Introductory Accounting Principles (Revised 2016)

Derrick Hayes
Faculty of Shannon School of Business

Cape Breton University
Sydney, Nova Scotia
2020
MBA Precore
Introductory Accounting Principles
Business can be defined as the process of producing and distributing goods and/or services to clients who desire or
need them. This is usually done to make a profit. (Revenue – Expenses = Profit) Although profit is usually the
motivating activity of business (Profit Entity) it can also come from a social responsibility point of view in
benevolent organizations (Not-for-profit Entity). Most of this paper will deal with the rules and procedures for
profit entities, however, Not-for-profits also follow a similar set of rules and procedures that are also contained in
the Chartered Professional Accountants (CPA) Handbook which contains the International Financial Reporting
Standards (IFRS) for public corporations and the Accounting Standards for Private Enterprises (ASPE) that includes
the section for Not For Profit Enterprises.
Entrepreneurship starts the business cycle. The entrepreneur has a dream, but how do they get it off the ground.
The first basic decision is “what are we doing or making”? From that the goals and objectives of the organization
can be established (aka. the mission and vision). It is then we look at our other needs such as a product (materials),
People (Labor) and a place to build and sell the product (Overhead) and how to finance (Debt or Equity).
Usually the first best practice listed in the literature for not-for-profit Boards and its members is to determine the
organization’s mission and purpose. This mission and vision of an organization is translated into a short and concise
paragraph and explanation. They help to focus the organization’s strategic planning and set benchmarks by which
management’s performance can be measured and evaluated from both an economical and outcome point of view.
For example, the CBU’s new mission statement is, “Cape Breton University is a multicultural, creative, innovative
and entrepreneurial academic institution committed to teaching excellence, world changing research and deep
engagement with the social, economic, environmental and cultural aspirations of every community and individual
we serve.” Countless literature can be found on how to distill the organizations goals down into such a concise
statement, but, do board members know what it is for their organization?
Terrell indicates there are four factors of production necessary for a business to get started as shown in the chart
below. Natural resources such as raw materials are required to start making products. Human resources, both
physical and intellectually are required at all levels of the firm to make the product and direct the business. Capital
should be broken down to two components: physical and financial. Physically you need a place to do business and
assets make your product such as land, buildings, equipment and other long term assets. Financially you need the
cash to finance the purchase of the items and services which can be raised by either debt (Financial Institutions) or
in the case of a corporation by issuing shares called equity financing.
Taking these factors into consideration the entrepreneur must put together a business plan that outlines the
business goals and objectives and an action plan on how the business will achieve them. A checklist to help
facilitate this process can be found in many books on the subject, however the one I like can be found in “A Survey
of Accounting” by Terrell and Terrell as follows:
1. Find competent people to be responsible for the four functions of the firm.
2. Decide upon the organizational form for the business.
3. Research the industry and the product.
4. Prepare a strategic plan.
5. Design internal controls for operations and information.
6. Secure financing.
7. Prepare initial capital and operating budgets.
Now that we have determined what business activity we are going to do, we must determine what type of
business category it falls. Is it a manufacturer that takes raw materials and converts them into a finished product, a
merchandiser who buys finished products and resells them to the end user (retailer) or to another business
(wholesaler), a service business that provide a service to the customer or is it a combination of two or more of
them. A good example of one that does them all would be a computer company that makes the computers, sells
them to business and to the end users as well as servicing them in the event of a problem with the product.
Locally, we could see a Ma and Pa bakery – making baked goods for sale at the counter and to grocery stores while
having a catering service as a sideline to the main operations or a large corporation such as Dell or Apple.
All businesses must be registered with the regulatory body in the individual province, in Nova Scotia it is the
Registry of joint stocks under Access Nova Scotia. There are three forms a business organization can take a Sole
Proprietorship; Partnership and Corporation. Which one depends on the circumstances and preferences of the
owners at the time of the incorporation.
Sole proprietorship
Is an unincorporated business that is owned by one individual that is very easy and inexpensive to create. The
primary advantages are that you have 100% control over the decision making and receive 100% of the profits
which are required by an owner looking for an independent lifestyle. However these are offset by several
disadvantages such as unlimited liability for the owner, the life of the business is limited to the life of the owner
who has to put a lot of time and the access to intellectual capital and financial capital is restricted to that of the
owner. In addition, they also are responsible for 100% of any losses. Therefore any debts the proprietorship incurs
are ultimately owed by the owner if the business cannot pay (Unlimited Liability).
Partnership
Is an unincorporated business that is owned by two or more individuals that is relatively easy and inexpensive to
create. The primary advantages are that you greater access to intellectual capital and financial capital and greater
business continuity. However these are offset by several disadvantages such as unlimited liability for the owner
(joint and severally liable) and the potential for conflicts between the owners. A partnership agreement is usually
drawn up to provide for how profits and losses will be allocated and dispute settlement procedures in case of a
conflict. The agreement will included a formula based on capital invested; time at work and intellectual property
and a proration of any residual value. A common agreement with the financial institutions will include a joint and
severally liable clause. This means that if two partners sign as guarantors of a loan, they don’t owe 50% each. In
fact if one partner for whatever reason (e.g. bankrupt) cannot pay, the other partner will owe 100% of the
remaining debt.
Corporation
Is a separate legal entity incorporated under the laws of the province in which it is located or federally under the
Canadian Business Corporation Act (CBCA). It can be owned by one or more shareholders. They are called
shareholders because the ownership of a corporation is in who owns the common shares of the company. The
voting power of these shares is usually one share equals one vote. Therefore to control a corporation you need to
own 50% of the common shares plus one share. For example: you need to raise $5000 capital by equity financing.
Accordingly you issue 5000 common shares for $1 each. To control this corporation you would need 2501 common
shares (50%+ 1 = 2500 + 1).
The primary advantages are that you greater access to intellectual and financial capital, there is limited liability
(you are at risk for only what you have invested in the corporation) and it has a continuity of life given the ease of
transferability of share ownership by selling and bequeathing. There are several disadvantages such as greater
regulation and tax burden and absentee ownership in larger corporation in that usually the owners do not run the
organization; they hire a management team to run the day to day operations.
The business environment and landscape has changed dramatically over the past 20 years even in the last 10 years.
Business today is not limited to the local geographical environment; it is global with the introduction of the
internet in the early 1990’s. E-Commerce reduces the communication time down to minutes and by using web
catalogues instead of printed catalogues which saves on printing and mailing costs. Accordingly, small businesses
are dealing with goods being imported and exported across international borders on a regular basis. Now they
must be aware of the political and economical conditions in the manufacturing countries that they deal in order to
ensure their goods will be delivered on time to their facilities.
Business is about making decisions
We are in an age where information is at our fingertips, whether it be from the internet or from a software
package. Accordingly you must avoid being overloaded with information and narrow it down to data that is reliable
and relevant to your decision. The primary purpose of accounting is to provide information to the users to make
informed business decisions. Decision making can be defined as identifying alternative paths for the organization,
analyzing them and choosing the one that is best suited to meet the goals of your organization. When choosing the
correct path we will always use a cost/benefit approach that takes into account both the extrinsic and intrinsic
benefits in comparison to their costs.
When you look at a company there are two main groups of decision makers: Those that make decisions for the
organization (Internal) and those that make decisions based on the financial strength and performance of the
organization (External). Both are very important to the growth of the organization and require different systems
for analyzing; recording and reporting the accounting information required to make those informed decisions.
Internal decision makers’ main tool is the use managerial accounting which helps to predict the future. They have
no set rules and are used to decide what path the organization will take, such as a budget. To be useful these
predictions are compared to the actual; results and the variances are analyzed to see if the planning stage needs
corrections or was there an unusual anomaly that caused the variation from budget.
External decision makers’ main tool is the use financial accounting which reports on the past performance and
present financial position of the organization and must follow generally accepted accounting principles (GAAP)
contained in the CPA Handbook. These reports are used to assess the financial strength of the organization in the
short and long term and the performance of management from a profitability and asset management point of
view.
Accounting has evolved just as business has evolved to a global marketplace. Accordingly as of January, 2011 GAAP
as we knew it will changed. Public Corporations fall under International Financial Reporting Standards (IFRS);
private enterprises fall under Accounting Standards for Private Enterprise GAAP with an option to follow IFRS and
Not-for-profits also fall under Accounting Standards for Private Enterprise GAAP. The conceptual framework as
outlined below stays intact under all the various GAAP’s.
Conceptual Framework
Accounting information has both quantitative and qualitative characteristics. Quantitative being the numerical
calculations performed where if the result leads to a $1 higher income or lower cost it is the better alternative. The
qualitative characteristics have no bearing on the numerical outcome, but can change the decision made by
management. The characteristics can be broken down into primary and secondary. There are two primary
qualitative characteristics relevance and reliability must be present in order for information to be useful to the
users in making their decisions.
Relevance indicates that the information affects the user’s decision and generally has three characteristics.
1. Timeliness – the information is presented in time to affect the decision, the closer the time the better the
information is to the decision.
2. Predictive value – the information will allow users to make predictions about the future and helps to
reduce risk.
3. Feedback value – the information must be analyzed and compared to the actual results in order to
ascertain whether the process needs to be adjusted or is working properly.
Reliability indicates whether the information is accurate; representational faithful and free from bias.
Representational faithful indicates that the information represents what actually happened, sometimes referred to
as substance over form. It also should be able to be verified by an independent person as to what happened and
they should draw the same conclusion, therefore free from bias.
The secondary characteristics provide additional support but are not required to make information useful. They are
comparability; consistency and understandable. In accounting, comparability indicates similar organizations will
show the information using the same set of rules (aka GAAP). Consistency refers to the application of the rules;
once a rule is applied using one method it is done so every year unless a valid business reason for a change
presents itself. For example: if the business decides that straight line amortization is best for their capital assets, it
must use straight line year after year unless there is a valid business reason to change, such as the business is
purchased by another business that uses another method. Accordingly you can change to that method in order to
merry up the reporting to the owners reporting since they actually own the business. The information must be
understood by the users, therefore, they are assumed to a sufficient level of knowledge to be able to read financial
information.
Organizations in Canada use accrual accounting to account for transactions rather than cash such as in China. This
is to say that an accounting system records the effects of a transaction as it occurs not when the cash is affected.
This gives rise to items such as accounts receivable from the sale of goods and services (a promise to be paid later)
and accounts payable from a purchase (a promise to pay later). Accordingly there are three specific rules under
GAAP that I would like to address at this time. 1) Historical cost – items are recorded at what was laid down not its
fair value. For example I paid $100 for a desk but I got it on sale, it is really worth $250. I record the cost of the
desk as $100 what I paid for it. 2) Revenue recognition – revenue is recognized when it is earned not when the
cash is received and 3) Matching – all costs that were incurred to produce the revenue recognized must be
recorded, accordingly at the period end adjustments will be made for:
 Corrections – To correct or adjust errors in recording of transactions

