Sample of Event Income Statement

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					       Financial Statements

                    Andrew Graham
Two Lectures     Queens University
             School of Policy Studies
  The Road to Financial
Statement Enlightenment




           Should I stop and ask for
                 directions?




  Canadian Public Sector Financial     2
           Management
   A number must be kept in context with the
   financial statement where it is presented…




Warning! All numbers
 are not the same!




                 Canadian Public Sector Financial   3
                          Management
        Beware of Financial Vertigo

• Easy to get confused with terminology
• Much of what passes for complexity in
  financial statements is a terminology
  issue
• Sometimes this is counterintuitive – debits
  and credits as an example
• Terminology used often has the same
  meaning, e.g. revenue and income do not
  mean the same thing
                   Canadian Public Sector Financial   4
                            Management
 Purpose of Financial Statements

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




                   Canadian Public Sector Financial   5
                            Management
Source: Public Service Accounting
Board, CICA Public Sector Financial
        Canadian                      6
             Management
     Section 1
The Accounting Cycle




    Canadian Public Sector Financial   7
             Management
Canadian Public Sector Financial   8
         Management
               The Accounting Cycle

    The accounting process is a series of activities that
    begins with a transaction and ends with the closing of
    the books. Because this process is repeated each
    reporting period, it is referred to as the accounting
    cycle and includes these major steps:
•   Identify the transaction or other recognizable
    event.
•   Prepare the transaction's source document such
    as a purchase order or invoice.
•   Analyze and classify the transaction.
•   Record the transaction by making entries in the
    appropriate journal. Such entries are made in
    chronological order.
                        Canadian Public Sector Financial     9
                                 Management
                 The Accounting Cycle

• Post general journal entries to the ledger accounts.

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

• Prepare the trial balance to make sure that debits equal
  credits.
• Correct any discrepancies in the trial balance. If the
  columns are not in balance, look for math errors, posting
  errors, and recording errors. Posting errors include:
            posting of the wrong amount,
            omitting a posting,
            posting in the wrong column, or
            posting more than once.
                           Canadian Public Sector Financial          10
                                    Management
                 The Accounting Cycle

• Prepare adjusting entries to record accrued,
  deferred, and estimated amounts.
• Post adjusting entries to the ledger accounts.
• Prepare the adjusted trial balance. This step is
  similar to the preparation of the unadjusted trial
  balance, but this time the adjusting entries are
  included. Correct any errors that may be found.
• Prepare the financial statements.
       Income statement: prepared from the revenue, expenses,
        gains, and losses.
       Balance sheet: prepared from the assets, liabilities, and equity
        accounts.
       Cash flow statement: derived from the other financial
                             Canadian direct or indirect
        statements using either thePublic Sector Financial method.         11
                                    Management
          The Accounting Cycle


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


                 Canadian Public Sector Financial   12
                          Management
          The Accounting Cycle


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



                Canadian Public Sector Financial   13
                         Management
        Section 2
The Fundamental Accounting
         Equation




         Canadian Public Sector Financial   14
                  Management
   The Fundamental Accounting Equation -
               Definitions
   The Basic Logic of the Equation: What
   you have minus what you is what you
                are worth.
• Assets = Have
  – Economic resources owned by the
    organization that are expected to be of benefit
    to it in the future
  – Rights owed that have a monetary value e.g.
    right to collect fees
  – Cash. Office supplies, inventory, furniture,
    land and buildings
                     Canadian Public Sector Financial   15
                              Management
   The Fundamental Accounting Equation -
               Definitions

Grouping of assets for presentation on
 Financial Reports:
     Very liquid – cash and securities
     Assets for immediate use - inventory
     Productive Assets – plant and machinery
     Accounts receivable
     Fixed Assets – capital holdings
     Restricted Assets – non-mission holdings
     or assets held subject to highly restrictive
     conditions.
                    Canadian Public Sector Financial   16
                             Management
   The Fundamental Accounting Equation -
               Definitions

• Liabilities = Owe
  – Outsider claims which are economic
    obligations payable to outsiders
  – Outside parties are called creditors




                      Canadian Public Sector Financial   17
                               Management
    The Fundamental Accounting Equation -
                Definitions

• Equity or Capital = Value to Owners = Worth
   – Insider claims to the organization‟s assets
   – From a public sector perspective, it reflects the
     public holdings that remain after transactions
     – these can be both assets and debts
   – An owner has a claim to the entity‟s assets
     because he or she has invested in the
     business
   – Amount of an entity‟s assets that remain after
     the liabilities are subtracted
   – Often referred to Canadian Public Sector Financial
                         as net assets                    18
                            Management
   The Fundamental Accounting Equation -
               Definitions

• All receivables are assets
• All payables are liabilities




                  Canadian Public Sector Financial   19
                           Management
   The Fundamental Accounting Equation -
               Definitions

• Capital stock – amount invested in
  the corporation by its owners
• Retained Earnings – amount earned
  by income-producing activities and
  kept for use in the organization
• Net Income, Earnings, Profit or Loss
  – result of taking total revenues and
  total expenses into account over a
  specified period Public Sector Financial
                  Canadian
                           Management
                                             20
The Fundamental Accounting Equation


