Chapter 1
Business Decisions and Financial Accounting
Accounting is the art of recording, classifying, and summarizing in a significant manner and in terms of money,
transactions and events which are, in part at least, of financial character, and interpreting the results thereof.
The main goal of an accounting system is to capture information about the operating, investing, and financing
activities of a company so that it can be reported to decision makers, both inside and outside the business.
There are three primary ways in which businesses can be organized:
1. Sole Proprietorship
A sole proprietorship is an unincorporated business owned by one person.
Owner receives any profits, suffers any losses, and is personally liable for all debts.
2. Partnership
A partnership is formed by two or more persons reaching mutual agreement about the terms of
the relationship to carry on as co-owners of a business for profit.
A limited liability partnership (LLP) combines legal characteristics of corporations (separate legal
identity and limited liability) with the tax treatment of partnerships.
3. Corporation
Ownership divided into shares.
Separate legal entity organized under corporation law.
The corporation, not its owners, is legally responsible for its own taxes and debts.
"The combined number of proprietorships and partnerships in the United States is more than
five times the number of corporations. However, the revenue produced by corporations is
eight times greater. Most of the largest enterprises in the United States--for example, Coca-
Cola, ExxonMobil, General Motors, Citigroup, and Microsoft--
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STUDY THE ACCOUNTING METHODS
The Basic Accounting Equation
Definitions of the elements relating to financial position
1. An asset is a resource controlled by the entity as a result of past events and from which future economic
benefits are expected to flow to the entity.
2. A liability is a present obligation of the entity arising from past events, the settlement of which is expected
to result in an outflow from the entity of resources embodying economic benefits.
3. Equity is the residual interest in the assets of the entity after deducting all its liabilities.
also
1) The owners have a claim on amounts they contributed directly to the company in exchange for its
shares (Contributed Capital).
2) The owners have a claim on amounts the company has earned through profitable business operations
(Retained Earnings).
Definitions of the elements relating to performance
1. Revenues are the amounts a business charges its customers when it provides goods or services.
Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or
decreases of liabilities that result in increases in equity, other than those relating to contributions from equity
participants.
2. Expenses are costs of operating the business, incurred to generate revenues in the period covered by the
income statement.
Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or
incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Exercise 1
# Assets Liabilities Equity Revenue Expenses Profit (Loss)
1 100 20 90 20
2 80 90 130 110
3 90 20 30 40
4 180 200 100 (30)
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FINANCIAL STATEMENTS
different reports that
collectively are called financial statements.
Financial statements can be prepared at any time during the year, although they are commonly prepared monthly,
every three months (quarterly reports), and at the end of the year (annual reports).
The term refers to four accounting reports, typically prepared in the following order:
1) Income Statement
Net Income/(Loss) is calculated by subtracting expenses from revenues; it indicates the amount by which
2) Statement of Retained Earnings
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3) Balance Sheet
4) Statement of Cash Flows
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Relationship Among the Financial Statements:
EVALUATE THE RESULTS
The financial statements are a key source of information when external users, like creditors and investors, make
decisions concerning a company.
1) Creditors are mainly interested in assessing the following:
Is the company generating enough cash to make payments on its loan?
Does the company have enough assets to cover its liabilities?
2) Investors expect a return on their contributions to a company.
The return may be immediate (through dividends) or long-term (through selling share certificates at a
price higher than their original cost).
Dividends and higher share prices are more likely if a company is profitable.
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USEFUL FINANCIAL INFORMATION
1) The Chartered Professional Accountants of Canada (CPA Canada) has the primary responsibility for setting the
underlying rules of accounting in Canada. As a group, these rules are called Generally Accepted Accounting
Principles (GAAP).
Publicly accountable profit-oriented enterprises, such as Lululemon and Shoppers Drug Mart, must follow
the principles and rules set out in the International Financial Reporting Standards (IFRS).