 Accruals – to recognize both revenue and expense items prior to the exchange of cash.
 Deferrals – to adjust for items in which cash was exchanged prior to the earning of revenue and the
incurrence of an expense and
 Depreciation – to systematically allocate the cost of a long lived asset over its useful life to expense as it
is used up.
Accounting Elements
1. ASSETS
2. LIABILITIES
3. EQUITY INVESTED AND EARNED
4. REVENUE
5. EXPENSE - product & period
6. GAINS (LOSSES) – ancillary items
These elements form the framework of accounting from which the basic financial statements as shown in the chart
below can be created after all the entries and transactions are recorded in the books and categorized into these
elements in the general ledger.
Balance Sheet
Not the only starting point, but the one I like to start with since it parallels a discussion of the accounting equation.
The balance sheet is the financial statement that shows the financial condition of an organization at a given point
in time. Accordingly it does not measure or accumulate anything for a period of time. The accounting equation is
basic to all accounting and is considered to be the building block for the accounting systems. The basic accounting
equation is:
ASSETS = LIABILITIES + EQUITY
The “=” sign indicates that it is equal or balanced. Hence it is called a balance sheet that must always be
balanced. The left side of the equation must always equal the right side of the equation. Otherwise like a seesaw it
will have one side down and the other up, in order to be balanced it must be distributed equally.
ying and yang
Now we should look at what are each of these elements used in the makeup of the balance sheet. Assets are
things that we “own” and will benefits the organization in the future; we have control of them and they are the
result of a past transaction. Liabilities are things we “owe to outsiders” and will pay with future benefits and/or
services; they are present obligations we cannot avoid and are the result of a past transaction. Equity I define as
what is “owed to the owners”; whether it is their investment in the business or their claim to the past earnings.
The CPA Handbook will define it as the residual interest in the assets and liabilities (Assets – Liabilities = Equity),
this works as well.
Equity invested is either in the form of shares in a corporation or additions to the owner’s capital account in a
proprietorship and/or partnership. Equity earned is the accumulation of the organizations past incomes since the
business started less the amounts that were given to the owners by dividends in a corporation or drawings in a
proprietorship or partnership.
Now it is time to expand the accounting equation to:
ASSETS = LIABILITIES + EQUITY INVESTED + EQUITY EARNED

The balance sheet is also known as the statement of financial position or the statement of financial condition and
is for a specific point in time. It can take on two forms:
In practice, accounting firms use the report form. However, I prefer to use the account form since it visually looks
like the accounting equation; assets on the left and liabilities and equity on the right. Therefore it is a better tool
for teaching and for learning the balance sheet as well as the concept of debts and credits as they pertain to the
accounting elements that will be discussed later in this report.
To start up a business it usually requires an investment by the owners. In a proprietorship if the owner (Kaitlynn
Hayes) invested $25000 to start up a dog grooming business. The business received $25,000 cash; therefore the
asset cash increased by $25,000 and the business owes the owner $25,000 since she gave it to us which means a
capital account has increased. The opening balance sheet would look like this:
If she had started a corporation, her equity investment would be done by the purchase of common shares in the
corporation instead of a capital account and would look like this:
The difference in presentation lies in the equity invested section of the balance sheets. A proprietorship has a
capital account whereas the corporation is common shares. These shares have the voting privileges of the
company usually one share = one vote. There are several terms associated with shares that should be defined.
Authorized shares are the maximum number of shares the corporation is allowed to issue. They can be in one of
two places either not sold or issued (sold) Issued shares are shares of stock sold to stockholders. They can be in
one of two places either outstanding or in treasury. Outstanding shares are the number of shares currently held by
stockholders outside the firm. Treasury stocks are shares reacquired by the corporation and therefore held by the
firm itself.
Common shares
Authorized (100)
Issued (75) Not sold (25)
Outstanding(65) Treasury (10)
As the organization grows it will require additional capital to finance these endeavors. This will take the form of
either debt or equity financing. Equity financing is when the corporation sells additional shares to raise the
required capital. The shareholder is looking to get paid an annual dividend and get an appreciation in the fair value
of the stock so as to make a profit on the eventual sale of the stock. Debt financing is when the corporation
borrows money from an external source usually a bank in the form of a note payable. A note payable is a written
agreement or debt instrument between a lender and a borrower that creates a liability for the borrower to repay
both principal and interest in the future. The lender is looking to get repaid their principle and get a return on the
investment.
The organization will start to use a classified balance sheet for reporting its financial position right away because it
provides more insight and detail into the financial strength or the organization. It separates the assets and
liabilities into current and long term. The line in the sand to distinguish between current and long term is normally
one year. Although GAAP states the longer of one year and the normal operating cycle.
Current assets are those assets that will be converted to cash or used up within one year and are presented on the
balance sheet in order of decreasing liquidity. Examples would be cash; marketable securities; accounts receivable;
inventories and prepaid expenses.
Long term assets would be those that will benefit the organization for longer than one year. Examples would be
long term investments (stocks and bonds of another company); capital assets (land, building, equipment);
intangibles (goodwill, patents, franchise rights) and other that don’t fit into another category such as restricted
funds.
Current liabilities are those items that require payment within the next twelve months including a portion of long
term debt. Examples would be accounts payable; accrued expenses; unearned revenue; payable for: wages, taxes,
interest, others and current portion of long-term debt.
Long term liabilities are those liabilities that require settlement one year or further down the road. Examples
would be notes payable; mortgages payable and bonds payable.
Now I want to expand the accounting equation further:
ASSETS = LIABILITIES + EQUITY INVESTED + EQUITY EARNED

current assets + long term assets = current liabilities + long term liabilities
+ invested equity + earned equity
(common shares) (retained earnings)
Income Statement
The income statement is the financial statement that informs reader as to the performance of the organization
over a period of time. Its basic equation is
Revenue – expenses = operating income (loss)

