Assets = Liabilities + Equity
Examples of Assets –
Licenses, franchise rights, patents
Investment in other businesses
Examples of Liabilities –
Salaries & Wages Payable
Examples of Equity –
Share Capital (e.g. Common Shares)
1 1. What are the three different forms of business organizations? What are the
advantages and the disadvantages to each of these forms?
Two different forms only: Business entities and Non-business entities
Business entities consist of: sole proprietorship, corporation and partnership
Business entities are organized to earn income
1. Sole Proprietorship
(1).  No organizational formalities.
(2).  Decision making is informal and centered in the owner.
(3).  No qualification requirements for doing business in other states.
(4).  Minimal reporting to governmental entities.
(5).  Business profits are subject to only one tax, at the individual level, and are not
subject to double tax as would be the case if the profits were realized by a C corporation.
(6).  Losses are available on the owner's personal income tax return and can offset
other income (subject to the passive loss rules).
(1).  Owner has unlimited liability for obligations and liabilities of the business.
(2).  Death or disability of owner terminates business.
(3).  Sale or other transfer of business requires transfer of individual assets.
(4).  No opportunity to utilize equity capital contributed by persons other than the
(5).  Business profits are taxed as income to the owner and, as a result, will be subject
to self-employment tax as well as income tax.
(1).  Multiple owners can provide a combination of individual resources and talents.
(2).  Minimal formalities are required for organization.
(3).  Decision making may be informal.
(4).  No qualification requirements for doing business in other states.
(5).  Minimal reporting to governmental entities.
(6).  Business profits are subject to only one tax, at the individual partner level, and
are not subject to double tax as would be the case if the profits were earned by a C
(7).  Losses are available on the partners' personal income tax returns and can offset
other income (subject to the passive loss rules).
(8).  Special allocations may be made for income tax purposes.
(9).  Disproportionate distributions may be made to partners.
(1).  Partners have unlimited liability for obligations and liabilities of the business.
(2).  Death, disability, or withdrawal of a partner may terminate partnership.
(3).  All partners have the right to participate in management.
(4).  All partners have broad authority to act on behalf of, and incur debts and
liabilities for, the partnership.
(5).  Business profits are taxed as income to the individual partners and, as a result,
may be subject to self-employment tax as well as income tax.
2 a. Advantages:
(1).  All shareholders enjoy limited liability.
(2).  Ownership interests are freely transferable.
(3).  Perpetual existence unaffected by the death of shareholders or transfer of shares.
(4).  Centralized management.
(5).  No limitation on the number or types of shareholders.
(6).  Flexibility of financing is available through the sale of various types of securities
to many investors.
(7).  Tax-favored fringe benefits are available to employee-shareholders.
(8).  Income is taxable at corporate rates, which are for the most part for the most part
lower than individual rates.
(9).  Noncorporate shareholders may qualify for an exclusion from federal income tax
of one-half of the capital gains realized on stock of a small business corporation organized
as a C corporation.
(1).  Formalities are required for organization and operation.
(2).  Qualification is required for doing business in other states.
(3).  Regular reporting to governmental entities is required.
(4).  Stock transfers are subject to securities law regulation.
(5).  Income is subject to double taxation.
(6).  Losses of business may not be deducted by individual shareholders.
(7).  The distribution of property by a C corporation to its shareholders is generally a
taxable event for income tax purposes as to both the corporation and the shareholders.
Thus, withdrawing property from a corporation can be extremely expensive from a tax
Non-business entities: organizations operated for some purpose other than to earn a
profit; hospitals, governments etc
Not sure about the advantages and disadvantages
2. Define the three business activities of a company and provide examples of each of
(1) Financing Activities: allocates the money needed to start a business ex. Issuance of
long-term debt, reduction of long-term debt, issuance of common shares, repurchase
of common shares and dividends paid
(2) Investing Activities: investing in productive assets ex. Property additions,
acquisitions, sale of central station complex, sale of investment
(3) Operating Activities: operations which satisfy the purpose of the business ex. Net
income, depreciation and amortization, differed income taxes, gain on sale, accounts
receivable, material and supplies, accounts payable and accrued charges and other net
current assets and liabilities
3. What is the purpose of financial accounting?
To communicate with outsiders through financial statements
4. Who are the primary users of accounting information?
Shareholders and potential shareholders
Bondholders, bankers, and other creditors
3 Government agencies
Other external users
5. What is the purpose of each of the financial statements? How are the financial
(1) Income Statement: summarizes revenues and expenses
(2) Statements of Retained Earnings: summarizes the incomes earned and dividends paid
over the life of a business
(3) Balance sheet: summarizes the assets, liabilities, and shareholders’ equity at a specific
They are interrelated because the net income allocated from the income statement is used
on the statement of retained earnings to calculate ending balance [total retained earnings]
and then the retained earnings is used on the balance sheet to calculate the total liabilities
and shareholders’ equity
6. What is the accounting equation and how is it connected to the financial statements?
The accounting equation is the foundation of the entire accounting system
It is connected to the financial statements because it builds up the balance sheet?
