BA 141

Sole Partnership Corporation

CHAPTER 1: INTRODUCTION TO CORPORATE FINANCE Proprietorship

Corporate Finance Advantages - Easy to start - Relatively - Limited

Corporate Finance: - Least regulated easy to start liability
● Area of finance dealing with efficient and effective - Single owner - More capital - Unlimited life
management of finances of an organization and the - Taxed 1x as than a sole - Transfer of
actions that managers take to increase the value of personal income proprietorship ownership is
the firm to the shareholders Income taxed easy
Corporate Objective: 1x as personal - Easier to
● Shareholder wealth maximization income raise capital
● Shareholder wealth maximization entails
maximization of dividends and capital gains that Disadvantages - Limited to life of - Unlimited - Separation
shareholders receive over time owner Liability of ownership
Types of Corporate Structures - Equity capital (General and
Sole Proprietorship limited to owner’s Partnership) management
● 1 person running his or her own business and personal wealth - Partnership - Double
individual is taxed on earnings at their personal - Unlimited dissolves taxation
income tax rate liability when one (income taxed
● All profits belong to the sole proprietor - Difficult to sell partner dies or at the
● Limited regulation as compared to other forms of ownership wishes to sell corporate rate
business organization, proprietor is free to make interest - Difficult to and then
decisions transfer dividends
● Personal liability for all debts, losses, and obligations ownership taxed at the
arising from the business activity beyond the assets personal rate)
held in the business
● Resources are limited for acquiring capital and
expertise Role of Finance Manager
Partnership 1. Understand and interpret the financial statements
● 2 or more persons forming the business ● Understands the “rules” of the game and tell
● Taxed at personal income level the “story” of the company through the use of
● There are 2 forms of partnership: general partnership financial statements
and limited partnership. General partners are involved 2. Make decisions for the business in relation to its
in the day-to-day operations and are personally liable finances
for all debts and obligations incurred in the course of ● Investing Decision (Where should a firm
business. Limits partners are not involved in the invest its resources?)
day-to-day operations and liability is limited to the ● Financing Decision (How should a firm fund
partner’s investment these investments?)
● Management is directed by the partners holding a ● Dividend Decision (What should the firm do
majority stake with its excess resources?)
● Resources are still limited for acquiring capital and Typical Functions of a Finance Manager
expertise ● Estimating funding requirements of the business
Corporation ● Deciding on the firm’s capital structure (debt to equity)
● Distinct legal entity separate from the people who own ● Evaluating financial performance in terms of return on
its shares investment
● Corporations pay taxes and can sue or be sued in a ● Handle financial negotiations with banks
court of law ● Manage the company’s credit (i.e. score, reputation)
● Shareholders have no liability for the debts of the ● Manage financial risk
corporation and there can be no additional levy on Risk and Return
shareholders if the debts of a bankrupt corporation ● Risk​: Refers to the possibility that actual return may
exceed the value of its realizable assets be different from expected return
● Corporation is controlled by its Board of Directors. ● Return​: Refers to financial rewards gained as a result
Members of the Board are elected by the of making an investment
shareholders ● Risk-Return Tradeoff​: Potential return rises with an
● Fund raising is much easier increase in risk
Types of Risks in Finance Accounting for Revenue
● Inflation Risk​: Uncertainty that money in the future is
not as valuable as money today
● Business Risk​: Uncertainty of the company’s future
performance
● Political Risk​: Uncertainty of government’s future
actions/instability associated with investing in a
particular country
● Regulatory Risk​: Uncertainty of business landscape
● Input Price Risk: ​Fluctuating price of inputs/raw
materials
● Liquidity Risk​: Uncertainty of being able to buy or
sell an asset at a fair price
● Interest Rate Risk​: Uncertainty of value of Accrued Revenue: ​Revenue that has been earned by
investment/payment requirements given changes in providing a good or service, but for which no cash has been
interest rates received and no billing has been made.
● Foreign Exchange Risk​: Risk of incurring losses
from an unfavorable change in exchange rates Things that Affect Equity
● Default Risk​: Risk of being unable to service debt ● Changes in the Income Statement which flow through
(interest and principal payments) to Retained Earnings and onto the Balance Sheet
● Concentration Risk​: Concentration to a single ● Changes in Shareholdings
counterparty, sector, country, etc. ● Dividend Declaration
The Agency Problem ● Appropriations
● The Agency Problem arises as a result of a ​conflict ● FX Translations
of interest ​between the principal (i.e.
shareholders/owners) and the agent (i.e. Actions of Corporation vs. Shareholders
management team) ● The actions of a corporation/company should be
● The problem exists because sometimes the agent is separate from the actions of a shareholder for his/her
motivated to act in his own best interests rather than own account.
those of the principal ○ If shareholders are providing funding to the
● Minimizing Risks: company, this is either a form of equity
○ Performance based compensation infusion (share issuance/related party debt)
○ Employee shares ○ If shareholders are using company funds for
○ Threat of losing job/ Performance feedback personal use, this is a form of related party
○ Checks and balances debt (shareholder borrowing funds from the
● Corporate Governance​: is the system of rules, company - related party loan receivable)
practices, processes by which a firm is directed and
controlled. Corporate governance essentially involves Operating, Investing, or Financing
balancing the interests of a company’s stakeholders
(shareholders, senior management, customers,
suppliers, financiers, etc.). A company’s BoD is the
primary force influencing corporate governance