Accordingly if revenues are greater than expenses you have a net income and if the opposite is true expenses are
greater than revenues you have a net loss. Revenues are the inflows of assets resulting from the business activity
of the organization. It can come from the selling and/or producing of products; rendering services in the ordinary
course of business. Expenses on the other hand are the outflows and/or using up of assets in producing the
revenue. They are usually broken down into two categories: product and period (selling and administrative).
Ancillary income and gains or losses are usually reported after operating income or expenses.
Revenue – expenses = operating income (loss) + gains – losses
= net income
The income statement comes in two forms the single step and the multi step. I like the multistep since it gives
more informative information and is the one chosen in practice.
The basic formula can be expanded to:
Revenue – cost of goods sold = gross profit
- expenses = operating income
+/- other income (expenses) = net income

Ultimately a net income increases earned equity whereas a net loss decreases earned equity. The owners can
access this equity and past equities by taking a draw in a proprietorship or a dividend in a corporation. Both of
which reduces earned equity. However, a dividend cannot be taken if there is not sufficient cash and/or it puts
earned equity into a negative position.
Statement of Owners Equity
The statement of owner’s equity is the link between the income statement and the balance sheet. It shows the
changes in owner’s equity during the period. It should be increased or decreased by the net income (loss) from the
income statement and decreased by any dividends and draws paid to the owners. The difference between a
corporation and a proprietorship / partnership would be that in a proprietorship / partnership the capital account
combines invested and earned equity and would also be increased by any owner investment. In a corporation
owner’s investment is in the form of common shares. In a corporation the earned equity account (retained
earnings) is unaffected by the owner’s investment. The basic formulas for both are:
Capital account
Beginning of period
+/- Net income (loss)

+ Owner investment
= Subtotal
- Drawings
= End of period
Retained earnings
Beginning of period
+/- Net income (loss)
= Subtotal
- Dividends
= End of period
Owner investment in a corporation is in two places. If it were a loan there would be a payable to shareholders
account (liability) and of course common shares (equity).
The three financial statements are said to be interdependent upon one another (see examples in appendix). The
income statement flows into the statement of owner’s equity (retained earning) which flows into the balance
sheet. This linkage is called articulation. The flow of information also sets the path for the financial statement
preparation. The income statement followed by the statement of owner’s equity (retained earnings) and then the
balance sheet. This is to say that the Net income is the same on both the income statement and the statement of
equity (N/I = $1620). The equity balance on the statement of equity agrees with the balance sheet (End = $1120).
The cash balance on the balance sheet agrees with the ending cash amount on the cash flow statement.
.
Accounting System
The basic accounting system analyzes records, classifies and then summarizes transactions in the accounts under
the accounting elements in order. Keeping the in order facilitates transposition of transactions and the ultimate
preparation of the financial statements. The elements in order once again are:
1. ASSETS
2. LIABILITIES
3. EQUITY INVESTED AND EARNED
4. REVENUE
5. EXPENSE
6. GAINS (LOSSES)
Each account within each element is assigned an account numbers. These account numbers are in ascending order
for example current assets could be 1 – 150; long term assets 151 – 300; current liabilities 301-399; long term
liabilities 400-499; equity 500-599; revenue 600-699; cost of goods sold 700-799; operating expenses 800-899 and
other items 900-999.
All the accounts are contained in order in a book called the general ledger. I equate the general ledger to a text
book. In that the text is broken down into chapters = elements; then the chapters have pages = accounts and the
pages have words = transactions. All in order and together paint a picture called a text book or for accounting
called a set of financial statements. The process followed each year is called the accounting cycle. The cycle is in a
particular sequence of steps as follows:
Step 1
Accounting Cycle
Step 2
Step 8 Step 4
Step 5
Step 7
Step 5 & 6
Requires manual manipulation all other steps can be done by the computer applications by pressing
the enter button.
In accounting, we only record actual transactions that have occurred not anticipated future events. The transaction
must be analyzed to see when it should be recorded and what accounts should be increased or decreased. Every
transaction involves at least two accounts the effects of which keep the accounting equation balanced. This is
called double entry accounting, in which every entry has equal debits and credits that will be explained shortly.
The process of recording each transaction is called making a journal entry. There is a journal entry for every
transaction. This entry records the transaction in a chronological order in a book that we call a journal. It shows the
date; the accounts affected and their changes.
This is the process of transposing the account changes in the journal entries into the appropriate accounts in the
general ledger. Since each entry is balanced so should the general ledger be balanced after all the entries are
posted and the accounts balances are calculated. Today the posting function is done by pressing your finger on the
keyboard since most businesses use some sort of accounting software package to keep their accounting records.
This is a simple listing of all the accounts in order to verify that the general ledger (accounting equation) is in
balance. If not balanced something has gone wrong and we must retrace our steps to find the error(s). Again, this
is usually at the press of a button. Most software packages will not allow you to post an unbalanced entry.
Accordingly this is a rare circumstance.
Adjusting journal entries are prepared to correct the accounts after they have been analyzed. This can be done to
correct an error; record revenue that has been earned; record expenses that have been incurred; amortize assets
and defer or accrue revenue and expenses now or into the future. They never have cash in them except when
recording adjustments to the bank after it has been reconciled. Once the adjusting journal entries are made they
are posted to the general ledger in the same way as journal entries.
An adjusted trial balance is then prepared in the same way that a trial balance was prepared. The only difference is
that it is done after the adjusting entries have been made and theoretically the accounts are correct.
It is from the adjusted trail balance that the financial statements are prepared. As discussed earlier they are
prepared in order: Income Statement; Statement of Retained Earnings (Capital); Balance Sheet and Statement of
Cash Flow which proves the idea of articulation. The Statement of Cash Flow is the only financial statement that
cannot be produced by a software package. This is due to the account analysis required to complete, that a
computer cannot generate.
As we have seen with articulation the income statement (net income) goes into the Statement of Retained
Earnings (Capital) and the ending balance of retained earnings (capital) goes directly to the Balance Sheet.
Accordingly all the revenue; expense; other items and distribution to owners end up in the ending balance on the
Balance Sheet. They accumulated data on a period by period basis, therefore are temporary and should be zero at
the beginning of the next period in order to accumulate data for that period. The process of making these accounts
zero is called closing journal entries. Once the closing journal entries are made they are posted to the general
ledger in the same way as journal entries and adjusting journal entries.
A closing trial balance is then prepared in the same way that a trial balance and adjusted trial balance was
prepared. The only difference is that it is done after the closing entries have been made and theoretically the
revenue and expense accounts and the distribution account is zero and the only accounts that have balances are
the balance sheet accounts. These accounts are always there and are called permanent.
Debits and Credits

