Accounting Principles, Sixth Canadian Edition Lecture Notes

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-1Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.CHAPTER 120-MINUTE QUIZ #1Circle the correct answer.True/FalseLO 1E1.Accounting is an information system thatidentifies, records, and communicates economicevents of an organization to interested users.TrueFalseLO 4 E2.According to the monetary unit assumption,inflation is ignored in accounting and onlytransactions that can be expressed as an amount ofmoney are recorded.TrueFalseLO 1 E3.The basic objective of financial reporting is toprovide useful information toinvestors and creditors tomake decisionsTrueFalseLO 2 E4.Private companies have a choice of whetherto followASPEor IFRS.TrueFalseLO 4 M5.According to the cost principle, assets shouldbe reported at their replacement cost, not theiroriginal cost.TrueFalseLO 2 M6.The economic entity assumption requires thatthe activities of the entity be kept separate and distinct fromthe activities of its owner and all other economic entities.TrueFalseLO 5 M7.Collection of an account receivable willincrease both cash and accounts receivable.TrueFalseLO 5 M8.An expense paid with cash would result in anequal decrease in liabilities and owner’s equity.TrueFalseLO 5 M9.Liabilities represent the ownership claim ontotal assets.TrueFalseLO 5 M 10.The going concern assumption assumes thata companywill liquidate in the near futureTrueFalse

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-2Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.Multiple ChoiceLO 3M1.In a proprietorship, owner’s equity increases when:a.the owner withdraws money for personal use.b.money is borrowed from the bank.c.cash is collected from a customer who had previously been billed for services.d.a service is provided to a customer on account.LO 3E2.A company has aprofitwhen:a.assets exceed liabilities for the period.b.investments exceed drawings for the period.c.revenues exceed expenses for the period.d.revenues exceed liabilities for the period.LO 3 M3.Owner’s Equity is not:a.existing debts and obligationsof the company.b.the owner’s claim on total assets.c.assets minus total liabilities.d.often called residual equity.LO 5 M4.A payment of accounts payable would:a.decrease liabilities and increase owner’s equity.b.decrease assets and decrease liabilities.c.decrease liabilities and decrease owner’s equity.d.increase assets and increase liabilities.LO 3 E5.The financial statement that reports the assets, liabilities, and owner’s equity at aspecific date is the:a.income statement.b.statement ofowner’s equity.c.balance sheet.d.cash flow statement.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-3Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.ANSWERS TO 20-MINUTE QUIZ #1True/False1.True6.True2.True7.False3.True8.False4.True9.False5.False10.FalseMultiple Choice1.d.2.c.3.a.4.b.5.c.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-4Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.20-MINUTE QUIZ #21.Define and give an example of each of the following terms. Assume that you are theproprietor of a house painting business.a)Assetsb)Liabilitiesc)Expenses2.How isprofitcalculated?3.Bob Manor is the proprietor of Manor Accounting. For each of the following transactions,indicate the effects on the company’s assets, liabilities, and owner’s equity. Indicate thedollar amount and whether it is an increase (+) or a decrease (-).TransactionsAssetsLiabilitiesOwner’s EquityCapitalDrawingsRevenueExpenses1.Prepares a taxreturn for a clientand bills the client$85.2.Buys $200 officesupplies on account.3.Pays for the officesupplies from #2.4.Collects the $85owed by thecustomer from #1.5.Pays $800 foremployee salaries.6.Does an audit for acustomer andreceives $2,500.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-5Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.ANSWERS TO 20-MINUTE QUIZ #21.Define and give an example of each of the following terms. Assume that you are theproprietor of a house painting business. (Various examples will be acceptable here.)a)AssetsResources owned by a businesswhich are capable of providing futureservices or benefitse.g., equipmentb)LiabilitiesCurrent obligations, arising from past events, to make future payments ofassets or services.e.g., accounts payablec)ExpensesThe cost of assets consumed or services used ina company’s ordinarybusiness activities.e.g., salaries expense2.How isprofitcalculated?Revenues–Expenses =Profit

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadian Edition20-Minute QuizChapter 1–Accounting in Action1-6Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.3.Bob Manor is the proprietor of Manor Accounting. For each of the following transactions,indicate the effects on the company’s assets, liabilities and owner’s equity. Indicate thedollar amount and whether it is an increase (+) or a decrease (-).TransactionsAssetsLiabilitiesOwner’s EquityCapitalDrawingsRevenueExpenses1.Prepares a taxreturn for a clientand bills the client$85.+$85+$852.Buys $200 officesupplies on account.+200+$2003.Pays for the officesupplies from #2.−200−2004.Collects the $85owed by thecustomer from #1.+85−855.Pays $800 foremployee salaries.−800−$8006.Does an audit for acustomer andreceives $2,500.+2,500+2,500Balance$1,785000$2,585−$800$1,785=$1,785

