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Accounting 1 & 2


The Purpose and Use of Financial Statements

• Accounting identifies and records the economic events of an organization and communicates to interested users
• There are two broad categories of users
o Internal users
o External users
• Regardless of the type of user, they use the information provided by accounting to make decisions
• Internal users
o Manage the company, non-profit, government organization
o Examples include: Company officers, managers and directors in finance, marketing, human resources, production & various other employees
• External users
o Do not work for the company
o Examples include: Investors, lenders and other creditors, customers, auditors, labour unions, taxing authorities and regulators

Ethical Behaviour

• For accounting information to have value, preparers must have high ethical standards
o Actions are legal and responsible
o Consider organization’s interests
• Accountants, other professionals, and most companies have rules or codes of conduct to guide ethical behavior


Forms of Business Organizations: Proprietorship

• Owned by one person (proprietor)
• Simple to set up
• Owner has total & sole control over business
• Limited life i.e. firm ends with the natural life of the owner
• Unlimited personal liability for business debts
• Income tax paid by the (sole) owner on the business’ income

Partnership

• Similar to proprietorship except owned by more than one person
• Often & should be formalized in a written agreement
• Limited life i.e. the particular partnership ends with the natural life of each partner
• Each partner has unlimited liability for all business debts
• Income tax paid by individual partners on their respective share of the business income


Corporations

• Separate legal entity owned by shareholders (owners of shares)
• Indefinite life e.g. Hudson Bay Co. has been a continuous corporation since May 2, 1670
• Greater ease of raising capital from a potentially larger pool of investors
• Shareholders enjoy limited liability to the extent of their $ investment
• Corporation pays income tax of the firm’s income
• May be public or private:
o Public if shares are publicly traded
o Private if shares are not available to the general public

Generally Accepted Accounting Principles (GAAP)

• Rules and guidelines:
ü Used by the world of business, finance & accounting
ü To record transactions
ü & prepare financial statements
• All Roads Lead Back to GASP…everything you learn in this and any subsequent accounting course will be based on one or more GAAPs
• It is, therefore, important that you know:
ü What the various GAAPs are
ü What they mean
ü & how to apply them
• There are some differences for publicly-traded and private corporations
ü Publicly-traded corporations use International Financial Reporting Standards (I F R S)
ü Private corporations may use I F R S or Accounting Standards for Private Enterprises (A S P E)
ü In general, both are often referred to collectively as GAAP
• Proprietorships and partnerships are private enterprises (not publicly owned/traded) & generally follow A S P E for external reporting
ü Not required to follow any particular standards for internal use


Three Types of Business Activities

• All companies are involved in all three activities:
ü Operating
ü Investing
ü Financing
• Each of these activities result in cashflows that are reported by the firm in the financial information provided by accounting

Operating Activities

• Operating activities are the main day-to-day activities of the business i.e. the making & selling of whatever the firm is in the business of making & selling
• Examples
o Revenues – price of goods or services delivered to customers
o Expenses – costs incurred to generate reveue
o Related activities in accounts such as accounts receivable from customers and accounts payable to suppliers

Investing Activities

• Purchase or sale of long-lived assets needed to operate the company
• Examples
o Purchase or sale of long-lived tangible assets such as property, plant and equipment and intangible assets such as franchise, trademarks etc.
o Purchase or sale of investments or financial securities, such as shares or debt securities of other companies


Financing Activities

• Obtaining (and repaying) funds to finance the operations of the business
o Selling or repurchasing shares (equity)
o Borrowing money or repaying loans (debt)
• Forms of debt
o Bank indebtedness, bank loans, long-term debt such as mortgages, bonds, finance leases


Financial Statements

• Income statement
o Reports revenues and expenses for a specific period of time
• Statement of changes in (owner’s) equity
o Reports the changes in each component of shareholders’ equity during a period of time
• Statement of financial position or Balance Sheet
o Shows the assets, liabilities and shareholders’ equity at a specific point in time
• Note the subtle but significant differences in the time represented by each of these statements
• Statement of cash flows
o Shows, for a specific period of time, how company obtained cash and how that cash was used
• The BADM1030 course will focus on the 1st three financial statements & BADM1060 will include the 4th, the statement of cashflows
• Order of preparation of statements – look for and understand why they are prepared in this order


