Notes for Accounting Fundamentals 1

**Learning Outcomes (chapter 1)** Learning outcomes are what you should **be able to do** after completing chapter 1: - *Identify* the use and users of accounting and the purpose of financial reporting - *Compare* different forms of business organizations - *Explain* generally accepted...

**Learning Outcomes (chapter 1)** Learning outcomes are what you should **be able to do** after completing chapter 1: - *Identify* the use and users of accounting and the purpose of financial reporting - *Compare* different forms of business organizations - *Explain* generally accepted accounting principles - *Describe* various financial statements - *Explain* the accounting equation - *Prepare* financial statements **Definition and Purpose of Accounting** - **Accounting**: A system that identifies, records, and communicates an organization\'s economic events. - Provides relevant and reliable **financial information** essential for decision-making. - Enables **transparent financial reporting** and a true representation of economic events. **Importance of Accounting** 1. **Wide Application** - Accountants are employed across industries and levels of business. - They contribute as CEOs, CFOs, managers, entrepreneurs, and more. 2. **Career Opportunities** - Accounting consistently ranks among the top career paths in business. - Pursuing a professional accounting credential is a pathway to the finance and business world. 3. **Versatility in Roles** - Accountants hold high-level positions in **governments** and **not-for-profit organizations**, as well as in the corporate sector. **Objective of Financial Reporting** - Deliver **transparent, relevant**, and **reliable financial information** to various users. - Supports the functioning of **economic systems** globally. **Learning Objective 1:** Identify the **uses and users of accounting** and the **objective of financial reporting**. **Steps in the Accounting Process** 1. **Identification** - Recognize economic events relevant to the business (e.g., sales, payments). - Examples: - Sale of apparel by Aritzia Inc. - Sale of coffee by Tim Hortons. - Payment of wages by Rogers Communications. 2. **Recording** - Systematic, chronological documentation of economic events in monetary terms. - Helps create a history of the company\'s financial activities. - Data is **aggregated** (e.g., total sales over a period) for ease of understanding. 3. **Communication** - Preparation of **financial statements** to report recorded data. - Information is communicated in a standardized and meaningful way. - Accountants analyze and interpret the information: - **Analysis**: Use of ratios, percentages, and visualization (graphs/charts) to identify trends. - **Interpretation**: Explaining uses, meaning, and limitations of reported data. **Bookkeeping vs. Accounting** - **Bookkeeping**: Involves only recording economic events. - **Accounting**: Encompasses identification, recording, and communication of events, along with analysis and interpretation. **Relevance of Accounting for Everyone** - **Entrepreneurs**: Essential for managing business finances and understanding profitability. - **Employees**: Helpful in making informed business decisions. - **Investors**: Enables understanding of financial statements to assess business performance. - Provides foundational knowledge in areas like **management**, **finance**, and **marketing**. **Cross-Functional Application** - **Marketing managers**: Use accounting to set pricing strategies based on costs. - **Professionals (e.g., doctors, lawyers, engineers, architects)**: Apply accounting basics to manage their finances or evaluate investments. **Key Takeaway** Accounting knowledge is a **lifetime skill**, invaluable regardless of career path, offering insights into how businesses and finances operate. **Visual Representation (Illustration 1.1)** 1. **Identification**: Select and recognize transactions. 2. **Recording**: Systematically document, classify, and summarize. 3. **Communication**: Prepare reports; analyze and interpret data for users. **Insight Features** - Examples connect accounting with **personal finance**, **organizational roles**, and **ethical considerations**. **Broad Categories of Accounting Information Users** 1. **Internal Users** - **Who they are**: Individuals within the company (e.g., finance directors, marketing managers, HR personnel, production supervisors). - **Purpose**: To plan, organize, and run the company. - Finance: *Is there enough cash to pay the bills?* - Marketing: *What price should we sell smartphones to maximize profits?* - Human Resources: *How many employees can we afford to hire this year?