Sources and References

Primary textbook — Introductory Accounting for Private and Public Companies (Top Hat interactive e-text, ISBN 978-1-77412-900-5; Top Hat Pro ISBN 978-0-9866151-0-8). This text covers both AFM 191 (private company focus) and AFM 182 (public company focus).

Supplementary — Charles T. Horngren, Walter T. Harrison Jr., and M. Suzanne Oliver, Financial Accounting, 10th Edition (Pearson, 2019); Robert Libby, Patricia Libby, and Frank Hodge, Financial Accounting, 10th Edition (McGraw-Hill, 2020).

Online resources — CPA Canada Learning Resources (cpacanada.ca); IFRS Foundation open educational materials (ifrs.org/supporting-implementation/); CFA Institute “Financial Reporting and Analysis” curriculum.

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Chapter 1: Accounting for Public Companies — Conceptual Framework

From Private to Public Company Accounting

AFM 191 introduced financial reporting in the context of private companies operating under Accounting Standards for Private Enterprises (ASPE). AFM 182 extends this foundation to public companies, which must comply with International Financial Reporting Standards (IFRS) in Canada. Understanding why the standards differ requires understanding the stakeholder landscape.

Private companies have a limited, identifiable set of stakeholders — owners and their banks. Information asymmetry is manageable; the owner often manages the firm. ASPE is therefore less onerous and permits more cost-benefit trade-offs in disclosure.

Public companies have diffuse, anonymous shareholders who cannot individually monitor management. This separation of ownership and control (the principal-agent problem) creates demand for rigorous, standardized financial reporting that allows shareholders to assess stewardship and make informed investment decisions.

The Conceptual Framework Under IFRS

The IASB’s Conceptual Framework for Financial Reporting provides the foundation for developing and evaluating accounting standards. It establishes:

Objective: Financial statements should provide information about a reporting entity’s financial position, financial performance, and cash flows that is useful to a wide range of users in making economic decisions.

Qualitative Characteristics: The framework distinguishes fundamental from enhancing characteristics.

Type	Characteristic	Meaning
Fundamental	Relevance	Information that makes a difference to users’ decisions (materiality is an aspect of relevance)
Fundamental	Faithful representation	Information that is complete, neutral, and free from error
Enhancing	Comparability	Users can compare across firms and across time
Enhancing	Verifiability	Independent observers can reach the same conclusion
Enhancing	Timeliness	Information is available to decision-makers before it loses capacity to influence decisions
Enhancing	Understandability	Information is comprehensible to users with a reasonable knowledge of business

The pervasive constraint is cost-benefit: the benefits of providing information must justify the costs.

Underlying Assumption: The going concern assumption presumes the entity will continue operating for the foreseeable future, which justifies deferring expense recognition and valuing assets above liquidation value.

Recognition, Measurement, and Disclosure

Recognition is the process of including an item in financial statements when it meets the definition of an asset, liability, income, or expense and can be measured reliably.

Measurement bases under IFRS include:

• Historical cost: the amount paid at the time of acquisition. Simple and verifiable.
• Fair value: the price that would be received to sell an asset (or paid to transfer a liability) in an orderly transaction between market participants at the measurement date.
• Net realisable value: estimated selling price less estimated costs of completion and selling.
• Amortised cost: historical cost adjusted for amortisation and impairment.

IFRS uses fair value more extensively than ASPE, reflecting the information needs of capital market investors.

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Chapter 2: Special Accounting Topics

Revenue Recognition Under IFRS 15

IFRS 15 (Revenue from Contracts with Customers) establishes a five-step model for recognizing revenue:

1. Identify the contract with the customer (enforceable rights and obligations).
2. Identify performance obligations — distinct goods or services promised in the contract.
3. Determine the transaction price — the amount expected to be received, considering variable consideration, financing components, and non-cash consideration.
4. Allocate the transaction price to each performance obligation based on relative standalone selling prices.
5. Recognize revenue when (or as) each performance obligation is satisfied — i.e., when control transfers to the customer.

Leases Under IFRS 16

IFRS 16 (Leases) fundamentally changed lessee accounting. Before IFRS 16, operating leases were kept “off-balance-sheet.” Now, virtually all leases result in recognition of a right-of-use (ROU) asset and a corresponding lease liability on the balance sheet.

