Statement of Financial Position

• The statement of financial position (or balance sheet –

B/S) is a snapshot of the firm’s assets and liabilities at a
given point in time
• Assets (A) are on the left side; Liabilities (D) and
Stockholders’ Equity (E) are on the right side
• A: listed in order of liquidity - ease of conversion to cash
without significant loss of value
• D: listed in order of maturity of obligation
• E: may include common stock, retained earning, capital
surplus
• B/S Identity: A = D + E
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Statement of Financial Position

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Net Working Capital (NWC) & Liquidity

• NWC = Current Assets - Current Liabilities

• Positive when the cash that will be received over the next
12 months exceeds the cash that will be paid out
• Usually positive in a healthy firm (one able to pay
obligations as they mature or become due)
• Liquidity: ability to convert assets to cash quickly
without a significant loss in value
• Liquid firms are less likely to experience financial distress;
however, liquid assets earn a lower return
• Tradeoff between liquid and illiquid assets

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Liquidity
• Too much liquidity generally implies high opportunity
cost (missed investment returns)
• Too little liquidity implies high risk of financial distress
• Cash flow / liquidity problem – trouble with cash to pay
current obligations
• Solvency problem – trouble / inability getting cash from
assets to pay obligations. Firm is insolvent when it cannot
pay obligations, essentially A< D {E<0}
• Bankruptcy – a legal process to deal with unpaid obligations
• CCAA (Canada) and Chapter 11 business reorganization
• Liquidation and chapter 7 bankruptcy

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 Canadian Enterprises
Statement of Financial Position
2014 2015 2014 2015

Assets Liabilities and Owners’ Equity

Current assets Current liabilities
Cash $ 114 $ 160 Accounts payable $ 232 $ 266
Accounts receivable 445 688 Notes payable 196 123
Inventory 553 555 Total $ 428 $ 389
Total $ 1,112 $ 1,403
Long-term debt $ 408 $ 454
Fixed assets Owners’ equity
Net, plant and equipment $ 1,644 $ 1,709 Common shares 600 640
Retained earnings 1,320 1,629
Total $ 1,920 $ 2,269
Total assets $ 2,756 3,112 Total liabilities and owners’ equity $ 2,756 $ 3,112

y-o-y: TA +356; FA +65; CA +291; CL – 39; LTD +46; CS +40; RE +309; NWC
+330 [291- - 39 or (1403-389) – (1112-428)]
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Value versus Cost

• The statement of financial position provides the book value of the

assets, liabilities and equity.
• Market value is the price at which the assets, liabilities or equity can be
bought or sold.
• Market value and book value are often very different. Why?
• Market value is more important to the decision-making process. It
represents the current economic value

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International Financial Reporting Standards (IFRS)

• IFRS allows companies to use the historical cost

method
• Also allows use of the revaluation (fair value) method
• All items in an asset class should be revalued
simultaneously
• Revaluation should be performed with enough
regularity to ensure that the carrying amount is not
materially different from the fair value

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Ex. Quebec Corporation

QUEBEC CORPORATION
Statement of Financial Position
Market Value versus Book Value
Book Market Book Market
Assets Liabilities and
Shareholders’ Equity
NWC $ 400 $ 600 LTD $ 500 $ 500
NFA 700 1,000 SE 600 1,100
1,100 1,600 1,100 1,600
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Statement of Comprehensive Income
• The statement of comprehensive income (or income
statement, I/S) is more like a video of the firm’s operations
for a specified period of time.
• You generally report revenues first and then deduct any
expenses for the period
• Matching principle – IFRS say to show revenue when it
accrues and match the expenses required to generate the
revenue
• Cost of capital asset purchase is spread-out (amortized or
depreciated) over the productive life of asset
• Net income does not measure cashflow as it includes non-cash
items like depreciation

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Canadian Enterprises Statement of
Comprehensive Income

2-9
Statement of Cash Flows

• Cash flow is one of the most important pieces of

information that a financial manager can derive from
financial statements
• We will look at how cash is generated from utilizing
assets (LHS of B/S) and how it is paid to those that
finance the purchase of the assets (RHS of B/S)

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Cash Flow From Assets

• Cash Flow From Assets (CFFA) = Cash Flow to

Bondholders + Cash Flow to Shareholders
• how the cash flow from the firm is divided among the
investors that financed the assets.
• CF(A) = CF(D) + CF(E)
• Cash Flow From Assets (CFFA) = Operating Cash Flow
(OCF) – Net Capital Spending (NCS) – Changes in NWC
• how firm receives the cash flow from its assets.

