Introduction to Financial Accounting 2024-A PDF

INTRODUCTION TO FINANCIAL ACCOUNTING D. ANNAND & H. DAUDERIS ADAPTED BY T. JENSEN & M. MORPURGO VERSION 2024-A WITH OPEN TEXTS (CC BY-NC-SA)  WITH OPEN TEXTS Open Texts and Editorial Support Digital access to our high...

INTRODUCTION TO FINANCIAL ACCOUNTING D. ANNAND & H. DAUDERIS ADAPTED BY T. JENSEN & M. MORPURGO VERSION 2024-A WITH OPEN TEXTS (CC BY-NC-SA)  WITH OPEN TEXTS Open Texts and Editorial Support Digital access to our high-quality Access to our in-house support team texts is entirely FREE! All content is is available 7 days/week to provide reviewed and updated regularly by prompt resolution to both student and subject matter experts, and the texts instructor inquiries. In addition, we are adaptable; custom editions can work one-on-one with instructors to be produced by the Vretta-Lyryx provide a comprehensive system, cus- editorial team for those adopting tomized for their course. This can Vretta-Lyryx assessment. Access to include managing multiple sections, the original source files is also open assistance with preparing online to anyone! examinations, help with LMS integra- tion, and much more! 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Citation Use the information below to create a citation: Author: H. Dauderis, D. Annand, T. Jensen, M. Morpurgo Publisher: Vretta‐Lyryx Inc. Book title: Introduction to Financial Accounting Book version: 2024‐A Publication date: February 7, 2024 Location: Toronto, Ontario, Canada Book URL: https://lyryx.com/introduction-financial-accounting/ For questions or comments please contact [email protected]  INTRODUCTION TO FINANCIAL ACCOUNTING by Henry Dauderis & David Annand Adapted by T. Jensen & M. Morpurgo Base Text Revision History Current Revision: Version 2024 — Revision A 2024 A Minor content fixes throughout. 2023 A Minor content fixes throughout. Refresh of years used in dates throughout in examples, exercises, and problems. Problem 2‐6 revised. 2021 A Front matter has been updated including cover, Vretta‐Lyryx with Open Texts, copyright, and revision pages. Attribution page has been added. 2019 B Minor content fixes throughout. 2019 A Content added on direct method cash flows. Links to videos have been added throughout the chapters. 2018 A Minor content fixes throughout. 2017 C Content added on book values with multiple share classes (Section 10.6). 2017 B Content added on special journals and subledgers in Section 2.4. 2017 A Additional exercises added throughout the text. Content added on detailed income statements with continuing and discontinued operations and EPS calculations (Section 11.4). Content added on bond retirement and interest accrual when bonds issued between interest payment dates (Appendix to Chapter 9). Content added on share retirement to Section 10.2.  Table of Contents Table of Contents iii 1 Introduction to Financial Accounting 1 Chapter 1 Learning Objectives.............................. 1 Concept Self‐Check.................................... 1 1.1 Accounting Defined................................. 3 1.2 Business Organizations............................... 3 1.3 Generally Accepted Accounting Principles (GAAP)................. 5 1.4 Financial Statements................................ 8 1.5 Transaction Analysis and Double‐entry Accounting................ 15 Summary of Chapter 1 Learning Objectives........................ 24 Discussion Questions................................... 25 Exercises.......................................... 26 Problems......................................... 39 2 The Accounting Process 45 Chapter 2 Learning Objectives.............................. 45 Concept Self‐Check.................................... 45 2.1 Accounts....................................... 46 iii  iv Table of Contents 2.2 Transaction Analysis Using Accounts........................ 51 2.3 The Trial Balance.................................. 58 2.4 Using Formal Accounting Records......................... 63 2.5 The Accounting Cycle................................ 72 Summary of Chapter 2 Learning Objectives........................ 73 Discussion Questions................................... 74 Exercises.......................................... 75 Problems......................................... 86 3 Financial Accounting and Adjusting Entries 99 Chapter 3 Learning Objectives.............................. 99 Concept Self‐Check.................................... 99 3.1 The Operating Cycle................................. 100 3.2 Adjusting Entries.................................. 106 3.3 The Adjusted Trial Balance............................. 119 3.4 Using the Adjusted Trial Balance to Prepare Financial Statements......... 120 3.5 The Accounting Cycle................................ 124 3.6 The Closing Process................................. 125 Summary of Chapter 3 Learning Objectives........................ 129 Discussion Questions................................... 132 Exercises.......................................... 133 Problems......................................... 143 4 The Classified Balance Sheet and Related Disclosures 155  v Chapter 4 Learning Objectives.............................. 155 Concept Self‐Check.................................... 155 4.1 Financial Statement Disclosure Decisions...................... 156 4.2 Classified Balance Sheet.............................. 158 4.3 Notes to Financial Statements........................... 162 4.4 Auditor’s Report................................... 166 4.5 Management’s Responsibility for Financial Statements.............. 168 Summary of Chapter 4 Learning Objectives........................ 169 Discussion Questions................................... 171 Exercises.......................................... 172 Problems......................................... 178 5 Accounting for the Sale of Goods 185 Chapter 5 Learning Objectives.............................. 185 Concept Self‐Check.................................... 185 5.1 The Basics of Merchandising............................ 187 5.2 The Purchase and Payment of Merchandise Inventory (Perpetual)........ 189 5.3 Merchandise Inventory: Sales and Collection (Perpetual)............. 192 5.4 Adjustments to Merchandise Inventory (Perpetual)................ 196 5.5 Merchandising Income Statement......................... 200 5.6 Closing Entries for a Merchandiser......................... 202 5.7 Appendix A: The Periodic Inventory System.................... 202 Summary of Chapter 5 Learning Objectives........................ 206  vi Table of Contents Discussion Questions................................... 208 Exercises.......................................... 208 Problems......................................... 214 6 Assigning Costs to Merchandise 223 Chapter 6 Learning Objectives.............................. 223 Concept Self‐Check.................................... 223 6.1 Inventory Cost Flow Assumptions.......................... 224 6.2 Financial Statement Impact of Different Inventory Cost Flows........... 238 6.3 Lower of Cost and Net Realizable Value (LCNRV).................. 240 6.4 Estimating the Balance in Merchandise Inventory................. 242 6.5 Appendix A: Ratio Analysis—Merchandise Inventory Turnover.......... 246 6.6 Appendix B: Inventory Cost Flow Assumptions Under the Periodic System.... 247 Summary of Chapter 6 Learning Objectives........................ 249 Discussion Questions................................... 251 Exercises.......................................... 252 Problems......................................... 256 7 Cash and Receivables 265 Chapter 7 Learning Objectives.............................. 265 Concept Self‐Check.................................... 265 7.1 Internal Control................................... 266 7.2 Petty Cash...................................... 268 7.3 Cash Collections and Payments........................... 271  vii 7.4 Accounts Receivable................................ 280 7.5 Short‐Term Notes Receivable............................ 289 7.6 Appendix A: Ratio Analysis—Acid Test....................... 291 7.7 Appendix B: Ratio Analysis—Accounts Receivable Turnover............ 292 Summary of Chapter 7 Learning Objectives........................ 293 Discussion Questions................................... 295 Exercises.......................................... 296 Problems......................................... 