  Assets = Liabilities + Equity
               or
  Assets - Liabilities = Equity

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

              Canadian Public Sector Financial   21
                       Management
The Fundamental Accounting Equation
 Resources                                                Claims by
                                                          Outsiders
             Assets = Liabilities + Equity


                                                    Sources of
                                                    Resources


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



     Equation must always be in balance!
                 Canadian Public Sector Financial                22
                          Management
           Components of Retained Earnings: Flow Chart to Better
                   Understand Financial Statements

Revenues
of the          minus
Period

              Expenses
              for the       equals
              Period

                          Net
Beginning                                                                   Ending
                          Income (or                   Dividends
Balance of      plus or                                                     Balance of
                          Net Loss)         minus      for the     equals
Retained         minus
                                                                            Retained
                          for the                      Period
Earnings                                                                    Earnings
                          Period




                              Canadian Public Sector Financial                  23
                                       Management
    Section 3
Recording Financial
   Information




       Canadian Public Sector Financial   24
                Management
Recording Financial Information

   A financial event is one that affects the fundamental
     accounting equation by changing any of its components:
                 Assets = Liabilities + Net Assets

   A journal is a chronological listing of every financial event
    that occurs in an organization.
   Every type of asset, liability, revenue, or expense is
    referred to as an account. Organizations may have as
    many accounts as they need.



                        Canadian Public Sector Financial      25
                                 Management
   Recording Financial Information –
          Debits and Credits
• Financial events are recorded as a series of
  debits and credits
• Increases in assets are recorded by debits and
  decreases are recorded by credits.
• Increases in liabilities and in owner's equity are
  recorded by credits and decreases are recorded
  by debits.




                      Canadian Public Sector Financial   26
                               Management
   Recording Financial Information –
          Debits and Credits
• Notice that the debit and credit rules are related
  to an account's location in the balance sheet. If
  the account appears on the left-hand side of the
  balance sheet (asset accounts), increases in the
  account balance are recorded by left-side entries
  (debits).
• If the account appears on the right-hand side of
  the balance sheet (liability and owner's equity
  accounts), increases are recorded by right-side
  entries (credits).



                      Canadian Public Sector Financial   27
                               Management
Debits, Credits and the T-Account

   Increases are
                                                     Title of
  recorded on one                                   Account
    side of the T-
    account, and                                  Left    Right
                                                   or       or
   decreases are                                  Debit   Credit
                                                  Side     Side
  recorded on the
     other side.

               Canadian Public Sector Financial                    28
                        Management
     Debit                        Credit

A debit in an        A credit is an
increase in an       increase in a
asset item; a        claim item; a
decrease in a        decrease in an
claim or             asset or
expense item         revenue item.
             Canadian Public Sector Financial   29
                      Management
             Debit and Credit Rules
        Debits and credits affect accounts as
                      follows:



    A = L + NA
    ASSETS               LIABILITIES                     NET ASSETS
  Debit   Credit     Debit     Credit                   Debit     Credit
   for      for        for      for                       for      for
Increase Decrease   Decrease Increase                  Decrease Increase

                    Canadian Public Sector Financial                30
                             Management
    A Sample Transaction
   Suppose HOS buys inventory for $2,000. We could just
    add it to assets. But, that puts the Fundamental Equation
    out of balance.

          Assets    =       Liabilities    + Net Assets
          $2,000    =       no change      + no change
   In a sense, we have not "paid" for the supplies. Suppose
    the
    seller sent HOS a bill. We would record the full
    transaction as:
          Assets    =       Liabilities    + Net Assets

         Supplies           Accounts Payable
         + $2,000 =             + $2,000                  + no change
   To record a financial event, at least two elements of the
    fundamental equation must change!
                         Canadian Public Sector Financial            31
                                  Management
    A One-Sided Change Example

   Not every financial event (transaction) results in
    changes to both sides of the fundamental equation.
    Suppose HOS paid for the inventory in cash. Then the
    transaction would have
    been recorded as follows:

      Assets    =                         Liabilities   + Net
    Assets
      Inventory          Cash
      + $2,000       - $2,000         =    no change     + no
    change

   The fundamental equation is still in balance. But, all of
    the
                         the left Sector Financial
    changes occurred on Canadian Public side of the equation.
                                 Management
                                                              32
Recording Transactions

   The first step in recording a transaction is determining
    what has happened and what accounts will be
    impacted.
   Suppose near the end of the year, HOS buys a one-year
    insurance policy for $100 and pays for the policy in
    cash. Two things have happened:
      - Cash has gone down by $100.
      - HOS owns a new $100 asset called "prepaid
        insurance."

   Here's the way the transaction would be recorded:
         Assets        = Liabilities  + Net Assets

      P/I      Cash
    + $100            = no change
              - $100 Canadian Public Sector Financial +   no change   33
                                Management
    Another Example

   HOS mails a cheque to its bedpan supplier for $2,000 to
    pay part of the $7,000 it owed them at the start of the
    year. Two things have happened:
      - Cash has gone down by $2,000.
      - HOS's accounts payable have decreased by $2,000.
    Here's the way the transaction would be recorded:

            Assets    =         Liabilities                  + Net Assets

              Cash   =       Accounts Payable
            - $2,000 =          - $2,000                     + no change



                          Canadian Public Sector Financial             34
                                   Management
A Non Transaction
   HOS signs a binding contract to buy an X-Ray
    machine that will cost $50,000.
   This event will not give rise to a journal entry
    because it does not meet the rules for recognition.

