1 environment accounting and the business - pearson · each chapter. key questions are ......

1 Defineaccounting,anddescribetheusersofaccountinginformation

LEARNING OBJECTIVESKEY QUESTIONS

Accounting and the Business

Environment1

Why is accounting important, and who uses the information?

Why is it important for accountants to be ethical? 2 Explainwhyethicsandrulesofconductarecrucialinaccountingandbusiness

In what form can we set up a company? 3 Describeanddiscusstheformsofbusinessorganizations

What are the rules of accounting, and why do we need them?

How do business transactions affect the accounting records of a company?

What financial statements are prepared by a company, and how do we create them?

4 Explainthedevelopmentofaccountingstandards,anddescribetheconceptsandprinciples

5 Describeandusetheaccountingequationtoanalyzebusinesstransactions

6 Prepareandevaluatethefinancialstatements

Learning Objectivesarea“roadmap”showingwhatwillbecoveredandwhatisespeciallyimportantineachchapter.

Key Questions arequestionsabouttheimportantconceptsinthechapterexpressedineverydaylanguage.

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3

Lisa Hunter graduated from university with a degree in environmental studies. She then went to work with an environmental consulting company and gained extensive expe-rience in the area of environmental sustainability. Lisa soon came to realize that many

businesses were starting to recognize the benefits of advancing their environmental per-formance and were seeing increasing opportunities to participate in the green economy. For these companies, the financial implications of “going green” were significant.

Lisa decided to go back to university to pursue an accounting designation. Within three years, she had successfully completed all the requirements and became designated as a professional accountant.

Lisa started her own consulting firm to combine her passion for environmental sus-tainability with her recently developed accounting skills. She named her new company “Hunter Environmental Consulting.” She was now an entrepreneur! She realized she needed to develop a business plan, secure clients, set up an office, and hire staff.

Lisa’s first year in business was stressful and successful. Her work in the first year was primarily in the area of energy efficiency and how her clients could reduce their energy consumption and their energy costs.

“My previous training and experience gave me the confidence to know that I could be successful in this field. However, I did not realize how carefully you have to watch the books—costs can get out control in a hurry if you are not careful!”

Achapter-opening storyshowswhythetopicsinthechapterareimportanttorealcompaniesandbusinesspeople.Werefertothisstorythroughoutthechapter.

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4 Part 1 TheBasicStructureofAccounting

ConnECting ChAptEr 1

Defineaccounting,anddescribetheusersofaccountinginformation

Explainwhyethicsandrulesofconductarecrucialinaccountingandbusiness

Describeanddiscusstheformsofbusinessorganizations

Explainthedevelop-mentofaccountingstandards,anddescribetheconceptsandprinciples

Describeandusetheaccountingequationtoanalyzebusinesstransaction

Prepareandevalu-atethefinancialstatements

Why is accounting important, and who uses the information? page 5

Why is it important for accountants to be ethical? page 7

In what form can we set up a company? page 9

What are the rules of accounting, and why do we need them? page 11

How do business transactions affect the accounting records of a company? page 16

What financial statements are prepared by a company, and how do we create them? page 23

Accounting:TheLanguageofBusiness,page5

EthicalConsiderationsinAccountingandBusiness,page7

FormsofBusinessOrganizations,page9

AccountingConcepts,page11

TheAccountingEquation,page16

TheFinancialStatements,page23

DecisionMakers:TheUsersofAccountingInformation,page 5

OtherConsiderationsinFinancialStatementPreparation,page13

AccountingforBusinessTransactions,page 17

RelationshipsamongtheFinancialStatements,page 24

TheHistoryofAccounting,page7

EvaluatingBusinessTransactions,page22

MyAccountingLab

RelationshipsamongtheFinancialStatements

MyAccountingLab • DemoDoc:BasicTransactions • StudentPowerPointSlides • AudioChapterSummary • AvarietyofvideosonChapter1topics.

