Financial Accounting: Tools for Business

Decision-Making
Seventh Canadian Edition
Kimmel Weygandt Kieso Trenholm Irvine Burnley

Chapter 1

The Purpose and Use of Financial

Statements
Learning Objectives
LO 1: Identify the uses and users of accounting.
LO 2: Describe the primary forms of business
organization.
LO 3: Explain the three main types of business activity.
LO 4: Describe the purpose and content of each of the
financial statements.

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Uses and Users of Accounting
• 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

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Users of Financial Information
• Internal users
o Manage the company, non-profit, government organization
o Company officers, managers and directors in finance,
marketing, human resources, production
• External users
o Do not work for the company as officers
o Investors, lenders, and other creditors.
o Customers, employees, labour unions
o Taxing authorities and regulators

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Discussion Question 1
Identify the internal and external users of financial
information for a local hospital.

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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

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Discussion Question 2
What are some ethical issues that might exist for financial
information in a local hospital?

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Forms of Business Organizations:
Proprietorship
• Owned by one person (proprietor)
• Simple to set up
• Owner has control over business
• Limited life
• Unlimited liability
• Income tax paid by owner

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Forms of Business Organizations:
Partnership
• Similar to proprietorship except owned by more than
one person
• Formalized in a written agreement
• Limited life
• Each partner has unlimited liability
• Income tax paid by individual partners

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Forms of Business Organizations:
Corporations
• Separate legal entity owned by shareholders (owners
of shares)
• Indefinite life
• Ease of raising capital
• Shareholders enjoy limited liability
• Corporation pays income tax
• May be public or private:
o Public if shares are publicly traded
o Private if shares are not available to the general public
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LLP
Limited liability partnership (LLP) is a partnership in which
some or all partners (depending on the jurisdiction) have limited
liabilities. It therefore can exhibit elements of partnerships and
corporations. In an LLP, each partner is not responsible or liable for
another partner's misconduct or negligence. This is an important
difference from the traditional partnership under the UK
Partnership Act 1890, in which each partner has
joint and several liability. In an LLP, some or all partners have a
form of limited liability similar to that of the shareholders of a
corporation. Unlike corporate shareholders, the partners have the
right to manage the business directly.

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LLC
A Limited Liability Company (LLC) is a hybrid form of business that has
some of the characteristics of a corporation and some of the characteristics
of a partnership or sole proprietorship: Like sole proprietorships or
partnerships, an LLC is an unincorporated entity.
Tax-wise an LLC is similar to a sole proprietorship or partnership. That is
income from the business flows through to the owners and investors and is
added to personal income on tax returns. 
Like a corporation, an LLC provides limited liability. That is the liability
of the owner(s) of the company is limited to the amount of their
investment in the company.
No, you cannot set up an LLC in Canada as this 
form of business ownership does not exist in Canada. The LLC is a type
of business structure that exists in the United States and United Kingdom,
Mexico, Switzerland, Chile, Columbia, Italy, Japan, India, etc.
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Generally Accepted Accounting Principles
(GAAP) in Canada
• Rules and practices for the preparation of financial
statements
• Different for publicly-traded and private corporations
o Publicly-traded corporations use International Financial
Reporting Standards (IFRS)
o Private corporations may use IFRS or Accounting Standards
for Private Enterprises (ASPE)
• Proprietorships and partnerships generally follow ASPE
for external reporting
o Not required to follow any particular standards for internal use

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Three Types of Business Activities
• All companies are involved in all three activities:
• Financing
• Investing
• Operating

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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

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Investing Activities
• Purchase or sale of long-lived assets needed to operate
the company
• Examples
o Purchase or sale of long-lived assets such as property, plant
and equipment and intangible assets
o Purchase or sale of investments, such as shares or debt
securities of other companies, not its own shares or debts

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Operating Activities
• Operating activities are the main day-to-day activities
of the business
• Examples
o Revenues (income)
o Expenses
o Related accounts such as accounts receivable and accounts
payable

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Discussion Question 3
What are the potential operating, investing, and financing
activities for a retail company? Would your answer differ
for a service company?

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Financial Statements (1 of 2)
• Income statement
o Reports revenues and expenses for a specific period of time
• Statement of changes in equity
o Reports the changes in each component of shareholders’ equity
during a period of time
• Statement of financial position
o Shows the assets, liabilities and shareholders’ equity at a
specific point in time

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Financial Statements (2 of 2)
• Statement of cash flows
o Shows, for a specific period of time, how company obtained
cash and how that cash was used
• Order of preparation of statements

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Income Statement
• Revenues
o Arise from sales of a products or services
o Result in an inflow of assets
• Expenses
o Costs of assets consumed or services used to generate revenues
• Net Income (loss) = Revenues − Expenses

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Income Statement - Example

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Statement of Changes in Equity (1 of 2)
• Shows the changes in each component of shareholders’
equity for the period
• Share capital
o Amounts contributed by shareholders
o May include common and preferred classes
• Retained earnings / deficit (if it’s a debit)
o Cumulative net income retained in the company
o Less dividends paid to shareholders
• Other shareholders’ accounts

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Statement of Changes in Equity (2 of 2)
Changes in shares

Changes in retained earnings

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Statement of Changes in Equity - Example

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Statement of Financial Position
• Assets
o Resources owned or controlled by a business
• Liabilities
o Claims of lenders and other creditors
• Shareholders’ equity
o Claims of shareholders
• Accounting equation
o Assets = Liabilities + Shareholders’ Equity

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Statement of Financial Position -
Example (1 of 2)
SIERRA CORPORATION
Statement of Financial Position
October 31, 2018

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Statement of Financial Position -
Example (2 of 2)

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Statement of Cash Flows
• Reports the effect on cash of the company’s
o Operating activities
o Investing activities
o Financing activities
• Shows net increase or decrease in cash for the period

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Statement of Cash Flows - Example
SIERRA CORPORATION
Statement of Cash Flows
Month Ended October 31, 2018

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Relationships Between Statements
• Statements are interrelated
o Results from some statements are used as data in other
statements
• Examples
o Net income from income statement is reported in statement
of changes in equity
o Ending balances of each shareholders’ equity account is
reported in both statements of financial position and changes
in equity
o Statement of cash flows is related to statement of financial
position

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