CHAPTER

1:
Business
Decisions
and
Financial
Accounting

Prepared by Debra Lee-Hue, CPA, CMA

© 2021 MCGRAW HILL
 YOUR
LEARNIN LO1-1 Describe various organizational forms
G and business decision makers.

OBJECTI LO1-2 Describe the purpose, structure, and

VES content of the four basic financial statements.

LO1-3 Explain how financial statements are

used by decision makers.

LO1-4 Describe factors that contribute to

useful financial information.

LO1-S1 Describe examples of how accounting

helps in pursuing other business careers.

© 2021 MCGRAW HILL 2

UNDERSTA There are three primary ways in which businesses
ND THE can be organized:

BUSINESS 1. Sole Proprietorship: A form of business

owned by one individual where all profits (or
losses) become a part of the taxable income of
the owner who is personally liable for all debts
of the business.
2. Partnership: A form of business where the
profits, taxes, and legal liability are the
responsibility of two or more owners instead of
just one.
3. Corporation: A form of business that is a
separate entity from both a legal and
accounting perspective. This means that the
corporation, not its owners, is legally responsible for
its own taxes and debts.

The only other form of business ownership is called

a limited liability partnership (LLP) where partners
have limited liability.

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 The
EXHIBIT 1.1
The Accounting System Reports Information for Decision
Makers

Accounting
System
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. 

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4
Accounting
for Business ◦ Managerial accounting reports are used
Decisions 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.

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 THE
ACCOUNTI
NG
METHODS Resources Owned . . . = Resources Owed . . .

by the company to creditors to shareholders

Assets = Liabilities + Shareholders’ Equity

The relationship between assets (A), liabilities (L), and shareholders’

equity (SE) is known as the basic accounting equation.

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Elements of ◦ An asset is an economic resource presently controlled
the basic by the company; it has measurable value and is
expected to benefit the company by producing cash
accounting inflows or reducing cash outflows in the future.

equation ◦ Liabilities are measurable amounts that the company

owes to creditors.
◦ Shareholders’ equity represents the owners’ claims on
the business. As illustrated below, these claims arise for
two reasons:

1. The owners have a claim on amounts they contributed

directly to the company in exchange for its shares
(Contributed Capital).
2. The owners have a claim on amounts the company has
earned through profitable business operations (Retained
Earnings).

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 Assets, liabilities, shareholders’ equity, revenues, expenses,
Financial and dividends appear in different reports that collectively
are called financial statements. The term financial
Statements 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

Financial statements can be prepared at any time during

the year, although they are most commonly prepared
monthly, every three months (quarterly reports), and at
the end of the year (annual reports).

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 Assets, liabilities, shareholders’ equity, revenues, expenses,
Financial and dividends appear in different reports that collectively
are called financial statements. The term financial
Statements statements refers to four accounting reports, typically
prepared in the following order for IFRS:

1. Statement of Earnings (IS)

2. Statement of Changes in Equity (RE)
3. Statement of Financial Position (BS)
4. Statement of Cash Flows (same)

Financial statements can be prepared at any time during

the year, although they are most commonly prepared
monthly, every three months (quarterly reports), and at
the end of the year (annual reports).

© 2021 MCGRAW HILL 9

 The EXHIBIT 1.3
Income Statement

Income PRAIRIE PROUD

Explanation
Who: Name of the entity

Statement Income Statement (Projected)

For the Month Ended September
30, 2020
What: Title of the statement
When: Accounting period

Revenues

Sales Revenue $11,000 Revenue earned from the sale of apparel to

The body of an income customers in September
statement has three Total Revenues 11,000 Total amount earned during September
major captions— Expenses
Revenues, Expenses, and Supplies Expense 4,000 Cost of ink and other supplies used up in
Net Income— September

corresponding to the Salaries and Wages

Expense
2,000 Cost of salaries and employee wages for work
done in September
equation for the income Rent Expense 1,500 Cost of rent for the month of September
statement (Revenues − Utilities Expense 600 Cost of utilities used in September
Expenses = Net Income). Insurance Expense 300 Cost of insurance coverage for September