301 8 Long‐lived Assets 309 Chapter 8 Learning Objectives.............................. 309 Concept Self‐Check.................................... 309 8.1 Establishing the Cost of Property, Plant, and Equipment (PPE)........... 310 8.2 Depreciation..................................... 314 8.3 Partial Year Depreciation.............................. 321 8.4 Revising Depreciation................................ 321 8.5 Impairment of Long‐lived Assets.......................... 325 8.6 Derecognition of Property, Plant, and Equipment................. 326 8.7 Intangible Assets.................................. 330 8.8 Goodwill....................................... 333 8.9 Disclosure...................................... 335 Summary of Chapter 8 Learning Objectives........................ 335 Discussion Questions................................... 339  viii Table of Contents Exercises.......................................... 341 Problems......................................... 347 9 Debt Financing: Current and Long‐term Liabilities 353 Chapter 9 Learning Objectives.............................. 353 Concept Self‐Check.................................... 353 9.1 Current versus Long‐term Liabilities........................ 354 9.2 Known Current Liabilities.............................. 356 9.3 Estimated Current Liabilities............................ 360 9.4 Long‐Term Liabilities—Bonds Payable....................... 363 9.5 Long‐term Liabilities—Loans Payable........................ 373 9.6 Appendix A: Present Value Calculations...................... 375 9.7 Appendix B: Additional Payroll Transactions.................... 379 9.8 Appendix C: The Effective Interest Rate Method.................. 382 Summary of Chapter 9 Learning Objectives........................ 387 Discussion Questions................................... 388 Exercises.......................................... 389 Problems......................................... 395 10 Equity Financing 397 Chapter 10 Learning Objectives.............................. 397 Concept Self‐Check.................................... 397 10.1 The Corporate Structure.............................. 398 10.2 Recording Share Transactions............................ 405  ix 10.3 Cash Dividends................................... 410 10.4 Share Dividends................................... 414 10.5 Book Value..................................... 416 10.6 Appendix A: Reporting for Multiple Classes of Shares............... 418 Summary of Chapter 10 Learning Objectives....................... 418 Discussion Questions................................... 420 Exercises.......................................... 421 Problems......................................... 430 11 The Statement of Cash Flows 435 Chapter 11 Learning Objectives.............................. 435 Concept Self‐Check.................................... 435 11.1 Financial Statement Reporting........................... 436 11.2 Preparing the Statement of Cash Flows....................... 437 11.3 Interpreting the Statement of Cash Flows..................... 451 11.4 Appendix A: Putting It All Together: Corporate Financial Statements....... 453 11.5 Appendix B: Statement of Cash Flows – Direct Method.............. 458 11.5.1 Preparing a Statement of Cash Flows: Direct Method........... 462 Summary of Chapter 11 Learning Objectives....................... 468 Discussion Questions................................... 469 Exercises.......................................... 469 Problems......................................... 484 12 Financial Statement Analysis 489  x Table of Contents Chapter 12 Learning Objectives.............................. 489 Concept Self‐Check.................................... 489 12.1 Introduction to Ratio Analysis............................ 490 12.2 Liquidity Ratios: Analyzing Short‐term Cash Needs................. 493 12.3 Profitability Ratios: Analyzing Operating Activities................. 501 12.4 Leverage Ratios: Analyzing Financial Structure................... 506 12.5 Market Ratios: Analysis of Financial Returns to Investors............. 509 12.6 Overall Analysis of Big Dog’s Financial Statements................. 512 12.7 Horizontal and Vertical Trend Analysis....................... 513 Summary of Chapter 12 Learning Objectives....................... 519 Discussion Questions................................... 520 Exercises.......................................... 521 Problems......................................... 530 13 Proprietorships and Partnerships 533 Chapter 13 Learning Objectives.............................. 533 Concept Self‐Check.................................... 533 13.1 Proprietorships................................... 534 13.2 Partnerships..................................... 539 Summary of Chapter 13 Learning Objectives....................... 545 Discussion Questions................................... 545 Exercises.......................................... 546 Problems......................................... 552  xi Solutions To Discussion Questions 553 Chapter 1 Solutions.................................... 553 Chapter 2 Solutions.................................... 555 Chapter 3 Solutions.................................... 557 Chapter 4 Solutions.................................... 561 Chapter 5 Solutions.................................... 562 Chapter 6 Solutions.................................... 563 Chapter 7 Solutions.................................... 566 Chapter 8 Solutions.................................... 568 Chapter 9 Solutions.................................... 572 Chapter 10 Solutions................................... 574 Chapter 11 Solutions................................... 578 Chapter 12 Solutions................................... 579 Chapter 13 Solutions................................... 583 Solutions To Exercises 585 Chapter 1 Solutions.................................... 585 Chapter 2 Solutions.................................... 597 Chapter 3 Solutions.................................... 610 Chapter 4 Solutions.................................... 622 Chapter 5 Solutions.................................... 630 Chapter 6 Solutions.................................... 638 Chapter 7 Solutions.................................... 642  xii Table of Contents Chapter 8 Solutions.................................... 648 Chapter 9 Solutions.................................... 657 Chapter 10 Solutions................................... 669 Chapter 11 Solutions................................... 684 Chapter 12 Solutions................................... 701 Chapter 13 Solutions................................... 711 Solutions To Problems 723 Chapter 1 Solutions.................................... 723 Chapter 2 Solutions.................................... 729 Chapter 3 Solutions.................................... 746 Chapter 4 Solutions.................................... 769 Chapter 5 Solutions.................................... 778 Chapter 6 Solutions.................................... 789 Chapter 7 Solutions.................................... 798 Chapter 8 Solutions.................................... 807 Chapter 9 Solutions.................................... 814 Chapter 10 Solutions................................... 816 Chapter 11 Solutions................................... 820 Chapter 12 Solutions................................... 828 Chapter 13 Solutions................................... 831 Chapter 1 Introduction to Financial Accounting Accounting involves a process of collecting, recording, and reporting a business’s economic ac‐ tivities to users. It is often called the language of business because it uses a unique vocabulary to communicate information to decision makers. To understand accounting, we first look at the basic forms of business organizations. The concepts and principles that provide the foundation for financial accounting are then discussed. With an emphasis on the corporate form of business organization, we will examine how we communicate to users of financial information using finan‐ cial statements. Finally, we will review how financial transactions are analyzed and then reported on financial statements. Chapter 1 Learning Objectives Watch video LO1 – Define accounting. LO2 – Identify and describe the forms of business organization. LO3 – Identify and explain the Generally Accepted Accounting Principles (GAAP). LO4 – Identify, explain, and prepare the financial statements. LO5 – Analyze transactions by using the accounting equation. Concept Self-Check Use the following as a self‐check while working through Chapter 1. 