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-1Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.CHAPTER 1Accounting in ActionLECTURE OUTLINE1.Why is Accounting Important?1.1Accountingis the information system thatidentifies, records and communicateseconomic events of organizations to interested users.Awide variety of usersdepend on transparent, relevant,understandable financial information thatprovides a true representation of the economic events.1.2Accountants use ratios, percentages, graphs, and charts to analyze and interpretfinancial information.They use this information to highlight significant financialtrends and relationships.1.3Whether you plan to own your own business, work for a business, invest in abusiness–whatever you choose,studyingaccountingwill teach you toread andinterpret financial informationwhich is a valuable set of skills.1.4Whether you plan to become a doctor, lawyer, social worker, teacher, engineer,architect or entrepreneur, a working knowledge of accounting will be relevantand useful to you.2.Using Accounting Information2.1Internal users are those whowork forthecompanyand use accounting data inplanning,organizing and runningthe organization.They include financedirectors, marketing managers, human resources personnel and companyofficers.They require answers to questions such as:-Is there sufficient cash to pay the bills this month?-What price must be charged for this product in order to make a profit?

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-2Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.TEACHING TIPILLUSTRATION 1-1illustrates questions asked by internal users.2.2External users are those users outside of the business who need informationabout the financial position and performance of the company. Included in thisgroup are:2.2.1Investors: Investors use accounting information to make decisions to buy,hold, or sell their ownership interest.2.2.2Creditors: Creditors use accounting information to evaluate the risks ofgranting credit or lending money to a business, such as suppliers andbankers.2.2.3Labour Unions: Labour unions want to know whether the owners can payincreased wages and benefits.2.2.4Customers: Customers are interested in whether a company will continueto honour its product warranties and support its product lines.Other external users are tax authorities such as Canada Revenue Agency;regulatory agencies such as provincial securities commissions; and economicplanners to forecast economic activity.Investors and creditors are the main external users of accounting information,but as seen above there are many external users with a large variety ofinformation needs and questions.TEACHING TIPILLUSTRATION 1-2illustrates questions asked by external users.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-3Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.3.Objectives of Financial Reporting:The main objective of the financial statements isto provide useful information to investorsand creditors (external users) to makedecisions about a business.3.1Financial Statementsmust give information about:3.1.1Economic resources: what resources does a business have to be used inits operations?.3.1.2What are the claims to the business’ economic resources?.3.1.3Is the business generating enough profits and enough cash to pay itsdebts and give a return to its owners?4.Ethicsin Financial Reporting4.1Ethicsis important to accountantsand decision makers who rely onand preparefinancial information. Financial information must be prepared with highstandards of ethical behaviour.4.2In the process of solving an ethical dilemma, the following steps should beapplied:4.2.1Recognize an ethical situation and identify the ethical issues involved.4.2.2Identify andanalyzethemainelements in the situation.4.2.3Identify the alternatives, and weigh the impact of each alternative onvarious stakeholders.TEACHING TIPILLUSTRATION 1-3illustrates the steps used to analyze ethical dilemmas.5.Forms of Business Organization5.1Proprietorship.A business owned by one person is generally a proprietorship.The owner receives all profits, suffers any losses, and is personally liable for alldebts of the business. This is known as unlimited liability. There is no legaldistinction between the owner and the business, so the life of the proprietorshipis limited to the life of the owner. However, the records of the business activitiesmust be kept separate from the activities of the owner. The profits of thebusiness are recorded on the owner’s personal income tax return.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-4Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.5.2Partnership.A business owned by two or more persons associated as partnersis a partnership. It is similar to a proprietorship, except that more than one owneris involved.Partnerships are often used for service-type businesses, such aslawyers, doctors, architects and accountants.Each partner generally hasunlimited liability for all debts of the partnership, even if one of theother partnerscreated the debt.5.3Corporation.A business organized as a separate legal entity under federal orprovincial corporation law and having ownership divided into transferable sharesis called a corporation. Owners, called shareholders, enjoy limited liability for thedebts of the business.In other words, they are not responsible for the debts ofthe corporate entity.Shareholders may sell their shares to other investors at anytime.Since ownership can be transferred without dissolving the corporation, thecorporation has an unlimited life.Examples of corporations areRoyal Bank ofCanada, Suncor Energy, Research Motion and Barrick Gold.5.3.1Public Corporations vs. Private Corporations.Public corporations havetheir shares listed onone of theStock exchangesand they commonlydistribute their financial statements to interested parties and the generalpublic. Private corporations do not issue publicly traded shares and theyalmost never distribute their financial statements publicly. Examples ofprivate corporations areEllisDon Inc.,and McCain Foods.An example ofa public corporation isReitmans.6.Accounting StandardsFinancial information is communicated in accounting reports, the most common beingfinancial statements. In order to make the information in the financial statementsmeaningful, accountants must prepare the reports in a standardized way.6.1Generally Accepted Accounting Principles (GAAP)6.1.1The common set of standards used by accountants in reporting economiceventsare called generally accepted accounting principles(GAAP)whichincludesbroadprinciples and practices, as well as rules and procedures.The CanadianInstituteofChartered Accountants, through an Accounting Standards Board(AcSB), isprimarilyresponsible for establishing generally accepted accounting principles inCanada.The basic objective of financial reporting is to communicate informationthat is useful to investors, creditors and other users when they make decisions.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-5Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.6.1.2A recent change in Canadian GAAP is the implementation of twosets of standards, International Financial Reporting Standards (IFRS), andAccounting Standards (ASPE)for Private Enterprises.Canadian publicenterprises must followInternational Financial Reporting Standards(IFRS),a set of global standards developed by the International AccountingStandards Board (IASB).In Canada, the decision to adoptIFRS was madeso that Canadian public companies are able to compete in an increasinglyglobalmarketplace.Because theusersof Private companiestypicallyrequireless information in the financial statements, the AcSB developedAccounting Standards for PrivateEnterprises (ASPE).CanadianPrivate Companies have the choice to report under IFRS or ASPE.6.1.3Both IFRS andASPEare considered “principles-based” as opposedto “rules-based” standards. “Principles-based” standards are designed toencourage the use of professional judgement.6.1.4It is important to understand that GAAP is not static and that it changesover time. The AcSBand IASB continue to create new standards and modifyGAAP.6.2Economic Entity Concept.The economic entity concept requires that theactivities of the entity be kept separate and distinct from the activities of itsowners, and all other economic entities. An economic entity can be anyorganization or unit.An economic entity may not necessarily be a separate legalentity.6.3Going Concern Assumption.It is assumed thata companywill continue tooperate in the foreseeable future.This assumption assumes that the companywill operate long enough to use its assets for their intended use and to fulfill itscommitments.This is one of most important assumptions in GAAP.Thisassumption supportsassets being recorded at cost. For example, if a companyis not a going concern, and an asset such asland is going to be sold, then thereadersofthe financial statements would be more interested in the land’s currentworth rather than what was paid for it.7.AccountingModel

