MGT201

ch1-3

| What is accounting?

The process of identifying, measuring, recording, and communicating financial information about a company's activities so decision makers can make informed decisions.

| What is bookkeeping?

Recording information and maintaining accounting records.

| What is financial accounting?

Accounting and reporting to satisfy outside users' demand for information, mainly investors and creditors.

| What does each user look for in the statements? (Investors, creditors, suppliers, employees, managers, auditors)

Investors: rate of return, growth vs. decline. Creditors/banks: ability to repay. Suppliers: reliability and consistency. Employees: salary, raises, company health. Managers: plan operating, investing, and financing activities. Auditors: whether the statements are fair (and fraud checks).

| What is a business entity?

A business with an identity separate from its owners and managers that maintains its own accounting records.

| Sole proprietorship: key features?

One owner. Easy to set up, and the owner has full control. Personally taxed, and formed or dissolved at the owner's wish.

| Partnership: key features?

Owned by two or more people or corporations. More financial resources than a sole proprietorship. Partners are jointly responsible for all debts. Dissolves automatically if a partner leaves.

| Corporation: key features?

Organized under provincial or territorial law. Raises large amounts of capital by issuing shares. Can be private or public.

| Public vs. private corporation?

Public: shares trade on a stock exchange (e.g., Apple, Uber, Spotify). Private: not everyone can buy in, but it isn't necessarily small. A company can go from public back to private.

| Three categories of business activities?

Financing, investing, and operating.

| Financing activities

Obtaining the funds to begin and operate a business, by issuing shares or borrowing (debt).

| Investing activities

Buying assets used in operations (property, plant, equipment).

| Operating activities

Day-to-day activities that earn revenue and incur expenses.

| Liability vs. creditor

Liability: an obligation to repay a creditor. Creditor: a person to whom the corporation owes money.

| Loans payable vs. bonds payable

Loans payable: borrowed money repaid with interest at a future date. Bonds payable: a special form used to raise large amounts.

| What are common shares?

The dollar amount paid to a corporation for shares, representing basic ownership.

| What are dividends?

A portion of earnings distributed to shareholders. The corporation isn't obliged to repay the shareholder's investment, but once dividends start, people expect them to continue.

| Who gets paid first in financial distress?

Creditors (liabilities) are paid before shareholders (equity).

| What is shareholders' equity?

The residual interest in assets after deducting liabilities.

| Revenue vs. expense

Revenue: an increase in assets from selling products or services. Expense: the cost of assets used or liabilities created in operating the business.

| Net income vs. net loss

Revenues > expenses = net income. Expenses > revenues = net loss.

| Accounts receivable vs. accounts payable

A/R: amount customers owe you (an asset). A/P: amount you owe suppliers (a liability).

| What are the 4 basic financial statements?

1) Statement of financial position, 2) Statement of comprehensive income (or income/earnings), 3) Statement of changes in equity, 4) Statement of cash flows.

| Statement of financial position

Reports assets and the claims against them (liabilities and equity) at a specific point in time. Private companies call it a balance sheet.

| Statement of comprehensive income

Reports revenues, expenses, and income over a period of time.

| Statement of changes in equity

Reports changes in components of shareholders' equity over a period: retained earnings, dividends, shares issued or repurchased. Private companies prepare a statement of retained earnings instead.

| Statement of cash flows

Reports sources and uses of cash over a period.

| Which statement is at a point in time, and which cover a period?

The statement of financial position is a point in time. The other three cover a period.

| What are the notes to the financial statements?

Supporting and explanatory information that accompanies the statements.

| Current vs. long-term

Current: within the next year. Long-term: beyond one year.

| What is an annual report?

A document that captures all of a company's information for the year for users to see.

| What is IFRS, and who must use it?

International Financial Reporting Standards, developed by the IASB. Mandatory for publicly accountable enterprises in Canada.

| What is ASPE?

