CHAPTER 1

Business
Decisions
and Financial
Accounting

© 2024 MCGRAW HILL

 YOUR LO1-1 Describe various organizational

LEARNI forms and business decision makers.

NG LO1-2 Describe the purpose, structure, and

content of the four basic financial
OBJECTI statements.

VES LO1-3 Explain how financial statements are

used by decision makers.

LO1-4 Describe factors that contribute to

useful financial information.

LO1-S1Describe examples of how

accounting helps in pursuing other business
careers.

LO1-S2 Describe the decision to become a

public company and explain the implications
for accounting.

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 UNDERSTAND THE
BUSINESS
There are three primary ways in which businesses can be organized:
1. Sole Proprietorship: A form of business owned by one
individual where all profits (or losses) become a part of the taxable
income of the owner who is personally liable for all debts of the
business.
2. Partnership: A form of business where the profits, taxes, and
legal liability are the responsibility of two or more owners instead of
just one. Partnership agreement determines distribution of
profits/capital.
3. Corporation: A form of business that is a separate entity from
both a legal and accounting perspective. This means that the corporation,
not its owners, is legally responsible for its own taxes and debts. Ownership
divided into units called shares of capital stock. Owners are
“shareholders” or “stockholders”
The only other form of business ownership is called a limited liability
partnership (LLP) where partners have limited liability.

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 Accounting for Business
Decisions
◦ Accounting is a system of analyzing, recording and
summarizing the results of a business’s activities and
then reporting the results to decision makers.

◦ Managerial accounting reports are used inside the

company. They include detailed financial plans and
reports about the operating performance of the
organization.

◦ Financial accounting reports are used outside the

company by creditors, investors, directors and
government. These reports are the financial
statements.

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 The Accounting System

The main goal of

EXHIBIT 1.1
an accounting The Accounting System Reports I nformation for Decision
system is to Makers
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.

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External and Internal Users,
and Uses of Financial
Statements

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 The Basic Accounting
Equation

Resources Owned . . . = Resources Owed . . .

by the company to creditors to shareholders
Assets = Liabilities + Shareholders’ Equity

The relationship between assets (A), liabilities (L),

and shareholders’ equity (SE) is called the basic
accounting equation.

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 Elements of the Basic
Accounting Equation
◦ An asset is an economic resource presently
controlled by the company; it has measurable
value and is expected to benefit the company
by producing cash inflows or reducing cash
outflows in the future.
◦ Cash
◦ Equipment

◦ Liabilities are measurable amounts that the

company owes to creditors.
◦ Purchases on account (accounts payable)
◦ Bank loans

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 Elements of the Basic
Accounting Equation

◦ Shareholders’ equity represents the

owners’ claims on the business. These claims
arise for two reasons:
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).

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 Financial Statements
Assets, liabilities, shareholders’ equity, revenues,
expenses, and dividends appear in different reports that
collectively are called financial statements. The
term financial statements refers to four accounting
reports, typically prepared in the following order:
1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows
Financial statements can be prepared at any time during the year,
although they are most commonly prepared monthly, every three
months (quarterly reports), and at the end of the year (annual reports).

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 1. The Income Statement
The body of the income statement has three major
captions – Revenues, Expenses, and Net Income
◦ Revenues are earned by selling goods or services to
customers.

◦ Expenses are all the costs of doing business that are

necessary to earn revenue.

◦ Net Income represents the Revenues - Expenses. This

is often called profit.

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 1. The Income Statement2
PRAIRIE PROUD Who: Name of the business
Income Statement (Projected) What: Title of the statement
For the Month Ended September 30, 2023 When: Accounting period

Revenues
Sales Revenue $11,000 Revenue earned from the sale of apparel to customers in September

Total Revenues 11,000 Total amount earned during September

Expenses
Supplies Expense 4,000 Cost of ink and other supplies used up in September

Salaries and Wages Expense 2,000 Cost of salaries and employee wages for work done in September

Rent Expense 1,500 Cost of rent for the month of September

Utilities Expense 600 Cost of utilities used in September

Insurance Expense 300 Cost of insurance coverage for September

Advertising Expense 100 Cost of advertising done in September

Income Tax Expense 500 Cost of taxes on September’s income

Total Expenses 9,000 Total expenses incurred in September to generate revenues

Net Income $ 2,000 Difference between total revenues and total expenses

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2. Statement of Retained
Earnings
This statement begins with the Retained
Earnings balance at the beginning of the period.

Next, the statement adds Net Income from the Income

Statement (Exhibit 1.3). (If there was a loss on the
Income Statement, the loss would have been
subtracted.)

Dividends for the current period are subtracted.

The Retained Earnings end of period balance is

calculated.