7. You are deciding whether to invest in a company shares. Which financial statement
would you want to see, and which areas would you be most interested in?
I would see the balance sheet and be most interested in the shareholders’ equity and the
amount of common shares
8. What is the conceptual framework and why is it important?
Conceptual framework aids accountants in their role as interpreters and communicators
of relevant information
Its purpose is to act as a foundation for specific principles and standards needed by the
Important part of conceptual framework is the assumptions accountants make in
preparing financial statements
Assumptions include: cost principle, going concern, monetary unit etc? [or they are only
9. Define the cost principle. Give an example of when the cost principle has been
violated. Define the going concern assumption. What other principle is interrelated
with the going concern assumption?
(1) Cost Principle: Assets are recorded at the cost to acquire them. The cost principle has
been violated by companies who do not carry assets at their market value, but at their
original cost referred to as historical cost
(2) Going Concern: the assumption that the entity is not in the process of liquidation and that
it will continue indefinitely – the monetary unity is interrelated with the going concern
10. Define the monetary unit assumption. Give an example of when it has been violated.
(1) Monetary Unit: the yardstick used to measure amounts in financial statements; the dollar.
It has been violated because it is subject to instability and will lose value within 10 years
11. Define the time period assumption. How is this assumption connected to accrual
(1) Time Period: artificial segment on the calendar, used as the basis for preparing financial
4 statements. This assumption connects to accrual accounting because accrual accounting is
recorded when revenue is earned which would fall under the artificial segment on the calendar.
12. What are generally accepted accounting principles?
The various methods, rules, practices, and other procedures that have evolved our time in
response to the need to regulate the preparation of financial statements
13. What are the five categories in the financial statements? What are the
characteristics or attributes of each of these five categories? Why is an
understanding of each of these categories and their characteristics important when
creating the financial statements?
(1) Assets: a future economic benefit to an organization
(2) Revenue: inflows of assets resulting from the sale of products and services
(3) Expense: outflows of assets resulting from the sale of goods or services
(4) Liability: obligation of a business
(5) Retained earnings: the part of the owners equity that represents the income earned less
dividends paid over the life of an entity
They are important because they provide the information needed to create the financial
Working Capital = Current Assets – Current Liabilities
- Current assets – anything other than supplies used, land, buildings, investments,
- Current Liabilities – anything other than bonds, and notes payable (over a year)
Current Ratio = Current Assets / Current Liabilities
- Ratio used to allow us to compare the liquidity of companies of different sizes
and of a single company over time. i.e. almost a 2 to 1 ratio for Dixon Sporting
Profit Margin = Net Income / Sales
- i.e Dixon Sporting goods 41000/ 357500 = 11%. So for every dollar of Sales,
Dixon has $0.11 in net income.
Balance Sheet – Shows all assets, liabilities, and equity.
Income Statement (Single-Step Format) – shows all expenses subtracted from all revenues to
display net income
5 Statement of Retained Earnings – shows retained earnings at the beginning of the year, adds the
net income of the year and then subtracts the dividends
declared and paid to give you the final retained earnings at the
end of the year.
1. What is the objective of financial reporting?
(1) The primary objective: provide information for decision making
(2) Supporting objective: assist with the prediction of cash receipts to investors and creditors
(3) Supporting objective: reflect the management’s stewardship of resources and claims to
2. What makes accounting information useful? List the qualitative characteristics that
underlie all financial statements. Define each of the qualitative characteristics.
The qualitative characteristics make it useful
(1) Understandability: the quality of accounting information that makes it comprehensible to
those willing to spend the necessary time
(2) Relevance: the capacity of information to make a difference in a decision
(3) Reliability: the quality that makes accounting information dependable in representing the
events that it purports to represent
a. Verifiability: info that is free from error
b. Representinal faithfulness: corresponds to actual event
c. Neutrality: neutral info – not slanted to bad or good
d. Conservatism: information that is uncertain
(4) Comparability: the quality that allows a user to analyze two or more companies and look
for similarities and differences
(5) Consistency: the quality that allows a user to compare two or more accounting periods of
a single company
(6) Materiality: the magnitude of accounting information omission or misstatement that will
affect the judgement of someone replying on the information
(7) Benefits versus cost constraint: benefits should exceed costs of providing information
3. What is depreciation?
The process of allocating the cost of a long-term tangible asset over its useful life. Also
4. What is materiality and why is it important for the financial statements?
Materiality: the magnitude of accounting information omission or misstatement that will
affect the judgement of someone replying on the information
Ex: Pens not important to count for in cost, but computer is important
5. What is the benefit versus cost constraint. How may this affect how a company
It is: benefits of accounting information should exceed the cost of providing it
Do not know how it affects company
6. What is a classified balance sheet and why is it important? Why do companies
produce classified balance sheets?
