Horngren’s Accounting
Volume One, Eleventh Canadian Edition
Chapter 1
Accounting and the Business
Environment
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Learning Objective (1 of 5)
Define accounting, and describe the users of accounting
information
• Why is accounting important, and who uses the
information?
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Accounting: The Language of Business
• Accounting is a type of language with specific terminology
• Bookkeeping is only one element of accounting
• Understanding what it all means and how it helps
make better decisions is even more important
• Accounting is an information system that:
– Measures business financial activities
– Processes that information into reports
– Communicates that information to decision makers
For this reason it is called “the language of business”
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Financial Statements
• The flow of information supports business decisions,
based on financial statements and financial reports
Should we
hire more
staff?
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Decision Makers: The Users of
Accounting Information
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Financial Accounting Versus
Management Accounting: (1 of 2)
There is an Important Distinction
Financial Accounting
Provides information for external decision makers*
Management Accounting
Provides information for internal decision makers ONLY
*Internal decision makers may use both Financial and
Management Accounting Information
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Financial Accounting Versus
Management Accounting: (2 of 2)
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Canadian Professional Accounting
Designations (1 of 4)
• Canada’s three professional accounting bodies have
unified into one:
Chartered Professional Accountants (CPA)
• All members certified under the CPA designation are
governed by the CPA Code of Professional Conduct
• The three former bodies were:
– Chartered Accountants (CA)
– Certified General Accountants (CGA)
– Certified Management Accountants (CMA)
• Those accountants who joined the CPA as a result of the
merger currently retain their legacy designation on their
business cards
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Canadian Professional Accounting
Designations (2 of 4)
• Audits are an example of work done by designated
accountants
• What is an audit?
– A financial examination
– Conducted by independent accountants
– Auditors express an opinion on whether or not the financial
statements fairly reflect the economic events that occurred during
the accounting period
– Auditing is not a perfect science; the financial results must provide
information that would allow users to make appropriate decisions
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Canadian Professional Accounting
Designations (3 of 4)
• Companies and their auditors must behave in an ethical
manner
• The relationship among accounting and business entities:
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Canadian Professional Accounting
Designations (4 of 4)
• A Canadian professional accounting designation is only
one option when building an accounting career
• CPA Advanced Certificate in Accounting and Finance
(ACAF) is an alternative certification for those pursuing a
career in accounting, without obtaining a full professional
designation
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Ethics in Canadian Professional
Accounting Designations
• Professional accountants are governed by standards of
professional conduct
• May apply whether public accountants or private
accountants
• Rules focus on:
–
–
–
–
–
–
Confidentiality of information
Maintenance of the profession’s reputation
Work with integrity, due care and competence
Refusal to be associated with false or misleading information
Compliance with professional standards
Independence
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Ethics in Accounting and Business (1 of 2)
Accountants hold a special position of trust in society!
• Circumstances or external pressures may influence
accountants to record or present financial information in a
manner that misleads decision makers
• There may be circumstances where accountants are
pressured by other parties to account for transactions in a
manner that may be misleading
• This bias is not always a pressure to make results “look
better”
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Ethics in Accounting and Business (2 of 2)
• Users must be confident that they can rely on the financial
information used for making decisions
• A breakdown in ethical behaviour has caused major
accounting scandals involving both public companies and
their auditors
• External audits are intended to provide users with
confidence
• New regulatory and reporting requirements are meant to
improve the quality of financial reporting
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Learning Objective (2 of 5)
Compare and contrast the forms of business
organizations
• In what form can we set up a company?
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Most Common Forms of Business
Organizations (1 of 2)
• Sole Proprietorship
• Partnership and Limited Liability
Partnership (LLP)
• Corporation
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Most Common Forms of Business
Organizations (2 of 2)
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Proprietorship
Partnership
Corporation
Owner(s)
Proprietor—one owner
Partners—two or more owners
Shareholder(s)—one or
many owners
Life of
organization
Limited by owner’s
choice or death
Limited by owners’ choices or
death of one of the partners
Indefinite
Personal liability
of owner(s) for
business debts
Owner is personally
liable
Partners are personally liable*
Shareholders are not
personally liable
Legal status
The owner and the
business are not legally
separate
The partnership is the
partners; they are not legally
separate
The corporation is
separate from the
shareholders (owners)
Taxation
The owner pays tax on
the proprietorship’s
earnings; income is
added onto the owner’s
personal tax return
The owners each pay tax on
their share of the partnership’s
earnings; income is added
onto each partner’s personal
tax return
Separate taxable entity;
the corporation pays
tax on its earnings
*Unless it is a limited-liability partnership (LLP)
With an LLP, the actions of one partner cannot create a
significant liability for the other partners
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Learning Objective (3 of 5)
Describe some concepts and principles of accounting
• What are some of the guidelines for accounting and why
do we need them?
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Accounting Concepts (1 of 2)
• How do we improve usefulness of financial
information?
