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