In contrast, private enterprises whose shares are not traded on a public stock exchange can choose to
follow either IFRS or Canadian Accounting Standards for Private Enterprises (ASPE).
2) The Accounting Standards Board (AcSB) is an independent body supported by CPA Canada to develop and
establish the standards and guidelines that govern financial accounting and reporting in Canada, using guidance
from the International Accounting Standards Board (IASB).
3) Key Concepts of External Financial Reporting:
4) CPA Canada requires that all its members adhere to a Code of Professional Conduct.
5) Different users have different needs. Most organizations are required by law to present annual financial
statements to shareholders. Certain stakeholders require some form of assurance (e.g., audit services) when
using financial statements for lending or investing decisions.
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Exercise 2
Identify an appropriate label for each item as it would be grouped and reported in the financial statements.
A = Assets; L = Liabilities; SE = S Equity; Rev = Revenues; Exp = expenses
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Exercise 3
Given that Apple Inc., reported the following financial information for the year ended September 30, 2020:
All numbers in billions
Accounts payable1 42 Long-term marketable securities 101
Accounts receivable2, net 16 Net sales - Products and Services 275
Cash and cash equivalents 38 Other current assets 33
Cash generated by operating activities 81 Other current liabilities 43
Cash used in financing activities -87 Other income 1
Cash used in investing activities -4 Other non-current assets 43
Common shares3 51 Other non-current liabilities 54
Cost of sales - Products and Services 169 Property, plant and equipment, net 37
Deferred revenues4 7 Research and Development Expenses 19
Dividends declared 14 Retained Earnings 5 15
Income Tax Expense 10 Selling, general and administrative expenses 20
Inventories 4 Short-term debt 14
Long-term debt 99 Short-term marketable securities 53
Instruction: Prepare the four basic financial statements
Apple Inc. Apple Inc.
Income Statement Statement of Retained Earnings
For the year ended September 30, 2020 For the year ended September 30, 2020
Revenues Retained Earnings (Beginning) 46
Subtract: Other adjustments (75)
Total Revenues Retained Earnings (Ending)
Expenses
Apple Inc.
Statement of Cash Flows
For the year ended September 30, 2020
Total Expenses
Net Income Change in Cash
Beginning Cash and cash equivalents
Ending Cash and cash equivalents
1 Amounts owed to suppliers for goods or services bought on credit.
2 The right to collect from customers for prior sales on credit.
3 Amount of cash (or other shares.
4 Amounts (customer deposits) received in advance of providing goods or services to customers.
5 Amount of accumulated earnings not distributed as dividends.
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Apple Inc.
Balance Sheet
As of September 30, 2020
Assets Liabilities
Total Current Liabilities
Total Current Assets
Total non-Current Liabilities
Shareholders' Equity
Total non-Current Assets Total Shareholders' Equity
Total Assets Total
Evaluate whether the company was profitable
Determine the beginning balance of cash and cash equivalents (using the relationship among financial
statements) Evaluate whether the company is financed mainly by creditors or shareholders
Evaluate whether current assets are sufficient to pay current liabilities
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Chapter 2
The Balance Sheet
Accounting for Business Activities:
Example
A key activity for any start-up company is to obtain financing, and to start investing in assets that will be later used
when the business opens.
Note: Analyze transactions from the standpoint of the business, not of its owners.
Business Activities Assets Liabilities Equity
Issued shares to owners as evidence of his
contribution of $10,000 cash
Borrowed $5,000 from a local bank
Bought and received $4,000 in equipment,
paying $1,000 in cash and giving an informal
promise to pay the remaining next month
Total
Business activities that affect the basic accounting equation (A = L + SE) are called transactions.
Duality of effects: means every transaction has at least two effects on the basic accounting equation (A = L + E).
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ACCOUNTING CYCLE
Elements of the Accounting Cycle:
The first three-step process of analyzing, recording and
summarizing is applied to:
1. daily transactions
2. adjustments at the end of the each month
3. the closing process at the end of each year
A chart of accounts designates a name and reference number that company will use when accounting for each
item that it exchanges.