* - Production: *Which product line is the most profitable?* - Forecasts of cash flows for the next year. - Projections of profit from new sales campaigns. - Analyses of salary costs. - Budgeted financial statements. - Internal users have **direct access** and can request tailored reports. 2. **External Users** - **Who they are**: Individuals or organizations outside the company (e.g., investors, creditors). - **Purpose**: To evaluate and make decisions regarding the company. - **Investors**: Use accounting information to decide whether to buy, hold, or sell ownership interest.\ *Question*: Is the company earning enough to give me a return on my investment? - **Creditors**: Use information to evaluate the risks of lending money or granting credit.\ *Question*: Does the company generate enough cash flow to pay the amounts owed? - **Labour Unions**: Want to know if owners can afford to increase wages and benefits. - **Customers**: Interested in whether the company can continue to service its products (e.g., honoring warranties). - **Tax Authorities**: Use accounting to ensure compliance with tax laws. - **Regulatory Agencies**: Assess adherence to established rules (e.g., securities regulations). - **Economic Planners**: Forecast economic activity. - Limited to **publicly available data** or what the business provides. - Determining what information external users need and how to provide it is the core of **financial accounting**. **Role of Data Analytics in Accounting** - **Definition**: Using statistical and software tools to analyze vast amounts of company data and draw inferences. - **Applications**: - Improves decision-making across various functions. - Enhances insights into operations, trends, and external relations (e.g., with suppliers and customers). - **Growing Use**: Increasingly common due to advancements in data access and analytics technology. **Key Takeaways** - Internal users focus on operational and strategic planning with customized, real-time access to accounting information. - External users depend on standardized and regulated financial reports to make investment, credit, and economic decisions. - Data analytics complements accounting, offering deeper insights for both internal and external decision-making. **Objective of Financial Reporting** - **Primary Purpose**: To provide useful information to **existing and potential investors and creditors** for decision-making regarding resource allocation to a business. - **Audience**: Primarily external users, though financial statements can also be used by internal users. - **Delivered Through**: General purpose financial statements. **Key Information Required by Users** 1. **Economic Resources**: What assets does the business own to perform its activities? 2. **Claims on Economic Resources**: - Amounts owed by the business. - Owners\' rights to the resources. 3. **Economic Performance**: - Is the business profitable? - Can it generate enough cash to meet obligations and reward owners? 4. **Management's Stewardship**: - Efficiency and effectiveness in managing resources. - Ability to provide future net cash flows. **DO IT! 1.1 -- Users of Accounting Information** **Action Plan** 1. Understand the distinction between internal and external users: - Internal: Work **within** the company and have full access to accounting data. - External: Operate **outside** the company and rely on publicly available or company-provided data. 2. Recognize that each user type requires specific information to make decisions. **Examples of Users and Questions** **User** **Internal or External** **Question** ---------------------------------- -------------------------- ---------------------------------------------------- **Creditor** External *Will the business be able to pay back the loan?* **Canada Revenue Agency** External *Is the company following the tax laws?* **Investor** External *Should I invest money in the company?* **General Manager (Production)** Internal *How much will it cost to produce the product?* **Manager (HR Department)** Internal *Can the company afford to give employees raises?* **Related Exercises:** BE1.1, E1.1, and E1.2. **Forms of Business Organization** **Importance** - The **form** of a business affects how financial statements are prepared and reported. - Understanding organizational forms is crucial for tailoring accounting practices to the specific nature of a business. **Common Forms** 1. **Proprietorship** - Owned by **one individual**. - Easy to establish, full control by owner, and owner bears all liabilities. 2. **Partnership** - Owned by **two or more individuals**. - Shared decision-making, profits, and liabilities. - Suitable for businesses requiring shared resources. 