Income Statement

• Revenues
o Arise from sales, i.e. the delivery, of a products or services to a customer
o Result in an inflow of assets e.g. cash or some other value to be received i.e. Accounts Receivable
• Expenses
o Costs of assets consumed or services used to generate revenues

• Revenues − Expenses = Net Income (loss)
o This is the basic, fundamental relationship on the Income Statement
o The income or loss has an effect on the equity of the firm – look for this on the Statement of changes in (Owner’s) equity


Income Statement – Example










Statement of Changes in (Owner’s) Equity

• Shows the changes in each component of shareholders’ equity for the period
• Primarily comprised of:
• Share capital
o Amounts contributed by shareholders
o May include common and preferred classes
• Retained earnings / deficit
o Cumulative net income/loss retained in the company since the firm began
o Will be net of any dividends to shareholders
• There can be other shareholders’ equity accounts e.g. Other Comprehensive Income



Changes in shares


Changes in retained earnings



Statement of Changes in (Owner’s) Equity Example












Statement of Financial Position or Balance Sheet

• Assets
o Resources owned or controlled by a business i.e. things owned
• Liabilities
o Claims of lenders and other creditors i.e. things owed
• Shareholders’ equity
o Claims of shareholders i.e. owner’s investment or capital
• Accounting relationship
o Assets = Liabilities + Shareholders’ Equity
o Or…What Got = Where Got
o This relationship will always be true, both at a point in time and regarding any changes that take place over a period of time


Statement of Financial Position or Balance Sheet – Example











Statement of Cash Flows

• Reports the effect on cash of the company as a result of:
o Operating activities
o Investing activities
o Financing activities
• Shows net increase or decrease in cash for the period
o The BADM1030 course will focus on the Income Statement, Statement of Financial Position or Balance Sheet and the Statement of Changes in (Owner’s) Equity… BADM1060 will include the 4th, the Statement of Cash Flows

Statement of Cash Flows – Example








Relationships Between Statements

• Statements are interrelated or connected
o Results from various statements are used as data in other statements
• Examples
o Net income / (loss) from income statement is reported in statement of changes in equity as an increase or decrease in equity
o Ending balances of each shareholders’ equity account is reported in both statements of financial position or balance sheet and changes in (owner’s) equity
o Statement of cash flows is related to changes in the statement of financial position or balance sheet
o Look for and make these connections & understand their implications!

Comparing I F R S and A S P E


Key Standard Differences International Financial Reporting Standards (I F R S) Accounting Standards for Private Enterprises (A S P E)
Accounting Standards Publicly traded corporations must use I F R S; private corporations can choose to use I F R S or A SP F Private corporations can choose to use I F R S or A S P E. Once the choice is made, it must be applied consistently. Proprietorships and partnerships generally follow A S P E.
Statement of changes in (owner’s) equity vs. statement of retained earnings A statement of changes in equity must be presented that shows the changes in all components of shareholder’s equity (for example, share capital and retained earnings). A statement of retained earnings is presented that shows the change in only one component-retained earnings-of shareholder’s equity.

















Chapter 2 - A Further Look at Financial Statements

• A classified statement of financial position generally contains the following standard classifications with some examples included:

Currents assets
Cash
Held for trading investments
Accounting receivable
Inventory
Supplies
Prepaid expenses
Non-current assets
Long-term investments
Property, plant, and equipment
Intangible assets
Goodwill Currents liabilities
Bank indebtedness
Accounts payable
Unearned revenue
Notes payable
Current maturities of long-term debt
Non-current liabilities
Bank loan payable
Shareholder’s equity
Share capital
Retained earnings


Current Assets

• Assets expected to be converted to cash, sold or used in the business typically within one year or one operating cycle, whichever is longer
o Operating cycle is the average time it takes to go from cash to cash in producing revenue
• Usually listed in order of liquidity or how quickly the asset can be turned into cash
o Reverse order of liquidity also possible
• Examples include:
o cash
o held-for-trading investments,
o accounts receivable
o inventory
o prepaid expenses e.g. rent, supplies, insurance