     - The value of the transaction is known.

     - The timing of the transaction is known.

     - But, HOS does not yet own the equipment.
       There has been no exchange. So HOS does not
       owe the money. No liability unless we owe the
       creditor.    Canadian Public Sector Financial
                             Management
                                                     35
         Section 4

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


           Canadian Public Sector Financial   36
                    Management
              There are only




         types of accounts in the accounting world

Assets
Liabilities
Equity         Cumulative Transactions


Revenue
Expense            Canadian Public Transactions
               Current Period Sector Financial       37
                           Management
        There are only




    Formal Financial Statements
           Balance Sheet
         Income Statement

     Statement of Cash Flows
 Statement of Shareholders‟ Equity
Statement of Comprehensive Income
             Canadian Public Sector Financial   38
                      Management
The Principal Financial Statements of
          an Organization
                                                        All Governed by
     Balance Sheet                                         Accounting
                                                         Policies of the
         Income Statement
                                                        Organization –
                                                        an integral part
              Statement of Cash Flows
                                                        of the financial
                                                          statements




                     Canadian Public Sector Financial              39
                              Management
Balance Sheet
                                                     Describes
                                                      where the
   Income Statement                                 organization
                                                     stands at a
        Statement of Cash Flows
                                                    specific date.




                 Canadian Public Sector Financial             40
                          Management
Balance Sheet

   Income Statement
                                                      Depicts the
                                                     revenue and
        Statement of Cash Flows                     expenses for a
                                                      designated
                                                    period of time.




                 Canadian Public Sector Financial              41
                          Management
Balance Sheet

   Income Statement

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

                 Canadian Public Sector Financial              42
                          Management
                    The Balance Sheet
          Operating
            Liabs
Assets = Short-term & + Paid-in Capital + Retained Earnings +
           Liabilities     Equity
          Long-term
                          Accum. Other Comprehensive Income
            Debt
                   The Income Statement
            Revenues - Expenses = Net Income


                 Statement of Cash Flows
 Reconciliation of the Change in Cash and Cash Equivalents



             Statement of Shareholders‟ Equity
Reconciliation of the Changes in the Owners‟ Equity Accounts

            Statement of Comprehensive Income
                Canadian Public Sector Financial
   Reconciliation of Fair Value Changes and Adjustments      43
                      Management
Statement of Financial Position or The
           Balance Sheet


     The Balance Sheet reports:


 Has Today = Owes today + Worth today


           A Snapshot in time


               Canadian Public Sector Financial   44
                        Management
Statement of Financial Position
(The Balance Sheet)
Balance sheets report:
   - what an organization owns (Assets),
   - what it owes to outsiders (Liabilities), and
   - the portion of the organization's assets owned by
     its owners. Called:
       –  Owner's Equity, Partner's Equity, Net Worth, or
          Stockholders’ Equity (for-profit organizations).

      –    Net Assets or Fund Balance (not-for-profit and
        governments).
   - at a specific point in time.
   - For example, at the end of the organization's Fiscal
     Year.            Canadian Public Sector Financial 45
                         Management
Meals for the Homeless Balance Sheet
          ASSETS                                     LIABILITIES & NET ASSETS
Current Assets                                   Liabilities
   Cash                                $ 1,000    Current Liabilities
   Marketable Securities                 3,000     Wages Payable (Accrued             $ 2,000
                                                 Expenses)
   Accounts Receivable                  55,000      Accounts Payable                    2,000
   Inventory                             2,000      Notes Payable                       6,000
   Prepaid Expenses                      1,000     Current Portion - Mortgage           4,000
                                                 Payable
     Total Current Assets              $62,000          Total Current Liabilities     $ 14,000


Long-Term Assets                                  Long-Term Liabilities
Fixed Assets                                        Mortgage Payable                  $ 12,000
   Property                           $ 40,000          Total Long-Term Liabilities   $ 12,000
   Equipment, Net                       35,000
Investments                              8,000   TOTAL LIABILITIES                    $ 26,000
    Total Long-Term Assets            $ 83,000 NET ASSETS                             119,000
                             Canadian Public Sector Financial                           46
                                      Management
Current and Long-Term Assets
   Assets on the balance sheet are divided into
    current or short-term (those that are cash or
    cash-equivalents or are expected to become cash
    or will be used up within twelve months) and long-
    term (those that will not).
   Short-Term or Current Assets are listed in order of
    declining liquidity and normally include:
     -     cash and cash equivalents,
     -     marketable securities,
     -     accounts receivable,
     -     inventory, and
     -     prepaid expenses (long-term prepaid expenses
                                 Charges)
         are called Deferred Public Sector Financial
                        Canadian                       47
                           Management
    Cash and Cash Equivalents

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

                Canadian Public Sector Financial   48
                         Management
Marketable Securities
    Marketable securities include equity and debt
     instruments that can be bought and sold in public
     and private markets.
    The values of marketable securities are reported
     by governments and not-for-profit organizations
     at fair market value.
    If there is any dispute about fair market value,
     then cost is used to provide a value.