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-6Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.7.1The main objective of the financial statements is to provide information aboutthebusiness’ resources, claims to its resources,and its ability to earn a profit andgenerate cash to allowinvestors and creditors (external users) to make decisionsabout a business.There are four basic financial statements: the balance sheet,income statement, statement of owner’s equity and cash flow statement.7.2. TheBalance Sheet(sometimes called statement of financial position)provides information aboutthe economic resources that the business can use tocarry out its businessactivities to earn a profit and the claims to these economicresources.The balance sheet is like a snapshot of the company’s financialcondition at a specific moment in time (usually the end of a month, quarter, oryear).Assets, liabilities, and owner’s equity are reported in thebalance sheet.7.2.1Assetsare resources ownedor controlledby a business. Every assetis capableofprovidingfuture services or benefitswhich results in future cashinflows.Exampleof assets are:accounts receivable,prepaid expenses, andvehicles.7.2.2Liabilitiesare current obligations, arising from past events, to make afuture payment of assets or services.In other words, liabilities are present debtsand obligations. The persons or entities a company owes money to are calledcreditors.Examples of Liabilities are: note payable, accounts payable andunearned revenue (which represents advance payments made by customers).7.2.3Owner’s equityis the owner’sclaim on total assets. It is equal to totalassets minus total liabilities. It is a residual claim, since claims of creditors rankahead of those of owners.This amount is often called net assets.In aproprietorship, owner’s equity isincreased by investments made by the ownerand decreased by withdrawals made by the owner.“Owner’s equity” is a termused for proprietorships. Partnerships use the term “partner’s equity” andcorporations use the term “shareholder’s equity”.7.2.4The basic accounting equation(sometimes referred to as the balancesheet equation) is:Assets = Liabilities + Owner’s EquityIt applies to all economic entities regardless of size, nature, or form of businessorganization.TEACHING TIP