Non-Current Assets

• Assets begin underline not end underline expected to be converted to cash, sold or used in the business within one year or one operating cycle
• All assets not considered current
• Examples:
ü Long-term investments
ü Property, plant, and equipment
ü Intangible assets and goodwill
ü Other assets


Long-Term Investments

• Multi-year investments in financial assets:
o Debt securities: loans, notes, bonds, mortgages
o Equity securities: shares of other companies
• These assets are normally not intended to be sold (and converted to cash) within one year


Property, Plant, and Equipment

• Characteristics:
ü Tangible assets
ü Relatively long useful lives i.e. > 1 year
ü Used in operating the business
• Examples:
ü Land
ü Buildings, Equipment
ü Furniture
ü Computers
ü Vehicles
• Usually listed in order of permanency or useful life


Depreciation

• Allocation or spreading the cost of property, plant, and equipment or intangible assets over their estimated useful lives:
o Companies systematically estimate & assign a portion of the cost of an asset used up to expense each year – various methods can be used to estimate the cost used up
o Under IFRS, this allocation is referred to as depreciation for property, plant, and equipment, and amortization for intangible assets
o Under ASPE, amortization is often used instead of depreciation for both property, plant, and equipment & intangible assets
• Important:
ü Depreciation or amortization is a cost allocation process or concept not a market valuation process or concept
• The cost of long-lived assets with indefinite lives is not depreciated (e.g. land) i.e. never used up
• Accumulated depreciation account shows the total amount of depreciation expense since the asset was acquired
• The difference between the cost of the asset and its accumulated depreciation is referred to as the carrying amount (CV) or net book value (NBV) of the asset
o Accumulated depreciation is a contra asset account

Intangible Assets

• Non-current assets that do not have physical substance and represent a privilege or a legal right held by the company
• Examples:
o Patents, copyrights, trademarks, licenses
o Goodwill: excess price paid on acquisition of another company
• Generate a future value to the company
• Amortized if they do not have an indefinite life e.g. Goodwill is not amortized

Current Liabilities

• Obligations that are to be paid or otherwise satisfied or settled within the (longer of) one year or one operating cycle
• Examples:
o Bank loans
o Accounts payable
o Unearned revenue – typically not paid in cash but otherwise satisfied by delivery of goods or services
o Bank loan/notes payable
o Current portion of long-term debt

Non-Current Liabilities

• Debts expected to be paid or settled after one year
• Examples:
o Long term Bank loan/notes payable
o Lease obligations
o Pension and benefit obligations
o Deferred income tax liabilities
• Usually accompanied by extensive notes to the financial statements


Shareholders’ Equity

• Share capital:
o Investment of cash (or other assets) in the company by shareholders in exchange for preferred or common shares or equity ownership
• Retained earnings:
o Cumulative net income/(losses) net of dividends retained or reinvested in the firm for use in the company

Using the Financial Statements

• Specific tools can be used to analyze the financial statements
• Ratio analysis expresses the relationships between selected financial statement data
• Use comparisons to aid in analyses:
o begin Intracompany comparisons end underline cover two or more periods for the same company
o begin underline Intercompany comparisons end underline between the company and a competitor
o begin underline Industry average comparison end underline based on averages for particular industries


• Measures a company’s short-term ability of to pay its obligations and to meet its unexpected needs for cash



Higher is generally better, but is subject to some limits


Solvency Ratios

• Measure a company’s ability to meet its longer term obligations:
o The higher the percentage of debt to total assets, the greater the risk that debts cannot be repaid when they are due



Lower is generally better, but too low is not always a good thing






Profitability Ratios

• Measure a company’s operating success of for a given period of time




Higher is generally & usually better


Conceptual Framework of Accounting

• Guides decisions about:
o what to present in financial statements
o alternative ways of reporting economic events
o appropriate ways of communicating this information

Conceptual Framework for Financial Reporting

• Five main sections:
ü Objective of financial reporting
ü Qualitative characteristics of useful financial information
ü Underlying assumption
ü Elements of financial statements
ü Measurement of the elements of financial statements