1. What is accounting? 2. What is the difference between internal and external users of accounting information? 3. What is the difference between managerial and financial accounting? 4. What is the difference between a business organization and a non‐business organization? 5. What are the three types of business organizations? 6. What is a PAE? A PE? 1  2 Introduction to Financial Accounting 7. What does the term limited liability mean? 8. Explain how ethics are involved in the practice of accounting. 9. Describe what GAAP refers to. 10. Identify and explain the six qualitative characteristics of GAAP. 11. Identify and explain at least five of the nine principles that support the GAAP qualitative characteristics. 12. How is financial information communicated to external users? 13. What are the four financial statements? 14. Which financial statement measures financial performance? Financial position? 15. What information is provided in the statement of cash flows? 16. Explain how retained earnings and dividends are related. 17. What are the three primary components of the balance sheet? 18. Equity consists of what two components? 19. How are assets financed? 20. Identify and explain the three types of activities a business engages in. 21. What are notes to the financial statements? 22. What is the accounting equation? 23. What are the distinctions among calendar, interim, and fiscal year ends? NOTE: The purpose of these questions is to prepare you for the concepts introduced in the chap‐ ter. Your goal should be to answer each of these questions as you read through the chapter. If, when you complete the chapter, you are unable to answer one or more the Concept Self‐Check questions, go back through the content to find the answer(s). Solutions are not provided to these questions.  1.1. Accounting Defined 3 1.1 Accounting Defined Watch video Accounting is the process of identifying, measuring, recording, LO1 – Define accounting. and communicating an organization’s economic activities to users. Users need information for decision making. Internal users of ac‐ counting information work for the organization and are responsi‐ ble for planning, organizing, and operating the entity. The area of accounting known as managerial accounting serves the decision‐ making needs of internal users. External users do not work for the organization and include investors, creditors, labour unions, and customers. Financial accounting is the area of accounting that focuses on external reporting and meeting the needs of external users. This book addresses financial accounting. Managerial ac‐ counting is covered in other books. 1.2 Business Organizations Watch video An organization is a group of individuals who come together to LO2 – Identify and describe pursue a common set of goals and objectives. There are two the forms of business orga‐ types of business organizations: business and non‐business. A nization. business organization sells products and/or services for profit. A non‐business organization, such as a charity or hospital, exists to meet various societal needs and does not have profit as a goal. All businesses, regardless of type, record, report, and, most im‐ portantly, use accounting information for making decisions. This book focuses on business organizations. There are three common forms of business organi‐ zations — a proprietorship, a partnership, and a corporation. Proprietorship A proprietorship is a business owned by one person. It is not a separate legal entity, which means that the business and the owner are considered to be the same entity. This means, for example, that from an income tax perspective, the profits of a proprietorship are taxed as part of the owner’s personal income tax return. Unlimited liability is another characteristic of a sole proprietorship meaning that if the business could not pay its debts, the owner would be responsible even if the business’s debts were greater than the owner’s personal resources.  4 Introduction to Financial Accounting Partnership A partnership is a business owned by two or more individuals. Like the proprietorship, it is not a separate legal entity and its owners are typically subject to unlimited liability. Corporation A corporation is a business owned by one or more owners. The owners are known as shareholders. A shareholder owns shares of the corporation. Shares1 are units of ownership in a corporation. For example, if a corporation has 1,000 shares, there may be three shareholders where one has 700 shares, another has 200 shares, and the third has 100 shares. The number of shares held by a shareholder represents how much of the corporation they own. A corporation can have different types of shares; this topic is discussed in a later chapter. When there is only one type of share, it is usually called common shares. A corporation’s shares can be privately held or available for public sale. A corporation that holds its shares privately and does not sell them publicly is known as a private enterprise (PE). A corpo‐ ration that sells its shares publicly, typically on a stock exchange, is called a publicly accountable enterprise (PAE). Unlike the proprietorship and partnership, a corporation is a separate legal entity. This means, for example, that from an income tax perspective, a corporation files its own tax return. The owners or shareholders of a corporation are not responsible for the corporation’s debts so have limited liability meaning that the most they can lose is what they invested in the corporation. In larger corporations, there can be many shareholders. In these cases, shareholders do not man‐ age a corporation but participate indirectly through the election of a Board of Directors. The Board of Directors does not participate in the day‐to‐day management of the corporation but delegates this responsibility to the officers of the corporation. An example of this delegation of responsibility is illustrated in Figure 1.1. 1 Shares are also called stock.  1.3. Generally Accepted Accounting Principles (GAAP) 5 SHAREHOLDERS (Owners) Elect BOARD OF DIRECTORS (Represent Owners) Appoint VICE PRES. VICE PRES. VICE PRES. PRESIDENT MARKETING FINANCE PRODUCTION Figure 1.1: Generalized Form of a Corporate Organization Shareholders usually meet annually to elect a Board of Directors. The Board of Directors meets regularly to review the corporation’s operations and to set policies for future operations. Unlike shareholders, directors can be held personally liable if a company fails. The focus of these chapters will be on the corporate form of business organization. The propri‐ etorship and partnership organizations will be discussed in more detail in Chapter 13. An exploration is available on the Lyryx site. Log into your Lyryx course to run Forms of Organization. 1.3 Generally Accepted Accounting Principles (GAAP) Watch video The goal of accounting is to ensure information provided to de‐ LO3 – Identify and explain cision makers is useful. To be useful, information must be rel‐ the Generally Accepted evant and faithfully represent a business’s economic activities. Accounting Principles This requires ethics, beliefs that help us differentiate right from (GAAP). wrong, in the application of underlying accounting concepts or principles. These underlying accounting concepts or principles are known as Generally Accepted Accounting Principles (GAAP). GAAP in Canada, as well as in many other countries, is based on International Financial Reporting Standards (IFRS) for publicly accountable enterprises (PAE). IFRS are issued by the International Accounting Standards Board (IASB). The IASB’s mandate is to promote the adoption of a single set  6 Introduction to Financial Accounting of global accounting standards through a process of open and transparent discussions among cor‐ porations, financial institutions, and accounting firms around the world. Private enterprises (PE) in Canada are permitted to follow either IFRS or Accounting Standards for Private Enterprises (ASPE), a set of less onerous GAAP‐based standards developed by the Canadian Accounting Stan‐ dards Board (AcSB). The AcSB is the body that governs accounting standards in Canada. The focus in this book will be on IFRS for PAEs2. Accounting practices are guided by GAAP which are comprised of qualitative characteristics and principles. As already stated, relevance and faithful representation are the primary qualitative characteristics. Comparability, verifiability, timeliness, and understandability are additional qual‐ itative characteristics. Information that possesses the quality of: relevance has the ability to make a difference in the decision‐making process. faithful representation is complete, neutral, and free from error. comparability tells users of the information that businesses utilize similar accounting prac‐ tices. verifiability means that others are able to confirm that the information faithfully represents the economic activities of the business. timeliness is available to decision makers in time to be useful. understandability is clear and concise. Table 1.1 lists the nine principles that support these qualitative characteristics. 