3. **Corporation** - A **separate legal entity** owned by shareholders. - Limited liability for owners, easier to raise capital, and more regulatory requirements. **Next Steps** - Explore how each form influences financial reporting and decision-making as we dive into later sections. **Key Notes on Forms of Business Organization** **1. Proprietorship** - **Definition**: A business owned and operated by one individual. - **Typical Examples**: Small service businesses (e.g., plumbers, hair stylists), farms, and independent retail stores. - **Key Features**: - Small amount of capital required to start. - Owner receives profits, bears losses, and is **personally liable** for debts (unlimited liability). - The business and owner are legally indistinct. - Limited to the life of the owner. - Profits are taxed on the owner's personal tax return. - Separate business and personal records must be maintained for accounting purposes. - **Popularity**: Many small businesses in Canada are proprietorships, but they generate a small percentage of total business revenue. **2. Partnership** - **Definition**: A business owned by two or more individuals (partners). - **Typical Examples**: Professional services (e.g., lawyers, doctors, architects). - **Key Features**: - Partners share initial investments, profits/losses, duties, and obligations, as outlined in a partnership agreement. - Partners are **personally liable** for all debts, including those incurred by other partners (unlimited liability). - Business activities are kept separate from partners\' personal records. - Profits are taxed on partners' individual income tax returns. - Life of a partnership is limited, depending on partners' continued involvement. - **Key Documentation**: Partnership agreement specifying responsibilities and profit-sharing. **3. Corporation** - **Definition**: A business organized as a separate legal entity under corporate law. - **Types**: Public corporations (trade shares on stock exchanges) and private corporations (no publicly traded shares). - **Key Features**: - Can have one or multiple owners (shareholders). - Ownership divided into **transferable shares**, enabling easy changes in ownership. - **Limited liability** for shareholders, meaning they can only lose their invested amount. - Separate legal identity from its owners. - Unlimited life, as ownership transfer does not dissolve the corporation. - Taxes are paid by the corporation on its profits. - **Examples**: - **Public Corporations**: Royal Bank of Canada, Canadian National Railway, Aritzia Inc. - **Private Corporations**: WestJet, McCain Foods, Goodlife Fitness. - **Tax and Reporting**: - Public corporations distribute financial statements widely. - Private corporations almost never share financial reports publicly. **Illustration 1.4 Summary of Business Organization Characteristics** **Characteristic** **Proprietorship** **Partnership** **Corporation** -------------------------- -------------------- ----------------------- --------------------------- **Owners** Proprietor: one Partners: two or more Shareholders: one or more **Owner's liability** Unlimited Unlimited Limited **Private or public** Private Usually private Private or public **Taxation of profits** Paid by the owner Paid by the partners Paid by the corporation **Life of organization** Limited Limited Unlimited **Helpful Hints:** - **Identifying Corporations**: Look for \"Ltd.,\" \"Inc.,\" or \"Corp.\" in the company name. - Public corporations have broader financial transparency and share ownership than private corporations. **Ethical Analysis Framework (Illustration 1.6)** **Steps for Addressing Ethical Issues:** 1. **Identify Ethical Issues**: - Pinpoint actions or decisions that may be ethically questionable. - Refer to personal and organizational ethical standards for guidance. 2. **Identify Stakeholders**: - Recognize all parties affected by the decision. - Consider their roles, responsibilities, and potential impacts. 3. **Evaluate Alternatives**: - Assess different courses of action and their consequences for stakeholders. - Aim to select the alternative that aligns most with ethical principles. **Case Study: Workplace Ethics in Action** **Scenario Overview:** Jennifer, an accountant at Currie Financial Services, is instructed to present falsified performance figures to secure a contract. Her boss insists this is necessary to win the deal, even though it's unethical and misrepresentative. **Stakeholders and Impacts:** 1. **Jennifer**: - Risks professional reputation and potential legal repercussions. - Violates ethical standards if she follows her boss\'s instructions. 