Introduction to Financial

Accounting
Chapter 1
Introduction to Financial Accounting

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1.1 Define Accounting
LO1 – Define accounting.

• What is accounting?
• A process that identifies, measures, records, and reports on a
business’s economic activities to various users
• Two areas of accounting are managerial accounting and
financial accounting
• Who are the users?
• Internal users – i.e. management – managerial accounting
• External users – i.e. investors, creditors, suppliers/vendors,
customers, and labour unions – financial accounting, CRA,
Government
• What is financial accounting?
• An area of accounting that focuses on external reporting for
external users
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Decision Makers: The Users of Accounting
Information
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

*Internal decisions makers may use both Financial and

Management Accounting Information
Financial Accounting Versus Management
Accounting: (2 of 2)
Canadian Professional Accounting
Designations
• 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 standards of professions conduct
• The three former bodies were:
• Chartered Accountants (CA)
• Certified General Accountants (CGA)
• Certified Management Accountants (CMA)
• CPA Advanced Certificate in Accounting and Finance
(ACAF) is an alternative to pursuing a full professional
designation
Ethics in Canadian Professional Accounting
Designations (1 of 3)
• 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
Ethics in Canadian Professional Accounting
Designations (2 of 3)
• 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
Ethics in Canadian Professional Accounting
Designations (3 of 3)
• Companies and their auditors must behave in an ethical
manner
• The relationship among accounting and business entities:
Ethical Considerations 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”
Ethical Considerations in Accounting and
Business (2 of 2)
• Users must be confident that they can rely on the financial
information used for making decisions
• External audits are intended to provide users with confidence
• A breakdown in ethical behaviour has caused major accounting
scandals involving both public companies and their auditors
• New regulatory and reporting requirements are meant to improve the
quality of financial reporting
Professional Accounting Bodies and
Standards of Professional Conduct
1.2 Business Organizations
LO2 – Identify and describe the forms of business organization.

• What are the types of organizations that use

accounting information?
• A business organization sells products and/or
services for profit
• A non-business organization does not have profit as
a goal; hospitals, schools or charities serve the
needs of society
• Three types of business organizations:
• A proprietorship, a partnership and a corporation

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Most Common Forms of Business
Organizations (2 of 2)
Blank 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 Limited by owners’ choices or Indefinite
or death death of one of the partners

Personal liability of Owner is personally liable Partners are personally liable* Shareholders are not
owner(s) for personally liable
business debts
Legal status The owner and the The partnership is the partners; The corporation is
business are not legally they are not legally separate separate from the
separate shareholders (owners).
Taxation The owner pays tax on The owners each pay tax on their Separate taxable entity;
the proprietorship’s share of the partnership’s the corporation pays tax
earnings; income is earnings; income is added onto on its earnings
added onto the owner’s each partner’s personal tax
personal tax return return

*Unless it is a limited-liability partnership (LLP)

With a LLP, the actions of one partner cannot create a

significant liability for the other partners
Proprietorship
• Proprietorship characteristics:
• A business that is owned by one person
• Not a separate legal entity
• Business profits are included in the owner’s personal tax return
• Unlimited liability with regard to debts owed by the business
• Are often small businesses

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Partnership
• Partnership characteristics:
• A business that is owned by two or more individuals
• Not a separate legal entity
• Owners are subject to unlimited liability with regard to debts owed by the
business

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Corporation
• Corporation characteristics:
• A business that is owned by one or more individuals, called shareholders,
where ownership is in the form of shares
• A separate legal entity
• Files its own tax return
• Liability of owners is limited to their investment in the corporation

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Corporation
• Corporation characteristics - continued:
• Shareholders can own any number of shares. The number of shares held by a
shareholder represents how much of the corporation they own
• A corporation can have different types of shares such as common shares and
preferred shares.
• Common shares can be privately held or publically traded
• Shareholders from larger corporations are represented by the Board of
Directors and daily management is delegated to officers of the corporation

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Corporation

Generalized Form of a Corporate Organization

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1.3 Accounting Standards
LO3 – Identify and explain the Generally Accepted Accounting
Principles (GAAP).

Generally Accepted Accounting Principles (GAAP):

Two standards in Canada:
• International Financial Reporting Standards
(IFRS) for publically-traded corporations
• Accounting Standards for Private Enterprises
(ASPE) for privately held corporations.

