AFA 100

Chapter 1
Michael

BUSINESS DECISIONS AND

FINANCIAL ACCOUNTING
UNDERSTAND THE BUSINESS
Organizational Forms
Sole Proprietorship

Business owned by one individual

Easiest to start; no special legal procedures
Part of owners life (profit and debt)

Partnership

Profits, taxes and legal liability shared between two people

Lawyer needed to draw up partnership agreement
Key advantage; more resources available, which can fuel the businesss growth

Corporation

Separate entity from both legal and accounting perspective

o Owners cannot lose more than their investment in the company
Two disadvantages; legal fees can be high and income tax returns must be filed
Ownership divided into shares; shareholders can buy and sell shares on the SE

Limited Liability Company

Characteristics of a partnership and corporation

Accounting for Business Decisions

Accounting

A system of analyzing, recording, and summarizing the results of businesss

activities and then reporting the results to decision makers
Terminology; language of business
Private Accountants work as an employee, Public Accountants work on contract
CA (chartered accountant), CFE (certified fraud examiner), CGA (certified
general accountant), CMA (certified management accountant), and CIA (certified
internal auditor)
o One distinction; CPA (chartered professional accountant)

Managerial Accounting Reports

o Detailed financial plans

and continually updated
reports about the operating
performance of the
company
o Available to internal users
only so they can make
business decisions related
to production, marketing,
human resources, and finance.

Financial Accounting Reports (Financial Statements)

o Prepared periodically to provide information to people not employed
o External Users include:
Creditors
Banks, Suppliers
Investors
Shareholders
Other
Customers, Governments

STUDY THE ACCOUNTING METHODS

The Basic Accounting Equation

What a company owns must equal what a company owes to its creditors and shareholders
Resources Owned

By the company

Assets

Resources Owed
To creditors

Liabilities

To shareholders

Shareholders Equity

Basic Accounting Equation (Balance Sheet Equation):

o A = L + SE
Assets
o Economic resource presently controlled by the company
Ex: Tables, chairs, other tangible items
Liabilities
o Measurable amounts that the company owes to creditors
Ex: Note Payable (owe a bank), Account Payable (owe a company),
Wages Payable (owe employees), Taxes Payable (owe the government)
Shareholders Equity
o The owners claim on the business

o Two parts:
Contributed Capital (paid in by shareholders)
Retained Earnings (earned by the company)
Components of Profit
o Revenues
Earned by selling goods or services to customers
o Expenses
The costs of doing business, necessary to earn revenue
o Net Income
Revenues minus expenses
By generating a net income, a company increases its shareholders equity
o Dividends
Distribution of net income to a companys shareholders (cash = most
common)
Dividends are not an expense incurred to generate earnings

Financial Statements
Refers to four accounting reports, typically prepared in the following order: Income
Statement, Statement of Retained Earnings, Balance Sheet, Statement of Cash Flows
o Can be prepared at any time of the year, but most commonly prepared monthly,
quarterly or annually
o Fiscal years can be any 12-month period ending on a day other than December 31

Income Statement (Statement of Operations)

o Reports the amount of revenues less expenses for a period of time
o Unit of Measure Assumption
Results of business activities should be reported in an appropriate
monetary unit
o Accounts
Accumulate and report the effects of each different business activity
Statement of Retained Earnings
o Reports the way that net income and the distribution of dividends affected the
financial position of the company during the period
Balance Sheet (Statement of Financial Position
o Reports the amount of assets, liabilities and shareholders equity of a business at a
point in time
o Assets/Liabilities listed in order of liquidity
o Cost Principle
Assets are initially reported on the balance sheet based on their original
cost to the company
Statement of Cash Flows

o Reports the operating, investing, and financing activities that caused increases and
decreases in cash during the period
o Three types of activities
Operating: Activities directly involved with running the business
Investing: Buying and selling productive resources
Financing: Any borrowing, paying or receiving

STUDY THE ACCOUNTING METHODS

Using Financial Statements

Creditors are mainly interested in assessing:

o Is the company generating enough cash to make payments on its loan?
o Does the company have enough assets to cover its liabilities?
Investors expect a return on their contributions to a company

Using Financial Information

Generally Accepted Accounting Principles (GAAP):

o Rules of accounting approved by the Canadian Institute of Chartered Accountants
International Financial Reporting Standards (IFRS):
o Rules of accounting created by the International Accounting Standards Board
(IASB) for international use
Accounting Standards for Private Enterprises (ASPE):
o Rules of accounting that address issues that are more relevant in a private
enterprise environment and therefore can be used by private enterprises only
Publicly accountable profit-oriented enterprise