Financial Accounting

Chapter 1:
 The core of financial accounting is based on the basic financial statements:
o Income statement (statement of profit or loss)
o Statement of retained earnings (included in the statement of changes
in owners’ equity)
o Balance sheet (statement of financial position)
o Cash flow statement
o Statement of other comprehensive income
 Financial statement: reports used to communicate their financial results of
the business to different groups such as investors, managers, and more.
Usually these groups will then use the information to whether invest or not.
 Why “accounting is the language of business”
o Accounting is an information system that records business activities,
then process data into reports and report them to various groups to
make decisions.
o Key to make better decisions.
o Produces financial statements
o Bookkeeping is the mechanical part of accounting
o Starts and ends with people’s decision making
 Accounting
o Almost everyone uses accounting
o Two types of accounting:
 Financial accounting
 Provides information for managers inside the business
and for decision makers outside the organization
 Management accounting
 Provides inside information for the manager of the
organization
 Business usually takes the forms of:
o Proprietorship
 An unincorporated business with a single owner known as the
proprietor
 Small business or individual
 Business records come from the proprietor, but does not
include personal finances
o Partnership
 An unincorporated business with two or more co-owners
 Not a taxpaying entity, but take equally share of the income
and pay tax base on their own or corporate rate.
 Can be quite risky
o Corporation
 An incorporated business owned by its shareholders, who own
shares of the partial ownership of the corporation.
  The ability to raise large sums of capital by issuing shares to
the public.
 Formed under federal or provincial law
 The shareholders have no personal responsibility over its debt,
have limited liability
 Corporation pays income taxes
 Any investor can buy the shares through the stock to become a
co-owner of the corporation
 Shareholders elect the member of the board of directors
 Set policy for the corporation and appoints officers
 Selects a chairman who’s powerful enough to carry the
title chief executive officer (CEO)
 Generally accepted accounting principles (GAAP) are financial accounting
information prepared by the accountants according to professional
guidelines
o Set to guidelines for the accountants to measures, report, and record
for the financial information
o Publicly accountable enterprises (PAEs)
 Corporations and other organizations that have issues or plan
to issue shares or debt in public markets
o International financial reporting standards (IFRs)
 Set by the international accounting standards board and have
been adopted by countries to enhance the comparability of the
financial information reported by public enterprises
o Private enterprises
 Have not issued and do not plan to issue shares or debt on
public markets
 Apply another set of GAAP known as Accounting standards
for private enterprises (ASPE)
 Accounting’s conceptual framework
o Provides the foundation for the specific accounting principles
included in IFRS and ASPE
 Though some small differences between the two frameworks
o Overall objective of accounting is to provides financial information
about the company that would be useful for current and future
investors and creditors when making investing and leading decisions
 Fundamental qualitative characteristics; must have two:
o Relevance
 Must have predictive value, confirmatory value or both
 Has a predictive value so the users can predict an
entity’s future business or financial outcomes
 Has a confirmatory value to confirms or changes prior
evaluations of an entity
 o Information must be material, which it is
significant enough that omitting or misstating it
could affect the decisions of an informed user
o All material information must be recorded in the
financial statements
o Faithful representation
 Must reflect the economic substance of a transaction or event,
which may not be the same as its legal form
 When presented to people it must be in reliable form
 Accounting information must possess four enhancing qualitative
characteristics:
o Comparability
 Must be possible/similar to compare with other companies’
 Consistent
o Verifiability
 Checked for accuracy
 Reflects a faithful representation
o Timeliness
 Report in time to the users for them to make their decisions
o Understandability
 Must be clear with reasonable knowledge
 Management is responsible for preparing accounting information
 Going-concern assumption
o Prepare financial information under the assumption that the
reporting entity is a going concern, which means that the corporation
will run normally
 Separate-entity assumption
o Under the assumption that the business activities of the reporting
entity are separate from the owners’ activities
 Historical-cost assumption
o States that assets should be recorded at their actual cost, measured on
the date of purchase as the amount of cash paid plus the dollar value
of all non-cash consideration also given in exchange
o Cost is a verifiable measure that is relatively free from bias
o Fair value is the amount they can sell the assets for
 Stable-monetary-unit assumption
o Reported under the assumption that the currency is stable
 Income statement (statement of profit or loss) measure a company’s
operating performance for a specified period of time
o Has two elements: income and expenses
 Income
o Both revenue and gains
 Revenue consists of amounts earned by a company’s activities,
earn through the sale of goods and services
  Gains represent other items that result in an increase in
economic benefits to a company and may or may not occur in
company’s business activities; usually reported separately in
an income statement
 Expenses
o Consists of losses and expenses that incurred in business activities
 Purchasing the goods and services that a company needs to run
its day-to-day basis
 Losses are opposite of gains, results in decrease in economic
benefits to a company
 The income statement also reports the company’s net income;
o Net income = total revenues and gains - total expenses and losses
 Net refers to the left over or deducted form the initial value
 When the total expenses exceed the total income, it will be net loss
 Net income is known as net earnings or net profit (most important in the
financial statement)
 Retained earnings represent that accumulated net income of the company
since the day it stated business
o When the accumulated amount is negative, the term deficit is used to
describe it
o Statement of retained earnings reports the changes in a company’s
retained earnings during the same period covered by the income
statement
 Balance sheet measures financial position
o Financial position consists of:
 The assets it controls
 The liabilities it is obligated to pay
 The equity its owners have accumulated in the business
o All reported in the balance sheet
o Reports a company’s financial statement as at a specific date
o The assets reported in the balance sheet must always be equal or be in
balance with the sum of the liabilities and equity it reports
 Known as accounting equation, provides the foundation for the
double-entry method of accounting
 Assets
o A resource controlled by the company as a result of past events and
from which the company expects to receive future economic benefits
o Two categories of assets on the balance sheet
 Current assets
 When expected to convert it to cash, sell it or consume it
within one year of the balance sheet date
 Listed in the order of their liquidity, which measure
how quickly they can be converted to cash
 Non-current assets
 Long-term assets
 Liabilities
o The responsibility 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
o Classify liabilities as current liabilities or non-current liabilities
 Current liabilities are debts the company expects to pay off
within one year of the balance sheet date or longer based on
the company’s operating cycle
 Non-current liabilities
 Long-term liabilities
 Debts that are expected to pay off beyond one year from
the balance sheet date
 Owner’s equity
o Owner’s remaining interest in the assets of the company after
deducting al its liabilities
o Owner’s claim on the company’s assets net of company’s liabilities,
sometimes refer to as the net assets of the company
o Owner’s equity = Assets – liabilities
 Statement of cash flows reports a company’s cash receipts and cash
payments for the same fiscal period covered by the income statement
o Operating activities
 Comprise the main revenue-producing activities of a company,
and generally result from the transactions and other events
that determine net income
o Investing activities
 Include the purchase and sale of long-term assets and other
investments that result in cash inflows or outflows related to
resources used for generating future income and cash flows
o Financing activities
 Result in changes in the size and composition of a company’s
contributed equity and borrowings
 Include the issuance and acquisition of shares, the payment of
cash dividends, the cash proceeds from borrowings, and the
repayment of amount borrowed
 Note to the financial statements are an integral part of the financial
statements