Accounting Standards for Private Enterprises. Private companies can choose IFRS or ASPE, but must be consistent once chosen.

| IFRS vs. ASPE: names of statements

Financial position: IFRS uses "statement of financial position"; ASPE uses "balance sheet". Equity: IFRS uses "statement of changes in equity"; ASPE uses "statement of retained earnings". Income: IFRS uses "statement of comprehensive income"; ASPE uses "statement of earnings" (no comprehensive income).

| What is the accounting cycle?

The procedures a company uses to transform the results of its business activities into financial statements.

| What are the 2 fundamental characteristics of useful information?

Relevance and faithful representation.

| Relevance

Info that can make a difference in a decision by having predictive value (helps predict the future) or confirmatory value (gives feedback on prior expectations).

| Materiality

Info is material if omitting or misstating it could influence a decision.

| Faithful representation

Information accurately depicts the real-world economic event it portrays.

| Comparability and consistency

Comparability: users can identify similarities and differences between companies or time periods. Consistency: applying the same accounting principles over time. Comparability is the goal, and consistency helps achieve it.

| Verifiability

Independent parties can reach a consensus on the measurement.

| Timeliness

Info is available before it loses its ability to influence decisions.

| Understandability

Users with reasonable knowledge of accounting and business can comprehend it with reasonable effort.

| What are the 2 constraints on qualitative characteristics?

Cost constraint: benefits of the info must exceed the cost of providing it. Prudence: take care not to overstate assets and revenues or understate liabilities and expenses.

| What are the 4 basic assumptions?

Separate entity, continuity (going concern), periodicity (time period), and unit of measure (monetary unit).

| Separate entity assumption

The business can be accounted for separately from its owners.

| Continuity (going-concern) assumption

The company will operate long enough to carry out its existing commitments.

| Periodicity assumption

A company's life can be divided into artificial time periods to measure net income.

| Unit of measure assumption

Business activities can be accounted for in monetary terms.

| What are the 3 principles?

Historical cost, revenue recognition, and full disclosure.

| Historical cost principle

Activities are initially measured at cost, the exchange price when the activity occurs.

| Revenue recognition principle

Revenue is recorded in the period it is earned and collection is reasonably assured.

| Full disclosure principle

Any information that would make a difference to users must be revealed.

| What is a transaction?

Any event, external or internal, that is recognized in the financial statements.

| What is transaction analysis?

Determining the economic effects of a transaction on the elements of the accounting equation.

| What are the 3 steps of transaction analysis?

1) Write the accounting equation. 2) Identify the financial statement elements affected. 3) Determine whether each increased or decreased.

| What are source documents?

Documents that describe business activities (internally or externally prepared), gathered at the start of transaction analysis.

| What is double-entry accounting?

Every transaction has a two-sided effect on the accounting equation, and both sides are recorded. The equation must always balance.

| What is an account?

A record of increases and decreases in each basic element of the financial statements.

| What is a chart of accounts?

The list of accounts a company uses. Once chosen, the accounts are locked in, though the chart can change as the business changes.

| What is an account balance?

The amount in an account at a given time.

| What is a T-account?

A graphical two-column account record: debit on the left, credit on the right.

| Do debit and credit mean increase and decrease?

No. They only show which side of the account the entry goes on. An increase or decrease depends on the account's normal balance.

| What must always be true of debits and credits?

Total debits must equal total credits (LHS = RHS).

| What are the 4 steps of the accounting cycle in Ch. 2?

1) Analyze transactions. 2) Journalize. 3) Post to the ledger. 4) Prepare a trial balance.

| What is a journal?

A chronological record of the debit and credit effects of transactions, also called the book of original entry.

| What are the 3 parts of a journal entry?

Date, accounts and amounts affected, and a brief explanation (written beneath the credit).

| What is a compound journal entry?

An entry affecting more than 2 accounts.

| What if you spot an error in a journal entry?

The accountant has an ethical responsibility to correct it.

| What is the general ledger, and what is posting?

Ledger: a collection of all of a company's individual accounts. Posting: copying information from the journal to the ledger, using posting reference numbers.

| Why use a ledger when you have a journal?

The journal is chronological, which makes it hard to find the balance of any one account.

| What is a trial balance, and what is it for?