AllMyAccountingLabresourcesarefoundbyclickingonChapterResourcesandthenMultimediaLibrary.

TheSummaryforChapter1appearsonpage30.Accounting Vocabularywithdefinitionsappearsonpage33.

1 2 3 4 5 6

role does accounting play in Lisa Hunter’s situation? Lisa hadtodecidehowtoorganizehercompany.Shesetupherbusinessasapropri-etorship—a single-owner company—with herself as the owner. As her busi-ness grows, she may decide to expand it by taking on a partner. She mightalsochooseto incorporate—that is, toformacorporation. Inthischapter,wediscussallthreeformsofbusinessorganization:proprietorships,partnerships,andcorporations.

Youmayalreadyknowvariousaccounting termsandrelationships,becauseaccountingaffectspeople’sbehaviourinmanyways.Thisfirstaccountingcoursewillsharpenyour focusbyexplaininghowaccountingworks.Asyouprogressthroughthiscourse,youwillseehowaccountinghelpspeoplelikeLisaHunter—andyou—achievebusinessgoals.

What

Connecting Chapter “X”appearsatthebeginningofeachchapterandgivesaguidetothecontentofthechapterwithpagerefer-ences,aswellasreferencestoMyAccountingLabsoyoucanconnecttowhatyouneedquicklyandeasily.

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Chapter 1 AccountingandtheBusinessEnvironment 5

Accounting: the Language of Business

Accountingistheinformationsystemthatmeasuresbusinessfinancialactivities,processes that information into reports, and communicates the results to deci-sionmakers.Forthisreasonitiscalled“thelanguageofbusiness.”Thebetteryouunderstandthelanguage,thebetteryourdecisionswillbe,andthebetteryoucanmanagefinancialinformation.Itisgenerallyrecognizedthatbusinessmanagersbelieveitismoreimportantforuniversitystudentstolearnaccountingthananyotherbusinesssubject.Decisionsconcerningpersonalfinancialplanning,educa-tionexpenses,loans,carpayments,incometaxes,andinvestmentsarebasedontheinformation systemthatwecallaccounting.

Financialstatementsareakeyproductofanaccountingsystemandprovideinformation that helps people make informed business decisions. Financial statements report on a business in monetary terms. Is my business making aprofit?ShouldIhireassistants?AmIearningenoughmoneytoexpandmybusi-ness?Answeringbusinessquestionsliketheserequiresaknowledgeoffinancialstatements.

Studentssometimesmistakebookkeepingforaccounting.Bookkeepingisapro-ceduralelementofaccounting,justasarithmeticisaproceduralelementofmath-ematics (or just as skating is a procedural element of hockey). There are manyaccountingsoftwarepackagesthatwillhandledetailedbookkeeping—inhouse-holds,businesses,andorganizationsofalltypes.Exhibit1–1illustratestheroleofaccountinginbusiness.Theprocessstartsandendswithpeoplemakingdecisions.

LO 1Whyisaccountingimportant,andwhousestheinformation?

IFRS

The Accounting System: The Flow of InformationExhibit 1–1

Decision Makers: the Users of Accounting information

Decisionmakersneedinformation.Themoreimportantthedecision,thegreaterthe need for information. Virtually all businesses and most individuals keepaccountingrecordstoaiddecisionmaking.Herearesomedecisionmakerswhouseaccountinginformation.

Individuals Peopleuseaccounting information inday-to-dayaffairs tomanagebankaccounts,evaluate jobprospects,make investments,andevenindecidingwhethertoleaseorbuyanewcar.

Businesses Business owners and managers use accounting information to setgoalsfortheirorganizations.Theyevaluatetheirprogresstowardthosegoals,and

BoldfacedwordsarenewtermsthatareexplainedhereanddefinedintheAccountingVocabularysectionatthe endofthischapterandtheGlossaryattheendofthebook.