At commencement:

• Lease liability = present value of future lease payments discounted at the lessee’s incremental borrowing rate.
• ROU asset = lease liability + initial direct costs + prepaid lease payments − lease incentives received.

Subsequently, the ROU asset is depreciated (typically straight-line) and the lease liability is unwound using the effective interest method.

The only exemptions are short-term leases (12 months or less) and leases of low-value assets, for which the old straight-line operating lease treatment remains optional.

Financial Instruments Under IFRS 9

IFRS 9 classifies financial assets into three measurement categories based on the entity’s business model and the contractual cash flow characteristics:

Category	Business Model	Cash Flow Characteristic	Measurement
Amortised cost	Hold to collect	SPPI test passes	Amortised cost
Fair value through OCI (FVOCI)	Hold to collect and sell	SPPI test passes	Fair value; gains/losses in OCI
Fair value through profit or loss (FVTPL)	Other	Any	Fair value; gains/losses in P&L

The SPPI test asks whether contractual cash flows are Solely Payments of Principal and Interest — i.e., whether the instrument has only basic loan features.

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Chapter 3: Public Markets

Capital Market Structure

Public companies access capital through organized markets where securities are traded between investors. The primary market is where new securities are first issued; the secondary market enables subsequent trading.

Going Public: The IPO Process

An Initial Public Offering (IPO) transforms a private company into a public one, allowing founders and early investors to realize liquidity and giving the company access to equity capital from a broad investor base. Key steps:

1. Engage investment banks as underwriters; select lead underwriter (book runner).
2. Conduct due diligence; prepare the prospectus (a detailed disclosure document).
3. File with securities regulators (securities commissions in each province; coordinated through the CSA).
4. Conduct a “road show” — management presentations to institutional investors.
5. Price the offering based on demand signals gathered during book-building.
6. Allocate shares; trading commences.

Equity Market Structure

Toronto Stock Exchange (TSX): Canada’s primary exchange for senior equities. Lists approximately 1,500 companies with strict listing standards.

TSX Venture Exchange (TSXV): A public venture capital marketplace for earlier-stage companies; lighter listing requirements than the TSX.

NEO Exchange: An alternative exchange offering lower costs and different market structure than the TSX.

Equity markets use continuous auction mechanisms matching buy and sell orders in real time. Market quality is measured by bid-ask spreads (transaction costs), depth (volume available at best quotes), and price discovery efficiency.

Equity Issuance by Public Companies

After the IPO, public companies may raise additional equity through:

• Seasoned equity offering (SEO) / secondary offering: Issuing new shares to the public.
• Rights offering: Offering existing shareholders the right to purchase new shares at a discount to market price, proportional to their current ownership.
• Private placement: Selling shares directly to a small group of accredited investors without a full prospectus; faster and cheaper but limited audience.
• Dividend reinvestment plan (DRIP): Allowing shareholders to receive dividends in the form of new shares rather than cash.

Debt Markets

Investment-grade corporate bonds (rated BBB- / Baa3 and above) are issued by financially strong companies and are held widely by institutional investors. High-yield (speculative-grade) bonds offer higher yields to compensate for default risk.

Covenants — contractual restrictions embedded in bond indentures — protect bondholders by limiting the issuer’s ability to take on additional debt, pay excessive dividends, or make risky acquisitions.

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Chapter 4: Corporate Governance and Organizational Structures

The Agency Problem

The principal-agent problem arises when a principal (shareholder) delegates decision-making authority to an agent (manager) whose interests may not align perfectly with the principal’s. Managers may prefer:

• Larger empires (excessive acquisitions)
• Excessive perquisites (corporate jets, lavish offices)
• Conservative risk-taking to protect their human capital invested in the firm
• Shorter horizons (managing to quarterly earnings rather than long-term value)

Corporate governance encompasses the mechanisms by which principals control agents and ensure accountability.

The Board of Directors

The board of directors is elected by shareholders and is responsible for:

• Hiring and firing the CEO
• Setting executive compensation
• Overseeing financial reporting and internal controls
• Approving major strategic decisions
• Ensuring legal and regulatory compliance

Independence is a cornerstone of board governance. An independent director has no material relationship with the company (is not a former employee, does not do business with the firm). The TSX and National Instrument 52-110 require that audit committees consist entirely of independent directors.