                     Canadian Public Sector Financial   49
                              Management
           Accounts Receivable
• When an organization produces a product,
  service or obligation for another entity and it is
  transferred to the entity, the organization
  acquires the right to collect the money from that
  entity – this establishes a receivable account
• An accounts receivable entry is made when this
  occurs but before the entity pays for it
• Knowing what the outstanding accounts
  receivable are for the organization is an important
  indicator of its anticipated income, the degree to
  which is it efficiently collecting for its services
  and the degree to which it is carrying debt that it
  should collect
                       Canadian Public Sector Financial   50
                                Management
                       Inventory

• Inventory is both the finished
  products held by the organization for
  sale to an outside buyer and the
  products used to make the finished
  product                        This becomes an
• Three kinds of inventory:          accounts
                                                     receivable when it
  – Raw material inventory                            is sold and cash
                                                     when the customer
  – Work-in-progress inventory                           pays for it.
  – Finished goods inventory
                  Canadian Public Sector Financial
                           Management
                                                                   51
          Pre-paid expenses

• Financial obligations that the organization
  has already paid for but not yet received
• Examples are: insurance, rent, deposits
  made with suppliers, salary advances
• They are current assets not because they
  can be turned into cash, but because the
  organization will have to use cash to pay
  for them in the near future and they are
  generally available for consumption within
  the twelve month period
                   Canadian Public Sector Financial   52
                            Management
Current Asset Cycle – a way to think of
 the relationship of these categories
                                                          This is why
                                                            they are
                          Cash                               called
                                                           “Working
                                                            Assets”


      Accounts
                                                      Inventory
      Receivable




                   Canadian Public Sector Financial                     53
                            Management
Long-Term Assets

Long-Term Assets are generally divided into
  three categories:
   1.Fixed Assets, which include:
        1.property (land) usually recorded at
          cost,
        2.plant (buildings) recorded at cost and
          reported at net book value, and
        3.equipment recorded at cost and
          reported at net book value
   2.Investments, and
   3.Intangibles
                 Canadian Public Sector Financial   54
                          Management
                Fixed Assets

• Productive assets not intended for sale.
• They will be used over and over again to
  produce value to the end product of the
  organizations
• Commonly include land, buildings,
  machinery, equipment, furniture, vehicles,
  etc.
• Normally reported on Balance Sheet in Net
  Fixed Asset format: blued at original cost
  minus an allowance for depreciation
                   Canadian Public Sector Financial   55
                          Management
Net Fixed Asset Determination

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


                       Canadian Public Sector Financial    56
                                Management
A Net Book Value Example


       Record the Van at Cost = $30,000


       Subtract two years of depreciation
       [($30,000 - $5,000 salvage)/5 yr life] x 2
       = $10,000


       Net Book Value =
       $30,000 cost - $10,000 Accumulated
       Depreciation = $20,000
               Canadian Public Sector Financial     57
                        Management
Fixed Assets on the Balance Sheet
All three values - cost, accumulated
depreciation, and net book value are shown.
                                Museum A Museum B
 Net Fixed Assets or
 Net Book Value                                    $1,000,000   $ 1,000,000
 PP&E at cost                                    $40,000,000    $ 2,000,000
 Accumulated Depreciation                        (39,000,000)   (1,000,000)

 Net Book Value                                   $ 1,000,000   $ 1,000,000


           Are these two museums really similar
           or different?

                       Canadian Public Sector Financial                 58
                                Management
Recognizing Asset Transactions

 Financial events are recorded at the
  time of Recognition
 Asset transactions are recognized

  when:
    - they are owned by the organization,
    - they have a monetary value,
    - that monetary value can be
      objectively determined.


              Canadian Public Sector Financial   59
                       Management
       Recognizing Asset Transactions



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


                  Canadian Public Sector Financial   60
                           Management
   Can Intangible Assets Appear on a
           Balance Sheet?
• What are intangible assets? An asset that
  has no substance or physical properties.
  Intangible assets include goodwill, patent
  rights, permits, copyrights and licenses.
• How are they assets? An intangible is any
  event that creates or modifies perceptions
  of the future behavior, value or relevance,
  of the organization but that are seen as
  usable assets that can be converted into
  (ultimately) cash.Canadian Public Sector Financial   61
                           Management
   Can Intangible Assets Appear on a
           Balance Sheet?
• Intangibles, intangible assets, knowledge assets
  and intellectual capital are more or less
  synonyms. All are widely used – intangibles
  specifically in the accounting literature,
  knowledge assets by economists and intellectual
  capital predominantly in the management
  literature.
• Intangibles create future value. All intangibles are
  future-oriented. (Because of this they are ignored
  by traditional accounting systems – conservatism
  concept, materiality concept).
• Rule of quantification – slippery slope of
  quantification       Canadian Public Sector Financial   62
                                  assets………
• Good will and knowledgeManagement
                      Meals for the Homeless
                          Balance Sheet
         ASSETS                                        LIABILITIES & NET ASSETS
Current Assets                                    Liabilities
  Cash                                  $ 1,000    Current Liabilities
  Marketable Securities                   3,000     Wages Payable (Accrued Expenses)     $ 2,000
  Accounts Receivable, Net               55,000      Accounts Payable                      2,000
  Inventory                               2,000      Notes Payable                         6,000
  Prepaid Expenses                        1,000      Current Portion – Mortgage            4,000
    Total Current Assets                $62,000           Total Current Liabilities      $ 14,000