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 2. Statement of Retained
Earnings2

Explanation
PRAIRIE PROUD Who: Name of the business
Statement of Retained Earnings (Projected) What: Title of the statement
For the Month Ended September 30, 2023 When: Accounting period

Retained Earnings, September 1, 2023 $ 0 Last period’s ending Retained Earnings balance

Add: Net Income 2,000 Reported on the income statement (Exhibit 1.3)

Subtract: Dividends (1,000) Distributions to shareholders in the current period

Retained Earnings, September 30, 2023 $1,000 This period’s ending Retained Earnings balance

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 3. The Balance Sheet
The third financial statement created is the
Balance Sheet or Statement of Financial
Position.

The purpose of the Balance Sheet is to report

the amount of a business’s assets, liabilities,
and shareholders’ equity at a specific point in
time.

Assets = Liabilities + Shareholders’ Equity

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 3. Balance Sheet2
Explanation
PRAIRIE PROUD Who: Name of the business
Balance Sheet (Projected) What: Title of the statement
At September 30, 2023 When: Point in time

Assets Resources controlled by the company

Cash $14,000 Amount of cash on hand and in the business’s bank account
Accounts Receivable 1,000 Prairie Proud's right to collect from customers for sales provided on account
Supplies 3,000 Cost of ink and other supplies on hand
Equipment 40,000 Cost of printing press, dryer, etc.
Total Assets $58,000 Total amount of the company’s resources

Liabilities and Shareholders’ Equity Claims on the company’s resources

Liabilities Creditors’ claims on the company’s resources
Accounts Payable $ 7,000 Amount owed to suppliers for prior credit purchases (on account)
Notes Payable 20,000 Amount of loan owed to the bank (for promissory note)
Total Liabilities 27,000 Total claims on the resources by creditors
Shareholders’ Equity Shareholders’ claims on the company’s resources
Contributed Capital 30,000 Amount shareholders contributed for company shares
Retained Earnings 1,000 Total earnings retained in the business (Exhibit 1.4)
Total Shareholders’ Equity 31,000 Total claims on the company’s resources by shareholders
Total Liabilities and Shareholders’ Equity $58,000 Total claims on the company’s resources

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4. Statement of Cash Flows
This statement is divided into three types of activities:

Operating Activities:
These cash flows arise directly from running the business to earn
profit.

Investing Activities:
These cash flows arise from buying and selling productive
resources with long lives, purchasing investment and lending to
others.

Financing Activities:
These cash flows include borrowing from banks, repaying bank
loans, receiving cash from shareholders for company shares, and
paying dividends to shareholders.

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 4. Statement of Cash
Flows2
PRAIRIE PROUD
Explanation
Who: Name of the business
Statement of Cash Flows (Projected)
What: Title of the statement
For the Month Ended September 30, 2023
When: Accounting period
Cash Flows from Operating Activities Activities directly related to earning income
Cash Received from Customers $10,000 Cash received from customers
Cash Paid to Employees and Suppliers (5,000) Cash paid to employees and suppliers of goods/services

Cash Provided by Operating Activities 5,000 Cash inflows minus outflows ($10,000 − $5,000)

Cash Flows from Investing Activities Activities related to the sale/purchase of productive assets
Cash Used to Buy Equipment (40,000) Cash spent on equipment
Cash Used in Investing Activities (40,000)
Cash Flows from Financing Activities Activities involving investors and banks
Capital Contributed by Shareholders 30,000 Cash received from owners for company shares
Cash Dividends Paid to Shareholders (1,000) Cash paid to distribute profit to owners
Cash Borrowed from the Bank 20,000 Cash received on loan from the bank
Cash Provided by Financing Activities 49,000 Cash inflows minus outflows ($30,000 − $1,000 + $20,000)

Change in Cash 14,000 Sum of three categories of cash flows ($5,000 − $40,000 + $49,000)

Beginning Cash, September 1, 2023 0 Cash balance at the beginning of the accounting period

Ending Cash, September 30, 2023 $14,000 Cash balance reported on the balance sheet

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 Relationship Among the
Financial Statements
The four basic financial statements connect to one another.
1. Net Income, from the income statement, is a component in
determining ending Retained Earnings on the statement of retained
earnings;
2. Retained Earnings from the statement of retained earnings is
then reported on the balance sheet; and
3. Cash on the balance sheet is equal to the Ending Cash reported on
the statement of cash flows.

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 the EXHIBIT 1.7

Financia Relationships Among the Financial Statements

l
Stateme
nts2

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Summary of Four Basic
Financial Statements

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 EVALUATE THE RESULTS
The financial statements are a key source of information when
external users, like creditors and investors, make decisions
concerning a company.