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Cash Flow Summary

2-12
CFs Ex. Canadian Enterprises
• OCF (I/S info) = EBIT + depreciation – taxes
= 694 + 65 – 250 = 509
• NCS (B/S and I/S) = ending NFA (2015) – beginning
NFA (2014) + depreciation
= 1709 – 1644 + 65 = 130
• Changes in NWC (B/S) = ending NWC (2015) –
beginning NWC (2014)
Ending NWC = 1403 – 389 = 1014
Beginning NWC = 1112 – 428 = 684
Changes in NWC = 1014 – 684 = 330

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CF Example continued
• CFFA = 509 – 130 – 330 = $49
• CF to Creditors (B/S and I/S) = interest paid – net new
borrowing
Interest paid = 70
Net New Borrowing = ending LT debt – beginning LT debt = 454 – 408 = 46
CF to creditors = 70 – 46 = 24
• CF to Stockholders (B/S and I/S) = dividends paid – net new
equity raised = $25
dividends = 65
net new equity (end – beg common shares) = 640 - 600 = 40
• CF to stockholders = 65 – 40 = 25
• CFFA = 24 + 25 = $49 cash flow identity holds.

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Taxes

• Individual vs. corporate taxes

• Marginal vs. average tax rates

• Marginal – the percentage paid on the last or next dollar earned
• Average – the percentage of your income that goes to pay taxes (tax bill /
taxable income)
- how marginal and average relate depends on tax structure (Excel example)

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Taxes on Investments

• When an investor holds stocks, they are subject to two types of taxes:
• Dividend tax credit – A tax formula that reduces the effective tax rate on
dividends
• credit applies to dividends paid by corporations' resident in Canada only.
• Capital gains tax – Tax is paid on the investment’s increase in value over its
purchase price
• Interest income is added to employment income and taxed accordingly.
• Capital gain taxes apply for most other assets sold at a gain. Exceptions
include sale of a primary residence
- For the same amount of earnings (ex. $10,000), in general, the order of
amounts paid in taxes: Interest > Dividends > Capital gains
i.e., capital gains are the most tax efficient source of earnings

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Capital Cost Allowance (CCA)
• CCA is depreciation for tax purposes (CRA)
• Not unusual for a firm to have specific financial statements for tax
filing purposes and statement for reporting purpose
• CCA is deducted before taxes and acts as a tax shield.
• will see PV CCA tax shield calculations in Chap 10
• Every capital asset is assigned to an asset class by CRA
• Every asset class is given a depreciation method and rate
• Half-year Rule – In the first year, only half of the asset’s cost
can be used for CCA purposes.
• Accelerated Investment Rule: one and a half asset cost times
CCA rate used in the first year

2-17
Some CCA Classes

Class Rate Assets

1 4% Buildings acquired after 1987
8 20 Furniture, photocopiers
10 30 Vans, trucks, tractors, and equipment
13 Straight-line Leasehold improvements
16 40 Taxicabs and rental cars
43 30 Manufacturing equipment

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Example: CCA Calculation

• ABC Corporation purchased $100,000 worth of photocopiers in 2020.

Photocopiers fall under asset class 8 with a CCA rate of 20%. How much
CCA will be claimed in 2020 and 2021?
• Note: Accelerated investment rule results in a larger depreciation (CCA)
charge in the current year compared to the Half Year Rule.