[Check Appendix for Dividend Policies]

CHAPTER 2: FINANCIAL STATEMENTS

Accounting for Expenses

Accrued Expense:​ Expense that has been incurred such that

a good or service has been provided, but for which no cash
has been received and no billing has been made
CHAPTER 2: FINANCIAL STATEMENTS
Philippine Financial Reporting Standards
● Financial statements are prepared in accordance with
generally accepted accounting principles (GAAP)
○ a set of externally imposed accounting and
reporting rules and standards for financial
statements issued to the general public
● Philippine GAAP consist of Philippine Financial
Reporting Standards (PFRS), Philippine Accounting
Standards (PAS) and their interpretations
● Promulgated by the Financial Reporting Standards
Council (FRSC)
● Mirrors the issuance of the International Accounting
Standards Board (IASB)
● There is room in the application of PFRS for the use
of judgment by management, through the accountant
Basic Principles that Guide the Preparation of Financial
Statements
Underlying Assumptions
Going Concern
● Financial statements are prepared with the
presumption that the entity will continue operating in
the foreseeable future
● Life of a reporting entity is divided into manageable
time periods
○ Calendar year, fiscal year or 12-month
period, quarter, month, day
Accrual
● The effects of business transactions are recognized in
the accounting periods and reported in the financial
statements of the periods in which they occur
● Revenues are recognized when realized and
expenses are reported when incurred even when no
money has changed hands yet
● *​Cash-basis accounting:​ recognizes revenue and
expenses only when cash is received or paid; not a
GAAP
● Realization Principle:​ revenue is realized and should
be recognized during the period in which the goods
were delivered or the service rendered and billable
● Matching Principle​: Expenses are incurred in order to
generate revenues
○ Expenses should be charged against income
in the accounting period that the related sale
(revenue) is recognized
● Rational Allocation​: Costs are allocated to the periods
benefited in a systematic and rational manner through
depreciation and amortization
● Immediate Recognition:​ Costs that are difficult to
match with revenues earned, or whose benefit in
future periods is uncertain or indeterminable, are
immediately recognized as expense
Measurement in terms of Money
● Resources and obligations of a company are
measured in monetary terms
● The only information presented in the financial
statements is that which can be expressed in
objectively determined monetary terms
Accounting Entity
● Enterprise be considered separate and distinct from
its owner and other stakeholders
Qualitative Characteristics of Financial Statements
Understandability
● The information in the FS should be understandable
in order to have value to its readers
Relevance
● Information is deemed relevant if it influences the
decision of the users
● For information to be relevant, it should be material
○ Materiality​: information is material if
knowledge of it would affect the judgment or
assessment of the reader of the financial
position or results of operations of the
company
Reliability
● Information in the FS are free from material errors and
bias
● Prudence or conservatism​: to err on the side of
understating profit or asset values
● Information in the FS must be materially complete
Comparability
● Information in the FS should be comparable vis-a-vis
that of other entities
● Comparability of operating performance and financial
position of one entity over time
● Consistency​: accounting methods applied in one
period be the same ones used in succeeding periods
Complete Set of Financial Statements
1. Statement of financial position as of the end of the
period
2. Statement of income for the period
3. Statement of changes in equity for the period
4. Statement of cash flows for the period