LearningObjectivesinthemarginsignalthebeginningofthesectionthatcoversthelearning-objectivetopic.LookfortheLearningObjectivewhenyouwanttoreviewthistopic.

Exhibitssummarizekeyideasinavisualway.

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theytakecorrectiveactionwhenitisnecessary.Forexample,LisaHuntermakesdecisionsbasedonaccountinginformation.Sheknowstheamountofrevenuethatwillbeearned,sincesheandherclientwillagreeonafeefortheconsultingworkshewillperform.Sheneedstodeterminethescopeofthework,howmanyconsul-tantsshewillrequire,andhowmanyhoursitwilltaketocompletetheproject.Sheneedstomakesurethathercostsdonotexceedthefeeshewillreceivefromherclientifshewantstomakesurethatshemaintainsaprofitablebusiness.

Investors Outsideinvestorsoftenprovidethemoneyabusinessneedstobeginoperations.Todecidewhether to invest,potential investorspredict theamountofincometobeearnedontheirinvestment.Thisevaluationmeansanalyzingthefinancial statements of the business and keeping up with developments in theworldofbusiness.

Creditors Beforelendingmoney,creditors(lenders)suchasbanksevaluatetheborrower’sabilitytomakescheduledpayments.Thisevaluationincludesareportoftheborrower’sfinancialpositionandapredictionoffutureoperations,bothofwhicharebasedonaccountinginformation.

Government Regulatory Agencies Mostorganizationsfacegovernmentregulation.Forexample,theprovincialsecuritiescommissions,suchastheBritishColumbiaSecuritiesCommissionandtheOntarioSecuritiesCommission,dictatethatbusi-nessessellingtheirsharestoandborrowingmoneyfromthepublicdisclosecer-tainfinancialinformationtotheinvestingpublic.

Taxing Authorities Provincial and federal governments levy taxes on individu-alsandbusinesses.Incometaxiscalculatedbyusingaccountinginformationasastartingpoint.Abusiness’saccountingsystemisrequiredtokeeptrackofpro-vincialsalestax,goodsandservicestax,andharmonizedsalestaxthatacompanycollectsfromitscustomersandpaystoitssuppliers.Businessesusetheseaccount-ingrecordstohelpthemdeterminetheirtaxesthatmustbepaidtotheprovincialandfederalgovernments.

Not-for-profit Organizations Not-for-profitorganizationssuchaschurches,hospi-tals,governmentagencies,universities,andcolleges,whichoperateforpurposesotherthantoearnaprofit,useaccountinginformationtomakedecisionsrelatedtotheorganizationinmuchthesamewaythatprofit-orientedbusinessesdo.

Other Users Employeesandlabourunionsmaymakewagedemandsbasedontheaccountinginformationthatshowstheiremployer’sreportedincome.Consumergroupsandthegeneralpublicarealso interested in theamountof incomethatbusinessesearn.Andnewspapersmayreport“animprovedprofitpicture’’ofamajor company as it emerges from economic difficulties. Such news, based onaccountinginformation,relatestothecompany’shealth.

Financial Accounting and Management AccountingUsersofaccountinginformationareadiversepopulation,buttheymaybegroupedasexternalusersorinternalusers.Thisdistinctionallowsustoclassifyaccountingintotwofields—financialaccountingandmanagementaccounting.

Financial accounting provides information to people outside the company.Creditors and outside investors, for example, are not part of the day-to-daymanagement of the company. Likewise, government agencies and the generalpublicareexternalusersofacompany’saccountinginformation.Thisbookdealsprimarilywithfinancialaccounting.

Management accountinggenerates informationfor internaldecisionmakers,such as company executives, department heads, university deans, and hospitaladministrators.

Exhibit1–2showshowfinancialaccountingandmanagementaccountingareusedbyHunterEnvironmentalConsulting’sinternalandexternaldecisionmakers.

