Forms of organizations:
sole proprietorship: 1 owner
-one example of economic entity concept
-it is not a taxable entity (any income earned by the business is taxed on the tax return of
partnership: 2 or more owners
-need an agree as to how much each will contribute to the business and how they will divide
-agreement is formalized in a written document
-not a taxable entity, the individual partners pay taxes on their proportionate shares of the
income of the business.
corporation: many owners
-ownership based on shares
-organized under province or federal government
-limited liability is a disadvantage
-advantage: makes it possible to raise larger amounts of money in a relatively brief period of
-once approved by government, a corporate charter is issued and the corporation can begin
to issue shares
-to raise money the company can sell a specific type of security called shares.
-another type of security called a bond or debenture.
-ease of transfer of ownership in a corporation is another advantage.
-both proprietors and general partners usually can be held personally liable for the debts of
When a business has unlimited liability the amount the owners can lose is NOT limited in
Business entities are generally organized by income (commonly termed a profit)
Non Business entities generally exist to serve various segments of society.
Individuals come together to pursue goals. The result of this gathering is called an
organization. All organizations require finances and must make financial decisions.
Accounting is often referred to as the language of business Non Business Entities: organized for a purpose other than to earn an income.
- to serve the needs of various segments in society
-distinguised by lack of an identifiable owner
-the lack of an identifiable owner and the profit motive changes to some extent the type of
accounting used by non-business entities called fund accounting
Organizations and Social Responsibility
- non-business entities are organized specifically to serve members of society
-business entities also have become more sensitive to their broader social responsibilities
-most large corporations recognize the societal aspects of their overall mission and have
established programs to meet their socials responsibilities
Types of Business Activities
-all business must start with financing
-money is needed to start a company
-financing activities bring up 2 important accounting terms: Liabilities and Capital Stock
-liabilities “payable” is and obligation of a business
-capital stock indicates dollar amount of shares sold to the public
-capital stock differs from liabilities in one very important way: those who buy shares in a
corporation are not lending money to the business, as are those who buy bonds in a
company, or who make a loan in some other form to the company.
-someone who buys shares and is providing a permanent form of financing to the business.
-There is no due date as to when the shareholder will get repaid.
-only way to get back your money is to sell your shares to someone else
-someone who buys bonds in a company or in some other way makes a loan to it is called a
- a creditor does not provide a permanent form of financing, expects repayment of the
amount loaned, in many instances, payment of interest for the use of the money as well.
-an asset is a future economic benefit to an organization, money spent on certain assets is
classified as investing.
-example property of land, buildings, and equipment, also purchases of some companies
such as BC Rail and Great Lakes Transport.
-when a company sells their old equipment it would be considered an investing activity
-once funds are obtained from financial activities and investments are made in productive
assets, a business is ready to begin operations.
-purpose of some businesses is to sell products, others is to provide services.
-some companies sell both products and services.
-a name for the sale of products and services is revenue -revenue represents the dollar amount of sales of products and services for a specific period
-a specific names for the costs incurred (to acquire or come into) in operating a business is
called an expense
What is accounting?
The process of identifying, measuring, and communicating economic information to various
Users of accounting:
-primarily the managers of a company, are involved in the daily affairs of the business.
-have access to majority of information
-management accounting: providing internal users (management) with information to
facilitate planning and control.
-don’t have unlimited access to info to make decisions
-must rely on information presented to them by management of a company
-financial accounting: communication with outsiders through financial statements
Income Statements: reports the results of operations for a specific period of time
- revenues – expenses = net income
- net income is transferred to statement of retained earnings
- revenue should be recognized when earned (good delivered/ service provided). Examples:
sales, fees, commission, rent, interest.
- expenses should be matched to the revenues they help to generate. They are the costs of
assets consumed or the costs of services used. Examples: cost of goods sold COGS,
salaries and wages, and depreciation.
Statement of Retained Earnings: reports the changes in retained earnings for a specific
period of time *always from the beginning* i.e. net income (+), dividends (-).
Retained Earnings: collection of all incomes
Beginning Balance R/EB
+ net income NI
- dividends D
Ending Balance R/E E
Ending Balance now becomes a beginning balance for the following year. Also is on the
balance sheet under Equity. Balance Sheet: financial position at a specific date i.e. assets, liabilities, shareholders
Assets = Liabilities + Shareholders Equity
*Both sides must be balanced* Assets: has future economic benefits
-controlled (usually owned, but not necessarily) by the entity
-may be tangible (e.g. physical item) or intangible (e.g. legal rights)
Cash Buildings, property
Inventories Licenses, franchise rights,
Prepaid Expenses Investment in other businesses
Liabilities “Payable”: Examples:
-owned to 3 parties (external) -Accounts Payable -Taxes Payable
-due at a future date -Loan Payable -Mortgage Payable
-Accrued Liabilities -Salaries & Wages Payable
-may settled in cash, goods, or services.