Key board committees: Audit Committee (oversees financial reporting, internal controls, external auditor relationship); Compensation Committee (designs executive pay); Governance and Nominating Committee (manages board composition and succession).

Executive Compensation

Executive compensation is designed to align manager interests with shareholder interests. Components include:

Component	Form	Alignment Mechanism
Base salary	Cash	Attracts and retains talent; no alignment
Annual bonus	Cash	Short-term performance (revenue, earnings)
Long-term incentive plan (LTIP)	Shares or options	Multi-year shareholder value creation
Stock options	Right to buy shares at strike price	Value created only if stock price rises above strike
Restricted share units (RSUs)	Shares vesting over time	Retention; loss aversion reduces horizon problem

Critics note that option compensation can induce excessive risk-taking (options pay off in good outcomes only; downside is capped at zero). Clawback provisions allow boards to recoup compensation if prior performance is later found to have been misstated.

Organizational Structures

Large public companies often operate through complex legal structures:

Subsidiary: A separate legal entity majority-owned by a parent. Consolidated financial statements aggregate the parent and all subsidiaries; non-controlling interests (NCI) represent the portion of subsidiaries not owned by the parent.

Associate: An investee over which the investor has significant influence (presumed at 20%–50% ownership) but not control. Accounted for using the equity method: carrying value = cost + share of post-acquisition earnings − dividends received.

Joint arrangement: Two or more parties share control. Under IFRS 11, joint arrangements are classified as joint operations (proportionate share of assets/liabilities consolidated) or joint ventures (equity method).

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Chapter 5: Environmental, Social, and Governance (ESG)

Why ESG Matters to Financial Reporting

ESG considerations have moved from the periphery to the centre of corporate reporting as institutional investors, regulators, and other stakeholders demand more information about non-financial performance. The core argument is that ESG risks and opportunities are financially material — they affect long-run cash flows, cost of capital, and firm value.

ESG Reporting Frameworks

Multiple frameworks have emerged, creating complexity for both reporters and users:

Framework / Standard	Scope	Status
GRI (Global Reporting Initiative)	Broad sustainability; primarily impact materiality	Widely used globally; voluntary
SASB (Sustainability Accounting Standards Board)	Industry-specific financial materiality	Adopted by many public companies
TCFD (Task Force on Climate-related Financial Disclosures)	Climate-related risks and opportunities	Basis for many regulatory requirements
ISSB (International Sustainability Standards Board)	Global baseline for sustainability disclosure	IFRS S1 (general) and IFRS S2 (climate) issued 2023

Canada’s securities regulators have proposed mandatory climate-related disclosure requirements aligned with TCFD. The SEC in the US adopted climate disclosure rules in 2024. The regulatory trajectory is toward mandatory, standardized ESG disclosure.

Environmental Accounting

Carbon pricing — either a carbon tax (price on emissions) or a cap-and-trade system — creates financial obligations for high-emission businesses. Under IFRS, emission allowances are financial assets; obligations to deliver allowances are financial liabilities.

Stranded asset risk: Fossil fuel reserves may become economically unviable if carbon regulations tighten, imposing impairment losses on energy companies. This risk is increasingly disclosed under TCFD frameworks.

Social and Governance Dimensions

Human capital disclosures — employee turnover, safety incidents, diversity metrics, training investment — are increasingly required or recommended. Evidence suggests workforce quality and stability is predictive of long-run performance.

Supply chain due diligence has become a legal obligation in some jurisdictions (Canada’s Fighting Against Forced Labour and Child Labour in Supply Chains Act, 2023). Companies must disclose steps taken to identify and address modern slavery risks.

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Chapter 6: Income Statement Analysis and Planning

Structure of the Income Statement Under IFRS

The income statement (or statement of profit or loss) under IFRS can be presented in two formats: by nature (expenses classified as raw materials, labour, depreciation) or by function (cost of goods sold, selling expenses, administrative expenses). The function format is more common for public companies and supports segment analysis.

A typical public company income statement structure:

Revenue                                    $X
Cost of goods sold                        ($X)
Gross profit                               $X
Selling, general & administrative costs  ($X)
Research and development                  ($X)
Other operating income / expenses          $X
Operating profit (EBIT)                    $X
Finance costs (interest expense)          ($X)
Share of profit of associates              $X
Profit before tax (EBT)                    $X
Income tax expense                        ($X)
Net profit for the period                  $X
  Attributable to:
    - Owners of the parent                 $X
    - Non-controlling interests            $X

Key Profitability Analysis

Gross margin = Gross Profit / Revenue. Reflects pricing power and production cost efficiency. Higher gross margins support competitive advantage (brand, scale, proprietary technology).