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the history and Development of Accounting

Accountinghasalonghistory.Somescholarsclaimthatwritingaroseinordertorecordaccountinginformation.Accountingrecordsdatebacktotheancientcivi-lizationsofChina,Babylonia,Greece,andEgypt.Therulersofthesecivilizationsusedaccountingtokeeptrackofthecostoflabourandmaterialsusedinbuildingstructureslikethegreatpyramids.Theneedforaccountinghasexistedaslongastherehasbeenbusinessactivity.

Accountingdevelopedfurtherasaresultoftheinformationneedsofmerchantsinthecity-statesofItalyduringthe1400s. Inthatbusycommercialclimate, themonkLucaPacioli,amathematicianandfriendofLeonardodaVinci’s,publishedthefirstknowndescriptionofdouble-entrybookkeepingin1494.

IntheIndustrialRevolutionofthe19thcentury,thegrowthofcorporationsspurredthe development of accounting. The corporation owners—the shareholders—were no longer necessarily the managers of their business. Managers had tocreateaccountingsystemstoreporttotheownersandgovernmenthowwelltheirbusinessesweredoing.Becausemanagerswanttheirperformancetolookgood,societyneedsawaytoensurethatthebusinessinformationprovidedisreliable.To meet this need, generally accepted accounting principles were developed.Thesewillbediscussedinmoredetailshortly.

Asrequiredinothersegmentsofsociety,accountingmustbepractisedinanethicalmanner.Welooknextattheethicaldimensionofaccounting.

How Financial Accounting and Management Accounting Are UsedExhibit 1–2

HunterEnvironmental

Consultingproprietorship

Hunter’s company lostmoney on its firstconsulting project.Management accountinginformation would be used to help Hunterdetermine costs and theamount she should charge for a consulting project.

A bank manager would use financial accounting informationto decide whether to lend money to Hunter’scompany to expand the business.

Just Checking questionsappearattheendofeachLearningObjective,allowingyoutotestyourmasteryoftheconceptsinthisLearningObjectivebeforemovingontothenextone.ThesolutionsappearattheendofthechapterandonMyAccountingLab.

Ethical Considerations in Accounting and Business

Ethical considerations affect all areas of accounting and business. Investors,creditors,andregulatorybodiesneedrelevantandreliable informationaboutacompany.Naturally,companieswant tomake themselves lookasgoodaspos-sibletoattractinvestors,sothereisapotentialforconflict.Anauditisafinancial

LO 2Whyisitimportantforaccountantstobeethical?

IFRS

1. Whatisaccounting?

2. Namethreedecisionmakersthatrelyonfinancialinformation,andbrieflydescribehowtheyuseit.

3. Whatisthedifferencebetweenfinancialaccountingandmanagementaccounting?

Just Checking Solutions appear at the end of this chapter and on MyAccountingLab.

JUST CHECKING MyAccountingLab

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examination.Auditsareconductedbyindependentaccountantswhoexpressanopinion on whether or not the financial statements fairly reflect the economiceventsthatoccurredduringtheaccountingperiod.Itisvitalthatcompaniesandtheirauditorsbehaveinanethicalmanner.Exhibit1–3illustratestherelationshipamong accounting and business entities that are public companies (companiesthatsellsharesofstocktoinvestors).

Relationship among Accounting and Business EntitiesExhibit 1–3

Provincial securities commissionsoversee operations of public companies

Decision makersinclude investors,creditors, andregulatoryorganizations

Public companiessell shares toinvestors, borrowmoney, and issuefinancial reports

Independentaccounting firmsperform audit,compliance, andadvisory services

Unfortunatelyfortheaccountingprofession,accountingscandalsinvolvingbothpubliccompaniesandtheirauditorshavemadetheheadlinesoverthepastfifteenyears.Attheturnofthiscentury,EnronCorporation,whichwastheseventh-largestcompanyintheUnitedStates, issuedmisleadingfinancialstatements.Enronwasforcedintobankruptcyanditsauditors’actionswerequestioned.TheimpactoftheEnronbankruptcywasfeltbymanydifferentparties,includingEnronshareholders,whosawtheirinvestmentsbecomeworthless;employeeswholosttheir jobsandtheirpensions;andtheaccountingprofession,whichlostsomeofitsintegrityandreputation as gatekeepers and stewards for the investing public. This situationshockedthebusinesscommunityandcausedinvestorstoquestionthereliabilityoffinancialinformation.