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Qualitative Characteristics
• Accounting practices are guided by qualitative characteristics and
principles
• Six qualitative characteristics:
1. Relevance – ability to make a difference
2. Faithful representation – complete, neutral, free from error
3. Comparability – utilizing similar accounting practices
4. Verifiability – financial reports logically flow from the data and are
reproducible
5. Timeliness – financial reports are available in time to be useful to
decision makers
6. Understandability – information is clear and concise
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Accounting Principles
• Nine principles - general rules and concepts that govern the field
of accounting:
1. Business entity – each economic entity maintains separate records
2. Consistency – a business uses the same accounting policies and
procedures from period to period
3. Cost – each economic transaction is based on the actual original cost
4. Full disclosure – accounting information is sufficient to make
knowledgeable decisions
5. Going concern – assume that the business will continue into the future

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Accounting Principles
• Principles – continued:
6. Matching – financial transactions are reported in the
period occurred/realized
7. Materiality – applies to items that are significant
enough to affect decisions made by users
8. Monetary unit – financial information expressed in stable units of
money
9. Recognition – revenues are recorded when earned and expenses are
recorded when incurred

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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?
Accounting Concepts (2 of 2)
• Canadian GAAP is administered by the Accounting Standards Board
(AcSB)
• 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
Framework for Financial Reporting
Objective
The objective of financial
reporting is to:

• Provide useful
Level 1 information to
decision-makers
Qualitative Characteristics

• Relevance
• Comparability
Level 2
• Reliability
• Understandability
Elements

• Assets
• Liabilities
Level 3 • Revenues and
expenses
• Gains and losses
Foundation: Assumptions, Principles,
Constraints (1 of 2)

• Considerations
Level 4 • Principles
• Constraints
Foundation: Assumptions, Principles, Constraints (2 of
2)
The Reliability Characteristic
• In order to accounting information to be useful, it must be reliable
• Information is reliable when it:
• Accurately represents the impact of the transaction
• Is free of error or bias
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
• Alternatively, a group of related corporations must ensure that they
account for business transactions accurately within each legal entity
• Able to evaluate the success of your business
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
Considerations: The Stable-Monetary-Unit
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
Principles: The Cost Principle of
Measurement
• Acquired assets and services should be recorded at their actual cost

Also known as original or historical cost

Constraints: Cost/Benefit and Materiality
• The benefits from the information produced should out-weigh the
time, effort and cost to produce it
• A piece of information of material if it would affect a decision maker’s
decision
• Materiality is judgment-based
• Would a $100K inventory error be material if:
• Inventory was $1M?
• Inventory was $100M?
1.4 Income Statement
LO4 – Identify, explain, and prepare the financial statements.

Financial Statements:
1. Income Statement: reports revenues and
expenses during the period

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Statement of Changes in Equity
• Financial Statements - continued:
2. Statement of Changes in Equity: reports changes in the
equity accounts during the period

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Balance Sheet (Statement of Financial
Position)
• Financial Statements - continued:
3. Balance Sheet: reports assets, liabilities, and equity at a
point in time

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Statement of Cash Flows

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Financial Statements Summary
• Financial Statements – how they link together

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Notes to the Financial Statements
• Financial Statements - continued:
Notes to the Financial Statements – essential notes that
accompany the financial statements that provides greater detail
about the various amounts shown in the financial statements.

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Financial Statements
Big Dog Carworks Corp. Big Dog Carworks Corp.
Income Statement Balance Sheet
for the month ended January 31, 2015 at January 31, 2015

Revenues Assets Liabilities

Repairs $10,000 Cash $3,700 Bank loan $ 6,000
Expenses Accounts receivable 2,000 Accounts payable 700
Rent $ 1,600 Prepaid insurance 2,400 Unearned revenue 400
Salaries 3,500 Equipment 3,000 $ 7,100
Supplies 2,000 Truck 8,000 Equity
Truck operation 700 Total assets $19,100 Share capital $ 10,000
Total expenses $7,800 Retained earnings 2,000
Net Income $2,200 12,000
Total liabilities and capital $19,100

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Financial Statements (continued)
Big Dog Carworks Corp.
Statement of Changes in Equity
for the month ended January 31, 2015

Share Retained Total

Capital Earnings Equity
Opening balance $0 $0 $0
Shares 10,000 10,000
Net income 2,200 2,200
Dividends   ( 200) ( 200)
Ending balance $10,000 $2,000 $12,000

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Financial Statements
Accounting Time Periods:
• Annual financial statements are prepared at the end of each fiscal
year

• Some companies prepare interim financial statements, usually

monthly or quarterly

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