAPTER 14: LEARNING OBJECTIVE 6
(2 of 2)
4. Explain the different types of accounting
changes and account for the correction of a
prior period error.
5. Prepare a statement of changes in
shareholders’ equity.
6. Explain earnings and dividend performance and
calculate performance ratios.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
34
Earnings Performance:
Earnings per Share
• Indicates profit earned by each common share
• Used under IFRS; not required under ASPE
• Formula to calculate:
• Weighted average number of common shares =
opening balance + (shares issued during the
year x the fraction of the year they are
outstanding)
Copyright ©2019 John Wiley & Sons Canada, Ltd.
35
Earnings per Share:
Complex Capital Structure (1 of 2)
• When a company has securities that can be
converted into common shares
• Example: convertible preferred shares
• If converted, the additional common shares will
result in a reduced (diluted) EPS figure
Copyright ©2019 John Wiley & Sons Canada, Ltd.
36
Earnings per Share:
Complex Capital Structure (2 of 2)
• Two EPS amounts are calculated:
• Basic EPS: calculation on preceding page
• Fully diluted EPS: calculated as if all securities
were converted into common shares
• Calculation of weighted average number of
shares becomes more complicated
Copyright ©2019 John Wiley & Sons Canada, Ltd.
37
Earnings Performance:
Price-Earnings Ratio
• Helps investors compare earnings of different
companies
• Formula to calculate:
• A high PE ratio is an indicator that investors
believe the company has good earnings
potential
Copyright ©2019 John Wiley & Sons Canada, Ltd.
38
Payout Ratio
• Indicates what percentage of profit a company
is distributing to its shareholders
• Can be calculated for common, preferred and
all dividends:
• Mature companies may have a higher payout
ratio due to limited growth potential
• A low payout ratio may indicate company is
retaining cash for possible future growth
• Payout ratios vary with between industries
Copyright ©2019 John Wiley & Sons Canada, Ltd.
39
Copyright
Copyright © 2019 John Wiley & Sons Canada, Ltd.
All rights reserved. Reproduction or translation of this work
beyond that permitted by Access Copyright (The Canadian
Copyright Licensing Agency) is unlawful. Requests for further
information should be addressed to the Permissions
Department, John Wiley & Sons Canada, Ltd. The purchaser
may make back-up copies for his or her own use only and not
for distribution or resale. The author and the publisher
assume no responsibility for errors, omissions, or damages
caused by the use of these programs or from the use of the
information contained herein.
Copyright ©2019 John Wiley & Sons Canada, Ltd.
40
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