Objective of Financial Reporting

• To provide financial information that is useful to existing and potential investors, lenders and other users to enable better decision making
• These decisions concern providing resources to a company:
o Buying, selling, holding equity and debt
o Providing or settling loans or other credit
• Financial information is provided by the 4 primary & general purpose financial statements

Qualitative Characteristics of Accounting Information

• Relevance:
ü Information has relevance if it makes a difference in users’ decisions
ü May have predictive value and/or confirmatory value
ü Materiality is important: will information influence the decisions of users?
• Faithful representation:
ü Information should reflect economic reality
ü It must be complete, neutral and free from error


Enhancing Qualities of Useful Information

• Comparability:
ü Users can identify and understand similarities and differences among items
• Verifiability:
ü Independent consensus that information is faithfully represented
• Timeliness:
ü Available before it loses its usefulness in decision-making
• Understandability:
ü Classified, characterized and presented clearly and concisely


Cost Constraint

• Ensures that the value of the information provided by financial reporting is greater than the cost of providing it
• The benefits of financial reporting should justify the costs of providing and using it


Going Concern Assumption

• The business will continue operating in the foreseeable future
• This is a key assumption – provides a foundation for accounting
• Provides justification for using cost as the value of certain assets & underlies the application of many or all other GAAPs / IFRSs i.e. the rules or guidelines governing the accounting & reporting process


Elements of Financial Statements

• Assets
• Liabilities
• Equity
• The above 3 comprise the Statement of Financial Position or Balance Sheet with the relationship: A = L + E
• Income
• Expenses
• The above 2 comprise the Income Statement with the relationship: Rev – Exp = Income/(loss)
• The above 2 financial statements are connected by the Statement of Changes in (Owner’s) Equity


Measurement of the Elements

• Accountants have developed principles that describe which, when and how the elements of financial statements should be:
o Recognized
o Measured, and
o Reported
• As introduced in chapter 1, the principles that describe which, when and how the elements of financial statements should be recognized, measured and reported are known as Generally Accepted Accounting Principles (G A A P)
• GAAP represents the rules and guidelines:
o Used by the world of business, finance & accounting
o To record transactions
o & prepare financial statements
• All Roads Lead Back to GASP…everything you learn in this and any subsequent accounting course will be based on one or more GAAPs
• It is, therefore, important that you know:
o What the various GAAPs are
o What they mean
o & how to apply them


Generally Accepted Accounting Principles

• Historical cost:
ü Assets and liabilities should be recorded at their cost when acquired
ü Not only at time of purchase, but throughout the life of each asset and liability
• Current Value:
ü Certain assets and liabilities should be recorded and reported at current value
• In choosing between these two, apply the concepts of begin underline relevance and faithful representation
• The implication of the above is that they can be multiple GAAPs applicable and they are inter-related

Comparing IFRS and ASPE

Key Standard Differences International Financial Reporting Standards (I F R S) Accounting Standards for Private Enterprises (A S P E)
Basic earnings per share Required to present in financial statements Not required to present in financial statements
Conceptual framework for financial reporting Still under development Same general framework currently under development by international and U.S. standard setters anticipated to be applied to private enterprises when complete




Revenue - is the price of goods and services delivered to the customer
Expenses – costs incurred to generate revenue


Only two things affects retained earnings, profits/loss and dividends

Only two things affects share capitals, issuing or buying back shares



Three types of business organizations
Sole proprietorship
Partnership
Corporation
















Investor – external user
Marketing manager – internal user
Creditor – external user
Chief financial officer – internal user
Canada Revenue Agency – external user
Labour union – external user

The standard
(Assets = Liability + Owner’s Equity)

Net Income
Equation: (Revenues – Expenses = Net Income)
Break-Even Point
Equation: (Break-Even Volume = Fixed Costs / Sales Price – Variable Cost Per Unit)
Cash Ratio
Equation: (Cash Ratio = Cash / Current Liabilities)