ACCOUNT An arrangement that shows the effect of transactions on each account.
The accounting equation is like a scale with assets on the left side of the equal sign and liabilities and
Account Name Two rules in the debit/credit framework:
Debit / Dr. Credit / Cr. 1) Accounts increase on the same side as they appear in
2) Left is debit (Dr) and right is credit (Cr)
Use debits for increases in assets and decreases in
Use credits
equity and decreases in asset accounts.
Ending balance =
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Step 1
Analyze the financial effects using the basic accounting equation
Business Activities Assets Liabilities Equity
Sep 1
Received $20,000 cash from the
investors who organized Simon Corp.
Sep 3
Borrowed $10,000 cash and signed a
note due in two years (ignore
interest)
Sep 4
Ordered computer equipment
costing $6,000
Sep 10
Received the equipment ordered on
Sep 4, paid for half of it, and put the
rest on account.
Sep 12
Purchased supplies for $2,000 on
account.
Step 2
Record Journal Entries:
a. Journal entries are used to record transactions and indicate the effects in a debits-equal-credits format.
b. All debits are listed first followed by credits indented from the left margin
c. Total dollar value of debits equal total dollar value of credits for each transaction
d. A brief explanation of the transaction is written below the debits and credits (Optional)
e. The reference column indicates summarization of the journal entry in the ledge accounts
Business Activities Record Journal Entries
Sep 1
Received $20,000 Date Account titles Ref. Debit Credit
cash from the
investors who
organized Simon
Corp.
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Sep 3
Borrowed $10,000 Date Account titles Ref. Debit Credit
cash and signed a
note due in two
years (ignore
interest)
Sep 4
Ordered computer Date Account titles Ref. Debit Credit
equipment costing
$6,000
Sep 10
Received the Date Account titles Ref. Debit Credit
equipment ordered
on Sep 4, paid for
half of it, and put the
rest on account.
Sep 12
Purchased supplies Date Account titles Ref. Debit Credit
for $2,000 on
account.
Step 3
Summarize in Ledger Accounts
Posting is the process of transferring details of journal entries into the corresponding ledger accounts
T-Accounts are a simplified format
of a ledger account. The normal
balance of an account is always on
the side where an increase occurs.
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Formal ledger page:
General Ledger: CASH Account # 101
Date Explanation Ref. Debit Credit Balance
General Ledger: Supplies Account # 102
Date Explanation Ref. Debit Credit Balance
General Ledger: Equipment Account # 105
Date Explanation Ref. Debit Credit Balance
General Ledger: Accounts Payable Account # 201
Date Explanation Ref. Debit Credit Balance
Informal ledger page:
Notes Payable (AC# 205) Contributed Capital (AC# 301)
Beg. Bal. 0 Beg. Bal. 0
Ending balance = Ending balance =
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Step 4
Preparing a Trial Balance & Balance Sheet
A trial balance is an internal report that lists all accounts and their (ending) balances.
Trial Balance
As of September 30, 20x1
Account # Account Name Debit Credit
Totals
concerned that you have made an error somewhere in
preparing or posting the journal entries to the T-accounts.
A classified balance sheet shows subtotals for current assets and current liabilities.
Balance Sheet
As of September 30, 20x1
Assets Liabilities and Shareholder
Cash Accounts Payable
Supplies Total Current Liabilities
Notes Payable
Total Liabilities
Total Current Assets
Equipment Contributed Capital
Total Assets Total
Note:
1. The current ratio liquidity ratio can be used to evaluate and measure performance.
2. Accountants provide advice either as an employee in a single organization (private accounting) or in a CPA firm
(public accounting) and is a popular career choice for college graduates.
3. Accountants may pursue a variety of certifications, including Chartered Professional Accountant (CPA),
Chartered Financial Analyst (CFA), Certified Fraud Examiner (CFE) and Certified Internal Auditor (CIA).
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