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Lecture Notes CH1.pdf

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Instructor's Resource Manual for Harrison et al., Financial Accounting, 5ce
Copyright © 2015 Pearson Canada Inc.
1 - 1
After studying Chapter 1, you should be able to:
1. Explain why accounting is the language of business
2. Explain accountings conceptual framework and underlying assumptions
3. Describe the purpose of each financial statement and explain the elements of each one
4. Explain the relationships among the financial statements
5. Make ethical business decisions
Instructor's Resource Manual for Harrison et al., Financial Accounting, 5ce
Copyright © 2015 Pearson Canada Inc.
1 - 2
OBJECTIVE 1: Explain why accounting is the language of business
A. Accounting is an information system that measures business activities, processes data into
reports, and reports results to decision makers. Exhibit 1-1 illustrates the flow of information
in an accounting system. Financial statements report this information to users.
B. Accounting information is used by
1. Managers to set goals, evaluate those goals, and take corrective action.
2. Investors to decide whether to invest in a business or evaluate an investment.
3. Creditors to evaluate a borrower’s ability to make required payments.
4. Government and regulatory bodies such as Canada Revenue Agency (CRA) to ensure
organizations pay the correct amount of taxes.
5. Individuals to make investment decisions and/or manage a bank account.
6. Not-for-profit organizations, which use accounting information in virtually the same
way as profit organizations.
C. Accounting information can be classified into two categories:
1. Financial accounting provides information for managers inside the business and for
decision makers outside the organization, such as investor and creditors.
2. Managerial accounting generates inside information for internal use by management.
D. Types of business organizations (summarized in Exhibit 1-2):
1. Proprietorshipan unincorporated business with a single owner. The owner has
unlimited liability which means that the owner assumes personal responsibility for the
debts of the business.
2. Partnershipan unincorporated business with two or more owners. Each partner has
unlimited liability.
3. Corporationan incorporated business owned by shareholders whose ownership is
evidenced by the number of shares held. Shareholders elect the members of the board of
directors, which sets policy for the corporation and appoints officers. A shareholder has
limited liability. A corporation is distinct from its owners and has many of the rights
entitled to a person.
Instructor's Resource Manual for Harrison et al., Financial Accounting, 5ce
Copyright © 2015 Pearson Canada Inc.
1 - 3
OBJECTIVE 2: Explain accounting’s conceptual framework and underlying assumptions
A. Generally Accepted Accounting principles (or GAAP) are the professional guidelines that
govern how accountants record, measure, and report financial information.
1. The Canadian Institute of Chartered Accountants (CICA) establishes GAAP.
2. There are multiple sets of GAAP and each is applicable according to the type of entity or
a. Publicly accountable enterprises (PAEs) must apply International Financial
Reporting Standards (IFRS) which are standards set by the International
Accounting Standards Board (IASB) to enhance the comparability of financial
information reported by public enterprises around the world. IFRS was effective
January 1, 2011 for Canadian public companies.
b. Private enterprises apply the Accounting Standards for Private Enterprises
(ASPE). However, private enterprises have the option of using IFRS or ASPE.
c. Other sets of GAAP are applicable to not-for-profit organizations, pension plans and
government entities.
3. A summary of IFRS-ASPE differences is presented at the end of the chapter.
B. The overall objective of financial reporting is to provide useful information to users to make
investing and lending decisions. The characteristics of useful information include: relevance,
faithful representation, comparability, verifiability, timeliness and understandability. (Exhibit
1-3 provides an overview of accountings conceptual framework.)
1. The relevance characteristic must be considered to ensure the financial statements
provide information to the user that is useful. To be relevant, financial information must
provide predictive and/or confirmatory value and must be material in nature or magnitude
that omitting or misstating it could affect the decisions of an informed user.
2. The faithful representation (or reliability) characteristic states that accounting records
should be based on accurate data. The actual cost of assets or services is usually more
reliable than market value.
NOTE: Consider the conflict between information that is timely (based on
estimates) and reliable that may require additional time to ensure accuracy
that may render the statements irrelevant.
C. There are four accounting assumptions underlying the conceptual framework.
1. The going-concern assumption assumes that the entity will remain in operation for the
foreseeable future. The market values of assets may vary from year to year, and for
this reason cost is deemed to be preferable to market value for measurement
2. The separate-entity assumption states that each entity is an economic unit and is kept
separate from other entities including the activities of its owners.
Assume that you own three businesses and maintain one chequebook for all three. How can this
situation prevent you from maximizing your profits? (If one or two of the businesses are
unprofitable, then you would make more money without them. However, you would have no way
of knowing.) The entity concept would require a separate set of records for each business.
3. The historical-cost assumption states that assets should be recorded at actual cost.

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Instructors Resource Manual for Harrison et al Financial Accounting 5ce LEARNING OBJECTIVES After studying Chapter 1 you should be able to 1 Explain why accounting is the language of business 2 Explain accountings conceptual framework and underlying assumptions 3 Describe the purpose of each financial statement and explain the elements of each one 4 Explain the relationships among the financial statements 5 Make ethical business decisionsCopyright2015 Pearson Canada Inc 11
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