Advertising Expense 100 Cost of advertising done in September

Income Tax Expense 500 Cost of taxes on September’s income

Total Expenses 9,000 Total expenses incurred in September to

generate revenues

Net Income $ 2,000 Difference between total revenues and total

expenses

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Statement EXHIBIT 1.4

of
Statement of Retained Earnings

Retained
Earnings PRAIRIE PROUD
Statement of Retained Earnings
(Projected)
Explanation
Who: Name of the business
What: Title of the statement
For the Month Ended September 30, 2020 When: Accounting period
The statement starts
with the Retained
Earnings balance at Retained Earnings, Last period’s ending Retained
the beginning of the September 1, 2020 $      0  Earnings balance
period. Next, the
Reported on the income statement
statement adds Net Add: Net Income 2,000  (Exhibit 1.3)
Income, and
Distributions to shareholders in the
subtracts any Subtract: Dividends (1,000) current period
Dividends for the
current period, to Retained Earnings, This period’s ending Retained
$1,000
arrive at Retained September 30, 2020 Earnings balance

Earnings at the end

of the period.

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11
 EXHIBIT 1.5
Balance Balance Sheet
Sheet
PRAIRIE PROUD
Balance Sheet (Projected)
At September 30, 2020
Assets
Cash
The balance sheet is Accounts Receivable
also known as the Supplies
statement of financial Equipment
Total Assets
position. The balance Liabilities and
sheet’s purpose is to Shareholders’ Equity
Liabilities
report the amount of a Accounts Payable
business’s assets, Note Payable
liabilities, and Total Liabilities
shareholders’ equity at Shareholders’ Equity
a specific point in time. Contributed Capital
Retained Earnings
Total Shareholders’ Equity
Total Liabilities and
Shareholders’ Equity
Explanation
Who: Name of the business
What: Title of the statement
When: Point in time
Resources controlled by the company
$14,000 Amount of cash on hand and in the business’s bank account
1,000 Prairie Proud's right to collect from customers for sales
provided on account
3,000 Cost of ink and other supplies on hand
  40,000 Cost of printing press, dryer, etc.
$58,000 Total amount of the company’s resources
Claims on the company’s resources
Creditors’ claims on the company’s resources
Amount owed to suppliers for prior credit purchases (on
$  7,000 account)
  20,000 Amount of loan owed to the bank (for promissory note)
  27,000 Total claims on the resources by creditors
Shareholders’ claims on the company’s resources
30,000 Amount shareholders contributed for company shares
    1,000 Total earnings retained in the business (Exhibit 1.4)
  31,000 Total claims on the company’s resources by shareholders
$58,000 Total claims on the company’s resources
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Statement
Statement of Cash Flows
of Cash
Flows
The statement of cash flows is
divided into three types of
activities:
Operating: These cash flows
arise directly from running the
business to earn profit.
Investing: These cash flows
arise from buying and selling
productive resources with long
lives, purchasing investments,
and lending to others.
Financing: These cash flows
include borrowing from banks,
repaying bank loans, receiving
cash from shareholders for
company shares, and paying
dividends to shareholders.
EXHIBIT 1.6
Explanation
PRAIRIE PROUD
Who: Name of the entity
Statement of Cash Flows (Projected)
For the Month Ended September 30, 2020 What: Title of the statement
When: Accounting period
Cash Flows from Operating Activities directly related to earning income
Activities
Cash Received from Customers $10,000  Cash received from customers
Cash Paid to Employees and
(5,000) Cash paid to employees and suppliers of goods/services
Suppliers
Cash Provided by Operating
Activities
5,000  Cash inflows minus outflows ($10,000 − $5,000)
Cash Flows from Investing
Activities related to the sale/purchase of productive assets
Activities
Cash Used to Buy Equipment (40,000) Cash spent on equipment
Cash Used in Investing
Activities (40,000)
Cash Flows from Financing Activities involving investors and banks
Activities
Capital Contributed by
Shareholders 30,000  Cash received from owners for company shares
Cash Dividends Paid to
(1,000) Cash paid to distribute profit to owners
Shareholders
Cash Borrowed from the Bank 20,000  Cash received on loan from the bank
Cash Provided by Financing
Activities
  49,000  Cash inflows minus outflows ($30,000 − $1,000 + $20,000)
Change in Cash 14,000  Sum of three categories of cash flows ($5,000 − $40,000 + $49,000)
Beginning Cash, September 1,
2020
           0  Cash balance at the beginning of the accounting period
Ending Cash, September 30, $14,000  Cash balance reported on the balance sheet (Exhibit 1.5)
2020
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 Relationshi EXHIBIT 1.7