The accounting system does not use “+” plusses and “-“minuses to indicate whether an account has been
increased or decreased. They make use of debits and credits that were developed in the late 1400’s. If we extend
the accounting equation to be in a corporation and draw a line under it and down the middle under the = sign it
will look like the capital “T”. Every account in its simplest form will look like this letter “T”, hence it is called a T
account. There is a left side of the T account is called a “DEBIT” and a right side of the T account is called a
“CREDIT”. That is the only definition you need to know. Do not try and make up a long a drawn out definition. As
shown below: Left = debit and Right = credit, that’s it.
As already stated the accounting system must stay in balance. Right side = Left side, therefore you must always use
a minimum of two numbers when making a journal entry (a debit and a credit). Equal debits and credits must be
contained in order for the accounting equation to remain balanced. This is called double entry accounting (debits =
credits).
If we extend the accounting equation again and draw the lines, we can say any addition on the left side (debit) of
the equation would increase the left side and any addition on the right side (credit) would increase the right side.
The exception would be if any account caused a side to go down not up such as expenses. Expenses are on the
right side, but causes retained earnings to go down. Therefore it is increased and decreased opposite to that of
retained earnings. The side that increases each of the accounting elements is illustrated in the chart below:
The entry that causes an account to increase is considered to be its normal account balance. For example a debit
increases cash therefore cash is considered to have a debit balance normally conversely if credit increases
accounts payable therefore accounts payable is considered to have a credit balance normally . To take this a step
further if a debit increases an account then a credit decreases it and conversely if a credit increase an account a
debit decreases it. The impact on the accounting elements are summarized below:
Remember whatever increases the other side decreases (debit goes up the credit goes down) (credit goes up then
debit goes down). This is essential for the accounting system to stay in balance. Equal debits and credits.
Every transaction is recorded chronologically in a journal, whether it be manually or by computer. This entry is
called a journal entry. A normal page normally would be set up as follows:
DATE | ACCOUNT | Posting Reference | DEBIT | CREDIT |
Each entry must include equal debits and credits. Today this is forced by most accounting software, in that it will
tell you when a journal entry is out of balance and ask you to correct it.
Remember we only record transactions that have actually occurred not anticipated future events. You must
analyze each transaction and determine: 1) what accounts are affected; 2) did each account increase or decrease;
3) by what amount and 4) do we have to use a debit or credit to make the appropriate entry. Let’s look at some
simple examples from Kaitlynn’s Dog Grooming Ltd.:
EVENT JOURNAL ENTRY

Posting was already defined as the transposition of the entries into the appropriate accounts. Today, that is done
with the press of a button within accounting software. Once done we can produce a trial balance, which is simply a
listing of all the accounts and their balances. It only proves that the debits equal the credits and hence we have a
balanced ledger. It does not prove that the accounts are correct. However, if wanted we could produce a draft set
of financial statements from which to start the period end work. A trial balance and a set of preliminary financial
statements for Kaitlynn’s Dog Grooming Ltd. are as follows:
The trail balance still needs to be examined to ensure the accuracy of the accounts. In many small businesses they
will concentrate on the balance sheet accounts. This will ensure that the bottom line (net Income) of the business
is correct. A normal examination would start with reconciling the bank to ensure that what we say is in the bank
and what is in the bank is the same amount. A simple schematic of a bank reconciliation is as follow:
BANK | OUR RECORDS |
Ending Balance per bank Ending Balance per our records
+ outstanding deposits
- outstanding cheques
+ credit memos from bank Requires
- debit memos from bank an AJE
+/- recording errors +/- recording errors
= Adjusted ending balance SAME = Adjusted ending balance
An adjusting journal entry is made for the items that affect our records according to the bank
reconciliation. We follow this by examining the other accounts. There are four main types of adjusting
journal entries: 1) accruals to record revenue and expenses not previously recorded; 2) deferrals to adjust
prepaid account for revenue and expenses as they are used up; 3) amortization (depreciation) of capital
assets and correcting items such as the bank reconciliation.
The process is quite simple: 1) examine the balance sheet account; 2) determine the correct ending
amount; 3) what has to be done to correct the account (debit or credit) and 4) prepare the adjusting
journal entry.
The following includes an example of a deferral and amortization adjusting journal entry.
These entries are then posted to the general ledger; with an adjusted trail balance then produced. An
adjusted trial balance means that all the adjusting entries have been made and theoretically the accounts
are correct. It is from this adjusted trial balance that the formal financial statements are produced. Again
this is at the press of a button today.
STATEMENT OF CASH FLOW
After the financial statements are produced we need to set up for the next year. Remember articulation showed us
that all the income statement accounts roll into retained earnings as well as any dividend accounts. This is shown
above with Retained earnings ending at $5,700. To start the next year all of the income statement and dividend
accounts will be zero. Accordingly they are called temporary accounts since they accumulate date for the year and
then are closed at the end of the year. Also the only accounts remaining will be the balance sheet accounts which
are called permanent accounts since they are not closed on an annual basis.
The process of closing the temporary accounts is called closing journal entries. The process can be as little as three
steps: 1) close all credit balance income statement accounts (usually revenue and gains) to retained earnings; 2)
close all debit balance income statement accounts (usually expenses and losses) to retained earnings and 3) close
the dividend account to retained earnings.
These are posted to the general ledger again at the press of a button. We can then produce a post closing trial
balance that only includes the balance sheet accounts. Now we are ready to start the process for the next year and
repeat the accounting cycle year after year.
Financial Statement Analysis
The process of gathering information that is not on the financial statements to be used in assessing the business
and to make informed business decisions by the users. There are four main user groups when looking at financial
statement analysis for small businesses: Short term creditors; long term creditors; present and potential investors
and management of the business all with slightly different objectives and concerns.
Short term creditors can either be suppliers or financial institutions. Both are looking at the company’s ability to
pay back the principal in the short term and interest if applicable. Accordingly they are concerned with the liquidity
of the company – ability to repay debt in the short term.
Long term creditors for small business are usually financial institutions but can include private lenders. Both are
looking at the company’s ability to pay back the principal and interest regularly over the long term. Accordingly
they are concerned with the solvency of the company – ability to repay debt and interest over the long term.
Investors are essentially the owners of a business and accordingly are looking for annual payment on their
investment (dividend) and an appreciation in the value of the ownership interest (stock value) in order to have a
gain on the eventual sale. They will of course be primarily looking at the profitability of the business and
secondarily at the management of the company’s assets.
Management runs the business on a day by day basis. Therefore their compensation package is based on the
efficient operation of the business and of course the profitability. They will of course be concentrating primarily on
the management of the assets and secondarily on the profitability of the business, since both tie into the
remuneration. The danger lies in them focusing on short term income and losing focus on the management of the
assets which essential over the long term.
As with any analysis you must look at both the economic and political conditions that a business finds itself. These
will help provide background and support for your analysis and your expectations for the business. Many people
will list off methods to analyze a business. I like to keep it simple and will offer three common ones used by all user
groups. In order for any analysis to be meaningful you must have something to compare it to. For example at a
minimum you could compare this year to last year and/or a budget if applicable.
1) Common sized income statements
A common sized income statement starts with putting this year and last year information side by side and inserting
percentage columns to the right of each year. Using net sales as a 100%, they will place a percentage on each line
item as a percentage of that figure. This allows for a quick comparison between this year and last year for any
significant variances.
For example, from below you note that that cost of goods sold dropped by 2.6% ; the selling and general expenses
dropped by 2.1% and the net income rose by 5.1%.
Musique Shoppe Inc.
Comparative Common-Size Income Statement
For the Years Ended December 31, 2005 and 2004
2005 2004
Total revenues…………………………………... 100.0% 100.0%
Expenses:
Cost of goods sold………………………….. 47.0 50.4
Selling and general expenses…………….. 22.8 24.9
Interest expense…………………………….. 1.6 1.1
Income tax expense………………………… 9.8 9.9
Total expense………………………………... 81.2 86.3
Net income……………………………………….. 18.8% 13.7%
Secondly many small businesses will then put this year and budget information side by side and inserting
percentage columns to the right of each year. Using net sales as a 100%, they will place a percentage on each line
item as a percentage of that figure. This allows for a quick comparison between this year and budget for any
significant variances and problems in the budgetary process can be spotted quickly.
Sound Design Stereo Shops Ltd.
Common-Size Income Statement
For the Year Ended December 31, 2006
ACTUAL BUDGET
Net sales……………………………………… 100.0% 100.0%
Cost of goods sold…………………………. 63.6 65.8
Gross margin………………………….……. 36.4 34.2
Operating expenses……………………….. 20.9 19.7
Operating income………………………….. 15.5 14.5
Other expenses……………………………... 0.8 0.4
Net income…………………………………… 14.7% 14.1%