2 It should be noted, however, that at the introductory level, there are no significant differences in how IFRS and ASPE are applied.  1.3. Generally Accepted Accounting Principles (GAAP) 7 Accounting Principle Explanation/Example Business entity Requires that each economic entity maintain separate records. Example: A business owner keeps separate accounting records for business transactions and for personal transactions. Consistency Requires that a business use the same accounting policies and procedures from period to period. Example: A business uses a particular inventory costing method. It cannot change to a different inventory costing method in the next accounting period. Cost Requires that each economic transaction be based on the actual original cost (also known as historical cost principle). Example: The business purchases a delivery truck advertised for $75,000 and pays $70,000. The truck must be recorded at the cost of $70,000, the amount actually paid. Full disclosure Requires that accounting information communicate sufficient information to allow users to make knowledgeable decisions. Example: A business is applying to the bank for a $1,000,000 loan. The business is being sued for $20,000,000 and it is certain that it will lose. The business must tell the bank about the lawsuit even though the lawsuit has not yet been finalized. Going concern Assumes that a business will continue for the foreseeable future. Example: All indications are that Business X will continue so it is reported to be a ‘going concern’. Business Z is being sued for $20,000,000 and it is certain that it will lose. The $20,000,000 loss will force the business to close. Business Z must not only disclose the lawsuit but it must also indicate that there is a ‘going concern’ issue. Matching Requires that financial transactions be reported in the period in which they occurred/were realized. Example: Supplies were purchased March 15 for $700. They will be recorded as an asset on March 15 and then expensed as they are used.  8 Introduction to Financial Accounting Accounting Principle Explanation/Example Materiality Requires a business to apply proper accounting only for items that would affect decisions made by users. Example: The business purchases a stapler for $5 today. Tech‐ nically, the stapler will last several years so should be recorded as an asset. However, the business will record the $5 as an expense instead because depreciating a $5 item will not impact the decisions of financial information. Monetary unit Requires that financial information be communicated in stable units of money. Example: Land was purchased in 1940 for $5,000 Canadian. It is maintained in the accounting records at $5,000 Canadian and is not adjusted. Recognition Requires that revenues be recorded when earned and expenses be recorded when incurred, which is not necessarily when cash is received (in the case of revenues) or paid (in the case of expenses). Example: A sale occurred on March 5. The customer received the product on March 5 but will pay for it on April 5. The business records the sale on March 5 when the sale occurred even though the cash is not received until April 5. Table 1.1: Accounting Principles Note: Some of the principles discussed above may be challenging to understand because related concepts have not yet been introduced. Therefore, most of these principles will be discussed again in more detail in a later chapter. 1.4 Financial Statements Watch video Recall that financial accounting focuses on communicating infor‐ LO4 – Identify, explain, and mation to external users. That information is communicated us‐ prepare the financial state‐ ing financial statements. There are four financial statements: ments. the income statement, statement of changes in equity, balance sheet, and statement of cash flows. Each of these is introduced in the following sections using an example based on a fictitious corporate organization called Big Dog Carworks Corp.  1.4. Financial Statements 9 The Income Statement An income statement communicates information about a business’s financial performance by summarizing revenues less expenses over a period of time. Revenues are created when a business provides products or services to a customer in exchange for assets. Assets are resources result‐ ing from past events and from which future economic benefits are expected to result. Examples of assets include cash, equipment, and supplies. Assets will be discussed in more detail later in this chapter. Expenses are the assets that have been used up or the obligations incurred in the course of earning revenues. When revenues are greater than expenses, the difference is called net income or profit. When expenses are greater than revenue, a net loss results. Consider the following income statement of Big Dog Carworks Corp. (BDCC). This business was started on January 1, 2023 by Bob “Big Dog” Baldwin in order to repair automobiles. All the shares of the corporation are owned by Bob. At January 31, the income statement shows total revenues of $10,000 and various expenses to‐ taling $7,800. Net income, the difference between $10,000 of revenues and $7,800 of expenses, equals $2,200. The heading shows the Big Dog Carworks Corp. name of the entity, Income Statement the type of financial For the Month Ended January 31, 2023 statement, and the period‐in‐time date. Revenues Repair revenues $10,000 Expenses Rent expense $1,600 Salaries expense 3,500 Supplies expense 2,000 Fuel expense 700 Total expenses 7,800 The net income is transferred to Net income $2,200 the statement of changes in equity. An exploration is available on the Lyryx site. Log into your Lyryx course to run Income Statement. The Statement of Changes in Equity The statement of changes in equity provides information about how the balances in Share capital and Retained earnings changed during the period. Share capital is a heading in the shareholders’  10 Introduction to Financial Accounting equity section of the balance sheet and represents how much shareholders have invested. When shareholders buy shares, they are investing in the business. The number of shares they purchase will determine how much of the corporation they own. The type of ownership unit purchased by Big Dog’s shareholders is known as common shares. Other types of shares will be discussed in a later chapter. When a corporation sells its shares to shareholders, the corporation is said to be issuing shares to shareholders. In the statement of changes in equity shown below, Share capital and Retained earnings balances at January 1 are zero because the corporation started the business on that date. During January, Share capital of $10,000 was issued to shareholders so the January 31 balance is $10,000. Retained earnings is the sum of all net incomes earned by a corporation over its life, less any distributions of these net incomes to shareholders. Distributions of net income to shareholders are called dividends. Shareholders generally have the right to share in dividends according to the percentage of their ownership interest. To demonstrate the concept of retained earnings, recall that Big Dog has been in business for one month in which $2,200 of net income was reported. Additionally, $200 of dividends were distributed, so these are subtracted from retained earnings. Big Dog’s retained earnings were therefore $2,000 at January 31, 2023 as shown in the statement of changes in equity below. The heading shows the Big Dog Carworks Corp. name of the entity, Statement of Changes in Equity the type of financial For the Month Ended January 31, 2023 statement, and the period‐in‐time date. Share Retained Total Capital Earnings Equity Opening balance $ ‐0‐ $ ‐0‐ $ ‐0‐ Shares issued 10,000 10,000 Net income 2,200 2,200 Dividends (200) (200) Ending balance $10,000 $2,000 $12,000 These totals are transferred to the balance sheet at Jan‐ uary 31, 2023. To demonstrate how retained earnings would appear in the next accounting period, let’s assume that Big Dog reported a net income of $5,000 for February, 2023 and dividends of $1,000 were given to the shareholder. Based on this information, retained earnings at the end of February would be $6,000, calculated as the $2,000 January 31 balance plus the $5,000 February net income less the $1,000 February dividend. The balance in retained earnings continues to change over time because of additional net incomes/losses and dividends.  