Understanding Accounting – Chapter 11

Learning Objectives

  • Role of accountants, Canadian CPA unification

  • Use of the accounting equation Assets=Liabilities+Owners’ Equity\text{Assets}=\text{Liabilities}+\text{Owners' Equity}

  • Purpose & structure of key financial statements (Balance Sheet, Income Statement, Statement of Cash Flows)

  • Core reporting standards (IFRS, ASPE) & principles (revenue recognition, matching)

  • Basic ratio analysis (solvency, profitability, activity)

  • Ethics & evolving competencies of modern accountants

Core Definitions

  • Accounting: system for collecting, analyzing, communicating financial info

  • Bookkeeping: recording transactions; part of the Accounting Information System (AIS)

  • Controller: leads AIS, supplies data for planning/decision-making

Branches of Accounting

  • Financial Accounting: external users (shareholders, creditors, regulators)

  • Managerial Accounting: internal users (management) for planning & control

Canadian Professional Designations

  • Historic: CA, CGA, CMA

  • Unified: Chartered Professional Accountant (CPA)

Accounting Services

  • Auditing (GAAP compliance)

  • Tax services (prep & planning)

  • Management consulting (personal → corporate planning)

International Standards

  • IASB: develops global rules

  • IFRS: mandatory for publicly accountable & gov’t enterprises

  • ASPE: option for Canadian private firms

The Accounting Equation

  • Assets: economic resources (current, fixed, intangible, goodwill)

  • Liabilities: debts (current < 11 yr, long-term > 11 yr)

  • Owners’ Equity: residual interest

Key Asset Classes

  • Current: cash, A/R\text{A/R}, inventory, prepaid expenses

  • Fixed: land, buildings, machinery (depreciation spreads cost over life)

  • Intangible: patents, trademarks, copyrights, franchise rights

  • Goodwill: excess paid over fair value of net assets

Double-Entry Bookkeeping

  • Every transaction recorded twice to keep Assets=Liabilities+OE\text{Assets}=\text{Liabilities}+\text{OE} balanced

Financial Statements

• Balance Sheet – financial position at a point in time
• Income Statement – Revenues−Expenses=Net Profit/Loss\text{Revenues}-\text{Expenses}=\text{Net Profit/Loss} (P&L)
• Statement of Cash Flows – sources/uses of cash by Operations, Investing, Financing

Recognition & Matching Principles

  • Revenue recorded when earnings cycle complete (revenue recognition)

  • Expenses matched to associated revenues for correct period (matching)

Budgets

  • Internal 11-year financial plan; actual vs. budget guides control

Ratio Analysis

Solvency
• Current Ratio =Current AssetsCurrent Liabilities=\dfrac{\text{Current Assets}}{\text{Current Liabilities}}
• Debt-to-Equity =Total DebtOwners’ Equity=\dfrac{\text{Total Debt}}{\text{Owners' Equity}} (leverage)

Profitability
• Return on Equity =Net IncomeTotal OE=\dfrac{\text{Net Income}}{\text{Total OE}}
• Return on Sales =Net IncomeSales Revenue=\dfrac{\text{Net Income}}{\text{Sales Revenue}}
• Earnings per Share =Net IncomeCommon Shares Out.=\dfrac{\text{Net Income}}{\text{Common Shares Out.}}

Activity
• Inventory Turnover =Cost of Goods SoldAverage Inventory=\dfrac{\text{Cost of Goods Sold}}{\text{Average Inventory}}

Ethics in Accounting

  • Integrity underpins public trust, capital markets, & usefulness of all accounting information

Emerging Competencies for Accountants

  • Strategic thinking & critical problem solving

  • Communication, interpersonal & leadership skills

  • Customer orientation

  • Integration of diverse data for insight

  • Proficiency with information technology