Chapter 1: Accounting and The Business Environment: Objective 1
Chapter 1: Accounting and The Business Environment: Objective 1
Chapter 1: Accounting and The Business Environment: Objective 1
Environment
Objective 1
Define accounting, and describe the users of accounting information
Why is accounting important, and who uses the information?
Decision makers need information. The more important the decision, the greater the need for
information. Virtually all businesses and most individuals keep accounting records to aid decision making.
Here are some decision makers who use accounting information.
Individuals: People use accounting information in day-to-day affairs to manage bank accounts, evaluate
job prospects, make investments, and decide whether to lease or buy a new car.
Businesses: Business owners and managers use accounting information to set goals for their
organizations. They evaluate their progress toward those goals, and they make changes when necessary.
Example: Lisa Hunter makes decisions based on accounting information. She knows the fee agreed upon
with her client. Therefore, she now has to determine the scope of work and how many people/hours are
required to complete the job.
Investors and Creditors: Investors and creditors and creditors provide the money to finance business
activities. To decide whether to invest, investors predict the amount of income that will be earned on
their investment. Before lending money, creditors such as banks and suppliers evaluate the borrower’s
ability to pay them back.
Government and Regulatory Bodies: Provincial and federal governments levy taxes on individuals and
businesses. Income tax is calculated by using accounting information as a starting point. A business’s
accounting system is required to keep track of provincial sales tax, and harmonized sales tax that a
business collects from its customers and pays to its suppliers. In addition, some companies are regulated
by provincial securities commissions, such as the British Columbia Securities Commission or the Ontario
Securities Commission, which dictate that businesses selling their shares to and borrowing money from
the public disclose certain financial information.
Not-for-Profit Organizations: Organizations such as churches, hospitals, government agencies,
universities, and colleges, which operate for purposes other than to earn a profit, use accounting
information to make decisions related to the organization in much the same way that profit-oriented
businesses do.
Other users: Employees and labour unions may make wage demands based on the accounting
information that shows their employer’s reported income. Consumer groups and the general public are
also interested in the amount of income that businesses earn.
Financial Accounting and Management Accounting
It is possible to classify the users of accounting information into two groups: external users and internal
users. This distinction allows us to separate/divide accounting between two fields: financial accounting
and management accounting.
Fianancial Accounting provides information primarily to people outside the company. Creditors and
outside investors, for example, are not part of the day-to-day management of the company. Likewise,
government agencies and the general public are external users of a company’s accounting information.
This book deals primarily with financial accounting.
Management Accounting generates information for internal decision makers, such as company
executives, department managers, and hospital administrators. Internal users ask questions such as,
What price should we set for our product in order to make the most money? How much of a raise can we
afford to give our employees?
Exhibit 1-2 | How Financial Accounting and Management Accounting Are Used
Exhibit 1-2 shows how financial accounting and management accounting are used by Hunter
Environmental Consulting’s internal and external decision makers.
Accountants
Canadian accountants have been going through a period of transition. The largest organization of
designated accountants in Canada is now the Chartered Professional Accountants (CPAs). Until
recently, there were three professional designations for accountants in Canada – Chartered
Accountants (CAs), Certified General Accountants (CGAs), and Certified Management Accountants
(CMAs). Those accountants who joined the CPA as a result of the merger of these organizations will
retain their legacy designation on their business cards.
Professional Conduct Professional accountants are governed by standards of professional conduct.
Many of these standards apply whether the members are public accountants who perform work for
other businesses or private accountants who are employed by a particular business. These rules
concern the confidentiality of information the accountant is privy to, maintenance of the profession’s
reputation, the need to work with integrity and due care, competence, refusal to be associated with
false or misleading information, and compliance with professional standards. Other rules are applicable
only to those members in public practice and deal with things like the need for independence and how
to advertise, seek clients, and conduct a practice. This helps the public determine its expectations of
members’ behaviour. However, the rules of professional conduct should be considered a minimum
standard of performance; ideally, the members should continually strive to exceed them.
Audits: One type of work done by designated accountants in an audit. An audit is a financial
examination. Audits are conducted by independent accountants who express an opinion on whether or
not the financial statements fairly reflect the economic events that occurred during the accounting
period. Companies and their auditors must behave in an ethical manner.
Exhibit 1-3| Relationship among Accounting and Business Entities
Exhibit 1-3 illustrates the relationship among accounting and business entities that are public
companies (companies that sell shares of stock to investors)
CPA Canada Advanced Certificate in Accounting and Finance (ACAF) The ACAF certificate program
prepares people for a career in accounting and finance as an alternative to pursuing a professional
designation.
Ethics in Accounting and Business
We need to consider ethics in all areas of accounting and business. Investors, creditors, and regulatory
bodies need reliable information about a company. Naturally, companies want to make themselves look
as good as possible to attract investors, so there is a potential for conflict. Unfortunately for the
accounting profession, accounting scandals involving both public companies and their auditors have made
the headlines over the years.