5. Notes to financial statements
Balance Sheet
● A report of the resources owned by the company
(assets) and the claims on these resources - creditors
(liabilities) and owners (owner’s equity)
● Assets = Liabilities + Owner’s Equity
● Net Assets: value of the owner’s equity
○ Residual claim of the company’s owners
over the company’s assets
● Creditors have legal priority over the assets; whatever
is left accrues to the company’s owners
Major Balance Sheet Categories and Items
Assets
● Current Assets​: resources expected to be converted
to cash within the next year or whose future benefit is
not expected to exceed the immediately succeeding
year
○ Receivables, inventories, current portion of
biological assets. prepaid expenses
○ Listed in order of decreasing liquidity
● Investments​: value of the interest of a company in its
affiliates and other long-term investments
● Property, plant and equipment, net(PPE)​:
acquisition cost of fixed assets used in operations
less the amount that has already been charged to
revenues as depreciation (book value)
● Investment properties: ​fixed assets owned but not
used for the normal operations of the company
● Biological assets​: investments in living plants and
animals
○ May be bearer or consumable
○ Measured at fair market value less point of
sale cost
● Goodwill: ​excess of the amount that a company had
paid over the fair market value of the net assets of the
subsidiaries that it has acquired
● Other intangible assets:​ patents, franchises, brand
names, trademarks
 ○ Not allowed to capitalize the costs of
developing intangible assets
● Deferred tax asset (DTA)​: advance payment of taxes
● Deferred tax liability (DTL):​ time difference that
gives rise to a future tax obligation; noncurrent
● Other assets: ​long-term receivables, funds set aside
for specific projects or purposes
Liabilities
● Current liabilities​: obligations that are expected to
be satisfied or extinguished within the normal
operating cycle or one year
● Accounts payable​: amount owed to suppliers and
trade creditors
● Accrued expenses​: payables arising from other
expenses (salaries/wages, rent, utilities, insurance)
● Drafts and acceptances payable:​ obligations
supported by drafts drawn by the supplier on the
purchaser of the goods and accepted by the
purchaser
● Long-term liabilities​: long-term debt and other
noncurrent liabilities
Stockholders’ equity
● Capital stock​: total number of shares issued valued
at par
○ Par value - market value of a share of stock;
price at which shares were issued to original
stockholders
● Common stock​: owners share equal rights and
privileges
○ Rights are detailed in the articles of
incorporation
● Preferred stock​: owners are given preference or
priority over common shareholders in terms of
dividend claims and/or claims to the net assets of the
corporation upon its liquidation; no voting rights;
entitled to fixed amount of dividends per share
● Redeemable preferred shares​: mandatorily
redeemable at established redemption prices and
fixed redemption date; debt instrument (legal form:
equity)
● Capital paid in excess of par value​: amounts paid
by shareholders in excess of par; part of paid-in
capital
● Cumulative translation adjustment​: changes in the
exchange rate used to value the net asset of
company’s foreign subsidiaries
● Retained earnings​: accumulated income of the
company, less all cash and stock dividends paid to
shareholders
● Treasury stock​: previously issued shares that have
been reacquired; deduction from stockholders’ equity
○ Reduces the outstanding shares (shares
held by entities external to the company)
● Minority interest:​ portion of the net assets of a
company’s subsidiaries owned by minority
shareholders
Income Statement
● Report of the results of operations of a company for a
given period bounded by two balance sheet dates
● Format:
○ Nature of expense - aggregates expenses
according to their nature
○ Function of expense - classifies expenses