Long-Term Assets                                   Long-Term Liabilities
Fixed Assets                                          Mortgage Payable                   $ 12,000
  Property                             $ 40,000           Total Long-Term Liabilities    $ 12,000
  Equipment, Net                         35,000
Investments                               8,000   TOTAL LIABILITIES                      $ 26,000
    Total Long-Term Assets             $ 83,000   NET ASSETS                             119,000


TOTAL ASSETS                                        Financial
                             Canadian Public SectorTOTAL LIABILITIES & NET ASSETS
                                       $145,000                                         63
                                                                                         $145,000
                                      Management
Liabilities

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

          Whether the debt is payable within the

            year
                    Canadian Public Sector Financial   64
                             Management
 Short-term or current liabilities

• Generally consist of:
  – specific "payables" which are typically due
    within a specified period, usually the
    current fiscal year, e.g. wages or salary
    payable
  – Generally have the following groupings:
    • Accounts payable to suppliers
    • Accrued expenses owed to employees and
      other for services
    • Current debt owed to lenders
    • Taxes owed Canadian Public Sector Financial   65
                       Management
     Accrued Expenses – Wage
             Payable
• Monetary obligations similar to accounts
  payable
• Some flexibility on how these categories
  are used
• Generally accrued expenses involve
  financial obligation within the organization
• Therefore, this often records salary earned
  but not yet paid, interest due but not yet
  paid on bank debt, pension buy-outs,
  outstanding training costs Financial
                    Canadian Public Sector       66
                       Management
             Accounts Payable

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



                       Canadian Public Sector Financial   67
                                Management
Notes Payable/Current Portion of Debt

• Short-term obligations that are
  payable in a year or less
• Brings in long-term obligations, but
  only the amount to be spent within
  the year to discharge it



                Canadian Public Sector Financial   68
                         Management
Long-Term Liabilities
       Long-Term Liabilities included in Liabilities
        section is the current portion of the long-term
        liability that would have to be paid in the next
        12 months:
          - Long-Term Debt,
              – Capital Leases
              – Long-Term Unsecured Loans
              – Mortgages
              – Bonds Payable
          - Pension Liabilities, and
          - Contingent Liabilities.

                    Canadian Public Sector Financial   69
                             Management
Amortizing Long-Term Debt
 Suppose that Meals buys a delivery van
  for $32,000.
 It finances $25,000 of the   purchase
  price with a five-year loan at 8%
  interest per annum.
 The loan calls for annual payments (in

  arrears) of $6,261.41.
 How much of each year's payment

  would be interest?
 What would be the amounts shown on

  the Balance Sheet at the end of year 3?
               Canadian Public Sector Financial   70
                        Management
         Amortizing Long-Term Debt
          Beginning      Total           Interest                       Ending

          Balance ($) Payment ($)        Portion           Principal    Balance
                                           ($)                ($)         ($)
Year 1        25,000         6,261            2,000             4,261     20,739

Year 2        20,739         6,261            1,659             4,602     16,136

Year 3        16,136         6,261            1,291             4,971     11,166

Year 4        11,166         6,261               893            5,368      5,798

Year 5         5,798         6,261               464            5,798             0


                  End of Year 3 Bal. Sheet: Short-term Liability
                       $5,368; Long-term Liability $5,798.
                       How was the $6,261.41 calculated?
                        Canadian Public Sector Financial                     71
                                 Management
Liability Recognition

   Liabilities are recognized when:
       they are legally owed,

       have to be paid, and

       the amount to be paid can be objectively

        measured.
   Which of the following should be recognized as
    a liability?
       a bill received from a vendor?

       wages that are due to a worker?

       a $5 million lawsuit filed against an

        organization?
                   Canadian Public Sector Financial   72
                            Management
Net Asset Categories
    The amount of total assets minus total liabilities equals
     equity. Because equity is equal to the net difference
     between assets and liabilities, it is also called net
     assets.
    Both ‘net worth’ and ‘book value’ hold the same
     meaning as ‘net assets’ and ‘shareholder value’
    The net worth of an organization represents the sum of
     the organization's earnings from inception plus any
     paid-in capital (in for-profits) less any payments that
     have been made to the organization's owners. Also call
     Capital Stock
    Retained earnings: money that is held after all liabilities
     have been discharged and not used for assets – can
     also be negative value, i.e. debt
                        Canadian Public Sector Financial      73
                                 Management
          Net Asset Categories