Example: At the turn of the century, Enron Corporation, which was the seventh-largest company in the
United States, issued misleading financial statements. Enron was forced into bankruptcy and its auditors’
actions were questioned. The impact of the Enron Bankruptcy was felt by many different parties, including
Enron shareholders, who saw their investments become worthless; employees. Who lost their jobs and
their pensions; and the accounting profession, which lost some of its integrity and reputation as
gatekeepers and stewards for the investing public. This situation shocked the business community and
caused investors to question the reliability of financial information.
Since the financial health of accompany is important to many different groups of users, these users must
be confident that they can rely on the financial information they are given when they are making
decisions. To increase users’ confidence, the accounting profession and other interested stakeholder
groups made important changes over the past decade to improve the quality of the financial information
provided.
TRY IT!
1. For each of the following users of accounting information, indicate if the user is an internal or
external user.
a. Supplier = external user
b. Owner = internal user
c. Marketing manager = internal user
d. Lender = external user
e. Ontario Securities Commission = external user
Objective 2
Compare and contrast the forms of business organizations
In what form can we set up a company?
Forms of Business Organizations, page 7
A business can be organized as a:
Proprietorship
Patrnership
Corporation
Exhibit 1-4 | Comparison of the Forms of Business Organization
Exhibit 1-4 summarizes some of the differences between the three forms of business organization.
Proprietorship
A proprietorship has a single owner, called the proprietor, who often manages the business.
Proprietorships tend to be small retail stores, restaurants, and service businesses, but they can also be
very large. From an accounting viewpoint, each proprietorship is distinct from its owner. Thus, the
accounting records of the proprietorship do not include the proprietor’s personal accounting records.
However, from a legal perspective, the business is the proprietor, so if the business cannot pay its debts,
lenders can take the proprietor’s personal assets (cash and belongings) to pay the proprietorship’s debt.
Advantages
Single owner
The business is separate and distinct from the owner (from an accounting viewpoint only)
Disadvantages
Limited life span
Unlimited liability
Limited availability to financial resources
Partnerships
A partnership joins two or more individuals together as co-owners. Each owner is a partner. Many retail
stores and professional organizations of physicians, lawyers, and accountants are partnerships.
Accounting treats the partnership as a separate organization distinct from the personal affairs of each
partner. From a legal perspective, though, a partnership is the partners in a manner similar to a
proprietorship. If the partnership cannot pay its debts, lenders can take each partner’s personal assets
to pay the partnership’s debts.
A Limited-Liability Partnership (LLP) is a partnership in which one partner cannot create a large liability
for the other partners. Each partner is liable only for his or her own actions and those actions under his
or her control.
Advantages
Two or more owners
More labour specialization
More financial resources available
Disadvantages
Unlimited liability for general partners
Potential conflicts among partners require written partnership agreements
Corporations
A corporation is a business owned by shareholders. These are the people or other corporations who
own shares of ownership in the business. Although proprietorships and partnerships are more
numerous, corporations engage in more business and are generally larger in terms of total assets,
income, and number of employees. In Canada, corporations generally have Ltd. or Limited, Inc. or
Incorporated. Corporations need not be large; a business with only one owner and only a few assets
could be organized as a corporation.
From a legal perspective, a corporation is formed when the federal or provincial government approves
its articles of incorporation. Unlike a proprietorship or a partnership, once a corporation is formed it is a
legal entity separate and distinct from its owners. The corporation operates as an “artificial person”
that exists apart from its owners and that conducts in its own name. The corporation has many of the
rights that a person has. For example, a corporation may buy, own, and sell property; the corporation
may enter into contracts and sue and be sued.
Corporations divide ownership into individual shares. Companies such as WestJet Airlines Ltd. and
Canadian Tire Corporation, Limited, have issued millions of shares of stock and have tens of thousands
of shareholders. An investor with no personal relationship either to the corporation or to any other
shareholder can become an owner by buying 30m 100, 5,000 or any number of shares of its stock. For
most corporations, the investor may sell shares at any time. It is usually harder to sell one’s investment
in a corporation.
Accounting for corporations includes some unique complexities. For this reason, we initially focus on
proprietorships. We cover partnerships in Chapter 12 and begin our discussion of corporations in
Chapter 13.
Advantages
Legal separate entity
Limited liability for shareholders
Transferability of ownership is relatively easy
Indefinite life of the organization
Disadvantages
Expensive to operate and set up
Extensive governmental rules and regulations
Limited-Liability Partnership (LLP) and Limited-Liability Company (LLC)
Advantages
One partner cannot create a large liability for the other partners
Each partner is liable for their own actions
With a LLC, the company and not the partners are liable for the company’s debts
Disadvantages
Written partnership agreements are still necessary
TRY IT!