Profit Margin
Equation: (Profit Margin = Net Income / Sales)
Debt-to-Equity Ratio
Equation: (Debt-to-Equity Ratio = Total Liabilities / Total Equity)
Cost of Goods Sold
Equation: (Cost of Goods Sold = Cost of Materials/Inventory – Cost of Outputs)
Retained earnings equation
Equation: Retained Earnings = Beginning Retained Earnings + Net Income or Net Loss – Cash Dividends
Gross margin
Sales – cost of sales
Net sales formula
Gross sales – sales discounts – sales returns and allowances
Current ratio
Current assets ÷ current liabilities
Quick ratio
(Current assets less inventory) ÷ current liabilities
Return on equity
Net income ÷ equity

Return on capital
Operating profit ÷ capital

Shareholder’s Equity = Assets – Liabilities
Important Accounting Formulas
Assets = Liabilities + Equity
CurrentAssetsCurrentLiabilities=CurrentRatio
Income – Expenses = Net Income
Beginning inventory value + Purchases of inventory – Ending inventory value = Cost of goods sold
Sales – Cost of goods sold = Gross profit
GrossProfitSales=GrossProfitMargin
FixedcostsSalespriceperunit−Variablecostperunit=BreakEvenPoint
Salespriceperunit×Break−evenpointinunits=BreakevenpointinRupees
Inventoryturnoverratio=CostofGoodsSoldInventory
AccountsReceivableTurnoverRatio=SalesoncreditAccountsReceivable
TotalAssetTurnover=SalesTotalAssets
DebttoEquityRatio=Debt–equityratio=TotalLiabilitiesShareholder′sEquity
Quickratio=CurrentAssets−InventoryCurrentLiabilities
CurrentRatio=CurrentAssetsCurrentLiabilities
ReturnonAssets=NetIncomeAverageTotalAssets
ReturnonEquity=NetIncomeAverageShareholder′sEquity
Beginning balance + net income – net losses – dividends = ending balance















Chapter 3 - The Accounting Information System


Accounting Transactions (1 of 2)

• Accounting information system:
o The system of collecting and processing transaction data and communicating / reporting financial information
• Can vary widely based on factors such as:
o Type of business and its transactions
o Size of company
o Amount of data
o Information requirements

• Transactions are economic events that must be recorded in the financial statements
• Not all events are recorded and reported as accounting transactions:
o Only those that change assets, liabilities, or shareholders’ equity
o Part of the initial challenge as you learn about accounting is to recognize those events that represent transactions and those that do not



Steps in the Accounting Cycle Recording Process

• Step 1: Analyze each transaction to determine its effect on accounts (if any)
o Evidence comes from a source document which can be in paper or electronic form
• Step 2: Record transaction as a journal entry in the general journal
• Step 3: Transfer journal entries recorded to appropriate accounts in the general ledger
Note: In BADM1030 we will illustrate and use an approach (combining steps 2 & 3) to record transactions directly to the general ledger or accounts without the necessity of repetitive steps including journal entries
• Step 4: Prepare a trial balance

Analyzing Transactions Step 1 of Accounting Cycle

• Transaction analysis determines impact on the accounting relationship
• Assets = Liabilities + Shareholders’ Equity
• The accounting relationship must always balance or be true
• Therefore, each transaction has a dual (double-sided) effect on the relationship


Analyzing Transactions



Account

• An individual accounting record of increases and decreases in a specific asset, liability, or shareholders’ equity item
• T Account—three parts:
Title of the account
A left or debit side
A right or credit side
• In its simplest form, these parts are positioned like the letter T; therefore called a T account








The T Account – Debit Balance


Total the entries to each side. If the greater sum is on the left, the account has a debit or left hand side balance

The T Account – Credit Balance



Total the entries to each side. If the greater sum is on the right, the account has a credit or right hand side balance


Rules of Dr. & Cr. For All Types of Accounts

• The following slides illustrate:
• The basic rules of Dr. & Cr. for all types of accounts &
• Pictorially shows the relationship, connection & consistency between these rules for Revenue, Expenses & Dividends and the impact that these types of accounts / transactions have on the Equity of the firm.
• These slides also details 3 things that will be true for every correct transaction you record & also warns that just because these 3 things are true, does not mean it is correct!









