Introduction to Financial Accounting: Users, Organizations, Activities, and Financial Statements

Introduction to Accounting

Accounting as the Language of Business

• Accounting is often referred to as the language of business because it communicates financial information to various stakeholders.

• The primary objective of accounting is to provide useful information for decision-making.

Users of Accounting Information

• Internal Users (Decision Makers):

  • Individuals within the organization who use accounting information to manage the company.

  • Examples: Management, Directors/VPs in specific departments.

• External Users:

  • Individuals or entities outside the organization who have access to public information.

  • Examples: Investors, Creditors, Government, Labour unions, Employees without a managing stake, CRA (Canada Revenue Agency).

Forms of Business Organization

Sole Proprietorship

• Owned by one individual.

• Easy to start, but owner has unlimited liability (personally responsible for all debts).

• No legal distinction between owner and business.

• Life of the business is limited to the owner's life.

• Examples: Lawyers, doctors, architects.

• Reporting Entity Concept: Owner's and business's accounts must be kept separate.

Partnership

• Owned by two or more individuals.

• Formed with a partnership agreement (distribution of income/loss, responsibilities, dissolution, etc.).

• Unlimited liability for partners.

• Life is limited to the partners' lives.

• No separate legal entity.

Corporation

• Owned by shareholders.

• Legal entity separate from its founders.

• Unlimited life (not affected by changes in ownership).

• Shareholders have limited liability.

• Tax benefits and must make statements public if publicly traded.

• Public companies must send/announce reports quarterly and annually.

Accounting Standards

• GAAP (Generally Accepted Accounting Principles): Standard framework of guidelines for financial accounting.

• ASPE (Accounting Standards for Private Enterprises): Used by private companies in Canada.

• IFRS (International Financial Reporting Standards): Used by public companies and some private companies for comparability and foreign subsidiaries.

• Reason private companies may use IFRS: To facilitate future interaction with public markets, compare with competitors, or for foreign subsidiaries required to use IFRS.

Types of Business Activities

Financing Activities

• Primary way to raise capital for the business.

• Sources: Issuing shares (common or preferred stock), borrowing (debt).

• Creditors are paid before shareholders in case of liquidation.

• Bank Indebtedness: Line of credit to cover cash shortfalls.

Investing Activities

• Involves the purchase or sale of long-lived assets (e.g., property, plant, equipment).

• Includes purchase/sale of debt securities and bonds.

Operating Activities

• Day-to-day activities that generate revenue and incur expenses.

• Examples: Sales revenue, service income, interest, rent.

• Outflows: Expenses such as cost of goods sold, general and administrative expenses, salaries, etc.

Financial Statements

Overview of Financial Statements

• Statement of Income (Income Statement): Reports revenues and expenses to show net income or loss for a period.

• Statement of Changes in Equity: Shows changes in owners' equity over a period, including share capital and retained earnings.

• Statement of Financial Position (Balance Sheet): Presents assets, liabilities, and equity at a specific point in time.

• Statement of Cash Flows: Summarizes cash inflows and outflows from operating, investing, and financing activities.

Key Terms and Equations

• Assets (A): Resources owned by the business.

• Liabilities (L): Obligations owed to outsiders.

• Equity (E): Owner's claim on assets after liabilities are settled.

Basic Accounting Equation:

$A = L + E$

Example Calculation

• If Equity = $120,000 and Liabilities = $55,000, then Assets = $120,000 + $55,000 = $175,000.

Changes in Financial Position

• Assets, liabilities, and equity change with business transactions (e.g., issuing shares, earning income, paying dividends).

• Retained earnings change with income, loss, and dividends.

• Total equity changes when retained earnings or share capital change.

Summary Table: Forms of Business Organization

Form	Owners	Liability	Legal Entity	Life	Reporting Requirement
Sole Proprietorship	1	Unlimited	No	Limited to owner	Personal tax return
Partnership	2 or more	Unlimited	No	Limited to partners	Personal tax return
Corporation	Shareholders	Limited	Yes	Unlimited	Public reporting if traded

Additional info:

• Deficit refers to a negative retained earnings balance, not the same as net loss or net income.

• Public companies must comply with IFRS, while private companies may use ASPE or IFRS.