2. **Currie Financial Services Employees**: - May face job loss if the company fails to secure more contracts. - Trust in management eroded if fraud becomes known. 3. **Competitors**: - Placed at an unfair disadvantage if Currie wins the contract using false information. 4. **Potential Client (Transportation Company)**: - Risks partnering with an unstable provider if Currie's performance falters. - Could suffer reputational damage or financial loss from poor service. **Possible Alternatives for Jennifer:** - **Option 1**: Follow her boss's instructions. - *Impact*: Secures the contract, but breaches ethical standards and risks severe professional/legal consequences. - **Option 2**: Refuse to falsify data and report concerns to higher authorities or a whistleblower hotline. - *Impact*: Upholds ethical integrity but risks conflict with her employer and possible retaliation. - **Option 3**: Discuss concerns with her boss, propose ethical alternatives, and warn of potential repercussions. - *Impact*: Attempts to find a balanced resolution without compromising ethics. **Conclusion:** Jennifer must prioritize ethical decision-making by adhering to accounting principles and refusing to mislead stakeholders. Reporting her concerns via appropriate channels can protect the organization and uphold the integrity of the financial reporting process. **1. Conceptual Framework and Its Purpose** - **Objective of Financial Reporting:** Provide useful information for decision-making. - **Key Components (Illustration 1.7):** - **Objective of Financial Reporting** - **Elements of Financial Statements**: Assets, liabilities, equity, revenue, expenses. - **Qualitative Characteristics**: - Fundamental: Relevance and faithful representation. - Enhancing: Comparability, verifiability, timeliness, and understandability. - **Recognition and Measurement**: Revenue recognition, matching principle, historical cost, fair value. - **Foundation Concepts**: Reporting entity, going concern assumption, periodicity, monetary unit. **2. Qualitative Characteristics of Useful Accounting Information** - **Fundamental Characteristics:** - **Relevance**: Information that can influence decisions. - **Faithful Representation**: Accurate depiction of events, including: - Completeness - Neutrality - Freedom from error. - **Enhancing Characteristics:** - **Comparability and Consistency**: Uniformity in principles used across entities and time periods. - **Verifiability**: Independent methods yielding similar results. - **Timeliness**: Availability of information before it loses relevance. - **Understandability**: Clear and concise presentation for informed users. **3. Recognition and Measurement** - **Recognition:** - Only record events that affect economic resources and can be measured in monetary terms. - **Revenue Recognition Principle:** Revenue is recorded when a performance obligation is satisfied, regardless of when cash is exchanged. - **Matching Principle:** Costs are matched to revenues in the period they relate to. - **Measurement:** - **Historical Cost Method:** Resources recorded at acquisition cost. - Advantages: Objectivity, verifiability, and relevance for long-term use. - **Fair Value Method:** Reflects the current market value, especially for tradeable investments. - **Monetary Unit Concept:** Only events measurable in monetary terms are recorded, using consistent units (e.g., Canadian dollar, US dollar). **4. Foundational Concepts** - **Reporting Entity Concept:** - Defined as any entity preparing financial statements (e.g., companies, governments, non-profits). - Business records are separate from owners\' personal records. - **Going Concern Assumption:** - Assumes entities will operate long enough to fulfill obligations and use resources for intended purposes. - **Periodicity Concept:** - Divides economic activities into standardized periods (e.g., monthly, quarterly, annually). **5. Accounting Standards and GAAP** - **Purpose:** Standards ensure consistent and useful financial reporting. - **Types of Economic Events:** - **External Events:** Transactions with other entities. - **Internal Events:** Resource use within the company. - **Key Accounting Standards:** - **IFRS (International Financial Reporting Standards):** Used globally for transparency and comparability. - **ASPE (Accounting Standards for Private Enterprises):** Simplified standards for Canadian private entities. - **Dynamic Nature of GAAP:** - Standards evolve to address new needs and scenarios. This conceptual framework acts as the foundation for applying accounting principles and preparing financial statements in a manner that meets users\' needs while aligning with regulatory requirements. Let me know if you\'d like to delve deeper into any section! **Key Points** 1. **Purpose of Accounting Standards:** - Accounting standards ensure that financial statements are meaningful and comparable by following generally accepted accounting principles (GAAP). - They stem from fundamental accounting principles, assumptions, and concepts. 