A classified balance sheet is a balance sheet which includes current and non-current
assets and current liabilities and long-term liabilities
Companies produce them because they provide details on current and non current assets
6 7. Define current assets. Define noncurrent assets. Define current liabilities and long-
term liabilities. What is shareholders equity?
Current assets: an asset that is expected to be realized in cash or sold or consumed during
the operating cycle or within one year if the cycle is shorter than one year
Noncurrent assets: any assets that do not meet the definition of a current asset
Current liabilities: an obligation that will be satisfied within the next operating cycle or
within one year if the cycle is shorter than one year
Long-term liabilities: any obligation that will not be paid or otherwise satisfied within the
next year of the operating cycle
Shareholders’ equity: the owners’ claims on the assets of the business. Claims arise from
2 sources: contributed capital and retained earnings
8. What is the purpose of the income statement? Is the income statement for a point in
time or a period of time? What is the single step income statement?
The purpose is to summarize the results of operating of an entity for a period of time
It is for period time
Single step income statement: an income statement in which all expenses are added
together an subtracted from all revenues
9. What is the purpose of the statement of retained earnings? What is included on the
statement of retained earnings?
Purpose if to explain the changes in the components of owners’ equity during the period
Retained earnings and capital stock are included on the statement
10. What is the purpose of the cash flow? What are the three activities that we will see
on the cash flow statement?
purpose is to summarize the cash flow effects of a company’s operating, investing, and
financing activities of the period.
Two types of events affect an entity: internal and external.
• An external event involves interaction between the entity and its environment. For
example, the payment of wages to an employee is an external event, as is the hiring
of a new sales manager.
• An internal event occurs entirely within the entity. The use of a piece of equipment
is an internal event.
We will use the term transaction to refer to any event, external or internal, that is
recognized in a set of financial statements.
Transactions typically include the following two types of events:
1. An external event that involves exchange of assets and liabilities between the entity
and external parties. Examples of such external events include paying a monthly
7 utility bill, selling merchandise to a customer, or issuing shares to new shareholders.
2. An internal event, where the effects on the entity can be reliably measured.
Examples of such events include using materials and equipment to manufacture a
product, incurring losses due to natural disaster, or accruing interest on a bank loan.
Source document - provides the evidence needed in an accounting system to record a transaction.
Source documents take many different forms. An invoice received from a supplier is the source document
for a purchase of inventory on credit. A cash register tape is the source document used by a retailer to
recognize a cash sale. The payroll department sends the accountant the time cards for the week as the
necessary documentation to record wages.
1. What is the difference between an event and a transaction? Which one is recorded on
the financial statements and which is not?
(1) Event: a happening of consequence to an entity
a. Internal: occurring within the entity
b. External: involving interaction between an entity and its environment
(2) Transaction: any event that is recognized in a set of financial statements
Transaction is recorded on financial statements
2. What is the cost principle? Give an example of when the cost principle would be
Requires that we record an asset at the cost to acquire it and continue to show this amount
on all balance sheets until we dispose of the asset
Would be violated when the asset is not carried at market value, but at its original cost
Realizable value - The amount of cash, or its equivalent, that could be received by selling an asset
Historical cost – The amount paid for an asset and used as a basis for recognizing it on the balance sheet
and carrying it on later balance sheets.
Recognition – The process of including an item in the financial statements of an entity.
8 Cash basis A system of accounting in which revenues are recognized when cash is received and expenses
when cash is paid.
Accrual basis A system of accounting in which revenues are recognized when earned and expenses when
The basic formula for computing interest follows:
I = P x R x T
I - the dollar amount of interest
P - the principal amount of the loan
R - the annual rate of interest as a percentage
T - time in years (often stated as a fraction of a year).
The total interest on Granger’s loan is as follows:
9 $20,000 = 0.09 x 3/12 x $450
Alternatively, the formula for finding the total interest on the loan can be modified to
compute the interest for one month:
$20,000 = 0.09 x 1/12 x $150
At the beginning of January, Glengarry acquired exercise equipment and issued a $100,000 note as part of
the payment. The note has an 18-month term and a 9% interest rate. Although interest will not be
repaid until the loan’s maturity date, Glengarry must accrue interest for the first month. The calculation of
interest for one month is
$100,000 x 0.09 x 1/12 = $750.
The adjusting entry is as follows:
(a) Interest Expense 750
Interest Payable 750
To record interest for one month on 9