Creditors are mainly interested in assessing the following:

• Is the company generating enough cash to make
payments on its loan? The statement of cash flows helps
answer this question. In particular, creditors are interested in
seeing whether operating activities are producing positive
cash flows.
• Does the company have enough assets to cover its
liabilities? Answers to this question will come from
comparing assets and liabilities reported on the balance
sheet.

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 EVALUATE THE RESULTS2

Investors expect a return on their contributions

to a company.
• The return may be immediate (through
dividends) or long-term (through selling shares at
a price higher than their original cost).
• Dividends and higher share prices are more likely
if a company is profitable. As a result, investors
look closely at the income statement (and
statement of retained earnings) for information
about the company’s ability to generate profits
(and distribute dividends).

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 Useful Financial
Information
•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).

•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).

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 Accounting Principles and
Rules
After much deliberation, the AcSB determined that one of
two different sets of accounting rules would be appropriate
for use in Canada.

• Publicly accountable profit-oriented enterprises, such as

lululemon and Loblaw Companies, 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).

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 Financial Reporting
Standards in Canada

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 Key Concepts for External
Financial Reporting
Objective of external financial reporting is to provide
useful financial information to external users for
decision making.

◦ It must be relevant and a faithful

representation of the business.

◦ The usefulness of financial information is

enhanced when it is: timely, verifiable,
comparable, and understandable.

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Key Concepts for External
Financial Reporting

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 Ethical Conduct

Ethics refers to the standards of conduct for judging

right from wrong, honest from dishonest, and fair from
unfair. Intentional financial misreporting is both unethical
and illegal.
CPA Canada requires that all its members adhere to a
Code of Professional Conduct.
When faced with an ethical dilemma, a three-step
process should be followed:

1. Identify who will be affected by the situation.

2. Identify the alternative courses of action.
3. Choose the alternative that is the most ethical.

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 Environmental, Social and
Corporate Governance (ESG)

ESG frameworks are used to assess an organization’s

business practices and measure performance on
sustainability and ethical impact of a company’s
operations.
The Canadian Securities Administrators (CSA) plan to
start requiring disclosures in 2024 for large Canadian
banks, insurance companies, and federally regulated
financial institutions. This requirement will expand to
other industries as the requirements are updated.

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Supple
ment 1A

Exhibit 1S.1 provides

samples of non-
accounting jobs that
could be available to
you at the world’s
leading companies
and explains how
accounting
knowledge can be
vital to these
positions.

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 There are advantages to being a public
company but some of the
disadvantages are:
1. Greater public reporting of
Supplem significant events affecting the
company
ent 1B
2. Increased accounting disclosures
3. Greater risk of litigation for
If a company misstatements in and omissions
needs more from public company financial
financing than it reporting
can privately
access, an option 4. Frequent updates about their
is to go public so business through press releases,
it can choose to financial statement reports,
issue its shares to and various filings with the
investors on a Canadian Securities Administrators
public stock (for Canadian publicly traded
exchange through companies) or the Securities and
an initial public Exchange Commission (for
offering (IPO). companies publicly traded in the
United States)
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 Supplement 1B - Press
Releases
The company must announce annual (and quarterly)
results through a press release sent to news agencies.
It typically includes:
oHighlights of key financial results for the period
oManagement’s discussion of these results
oAttachments containing a condensed income
statement and balance sheet
The press release is issued three to five weeks after the
accounting period ends and many companies follow up
with a conference call broadcast on the Internet, which
allows analysts to ask questions to senior executives.

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 Supplement 1B - Financial
Statement Reports
Several weeks after the preliminary press release, a public
company releases its completed financial statements as part
of an annual (or quarterly) report.
The report begins with a letter to investors from the CEO,
followed by comments about the company’s business and a
financial section outlined in Exhibit 1B.1.
The annual report includes the following items: Summarized
financial data, management’s discussion and analysis
(MD&A), management’s report on internal control, auditors
report, comparative financial statements and notes to those
statements, recent stock price data, and a list of directors
and officers.

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 Chapter 1 Summary
◦ There are various organizations forms: sole
proprietorship, partnership and corporation.

◦ There are various business decision makers:

creditors, investors, customers, government and
other external users.

◦ There are four basic financial statements: income

statement, statement of retained earnings,
balance sheet and statement of cash flows.

◦ Financial statements are used by decision makers

to assess credit worthiness and a company’s
ability to generate profits and distribute dividends.
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 Chapter 1 Summary2
◦ Companies generate useful financial information
by applying GAAP and using either IFRS or ASPE,
depending on the type of enterprise involved.

◦ Accounting knowledge can be vital to finding non-

accounting jobs with the world’s leading
companies.

◦ Companies needing additional financing may go

public. There are additional reporting requirements
for public companies that need to be researched
prior to the initial public offering.

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