2. **Types of Economic Events in Accounting:** - **External events:** Transactions involving another company or entity. - **Internal events:** Transactions within a company, such as depreciation of equipment. 3. **Standard-Setting in Canada:** - The Accounting Standards Board (AcSB) is responsible for developing GAAP in Canada. - The primary goal is to provide the most useful financial information to external users for decision-making. 4. **Two Main Accounting Standards in Canada:** - **International Financial Reporting Standards (IFRS):** - Developed by the International Accounting Standards Board (IASB). - A global standard used in over 120 countries, including Canada. - Mandatory for publicly accountable enterprises (e.g., publicly traded corporations, securities dealers, banks). - **Accounting Standards for Private Enterprises (ASPE):** - Developed by AcSB for Canadian private companies. - Requires less disclosure than IFRS. - Examples of companies using ASPE include private firms such as McCain Foods and EllisDon Inc. 5. **Comparison Between IFRS and ASPE:** - Both are principles-based frameworks encouraging professional judgment. - IFRS focuses on greater disclosure and is used by public entities globally. - ASPE caters to private entities with simpler disclosure needs, as private users often have direct access to additional information. 6. **Global and Canadian Context:** - While IFRS fosters global comparability, the U.S. has not yet fully adopted it. - Canadian private companies have the flexibility to choose between IFRS and ASPE depending on their needs. 7. **Dynamic Nature of GAAP:** - GAAP evolves with time, necessitating periodic updates in textbooks and educational materials to reflect current or proposed standards. - The CPA Canada Handbook is the authoritative source of accounting standards in Canad **1. Financial Statements** Businesses prepare the following financial statements: - **Balance Sheet (Statement of Financial Position):** Provides a snapshot of a company\'s financial position at a specific time. - **Income Statement (Statement of Earnings):** Reports profitability over a specific period (revenues minus expenses). - **Statement of Owner\'s Equity:** Shows changes in equity, including investments, withdrawals, and profits or losses. - **Cash Flow Statement (Statement of Cash Flows):** Tracks cash inflows and outflows in operating, investing, and financing activities. **2. Elements of Financial Statements** Each element defines the information presented: - **Assets:** Economic resources with future benefits (e.g., cash, accounts receivable, inventory). - **Liabilities:** Obligations requiring future economic sacrifices (e.g., accounts payable, loans). - **Owner's Equity:** Residual claim on assets after liabilities (e.g., owner's capital, retained earnings). - **Revenues:** Inflows from business operations increasing equity. - **Expenses:** Costs of business activities decreasing equity. **3. The Accounting Equation** The basic equation is: Assets=Liabilities+Owner's Equity\\text{Assets} = \\text{Liabilities} + \\text{Owner's Equity}Assets=Liabilities+Owner's Equity This fundamental rule ensures that all financial transactions are balanced. **4. Expanded Accounting Equation** The equation expands to account for components of equity: Assets=Liabilities+(Owner's Capital−Drawings+Revenues−Expenses)\\text{Assets} = \\text{Liabilities} + (\\text{Owner\'s Capital} - \\text{Drawings} + \\text{Revenues} - \\text{Expenses})Assets=Liabilities+(Owner's Capital−Drawings+Revenues−Expenses) This provides a framework to prepare: - **Income Statement (Revenues and Expenses)** - **Statement of Owner's Equity (Capital and Drawings)** - **Balance Sheet** **5. Differences by Business Structure** Equity and terminology vary: - **Proprietorships:** Owner's equity in a single capital account. - **Partnerships:** Separate capital accounts for each partner. - **Corporations:** Shareholders' equity with accounts like share capital and retained earnings. **Learning Objective:** Understand how financial elements and equations interconnect to prepare the **balance sheet, income statement, statement of owner's equity, and cash flow statement**. This structure supports the accurate recording and reporting of a business's financial health. This section delves into transaction analysis, providing the foundation for understanding the impact of business activities on the accounting equation. Here\'s a concise breakdown of the key concepts: **1. Transaction Analysis and the Accounting Equation** - The **accounting information system** collects, processes, and communicates data to decision-makers, whether through computerized systems or manual methods. - Each transaction has a **dual effect** on the accounting equation:\ **Assets = Liabilities + Owner's Equity**.