according to their function
● Interest expense or financing charges
● Interest income
● Foreign exchange gain
● Equity in net earnings of affiliates
● Other income - various gains and losses realized from
sources other than the company’s main businesses
● Earnings per share (EPS): computed by dividing net
income accruing to common stockholders by the
weighted average number of outstanding shares
Statement of Changes in Equity
● Reports:
○ Transactions with equity holders in their
capacity as owners of the reporting entity
○ Linkage between income statement and
balance sheet
○ Gains and losses that did not pass through
the income statement
● Capital stock, additional paid in capital, treasury
shares​: transactions with equity holders such as
subscription and issuance of stocks, acquisition of
treasury shares, and retirement of stocks
● Net change in ​retained earnings​: portion of net
income plowed back to the entity
● Revaluation increment, cumulative translation
adjustments, valuation adjustments: ​gains and
losses from measurement of the company’s assets
Statement of Cash Flows
● Flow of the cash resulting from operating, investing,
and financing activities of the company
● Operating cash flows​: cash received and paid for
the activities associated with the operations of the
business
○ Cash receipts from customers, cash
payments to suppliers, employees,
government for taxes and for other expenses
● Investing activities​: acquiring and disposing of
long-lived assets
○ PPE, investments and divestments in
securities, lending to and collecting from
third parties
● Financing activities​: borrowing of funds and the
issuance of capital stock, the repayment of the
principal amount of money borrowed, cash dividend
payments, treasury stock transactions
● Cash receipts from interest​ and ​investment
income ​- operating or investing
● Cash payments for interest​ and ​dividends​ -
operating or financing
● Effect of exchange rate changes on cash and cash
equivalents
● Indirect method
○ Commonly used method
○ Converting the before tax income to net cash
flow from operations
○ Adjustments: adding back all non-cash
expenses and losses, deducting non-cash
revenues and gains; changes in the current
assets and current liabilities accounts
Notes to the Financial Statements
● Describe the nature of the reporting entity’s
operations
● Define the accounts used by the company
● Identify accounting methods used
● Detail certain items not presented in the face of the
FS
● Important disclosures
Independent Auditor’s Report
● 4 kinds of auditor’s opinion: unqualified, qualified,
adverse, disclaimer
● Unqualified​: FS presents fairly, in all material
aspects, in accordance with PFRS
 ● Disclaimer: ​scope limitation is so material that there
is no reasonable basis for an independent opinion; his
audit was unable to gather sufficient evidence to
support an opinion
● Adverse​: FS are materially misstated due to the use
of non-IFRS compliant accounting policies or
disclosures presented are materially inadequate
● Qualified​: middle ground between an unqualified
opinion and both adverse opinion or disclaimer
Statement of Management’s Responsibility
● Convey explicitly that it is the role of a company’s
management to ensure the integrity of the information
contained in these reports
● Responsibility is discharged by insuring that:
○ PFRS was followed in the preparation of the
FS
○ System of internal controls
○ Reputable independent auditors
○ System of checks and balances
Uses and Limitations of Financial Statements
Uses
● Bases for evaluating liquidity, operating capability,
financial flexibility
● Indication of enterprise performance, earning power,
quality of firm’s earnings
Limitations
● Difficult to understand, much less to apply
● Criticized for permitting alternative treatments
● Differences in accounting methods used make
comparing different companies’ financial position and
results of operations difficult