1.4. Financial Statements 11 An exploration is available on the Lyryx site. Log into your Lyryx course to run Statement of Changes in Equity. The Balance Sheet The balance sheet, or statement of financial position, shows a business’s assets, liabilities, and equity at a point in time. The balance sheet of Big Dog Carworks Corp. at January 31, 2023 is shown below. Big Dog Carworks Corp. The heading shows the name of Balance Sheet the entity, the type of financial statement, and the point‐in‐time At January 31, 2023 date. Assets Liabilities Cash $ 3,700 Bank Loan $ 6,000 Accounts receivable 2,000 Accounts payable 700 Prepaid insurance 2,400 Unearned revenue 400 Equipment 3,000 Total liabilities $ 7,100 Truck 8,000 Equity Share capital $10,000 Retained earnings 2,000 Total equity 12,000 Total assets $19,100 Total liabilities and equity $19,100 Total assets ($19,100 here) always equal Total liabilities ($7,100) plus Equity ($12,000). What Is an Asset? Assets are economic resources that provide future benefits to the business. Examples include cash, accounts receivable, prepaid expenses, equipment, and trucks. Cash is coins and currency, usually held in a bank account, and is a financial resource with future benefit because of its pur‐ chasing power. Accounts receivable represent amounts to be collected in cash in the future for goods sold or services provided to customers on credit. Prepaid expenses are assets that are paid in cash in advance and have benefits that apply over future periods. For example, a one‐year in‐ surance policy purchased for cash on January 1, 2023 will provide a benefit until December 31, 2023 so is a prepaid asset. The equipment and truck were purchased on January 1, 2023 and will  12 Introduction to Financial Accounting provide benefits for 2023 and beyond so are assets. What Is a Liability? A liability is an obligation to pay an asset in the future. For example, Big Dog’s bank loan represents an obligation to repay cash in the future to the bank. Accounts payable are obligations to pay a creditor for goods purchased or services rendered. A creditor owns the right to receive payment from an individual or business. Unearned revenue represents an advance payment of cash from a customer for Big Dog’s services or products to be provided in the future. For example, Big Dog collected cash from a customer in advance for a repair to be done in the future. An exploration is available on the Lyryx site. Log into your Lyryx course to run Balance Sheet. What Is Equity? Equity represents the net assets owned by the owners (the shareholders). Net assets are assets minus liabilities. For example, in Big Dog’s January 31 balance sheet, net assets are $12,000, cal‐ culated as total assets of $19,100 minus total liabilities of $7,100. This means that although there are $19,100 of assets, only $12,000 are owned by the shareholders and the balance, $7,100, are financed by debt. Notice that net assets and total equity are the same value; both are $12,000. Equity consists of share capital and retained earnings. Share capital represents how much the shareholders have invested in the business. Retained earnings is the sum of all net incomes earned by a corporation over its life, less any dividends distributed to shareholders. In summary, the balance sheet is represented by the equation: Assets = Liabilities + Equity. Assets are the investments held by a business. The liabilities and equity explain how the assets have been financed, or funded. Assets can be financed through liabilities, also known as debt, or equity. Equity represents amounts that are owned by the owners, the shareholders, and consists of share capital and retained earnings. Investments made by shareholders, namely share capital, are used to finance assets and/or pay down liabilities. Additionally, retained earnings, comprised of net income less any dividends, also represent a source of financing. An exploration is available on the Lyryx site. Log into your Lyryx course to run Account Types.  1.4. Financial Statements 13 The Statement of Cash Flows (SCF) Cash is an asset reported on the balance sheet. Ensuring there is sufficient cash to pay expenses and liabilities as they come due is a critical business activity. The statement of cash flows (SCF) explains how the balance in cash changed over a period of time by detailing the sources (inflows) and uses (outflows) of cash by type of activity: operating, investing, and financing, as these are the three types of activities a business engages in. Operating activities are the day‐to‐day processes involved in selling products and/or services to generate net income. Examples of operating activi‐ ties include the purchase and use of supplies, paying employees, fuelling equipment, and renting space for the business. Investing activities are the buying of assets needed to generate revenues. For example, when an airline purchases airplanes, it is investing in assets required to help it gen‐ erate revenue. Financing activities are the raising of money needed to invest in assets. Financing can involve issuing share capital (getting money from the owners known as shareholders) or bor‐ rowing. Figure 1.2 summarizes the interrelationships among the three types of business activities. Cash flows result‐ Operating Cash flows resulting ing from operating Activities from operating activities can be activities can be reinvested in (creates net used to pay down income) Investing Financing Activities Activities (buys assets to (raises money to generate revenues) Cash flows resulting invest in assets) from financing activities can be used to buy assets Figure 1.2: Relationships Among the Three Types of Business Activities The statement of cash flows for Big Dog is shown below.  14 Introduction to Financial Accounting The heading shows Big Dog Carworks Corp. the name of the en‐ Statement of Cash Flows tity, the type of finan‐ cial statement, and For the Month Ended January 31, 2023 the period‐in‐time date. Operating activities: Net income $ 2,200 Adjustments: Increase in unearned revenues 400 Increase in accounts payable 700 Increase in prepaid insurance (2,400) Increase in accounts receivable (2,000) Net cash used by operating activities $(1,100) Investing activities: Purchase of equipment $(3,000) Purchase of truck (3,000) Net cash used by investing activities (6,000) Financing activities: Issued shares $10,000 Borrowed from bank 3,000 Payment on bank loan (2,000) Paid dividends (200) Net cash provided by financing activities 10,800 Net increase in cash 3,700 Cash balance, January 1 ‐0‐ Cash balance, January 31 $3,700 This agrees with the Cash amount shown on the Balance Sheet at January 31, 2023. The statement of cash flows is useful because cash is one of the most important assets of a corpo‐ ration. Information about expected future cash flows are therefore important for decision makers. For instance, Big Dog’s bank manager needs to determine whether the remaining $6,000 loan can be repaid, and also whether or not to grant a new loan to the corporation if requested. The state‐ ment of cash flows helps inform those who make these decisions. Notes to the Financial Statements An essential part of financial statements are the notes that accompany them. These notes are generally located at the end of a set of financial statements. The notes provide greater detail about various amounts shown in the financial statements, or provide non‐quantitative information that is useful to users. For example, a note may indicate the estimated useful lives of long‐lived assets, or loan repayment terms. Examples of note disclosures will be provided later.  