ADMS 1500 – An Introduction to Accounting Course Director: Prof Paul Evans

1. ADMS 1500 – An Introduction to Accounting Course Director: Prof Paul Evans www.atkinson.yorku.ca/pevans pevans@yorku.ca 416-219-4170 Always bring Parkinson to class.

2. Accounting Characteristics Relevance Reliability Accounting Concepts: (Generally Accepted Accounting Principles, or GAAP): Business entity; Historic cost; Going concern; Periodicity; Disclosure; Conservatism; Recognition; Matching. (also consider Materiality & Consistency)

3. General purpose financial statements to external users: Income statement (for the year ended ….) (revenues, expenses and profits for a year) Balance sheet (as at ….) (assets, liabilities and equity at the end of the year) Statement of owners’ equity (for the year ended ….) (changes in owners’ equity) Cash flow statement (for the year ended ….) (changes in cash) Notes

4. Chapter 5: Retained Earnings & Cash Flow: • Learning Objectives: • After studying this chapter you should be aware of: • The role of retained earnings; • The statement of changes in financial position

5. Chapter 5: Retained Earnings & Cash Flow Retained earnings arises as a result of making a profit, and distributing less than 100% of the profit to shareholders. i.e. accumulated dividends are less than accumulated net income. Annual movements are reported on the Statement of Retained Earnings When net assets increase the accounting equation is balanced by increasing retained earnings. Retained earnings belong to common shareholders. Increases should cause share prices to rise, because: 1: they mean more assets per share; 2: we should expect higher earnings per share

6. Statement of Retained Earnings: Retained earnings at the beginning of the year: $773 Add: net income for the year: 148 921 (note that, legally, this $921 is the maximum amount available for distribution as dividend) Less: dividends: 31 (preference, common etc) Less: (or plus) any other “below the line” adjustments 3061 Retained earnings at the end of the year $860

7. Earnings per share: Earnings per share is reported on the income statement: EPS = Total net income / # common shares e.g. $5,000,000 / 500,000 = $10 EPS If net income increases, while common shares stay the same, EPS will increase. Shareholders will perceive their shares as more valuable. If net income stays the same, while common shares increase, EPS will decrease. Shareholders will perceive their shares as less valuable.

8. Diluted Earnings Per Share: • In some circumstances the existing number of shares is not a good guide to the number that could potentially exist. • The existing common shares could be diluted by the issue of additional shares: • Free to managers as a reward for service; • To managers at an advantageous price as a reward for service; • In exchange for preference shares; • In exchange for debt. • Fully diluted EPS accommodates these scenarios. • Preference dividends or interest that would be avoided are added back to the net income. • New shares to be issued are added to the existing common shares.

9. Jones Co: Net income: $6,000,000, Common shares in issue: 500,000 EPS: $6,000,000/500,000 = $12 There is a $100,000, 6% debenture loan which is convertible into 10,000 common shares. If the conversion were to be exercised the loan interest of $6,000 would be avoided, making net income higher. There are managers share options open which would entitle managers to buy 90,000 common shares at a price of $50. Fully diluted EPS: ($6,000,000 + $6,000 + interest on 90,000*$50) / (500,000 + 10,000 + 90,000) = $10.01 The additional shares would dilute the EPS from $12 to a lower amount.

10. Statement of Cash Flows: • Running out of cash is a serious threat to the continuation of the business. Liquidity can be assessed through liquidity ratios such as the current ratio and the quick ratio. Liquidity can also be monitored through the Statement of Cash Flows. • This is a required report that supplements the balance sheet income statement and statement of retained earnings. • Four headings: • Cash from (used in) operations • Cash from (used in) financing activities • Cash from (used in) investing activities • Change in cash balance.

11. Cash from (used in) operations • Net income for the year • All other things being equal, net income increases cash • + Depreciation & amortization etc • These are expenses deducted in calculating net income, but they do not require any cash flow. • + Decrease in non-cash working capital • Decreasing inventory, receivables etc frees up cash flow • - Increase in non-cash working capital • Adding inventory & receivables or paying off creditors will reduce available cash flow • = Cash from operations • For the company to be healthy, cash from operations should be positive

12. 2: Cash from (used in) financing activities • Increases in long-term debt • + Proceeds of new share issues • Repayment of long-term debt • Redemption of shares • Payment of dividends • = Cash from (used in) financing activities • A growing company will have positive cash flow from financing activities

13. 3: Cash from (used in) investing activities Investment in long-term assets - Proceeds of disposal of long-term assets = Cash used in investing activities A growing company will demonstrate cash being used in investment in long-term assets 4: Change in cash balance. This is the total of 1-3: It shows how much cash increased or decreased during the year. A company that shows decreases every year will eventually run out of cash