p Among Relationships Among the Financial Statements

the
Financial
Statements
The four basic financial
statements connect to one
another.
1. Net Income, from the income
statement, is a component in
determining ending Retained
Earnings on the statement of
retained earnings;
2. Retained Earnings from the
statement of retained earnings
is then reported on the balance
sheet; and
3. Cash on the balance sheet is
equal to the Ending Cash
reported on the statement of
cash flows.
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 The financial statements are a key source of
EVALUAT information when external users, like creditors and

E THE investors, make decisions concerning a company.

RESULTS Creditors are mainly interested in assessing

the following:
• Is the company generating enough cash
to make payments on its loan? The
statement of cash flows helps answer this
question. In particular, creditors are
interested in seeing whether operating
activities are producing positive cash flows. 
• Does the company have enough assets to
cover its liabilities? Answers to this
question will come from comparing assets
and liabilities reported on the balance sheet. 

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 E THE
Investors expect a return on their
RESULTS contributions to a company. 
• The return may be immediate (through
dividends) or long-term (through selling
Pt. 2 share certificates at a price higher than
their original cost).
• Dividends and higher share prices are more
likely if a company is profitable. As a
result, investors look closely at the income
statement (and statement of retained
earnings) for information about the
company’s ability to generate profits (and
distribute dividends).

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 Useful
Financial •The Chartered Professional Accountants of Canada
Informati (CPA Canada) has the primary responsibility for
setting the underlying rules of accounting in Canada.
on As a group, these rules are called Generally Accepted
Accounting Principles (GAAP).

•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, using guidance from the International
Accounting Standards Board (IASB).

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Accountin After much deliberation, the AcSB determined
g that one of two different sets of accounting rules
would be appropriate for use in Canada.
Principles
and Rules • Publicly accountable profit-oriented enterprises,
such as Lululemon and Shoppers Drug Mart, must
follow the principles and rules set out in the
International Financial Reporting Standards (IFRS).

• In contrast, 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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 Financial
Reporting
Standards
in Canada

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 Key
Concepts for
External
Financial
Reporting

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 Ethics refers to the standards of conduct for judging right
Ethical from wrong, honest from dishonest, and fair from unfair.
Intentional financial misreporting is both unethical and
Conduct illegal.
CPA 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.

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Supplemen
t 1A
Exhibit 1S.1 provides
samples of non-
accounting jobs that
could be available to
you at the world’s
leading companies and
explains how
accounting knowledge
can be vital to these
positions. 

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22
 ◦ There are various organizations forms: sole
Chapter 1 proprietorship, partnership and corporation.

Summary ◦ There are various business decision makers: creditors,

investors, customers, government and other external users.

◦ There are four basic financial statements: income

statement, statement of retained earnings, balance sheet
and statement of cash flows.

◦ Financial statements are used by decision makers to assess

credit worthiness and a company’s ability to generate
profits and distribute dividends.

◦ Companies general useful financial information by

applying GAAP and using either IFRS or ASPE,
depending on the type of enterprise involved.

◦ Accounting knowledge can be vital to finding non-

accounting jobs with the world’s leading companies.

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