• Develop common guidelines for how accountants
measure, process, and communicate financial information,
known as General Accepted Accounting Principles
(GAAP)
• Historically, each country had its own GAAP
• Canada has joined much of the developed world in
adopting International Financial Reporting Standards
(IFRS) as its GAAP for Publicly Accountable Enterprises
Which important country has not adopted IFRS?
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Accounting Concepts (2 of 2)
• Canadian GAAP is administered by the Accounting
Standards Board (AcSB)
• IFRS applies to publicly accountable enterprises
• For small to medium sized businesses, the AcSB
developed the Accounting Standards for Private
Enterprises (ASPE), a simplified version of IFRS
• IFRS and ASPE are prepared under the authority of the
Accounting Standards Board and are published as part of
the CPA Canada Handbook
• IFRS and ASPE are “principles-based”, requiring
professional judgment in some circumstances
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Framework for Financial Reporting
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Objective
Level 1
• The objective of financial reporting is
to communicate useful information
to users
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Qualitative Characteristics
Level 2
•
•
•
•
Relevance
Comparability
Reliability
Understandability
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Elements
Level 3
•
•
•
•
Assets
Liabilities
Equity
Revenues, expenses, gains
and losses
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Foundation: Key Assumptions,
Principles, Constraints
Level 4
• Assumptions
• Principles
• Constraints
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Three Main Characteristics of
Accounting Information
• Relevant: provides important information upon which you can
base your investment decision.
• Reliable – in order to accounting information to be useful, it
must be reliable; information is reliable when it accurately
represents the impact of the transaction, and is free of error
or bias
• Comparable – users should be able to compare the
information against the business’s own financial results in
previous years or against the results of another company in
the same industry
• Understandable – it clear and concise, so that information is
not misunderstood
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Considerations: The Economic-Entity
Consideration
• Each entity is accounted for separately and distinctly from
other entities (organizations and persons)
• For example:
– A sole proprietor must ensure that the accounting for business
transactions is kept separate from personal transactions
– A group of related corporations must ensure that they account for
business transactions accurately within each legal entity
– A company may keep each department’s accounting separate
from all the other departments to assess and evaluate the
performance of each department
• Able to evaluate the success of your business
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Considerations: The Going-Concern
Assumption
• We assume that an entity will remain in operation for the
foreseeable future
• This allows it to use its resources rather than being forced
to accept whatever price it can get due to bankruptcy
• If an entity is not a going concern, then accounting is done
under bankruptcy conditions, which impacts valuations,
presentation and disclosure
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Considerations: The Stable-MonetaryUnit Assumption
• The dollar’s purchasing power is relatively stable
Assume inflation is at normal levels
• This allows accountants to ignore the effect of inflation in
the accounting records
• In hyper-inflationary or significant deflationary situations,
accountants must use specialized accounting treatments
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Principles: The Cost Principle of
Measurement
• Acquired assets and services should be recorded at their
actual cost
Also known as original or historical cost
• They continue to be accounted for at historical cost,
because, in most circumstances, this is more reliable
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Constraints: Cost/Benefit and
Materiality
• The benefits from the information produced should outweigh the time, effort and cost to produce it
• A piece of information is material if it would affect a
decision maker’s decision
• Is the value of the item important?
• Materiality is judgment-based
• Would a $100K inventory error be material if:
– Inventory was $1M?
– Inventory was $100M?
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Learning Objective (4 of 5)
Use the accounting equation to analyze business
transactions
• How do business activities affect the accounting records of
a company?
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The Accounting Equation
Assets
Economic
Resources
Liabilities
Owed to
Outsiders
Owners’
Equity
Owed to
Owners
• The value of an entity’s Assets are split between (equal to) Liabilities
and Owner’s Equity!
