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AFM101 Chapter Notes - Chapter 12: Sole Proprietorship, Retained Earnings, Financial Statement

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lilacmouse857
26 Jun 2018
School
University of Waterloo
Department
Accounting & Financial Management
Course
AFM101
Professor
Donna Psutka

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AFSA Education
Measuring and Reporting Changes in Shareholders’ Equity
Retained Earnings
- There may be a statement that includes an adjustment to the beginning balance of retained
earnings resulting from a correction of an error that occurred in the financial statements of a
prior period
- Financial statements of the prior period are restated to reflect the correction of the error (to
avoid improperly measuring current net earnings)
- Adjustments of prior periods should be made if the entity changes its accounting policies (ex.
FIFO to LIFO)
Accumulated Other Comprehensive Income (Loss)
- This equity item reflects the financial effect of events that cause changes in shareholders’
equity, other than investments by shareholders or distributions to shareholders
Accounting and Reporting for Unincorporated Businesses
- Sole proprietorship – unincorporated business owned by one individual
- Partnership – unincorporated business owned by two or more people
- Not separate legal entities
Typical Account Structure
Corporation
(Shareholders’ equity)
Sole Proprietorship
(Owner’s Equity)
Partners
hip
(Partners’ Equity)
Share Capital, contributed
surplus
Able, capital; Baker, capital
Retained earnings
Not used
Not used
Dividends paid
Doe, drawings
Able, drawings; Baker, drawings
Ratios
Earnings per Share Ratio
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒 = 𝑁𝑒𝑡 𝑒𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐴𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒 𝑡𝑜 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝐶𝑜𝑚𝑚𝑜𝑛 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
Dividend Yield Ratio
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑌𝑖𝑒𝑙𝑑 𝑅𝑎𝑡𝑖𝑜 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑆ℎ𝑎𝑟𝑒
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AFM101 Full Course Notes
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Document Summary

There may be a statement that includes an adjustment to the beginning balance of retained earnings resulting from a correction of an error that occurred in the financial statements of a prior period. Financial statements of the prior period are restated to reflect the correction of the error (to avoid improperly measuring current net earnings) Adjustments of prior periods should be made if the entity changes its accounting policies (ex. This equity item reflects the financial effect of events that cause changes in shareholders" equity, other than investments by shareholders or distributions to shareholders. Sole proprietorship unincorporated business owned by one individual. Partnership unincorporated business owned by two or more people.

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Related Questions

ASC 250 “Accounting Changes and Error Corrections”

This case clarified the treatment of accounting changes afteracquisitions. As we have seen, FASB’s guidance comes through ASC805 “Business Combinations.” However, the guidance for other typesof accounting changes is in ASC 250 “Accounting Changes and ErrorCorrections.” This section will integrate accounting changes afteran acquisition with the accounting changes listed in ASC 250.

ASC 250 lists four types of accounting changes.

Change in Accounting Principle – for example, a newrevenue-recognition standard

Change in Accounting Estimate – for example, change inestimated useful life of a depreciable asset

Change in Reporting Entity

Correction of an Error in previously issued financialstatements – for example, last period’s inventory and thereforeretained earnings were overstated

One particularly confusing element of ASC 250 is the categorycalled “change in reporting entity.” To the unwary observer thissounds a lot like an acquisition, but that is actually not thecase. The reason that the distinction is critical is that ASC 250prescribes a retroactive accounting to “change in reportingentity,” but as we just saw the accounting treatment foracquisitions is prospective, with only limited pro-formalretroactive disclosures.

The key accounting question for these four types of changes anderrors is whether the change is accounted forretrospectively orprospectively. In the former case, weadjust previous financial statements to reflect the newinformation. In the latter case, we make no adjustments to previousfinancial statements.

To help you become more familiar with these terms and therequirements of the codification, Work Schedule 6 lists the fourscenarios covered by ASC 250. As the schedule shows, three of thefour scenarios are treated retrospectively, including a “change inreporting entity.” To gain a better understanding of whatretrospective and prospective means, please identify the paragraphnumber that prescribes the appropriate accounting treatment(retrospective or prospective) to the four scenarios. Although youare only asked to identify the paragraph number, it is suggestedthat you also identify the specific word(s) in the paragraph thatindicate retrospective or prospective treatment for each of thefour types of changes.

Work Schedule 6. ASC 250 “Accounting Changesand Error Corrections”.

