Accounting Chapter 1 (redo... again)

What is accounting?

An information system that identifies, records, and communicates the economic activities of an organization; also called external financial reporting.

What is the purpose of accounting?

To provide objective, accurate, and reliable financial information to help users make informed decisions.

Why is accounting called the language of business?

Because it communicates financial performance, financial position, cash flows, and changes in equity.

What qualities make accounting information useful?

It is relevant, complete, neutral, and free from error, faithfully representing economic events.

Who are internal users of accounting information?

Employees, managers, and company directors who use accounting information to plan operations, manage resources, and evaluate performance.

Who are external users of accounting information?

Investors/shareholders, lenders/banks, government agencies (CRA), customers, regulators, and analysts.

Why do investors use accounting information?

To track profits, growth, dividends, and evaluate a company before investing.

Why do lenders use accounting information?

To assess a company’s ability to repay loans and interest obligations.

Why do government agencies use accounting information?

To verify tax compliance and financial accuracy.

Who are regulators and analysts as users of accounting information?

They evaluate compliance, financial health, and investment potential.

What is a sole proprietorship?

A business owned by one person with unlimited liability and no separate legal identity.

What is a partnership?

A business owned by two or more individuals sharing profits, losses, and liabilities according to an agreement.

What is a corporation?

• A business with a separate legal identity

• limited liability

• unlimited life

• ownership represented by shares

• can be public or private

What is a public corporation?

A corporation whose shares trade on a public exchange; subject to regulatory oversight.

What is a private corporation?

A corporation whose shares do not trade publicly; fewer reporting obligations.

What is the accounting equation?

Assets = Liabilities + Equity; shows how resources are financed by creditors and owners.

What are assets?

• Resources that provide future economic benefits

• such as cash, inventory, equipment, accounts receivable, goodwill, and temporary investments.

What are liabilities?

Obligations requiring future economic sacrifice, like loans, accounts payable, wages payable, and deferred revenue.

What is equity?

The owner’s residual interest in assets after liabilities; includes share capital and retained earnings.

What is revenue?

Inflows from ordinary business activities that increase equity.

What is gross profit?

Sales revenue minus cost of goods sold; shows profit before operating expenses.

What are expenses?

Costs incurred to earn revenue that decrease equity.

What is net income?

When revenues exceed expenses; measure of business performance.

What is net loss?

When expenses exceed revenues.

What are retained earnings?

Profits kept in the company for reinvestment instead of paying dividends.

What are dividends?

Payments to shareholders declared by the board; reduce retained earnings.

How do you calculate ending retained earnings?

Ending RE = Beginning RE + Net Income − Dividends declared.

Example: Newton Inc has revenue $75,000, expenses $22,000, dividends $10,000, beginning RE $217,000. What is ending RE?

$217,000 + ($75,000 − $22,000) − $10,000 = $260,000.

What is the income statement?

Shows revenues and expenses over a period to measure profitability; net income flows to retained earnings.

What is the balance sheet (Statement of Financial Position)?

Shows assets, liabilities, and equity at a specific point in time; based on the accounting equation.

What is the statement of changes in equity?

Shows changes in shareholders’ equity over time, including share capital, net income, and dividends.

What is the statement of cash flows?

Reports cash inflows and outflows from operating, investing, and financing activities.

What are operating activities?

Cash flows from day-to-day business operations, like cash received from customers or cash paid to suppliers.

What are investing activities?

Cash flows from buying or selling long-term assets and investments, like equipment or property.

What are financing activities?

Cash flows from raising or returning capital, like issuing shares, borrowing/repaying loans, or paying dividends.

Example: A company buys a delivery truck. Which cash flow category is this?

Investing activity.

Example: A company issues shares to raise capital. Which cash flow category is this?

Financing activity.

Example: A company pays wages and advertising costs. Which cash flow category is this?

Operating activity.

What are notes to financial statements?

Provide additional explanations of accounting policies, assumptions, and details of financial statement items.

What is the MD&A (Management Discussion and Analysis)?

Management’s commentary on financial results, operations, risks, cash flows, future plans, and ESG; not part of financial statements.

What is included in an annual report?

Financial statements, notes to the financial statements, and the MD&A.

What are IFRS and GAAP?

• IFRS: International Financial Reporting Standards used internationally for public companies

• GAAP: Generally Accepted Accounting Principles used in the U.S.

Why are accounting standards important?

They ensure consistency, transparency, comparability, and reliability in financial reporting.

What is the role of a CPA?

To ensure accounting information is accurate, reliable, and ethically prepared; combines CGA, CMA, and CA in Canada.

What ethical responsibilities do accountants have?

Maintain independence, professional competence, confidentiality, integrity, and report financial results accurately.

What is deferred revenue?

Cash received before delivering goods or services, recorded as a liability until earned.

What is earnings per share (EPS)?

Net income ÷ average number of shares outstanding.

What is earnings management?

Choosing accounting methods to influence reported earnings.

What is working capital?

Current assets - current liabilities; measures short-term financial health.

What is liquidity?

A company’s ability to meet short-term obligations.

What documents are often included with financial statements for additional context?

Notes to the Financial Statements, Management Discussion & Analysis (MD&A), Annual Report