• In not-for-profit organizations, net
  worth is called "Net Assets" and is
  broken down into three categories.
  – Unrestricted Net Assets, which have not
    been restricted by donors (also
    cumulative profits appear here).
  – Temporarily Restricted Net Assets, the
    use of which has been restricted by
    donors.
  – Permanently Restricted Net Assets,
    which are restricted in perpetuity.
                   Canadian Public Sector Financial
                            Management
                                                      74
    Balance Sheet with Net Asset Categories
               ASSETS                                             LIABILITIES
Current Assets                                   Current Liabilities
 Cash                          $ 52,000           Accounts Payable                    $     7,000
 Accounts Receivable             18,000           Wages Payable                            30,000
 Inventory                        5,000                 Total Current Liabilities     $ 37,000
 Prepaid Insurance                    0
   Total Current Assets        $ 75,000          Long-Term Liabilities
                                                   Mortgage Payable                   $140,000
Long-Term Assets                                        Total Long-Term Liabilities   $140,000
 Fixed Assets                                    Total Liabilities                    $177,000
  Property and Equipment-Net   $240,000          NET ASSETS
   Total Long-Term Assets      $240,000            Unrestricted                       $113,000
                                                   Temporarily Restricted                  15,000
                                                   Permanently Restricted                  10,000
                                                 Total Net Assets                     $138,000
Total Assets                   $315,000          Total Liabilities and Net Assets     $315,000




                                Canadian Public Sector Financial                      75
                                         Management
        Section 5

Generating a Balance Sheet




            Canadian Public Sector Financial   76
                     Management
Generating a Balance Sheet

   Generating a balance sheet involves:

     Beginning with the starting balance sheet,
     Recording all of the transactions for the period,
     Adding the impact of the transactions to the
      starting balance sheet,
     Formatting the resulting balance sheet
      accounts into the balance sheet reporting
      format.



                   Canadian Public Sector Financial   77
                            Management
                 The Starting Balance Sheet
             ASSETS                              LIABILITIES AND NET ASSETS

Current Assets                                  Current Liabilities
 Cash                          $ 52,000           Accounts Payable                $     7,000
 Accounts Receivable             18,000           Wages Payable                        30,000
 Inventory                        5,000             Total Current Liabilities     $ 37,000
 Prepaid Insurance                    0
   Total Current Assets        $ 75,000         Long-Term Liabilities
                                                   Mortgage Payable               $140,000
Long-Term Assets                                    Total Long-Term Liabilities   $140,000
 Fixed Assets                                   Total Liabilities                 $177,000
 Property and Equipment, Net   $240,000

   Total Long-Term Assets      $240,000         Total Net Assets                      138,000




Total Assets                                   Total Financial
                               $315,000 Public SectorLiabilities and Net Assets
                                Canadian                                          $315,000
                                                                                    78
                                          Management
           Transactions Work Sheet
                            ASSETS                                      LIABILITIES &    NA


                       Accounts               Ppd.   Plant &     Accoun     Wages     Mortgage    Net
             Cash      Receivabl   Inventor   Ins.   Equipme       ts       Payable   Payable    Assets
                          e           y                 nt       Payable
Beginning   $52,000     $18,000      $5,000          $240,000     $7,000    $30,00    $140,000   $138,000
Balance                                                                          0
Buy Fire      (100)                           $100
Insurance
Pay          (2,000)                                              (2,000)
Supplies
Buy                                   3,000                         3,000
Inventory
Receive
Payment     (12,000)    (12,000)
Ending      $61,900     $ 6,000      $8,000   $100   $240,000     $8,000    $30,00    $140,000   $138,000
Balance                              Canadian Public Sector Financial            0               79
                                              Management
        The Ending Balance Sheet
             ASSETS                                        LIABILITIES
Current Assets                                 Current Liabilities
 Cash                        $ 61,900            Accounts Payable                 $     8,000
 Accounts Receivable            6,000            Wages Payable                         30,000
 Inventory                      8,000              Total Current Liabilities      $ 38,000
 Prepaid Insurance                100
   Total Current Assets      $ 76,000          Long-Term Liabilities
                                                  Mortgage Payable                $140,000
Long-Term Assets                                   Total Long-Term Liabilities    $140,000
 Fixed Assets                                  Total Liabilities                  $178,000
 Property and Equipment,     $240,000
Net
   Total Long-Term Assets    $240,000          Total Net Assets                       138,000




Total Assets                 $316,000          Total Liabilities and Net Assets   $316,000

                            Canadian Public Sector Financial                      80
                                     Management
            Section 6
     The Income Statement or
     Statement of Operations
(Also called Activity Statement, Statement of
Revenues and Expenses, or Profit and Loss
           (P&L) Statement)



                  Canadian Public Sector Financial   81
                           Management
     What is an Income Statement?


• Reports on cash movements in the
  organization
• Statement of cash movement for a
  specific period of time, usually a
  quarter, month or year – a specified
  period of time.
• Unlike a Balance Sheet which is a
  snapshot of a specific day
                 Canadian Public Sector Financial   82
                          Management
   What is an Income Statement?