2) Trend analysis
A trend analysis looks at line items over several years in which your oldest year is 100% and each subsequent year
is represented as a percentage of the base year. This is a quick analytical tool that small owners will usually use
again with the income statement to see if the trends are meeting with their expectations.
A trend analysis would look like this:
Year 5 Year 4 Year 3 Year 2 Year 1
Total revenue.. 136% 114% 106% 97% 100%
Net income…... 155 134 98 84 100
A quick comment from looking at this is net income grew by 55% during the period, compared to 36% for total
revenue.
3) Ratio analysis
In a ratio analysis one item is compared to another item to draw a conclusion. Ratios are used by financial
institutions and will be placed in loan agreements as covenants. The common ratios used in small business are
similar to big business the only difference is in the value derived and/or expected. I would provide the following
toolbox as a guide to ratio analysis which separates the ratios into financial strength and management
performance and then subdivides them by the user objectives. In it the higher the ratio the better it is except for
the four starting with “D” in which down is better. Again, In order for any analysis to be meaningful you must have
something to compare it to. For example at a minimum you could compare this year to last year and/or a budget if
applicable. If available you can even compare yourself to the industry that you are in at the time.
Samples of Basic Financial Statements
Kyle’s Lawns, Inc.
Income Statement
For the Year Ending November 30, 2005
Sales $ 3,000,000
Cost of Goods Sold (2,000,000)
Gross Margin 1,000,000

Total Operating Expenses (380,000)
Operating Income 620,000
Other Revenues:
Interest Revenue 2,000
Other Expenses:
Interest Expense (22,000)
Income Before Income Tax 600,000
Income Tax Expense (180,000)
Net Income $ 420,000
Statement of Retained Earnings
For the Year Ending November 30, 2005
Retained Earnings, December 1, 2004 $122,000

Net Income 420,000
542,000
Dividends (42,000)
Retained Earnings, November 30, 2005 $500,000

Balance Sheet
November 30, 2005
ASSETS:
Current Assets:
Cash $ 125,000
Accounts Receivable 175,000
Merchandise Inventory 245,000
Other Current Assets 25,000
Total Current Assets 570,000

Long-Term Assets:
Property, Plant, and Equipment $ 965,000
Accumulated Depreciation (335,000)
Total Property, Plant, and Equipment 630,000
Total Long-Term Assets 630,000
Total Assets $1,200,000
LIABILITIES:
Current Liabilities:
Accounts Payable $ 285,000
Current Notes Payable 10,000
Wages Payable 5,000
Total Current Liabilities 300,000

Long-Term Liabilities:
Long-Term Notes Payable 50,000
Total Long-Term Liabilities 50,000

Total Liabilities 350,000
STOCKHOLDERS' EQUITY:
Contributed Capital:
Common Stock, $1 Par Value, 95,000

Shares Issued and Outstanding 95,000
Additional Paid-in Capital – Common 255,000
Total Contributed Capital 350,000
Retained Earnings 500,000
Total Stockholders' Equity 850,000
Total Liabilities and Stockholders' Equity $1,200,000

Fashions by Christie Ltd.
Income Statement
For the Year Ending December 31, 2004
Sales $ 350,000
Cost of Goods Sold (150,000)
Gross Margin 200,000

Other Revenues:
Other Expenses:
Net Income $ 35,000
Retained Earnings, January 1, 2004 $57,000

Net Income 35,000
92,000
Dividends (17,000)

Balance Sheet
December 31, 2004
ASSETS:
Current Assets:
Cash $ 62,000
Inventory 78,000

Long-Term Assets:
Total Assets $300,000
LIABILITIES:



Total Liabilities and Stockholders' Equity $300,000

Adrienne’s Cosmetics Limited
Income Statement
Sales $1,525,000

Other Revenues:
Other Expenses:
Income from Continuing Operations before Tax 202,000
Income from Continuing Operations $ 129,280
Extraordinary Loss
($36,000 less income taxes of $12,960) (23,040)
Net Income $ 106,240
Retained Earnings, January 1, 2004 $160,000

Net Income 106,240
266,240
Dividends (20,000)

Balance Sheet
December 31, 2004
ASSETS:
Current Assets:
Cash $ 126,500
Inventory 225,500

Long Term Assets:
Property, Plant, and Equipment $875,000
Total Long Term Assets 525,000
LIABILITIES:

Long Term Notes Payable 37,000
Total Long Term Liabilities 37,000



Kevin’s Toy Stores
Income Statement
Sales $1,268,000

Other Revenues:
Rent Revenue 6,000
Other Expenses:
Kevin’s Toy Store
Statement of Owners Equity
Captial, January 1, 2004 $739,460

Net Income 45,540
785,000
Withdrawls (10,000)
Capital, December 31, 2004 $775,000
Kevin’s Toy Store
Balance Sheet
December 31, 2004
ASSETS:
Current Assets:
Cash $ 126,000
Inventory 225,000

Long-Term Assets:
LIABILITIES:


PROPRIETORS' EQUITY:
Total Capital 775,000
GRAW CONSTRUCTION
Income Statement
For Year Ended December 31, 2002
Revenues:
Professional fees earned $96,000
Rent earned 13,000
Total revenues $109,000
Operating expenses:
Amortization expense, building $ 10,000
Amortization expense, equipment 5,000
Wages expense 31,000
Interest expense 4,100
Insurance expense 9,000
Supplies expense 6,400
Telephone expense 2,200
Utilities expense 3,600
Total operating expenses 71,300
Net income $ 37,700
GRAW CONSTRUCTION
Statement of Owner’s Equity
Tracy Graw, capital, January 1 $ 6,900
Add: Investments by owner $50,000
Net income 37,700 87,700
Total $94,600
Less: Withdrawals by owner 12,000
Tracy Graw, capital, December 31 $82,600
GRAW CONSTRUCTION
Balance Sheet
December 31, 2002
Assets
Current assets:
Cash............................................................................. $ 4,000
Temporary investments............................................. 22,000
Supplies....................................................................... 7,100
Total current assets.................................................... $ 33,100
Capital Assets:
Equipment.................................................................. $ 39,000
Less: Accumulated amortization.......................... 20,000 $ 19,000
Building....................................................................... $130,000
Less: Accumulated amortization.......................... 55,000 75,000
Land............................................................................ 45,000
Total capital assets..................................................... 139,000
Total assets...................................................................... $172,100
Liabilities
Current liabilities:
Accounts payable....................................................... $ 15,500
Interest payable.......................................................... 1,500
Unearned professional fees........................................ 6,500
Current portion of long-term notes payable........... 6,600
Total current liabilities.............................................. $ 30,100
Long-term liabilities:
Long-term notes payable (less current portion)...... 59,400
Total liabilities................................................................ $ 89,500
Owner’s Equity
Tracy Graw, capital....................................................... 82,600
Total liabilities and owner’s equity.................................. $172,100
T & D AUTOBODY
Income Statement
Revenue:
Repair fees earned $77,750
Operating expenses:
Amortization expense, equipment $ 4,000
Wages expense 36,500
Insurance expense 700
Rent expense 9,600
Office supplies expense 2,600
Utilities expense 1,700
Total operating expenses 55,100
Net income $22,650
T & D AUTOBODY
Statement of Owner’s Equity
Ted Dunwood, capital, January 1 $40,000

Add: Net income 22,650
Total $62,650
Less: Withdrawals 15,000
Ted Dunwood, capital, December 31 $47,650
T & D AUTOBODY
Balance Sheet
December 31, 2002
Assets
Current assets:
Cash.................................................................................. $13,000
Office supplies.................................................................. 1,200
Prepaid insurance............................................................. 1,950
Total current assets.......................................................... $16,150
Capital Assets:
Equipment........................................................................ $48,000
Less: Accumulated amortization................................... 4,000 44,000
Total assets.............................................................................. $60,150
Liabilities
Current liabilities:
Accounts payable............................................................. $12,000
Wages payable................................................................. 500
Total current liabilities...................................................... $12,500
Owner’s Equity
Ted Dunwood, capital .......................................................... 47,650
Total liabilities and owner’s equity.......................................... $60,150
References
Werner, Michael L. and Jones, Kumen H., Introduction to Accounting, A Users Perspective, 2 nd edition, Pearson
Publishing, 2000.
Austin, Bryan J., Financial Accounting and Reporting, 2 nd Canadian edition, McGraw Hill Ryerson, 2000.
Terrell, Katherine, Terrell, Robert, Survey of Accounting, Making Sense of Business, Pearson Publishing, 2005.
Garrison, Ray, Managerial Accounting, 8th Canadian edition, McGraw Hill Ryerson, 2009.
Beechy, Thomas, Conrad, Joan, Intermediate Accounting, volume 1, 4 th edition, McGraw Hill Ryerson, 2008.
Beechy, Thomas, Conrad, Joan, Intermediate Accounting, volume 2, 4 th edition, McGraw Hill Ryerson, 2008.
Larson, Kermit, Jensen, Tilly, Fundamental Accounting Principles, volume 1, 11 th edition, McGraw Hill Ryerson,
2005.
ASSOCIATION A – FINANCIAL STATEMENTS – AS AT MARCH 31, 20X1
(NFPO WITH LESS THAN $500,000 IN GROSS REVENUES)

