RSM219H1 Chapter 1 Notes

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Rotman Commerce
Course Code
Alexander Edwards- Universityof Toronto( St.George)

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RSM219H1 Textbook Notes Chapter 1: The Purpose and Use of Financial Statements  Accounting (“the language of business”): the information system that identifies and records the economic events of an organization, and then communicates them to a wide variety of interested users.  Users of accounting information can be divided into: o Internal Users  They plan, organize, and run companies (work for the companies).  Include:  Finance directors  Marketing managers  Human resource personnel  Production supervisors  Company officers  Questions they may need to answer:  Is there enough cash to pay the bills? (finance)  What should we sell iPads for to maximize profit? (marketing)  How many employees can we afford to hire this year? (human resources)  Which production line is the most profitable? (production)  Accounting information must be available when its needed. o External Users  Include:  Investors (whether to buy, hold, or sell their ownership Primary/key interest) external users  Lenders (evaluate risks of lending money)  Other creditors i.e. suppliers (whether or not to grant credit; sell on account)  Employees and labour unions (can they provide employment opportunities and pay salaries and benefits)  Customers (will they support its product lines and honour product warranties)  Taxing authorities (are they respecting tax laws)  Regulatory agencies i.e. provincial securities commissions (are they operating within prescribed rules)  Questions they may need to answer:  Is the company earning enough to give me a return on my investment?  Will the company be able to pay its debts as they come due?  Accountants and other professionals have extensive rules of conduct to guide their behaviour with each other and the public. o Many companies also have codes of conduct that outline their commitment to ethical behaviour in their internal/external relationships.  When analyzing ethical situations, you should: o Recognize an ethical situation and the ethical issues involved  Use personal ethics or an organization’s code of ethics to identify ethical situations and issues. o Identify and analyze the main elements in the situation  Identify the persons or groups who may be harmed or benefited (stakeholders).  Ask: What are the responsibilities and obligations of the parties involved? o Identify the alternative, and weigh the impact of each alternative on various stakeholders  Select the most ethical alternative, considering all the consequences (may not exist just one right answer).  Three common forms of business organization: o Proprietorships  A business owned by one person (often called a sole proprietorship).  Unlimited liability: the owner is personally liable for all debts of the business.  Business profits are reported as self-employment income and taxed on the owner’s personal income tax return.  Reporting entity concept: economic activity that can be identified with a particular company be kept separate and distinct from the activities of the owner(s) and of all other economic entities. o Partnerships  A business owned by more than one person.  Usually formed because one person does not have enough economic resources to initiate/expand the business, or because partners bring unique skills/resources to the table.  Partnership agreement (written): outlines the formation of the partnership, partners’ contributions, how profits and losses are shared, provisions for withdrawals of assets and/or partners, dispute resolution, and partnership liquidation.  Partners usually have unlimited liability.  Assets: resources that provide future economic benefits.  Profits are reported as self-employment income and taxed on each partner’s personal income tax return.  Typically used to organize professional service businesses (i.e. practices of lawyers, doctors, architects, engineers, and accountants). o Corporations  A business organized as a separate legal entity owned by shareholders.  Easier to raise capital than proprietorship and partnerships because of:  Indefinite life o It continues on regardless of who owns its shares (not affected by withdrawal, death, or incapacity of an owner).  Ease of transferring ownership o Shares can be easily sold on stock exchanges.  Limited liability o Shareholders are not responsible for corporate debts unless they have personally guaranteed them.  They pay income tax as separate legal entities on any corporate profits.  # of proprietorships + partnerships > # of corporations  Revenue of corporations > revenue of proprietorships + partnerships  Public corporations: shares sold to the public on stock exchanges.  Financial statements are distributed publicly.  Private corporations: shares are issued but are not made available to the general public nor are they traded on public stock exchanges.  Financial statements are almost never distributed publicly.  Consolidated: financial results include results from all companies that are owned or controlled by a corporation.  Individual accounting records and financial statements are also produced for each company (needed to accurately assess the performance and financial position of each company.  Another application of the reporting entity concept.  Generally Accepted Accounting Principles (GAAP): include broad policies and practices as well as rules and procedures that have substantive authoritative support and agreement about how to report economic events.  Publicly traded corporations must use International Financial Reporting Standards (IFRS). o A set o global accounting standards developed by the International Accounting Standards Board (IASB).  Private corporations have a choice between using IFRS or Accounting Standards for Private Enterprises (ASPE). o Developed by the Canadian Accounting Standards Board (CASB).  Proprietorships/partnerships do not have to choose between either as their statements are generally prepared only for internal use of the owners.  There are three types of activity that all businesses are involved in: o Financing  Two ways of raising capital in a corporation:  Debt financing (take out a loan)  Equity financing (sell shares)  Can also include repaying debt.  Creditors (lenders): those who you owe money to.  Liabilities: the debts and obligations of a business. Liabilities are claims of lenders and other creditors on the assets of a business.  Operating line of credit: a pre-arranged bank loan for a maximum amount that allows a company to draw more money than there is on hand in its bank account.  Results in a liability called bank indebtedness.  Long-term debt can be:  Mortgages payable  Bonds payable  Finance lease obligations  Other types of debt securities borrow for longer periods of time  Common shares: the amount paid by investors for shares of ownership in a company.  Lenders generally have a payment schedule for when the money is to be paid (interest included).  Creditors have a legal right to be paid at the agreed time (you may force the company to sell assets to pay its debts).  Companies are not obligated to buy back shares.  Creditors and lenders receive their payment and only after will shareholders be paid in the event of bankruptcy.  Dividends: the distribution of retained earnings from a corporation to its shareholders, often-in cash form. o Investing  Involve the purchase (or sale) of long-lived assets that a company needs in order to operate.  Assets: resources that a company owns or controls.  Long-lived assets are referred to as property, plant, and equipment.  Investments: when a company has excess cash that they don’t need for a while and decide to purchase bonds/secu
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