1.5. Transaction Analysis and Double-entry Accounting 15 An exploration is available on the Lyryx site. Log into your Lyryx course to run Communicating Through Financial Statements. 1.5 Transaction Analysis and Double-entry Accounting Watch video The accounting equation is foundational to accounting. It shows LO5 – Analyze transactions that the total assets of a business must always equal the total by using the accounting claims against those assets by creditors and owners. The equa‐ equation. tion is expressed as: ASSETS = LIABILITIES + EQUITY (economic resources (creditors’ claims (owners’ claims owned by an entity) on assets) on assets) When financial transactions are recorded, combined effects on assets, liabilities, and equity are always exactly offsetting. This is the reason that the balance sheet always balances. Each economic exchange is referred to as a financial transaction — for example, when an orga‐ nization exchanges cash for land and buildings. Incurring a liability in return for an asset is also a financial transaction. Instead of paying cash for land and buildings, an organization may borrow money from a financial institution. The company must repay this with cash payments in the fu‐ ture. The accounting equation provides a system for processing and summarizing these sorts of transactions. Accountants view financial transactions as economic events that change components within the accounting equation. These changes are usually triggered by information contained in source documents (such as sales invoices and bills from creditors) that can be verified for accuracy. The accounting equation can be expanded to include all the items listed on the Balance Sheet of Big Dog at January 31, 2023, as follows: ASSETS = LIABILITIES + EQUITY Cash + Accounts + Prepaid + Equipment + Truck = Bank + Accounts + Unearned + Share + Retained Receivable Insurance Loan Payable Revenue Capital Earnings If one item within the accounting equation is changed, then another item must also be changed to balance it. In this way, the equality of the equation is maintained. For example, if there is an  16 Introduction to Financial Accounting increase in an asset account, then there must be a decrease in another asset or a corresponding increase in a liability or equity account. This equality is the essence of double‐entry accounting. The equation itself always remains in balance after each transaction. The operation of double‐ entry accounting is illustrated in the following section, which shows 10 transactions of Big Dog Carworks Corp. for January 2023.  1.5. Transaction Analysis and Double-entry Accounting 17 Effect on the Accounting Equation Transaction Number Date Description of Transaction ASSETS = LIABILITIES + EQUITY 1 Jan.1 Big Dog Carworks Corp. issued 1,000 shares to Bob Baldwin, the owner or shareholder, for $10,000 cash. The asset Cash is increased while the equity item Share Capital is also increased. The impact on the equa‐ tion is: CASH +10,000 SHARE CAPITAL +10,000 2 Jan.2 Big Dog Carworks Corp. borrowed $3,000 from the bank and de‐ posited the cash into the business’s bank account. The asset Cash is increased and the liability Bank Loan is also increased. The impact on the equation is: CASH +3,000 BANK LOAN +3,000 3 Jan.2 The corporation purchased $3,000 of equipment for cash. There is an increase of the asset Equipment and a decrease to an‐ other asset, Cash. The impact on the equation is: EQUIPMENT +3,000 CASH ‐3,000 4 Jan.2 The corporation purchased a tow truck for $8,000, paying $3,000 cash and incurring an additional bank loan for the balance. The asset Cash is decreased while the asset Truck is increased and the liability Bank Loan is also increased. The impact on the equation is: CASH ‐3,000 TRUCK +8,000 BANK LOAN +5,000  18 Introduction to Financial Accounting Effect on the Accounting Equation Transaction Number Date Description of Transaction ASSETS = LIABILITIES + EQUITY 5 Jan.5 Big Dog Carworks Corp. paid $2,400 for a one‐year insurance policy, ef‐ fective January 1. Here the asset Prepaid Insurance is increased and the asset Cash is de‐ creased. The impact on the equa‐ tion is: PREPAID INSURANCE +2,400 CASH ‐2,400 Since the one‐year period will not be fully used at January 31 when financial statements are prepared, the insurance cost is considered to be an asset at the payment date. The transaction does not affect lia‐ bilities or equity. 6 Jan.10 The corporation paid $2,000 cash to the bank to reduce the loan out‐ standing. The asset Cash is decreased and there is a decrease in the liability Bank Loan. The impact on the equa‐ tion is: BANK LOAN ‐2,000 CASH ‐2,000 7 Jan.15 The corporation received $400 as an advance payment from a cus‐ tomer for services to be performed in the future. The asset Cash is increased by $400 and a liability, Unearned Revenue, is also increased since the revenue has not been earned as of January 15. It will be earned when the work is performed in the future. At January 31, these amounts are re‐ payable to customers if the work is not done (and thus a liability). The impact on the equation is: CASH +400 UNEARNED REVENUE +400  1.5. Transaction Analysis and Double-entry Accounting 19 Effect on the Accounting Equation Transaction Number Date Description of Transaction ASSETS = LIABILITIES + EQUITY 8 Jan.20 Automobile repairs of $10,000 were made for a customer; $8,000 of repairs were paid in cash and $2,000 of repairs will be paid in the future. Cash and Accounts Receivable as‐ sets of the corporation increase. The repairs are a revenue; rev‐ enue causes an increase in net in‐ come and an increase in net income causes an increase in equity. The impact on the equation is: CASH +8,000 ACCOUNTS RECEIVABLE +2,000 REPAIR REVENUE +10,000 This activity increases assets and net income. 9 Jan.31 The corporation paid operating ex‐ penses for the month as follows: $1,600 for rent; $3,500 for salaries; and $2,000 for supplies expense. The $700 for truck operating ex‐ penses (e.g., oil, gas) was on credit. There is a decrease in the asset Cash. Expenses cause net income to decrease and a decrease in net income causes equity to decrease. There is an increase in the liability Accounts Payable. The impact on the equation is: RENT EXPENSE ‐1,600 SALARIES EXPENSE ‐3,500 SUPPLIES EXPENSE ‐2,000 TRUCK OPERATING EXPENSE ‐700 CASH ‐7,100 ACCOUNTS PAYABLE +700 10 Jan.31 Dividends of $200 were paid in cash to the only shareholder, Bob Bald‐ win. Dividends cause retained earnings to decrease. A decrease in retained earnings will decrease equity. The impact on the equation is: DIVIDENDS ‐200 CASH ‐200 These various transactions can be recorded in the expanded accounting equation as shown below: ASSETS = LIABILITIES + EQUITY Trans. Cash + Acc. + Prepaid + Equip. + Truck = Bank + Acc. + Unearned + Share + Retained Rec. Insur. Loan Pay. Revenue Capital Earnings 1. +10,000 +10,000 20 2. +3,000 +3,000 3. ‐3,000 +3,000 Introduction to Financial Accounting 4. ‐3,000 +8,000 +5,000 5. ‐2,400 +2,400 6. ‐2,000 ‐2,000 7. +400 +400 8. +8,000 +2,000 +10,000 9. ‐7,100 +700 ‐1,600 These numbers are used to pre‐ ‐3,500 pare the Income ‐2,000 Statement. ‐700 10. ‐200 ‐200 3,700 + 2,000 + 2,400 + 3,000 + 8,000 = 6,000 + 700 + 400 + 10,000 + 2,000 Figure 1.3: Transactions Worksheet for January 31, 2023 Transactions in these columns are used to prepare the Statement of Changes in Equity. Column totals are used to prepare the Balance Sheet. ASSETS = $19,100 LIABILITIES + EQUITY = $19,100  1.5. Transaction Analysis and Double-entry Accounting 21 Transactions summary: 1. Issued share capital for $10,000 cash. 2. Received a bank loan for $3,000. 3. Purchased equipment for $3,000 cash. 4. Purchased a truck for $8,000; paid $3,000 cash and incurred a bank loan for the balance. 5. Paid $2,400 for a comprehensive one‐year insurance policy effective January 1. 6. Paid $2,000 cash to reduce the bank loan. 7. Received $400 as an advance payment for repair services to be provided over the next two months as follows: $300 for January, $100 for February. 8. Performed repairs for $8,000 cash and $2,000 on credit. 9. Paid a total of $7,100 for operating expenses incurred during the month; also incurred an expense on account for $700. 10. Dividends of $200 were paid in cash to the only shareholder, Bob Baldwin. The transactions summarized in Figure 1.3 were used to prepare the financial statements de‐ scribed earlier, and reproduced in Figure 1.4 below.  