\ If one side changes, the other must as well to maintain balance. **2. Sample Transactions and Their Impact** **Transaction 1: Owner\'s Investment** - **Effect**: - Increase in assets (Cash: +\$15,000). - Increase in owner\'s equity (A. Leonid, Capital: +\$15,000). - **Balance**: Assets = \$15,000, Owner's Equity = \$15,000. **Transaction 2: Purchase of Equipment (Cash)** - **Effect**: - Decrease in one asset (Cash: -\$7,000). - Increase in another asset (Equipment: +\$7,000). - **Balance**: Total assets remain \$15,000; no change in liabilities or owner\'s equity. **Transaction 3: Supplies Purchased on Credit** - **Effect**: - Increase in assets (Supplies: +\$1,600). - Increase in liabilities (Accounts Payable: +\$1,600). - **Balance**: - Total assets = \$16,600. - Liabilities = \$1,600; Owner\'s Equity = \$15,000. **Transaction 4: Cash Revenue from Services** - **Effect**: - Increase in assets (Cash: +\$1,200). - Increase in owner's equity (Service Revenue: +\$1,200). - **Balance**: Total assets = \$17,800; Liabilities = \$1,600; Equity = \$16,200. **Transaction 5: Advertising on Credit** - **Effect**: - Increase in liabilities (Accounts Payable: +\$250). - Decrease in owner's equity (Advertising Expense: -\$250). - **Balance**: - Assets = \$17,800. - Liabilities = \$1,850. - Equity = \$15,950 (\$15,000 Capital + \$1,200 Revenue - \$250 Expenses). **Key Insights** 1. Transactions are categorized and analyzed based on their impact on **specific accounts** and **total amounts**. 2. The accounting equation must balance after every transaction. 3. Revenue increases, and expenses decrease, owner's equity. This foundation aids in preparing financial statements and interpreting business performance through accounting data. **1. Transaction Effects on the Accounting Equation** Each transaction has been meticulously analyzed to show how it affects: - **Assets**: Components include cash, accounts receivable, supplies, and equipment. - **Liabilities**: Focused on accounts payable. - **Owner's Equity**: Captures investments, revenues, expenses, and withdrawals. **Significant Transactions** 1. **Service Revenues (Transaction 6)** - **Impact**: An increase in cash and accounts receivable, with a corresponding increase in owner's equity via service revenue. - **Explanation**: Recognizing revenue is independent of cash collection. 2. **Expenses Paid (Transaction 7)** - **Impact**: Decrease in cash and an increase in expenses, leading to a reduction in owner's equity. - **Examples**: Store rent, employee salaries, and utilities. - **Insight**: Expenses reduce owner's equity directly as they are incurred. 3. **Account Payable Payment (Transaction 8)** - **Impact**: Decrease in both liabilities and assets (cash). - **Observation**: The expense was previously recorded, so no additional impact on owner's equity. 4. **Customer Payments (Transaction 9)** - **Impact**: Increase in cash with an equivalent decrease in accounts receivable. - **Insight**: Collection on account does not affect equity as revenue was already recognized. 5. **Contract to Rent Equipment (Transaction 10)** - **Impact**: No immediate effect on the accounting equation. - **Rationale**: This is a future obligation, not a current financial activity. 6. **Owner\'s Withdrawal (Transaction 11)** - **Impact**: Reduction in cash (asset) and owner\'s equity via drawings. - **Explanation**: Drawings represent personal use of funds, separate from expenses. **Summary of Cumulative Changes** The tabular summary in **Illustration 1.26** consolidates all transactions, ensuring: 1. **Balance Integrity**: The equation remains balanced at every stage. 2. **Comprehensive Records**: It reflects how components like revenues and expenses cumulatively influence the business\'s financial position. **Foundational Lessons for Accounting** - **Revenue Recognition**: Revenue is recognized when services are performed, not necessarily when cash is received. - **Expense Impact**: Expenses directly reduce owner's equity but are tracked separately from withdrawals. - **Dual Impact of Transactions**: Every transaction affects at least two accounts, maintaining the equation\'s balance. - **Practical Understanding**: Grasping these fundamentals is crucial before delving into formal journal entries.