For:

Accounting Treatment

Paragraph Number

Change in Accounting Principle

Retrospective

Indicate the paragraph number in the box above and copy andpaste the paragraph and highlight/underline the words indicatingretrospective application.

Change in Accounting Estimate

Prospective

Indicate the paragraph number in the box above and copy andpaste the paragraph and highlight/underline the words indicatingprospective application.

Change in Reporting Entity

Retrospective

Indicate the paragraph number in the box above and copy andpaste the paragraph and highlight/underline the words indicatingretrospective application.

Correction of an Error

Retrospective

Indicate the paragraph number in the box above and copy andpaste the paragraph and highlight/underline the words indicatingretrospective application.

As the schedule indicates, changes and corrections are accountedfor retrospectively, with the exception of a change in estimatewhich is accounted for prospectively. Our focus here is to clarifythat changes in accounting entity does not coveracquisitions. According the ASC 250-10-34-21, “Changes inAccounting entity” consists of an accounting change that results ina “different reporting entity”. To the casual observer,acquisitions would seem to fit this category, with the requirementof retroactive restatement of all prior periods as if the acquiredcompany had always been a part of the acquirer. However, this isnot the case, as ASC 250-10-20 indicates (emphasis added):

A change in reportingentity is limited mainly to the following:

Presenting consolidated or combined financial statements inplace of financial statements of individual entities

Changing specific subsidiaries that make up the group ofentities for which consolidated financial statements arepresented

Changing the entities included in combined financialstatements.

Item (b) at first view seems to include acquisitions, however thecodification adds the following exclusionarystatement:

Neither a business combinationaccounted for by the acquisition method nor the consolidation of aVIE pursuant to topic 810 is a change in reporting entity.

To summarize, “change in reporting entity”, which are accounted forretroactively, relates to the decision to consolidate existingsubsidiaries (a topic that is sometimes covered in a senior-levelaccounting course). It does not relate to newly-acquiredsubsidiaries, which are accounted for prospectively with limitedretrospective disclosures. The main takeaway is that acquisitionsare not covered by “change in reporting entity” and receiveprospective accounting treatment with only limited retrospectivedisclosures.

1. Creditors' claims on the assets of a company are called: (Points : 2)
 
Net losses
Expenses
Revenues
Equity
Liabilities
 
2. The primary objective of financial accounting is: (Points : 2)
 
To serve the decision-making needs of internal users
To provide financial statements to help external users analyze and interpret an organization's activities
To monitor and control company activitiesTo provide information on both the costs and benefits of managing products and services
To know what, when and how muchto produce
 
3. Assets created by selling goods and services on credit are: (Points : 2)
 
Accounts payable
Accounts receivable
Liabilities
Expenses
 
4. The debt ratio is used: (Points : 2)
 
To measure the amount of equity relative to the expenses
To reflect the risk associated with a company's debts
Only by banks when a business applies for a loan
To determine how much debt a firm should pay off
 
5. Net Income: (Points : 2)
 
Decreases equity
Represents the amount of assets owners put into a business
Equals assets minus liabilities
Is the excess of revenues over expenses
Represents the owners' claims against assets
 
6. Internal users of accounting information include: (Points : 2)
 
Shareholders
Customers
Creditors
Government regulators
Line Supervisor
 
7. Risk is: (Points : 2)
 
Net income divided by average total assets
The reward for investment
The uncertainty about the expected return that will be earned from an investment
Unrelated to expected return
 
8. An example of an operating activity is: (Points : 2)
 
Paying wages
Purchasing office equipment
Borrowing money from a bank
Selling stock
Paying off a loan
 
9. Which accounting assumption assumes that all accounting information is reported monthly or yearly? (Points : 2)
 
Business entity assumption
Monetary unit assumption
Value assumption
Cost assumption
Time period assumption
 
10. Distributions of assets by a business to its stockholders are called: (Points : 2)
 
Dividends
Expenses
Assets
Retained earnings
Net Income

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders

Amazon.com, Inc.

We have audited Amazon.com, Inc.’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Amazon.com, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Amazon.com, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Amazon.com, Inc. as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013 of Amazon.com, Inc. and our report dated January 30, 2014 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Seattle, Washington

January 30, 2014

Please answer the following:

review the audit report prepared by the auditors. Let us know the name of the company, the name of the CPA firm that prepared the audit report and tell us the type of opinion that was provided. Also, discuss the role of the audit firm in the audit process.