Chapter 1

Financial Statements and Business

Decisions
Types of Business

Proprietorship Partnership Corporation

 Typically owned by  Owned and  Ownership

one person who runs operated by two or divided into
the operation
more people. shares of stock
 Small service
business (Mom and
 Retail or service-  Separation of
Pop store). type business – ownership from
Accounting/Law control
firm
 Separate legal
 Governed by a
entity organized
partnership
under state
agreement
corporation law
 Organizational Forms - Sole proprietorship
• Advantages:
• Easy to establish since it does not need to be registered.
• Owner-manager has full control over operations
• Owner-manager keeps all the profits.
• No risk of leaking of proprietary information
• Disadvantages:
• Owner-manager bears all the risks (unlimited liability).
• Poor continuity - business might die with the owner.
• Owner-manager may not have the financial resources
needed to make investments to keep the business
viable.
Organizational Forms- Partnership
• Advantages:
• Greater access to capital and expertise since partners
can pool resources.
• Shared workload and profits in the agreed percentage.
• Disadvantages:
• Continuity is less certain than proprietorship, due to
trust issues.
• Risks are shared (maybe not equally) by all the
partners (unlimited liability).
Organizational Forms- Corporation
• Advantages:
• Shareholders are not liable for corporate debts (limited liability).
• Continuity of life – does not cease to exist if shareholders,
or officers die.
• Corporations can raise capital easily , by selling shares of stock.
• Ease of transferring ownership interests.
• Disadvantages
• Expensive to establish and involves the most paperwork
• Double taxation: the firm may pay taxes on its income, after
which shareholders pay taxes on any dividends received, so
income is taxed twice
 The Business Operations
Business Activity Stakeholder Affected
• Selling shares to raise capital • Shareholders
• Borrowing money/selling bonds to • Creditors
raise money. Paying back loans
• Electing a CEO to run the business • Board of Directors
• Hiring and paying laborers • Managers
• Purchasing and paying for raw • Suppliers
materials
• Selling products and collecting
• Customers
payments
 Users of Accounting Information
Questions that Stakeholders ask Stakeholder

1. Can we increase employees

wages?
2. Is income satisfactory?

3. Which of these two products

should we stop making?
4. Can we pay dividends to
shareholders?
5. What price should we charge for
our product?
6. Will the firms be able to pay its
debts?
 Investors and Creditors
• Business owners (investors or shareholders)
profit from the corporation in two ways:
– By selling their ownership interest in the future
for more than they paid.
– By receiving a portion of the company’s earnings
in cash or kind (dividends).
• Creditors lend money to a company for a
specific length of time and gain by charging
interest on the money loaned.
The Role of the Accounting System

To identify, collect and process, record, and

communicate economic events of the firm to
stakeholders for:

• Internal decision making (e.g. Managers)

• External decision making (e.g. Investors and

Creditors)
Users of Accounting Information

Management CRA
Human Investors
Resources
Financial Accounting serves
external users. Labor
Unions
Finance
Managerial Accounting
serves internal users.
Creditors
Marketing
Customers OSC
& Suppliers
Types of Financial Statements

 Statement of Financial Position/Balance

Sheet
 Statement of Comprehensive
Income/Income Statement
 Statement of Changes in
Equity/Statement of Stockholders’ Equity
 Statement of Cash Flows

Note Disclosure
• Reports the financial position of an accounting
entity at a point in time.
• Also called the “Balance Sheet”
• The equation A=L + SE must always be in balance
 The Statement of Financial Position
ASSETS = LIABILITIES SHAREHOLDERS’ EQUITY
 
Economic Amounts Owed Amounts invested by shareholders and
resources earnings retained in the business

Element on the Statement of Financial Position

Assets - Economic resources controlled by the entity as a result of past
transactions that will produce future economic benefit to the entity
 
Liabilities - Obligations from past transactions that will require the sacrifice
of future economic resources that the entity cannot avoid

Shareholders’ Equity includes:

- Contributed capital - amounts invested by the owners
- Retained earnings – accumulated earnings minus previous dividends
- Other components to be discussed later in the term
 Practice 1.1
List each of the following accounts as an asset (A), Liability (L), or Shareholder’s Equity (SE)
 _______ Inventory
_______ Cash
_______ Patent
_______ Contributed Capital
_______ Buildings
_______ Accounts receivable
_______ Accounts Payable
_______ Prepaid Rent
_______ Investments
_______ Land
_______ Retained Earnings
_______ Equipment
_______ Income taxes payable
 Practice 1.2
The accounting equation A=L + SE must always be in balance.
A December 31, 2017 statement of financial position for Leon’s
Furniture contained the following items (in millions). Prepare a
statement of financial position as at December 31, 2017, solving for the
missing amount.

Cash and cash equivalents $     18 Other components of equity 8

 
Contributed capital 31 Other liabilities 460
 
Dividends payable 7 Property, plant, and equipment 334
 
Income tax payable 35 Retained earnings 510
 
Intangible assets and goodwill 739 Total assets 1,563
 

Inventories 267 Total liabilities and shareholders’ equity ?