MODEL FINANCIAL STATEMENTS – NOT-FOR-PROFIT ORGANIZATIONS
COMMENTS
AUDITOR’S REPORT
(1) This example of an auditor’s report must be used only in the case of an opinion without reservation.
CICA Handbook Section 5510 provides examples of auditor’s reports with reservations: qualification,
denial and adverse opinion.
(2) When auditors are unable to ensure that the organization has received all revenues from donations or
certain fund-raising activities, such as lotteries, their report should include a reservation (see example
on page B.3). However, this reservation should not be automatically included. Factors such as the
materiality of the amounts in question, the existence of controls over amounts received, and the
feasibility of applying conclusive control tests or substantive procedures should be taken into account.
(3) Replace the auditor’s report by a review engagement report or notice to reader, depending on the
nature of the engagement.
(4) Where the firm has several partners, the title may be AUDITORS’ REPORT. The plural should
therefore be used in the text of the report and in respect of the signature.
(5) The exact name of the organization, as it appears in its articles of incorporation, must be used.
(6) Make sure the various financial statements are properly named. Where appropriate, add the word
consolidated, non-consolidated, or combined.
(7) The expression “cash flow” should be used in the opinion paragraph. The auditor’s opinion should
always cover cash flows even if a separate statement was not presented because the required cash
flow information is readily apparent from the other financial statements or is adequately disclosed in
the notes to the financial statements (CICA 5400.14). No reference should be made to the statement
of cash flows in the introductory paragraph (first paragraph) of the report where no separate
statement has been prepared. However, when a separate statement of cash flows is presented, the
introductory paragraph should also mention the statement of cash flows.
(8) Should the auditor find it useful to include additional information or explanations that are not required
by legislation and that are not intended as a reservation, this should be done in a paragraph following
the opinion paragraph.
Where the comparative figures are based on financial statements that were audited by another
auditor, this fact should be disclosed in the notes to the financial statements or in a separate
paragraph following the opinion paragraph.
Example: “The comparative figures have been audited by another auditor.”
If the financial statements do not clearly indicate that the comparative figures are unaudited, this
should be mentioned in the auditor’s report, in a separate paragraph following the opinion paragraph
or in the notes to the financial statements.
Example: “The comparative figures are unaudited. I do not express any opinion on these
comparative figures.”
©Ordre des comptables agréés du Québec - A.52 -

September 2007
If the auditor feels it is appropriate to mention the reservations with respect to the prior year, this
should be done in a separate paragraph following the opinion paragraph.

September 2007
(1)
(2)
(3)
(4) AUDITOR’S REPORT
To the members of
(5) ASSOCIATION A
(6) I have audited the statement of financial position of ASSOCIATION A as at March 31, 20X1,
and the statements of operations, changes in net assets and cash flows for the year then ended.
These financial statements are the responsibility of the association’s management. My
responsibility is to express an opinion on these financial statements based on my audit.
I conducted my audit in accordance with Canadian generally accepted auditing standards.

Those standards require that I plan and perform an audit to obtain reasonable assurance
whether the financial statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement presentation.
(7) In my opinion, these financial statements present fairly, in all material respects, the financial
position of the association as at March 31, 20X1, and the results of its operations and its cash
flows for the year then ended, in accordance with Canadian generally accepted accounting
principles.
(8)
Chartered accountant
City
Date

September 2007
COMMENTS
STATEMENT OF OPERATIONS
(1) This statement may also be referred to as the STATEMENT OF REVENUES AND EXPENSES (CICA
4400.30).
(2) Revenues and expenses should be disclosed at their gross amounts. The gross amounts are
recognized in the statement of operations or disclosed in the notes to the financial statements,
depending on what the organization considers most appropriate in the circumstances. In general, it is
preferable to disclose the gross amounts directly in the statement of operations (CICA 4400.38).
However, it may be preferable to disclose the gross amounts in the notes to the financial statements
when the net proceeds related to an event ancillary to the organization’s main operations are
insignificant but the gross amounts are so significant that they could distort the financial statements.
(3) Contributions should be disclosed by major source (CICA 4410.22) Information about the sources of
contributions will help financial statement users to assess the organization’s economic relationship
with other entities and to predict its ability to generate future cash flows. This information would be
disclosed for each source of significant contributions to the organization. The sources would be
grouped by major categories, such as different levels of government, foundations, corporate
contributors, individuals and other not-for-profit organizations. It may be desirable to name individual
entities providing significant levels of support unless there is reason for them to remain anonymous.
(4) NFPOs may classify expenses in the statement of oprations using several different methods: by
object (e.g. salaries, rent, etc.), by function (e.g. administration, research, etc.) or by program,
depending on what the organization considers the most meaningful presentation in the circumstances
(CICA 4400.31). In this example, expenses are classifed by function.

September 2007
ASSOCIATION A
(1) STATEMENT OF OPERATIONS

FOR THE YEAR ENDED MARCH 31, 20X1
20X1 20X0
(2)
(3) REVENUES
Fees $ 92,000 $105,000
Provincial government grants 115,000 90,000
Seminar fees 125,000 123,000
Interest 4,000 1,000
Maintenance contract 1,000 3,000
Contributions from individuals 5,000 3,000
342,000 325,000
(4) EXPENSES
Administration 86,000 88,000
Seminars 145,000 140,000
Conference 14,000 16,000
Public awareness and training 55,000 75,000
Capital assets purchased with revenues 5,000 2,000
305,000 321,000
EXCESS OF REVENUES OVER EXPENSES $ 37,000 $ 4,000

September 2007
COMMENTS
STATEMENT OF CHANGES IN NET ASSETS
(1) If the organization does not use fund accounting, it must still disclose the following items separately
in the statement of changes in net assets:
(a) net assets invested in capital assets;
(b) net assets subject to restrictions requiring that they be maintained permanently as
endowments;
(c) other restricted net assets;
(d) unrestricted net assets; and
(e) total net assets.
(CICA 4400.41)
(2) Under the deferral method, endowment contributions should be recognized as direct increases in net
assets in the current period (CICA 4410.29).
(3) An internal restriction is reported directly in the statement of changes in net assets.
Judgment would be exercised in determining the level of disclosure to provide for interfund transfers.
It may not always be necessary to disclose individual transfers. Interfund transfers that are similar in
nature may be aggregated (CICA 4400.16).

September 2007
ASSOCIATION A
(1) STATEMENT OF CHANGES IN NET ASSETS

20X1 20X0
Restricted
for
Endowment research
contributions purposes Unrestricted Total Total
BALANCE, BEGINNING OF
YEAR $ — $ — $29,500 $29,500 $25,500
Excess of revenues over

expenses 37,000 37,000 4,000
(2) Endowment contributions 7,000 7,000 —
(3) Internal restrictions (Note 3) 10,000 (10,000) — —

BALANCE, END OF YEAR $7,000 $10,000 $56,500 $73,500 $ 29,500

September 2007
COMMENTS
STATEMENT OF FINANCIAL POSITION
(1) This statement may also be referred to as the BALANCE SHEET (CICA 4400.20).
(2) Due to the application of Sections 3855 and 3861 on financial instruments, disclosures on the fair
value presentation of financial instruments are mandatory for fiscal years beginning on or after
October 1, 2006 (and due to Section 3860 before this).
As of October 1, 2007, Section 3861, “Financial Instruments — Disclosure and Presentation” will be
replaced by Sections 3862, “Financial Instruments — Disclosures,” and 3863, “Financial Instruments
— Presentation.” However, NFPOs may choose to adopt these Sections before that date.
(3) Details of the allocation of net assets may also be disclosed in a note to the financial statements to
which the item would refer (see example on page B.21, Note 12).
(4) Internally restricted net assets or fund balances may also be referred to as “reserves” or
“appropriations.”

