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Class Notes for Financial Accounting: Tools for Business Decision-Making, Seventh Canadian Edition

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 1 CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS LEARNING OBJECTIVES 1. Identify the uses and users of accounting information . 2. Describe the primary forms of business organization. 3. Explain the three main types of business activity. 4. Describe the purpose and content of each of the financial statements.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 2 CHAPTER OUTLINE Learning Objective 1 – Identify the Uses and Users of Accounting information Accounting is the information system that identifies and records the economic events of an organization, and then communicates them to a wide variety of interested users. Teaching suggestion – Ask students to try to identify situations where accounting matters. The users of financial information fall into two categories — internal users and external users.  Internal users – users within the organization who have access to internal accounting information to help them make decisions required to run the company .  External users – users who are outside the organization. These users are not involved in managing a company and do not have access to accounting information other than that which is available to the general public.  Investors (also known as shareholders)  Lenders (also known as creditors)  Other creditors  Others (i.e., Canada Revenue Agency, security commissions and other regulatory agencies, labour unions, potential employees, current employees not involved in managing a company, etc.) Teaching suggestion – Ask students to assume they are managers of XYZ Corp., and consider possible questions they might have that could be answered using financial information (for example, the ability to earn income , generate future cash flows to meet obligations, produce satisfactory return on investment). Next, ask them to assume they are potential lenders or other creditors and think of questions they might have that could be answered using financial information . Learning Objective 2 – Describe the Primary Forms of Business Organization A business may be organized as proprietorships , partnerships , or corporations .  Proprietorship or sole proprietorship – a business owned by one person  Advantages  simple to establish  owner controlled  small amount of capital is needed  owner receives any net income  Disadvantages  proprietor personally liable  financing may be difficult to obtain

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 3  transfer of ownership may be difficult  Partnership – a business owned by two or more people  Advantages  simple to establish  broader skills and resources  shared financial resources  shared control  Disadvantages  partners personally liable  transfer of ownership may be difficult  Corporation – a separate legal entity owned by shareholders  Advantages  easy to sell or transfer ownership  greater capital raising potential  legal liability limited to the net assets of the corporation  some favourable income tax advantages  indefinite life  Disadvantages  more expensive and complex to set up  must file corporate income tax returns annually  Distinguish between public and private corporations  public companies list and trade their shares on public stock exchanges  private companies do not make their shares available to the general public nor trade their shares on public stock exchanges Teaching suggestion – There is a passage in the text, which states, "Although the combined number of proprietorships and partnerships in Canada is more than the number of corporations, the revenue produced by corporations is far greater." Most of the largest companies in Canada — for example, Manulife Financial, Power, Weston, Loblaw, Alimentation Couche - Tard, Royal Bank , Suncor , and Empire — are corporations. Why do you think this is true?  Business records must be kept separate from those related to the proprietor’s, partners’, and shareholders’ personal activities in a proprietorship, partnership, and corporation, respectively. The reporting entity concept requires that the economic activity that can be identified with a company be kept separate and distinct from the activities of the owner(s) and of all other economic entities.  Generally accepted accounting principles (GAAP) are the broad policies and practices as well as rules and procedures that have substantive authoritative support and agreement about how to record and report economic events . Principles are also commonly known as policies or standards.  Publicly traded corporations must use international financial reporting standards ( IFRS). ASPE comparison – Private corporations can choose to follow ASPE (Accounting Standards for Private Enterprises) or IFRS. Once the selection has been made the accounting standards must be consistently applied.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 4 Teaching suggestion – Provide some examples of local private companies and discuss whether it would make sense for the company to should follow ASPE or IFRS. Learning Objective 3 – Explain the Three Main Types of Business Activity There are three types of business activity: financing, investing, and operating. Stress to students that these will be covered in more detail later in the book when the statement of cash flows is discussed in Chapter 13.  Financing activities – to start or expand a business, the company quite often needs cash from outside sources. The two primary sources are:  Debt: Borrowing money from lenders and other creditors which creates a liability  bank loan  debt securities (bonds)  goods on credit from suppliers  Equity: Issuing (selling) ownership interests (shares) in the corporation to shareholders  Investing activities – purchasing (or selling) assets needed to operate the business ( such as equipment, land, etc.) and purchasing or selling shares o r debt securities (such as bonds) of other companies. ( in long - term investments , for example ). Teaching suggestion – At this point, ask students to assume they have extra money to invest and ask them how they would prefer to invest the money. Would they consider loaning money to a corporation or would they rather buy shares in the company? Then ask students why they mad e the decision to lend or buy? Teaching suggestion – Explain to students that investing does not just mean investments. For most companies, the vast majority of investing activities are normally related to the purchase and sale of long - term assets, rather than investments in shares or debt securities of other companies.  Operating activities – comprise the primary activities for which the organization is in business.  Income results from increases in economic resources – normally an increase in an asset but sometimes a decrease in a liability – that result from the sale of a product or service in the normal course of business. Teaching suggestion – Stress the fact that just because a business is earning income it is no reason to assume that the business has a lot of cash in the bank. Focus students’ attention on the three types of business activity and let them think about what could have happened to the money the business has made. You might also ask students how a business reporting a loss could have money in the bank.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 5 Teaching suggestion – Ask students to think about some of the ‘dotcom’ businesses. Many of these companies received large amounts of cash from stockholders and creditors (financing activities). The cash was spent on salaries, advertising, entertainment, equipment and other expe nses and assets (investing and operating activities). Unfortunately, many of these businesses were unable to generate sufficient revenues. When the cash ran out, many of the businesses went under. Many shareholders lost their investments and many creditors were unable to collect on debts. Learning Objective 4 – Describe the Purpose and Content of Each of the Financial Statements Accountants communicate with users through four financial statements :  Income Statement  Reports success or failure of the company’s operations over a specific period of time.  Summarizes all revenue and expenses for the period — month, quarter, or year. If revenues exceed expenses, the result is a net income . If expenses exceed revenues, the result is a net loss .  Also commonly known as the statement of earnings or statement of profit and loss. Net i ncome is also known as profit, or net earnings.  Must be prepared first as net income is a required component to complete the statement of changes in equity.  Statement of Changes in Equity  Shows the amounts and causes of the changes in total shareholders’ equity for the period as well as changes in each component of shareholders’ equity during the period.  Reconciles changes in share capital, retained earnings and any other equity accounts (such as accumulated other comprehensive income) from the beginning to the end of the period.  Covers the same period of time as the income statement.  Must be completed after the income statement and prior to the statement of financial position as ending shareholders’ equity is a required component of the statement of financial position. ASPE comparison – A statement of retained earnings is presented that shows the change in only one component – the retained earnings – of shareholders’ equity. Under IFRS the statement of changes in equity shows changes in all components of shareholders’ eq uity including share capital and retained earnings, and any other equity items.  Statement of Financial Position  Shows the relationship between assets, liabilities and equities on a particular date at the end of a period, rather than for a period of time.  Assets = Liabilities + Shareholders’ Equity.  Also commonly known as the balance sheet (especially for companies reporting under ASPE).