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Accelerated rule CCA Example

$30,000 or 30% in 2020, $14,000 in 2021

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Hall year rule CCA Example

Beginning Ending
Fixed Fixed
Year Assets CCA Assets

50000 10,000 40000

2020
(100,000 x 50%) (50,000 x 20%) (50,000 - 10,000)

90,000 18,000 72,000

2021
(40,000 + 50,000) (90,000 x 20%) (90,000 - 18,000)

$10,000 or 10% in 2020, $18,000 in 2021

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CCA – Additional Concepts

• Usually firms have multiple machines (i.e., more than one photocopier)
in an asset class.
• When an asset is sold, the asset class is reduced by the realized value of
the asset, or by its original cost, whichever is less.

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Closing an Asset Class
• Usually, firms have multiple assets in an asset class.
• When an asset is sold, the asset class is reduced by the realized
value of the asset, or by its original cost, whichever is less.
• When the last asset in an asset class is sold, the asset class is
terminated. This can result in a terminal loss or recaptured CCA.
• Terminal Loss – The difference between the UCC (undepreciated
capital cost) and the adjusted cost when the UCC is greater.
• Asset sold at $$ < UCC $$. Loss is deductible from income thereby
reducing tax paid (i.e., company overpaid taxes because of lower
depreciation)
• Recaptured CCA – The taxable difference between the adjusted
cost and the UCC when the UCC is smaller.
• Asset sold $$ > UCC $$. Tax is paid on recaptured CCA (company
underpaid taxes because of higher depreciation)
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Another CCA Example

• Kool Drinks Corporation purchased $300,000 worth of bottling

machinery in 2019. Machinery falls under asset class 43 with a CCA rate
of 30%. In 2021, Kool Drinks sold their machinery for $150,000 and
moved their production to Mexico. Was there a capital gain, a CCA
recapture or a terminal loss? What if the machinery was sold for
$120,000? Assume 40% tax rate and Half –Year Rule.

2-24
 Another CCA Example - Solution
LO5

Beginning Ending
Year UCC CCA UCC

2019 150,000 45,000 105,000

2020 255,000 76,500 178,500

2021 178,500 53,550 124,950

2-25
CCA Ex Solution continued
• There is no capital gain because the machinery was
sold for less than its original cost of $300,000.
• At $150,000, there is a CCA recapture of $25,050. Sale
price is $25,050 over UCC i.e.,
• Company over depreciated by $25,050 (150,000 – 124,950) and must pay
back taxes of $10,020 (25,050*0.4)
• At $120,000 there is a terminal loss of $4,950.
• Company under depreciated by $4,950 (120,000 – 124,950), deducts the loss
from income and reduces taxes by $1,980 (4950*0.4)

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 Kool Drinks – Accelerated Rule

Beginning Ending
Year UCC CCA UCC
2019 $300,000 $135,000 $165,000
2020 $165,000 $49,500 $115,500
2021 $115,500 $34,650 $80,850

$300,000*1.5*0.3 = $135,000 CCA in 2019

½ year rule: $300,000*0.5*.3 = $45,000 in 2019

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 Accelerated rule Ex

• There is no capital gain because the machinery was sold for less than its
original cost of $300,000.
• At $150,000, there is a CCA recapture of $69,150. (150,000 – 80,850)
• At $120,000 there is a CCA recapture of $39,150.
• If sale price was to be $75,000, there is a terminal loss of $5,850.

2-28
 Self test: create I/S & B/S; and
calculate Cash Flows
• Current Accounts
• 2011: CA = 1500; CL = 1300
• 2012: CA = 2000; CL = 1700
• Fixed Assets and Depreciation
• 2011: NFA = 3000; 2009: NFA = 4000
• Depreciation expense = 300
• LT Liabilities and Equity
• 2011: LTD = 2200; Common Equity = 500; RE = 500
• 2012: LTD = 2800; Common Equity = 750; RE = 750
• Statement of Comprehensive Income Information
• EBIT = 2700; Interest Expense = 200; Taxes = 1000; Dividends =
1250; Sales = 5000; Costs = 2000

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