CHAPTER

1
Business
Decisions and
Financial
Accounting

Prepared by Shannon Butler, CPA, CA, Carleton University

© 2018 McGraw-Hill Ryerson Limited 1

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Course Overview(Part 1)
 Ultimate goal is to understand and use the Financial
Statements (F/S) of an organization:
 1st pass: start with broad overview
 Introduce the 4 basic F/S and the goals and uses of of
financial reporting
 Week 1

 2nd pass: look at each of the 4 F/S in more detail

 Weeks 2 to 6

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Accounting for Business

Decisions
• Accounting is a system of analyzing, recording and
summarizing the results of a business’s activities and then
reporting the results to decision makers.

• The main goal of an accounting system is to capture

information about the operating, investing, and financing
activities of a company so that it can be reported to decision
makers, both inside and outside the business.

© 2018 MGraw-Hill Ryerson Limited 3

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Chapter 1 Overview
• Objective -> to understand and explain the:
1. Elements of each Financial Statement;
2. Information conveyed in each Financial Statement;
3. Time period of Financial Statements;
4. Relationships among the Financial Statements; and
5. Reason why each element is important for decision
making (managers, owners, creditors).

4
 Understanding the Business
Users of the F/S 1. Investors (external)
( Financial statement):
2. Creditors (external)
3. Managers (internal)

The
Business
Operations

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 1. Investors
• Individuals and groups who provide capital to a business.

• They own shares of the business  shareholders

• Investors/shareholders look for two sources of possible gain:

Sell
Receive a
ownership
portion of the
interest in the
company’s
future for more
earnings in cash
than they
(dividends).
paid.

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 2. Creditors
Creditors provide the company with resources but do not own a
share of the company.

→ Ex. a bank lends funds to the company that must be

repaid in the future along with interest.

Loan
Company ABC

Interest
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3. Management
Marketing managers and credit managers use
customers’ financial statements to decide
whether to extend credit.

Purchasing managers use suppliers’ financial

statements to decide whether suppliers have
the resources to meet the demand for
products.

Employees’ union and human resource

managers use the company’s financial
statements as a basis for contract negotiations
over pay rates.
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Understanding Business Operations
Manufacturing

Manufacturer Product Customer

Retail Service

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Understanding the Business

10
 Types of Activities
• Operating Activities - A company’s core business activities that
generate income.
• Financing Activities - When a company exchanges money with its
lenders and owners.

• Investing Activities - When a company buys or sells property/

equipment.

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 Objective of Accounting

To identify and measure the activities of a

business entity in order to
• Evaluate its performance and assess its
financial health, and
• Communicate the results to stakeholders.

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Accounting for Business

Decisions
• Managerial accounting reports are used inside the
company. They include detailed financial plans and reports
about the operating performance of the organization.

• Financial accounting reports are used outside the company

by creditors, investors, directors and government. These
reports are the financial statements.

© 2018 McGraw-Hill Ryerson Limited 13

 The Accounting System

Managers
(internal
decision
Reports makers)
Collects and
information
processes
to decision
financial information
makers Investors
and
Creditors
(external
decision
makers)
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 The Accounting System
Accounting System

Financial Accounting Reports Managerial Accounting Reports

Periodic financial statements and Detailed plans and continuous
related disclosures performance reports

External Decision Makers Internal Decision Makers

Investors, creditors, Managers throughout the
suppliers, customers, etc. organization

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Financial Statements
The term financial statements refers to four accounting reports,
typically prepared in the following order:

1. Income Statement
2. Statement of Retained Earnings
3. Balance Sheet
4. Statement of Cash Flows

© 2018 McGraw-Hill Ryerson Limited 16

 The Statement of Financial
Position (Balance Sheet)
Elements

Assets
Economic resources controlled by the entity as a result
of past business events from which future economic
benefits may be obtained.

Liabilities
Debts or legal obligations of the entity that result from
past business events.

Shareholders’ Equity
Amount of financing provided by owners of the
corporation and from earnings over time.

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 Statement of Financial
Position
The Accounting Equation:

A = L + SE
(Assets) (Liabilities) (Shareholders’ Equity)

Economic Sources of Financing Economic

Resources Resources:
1. Liabilities  Financing provided by creditors
2. SE Financing provided by Shareholders

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Balance Sheet
The Balance Sheet reports the
amount of assets, liabilities, and
shareholders’ equity of a business
at a point in time.
Assets =
Liabilities + Shareholders’ Equity

© 2018 McGraw-Hill Ryerson Limited 19

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Income Statement
Revenue
• The amount earned by selling goods or services to customers.
• E.g. Interest revenue, rent

Expenses
• The costs of doing business that are necessary to earn revenue.
• E.g. rent, advertisement

Net Income
• Revenue - expenses= net income
• By generating net income, a company increases its shareholders’ equity.

© 2018 McGraw-Hill Ryerson Limited 20

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Statement of Retained
Earnings
Dividends
• The distribution of a company’s earnings to its shareholders as a return
on their investment.
• Dividends are not an expense.

Retained Earnings
• Increase with Net Income (profit generated)
• Decrease with Dividends (profit distributed)

© 2018 McGraw-Hill Ryerson Limited 21

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Income Statement

The Income Statement reports the amount of revenues less

expenses for a period of time.

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 Income Statement - Revenues
Revenues  earnings from the sale of goods or services.

Revenue is recognized in the period in which

goods and services are delivered, not necessarily
the period in which cash is received.

When will the revenue from this transaction be recognized?