2. For each of the following scenarios, indicate the applicable form of business in the space
provided.
a. The business is not making enough money to pay its bills. The owners do not have to
make up the difference with their personal funds. = Corporation
b. Anna and Sui have owned their business together for 5 years. Anna dies. The business
must be closed if they chose this form of business. = Partnership.
c. An unincorporated business with five owners is a Partnership.
d. The profits of Chi’S business must be reported on her tax return = Proprietorship
e. There is a lawsuit against a business and there is not enough money to pay the claim. The
owners only lose the amount they have invested into the business. = Corporation
Objective 3
Describe some concepts and principles of accounting
What are some of the guidelines for accounting, and why do we need them?
Conceptual Framework
Objective 5
Describe and use the accounting equation to analyze business transactions
The Accounting Equation
Assets
Defined: Resources controlled by an entity that provide future benefit
Examples of assets include:
Cash
Accounts Receivable
Office supplies
Merchandise inventory
Furniture and fixtures
Land
Buildings
Liabilities
Defined: Debts that are payable to outsiders (creditors)
Examples of liabilities include:
Accounts payable
Notes payable
Salaries payable
Deferred or unearned revenues
Owner’s Equity
Defined: The amount of an entity’s assets that remains after the liabilities are subtracted
Owner’s equity is often referred to as net assets
Transactions That Increase and Decrease Owner’s Equity
Revenues
Defined: Amounts earned by delivering goods or services to customers
Examples of revenues include:
Fees earned or service revenue
Sales
Rent earned
Interest earned
Expenses
Defined: Amounts that have been paid or will be paid for costs that have been incurred to
earned revenue
Examples include:
Rent
Salaries and wages
Utilities
Supplies
Amortization or depreciation
Accounting for Business Transactions
An event that affects the financial position of the business entity, and can be measured or
recorded reliably
Accounting for Business Transactions – An Example
1. The owner, John Ladner, invests $250,000 to start a new business, LES
2. LES purchases land for a future office location, paying $100,000 cash
3. Purchases $5,000 office supplies on credit
4. LES completes a consulting job for $20,000 cash
5. LES completes a consulting job on credit for $15,000
6. LES pays expenses for the month: salary $3,500; rent $3,000; utilities, $1,000
7. LES pays $4,000 to the store from which it purchased $5,000 worth of office supplies in
transaction 3
8. LES collections $11,000 from the customer of transaction 5
9. LES sells 50% of the land purchased in transaction 2 for $50,000 cash
10. Ladner withdraws $5,500 cash for his personal use from LES
Objective 6
Prepare and evaluate the financial statements
The Financial Statements
Financial statements are the formal reports of an entity’s financial information
The primary financial statements are:
Income statement (statement of earnings or statement of operation)
Statement of owner’s equity
Balance sheet (statement of financial position)
Cash flow statement
Income Statement
Statement of Owner’s Equity
Balance Sheet
Cash Flow Statement
Assets
Assets are economic resources that will benefit the business in the future.
Assets include:
Cash
Accounts receivable
Notes receivable
Prepaid expenses
Land
Building
Equipment
Liabilities
Liabilities are debts incurred by the business
Liabilities include:
Accounts payable
Notes payable
Accrued liabilities (taxes payable, salary payable, interest payable)
Owner’s Equity
The owner’s claims to the assets of a business
Owner’s equity includes:
Capital
Withdrawals
Revenues
Expenses
Capital Account
Chart of Accounts
Lists all accounts along with a unique account number for each individual account
One example has assets begin with 1, liabilities with 2, owner’s equity with 3, revenues with 4,
and expenses with 5
Chart of Accounts – Ladner Environmental Services
Objective 2
Apply the rules of debit and credit
Double-Entry Accounting
Double entry accounting = duel effects of each transaction
Each transaction affects at least two accounts
The owner invests $250,000 into a new business
ASSETS = LIABILITES + OWNER’S EQUITY
Double-Entry Accounting: An Example
Credit purchase of a truck for $50,000
The T-Account
Objective 3
Analyze and record transactions in the journal
Source Documents and Recording the Transactions in the Journal
Source documents are the evidence of transactions
Journalizing a transaction is the chronological record of the entity’s transaction
Steps to journalizing are:
Identify the transaction from the source document
Identify each account affected by the transaction
Apply the rules of debit and credit
Record the transaction in the journal with an explanation or description
Journal Entries include….
The date of the transaction
The title of the account debited, along with the dollar amount
Title of the account credited, along with the dollar amount
A short explanation of the transaction
Recording Transactions
Objective 4
Post from the journal to the ledger
Posting from the Journal to the Ledger
Posting is the transferring of the data from the journal to the ledger
Objective 5
Prepare and use a trial balance
The Trial Balance
A trial balance summarizes the ledger by listing all accounts with their balances
Before computers, the trial balance provided a check on accuracy by showing whether total
debits equal total credits
Locating Trial Balance Errors
Search for missing accounts
Search the journal for the amount of the difference
Divide the difference by 2
Divide the out-of-balance amount by 9
Objective 6
Apply international financial reporting standards (IFRS) to recording business transactions
The procedures that identify and record business transactions described previously are followed
by companies that report their results using international financial reporting standards (IFRS)