EBIT margin = EBIT / Revenue. Reflects operating efficiency, including SG&A discipline. Sometimes referred to as operating margin.

EBITDA = EBIT + Depreciation + Amortisation. A rough proxy for operating cash generation; widely used in valuation (EV/EBITDA multiples) and debt covenant analysis. Not an IFRS-defined measure; treat with caution.

Non-recurring items (restructuring charges, impairments, gains/losses on asset sales) should be separated when assessing underlying or normalized earnings — the sustainable earnings power of the business.

Income Statement Forecasting

Forecasting begins with a revenue model — a bottom-up or top-down projection of sales growth:

\[ Revenue_t = Revenue_{t-1} \times (1 + g_t) \]

where \(g_t\) is projected growth informed by market share analysis, industry outlook, and management guidance.

Operating leverage describes the sensitivity of operating profit to revenue changes. A firm with high fixed costs has high operating leverage: a 10% revenue increase produces a more than 10% increase in EBIT.

\[ Operating\ Leverage = \frac{Contribution\ Margin}{Operating\ Profit} = \frac{Revenue - Variable\ Costs}{EBIT} \]

Percentage-of-sales forecasting is a simple but widely used method: assume operating costs, receivables, inventory, and payables maintain constant ratios to revenue. This is the starting point for pro-forma financial statement construction.

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Chapter 7: Balance Sheet Analysis and Planning

Structure of the Balance Sheet Under IFRS

IFRS requires balance sheet items to be classified as current or non-current:

• Current assets: expected to be realized or consumed within 12 months (cash, receivables, inventory, prepaid expenses).
• Non-current assets: longer-lived assets (property, plant and equipment; intangibles; financial assets; investments in associates).
• Current liabilities: expected to be settled within 12 months.
• Non-current liabilities: due beyond 12 months (long-term debt, deferred tax, lease liabilities).

Key Balance Sheet Items

Property, Plant and Equipment (PP&E)

Under IFRS, PP&E is initially measured at cost. Subsequently, the entity can apply either the cost model (carrying value = cost − accumulated depreciation − impairment) or the revaluation model (carrying value = fair value at revaluation date − subsequent depreciation − impairment).

Impairment testing under IAS 36: If there are impairment indicators, the asset’s carrying amount is compared to its recoverable amount = max(fair value less costs to sell, value in use). An impairment loss is recognized if carrying amount exceeds recoverable amount.

Goodwill and Intangible Assets

Goodwill arises in a business combination when the acquisition price exceeds the fair value of identifiable net assets acquired. It represents unidentifiable future economic benefits (brand, customer relationships, assembled workforce).

Under IFRS 3 and IAS 36, goodwill is not amortised but is subject to annual impairment testing (and interim testing if indicators exist). This is a significant departure from US GAAP, which recently permitted optional amortization of goodwill.

Other intangibles (patents, customer lists, software) acquired in a business combination are recognized separately at fair value and amortised over their useful lives.

Working Capital Management

Working capital = Current Assets − Current Liabilities. Positive working capital means the firm can cover its short-term obligations.

The cash conversion cycle (CCC) measures how long cash is tied up in operations:

\[ CCC = Days\ Inventory\ Outstanding + Days\ Sales\ Outstanding - Days\ Payable\ Outstanding \]\[ DIO = \frac{Average\ Inventory}{COGS/365} \quad DSO = \frac{Average\ Receivables}{Revenue/365} \quad DPO = \frac{Average\ Payables}{COGS/365} \]

A shorter CCC generally improves liquidity and reduces financing needs.

Balance Sheet Forecasting

In pro-forma balance sheet construction, working capital items (receivables, inventory, payables) are typically forecast as a percentage of revenue or COGS, maintaining historical efficiency ratios. PP&E is projected based on a capex schedule, with annual depreciation subtracted. The balance sheet must balance: after projecting assets and most liabilities, the plug variable (often short-term debt or cash) ensures that Assets = Liabilities + Equity.