September 2007
ASSOCIATION A
(1) STATEMENT OF FINANCIAL POSITION

AS AT MARCH 31, 20X1
20X1 20X0
ASSETS
CURRENT ASSETS
(2) Cash $25,000 $23,000
(2) Term deposits (Note 8) 144,500 53,000
(2) Accounts receivable 55,000 20,000
Expenses chargeable to the next year 1,000 1,000
$225,500 $97,000
LIABILITIES
CURRENT LIABILITIES
Bank loan, 10% $— $2,000
(2) Accounts payable and accrued liabilities 2,000 1,500
Deferred contributions (Note 4) 150,000 64,000
152,000 67,500
(3) NET ASSETS
Net assets restricted for endowment 7,000

(4) Internally restricted net assets (Note 3) 10,000
Unrestricted net assets 56,500 29,500
73,500 29,500
$225,500 $97,000
ON BEHALF OF THE BOARD OF DIRECTORS
___________________________________, Director
___________________________________, Director

September 2007
COMMENTS
STATEMENT OF CASH FLOWS
(1) This statement may also be referred to as the STATEMENT OF CHANGES IN FINANCIAL POSITION or
STATEMENT OF SOURCES AND USES OF CASH (CICA 4400.48).
In general, the figures corresponding to cash outflows are shown in parentheses and those corresponding to
cash inflows are shown without parentheses.
(2) It is not necessary to prepare a statement of cash flows when such a statement would not provide additional
useful information (CICA 4400.55).
(3) The statement of cash flows may be prepared using the direct method — similar to a statement of operations
prepared on a cash basis — or using the indirect method by reconciling the excess of revenues over expenses
for the general fund and any restricted funds of an operating nature to cash flows from operations (CICA
4400.50). In the example, the statement is prepared using the indirect method (for an example of a statement
prepared using the direct method, see page C.11).
(4) The components of cash and cash equivalents can be presented in note form at the bottom of the statement or
in table form at the bottom of the statement or in a note to the financial statements.
 Example of a note: “Cash and cash equivalents consist of cash on hand and term deposits less the
bank overdraft.”
 Example of a table:
20X1 20X0
CASH AND CASH EQUIVALENTS
Cash $ XXX $ —
Term deposits XXX XXX
Bank overdraft — (XXX)
$ XXX $ XXX
In general, an investment would be included under cash and cash equivalents when it has a maturity period of
three months or less from the date of acquisition.
Bank overdrafts may be included as a component of cash and cash equivalents only when the bank balance
fluctuates frequently from being positive to overdrawn. The line of credit used and bank borrowings should not
normally be included under cash and cash equivalents and should be classified as financing activities.
Cash subject to restrictions that prevent its use for current purposes, such as compensating balances required
in accordance with lending arrangements, would not be included among cash and cash equivalents. Cash
subject to restrictions would be classified on the balance sheet in accordance with “Cash,” Section 3000.
(5) The entity should establish a policy to determine which items to include in cash and cash equivalents. The
accounting policy adopted by the entity in this regard should be disclosed in the financial statements.
Example of an accounting policy:
“The entity’s policy is to disclose bank balances under cash and cash equivalents, including bank overdrafts
with balances that fluctuate frequently from being positive to overdrawn and term deposits with a maturity period
of three months or less from the date of acquisition. Term deposits that the entity cannot use for current
transactions because they are pledged as security are also excluded from cash and cash equivalents.”

September 2007
ASSOCIATION A
(1)(2)
STATEMENT OF CASH FLOWS
20X1 20X0
(3) CASH FLOWS FROM OPERATIONS
Excess of revenues over expenses $37,000 $4,000
Net change in non-cash working capital (34,500) (15,000)
Increase in deferred contributions related to operations 86,000 10,000

88,500 (1,000)
CASH FLOWS FROM FINANCING ACTIVITIES

Cash from endowment contributions 7,000
Bank loan 2,000
Repayment of bank loan (2,000)
5,000 2,000
CASH (AND CASH EQUIVALENTS) INCREASE) 93,500 1,000
CASH (AND CASH EQUIVALENTS), BEGINNING OF 76,000 75,000

YEAR
CASH (AND CASH EQUIVALENTS), END OF YEAR $169,500 $76,000
(4)(5) Cash (and cash equivalents), end of year

Cash $25,000 $23,000
Term deposits 144,500 53,000
169,500 76,000

September 2007
COMMENTS
NOTES TO THE FINANCIAL STATEMENTS
(1) The financial statements should include a description of the organization’s purpose, its intended
community of service, its status under income tax legislation and its legal form (CICA 4400.04).
(2) Organizations having average of annual revenues for the current and preceding fiscal period (gross
revenues including the revenue of any entities it controls) of less than $500,000 may choose not to
capitalize or amortize their capital assets.
Accordingly, they should disclose:
 the policy followed in accounting for capital assets;
 information about the major categories of capital assets not recorded in the
statement of financial position;
 the amount of capital assets expensed in the current period.
However, CICA Handbook paragraph 4430.04 encourages capital asset capitalization and
amortization even if the average of annual revenues is less than $500,000.
(3) Any organization that receives substantial contributed materials and services should disclose the
policy followed in accounting for such contributions (CICA 4410.23). This information is required even
if the organization does not recognize contributed materials and services.
In addition, the organization should disclose the nature and the amount of contributed materials and
services recognized in the financial statements (CICA 4410.24).
An organization may recognize contributions of materials and services under the following
conditions:
 the fair value of these services or materials can be reasonably estimated;
 these services and materials are used in the normal course of the
organization’s operations and would otherwise have been purchased (CICA 4410.16).
An organization should account for contributed materials or services at their fair value at their date of
contribution. Their fair value may be determined on the basis of their market or appraisal values or the
market value of similar materials or services.
For example, the policy followed in accounting for contributed services could be described as follows:
In its day-to-day operations, the organization uses the services of many volunteers. These
services are reported in the organization’s revenues. The hours contributed by volunteers
are compiled and recognized according to an hourly rate corresponding to 2/3 of the
average market rate for similar services.

September 2007
ASSOCIATION A

(1) 1. STATUS AND PURPOSE OF THE ORGANIZATION
ASSOCIATION A is incorporated under Part III of the Quebec Companies Act as a not-for-
profit organization and is a registered charity under the Income Tax Act. Its purpose is to
forge ties and develop solidarity with Third World populations through information,
fundraising, solidarity campaigns and bringing together volunteers.
2. STATEMENT OF ACCOUNTING POLICIES
(a) Revenue recognition

ASSOCIATION A follows the deferral method of accounting for contributions. Restricted
contributions are recognized as revenue in the year in which the related expenses are
incurred. Unrestricted contributions are recognized as revenue when they are received
or receivable if the amount to be received can be reasonably estimated and collection is
reasonably assured. Endowment contributions are recognized as direct increases in net
assets in the year.
Seminar fees are recognized as revenue when the seminars are held.
Member fees are recognized as revenue proportionately over the fiscal year to which
they relate.
(2) (b) Capital Assets

Capital assets are recorded as expenses in the year they are acquired.
(3) (c) Contributed services

Volunteers contribute about 500 hours per year to assist ASSOCIATION A in carrying
out its service delivery activities. Because of the difficulty of determining their fair value,
contributed services are not recognized in the financial statements.
(d) Presentation of the controlled foundation

FOUNDATION X, which is controlled by ASSOCIATION A, is not consolidated in the
association’s financial statements.

September 2007
COMMENTS
(1) The organization should present deferred contributions balances in the statement of financial
position outside net assets. It should disclose the amount and nature of changes in deferred
contributions balances for the period (CICA 4410.52 and .53).
(2) Organizations having average of annual revenues for the current and preceding fiscal period (gross
revenues including the revenue of any entities it controls) of less than $500,000 may choose not to
capitalize or amortize their capital assets.
Accordingly, they should disclose:
 the policy followed in accounting for capital assets;
 information about the major categories of capital assets not recorded in the
statement of financial position;
 the amount of the capital assets expensed in the current period.

