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 EditionChapter 1–The Purposeand Useof Financial Statements1-1CHAPTER 1THE PURPOSE AND USE OF FINANCIALSTATEMENTSLEARNINGOBJECTIVES1.Identify the uses and users of accountinginformation.2.Describe the primary forms of business organization.3.Explain the three main types ofbusiness 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 EditionChapter 1–The Purposeand Useof Financial Statements1-2CHAPTER OUTLINELearningObjective 1–Identify the Uses and Users ofAccountinginformationAccountingis the information system that identifies andrecords the economic events of anorganization, 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 intotwo categories—internalusers and external users.Internal users–users within the organization whohave access to internal accountinginformation to help them make decisions required to run the company.External users–users who are outside the organization.These users are not involvedin managing a company and do not have access to accounting information other thanthat 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 regulatoryagencies, labour unions,potential employees, current employees not involved inmanaging a company,etc.)Teaching suggestion–Ask students to assume they are managers of XYZ Corp., and considerpossible questions they might have that could be answered using financial information (forexample, the ability toearn income, generate future cash flows to meet obligations, producesatisfactory return on investment). Next, ask them to assume they are potential lenders or othercreditors andthink ofquestions they mighthave that could beansweredusingfinancialinformation.LearningObjective 2–Describe the Primary Forms ofBusiness OrganizationA business may be organized asproprietorships,partnerships, orcorporations.Proprietorship or sole proprietorship–a business owned by one personAdvantagessimple to establishowner controlledsmall amount of capital is neededowner receives anynetincomeDisadvantagesproprietor personally liablefinancing may be difficultto obtain

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley:Financial Accounting, Seventh Canadian EditionChapter 1–The Purposeand Useof Financial Statements1-3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 betweenpublic 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 nortrade their shares on public stock exchangesTeaching suggestion–There is a passage in the text, which states, "Although the combinednumber 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, andcorporation, respectively. Thereporting entity conceptrequires that the economicactivity that can be identified with a company be kept separate and distinct from theactivities of the owner(s) and of all other economic entities.Generally accepted accounting principles (GAAP) are the broad policies and practicesas well as rules and procedures that have substantive authoritative support andagreement about how torecord andreport economic events.Principles are alsocommonly known as policies or standards.Publicly tradedcorporations must use international financial reporting standards(IFRS).ASPE comparison–Private corporations can choose to follow ASPE(Accounting Standards forPrivate Enterprises) or IFRS. Once the selection has been made the accounting standards mustbe consistently applied.

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley:Financial Accounting, Seventh Canadian EditionChapter 1–The Purposeand Useof Financial Statements1-4Teaching suggestion–Provide some examples of local private companies and discuss whetherit would make sense for the company to should follow ASPE or IFRS.LearningObjective 3–Explain the Three Main Types ofBusiness ActivityThere are three types of business activity: financing, investing, and operating. Stress to studentsthat these will be covered inmore detail later in the book when the statement of cash flows isdiscussed in Chapter 13.Financing activities–to start or expand a business, the company quite often needscash 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 asequipment, land, etc.) andpurchasing or selling shares ordebt securities(such as bonds) of other companies.(inlong-term investments, for example).Teaching suggestion–At this point, ask students to assume they have extra money to invest andask them how they would prefer to invest the money. Would they consider loaning money to acorporation or would they rather buy shares in the company? Then ask students why they madethe decision to lend or buy?Teaching suggestion–Explain to students that investing does not just mean investments. Formost companies, the vast majority of investing activities are normally related to the purchase andsale 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 inbusiness.Incomeresults from increases in economic resources–normally an increase in anasset but sometimes a decrease in a liability–that result from the sale of a product orservice in the normal course of business.Teaching suggestion–Stress the fact that just because a business isearning incomeit is noreason to assume that the business has a lot of cash in the bank. Focus students’ attention onthe three types of business activity and let them think about what could have happened to themoney the business has made. You might also ask studentshow a business reporting a losscould have money in the bank.

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley:Financial Accounting, Seventh Canadian EditionChapter 1–The Purposeand Useof Financial Statements1-5Teaching suggestion–Ask students to think about some of the ‘dotcom’ businesses. Many ofthese companies received large amounts of cash from stockholders and creditors (financingactivities). The cash was spent on salaries, advertising, entertainment, equipment and otherexpensesandassets(investingandoperatingactivities).Unfortunately,manyofthesebusinesses were unable to generate sufficient revenues. When the cash ran out, many of thebusinesses went under. Many shareholders lost their investments and many creditorswereunable to collect on debts.LearningObjective 4–Describe the Purpose and Content ofEach of the Financial StatementsAccountants communicate with users through fourfinancial 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. Ifrevenues exceed expenses, the result is anetincome. If expenses exceed revenues,the result is anet loss.Also commonly known as the statement of earnings or statement of profit and loss.Netincomeis also known asprofit,or net earnings.Must be prepared first asnetincomeis a required component to complete thestatement of changes in equity.Statement of Changes in EquityShows the amounts and causes of the changes in total shareholders’ equity for theperiod 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 ofthe period.Covers the same period of time as the income statement.Must be completed after the income statement and prior to the statement of financialposition as ending shareholders’ equity is a required component of the statement offinancial position.ASPE comparison–A statement of retained earnings is presented that shows the change in onlyone component–the retained earnings–of shareholders’ equity. Under IFRS the statement ofchanges in equity shows changes in all components of shareholders’ equity including sharecapital and retained earnings, and any other equity items.Statement of Financial PositionShows the relationship between assets, liabilities and equities on a particular date atthe 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 underASPE).