Rules of Debit & Credit



Note the consistency of the rules of Dr & Cr for Revenue, Expenses & Dividends and the impact these accounts have on Equity... they are, in fact, subsets of equity


TTWIIBTTWII is an acronym that stands for: That’s The Way It Is, Because That’s The Way It Is! The rules for Debit & Credit are by definition as determined by the originators of modern day Accounting. Therefore, the answer to the question: why does a Dr. increase an Asset is: TTWIIBTTWII or ‘because’, one of the very few times when a complete and accurate answer to a question is ‘because’!!

General Journal Step 2 of Accounting Cycle

• Accounting record where the transactions are typically recorded in chronological order
• General journal is most common type of journal
• Other journals can include:
o Cash receipts
o Cash disbursements
o Sales
o Purchases
• Entering analyzed transaction data is known as journalizing

General Ledger Step 3 of Accounting Cycle

• Entire group of accounts maintained by a company
o List of accounts is called a chart of accounts
• The General Ledger or Super T contains all the asset, liability, and shareholders’ equity accounts
• Posting is the process of transferring journal entries from the general journal to the general ledger accounts
• As mentioned previously, in BADM1030 we will take a ‘short cut’ & analyze and record transactions directly to the Super T without using journal entries (combining steps 2 & 3) … this is less repetitive & time consuming and loses nothing in your learning process of recording and reporting accounting information.


Trial Balance Step 4 of Accounting Cycle

• List of the general ledger accounts and sorts them into columns according to their balances at a specific time
• Serves to prove the mathematical equality (only) of debits and credits after posting
o i.e. sum of debits = sum of credits or the trial balance balances
• Aids in the preparation of financial statements
• Subject to limitations
o Does not prove that the general ledger is correct but merely that the ledger ‘balances’
o The objective is not to balance, but to record transactions correctly, in a balanced way



Notice that this trial balance balances (Dr = Cr) but this does not mean the ledger is correct or any or all of the transactions have been recorded correctly!

Assets are on the left side of the accounting equation and T account shown above. Consequently, if the normal balance of an account is always on its increase side, asset accounts normally have debit (left-side) balances. Increases in asset accounts are entered on the left or debit side of a T account while decreases in assets are entered on the right or credit side.
Liabilities are on the right side of the accounting equation so liability accounts normally have credit (right-side) balances. Increases in liability accounts are entered on the right or credit side of a T account while decreases in liability accounts are entered on the left or debit side.
• Increases in common shares, retained earnings, and revenue accounts are recorded by credits and have normal credit balances.

GENERAL JOURNAL



Asset Accounts
• Cash (including petty cash)
• Accounts receivable (including customer deposits)
• Office furniture (filing cabinets, desks, sofas, chairs etc.)
• Office equipment (photocopiers, fax machines, postage meter etc.)
• Fixtures (sinks, lighting, faucets etc.)
• Deferred discounts
• Cell phones
• Computer hardware
• Computer software
• Tools
• Machinery
• Equipment
• Boats
• Vehicles
• Buildings
• Lease agreements
• Costs incurred to improve a leased space
• Land
• Modular office buildings
• Company or customer parking lot or garage
• Warehouses
• Inventory
• Any investment that matures in less than 90 days (i.e. stocks, U.S. treasuries, bonds, mutual funds, money-market funds)
• Pre-paid insurance
• Intellectual property (i.e. know-how)
• Brand equity (recognition)
• Company reputation
• Copyrights
• Goodwill
• Trademarks
• Franchises
• Patents
• Intellectual property
• Domain name
• Employment contracts
• Licensing agreements
• Client relationships
• Customer lists


Liability and Stockholders' Equity Accounts
• Accounts payable (money owed to suppliers, includes accrued payroll and accrued rent)
• Unearned revenue
• Customer credit
• Credit card
• Taxes on investments
• Wages owing
• Salaries owing
• Sales tax payable
• Interest payable
• Income tax payable
• Lawsuits payable
• Customer deposits or pre-payments for goods or services not provided yet
• Debt payable
• Lease agreement
• Insurance payable
• Benefits payable
• Contracts
• Accrued liabilities (such as interest that the lender hasn’t billed for yet)


Revenue is always Goods or Services

Events are not recorded in a transaction

Add more to AP because you owe more than before

This is a satirical website. Don't take it Seriously. It's a joke.