 
Loans and borrowings 315 Trade receivables 112
 
Other assets 93 Trade and other payables 197
 
• Reports the net earnings achieved during the
accounting period, and income and expenses
not recognized in net earnings.
 The Statement of Comprehensive
Income
The statement of comprehensive income has two parts.
1. The company's performance from business operations ("net earnings").
2. Other comprehensive income (items not recognized in earnings).
It shows the equation :
 Revenues + Gains – Expenses – Losses = Net Earnings
Revenues- increases in assets or settlement of liabilities from ongoing
operations; amounts expected to be received for goods or services that have
been delivered to a customer, even if the customer has not yet paid.
Gains - increases in assets or settlement of liabilities from peripheral activities
 Expenses - decreases in assets or increase in liabilities from ongoing
operations; resources the entity used up to earn revenues during the period
 Losses - decreases in assets or increase in liabilities from peripheral activities
 Practice 1.3
A recent annual statement of earnings for Corus Inc. contained the following items
(in thousands of Canadian dollars). Solve for the missing amounts and prepare a
condensed statement of earnings for the year ended August 31, 2015. (Hint: First
order the items as they would appear on the statement of earnings and then solve
for the missing values.)

Cost of sales $533,529

Interest expense 46,332

Net earnings 165,749

Revenues ?

Depreciation expense 26,903

Income tax expense 39,759

Total expenses excluding income taxes ?

Earnings before income tax ?

• Reports the way that elements of
comprehensive income, dividends and
changes to contributed capital affected the
financial position of the company during the
accounting period.
 Practice 1.4
Sultan Inc. was organized on January 1, 2017. It reported the following for its first
two years of operations:
Required:
Compute the ending balance of retained earnings for Sultan Inc. as at December
31, 2018. Show computations.

Net earnings for 2017 $  31,000

Dividends for 2017 14,200

Total shareholders’ equity at end of 2017 130,000

Net earnings for 2018 42,000

Dividends for 2018 18,700

Total shareholders’ equity at end of 2018 250,000

• Reports inflows and outflows of cash during
the accounting period in operating, investing
and financing activities.
 Statement of Cash Flows
• Operating Activities -Cash inflows and outflows
directly related to earnings from normal operations.
• Investing Activities - Cash inflows and outflows
related to the acquisition or sale of plant, equipment,
intangibles and investments in the securities of other
companies.
• Financing Activities - Cash inflows and outflows
related to transactions with owners and creditors.
 Practice 1.5
Mark each item in the list as a cash flow from operating activities (O),
investing activities (I), or financing activities (F). Place parentheses around
the letter only if it is a cash outflow.

_____ (1)Cash paid to suppliers

_____ (2)Cash received from customers

_____ (3)Dividends paid

_____ (4)Issuance of share capital

_____ (5)Interest paid

_____ (6)Proceeds from disposal of investment

_____ (7)Purchases of property, plant, and equipment

_____ (8)Repurchase of share capital

 Question
• What information should be included in the
headings of the four primary financial
statements?
 Question
• Explain why the statement of earnings and
statement of cash flows are dated, e.g., “For
the Year Ended December 31, 2014,” whereas
the statement of financial position is dated,
e.g., “At December 31, 2014.”
Relevant Standard-setting bodies

Relevant Standard-setting bodies:

► International Accounting Standards Board (IASB) -
CANADA
► Ontario Securities Commission (OSC) in Canada &
Securities and Exchange Commission (SEC) - US
► Accounting Standards Board (AcSB) in Canada &
Financial Accounting Standards Board (FASB) - US
Generally Accepted Accounting Principles

Generally Accepted Accounting Principles (GAAP) – Standards

that are generally accepted and universally practiced and that
govern how to report economic events.

Publicly Accountable for-profit firms

◦ International Financial Reporting Standards (IFRS)

Private enterprises
◦ Accounting Standards for Private Enterprises (ASPE)
Generally Accepted Accounting Principles

Measurement Principles
Historical Cost Principle – companies record assets at
their cost.

Fair Value Principle – assets and liabilities should be

reported at fair value.

LO 4 Explain generally accepted accounting principles.

Generally Accepted Accounting Principles

Assumptions
Monetary Unit – only record transactions that can be
expressed in terms of money.

Economic Entity – activities of the entity are separated

from other economic entities (including owner).

Q: Why is a business treated as a separate entity for

accounting purposes?
 Question
• Why is a business treated as a separate entity
for accounting purposes?

• A business is defined and treated as a separate

entity because the owners, creditors, investors,
and other interested parties need to evaluate
its performance and its potential separately
from other entities and from its owners.
Match each element with its financial statement

Element
_____ (1) Expenses
_____ (2) Cash flow from investing activities
_____ (3) Assets
_____ (4) Dividends
_____ (5) Revenues
_____ (6) Cash flow from operating activities
_____ (7) Liabilities
_____ (8) Cash flow from financing activities