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley:Financial Accounting, Seventh Canadian EditionChapter 1–The Purposeand Useof Financial Statements1-6Teaching suggestion–Give examples of assets (i.e. cash, accountsreceivable, inventories,furniture and fixtures, and equipment). Explain the difference between accounts receivable andnotes receivable.Teaching suggestion–Discuss the concept that assets are the resources that are used by thefirm to create moremoney than what was paid for the assets. Liabilities and shareholders’ equityis 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 periodof time.Shows cash increases and decreasesfor each business activity;operating, investing,and financing activities.Indicates net increase or decrease in cash during the period as well as ending cashbalance.Covers the same period of time as the income statement and statement of changes inequity.Ending cash in this statement agrees to the ending cash reported in the statement offinancial position.Teaching suggestion–Using the statements in theNorth WestCompanyillustration, show theinterrelationships between the financial statements and the sequence of preparation. (Note: thearrows in the example help to illustrate this.)1.Income statement (net incometo statement of changes in equity).2.Statement of changes in equity (net incomefrom income statement added to retainedearnings account. Ending shareholders’ equity for each account and in total from statementof 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 fromstatement of changes in equity).4.Statement of cash flows (ending cash agrees with cash shown on statement of financialposition).Teaching suggestion–Ask students to open their books to the “Sierra Corporation” financialstatementsfound in the “Communicating with Users” section of the text. Follow the example toillustrate how the statements link together.Teaching suggestion–Ask students to prepare selected financial statements including theincomestatement, statement of changes in equity, statementof financial position,and/orstatement of cash flows. This is an activity that can kindle thinking. In addition, students maybepleasantly surprised to find that cash outflows they previously thought of as expenses are actuallyinvestment activities (such aspaymentsto purchase a car).

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley:Financial Accounting, Seventh Canadian EditionChapter 1–The Purposeand Useof Financial Statements1-7SUGGESTED TOPICS TO GENERATE CLASS DISCUSSIONThe following list of topics isprovided as ideas to help professors generate class discussion. Wehope you find one or more suggestions useful. Suggested solutions are not included as answerscan 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 youselect?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 yourcompany money? Should the bank consider your personal, as well as business, informationin 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 EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-1CHAPTER 1THE PURPOSE AND USE OF FINANCIAL STATEMENTS1 MINUTE QUESTIONThe purpose of these short 1 minute questions is to encourage students to come to class prepared forthe lesson, having read the chapter. One of thesequestions may be given at the beginning of the classand 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 EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-2VOCABULARY QUIZ1.The amount by which expenses exceedrevenues.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 specificdate.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 thecompany.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 EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-3ANSWERSTO VOCABULARY QUIZ1.Loss (or net loss)2.Partnership3.Statement of financial position4.Proprietorship5.Lenders and other creditors6.The accounting equation7.Liabilities8.Annual report9.Retained earnings10.Expenses

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-4MULTIPLE CHOICE QUIZ1.All of the following are characteristics of a sole proprietorship,excepta.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 ofthe above2.All of the following are characteristics of a corporation,excepta.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 above3.Corporations may issue several classes of shares, but the shares representing the primaryownership interest area.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 area.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 isa.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 intime is a(n)a.income statement.

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-5b.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 retainedearnings in thea.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 ofthea.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.operatingactivityb.financing activityc.borrowing activityd.investing activity11.Paying dividends declared is considered what type of business activity?a.operating activityb.financing activityc.payment activityd.investing activity12.Purchasing a building is considered what type of business activity?a.operating activityb.financing activityc.buying activityd.investing activity13.A publicly traded corporation needs to follow which type of accounting standards?a.International financial reporting standardsb.Accounting standards for private enterprisesc.Not-for-profit accounting standardsd.Public company standards14.Which of the following variations of the accounting equation isincorrect?a.Assets = Liabilities-Shareholders’ Equityb.Assets-Liabilities = Shareholders’ Equity

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-6c.Assets-Shareholders’ Equity = Liabilitiesd.Assets-Shareholders’ Equity-Liabilities = 0e.none of the above15.The statement of financial position is also commonly called thea.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 EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-7ANSWERSTO MULTIPLE CHOICE QUIZ1.c2.d3.a4.d5.d6.b7.c8.b9.a10.b11.b12.d13.a14.a15.c

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, and Burnley: Financial Accounting, Seventh Canadian EditionQuizzesChapter 1–The Purpose and Use of Financial Statements1-820-MINUTE QUIZ #1Circle the correct answer.True/False1.Accounting is an information system that identifies,TrueFalserecords, and communicates economic events of anorganization to interested users.2.Internal usersinclude investors, lenders, and creditors.TrueFalse3.Issuing shares is considered an investing activity.TrueFalse4.Private companies have a choice of whether toTrueFalsefollow ASPE or IFRS.5.The statement of financial position covers aTrueFalseperiod of time.6.The reporting entity concept requires thatTrueFalsethe activities of the entity be kept separateand distinct from the activities of its ownerand all other economic entities.7.The income statement can be preparedTrueFalsemonthly, quarterly, or annually.8.The statement of financial position is alsoTrueFalseknown asthebalance sheet.9.Liabilities represent the ownership claim onTrueFalsetotal assets.10.A sale of a delivery truck previously used inTrueFalsethe company’s operations is an example ofan operating activity.

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