• Linkage is that the net income for this year
  as shown on an Income Statement is added
  to Retained Earnings on the Balance Sheet to
  show increase/decrease in Net Assets as a
  result of this year‟s income
• Therefore, the Income Statement shows for a
  period all the transactions taken by the
  organization to either increase assets or
  decrease liabilities on the Balance Sheet
• Key tool in financial control and budgetary
  management: used to inform of current
  financial situation, identify surplus/deficits,
  measure performance Financial
                  Canadian Public Sector        83
                     Management
 Basic Income Statement Formula


Revenues – Expenses = Net Income
           (Net Loss)




             Canadian Public Sector Financial   84
                      Management
                Revenues and Support                       2000         1999
                Meals
                 Client Revenue                        $ 10,000      $ 8,000
                 City Revenue                              20,000      16,000
                Shelter Counseling

Meals for the    Client Revenue
                 County Revenue
                                                            1,000
                                                           10,000
                                                                        1,000
                                                                       10,000

 Homeless       Fundraising
                 Foundation Grants                         70,000      50,000
  Activity       Annual Ball                               12,000      11,000

 Statement       Telephone Solicitation
                Mail Solicitation
                                                           25,000
                                                           48,000
                                                                       28,000
                                                                       45,000
                Total Revenue and Support              $196,000     $169,000
                Expenses:
                 Food                                  $ 17,000     $ 16,000
                 Kitchen Staff                             35,000      33,000
                 Counseling Staff                          35,000      34,000
                 Rent on Kitchen Locations                 15,000      14,000
                 Administration and General                75,000      65,000
                 Bad Debts                                  4,000       4,000
                 Depreciation                              10,000      10,000
                Total Expenses                         $191,000     $176,000
                    Canadian Assets
                Change in NetPublic Sector Financial   $    5,000   85 (7,000)
                                                                     $
                             Management
The Income Statement: Revenues and
             Support

– represent inflows that the organization
  has received or is entitled to receive.
– result in an inflow of Assets to the
  organization and an increase in Net
  Assets.




                Canadian Public Sector Financial   86
                         Management
The Income Statement: Revenues and
             Support
• Revenues are generally the result of an
  exchange for goods and services that the
  organization has provided or budgetary
  decisions that a government makes
• Support is the result of gifts, grants, and
  other contributions to the organization.
• Category of other income from fees or
  non-tax income streams

                   Canadian Public Sector Financial   87
                            Management
Expenses and Net Income

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




                      Canadian Public Sector Financial   88
                               Management
        Expenses and Net Income


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


                Canadian Public Sector Financial   89
                         Management
            Cost vs. Expense


• Cost describes how money is spent
  to build inventories or add to plant or
  capacity
• Expense is any other operating
  expenditure.
• Note: An expenditure can be either a
  cost or an expense. Expenditure
  simply means the use of cash to pay
  for an item purchased. Financial
                 Canadian Public Sector
                          Management
                                            90
Recognizing Revenue and Support
   Revenue is recognized if:
     - the goods or services have been provided,
     - the amount to be collected can be objectively
       measured,
     - there is a reasonable likelihood of collection.

   Support is recognized if:
     - all of the conditions of the gift have been met,
     - the value of the pledge can be objectively
       measured, and
     - there is a reasonable likelihood of collection.

                     Canadian Public Sector Financial   91
                              Management
Recognizing Expenses

   Expense Recognition depends on the type of
    expense:

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

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

                           Canadian Public Sector Financial   92
                                    Management
Expired and Unexpired Costs

   Suppose Meals bought 100 canned hams at a cost of
    $1,000 in March. At acquisition, Meals would
    recognize the hams as an asset (Inventory). They are
    also an unexpired cost.
   If they paid for the hams in cash, Cash would go
    down by $1,000. Otherwise Accounts Payable
    increases $1,000.
   In May, Meals used 50 of the hams to produce meals.
      -    At use, the hams become an expense (expired
         cost) of $500 (50 hams * $10 per ham = $500),
         and the value of the asset (Inventory) is reduced
         by $500.
   This is a Product Cost. The inventory becomes an
    expense as used to provide service.
                        Canadian Public Sector Financial     93
                                 Management
    Inventory Expense


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

          Beginning Inventory + Purchases - Consumption = Ending

                   5      +        10           -           13   =2




                         Canadian Public Sector Financial             94
                                  Management
Deferred Revenue
   Deferred or unearned revenues arise when an
    organization is paid in advance for goods or services.
    Deferred usually long term, Unearned usually short term.

     - Why is deferred revenue a liability to an organization?

   A museum sells a five-year membership for $250.

     - How much of the $250 should be recorded as deferred
       revenue?

     - How much of the $250 would the museum recognize
       as revenue during the first year of the membership?

                        Canadian Public Sector Financial         95
                                 Management
Where the Income Statement and Balance
              Sheet Meet
                    Event              Statement Impact                Note
Revenue       You provide a          AR or Cash up             AR is a “holding
Recognized    service and            B/S                       area”for unpaid bills
              earn revenue           Revenue up    I/S         that you have sent
                                                               out
No impact     Someone pays           AR down            B/S
on revenue    a bill you sent        Cash up            B/S
No impact     When you buy           AP up or                AP is where you keep
on expenses   something              Cash down           B/S track of what you
                                     Inventory up        B/S owe to others

Expense       When you use           Asset down or
Recognized    something              Liability up
                                     B/S
                                     Expense up    I/S
                            Canadian Public Sector Financial                       96
                                     Management
          Reflecting the Change in Net Assets
                  on the Balance Sheet
Net income is reported as a change in net assets on the
 balance sheet.