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Chapter 8: Cash Flow Analysis and Planning

The Statement of Cash Flows Under IFRS

The statement of cash flows classifies cash inflows and outflows into three activities:

Operating activities: Cash generated by the firm’s core business operations. Under IFRS, interest paid may be classified as operating or financing; interest received and dividends received may be operating or investing; dividends paid may be operating or financing (choice must be consistent). This flexibility complicates cross-company comparisons.

Investing activities: Cash used to acquire long-term assets (PP&E, intangibles, investments) or received from their disposal.

Financing activities: Cash flows related to debt and equity financing (proceeds from borrowing, repayments, equity issuances, dividends paid to shareholders).

Direct vs. Indirect Method

The operating section can be prepared using either the direct method (reporting cash receipts from customers, cash paid to suppliers, etc.) or the indirect method (starting with net income and adjusting for non-cash items and working capital changes). The indirect method is far more common in practice.

Indirect method reconciliation:

Net income                                          $X
Add: Non-cash charges (depreciation, amortisation)  $X
Add/Deduct: Changes in working capital:
    Decrease (increase) in receivables              $X
    Decrease (increase) in inventory                $X
    Increase (decrease) in payables                 $X
Cash flow from operating activities                 $X

Free Cash Flow Analysis

Free Cash Flow to the Firm (FCFF) is the cash flow available to all providers of capital after reinvestment needs are met:

\[ FCFF = CFO + Interest \times (1 - t) - Capital\ Expenditures \]

Free Cash Flow to Equity (FCFE) is the cash available to equity holders:

\[ FCFE = CFO - Capital\ Expenditures + Net\ Borrowing \]

FCF analysis is more difficult to manipulate than earnings and is therefore preferred in valuation and credit analysis. A firm that consistently generates positive free cash flow is financially self-sustaining; one that is free-cash-flow-negative must continually access capital markets to fund operations.

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Chapter 9: Performance Management Systems

Strategy and the Balanced Scorecard

The Balanced Scorecard (BSC) (Kaplan and Norton, 1992) integrates financial and non-financial performance measures across four perspectives:

Perspective	Core Question	Example Measures
Financial	How do we look to shareholders?	ROE, revenue growth, EBIT margin
Customer	How do customers see us?	Customer satisfaction score, retention rate, market share
Internal Processes	What must we excel at?	Defect rate, cycle time, on-time delivery
Learning & Growth	Can we continue to improve?	Employee engagement, training hours, R&D investment

The BSC’s power lies in making the strategy map explicit: measures at the Learning & Growth perspective drive Internal Process improvements, which deliver Customer value, which ultimately generates Financial results.

Responsibility Accounting

In large organizations, performance measurement must be tied to a manager’s sphere of responsibility. Responsibility centres are organizational units for which managers are held accountable:

Return on Investment and Economic Value Added

\[ ROI = \frac{Operating\ Profit}{Invested\ Capital} \]

ROI is widely used but can be gamed by avoiding positive-NPV investments that would dilute the existing ROI. Economic Value Added (EVA) corrects this:

\[ EVA = NOPAT - (WACC \times Invested\ Capital) \]

where NOPAT is Net Operating Profit After Tax. EVA is positive only when the unit earns above its cost of capital, making it theoretically superior to ROI as a value-alignment measure.

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Chapter 10: Relevant Costs and Benefits

The Relevant Cost Framework

Management accounting for decision-making focuses on how costs and revenues change in response to a particular decision. Irrelevant costs — those that do not change — should be excluded from analysis.

Make-or-Buy Decisions

Should a firm produce a component in-house or purchase it from an outside supplier? The relevant comparison:

• Cost to make = incremental variable costs of production + incremental fixed costs (that would be avoided if buying) + opportunity cost of capacity used.
• Cost to buy = purchase price from supplier.

If the firm has idle capacity, the opportunity cost of using it for production is zero — which often makes in-house production attractive.

Special Orders

A customer requests a one-time order at a price below the regular selling price. The order is profitable if:

\[ Special\ Order\ Price > Incremental\ Cost\ per\ Unit \]

Fixed costs allocated to regular production are irrelevant if they would not change with the special order. However, strategic considerations (impact on regular customers’ perceptions of fairness, precedent-setting) extend beyond the financial comparison.