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 6 Teaching suggestion – Give examples of assets (i.e. cash, accounts receivable, inventories, furniture and fixtures, and equipment ) . Explain the difference between accounts receivable and notes receivable. Teaching suggestion – Discuss the concept that assets are the resources that are used by the firm to create more money than what was paid fo r the assets. Liabilities and share holders’ equity is how the assets were acquired by the business.  Statement of Cash Flows  Reports the cash effects (receipts and payments) of a company’s activities for a period of time.  Shows cash increases and decreases for each business activity; operating, investing, and financing activities.  Indicates net increase or decrease in cash during the period as well as ending cash balance.  Covers the same period of time as the income statement and statement of changes in equity.  Ending cash in this statement agrees to the ending cash reported in the statement of financial position. Teaching suggestion – Using the statements in the North West Company illustration, show the interrelationships between the financial statements and the sequence of preparation. (Note: the arrows in the example help to illustrate this.) 1. Income statement ( net income to statement of changes in equity). 2. Statement of changes in equity ( net income from income statement added to retained earnings account. Ending shareholders’ equity for each account and in total from statement of changes in equity to shareholders’ equity section of statement of financial position). 3. Statement of financial position (ending shareholders’ equity for each account and in total from statement of changes in equity). 4. Statement of cash flows (ending cash agrees with cash shown on statement of financial position). Teaching suggestion – Ask students to open their books to the “Sierra Corporation” financial statements found in the “Communicating with Users” section of the text . Follow the example to illustrate ho w the statements link together. Teaching suggestion – Ask students to prepare selected financial statements including the income statement, statement of changes in equity, statement of financial position, and/or statement of cash flows. This is an activity that can kindle thinking. In addition, students may be pleasantly surprised to find that cash outflows they previously thought of as expenses are actually investment activities ( such as payments to purchase a car ).

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting , Seventh Canadian Edition Chapter 1 – The Purpose a nd Use o f Financial Statements 1 - 7 SUGGESTED TOPICS TO GENERATE CLASS DISCUSSION The following list of topics is provided as ideas to help professors generate class discussion. We hope you find one or more suggestions useful. Suggested solutions are not included as answers can be expected to vary widely.  Why does Canada have different accounting standards for different types of corporations?  Shouldn’t all companies follow the same set of accounting standards?  Why would a private company decide to adopt ASPE instead of IFRS?  If you had a private company, what accounting standard — ASPE or IFRS — would you select?  Why are there different terms to describe the same concept?  Do you think that a business needs a code of ethics?  If you were setting up a business, how would you structure the business?  Why would two businesses structure their companies in different ways?  Why would a bank require financial information when examining whether to loan your company money? Should the bank consider your personal, as well as business, information in the determination of whether to offer your business a loan?  Is “business ethics” an oxymoron?

