Accounting is the information system that identifies and records the
economic events of an organization, and then communicates them to a wide
variety of users.
Users and Uses of Accounting
There are two types of users: Internal users and external users.
Internal users of accounting information plan, organize, and run companies.
o Include finance directors, marketing managers, human resource
personnel, production supervisors, and company officers.
o Accounting provides internal reports: Finance (whether there is
enough money), marketing (what prices to charge), human resources
(how many employees can we hire) and production (most profitable
External users: There are several different types of external users in
o Investors (make decisions to buy, sell, or hold ownership interest),
creditors (suppliers and bankers need to evaluate risks of granting or
loaning money). These are the two main types of external users of
o Labor unions (Can the company afford the pay rise we are
demanding?), customers (will the company stay in business long
enough to service the products I buy from it?).
o Taxing authorities (does the company respect tax laws), regulatory
agencies (is the company operating within prescribed rules) and
economic planners (analyze and forecast economic activity).
Ethical behavior: in order for financial information to have value to its
users, whether internal or external, individuals with high standards of ethical
behavior must prepare it.
o Consider the organization’s interests when making decisions.
o Accountants have extensive rules of conduct to guide their behavior
with each other and the public.
o Many companies now have codes of conduct outlining their
commitment to ethical behavior in external and internal relationships.
Forms of Business Organization
There are three forms of business organizations:
o Proprietorship- a business owned by one person.
Usually operated by the owner.
Simple to set up and gives you control over the business.
Usually a small amount of capital is needed to start the
The owner receives profits, suffers losses and is 100% liable.
Small service businesses such as hair salons, plumbers and
mechanics are examples. Also farms and small retail stores. o Partnership- a business owned by more than one person.
Usually formed because one person does not have enough
economic resources to initiate or expand the business, or
because partners bring unique skills or resources to the
Each partner generally has unlimited liability for all debts of
the partnership, even if one of the other partners created the
Any one of the partners can be forced to give up his or her
personal assets to repay the debts.
Typically used to organize retail and service businesses,
including the professional practices of lawyers, doctors and
o Corporation- a business organized as a separate legal entity owned
As an investor in a corporation you receive shares to indicate
your ownership claim.
Successful organizations often have thousands of shareholders,
and their shares are often traded on organized stock
Corporate shareholders have limited liability equal to the
Corporations pay income taxes as separate legal entities on any
Revenue received by corporations is much greater than other
Extremely large corporations are publicly traded, that is their
shares are listed in the Canadian Stock Exchange.
Public corporations commonly distribute their financial
statements to shareholders, creditors, other interested parties,
and the general public upon request. (Loblaw’s, Shoppers)
Private corporations do not issue publicly traded shares.
(Sobeys, McCain foods)
These companies almost never distribute their financial
All businesses are involved in three types of activity: financing, investing and
The two primary ways of raising outside funds for corporations are (1)
borrowing money and (2) issuing (selling) shares in exchange for stock.
Corporations can borrow money in a variety of ways such as taking out loans
from a bank or borrowing money from other lenders. Amounts owed to creditors-in the form of debt and other obligations-are
Specific names are given to different types of liabilities:
o Bank indebtedness results when corporations have taken funds
from an operating line of credit with its bank.
o It may have a short-term note payable to a bank for the money
borrowed to purchase items needed.
o It may also have long-term debt, which can include note payable,
mortgages payable, lease obligations, and other types of debt
securities borrowed for longer periods of time.
o A corporation may also obtain financing by selling shares of
ownership, or share capital, to investors.
o Common shares are the term used to describe the amount paid by
investors for shares of ownership in a company.
One class or type of share capital that a company can issue.
Can also use cash for financing activities such as repaying debt.
If you loan money to a company, you are one of its creditors.
o In loaning money you specify a repayment schedule (paid by a certain
time). Usually you add interest to the amount owing or amount
o As a creditor, you have the legal right to be paid by the specified time
period. In the event of nonpayment, you may force the company to sell
its property to pay the debts.
o The law requires that creditor claims be paid before shareholder
o If you buy companies shares instead of loaning it money, you have no
legal right to expect any payments until all of its creditors are paid.
o Once shares are issued, the company has no obligation to buy them
back, whereas debt obligations must be repaid.
o Payments to shareholders are called dividends.
Investing activities involve the purchase (or sale) of the long-lived sources-
called assets- that a company needs in order to operate.
o Assets are resources that a company owns.
o Investing activities generally involve long-lived assets (vehicles,
o Together, long-lived assets and investing activities are referred to as
property, plant and equipment or “property and equipment,”
o Cash is one of the more important assets owned by any business.
Cash is not an investing activity!
Excess cash that companies have is invested in debt and equity
securities of other corporations or organizations.
o Investments are another example of an asset and an investing
activity. Investments can be either short-term or long-term. Operating Activities
Most of a company’s long-lived assets are purchased through investing
Operating activities are transactions, which create revenues and expenses.
Amounts earned from sales are referred to as revenues.
In accounting language revenues are increases in economic resources-
normally an increase in an asset but sometimes a decrease in a liability-that
result from a business’ operating activities.
Sources of revenue that are common to many businesses are sales revenue,
service revenue, and interest revenue.
The right to receive money in the future is known as account receivable.
o Accounts receivable are assets because they will result in a future
benefit-cash-when the amounts owed are eventually collected.
o Companies also have other types of receivables, such as income tax
receivable (also known as “future income tax assets”) that is due from
Items that are held for future sale to customers result in an asset called
inventory or merchandise inventory.
o Once the goods are sold, they are called expenses.
o More specifically, the cost of the merchandise inventory sold is called
cost of goods sold.
o In accounting language, expenses are the cost of assets that are
consumed or services that are used in the process of generating
Cost of goods sold, opera