Chapter 1: The Financial Statements – Foundations of Financial Accounting

Financial Accounting: Introduction

Overview

Financial accounting is the process of recording, summarizing, and reporting the financial transactions of a business. It is often referred to as the language of business because it communicates essential information to various stakeholders.

• Purpose: To provide useful financial information to external and internal users for decision-making.

• Key Output: Financial statements that summarize business activities.

Learning Objective One: Accounting as the Language of Business

Why Accounting is Essential

Accounting enables businesses to communicate their financial performance and position to stakeholders. It provides a standardized method for reporting and analyzing financial data.

• Decision-Making: People make decisions based on accounting information.

• Business Transactions: Accounting records and reports the results of business transactions.

• Stakeholders: Includes managers, investors, creditors, government agencies, individuals, and not-for-profit organizations.

Types of Accounting

Financial Accounting vs. Management Accounting

There are two primary branches of accounting, each serving different user groups and purposes.

• Financial Accounting: Provides information for both external and internal users, such as managers, investors, creditors, government agencies, and the public.

• Management Accounting: Provides information for internal users only, focusing on budgets, forecasts, and projections.

Organizing a Business

Forms of Business Organization

Businesses can be organized in several legal forms, each with distinct characteristics regarding ownership and liability.

Form	Proprietorship	Partnership	Corporation
Owner(s)	Proprietor - one	Partners – two or more	Shareholders – usually many
Personal liability for business debts	Proprietor is personally liable	Partners are usually personally liable	Shareholders are not personally liable

Proprietorships

A proprietorship is a business owned by a single individual. It is a common form for small retail stores and professional service providers.

• Liability: The proprietor is personally liable for business debts.

Partnerships

A partnership involves two or more parties as co-owners. It is not a separate taxpaying entity; income passes through to the partners.

• Liability: Partners are usually personally liable, though limited liability partnerships can reduce risk.

Corporations

A corporation is owned by shareholders, with shares representing ownership. Corporations can raise large sums of capital and are generally larger than proprietorships and partnerships.

• Legal Formation: Formed under federal or provincial law and legally distinct from its owners.

• Double Taxation: Corporate income is taxed, and shareholders are taxed on distributions (dividends). Canadian tax laws attempt to minimize double taxation.

• Governance: Shareholders elect a Board of Directors to set policy and appoint officers.