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Canada (158,278)
RSM219H1 (136)
Chapter 1

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University of Toronto St. George
Rotman Commerce
Elisa Zuliani

Chapter 1: The Purpose and Use of Financial Statements  Accounting is the information system that identified and records the economic events of an organization, and then communicates the to a wide variety of interested users  Economic systems depend on highly transparent, reliable, and accurate financial reporting  Accounting = “language of business”  Users of accounting information divided broadly into two types—internal and external users  Internal users – plan, organize, and run companies  i.e. finance directors (is there enough cash to pay the bills), marketing managers (what price should we sell iPods to maximize profits?), human resource personnel (how many employees can we afford to hire this year?), production supervisors (which product line is the most profitable?), and company officers  To answer these questions, accounting information must be available on a timely basis  External users – investors use info to make decisions to buy, hold, or sell their ownership interest, OR creditors, such as suppliers and bankers, use accounting information to evaluate the risks of granting credit or lending money  Investors + creditors are the main external users of accounting information, but others exist: o Labour unions want to know whether company can pay increased wages/benefits o Customers – will a company support its product lines and honour product warranties? o Taxing authorities such as CRA want to know whether the company respects the tax law o Regulatory agencies such as provincial securities commissions want to know whether the company is operating within prescribed rules o Economic planners use accounting info. to analyze and forecast economic activity  Financial info. must be prepared by individuals with high standards of economic behaviour  Accountants and other professionals have extensive rules of conduct to guide their behaviour with each other and the public  In addition, many companies today have extensive rules of conduct to guide their behaviour with each other and the public Forms of Business Organization (proprietorship = owned by one person, partnership = owned by more than one person, corporation = separate legal entity) Proprietorship  Simple to set up, gives YOU control, and is usually operated by owner  Only small amount of capital needed to start one  Owner receives profits, suffers losses, and is personally liable for all debts of the business  No legal distinction between business as an economic unit and the owner  i.e. hair salons, farms, small retail stores Partnership  In many respects, similar to a proprietorship, but more than one owner  Often formed because one person does not have enough money or adequate skills/resources to begin the company themselves  Each partner has unlimited liability for all debts of partnership—so, regardless of who created debt, the other partner is held responsible  Any of the partners can be forced to give up personal assets to repay the partnership debt just as can happen to an owner in a proprietorship  Partnerships CAN be formed with limited liability for certain partners  i.e. retail/service businesses like professional practices of lawyers, doctors, architects, engineers, and accountants Corporation  Shares = stock  Investors receive shares to indicate their ownership claim  Individuals can become shareholders by investing relatively small amounts of money  Makes it easier for corporations to raise funds  Selling a proprietorship/partnership interest is much more complicated than selling the shares of a corporation—consequently, more people are interested in purchasing stock  TSX is part of the TMX Group in Canada  Many businesses start as proprietorships/partnerships, and then eventually incorporate  You can be a private corporation OR a publicly traded company  Corporate shareholders are not personally liable for all debts of a business  Shareholders have limited liability since they risk losing only what they invested in the company to begin with  Proprietorships/partners pay personal income tax on their respect share of the profits, while corporations pay income taxes as separate legal entities  Corporations also MAY receive more favourable tax treatment than other forms of businesses  While # of proprietorships + partnerships > corporations, revenue produced by corporations is much greater  Most of the largest companies in Canada are corporations – 50 of Canada’s corporations reported annual revenues of more than $7.5 billion  Public corporations = shares listed on a Canadian stock exchange, distribute their financial statements to shareholders/creditors/other interested parties, and general public upon request  Private corporations = do not issue publicly traded shares, and like proprietorships/partnerships, these companies never distribute their financial statements publicly Business Activities (financing, investing, and operating) Financing Activities  It takes money to make money  Two ways of raising money: 1) borrow money, 2) issue shares in exchange for cash  Borrow money = take loan from a bank, or borrow money from other lenders  People or companies that are owed money are known as “creditors” = primary users of accounting information  Liabilities = amounts owed to creditors (in the form of debt and other obligations)  Different names given to different types of liabilities  Funds taken from an operating line of credit = bank indebtedness  Note payable  Long-term debt = notes payable, mortgages payable, lease obligations  Corporation may also obtain financing by selling shares of ownership or share capital  Common shares = term used to describe the amount paid by investors for shares of ownership in a company  Common shares are just one class or type of share capital that a company can issue  Companies can also use cash for financing activities such as repaying debt or repurchasing shares from investors  Clams of creditors differ from those of shareholders  If you loan money to a company, you are its creditor  In loaning money, you specify a repayment schedule, such as monthly payments  Interest is normally added to the amount due or overdue  As a creditor, you have a legal right to be paid at the agreed time  In the event of nonpayment, you may force the company to sell its property to pay its debts  The law requires creditor claims be paid before shareholder claims  Shareholders have no claim to corporate resources until the claims of creditors have been satisfied  If you buy a company’s shares instead of loaning it money, you have no legal right to expect any payments until all of its creditor are paid  Once shares are issued the company has no obligation to buy them back, whereas debt obligations must be repaid  Payments to shareholders are called dividends – they are paid so long as there is enough cash to cover required payments to creditors Investing Activities  After a company raises $ through financing activities, it uses that money for investing activities  Investing activities involve purchase/sale of long-lived resources (called assets) that a company needs in order to operate  Assets are resources that a company owns  Every asset is capable of providing future services/benefits that can be short/long lived  Investing activities will often consist of long-lived assets like the purchase of restaurant equipment, computers, vehicles, etc.  Together, they are referred to as property, plant, and equipment  Cash = asset  Cash can be used for, or result from, an investing activity, but it is not itself an investing activity  For example, if a company has excess cash that it does not need for a while, it might choose to invest it in debt/equity securities of other corporations/organizations  Investments are also an asset and an investing activity—they can be long/short term Operating Activities  Assets with shorter lives typically result from operating activities  Operating activities = transactions which create revenues and expenses  Revenues = amounts earned from the sale of goods  In accounting, revenues are an increase in economic resources—normally an increase in an asset, but sometimes a decrease in a liability  Types of revenue = sale revenue, service revenue, and interest revenue 
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