22 Introduction to Financial Accounting Big Dog Carworks Corp. Big Dog Carworks Corp. Balance Sheet Income Statement At January 31, 2023 For the Month Ended January 31, 2023 Assets Cash $ 3,700 Accounts receivable 2,000 Prepaid insurance 2,400 Equipment 3,000 Truck 8,000 Revenue $19,100 Repairs $10,000 Liabilities Expenses Bank loan $ 6,000 Rent $ 1,600 Accounts payable 700 Salaries 3,500 Unearned revenue 400 7,100 Supplies 2,000 Truck operation 700 Equity Total expenses 7,800 Share capital $10,000 Retained earnings 2,000 Net income $2,200 12,000 $19,100 The components of Net Income be‐ equity are shown on comes part of Re‐ the Balance Sheet. Big Dog Carworks Corp. tained Earnings. Statement of Changes in Equity For the Month Ended January 31, 2023 Share Retained Total Capital Earnings Equity Opening balance $ ‐0‐ $ ‐0‐ $ ‐0‐ Shares issued 10,000 10,000 Net income 2,200 2,200 Dividends (200) (200) Ending balance $10,000 $2,000 $12,000 Figure 1.4: Financial Statements of Big Dog Carworks Corp. Accounting Time Periods Financial statements are prepared at regular intervals — usually monthly or quarterly — and at the end of each 12‐month period. This 12‐month period is called the fiscal year. The timing of the financial statements is determined by the needs of management and other users of the financial statements. For instance, financial statements may also be required by outside parties,  1.5. Transaction Analysis and Double-entry Accounting 23 such as bankers and shareholders. However, accounting information must possess the qualitative characteristic of timeliness — it must be available to decision makers in time to be useful — which is typically a minimum of once every 12 months. Accounting reports, called the annual financial statements, are prepared at the end of each 12‐ month period, which is known as the year‐end of the entity. Some companies’ year‐ends do not follow the calendar year (year ending December 31). This may be done so that the fiscal year coincides with their natural year. A natural year ends when business operations are at a low point. For example, a ski resort may have a fiscal year ending in late spring or early summer when business operations have ceased for the season. Corporations listed on stock exchanges are generally required to prepare interim financial state‐ ments, usually every three months, primarily for the use of shareholders or creditors. Because these types of corporations are large and usually have many owners, users require more up‐to‐ date financial information. The relationship of the interim and year‐end financial statements is illustrated in Figure 1.5. Jan. 1, 2023 Jan. 31, 2023 Dec. 31, 2023 (commencement (interim) (fiscal year end) of operations) INTERIM INCOME INTERIM YEAR STATEMENT BALANCE END INTERIM STATE‐ SHEET BALANCE MENT OF CHANGES (prepared SHEET IN EQUITY on this (prepared date) on this INTERIM STATEMENT date) OF CASH FLOWS (for the month of January) These may be prepared. YEAR END INCOME STATEMENT YEAR END STATEMENT OF CHANGES IN EQUITY YEAR END STATEMENT OF CASH FLOWS These must be prepared. Figure 1.5: Relationship of Interim and Year‐end Financial Statements  24 Introduction to Financial Accounting An exploration is available on the Lyryx site. Log into your Lyryx course to run Accounting Equation. Summary of Chapter 1 Learning Objectives LO1 – Define accounting. Accounting is the process of identifying, measuring, recording, and communicating an organiza‐ tion’s economic activities to users for decision making. Internal users work for the organization while external users do not. Managerial accounting serves the decision‐making needs of internal users. Financial accounting focuses on external reporting to meet the needs of external users. LO2 – Identify and describe the forms of business organization. The three forms of business organizations are a proprietorship, partnership, and corporation. The following chart summarizes the key characteristics of each form of business organization. Characteristic Proprietorship Partnership Corporation Separate legal entity No No Yes Business income is taxed as part of the business No3 No4 Yes Unlimited liability Yes Yes No One owner permitted Yes No Yes5 Board of Directors No No Yes LO3 – Identify and explain the Generally Accepted Accounting Principles (GAAP). GAAP followed in Canada by PAEs (Publicly Accountable Enterprises) are based on IFRS (Interna‐ tional Financial Reporting Standards). PEs (Private Enterprises) follow GAAP based on ASPE (Ac‐ counting Standards for Private Enterprises), a less onerous set of GAAP maintained by the AcSB (Accounting Standards Board). GAAP have qualitative characteristics (relevance, faithful repre‐ sentation, comparability, verifiability, timeliness, and understandability) and principles (business entity, consistency, cost, full disclosure, going concern, matching, materiality, monetary unit, and recognition). 3 Business income is added to the owner’s personal income and the owner pays tax on the sum of the two. 4 Business income is added to the owner’s personal income and the owner pays tax on the sum of the two. 5 A corporation can have one or more owners.  Discussion Questions 25 LO4 – Identify, explain, and prepare the financial statements. The four financial statements are: income statement, statement of changes in equity, balance sheet, and statement of cash flows. The income statement reports financial performance by detailing revenues less expenses to arrive at net income/loss for the period. The statement of changes in equity shows the changes during the period to each of the components of equity: share capital and retained earnings. The balance sheet identifies financial position at a point in time by listing assets, liabilities, and equity. Finally, the statement of cash flows details the sources and uses of cash during the period based on the three business activities: operating, investing, and financing. LO5 – Analyze transactions by using the accounting equation. The accounting equation, A = L + E, describes the asset investments (the left side of the equa‐ tion) and the liabilities and equity that financed the assets (the right side of the equation). The accounting equation provides a system for processing and summarizing financial transactions re‐ sulting from a business’s activities. A financial transaction is an economic exchange between two parties that impacts the accounting equation. The equation must always balance. Discussion Questions 1. What are generally accepted accounting principles (GAAP)? 2. When is revenue recognised? 3. How does the matching concept more accurately determine the Net Income of a business? 4. What are the qualities that accounting information is expected to have? What are the limi‐ tations on the disclosure of useful accounting information? 5. What are assets? 6. To what do the terms liability and equity refer? 7. Explain the term financial transaction. Include an example of a financial transaction as part of your explanation. 8. Identify the three forms of business organization. 9. What is the business entity concept of accounting? Why is it important? 10. What is the general purpose of financial statements? Name the four financial statements?  26 Introduction to Financial Accounting 11. Each financial statement has a title that consists of the name of the financial statement, the name of the business, and a date line. How is the date line on each of the four financial statements the same or different? 12. What is the purpose of an income statement? a balance sheet? How do they interrelate? 13. Define the terms revenue and expense. 14. What is net income? What information does it convey? 15. What is the purpose of a statement of changes in equity? a statement of cash flows? 16. Why are financial statements prepared at regular intervals? Who are the users of these statements? 17. What is the accounting equation? 18. Explain double‐entry accounting. 19. What is a year‐end? How does the timing of year‐end financial statements differ from that of interim financial statements? 