Lecture Notes for Principles of Financial Accounting, Canadian Edition

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John 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.1.5In 2013, Ontario’s Chartered Accountants and Certified ManagementAccountants joined together under a new designation: Chartered ProfessionalAccountant. At the time of publication (March 2014), a Memorandum ofUnderstanding had been signed in support of continuing the unification ofOntario’s accountants by including Ontario’s Certified General Accountants asmembers of CPA Ontario.In light of these changes and anticipated changes, it islikely that current high school students who wish to pursue a career inaccounting will follow the path towards the CPA designation, rather than facing achoice among the predecessor designations.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.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?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.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.TEACHING TIPILLUSTRATION 1-2illustrates questions asked by external users.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.Although the businessand its owner represent two separateand distinct economic entities,thereis nolegal distinction betweenthe two from a legal standpoint, so the life of the

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.proprietorship is limited to the life of the owner. However, the records of thebusiness activities must be kept separate from the activities of the owner.This isconsistent with the Economic Entity GAAP.The profits of the business arerecorded on the owner’s personal income tax return.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 accountantswho are not allowed to incorporateEach partner generally has unlimited liability for all debts of the partnership, evenif one of theother partners created 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.6.1.2A recent change in Canadian GAAP is the implementation of two sets of

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.standards, International Financial Reporting Standards (IFRS), andAccounting Standards (ASPE)for Private Enterprises.Canadian publicenterprises must follow International 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 the users of Private companies typicallyrequire less information in the financial statements, the AcSB developedAccounting Standards for Private Enterprises (ASPE). Canadian PrivateCompanies have the choice to report under IFRS or ASPE.6.1.3Both IFRS andASPEare considered “principles-based” as opposed to“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.AccountingModel7.1The 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.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.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 benefitsand helps the businessgenerate revenuewhich results in future cash inflows.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 customersi.e.when a professional sports team or musical act sells tickets in advance).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.The accounting equation also shows that a business’s assets arefinanced by a combination of debts owed to creditors (i.e., liabilities) and theowner’s investment (i.e., equity).TEACHING TIPUseILLUSTRATION 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 specified period of time (a month, quarter, or year).

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.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 dec-reases 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 renting propertyout to tenants.7.3.3Expensesare the costs of assets consumed or services used in thecompany’s ordinary business activities.Essentially, they can be thought of asthe “costs of doing business” in the sense that they help a business generaterevenue.Expenses are decreases in assets or increases in liabilities,excluding withdrawalsmade by the owners, and result in a decrease toowner’s equity.Examples of expenses are: telephone expense, suppliesexpense, 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 owners from their personal resourcesand profits made by the business, and decreased by withdrawals made by theowner and losses made by 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.TEACHING TIP

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.ILLUSTRATION 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.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 TIP

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.ILLUSTRATION 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 Analysis11.1Transactions are the economic events of acompanythat are recorded.Once ithas been determined that an event or transaction should be recognized, it mustbe analyzed for its effect on the components of the accounting equation before itcan be recorded. This analysis must identify the specific items that are affectedand the amount of change in each item.11.2The two sides of the accounting equation must always be equal.11.2.1Each transaction must have a dual effect on the equation.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.11.2.2If an asset is increased, there must be a corresponding:11.2.2.1Decrease in another asset, or11.2.2.2Increase in a liability, or11.2.2.3Increase in owner’s equity.11.3Each transaction must beanalyzed in terms of its effects on specific items withinthe components of the accounting equation. The two sides of the equationremainequal.TEACHING TIPILLUSTRATION 1-10summarizes the effect of transactionson the accounting equation.The illustration demonstrates that each transaction must be analyzed for its effects on thethree components of the accounting equation(assets, liabilities, and owner’s equity), thespecific items within each component; and thatthe two sides of the equation arealwaysequal.12.PreparingFinancial Statements12.1Anincome statementpresents the revenues and expenses andtheresultingprofitor loss for a specific period of time.The income statement is alwaysprepared first in order to determine the amount of profit (to be added to capital)or loss (to be subratcted from capital) in the Statement of Owner’s Equity.12.2Astatement of owner’s equitysummarizes the changes in owner’s equity for aspecific period of time.12.3Abalance sheetreports the assets, liabilities, and owner’s equity of a companyat a specific date.12.4Acash flow statementsummarizes information concerning the cash inflows(receipts) and outflows (payments) for a specific period of time.12.5The financial statements are interrelated. The income statement is prepared first.Theprofitor loss becomes part of the statement of owner’s equity, which isprepared next. The ending capital balance from the statement of owner’s equitythen becomes part of the balance sheet. Lastly, the ending cash balance fromthe balance sheet appears in the cash flow statement.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of FinancialAccounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.TEACHING TIPUseILLUSTRATION 1-11to demonstrate the relationship between the four financialstatements.13.Using the Information in the Financial Statements13.1Financial statements of publicly traded companies are presented in anannual report.13.2The annual report includes useful non-financial information about thecompany, as well as financial information.Non-financial information mayinclude a management discussion of various aspects of the company,such as the company’s mission, goals and objectives. Financialinformation may include a review of currentoperations,ratio analysis ofhistorical information, and comparative financial statements.13.3The financial statements of public companies are auditedby a publicaccounting firmand include an auditors’ report.The annual report alsoincludes a statement of management responsibility for the statements.

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of Financial Accounting, Canadian EditionCopyright ©2014John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.CHAPTER 1ONE-MINUTE CHAPTER QUESTIONSTEACHING TIPThe purpose of chapter questions is to encourage students to read the chapter materialbefore coming to class. They are normally given in the first few minutes of the class beforethe lecture begins and can count for ½ to 1 mark of a student’s grade.Question1:State the basic accounting equation.Question 2:What are the fourbasicfinancial statements?Suggested Solutions:Question 1:Assets = Liabilities + Owner’s EquityQuestion 2: The fourbasicfinancial statements are:(1)Income Statement(2)Statement of owner’s equity(3)Balance sheet(4)Cash flow statement

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of Financial Accounting, Canadian EditionCopyright © 2014 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictlyprohibited.CHAPTER 120-MINUTE QUIZ #1Circle the correct answer.True/FalseLO 1E 1.Accounting is an information system thatidentifies, records, and communicates economicevents of an organization to interested users.TrueFalseLO 4 E 2.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 to investors and creditors tomake decisionsTrueFalseLO 2 E4.Private companies have a choice of whetherto follow ASPE or 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 M 7.Collection of an account receivable willincrease both cash and accounts receivable.TrueFalseLO5 M 8.An expense paid with cash would result inanequal decrease in liabilities and owner’s equityTrueFalseLO 5 M9.Liabilities represent the ownership claim ontotal assets.LO 5 M 10.The going concern assumption assumes thata companywill liquidate in the near futureTrueTrueFalseFalse

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Weygandt, Kieso, Kimmel, Trenholm, Kinnear, Barlow, AtkinsPrinciples of Financial Accounting, Canadian EditionCopyright ©2014John 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, Barlow, AtkinsPrinciples of Financial Accounting, Canadian EditionCopyright ©2014John 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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