Sincethefinancialhealthofacompanyisimportanttomanydifferentgroupsofusers,theseusersmustbeconfidentthattheycanrelyonthefinancialinformationtheyaregivenwhentheyaremakingdecisions.Toincreaseusers’confidence,theaccountingprofessionandother interestedstakeholdergroupsmade importantchangesoverthepastdecadetoimprovethequalityofthefinancialinformationprovided.Wewilldescribethesechangeslaterinthischapter.

The Professional Accounting Bodies and Their Standards of Professional ConductThe members of the four accounting organizations in Canada—CharteredAccountants (CAs), Certified General Accountants (CGAs), Certified Manage-mentAccountants(CMAs)andCharteredProfessionalAccountants(CPAs)—areallgovernedbyrulesofprofessionalconductcreatedbytheirrespectiveorganiza-tions.Manyoftherulesapplywhetherthemembersarepublicaccountantswork-inginpublicpracticeorprivateaccountantsworkinginindustryorgovernment.Theserulesconcerntheconfidentialityofinformationtheaccountantisprivyto,maintenanceofthereputationoftheprofession,theneedtoperformaccountancyworkwithintegrityandduecare,competence,refusaltobeassociatedwithfalseormisleadinginformation,andcompliancebytheaccountantwithprofessionalstandards.Other rulesareapplicableonly to thosemembers inpublicpractice,anddealwiththingsliketheneedforindependence,andhowtoadvertise,seekclients,andconductapractice.

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The rulesofprofessional conduct serveboth themembersof theaccountingbodies and the public. The rules serve members by setting standards that theymustmeet,andprovidingabenchmarkagainstwhichtheywillbemeasuredbytheirpeers.Thepublicisservedbecausetherulesofprofessionalconductprovideitwithalistofthestandardstowhichthemembersofthebodyadhere.Thishelpsthepublicdetermineitsexpectationsofmembers’behaviour.However,therulesofprofessionalconductshouldbeconsideredaminimumstandardofperformance;ideally,themembersshouldcontinuallystrivetoexceedthem.

Throughoutthisbook,weprovideseveralproblemsthatallowyoutoconsiderethicaldilemmas.Considerthemcarefully.Theperceptionthataccountantsfollowthehigheststandardofprofessionalconductmustalsobethereality.Intoday’sbusinessclimate,behavinginanethicalmanneriscrucial.

Codes of Business Conduct of CompaniesMany companies have codes of conduct that apply to their employees in theirdealingswitheachotherandwiththecompanies’suppliersandcustomers.Someofthesecompaniesmentiontheircodeintheirannualreportorontheirwebsite.Forexample,VancouverCitySavingsCreditUnionstatesonitswebsite:

Our Values

Integrity: Weactwithcourage,consistencyandrespecttodowhatishonest,fairandtrustworthy.Innovation: Weanticipateandrespondtochallengesandchangingneedswithcreativity,enthusiasmanddetermination.Responsibility: We are accountable to our members, employees, colleaguesandcommunitiesfortheresultsofourdecisionsandactions.

Source: From Vancouver City Savings Credit Union’s website, www.vancity.com (accessed May25,2012)

Thecompanyindicatestoitsemployeesandtothegeneralpublichowmanage-mentexpectsemployeestobehave.