Dropping a Product or Segment

A segment appears unprofitable, but should it be dropped? Only if the revenues lost exceed the costs that would actually be eliminated. Common fixed costs — allocated overheads that would remain even if the segment is dropped — are irrelevant to the drop/keep decision.

Contribution margin is the critical metric: if a segment generates positive contribution margin (Revenue − Variable Costs), dropping it reduces total firm profit by that amount, even if the segment shows an accounting loss after allocated fixed cost absorption.

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Chapter 11: Investing Decisions — Capital Budgeting

The Capital Budgeting Process

Capital budgeting decisions involve committing resources today to generate future returns. These decisions are among the most consequential a firm makes because they are large, long-lived, and often irreversible.

The process involves:

1. Identifying investment opportunities
2. Estimating incremental cash flows
3. Evaluating proposals using financial criteria
4. Implementation and post-audit

Net Present Value (NPV)

NPV is the theoretically correct decision criterion. Accept a project if and only if NPV > 0; among mutually exclusive projects, choose the highest NPV.

\[ NPV = \sum_{t=0}^{n} \frac{C_t}{(1+r)^t} \]

where \(C_t\) is the incremental after-tax cash flow in period \(t\) (negative for initial investment) and \(r\) is the risk-adjusted discount rate (WACC for average-risk projects).

Internal Rate of Return (IRR)

The IRR is the discount rate that makes NPV = 0:

\[ 0 = \sum_{t=0}^{n} \frac{C_t}{(1+IRR)^t} \]

Decision rule: Accept if IRR > cost of capital.

For conventional cash flows (one sign change), IRR and NPV give the same accept/reject decision. However, IRR has well-known pitfalls:

• Multiple IRRs when cash flows change sign more than once.
• Scale problem: IRR ignores absolute investment size; a small high-IRR project can score above a large lower-IRR project with higher absolute NPV.
• Reinvestment rate assumption: IRR implicitly assumes interim cash flows are reinvested at the IRR, which may be unrealistic.

NPV is always the correct decision criterion when ranking mutually exclusive projects.

Payback Period

The payback period is the time required to recover the initial investment from operating cash flows. It is simple to compute and understand, and it addresses liquidity risk. However, it ignores the time value of money and ignores all cash flows beyond the payback period — a serious flaw for long-lived projects.

Discounted payback uses the time to recover investment from discounted cash flows, addressing the TVM criticism but still ignoring post-payback cash flows.

Estimating Project Cash Flows

Only incremental, after-tax cash flows are relevant. Key principles:

• Sunk costs: Exclude. Money already spent is irrelevant.
• Opportunity costs: Include. If a project uses an asset that could be sold or leased, the foregone proceeds are a cost.
• Side effects: Include. If a new product cannibalizes existing product sales (cannibalization), the lost contribution is a relevant cost.
• Tax shield on depreciation: Capital cost allowance (CCA) in Canada provides a tax shield. The after-tax cost of an investment is reduced by the PV of the CCA tax shield (half-year rule applies in the year of acquisition).

Sensitivity and Scenario Analysis

No projection is certain. Sensitivity analysis asks: how much does NPV change when one variable (sales volume, price, cost) changes, holding all else constant? This identifies the key value drivers and risks.

Break-even analysis finds the minimum volume (in units) at which the project NPV = 0. Below this volume, the project destroys value.

\[ Break-even\ (accounting) = \frac{Fixed\ Costs}{Selling\ Price - Variable\ Cost\ per\ Unit} \]\[ Break-even\ (NPV) = \frac{Fixed\ Costs + EAC_{capital}}{Selling\ Price - Variable\ Cost\ per\ Unit} \]

where \(EAC_{capital}\) is the Equivalent Annual Cost — the annuity whose PV equals the initial investment over the project’s life.

WACC as the Discount Rate

For projects of average risk, the appropriate discount rate is the firm’s Weighted Average Cost of Capital (WACC):

\[ WACC = \frac{E}{V} k_e + \frac{D}{V} k_d (1 - t) \]

where \(E/(E+D)\) and \(D/(E+D)\) are equity and debt weights at market value, \(k_e\) is the cost of equity (estimated using CAPM), \(k_d\) is the pre-tax cost of debt, and \(t\) is the corporate tax rate. The tax shield on interest payments reduces the effective cost of debt below the pre-tax rate.