A list of all active accounts and their debit or credit balances. It proves debits equal credits and helps identify errors quickly.

| IFRS vs. ASPE: presentation and measurement

IFRS: traditional (liquidity-focused) or nontraditional presentation; historical cost or revaluation (fair value) model, applied consistently. ASPE: traditional presentation only; historical cost model only.

| Cash basis accounting

Records revenue only when cash is received and expenses only when cash is paid. It suits small, simple businesses.

| Accrual basis accounting

Records revenue when earned and matches expenses to the period they help produce revenue, regardless of cash timing. It is required by GAAP and gives the most accurate picture.

| What three ideas does accrual accounting rest on?

The periodicity assumption, the revenue recognition principle, and the matching concept.

| What are the 5 steps of revenue recognition under IFRS 15?

1) Identify the contract. 2) Identify the performance obligations. 3) Determine the transaction price. 4) Allocate the price to the obligations. 5) Recognize revenue as obligations are satisfied.

| What are the older criteria for recognizing revenue?

1) Risks and rewards of ownership transferred. 2) Amount reliably measurable. 3) No continuing managerial involvement or control by the seller. 4) Economic benefits probably flow to the seller. 5) Costs reliably measurable.

| Matching process

Matching expenses incurred with the revenue earned in a specific period. An expense is recorded when incurred, regardless of when cash is paid.

| How can revenue recognition and matching be abused?

Recognizing revenue not yet earned or hiding expenses to prop up share price, or paying management with stock options.

| What are adjusting entries?

Journal entries made at the end of a period to record the completed portion of partially completed transactions. They are the last chance to fix the accounts before preparing statements.

| What are the 2 categories and 4 types of adjusting entries?

Accruals: accrued revenues and accrued expenses. Prepayments: unearned revenues and prepaid expenses.

| Accrued revenues

Revenues earned but not yet recorded and no cash received yet.

| Accrued expenses

Expenses incurred but not yet recorded or paid in cash.

| Unearned revenues

A liability from receiving cash before the revenue is earned (e.g., subscriptions, rent in advance, advance tickets).

| Prepaid expenses

An asset from paying cash for goods or services not yet used or consumed.

| Is cash ever affected by an adjusting entry?

Never. Each adjusting entry affects at least one income statement account and one statement of financial position account.

| What is the 4-step process for adjusting entries?

1) Identify accounts needing adjustment. 2) Calculate the amount. 3) Record the entry. 4) Prepare the adjusted trial balance.

| What is depreciation?

Systematically assigning the cost of property, plant, and equipment as an expense over the periods it is used. Land does not depreciate.

| What is a contra account?

An account with a balance opposite to its related account, netted against it. For example, accumulated depreciation is subtracted from the asset's cost.

| Interest formula for accruing interest

Principal × annual rate × time (fraction of a year).

| What is the adjusted trial balance used for?

To confirm debits still equal credits after adjusting entries, and as the source for preparing the statements.

| In what order are statements prepared?

1) Statement of earnings. 2) Statement of retained earnings (uses net income). 3) Statement of financial position (uses ending retained earnings).

| Permanent vs. temporary accounts

Permanent: asset, liability, and equity accounts, with balances carried forward. Temporary: revenue, expense, and dividend accounts, which cover one period only.

| Why do we close accounts?

To zero out the temporary accounts and transfer their balances to retained earnings, so next period starts clean.

| What is the income summary account?

A temporary account that aids the closing process.

| What are the 4 closing entry steps?

1) Close revenues to income summary. 2) Close expenses to income summary (the balance now equals net income or loss). 3) Close income summary to retained earnings. 4) Close dividends declared to retained earnings.

| What is the last step of the cycle, after closing?

Prepare a post-closing trial balance to confirm the ledger is in balance.

| Which steps repeat during the period, and which happen only at period-end?

Steps 1–3 (analyze, journalize, post) repeat many times. Steps 4–7 (trial balance, adjusting entries, statements, closing) happen only at period-end.

| IFRS vs. ASPE: revenue recognition

IFRS 15: detailed rules for complex transactions. ASPE Section 3400: judgment-based risk-and-reward model with few details.