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Assets
• Economic resources controlled by an entity that are
expected to benefit the business in the future
• Examples of assets include:
–
–
–
–
–
–
Cash
Accounts Receivable (amounts owed from customers)
Notes Receivable
Prepaid Expenses
Land and Building
Equipment, Furniture, and Fixtures
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Liabilities
• Debts and amounts owed, that are payable to outsiders
(often called creditors)
• Examples of liabilities include:
– Accounts payable (amounts owed to suppliers)
– Notes payable (loans from financial institutions)
– Unearned revenue
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Owners’ Equity (1 of 2)
• Considered the amount owed to the owner(s)
• Owner’s Equity is often referred to as net assets
• Owner’s Equity is a combination of:
– Capital – direct investments of cash or assets by the owner(s)
– Withdrawals – cash or assets distributed to owner(s)
– Revenues – amount earned
– Expenses – cost of doing business
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Owners’ Equity (2 of 2)
• Terminology for Owner’s Equity varies depending on the
type of organization:
Sole Proprietorship
Partnership
Corporation
Equity terminology
Owner’s Equity
Partners’
Equity
Shareholders’
Equity
Resources removed
from the business by
the owner
Withdrawals, or Drawings
Withdrawals, or Dividends
Drawings
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Transactions That Increase and
Decrease Owner’s Equity
INCREASES
DECREASES
Owner investments
in the business
Owner with drawls
from business
Owners’
Equity
Revenues
Expenses
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Revenues
• Amounts earned by delivering goods or services to
customers
• Examples of revenues include:
–
–
–
–
Fees earned (service revenue)
Sale of merchandise
Rent earned
Interest earned
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Expenses
• Amounts that have been paid or will be paid for costs
that have been incurred to earned revenue
• Examples include:
–
–
–
–
–
Rent
Salaries and wages
Utilities
Supplies
Amortization or depreciation
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Expanded Accounting Equation
• Expanding OE helps to better understand the relationship
between the various aspects of the accounting equation:
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Accounting for Business Transactions
• It is critical that we record relevant business transactions
• Relevant business transactions are defined as:
– Any event that affects the financial position of the business entity
AND
– Can be measured reliably
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Accounting for Business Transactions:
An Example (1 of 3)
1. The owner, Lisa Hunter, invests $250,000 to start a new
business, HEC
2. HEC purchases land for a future office location, paying
$100,000 cash
3. HEC buys stationery and other office supplies, agreeing
to pay $7,000 within 30 days
4. HEC earns service revenue by providing environmental
consulting services for clients. Assume the business
earns $30,000 and collects this amount in cash.
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Accounting for Business Transactions:
An Example (2 of 3)
5. HEC performs consulting services for clients who do not
pay immediately. In return for the services, HEC issues
an invoice, and the clients will pay the $25,000 amount
within one month.
During the month, HEC pays $12,000 in cash expenses:
6. Office rent, $4,000
7. Employee salaries, $6,500
8. Utilities, $1,500
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Accounting for Business Transactions:
An Example (3 of 3)
9. HEC pays $5,000 to the store from which it purchased
$7,000 worth of office supplies in Transaction 3
10. Lisa Hunter remodels her home at a cost of $30,000,
paying cash from personal funds
11. The business collects $15,000 from the client, as partial
payment for the consulting services performed in
Transaction 5
12. Lisa withdraws $6,000 cash for her personal use
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Accounting for Business Transactions
(1 of 2)
• Pay attention to the specific words and phrases used
• For example:
– “Received” means a sale settled in Cash
– A “sale on account” means that the Cash will be received (a
Receivable) at a later date
– Purchased on “credit” means the expense was incurred, but it will
be paid for at a later date
– “Paid” means they “paid using Cash”.
– A “payment on account” means cash was used to pay a prior bill
(account)
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Accounting for Business Transactions
(2 of 2)
Bla
nk
Bla
nk
Assets
Cash
Accounts
Receivable
Supplies
Land
= Liabilities
+ Owner’s
Equity
Accounts
Payable
L. Hunter,
Capital
1.
+250,000
Blank
Blank
Blank
Blank
2.
−100,000
Blank
Blank
+100,000
Blank
3.
Blank
4.
Blank
+30,000
5.
+7,000
Blank
Blank
+25,000
Blank
+250,000
Blank
+7,000
Blank
Blank
Blank
Blank
+30,000
Blank
Blank
Blank
+25,000
Blank
−12,000
6.
−12,000
Blank
Blank
Blank
7.
−5,000
Blank
Blank
Blank
8.
N/A
Blank
Blank
Blank
Blank
Blank
9.
+15,000
−15,000
Blank
Blank
Blank
Blank
10.
−6,000
_____
_____
______
____
−6,000
172,000
10,000
7,000
100,000
2,000
287,000
Blank
−5,000
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Learning Objective (5 of 5)
Prepare financial statements
• What financial statements are prepared by a company, and
how do we create them?
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The Financial Statements
• Financial statements are the formal reports of an entity’s
financial information
• The primary financial statements, in order of preparation,
are:
1. Income Statement – presents a summary of the revenues and
expenses of an entity for a period of time
2. Statement of Owner’s Equity – presents changes in OE for a
period of time
3. Balance Sheet (Statement of Financial Position) – lists all the
assets, liabilities, and owner’s equity of an entity as of a specific
date
4. Cash Flow Statement – reports the cash coming in and the cash
going out during a period of time (covered in Chapter 17)
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Income Statement
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Statement of Owner’s Equity
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Balance Sheet
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Relationship Among the Financial
Statements (1 of 3)
• The Income Statement
is prepared first
• Net Income from the
Income Statement
feeds into the
Statement of Owner’s
Equity, which is
prepared second
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Relationship Among the Financial
Statements (2 of 3)
• The closing Capital balance is feeds the Balance
Sheet, which is prepared third
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Relationship Among the Financial
Statements (3 of 3)
• The Cash Flow
Statement explains the
change in Cash during
the period, and is
prepared fourth
• The ending Cash
balance must be the
same on the Balance
Sheet and Cash Flow
Statement
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