 Total Revenue and Support                   $81,000

 Total Expenses                              - 80,050                     Activity
 Increase in Net Assets                      $     950                    Statement
                                                                               Balance
                                                                               Sheet
                                                 Unrestricted      Temp. Rest.    Perm. Rest.
                   Beginning Balances               $113,000            $15,000      $10,000
                   Increase in Net                       950
                   Assets
                   Ending Balances                  $113,950            $15,000      $10,000

                                     Canadian Public Sector Financial                           97
                                              Management
      Section 7
Cash Flow Statements




       Canadian Public Sector Financial   98
                Management
      The Cash Flow Statement

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




                  Canadian Public Sector Financial   99
                           Management
            There are only




  Sections on the Cash Flow Statement



•Change in Cash & Cash Equivalents
•Net Income Line
•Cash Generated by Operating Activities
•Cash Generated by Investing Activities
•Cash Generated by Financing Activities
            Canadian Public Sector Financial   100
                     Management
  The Cash Flow Statement
– Why does an organization need both an
  operating statement and a cash flow
  statement?
   • Cash flow statements provide vital budget to plan
     information in purely cash terms
   • Cash flow information gives you information on your
     budgetary flexibilities and also on the actual cash
     performance versus the predicted one for
     cash/budget management purposes
– Why is it important to know the sources and
  uses of cash flow?
   • This will depend on the nature of the organization –
     less so with single source (budget funds) of cash
                      Canadian Public Sector Financial      101
                               Management
  The Cash Flow Statement
– Isn't knowing if cash increased or
 decreased enough?
  • No, source and availability are important




                  Canadian Public Sector Financial   102
                           Management
           The Cash Flow Statement
Start with Change in Net Assets [i.e., net income] as a first
approximation of cash
flow, and then make adjustments. Why isn't this good
enough? Why are the other adjustments needed?
Assets   =    Liabilities +   Net Assets
  Assets =      Liabilities +     Net Assets


  Cash +      Other Assets =             Liabilities +     Net
Assets
  Cash                  =            Liabilities +        Net Assets
       Other Assets

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


                       Canadian Public Sector Financial           103
                                Management
  Example: Assume This Activity
Statement for Meals

                       Revenue
The first              Clients                     5,000
estimate                   City                   35,000
                           Donations              20,000
of cash
                        Total Revenue            $60,000
flow from              Expense
operations             Food                      $20,000
is the                 Labor                      25,000
change in              Depreciation               10,000
net assets.                Total Expenses        $55,000
                       Increase in Net Assets    $ 5,000

              Canadian Public Sector Financial             104
                       Management
Adjusting the Increase in Net Assets
to Cash Flow
  The Increase in Net Assets is an
  approximation of cash flow. Adjustments are
  needed to arrive at true cash flow.
  The first adjustment is for "Expenses not
  requiring cash" such as depreciation or
  amortization. Why doesn't depreciation
  require cash?
  The remainder of the adjustments to
  operating cash flow are for changes in
  balance sheet accounts related to operations.

                 Canadian Public Sector Financial   105
                          Management
Adjusting the Increase in Net Assets to Cash
                    Flow

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

                  Canadian Public Sector Financial   106
                           Management
The Statement of Cash Flows
  Cash Flows from Operating Activities                            2000        1999
   Increase in Net Assets                                      $ 5,000     $ (7,000)
  Add Expenses Not Requiring Cash:
   Depreciation                                                 10,000      10,000
  Other Adjustments:
   Add Decrease in Inventory                                     2,000        2,000
   Add Increase in Notes Payable                                 1,000        3,000
   Subtract Increase in Receivables                            (17,000)     (12,000)
   Subtract Decrease in Wages Payable                           (1,000)          0
   Subtract Decrease in Accounts Payable                        (1,000)      (2,000)
   Subtract Increase in Prepaid Expenses                        (1,000)          0
     Net Cash Used for Operating Activities                    $ (2,000)   $ (6,000)


                            Canadian Public Sector Financial                         107
                                     Management
The Statement of Cash Flows, continued
                                                                    2000              1999
Cash Flows from Investing Activities
 Sale Stock Investments                                         $ 4,000     $     5,000
 Purchase of Delivery Van                                                       (32,000)
  Net Cash from Investing Activities                            $ 4,000     $ (27,000)
Cash Flows from Financing Activities
 Increase in Mortgages                                                      $ 25,000
 Repayments of Mortgages                                        $ (5,000)        (4,000)
  Net Cash from Financing Activities                            $ (5,000)   $ 21,000
Net Increase/(Decrease) in Cash                                 $ (3,000)   $ (12,000)
Cash, Beginning of Year                                            5,000         17,000
Cash, End of Year                                               $ 2,000     $     5,000
                             Canadian Public Sector Financial                   108
                                      Management
            The Cash Flow Statement

   Cash flows relating to investment and
    financing activities are listed separately.

   The method shown was the indirect method.
    The direct method is easier, just requiring a
    listing of all cash inflows and outflows (could
    be taken from transactions worksheet cash
    column). But indirect method provides more
    information.


                       Canadian Public Sector Financial   109
                                Management
       How to Cook the Books

• There is fraud and there is distortion
  possible in all this. So too is creative
  accounting.
• So much relies upon issues such as
  recognition rules, when expenses and
  expenditures are actually recognized




                   Canadian Public Sector Financial   110
                            Management
        How to Cook the Books

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




                        Canadian Public Sector Financial   111
                                 Management
                                    Are we
                                   having fun
                                      yet?




Canadian Public Sector Financial          112
         Management

				
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