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-7Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.UseILLUSTRATION 1-5to demonstrate the accounting equation.7.3TheIncome Statement(sometimes called statement of earnings orstatement of operations)reports the profitability of the business’s operationsover a specifi ed period of time (a month, quarter, or year).7.3.1Revenues increase owner’s equity and expenses decrease owner’sequity.Profitresults when revenues exceed expenses for the period.Therefore, profitincreases owner’sequity.Alossis the result whenrevenues are less than expenses for the period.Therefore, aloss decreases owner’sequity.Profit is also referred to as net income or earnings.7.3.2Revenuesare increases in net assets(i.e. an increase in an asset or adecrease in a liabilityand an increase in owner’s equity)that result frombusiness activities performed to earnprofit.Common sources of revenueinclude sales, fees, services, commissions, interest,and rent.7.3.3Expensesare the costs of assets consumed or services used in thecompany’s ordinary business activities.Expenses are decreases in assetsor increases in liabilities, excluding withdrawalsmade by the owners, andresult in a decrease to owner’s equity.Examples of expenses are: telephoneexpense, supplies expense, and rent expense.7.4Statement of Owner’s Equityshows the changes in owner’s equity for thesame period of time as the income statement. In a proprietorship, owner’s equityis increased by investments made by the owner and profits made by thebusiness, and decreased by withdrawals made by the owner and losses madeby the business.7.4.1Investments.When an owner invests assets into the business, theowner’s capitalaccount increases by the value of the assets invested.Therefore, investments increase an asset and owner’s equity.7.4.2Drawingsare withdrawals of cash or other assets from anunincorporated business for the personal use of the owner. Drawings canbe recorded as a decrease to owner’s equity directly or they can berecorded in a separate account calleddrawings.Drawings results in adecrease of an asset and a decrease in owner’s equity.7.4.3Revenues increase owner’s equity and expenses decrease owner’sequity. Therefore,profitsincreaseowner’s equityandlossesdecreaseowner’s equity.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-8Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.TEACHING TIPILLUSTRATION 1-6illustrates transactions that increase and decrease owner’s equity.7.5Cash Flow Statementgives information about the cash receipts and cashpayments made by a business over a specific period of time.The cash flows aredivided into three categories: operating activities, investing activities (e.g. the purchaseand sales of property, plant and equipment) and financing activities (e.g. the borrowingand repayment of debt).8.AccountingDifferencesby Type of Business Organization8.1In a proprietorship, equity is calledowner’s equity.Investments by the ownerareadded to theOwner’s capital account and withdrawals by the ownerarerecordedin a Drawings account.In a partnership,equityis calledpartners’equity. Each partner has a Capital account and a Drawings account. In acorporation, equity is known asshareholders’ equity.It consists of twocategories: the investments made by the shareholders, calledshare capital,and theprofit (orearnings)generated and kept by the company, calledretainedearnings.Dividendsare distributions to the shareholders, and are similar todrawings.Dividends are deducted from retained earnings.TEACHING TIPILLUSTRATION 1-7illustrates the accounting differences by different accountingorganizations.9.The Expanded Accounting Equation9.1 The Basic Accounting Equation can be expanded to include all the differentparts of owner’s equity and show the relationships between revenues, expenses, profits(losses) and owner’s equity.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, BarlowAccounting Principles,SixthCanadianEditionLecture OutlinesChapter 1–Accounting in Action1-9Copyright ©2013John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.9.2From the expanded equation we can see that if revenue increases, owner’sequity increases and thereforeeither assets increase or liabilities decrease to keep theequation balanced. Conversely if expenses increase, owner’s equity decreases andtherefore either assets decrease or liabilities increase to keep the equation balanced.TEACHING TIPILLUSTRATION 1-8illustrates the accounting differences by different accountingorganizations.10.Building the Financial Statements10.1Recognition and Measurement:The first step in preparing financialstatements is to determine what the company should record. Not all events arerecorded and reported in the financial statements. Recognition is the process ofrecording an asset, liability, revenue or expense in the accounting records.Measurement is the process of determining the amount to be recognized.10.1.1 Thecost principle(also known as the historical cost principle)refers to the concept that historical cost is used as the primary basis of measurement.That is, the transaction is first measured at the amount of cash that was paid or at thevalue exchanged. Cost is reliable, definite, verifiable and objectively measured.However, cost may not always be the most relevant measure of certain types of assets.and fair valuesmay provide more useful information.10.1.2Monetary Unit Assumption. Only transactions that can beexpressed in terms of money are recorded in the accounting records. InCanada, we use the dollar to record transactions.10.1.2.1This assumption does prevent some relevant informationfrom being included in the accounting records.10.1.2.2An important part of the monetary unit assumption is theadded assumption that the dollar remains sufficiently constant overtime. Inflation and deflation are ignored for accounting purposes inCanada.11.Transaction Analysis

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