4. What isanaudit,andwhyis it important that itbeperformedby independentaccountants?

5. Whydotheprofessionalaccountingbodiesestablishrulesofprofessionalconductfortheirmembers?

6. Refer to theStudentPolicies,Bylaws,andCodesofConductofyourcollegeoruniversity.Whydothesepoliciesexist?


JUST CHECKING

Forms of Business organizations

Abusinesscanbeorganizedasa

• Proprietorship• Partnership• Corporation

Youshouldunderstandthedifferencesamongthethree.

Proprietorship Aproprietorshiphasasingleowner,calledtheproprietor,whooftenmanagesthebusiness.Proprietorshipstendtobesmallretailstores,res-taurants,andservicebusinesses,butalsocanbeverylarge.Fromanaccounting

LO 3Inwhatformcanwesetupacompany?

IFRS

MyAccountingLab

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viewpoint,eachproprietorshipisdistinctfromitsowner.Thus,theaccountingrecordsoftheproprietorshipdonotincludetheproprietor’spersonalaccount-ingrecords.However,fromalegalperspective,thebusinessistheproprietor,so if thebusiness cannotpay itsdebts, lenders can take theproprietor’sper-sonalassets(cashandbelongings)topaytheproprietorship’sdebt.Inthisbook,westartwithaproprietorshipbecausemanystudentsorganizetheirfirstbusi-nessthatway.

Partnership A partnership joins two or more individuals together asco-owners.Eachownerisapartner.Manyretailstoresandprofessionalorga-nizations of physicians, lawyers, and accountants are partnerships. Mostpartnershipsaresmallandmedium-sized,butsomearequite large; therearepublicaccountingfirmsandlawfirmsinCanadawithseveralhundredpartners.Accountingtreatsthepartnershipasaseparateorganizationdistinctfromthepersonalaffairsofeachpartner.Butagain,fromalegalperspective,apartner-shipisthepartnersinamannersimilartoaproprietorship.Ifthepartnershipcannotpayitsdebts,lenderscantakeeachpartner’spersonalassetstopaythepartnership’sdebts.

Corporation A corporation is a business owned by shareholders. These arethe peopleorothercorporationswhoownsharesofownershipinthebusiness.The corporation is the dominant form of business organization in Canada.Althoughproprietorshipsandpartnershipsaremorenumerous,corporationsengageinmorebusinessandaregenerallylargerintermsoftotalassets,income,andnumberofemployees.InCanada,generally,corporationsmusthaveLtd.orLimited, Inc.orIncorporated,orCorp.orCorporationintheirlegalnameto indi-catethattheyareincorporated.Corporationsneednotbelarge;abusinesswithonlyafewassetsandemployeescouldbeorganizedasacorporation.

Fromalegalperspective,acorporationisformedwhenthefederalgovernmentoraprovincialgovernmentapprovesitsarticlesofincorporation.Unlikeapropri-etorshiporapartnership,onceacorporationisformed,itisalegalentityseparateanddistinct from itsowners.Thecorporationoperatesasan“artificialperson”thatexistsapartfromitsownersandthatconductsbusinessinitsownname.Thecorporationhasmanyoftherightsthatapersonhas.Forexample,acorporationmaybuy,own,andsellproperty.Thecorporationmayenterintocontractsandsueandbesued.

Since corporations are entities separate from their owners, they willprepare financial reports separate from their owners. Over the years, theaccounting profession has developed accounting and reporting standardsthatcorporationsmustfollowwhenpreparingtheirfinancialreports.Wewillexaminethemingreaterdetailinthenextsectionofthischapter.Corporationsdiffer significantly from proprietorships and partnerships in another way.If a proprietorship or partnership cannot pay its debts, lenders can take theowners’personalassetstosatisfythebusiness’sobligations.Butifacorporationgoesbankrupt,lenderscannottakethepersonalassetsoftheshareholders.Thislimited personal liability of shareholders for corporatedebts explainswhycor-porationsaresopopularcomparedtoproprietorshipsandpartnerships,whichhaveunlimited personal liability.Exhibit1–4showstheformationandownershipofacorporation.