$1,000 sale made Cash from sale

on May 25. collected on June 10.

May 2018 June 2018

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 Income Statement - Expenses
Expenses  amount of resources used up by the entity
to earn revenues during a period.

An expense is recognized in the period in which

goods and services are used, not necessarily
the period in which cash is paid.

When will the expense for this transaction be recognized?

Paid $75 cash on May 11 Ad appears

for newspaper ad. on June 8.

May 2015 June 2015

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 Income Statement – Net
Earnings
Net Earnings  Excess of total revenues over total
expenses incurred during the period.

NOTE: Net income/net loss for the period.

 If revenues > expenses  net income

 If revenues < expenses  net loss (loss) brackets mean

negative

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 Income Statement
Typical Account Titles

Revenues Expenses
Sales Revenue Cost of Sales
Fee Revenue Wages Expense
Interest Revenue Rent Expense
Rent Revenue Interest Expense
Depreciation Expense
Advertising Expense
Insurance Expense
Repair Expense
Income Tax Expense

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Statement of Retained
Earnings

The Statement of Retained Earnings reports the way that net

income and the distribution of dividends affected the financial
position of the company during a period of time.

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 Statement of Changes in
Equity
Shows how the income of the period affects shareholders’ equity
 Links Income Statement to Balance Sheet

Shareholders’ equity (SE) is the shareholders’ residual interest:

A - L = SE
Contributed Capital Retained Earnings

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Statement of Cash Flows

The Statement of Cash Flows
reports the operating,
investing, and financing
activities that caused
increases and decreases in
cash during a period of time.

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Statement of Cash Flows

The Statement of Cash Flows is divided into three types of
activities:

• Operating activities are directly related to running the business.

• Investing activities involve buying and selling productive resources with

long lives, purchasing investments, and lending to others.

• Financing activities involve borrowing from banks, repaying bank loans,

receiving contributions from shareholders or paying dividends.

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Statement of Cash Flows
Because . . . and expenses
revenues reported reported do not
do not always equal always equal
cash collected. . . cash paid . . .

Net earnings are

usually not equal
to the change
in cash for
the period.

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Relationships Between
Financial Statements
1. Net Income, from the income statement, is a component in
determining ending Retained Earnings on the statement of
retained earnings.

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Relationships Between
Financial Statements
2. Ending Retained Earnings from the statement of retained
earnings is then reported on the balance sheet.

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Relationships Between
Financial Statements
3. The Cash on the balance sheet is equal to the ending Cash
reported on the statement of cash flows.

© 2018 McGraw-Hill Ryerson Limited 34

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Summary of Four Basic

Financial Statements

© 2018 McGraw-Hill Ryerson Limited 35

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Useful Financial
Information
Generally Accepted Accounting Principles (GAAP)

• Chartered Professional Accountants of Canada (CPA Canada) has the

primary responsibility for setting the underlying rules of accounting in
Canada.

• The Accounting Standards Board (AcSB) is an independent body supported

by CPA Canada to develop and establish the standards and guidelines that
govern financial accounting and reporting in Canada.

© 2018 McGraw-Hill Ryerson Limited 36

Generally Accepted Accounting
Principles

Companies incur the cost of preparing

the financial statements and bear the
following economic consequences . . .

 Effects on the selling price of shares.

 Effects on the amount of bonuses
received by managers and other employees.
 Loss of competitive information to other
companies.

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Useful Financial
Information
There are two different sets of accounting rules in Canada:
• Worldwide: Publicly accountable profit-oriented enterprises must follow
International Financial Reporting Standards (IFRS).

• Canada: Private enterprises whose shares are not traded on a public

stock exchange can choose to follow either IFRS or Canadian Accounting
Standards for Private Enterprises (ASPE).

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Useful Financial
Information
The objective of external financial reporting is to provide useful
financial information to external users for decision making.

• It must be relevant and a faithful representation of the business.

• The usefulness of financial information is enhanced when it is: timely,

verifiable, comparable, and understandable.

© 2018 McGraw-Hill Ryerson Limited 39

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Useful Financial
Information

© 2018 McGraw-Hill Ryerson Limited 40

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Key Concepts for External

Financial Reporting

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Ethical Conduct
Ethics refers to the standards of conduct for judging right
from wrong, honest from dishonest, and fair from unfair.
CPA of Canada requires that all its members adhere to a Code
of Professional Conduct.
When faced with an ethical dilemma, a three-step process
should be followed:

1. Identify who will be affected by the situation.

2. Identify the alternative courses of action.
3. Choose the alternative that is the most ethical.

© 2018 McGraw-Hill Ryerson Limited 42

Responsibilities for the Accounting
Communication Process
Effective communication means that
the recipient understands what the
sender intends to convey.

Decision makers need to understand

accounting measurement rules.

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 Test Your Knowledge
Case Total Total Net Total Total S/H’s
Revenues Expenses Income Assets Liabilities Equity

A $91,700 $76,940 ___14760 $140,200 $69,000 71200__

__28,870_
B __88,980_ 74,240 14,740 107,880 79,010

C 69,260 76,430 (7170)__ 97,850 69,850 _28,000

D 58,680 36910___ 21,770 96,570 17,890 78,680

E 84,840 78,720 6120____ 105,100 25,520 79,580

Net Income = Assets = Liabilities +

Revenue - Expenses Owners’ Equity
End of Chapter Summary

This chapter focused on the key financial reports that

businesspeople rely on when evaluating a company’s
performance.

© 2018 McGraw-Hill Ryerson Limited 45