September 2007
ASSOCIATION A

3. INTERNAL RESTRICTIONS
In 20X1, the board of directors of ASSOCIATION A allocated $10,000 for research

purposes. ASSOCIATION A may not use these internally restricted amounts for any other
purpose without the approval of the board of directors.
(1) 4. DEFERRED CONTRIBUTIONS
Related to operating activities
20X1 20X0
BALANCE, BEGINNING OF YEAR $64,000 $54,000
LESS: amount recognized as revenue in the year (34,000) (24,000)
PLUS: amount received related to the following year 120,000 34,000
BALANCE, END OF YEAR $150,000 $64,000
(2) 5. CAPITAL ASSETS CHARGED TO THE STATEMENT OF OPERATIONS
The cost of the capital assets held by ASSOCIATION A is as follows:
20X1 20X0
$12,000 $9,000
Furniture and equipment
Leasehold improvements 7,500 7,500
Computers 8,000 6,000
Photocopier 3,500 3,500
$31,000 $26,000

September 2007
COMMENTS
(1) A not-for-profit organization should disclose the following information about its transactions with
related parties (CICA 4460.07):
 a description of the relationship between the transacting parties;
 a description of the transactions, including those for which no amount

has been recorded;
 the recorded amount of the transactions classified by financial statement

category;
 the measurement basis used for recognizing the transactions in the financial
statements;
 amounts due to or from related parties and the terms and conditions relating
thereto;
 contractual obligations with related parties, separate from other contractual

obligations; and
 contingencies involving related parties, separate from other contingencies.
(2) An NFPO should disclose the following in its financial statements in respect of its controlled
organizations, regardless of the presentation method used for these controlled organizations (CICA
4450.15):
 the policy followed in reporting the controlled organization;
 a description of the relationship with the controlled organization;
 a clear and concise description of the controlled organization’s purpose, its

intended community of service, its status under income tax legislation and its legal form; and
 the nature and extent of any economic interest that the reporting
organization has in the controlled organization.
In addition, a not-for-profit organization may choose one of the following ways to present its
controlled NFPOs in its financial statements. It may:
(i) consolidate the controlled organization in its financial statements;

(ii) not consolidate the controlled organization but disclose its:
 total assets, liabilities and net assets at the reporting date;
 revenues (including gains) and expenses (including losses), reported in the

period;
 cash flows from operating, financing and investing activities reported in the
period;

September 2007
 details of any restrictions, by major category, on the resources of the

controlled organization; and
 significant differences in accounting policies from those followed by the

reporting organization (CICA 4450.22).
This note provides examples of the latter option.

September 2007
ASSOCIATION A

(1) 6. RELATED PARTY TRANSACTIONS
ASSOCIATION A and ORGANIZATION A are common control organizations since they

have the same board of directors.
ASSOCIATION A leases the following assets from ORGANIZATION A:
20X1 20X0
Telephone system $100/month $100/month
Fax machine $ 30/month $ 30/month
Air exchange system $ 50/month $ 50/month
ASSOCIATION A paid ORGANIZATION A $2,160 for these leases during the year ($2,160
in 20X0).
ORGANIZATION A donated $4,000 to ASSOCIATION A in the year ($3,000 in 20X0).
ASSOCIATION A paid ORGANIZATION A $24,500 in management fees during the year

($24,000 in 20X0).
All these transactions were carried out in the normal course of operations and are recorded
at the exchange value. This value corresponds to the consideration agreed upon by the
parties and is determined using the cost recovery method.
(2) 7. CONTROLLED FOUNDATION
FOUNDATION X
FOUNDATION X is controlled by ASSOCIATION A since the management of

ASSOCIATION A was closely involved in developing the policies of FOUNDATION X and
can influence their content.
FOUNDATION X, which was created to raise funds to finance ASSOCIATION A, is

incorporated under Part III of the Quebec Companies Act. As a registered charity within the
meaning of the Income Tax Act, it may issue receipts for charitable donations.

September 2007
COMMENTS
(1) This information is required under Sections 3855 and 3861 on financial instruments.
Disclosures on the fair value presentation of financial instruments are mandatory for fiscal years
beginning on or after October 1, 2006 (and under Section 3860 before this).
As of October 1, 2007, Section 3861, “Financial Instruments — Disclosure and Presentation” will be
replaced by “Sections 3862, Financial Instruments — Disclosures,” and 3863, “Financial Instruments
— Presentation.” However, NFPOs may choose to adopt these Sections before that date.
(2) The first sentence may be presented in the note on accounting policies. In these financial statements,
it was included in the note on financial instruments for the sake of simplicity.

September 2007
ASSOCIATION A

7. CONTROLLED FOUNDATION (cont’d)
The summary financial statements of FOUNDATION X are as follows:
20X1 20X0
Statement of financial position
Assets $5,000 $4,000

Liabilities 3,000 3,000
Net assets:
Externally restricted 2,000 1,000
Statement of operations
Revenue 50,000 45,000

Expenses 50,000 45,000
Statement of cash flows
Operating activities 2,000 1,500

Financing and investing activities 500 500
(1) 8. FINANCIAL INSTRUMENTS
(2) The organization’s financial assets and financial liabilities are held for trading.
The carrying amount of cash, term deposits, accounts receivable, accounts payable and
accrued liabilities is a reasonable approximation of their fair value given their short-term
maturity.
The association manages its term deposit portfolio according to its cash needs and in such
a way as to maximize interest income. The average interest rate on term deposits at year
end was 4.6% (3.5% in 20X0) and their due dates range from 45 days to three months.

September 2007

September 2007

September 2007

September 2007

Introductory Accounting Principles (Revised 2016)

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Introductory Accounting Principles (Revised 2016)

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Derrick Hayes

Faculty of Shannon School of Business

2. Decide upon the organizational form for the business.

3. Research the industry and the product.

4. Prepare a strategic plan.

5. Design internal controls for operations and information.

7. Prepare initial capital and operating budgets.

Business is about making decisions

 Corrections – To correct or adjust errors in recording of transactions

ASSETS = LIABILITIES + EQUITY

ying and yang

Now it is time to expand the accounting equation to:

ASSETS = LIABILITIES + EQUITY INVESTED + EQUITY EARNED

Issued (75) Not sold (25)

Outstanding(65) Treasury (10)

Now I want to expand the accounting equation further:

ASSETS = LIABILITIES + EQUITY INVESTED + EQUITY EARNED

+ invested equity + earned equity

(common shares) (retained earnings)

Revenue – expenses = operating income (loss)

Revenue – expenses = operating income (loss) + gains – losses

Revenue – cost of goods sold = gross profit

- expenses = operating income

+/- other income (expenses) = net income

Statement of Owners Equity

+/- Net income (loss)

+/- Net income (loss)

Debits and Credits

DATE | ACCOUNT | Posting Reference | DEBIT | CREDIT |

EVENT JOURNAL ENTRY

BANK | OUR RECORDS |

Ending Balance per bank Ending Balance per our records

+ credit memos from bank Requires

- debit memos from bank an AJE

+/- recording errors +/- recording errors

= Adjusted ending balance SAME = Adjusted ending balance

Financial Statement Analysis

1) Common sized income statements

Comparative Common-Size Income Statement

For the Years Ended December 31, 2005 and 2004

Total revenues…………………………………... 100.0% 100.0%

Cost of goods sold………………………….. 47.0 50.4

Selling and general expenses…………….. 22.8 24.9

Interest expense…………………………….. 1.6 1.1

Income tax expense………………………… 9.8 9.9

Total expense………………………………... 81.2 86.3

Net income……………………………………….. 18.8% 13.7%

Sound Design Stereo Shops Ltd.

Common-Size Income Statement

For the Year Ended December 31, 2006

Net sales……………………………………… 100.0% 100.0%

Cost of goods sold…………………………. 63.6 65.8

Gross margin………………………….……. 36.4 34.2

Operating expenses……………………….. 20.9 19.7

Operating income………………………….. 15.5 14.5

Other expenses……………………………... 0.8 0.4

Net income…………………………………… 14.7% 14.1%

A trend analysis would look like this:

Year 5 Year 4 Year 3 Year 2 Year 1

Total revenue.. 136% 114% 106% 97% 100%

Net income…... 155 134 98 84 100

For the Year Ending November 30, 2005

Cost of Goods Sold (2,000,000)