Another factor for corporations is the division of ownership into individualshares.CompaniessuchasWestJet,CanadianImperialBankofCommerce,andCanadianTireCorporation,Limited,haveissuedmillionsofsharesofstockandhave tensof thousandsof shareholders.An investorwithnopersonal relation-shipeithertothecorporationortoanyothershareholdercanbecomeanownerbybuying30,100,5,000,oranynumberofsharesofitsstock.Formostcorpora-tions,theinvestormaysellthesharesatanytime.Itisusuallyhardertosellone’sinvestmentinaproprietorshiporapartnershipthantosellone’sinvestmentinacorporation.

Aproprietorshipandapartnership(Ch.12)arenotlegalentitiesseparatefromtheirowners,sotheincomefromproprietorshipsandpartnershipsistaxabletotheirowners,nottothebusiness.Butinaccounting,theownerandthebusinessareconsideredseparateentities,andseparaterecordsarekeptforeach.Acorporation(Ch.13)isaseparatelegalentity.Thecorporationistaxedonitsincome,andtheownersaretaxedonanyincometheyreceivefromthecorporation.

KEY POINTS

Key Pointshighlightimportantdetailsfromthetextandaregoodtoolsforreviewingconcepts.

Exhibit 1–4

Federal or provincialgovernment approves Articles of Incorporation

Shareholders invest incorporations

Corporations Examples includeWestJet Airlines Ltd.Canadian Western BankSun-Rype Products Ltd.

The Formation and Ownership of a Corporation

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Limited-Liability Partnership (LLP) Alimited-liability partnership (LLP)isapart-nershipinwhichonepartnercannotcreatealargeliabilityfortheotherpartners.Eachpartnerisliableonlyforhisorherownactionsandthoseactionsunderhisorhercontrol.

Exhibit1–5summarizesthedifferencesbetweenproprietorships,partnerships,andcorporations.

Accountingforcorporationsincludessomeuniquecomplexities.Forthisrea-son,weinitially focusonproprietorships.Wecoverpartnerships inChapter12andbeginourdiscussionofcorporationsinChapter13.

7. Howdoesapartnershipdifferfromaproprietorship?

8. Howdoesacorporationdifferfromeitheraproprietorshiporapartnership?

9. Listtwoadvantagesofthecorporateformofbusinessoveraproprietorship.


JUST CHECKING

Exhibit 1–5 Comparison of the Three Forms of Business Organization

Proprietorship Partnership Corporation

1. Owner(s) Proprietor—oneowner Partners—twoormoreowners

Shareholders—generallymanyowners

2. Lifeoforganization Limitedbyowner’schoiceordeath

Limitedbyowners’choicesordeathofoneofthepartners

Indefinite

3. Personalliabilityofowner(s)forbusinessdebts

Proprietorispersonallyliable

Partnersarepersonallyliable*

Shareholdersarenotperson-allyliable

4. Legalstatus Theproprietorshipistheproprietor

Thepartnershipisthepartners*

Thecorporationissepa-ratefromtheshareholders(owners)

*Unlessitisalimited-liabilitypartnership(LLP)

Accounting Concepts

Earlier in this chapter,wediscussed the importanceof financial information tovarioususergroups.Usersmustbeconfidentthattheycanrelyonthefinancialinformationtheyaregivenwhentheyaremakingdecisions.Toincreaseusers’con-fidence,accountingpracticesneedtofollowcertainguidelines.Therulesthatgov-ernhowaccountantsmeasure,process, andcommunicate financial informationareknownasgenerally accepted accounting principles,orGAAP.Accountingprinciplesdrawtheirauthorityfromtheiracceptanceinthebusinesscommunity.Theyaregenerallyacceptedbythosepeopleandorganizationswhoneedguide-linesinaccountingfortheirfinancialundertakings.