20. How does a fiscal year differ from a calendar year? Exercises EXERCISE 1–1 (LO1,2,3) Matching Ethics Managerial accounting Financial accounting Partnership International Financial Reporting Standards Separate legal entity Limited liability Unlimited liability Required: Match each term in the above alphabetized list to the corresponding description below. a. The owners pay tax on the business’s net income. b. Accounting standards followed by PAEs in Canada. c. Rules that guide us in interpreting right from wrong. d. Accounting aimed at communicating information to external users. e. Accounting aimed at communicating information to internal users. f. The business is distinct from its owners. g. The owner(s) are not responsible for the debts of the business. h. If the business is unable to pay its debts, the owner(s) are responsible.  Exercises 27 EXERCISE 1–2 (LO3) Accounting Principles Business entity Full disclosure Materiality Consistency Going concern Monetary unit Cost Matching Recognition Required: Identify whether each of the following situations represents a violation or a correct application of GAAP, and which principle is relevant in each instance. a. A small storage shed was purchased from a home supply store at a discount sale price of $5,000 cash. The clerk recorded the asset at $6,000, which was the regular price. b. One of the business partners of a small architect firm continually charges the processing of his family vacation photos to the business firm. c. An owner of a small engineering business, operating as a proprietorship from his home office, also paints and sells watercolour paintings in his spare time. He combines all the transactions in one set of books. d. ABS Consulting received cash of $6,000 from a new customer for consulting services that ABS is to provide over the next six months. The transaction was recorded as a credit to revenue. e. Tyler Tires, purchased a shop tool for cash of $20 to replace the one that had broken earlier that day. The tool would be useful for several years, but the transaction was recorded as a debit to shop supplies expense instead of to shop equipment (asset). f. Embassy Lighting, a small company operating in Canada, sold some merchandise to a cus‐ tomer in California and deposited cash of $5,000 US. The bookkeeper recorded it as a credit to revenue of $7,250 CAD, which was the Canadian equivalent currency at that time. g. An owner of a small car repair shop purchased shop supplies for cash of $2,200, which will be used over the next six months. The transaction was recorded as a debit to shop supplies (asset) and will be expensed as they are used. h. At the end of each year, a business owner looks at his estimated net income for the year and decides which depreciation method he will use in an effort to reduce his business income taxes to the lowest amount possible. i. XYZ is in deep financial trouble and recently was able to obtain some badly needed cash from an investor who was interested in becoming an equity partner. However, a few days ago, the investor unexpectedly changed the terms of his cash investment in XYZ company from the proposed equity partnership to a long‐term loan. XYZ does not disclose this to their bank, who they recently applied to for an increase in their overdraft line‐of‐credit.  28 Introduction to Financial Accounting EXERCISE 1–3 (LO4) Calculating Missing Amounts Assets = Liabilities + Equity a. 50,000 = 20,000 + ? b. 10,000 = ? + 1,000 c. ? = 15,000 + 80,000 Required: Calculate the missing amounts in a, b, and c above. Additionally, answer each of the questions in d and e below. d. Assets are financed by debt and equity. The greatest percentage of debt financing is reflected in a, b, or c? e. The greatest percentage of equity financing is reflected in a, b, or c? EXERCISE 1–4 (LO4) Calculating Missing Amounts Required: Calculate the missing amounts for companies A to E. A B C D E Cash $3,000 $1,000 $ ? $6,000 $2,500 Equipment 8,000 6,000 4,000 7,000 ? Accounts Payable 4,000 ? 1,500 3,000 4,500 Share Capital 2,000 3,000 3,000 4,000 500 Retained Earnings ? 1,000 500 ? 1,000 EXERCISE 1–5 (LO4) Calculating Missing Amounts Assets = Liabilities + Equity Balance, Jan. 1, 2023 $50,000 $40,000 ? Balance, Dec. 31, 2023 40,000 20,000 ? Required: Using the information above, calculate net income under each of the following assump‐ tions. a. During 2023, no share capital was issued and no dividends were declared.  Exercises 29 b. During 2023, no share capital was issued and dividends of $5,000 were declared. c. During 2023, share capital of $12,000 was issued and no dividends were declared. d. During 2023, share capital of $8,000 was issued and $12,000 of dividends were declared. EXERCISE 1–6 (LO4) Identifying Assets, Liabilities, Equity Items Required: Indicate whether each of the following is an asset (A), liability (L), or an equity (E) item. a. Accounts Payable k. Dividends b. Accounts Receivable l. Interest Receivable c. Bank Loan Payable m. Retained Earnings d. Building n. Interest Revenue e. Cash o. Interest Payable f. Share Capital p. Interest Expense g. Loan Payable q. Prepaid Insurance h. Office Supplies r. Insurance Expense i. Prepaid Insurance s. Insurance Revenue j. Utilities Expense t. Machinery EXERCISE 1–7 (LO4) Calculating Financial Statement Components The following information is taken from the records of Jasper Inc. at January 31, 2023, after its first month of operations. Assume no dividends were declared in January. Cash $33,000 Equipment $30,000 Accounts Receivable 82,000 Bank Loan 15,000 Unused Supplies 2,000 Accounts Payable 27,000 Land 25,000 Share Capital ? Building 70,000 Net Income 40,000 Required: a. Calculate total assets. b. Calculate total liabilities. c. Calculate share capital.  30 Introduction to Financial Accounting d. Calculate retained earnings. e. Calculate total equity. EXERCISE 1–8 (LO4) Net Income, Shares Issued Accounts Receivable $4,000 Miscellaneous Expense $ 2,500 Accounts Payable 5,000 Office Supplies Expense 1,000 Cash 1,000 Service Revenue 20,000 Equipment 8,000 Share Capital ? Insurance Expense 1,500 Wages Expense 9,000 Required: Using the alphabetized information above for EDW Inc. after its first month of opera‐ tions, complete the income statement, statement of changes in equity, and balance sheet using the templates provided below. EDW Inc. EDW Inc. Income Statement Statement of Changes in Equity Month Ended March 31, 2023 Month Ended March 31, 2023 Revenues Share Retained Total Service Revenue $ Capital Earnings Equity Expenses Opening Balance $ $ $ Wages Expense $ Shares Issued Miscellaneous Expense Net Income Insurance Expense Ending Balance $ $ $ Office Supplies Expense Net Income $ EDW Inc. Balance Sheet March 31, 2023 Assets Liabilities Cash $ Accounts Payable $ Accounts Receivable Equipment Equity Share Capital $ Retained Earnings Total Equity Total Assets $ Total Liabilities and Equity $  Exercises 31 EXERCISE 1–9 (LO4) Net Income, Dividends Accounts Receivable $17,000 Machinery $14,000 Accounts Payable 3,000 Note Payable 18,000 Advertising Expense 5,000 Retained Earnings 6,000 Cash 9,000 Salaries Expense 64,000 Dividends 2,000 Service Revenue 81,000 Insurance Expense 7,000 Share Capital 10,000 Required: Algonquin Inc. began operations on August 1, 2021. After its second year, Algonquin Inc.’s accounting system showed the information above. During the second year, no additional shares were issued. Complete the income statement, statement of changes in equity, and balance sheet using the templates provided below. Algonquin Inc. Algonquin Inc. Income Statement Statement of Changes in Equity Year Ended July 31, 2023 Year Ended July 31, 2023 Revenues Share Retained Total Service Revenue $ Capital Earnings Equity Expenses Opening Balance $ 10,000 $ 6,000 $ 16,000 Advertising Expense $ Net Income Insurance Expense Dividends Salaries Expense Ending Balance $ $ $ Net Income $ Algonquin Inc. Balance Sheet July 31, 2023 Assets Liabilities Cash $ Accounts Payable $ Accounts Receivable Note Payable Machinery Total Liabilities $ Equity Share Capital $ Retained Earnings Total Equity Total Assets $ Total Liabilities and Equity $  32 Introduction to Financial Accounting EXERCISE 1–10 (LO4) Net Income, Dividends, Shares Issued Watch video Required: Refer to EXERCISE 1–9. Use the same information EXCEPT assume that during the sec‐ ond year, additional shares were issued for cash of $3,000. Complete the income statement, state‐ ment of changes in equity, and balance sheet using the templates provided below. Algonquin Inc. Algonquin Inc. Income Statement Statement of Changes in Equity Year Ended July 31, 2023 Year Ended July 31, 2023 Revenues Share Retained Total Service Revenue $ Capital Earnings Equity Expenses Opening Balance $ $ $ Advertising Expense $ Shares I