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 1 CHAPTER 1 THE PURPOSE AND USE OF FINANCIAL STATEMENTS 1 MINUTE QUESTION The purpose of these short 1 minute questions is to encourage students to come to class prepared for the lesson, having read the chapter. One of these questions may be given at the beginning of the class and count for ½ to 1 mark. Name two of the external users of accounting information. Answer: External users: Investors, lenders, other creditors, regulators, customers, labour unions, potential employees, current employees not involved in managing a company, and the like.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 2 VOCABULARY QUIZ 1. The amount by which expenses exceed revenues. 2. An association of two or more persons to carry on as co - owners of a business for profit. 3. A financial statement that reports the assets, liabilities, and shareholders’ equity at a specific date. 4. A business owned by one person. 5. Users of financial information that use the information to determine whether or not to lend money. 6. Assets = Liabilities + Shareholders’ equity. 7. Debts and obligations of a business. 8. A report prepared by management that presents financial and non - financial information about the company. 9. The amount of accumulated net income that has been retained in the corporation . 10. The cost of assets consumed or services used in ongoing operations to generate revenues.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 3 ANSWERS TO VOCABULARY QUIZ 1. Loss (or net loss) 2. Partnership 3. Statement of financial position 4. Proprietorship 5. Lenders and other creditors 6. The accounting equation 7. Liabilities 8. Annual report 9. Retained earnings 10. Expenses

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 4 MULTIPLE CHOICE QUIZ 1. All of the following are characteristics of a sole proprietorship, except a. a business owned by one person. b. owner has control of the business. c. a separate legal entity. d. owner has unlimited legal liability. e. none of the above 2. All of the following are characteristics of a corporation, except a. a separate legal entity. b. ownership evidenced by shares. c. produce far more revenue than sole proprietorships and partnerships in Canada. d. shareholders have unlimited liability. e. none of the above 3. Corporations may issue several classes of shares, but the shares representing the primary ownership interest are a. common shares. b. retained earnings. c. financing activity. d. dividends declared. 4. Resources owned by a business and used in carrying out its operating activities are a. liabilities. b. shareholders’ equity. c. revenues. d. assets. 5. Acquiring property, plant, and equipment necessary to operate the business is called a(n) a. financing activity. b. operating activity. c. revenue activity. d. investing activity. 6. The term used to describe the amount that a company earns in exchange for its products is a. cash. b. revenue. c. inventory. d. accounts receivable. 7. The financial statement which presents a picture of what a business owns and owes at a point in time is a(n) a. income statement.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 5 b. statement of changes in equity. c. statement of financial position. d. statement of cash flows. 8. Net income shown on the income statement is added to the beginning balance of retained earnings in the a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows. 9. To report the success or failure of the company’s operations during the period is the purpose of the a. income statement. b. statement of changes in equity. c. statement of financial position. d. statement of cash flows. 10. Borrowing money is considered what type of business activity? a. operating activity b. financing activity c. borrowing activity d. investing activity 11. Paying dividends declared is considered what type of business activity? a. operating activity b. financing activity c. payment activity d. investing activity 12. Purchasing a building is considered what type of business activity? a. operating activity b. financing activity c. buying activity d. investing activity 13. A publicly traded corporation needs to follow which type of accounting standards? a. International financial reporting standards b. Accounting standards for private enterprises c. Not - for - profit accounting standards d. Public company standards 14. Which of the following variations of the accounting equation is incorrect? a. Assets = Liabilities - Shareholders’ Equity b. Assets - Liabilities = Shareholders’ Equity

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 6 c. Assets - Shareholders’ Equity = Liabilities d. Assets - Shareholders’ Equity - Liabilities = 0 e. none of the above 15. The statement of financial position is also commonly called the a. Income statement. b. Statement of changes in financial position. c. Balance sheet. d. Statement of changes in equity.

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 7 ANSWERS TO MULTIPLE CHOICE QUIZ 1. c 2. d 3. a 4. d 5. d 6. b 7. c 8. b 9. a 10. b 11. b 12. d 13. a 14. a 15. c

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    Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley : Financial Accounting , Seventh Canadian Edition Quiz zes Chapter 1 – The Purpose and Use of Financial Statements 1 - 8 20 - MINUTE QUIZ #1 Circle the correct answer. True/False 1. Accounting is an information system that identifies, True False records, and communicates economic events of an organization to interested users. 2. Internal users include investors, lenders, and creditors. True False 3. Issuing shares is considered an investing activity. True False 4. Private companies have a choice of whether to True False follow ASPE or IFRS. 5. The statement of financial position covers a True False period of time. 6. The reporting entity concept requires that True False the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. 7. The income statement can be prepared True False monthly, quarterly, or annually. 8. The statement of financial position is also True False known as the balance sheet. 9. Liabilities represent the ownership claim on True False total assets. 10. A sale of a delivery truck previously used in True False the company’s operations is an example of an operating activity.

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