Equity: belongs to owners (shareholders in case of corporation.
-NOT equal to value / worth of an enterprise
-paid out to shareholders most commonly as dividends OR retained in company for future
-Share Capital (e.g. Common Shares)
-Retained Earnings Chapter 2
Objective for Financial Reporting: provide info for decision making.
Primary Objective: provide info
Principles, assumptions and constraints:
-These are what accountants follow to ensure the qualitative characteristics are met and the
information provided is useful.
-characteristics of information that users WANT because it makes information useful
Understandability: to those willing to take the time to understand it
Relevance: has capacity to make a difference
Reliability: represents what it is supposed to
-verifiability: free from error (bank statement)
-representational faithfulness: info that corresponds to an actual event
-neutrality: info should not be slanted in any way
-conservatism: when in doubt, error on negative side.
Comparability: between companies
Consistency: from one period to the next Materiality: will it make a difference to the decision maker? Size of Error, impact (not about
Benefit vs. Cost: benefit of accounting information should exceed its cost (benefits exceed
cost). Overload of info may not be useful
Financial Statement Assumptions
economic entity concept: separate companies of the same company has own financial state
cost principle: what has been paid for it
going concern: expecting to continue
monetary unit: measuring unit i.e. Canadian dollar
time period: time period of the same length
Original value – accumulated depreciation = net book value
-Assets expected to be converted to cash or sold/used up/consumed in the business within
the year of the balance sheet date.
-Listed in order of liquidity (how fast that happens!)
Examples: Cash, Short-term investments, Accounts Receivable, Inventories, Prepaid
Long Term Assets:
-Assets expected to be converted to cash or sold/used up/consumed in the business over
more than one year.
-Used in the OPERATION of the business to help generate revenue.
-Divided between: Long-Term Investments, Property, Plant, and Equipment, Intangible
-Obligations that are to be settled within 1 year
-Paid in cash or goods or services -Listed in order of how soon paid
Examples: A/P, Wages Payable, Current Portion of Bank Loan, Taxes Payable
Long Term Liabilities:
-Obligations that are due BEYOND 1 year or over several periods (years)
-Paid in cash
Examples: Bank loans Payable, Mortgages Payable, Notes Payable
-Owed to shareholders
-Made up of 2 accounts: Common shares & Retained earnings
-All components of Equity are classified as “long-term”.
-There is no change to how this section is shown on the Classified Balance Sheet.
Current assets pay off current liabilities
Current Ratio: Current Assets (CA)__ 258750
Current Liabilities (CL) 120465
This ratio means that we have $2.15 CA to pay off $1 in CL (2 :1)
Single Step Income Statement: group all accounts as either revenues or expenses (no sub-
*PREPAID are NOT expenses they are asset accounts.
GAAP: Generally Accepted Accounting Principles
- The various methods, rules, practises, and other procedures, that have evolved over
time in response to the need to regulate the preparation of financial statements.
External Events: interaction between an entity and outside environment
Internal Events: interaction within entity
Event vs. Transaction
-if an event is measureable and realized then it’s a transaction.
-Only transactions are recorded.
Source Documents: evidence needed in an accounting system to record transactions.
Examples: Sales invoice, cheques, receiving document, shipping document, payroll records,
cash register tape, and purchase invoice. Transaction analysis: we use the accounting equation to analyze the impact on the
two accounts are impacted by transaction i.e. give and take
*accounting equation= balance sheet
Prepaid rent= Asset : has future benefit
-revenue increases R.E : will increase as long as we generate revenue
-Expenses decrease R.E
Transaction Analysis (individual) & Financial Statements (cumulative)
Sold for Cash= increase in assets
Annual memberships= increase in liabilities (unearned revenue)
Pay salary and wages= decrease in R.E
Pay dividends= decrease in assets and R.E
Issue capital stock= increase in assets and shareholders equity
Paid=decrease in cash (asset)
On credit/ on account= increase in liabilities “accounts payable”
Retained Earnings under shareholders equity is divided into Revenue (+), vendor expense