For thepasteightyyears, individualcountriesdetermined theirownGAAP.Theirgoalwastoprovideaccountingstandardsthatcouldbeusedbycompaniesintheircountriestoproducereliable,comparablefinancialstatements.Duringthisperiodoftime,mostcompaniesdidnotcompeteinaninternationaleconomyandmostofacompany’sshareholderswereresidentsofthecountrywherethecom-panywasheadquartered.

Inthepasttwenty-fiveyears,thecircumstancesunderwhichcompaniescom-peteforbusiness,andwheretheirshareholdersandcreditorsresidehavechanged.

LO 4Whataretherulesofaccounting,andwhydowe needthem?

IFRS

MyAccountingLab

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Manymorebusinesseseitherpurchaseorsell inmarketsoutside theircountry,andshareholdersofcompaniescanresideanywhereintheworld.Theadventoftechnologyhasgreatlyaidedthisexpansion.

Untilrecently,however,GAAPhadnotkeptupwiththechangesinthewaycompaniesdobusiness.Accountingstandardswerestillnational.Itmeantinves-torsandcreditorswhohadbusinessdealingsindifferentareasoftheworldhadtounderstandvariousaccountingstandards.Althoughmanyofthestandardsweresimilaramongcountries,therewerealsomanysignificantdifferences.Forexam-ple,aCanadiancompanythatsolditssharesonastockexchangeintheUnitedStates actually had to prepare one set of financial statements under CanadianGAAPandanotherunderUnitedStatesGAAPor,atleast,provideareconciliationfromonetotheother.Thisduplicationwasinefficientandcostly.

Given the likelihood that companies would continue to expand globally, agroupofcountriesstartedtoworktogetheronaccountingstandardswithagoalofdevelopinginternationalaccountingstandardsthatcouldbeappliedanywherein the world. This group formed the International Federation of Accountantsand developed International Financial Reporting Standards, or IFRS, as wemorecommonlyrefertothem.Thesestandardshavenowbeenacceptedbyover110 countriesintheworld.Canadaadoptedthesestandardsin2011forcompaniesthatqualifyaspubliclyaccountableenterprises.

Publicly accountable enterprises, generally speaking, are companies thatarepubliclytradedorforwhichastrongpublicinterestexists.InCanada,pub-licly accountable enterprises are small in number but contribute heavily to oureconomy.

TheIFRSstandardsaremuchmorecomplexthanmanyCanadianbusinessesrequire in preparing their financial statements. Most Canadian businesses aresmalltomediuminsizeandareprivatelyowned.Themostsignificantusersoftheirfinancialinformationaretheircreditors(likelytheirbank)andthegovern-ment(forcomputingincometaxesandsalestaxes).Consequently,asecondsetofaccountingstandards,Accounting Standards for Private Enterprises,orASPE,wasdevelopedforthesetypesofbusinesses.

TheprimaryreasonforthedevelopmentofASPEisusers’accesstoacompa-ny’sfinancialinformation.Forsmaller,privatebusinesses,whethertheyarepro-prietorships,partnerships,orcorporations,thevarioususergroupsthatinteractwiththecompanytypicallyhavebetteraccesstotheownersandmanagersofthecompany.Therefore,theusersdonotneedasmuchinformationfromthefinancialstatements,whichmakesrecordkeepingandfinancial-statementproductionlesscostlyforprivatecompanies.Ifabankerhasaquestionaboutaprivatecompany’spurchasesofequipment,thebankercanasktheownerdirectly.However,manyoftheusergroupswhoneedfinancialinformationaboutlarger,publiclytradedcompaniesdonothavethesameaccesstothemanagersand,therefore,needmoreinformationinthefinancialstatements.FinancialstatementspreparedusingIFRSprovidethisadditionalinformation.ThefocusofthistextbookwillbeASPE,withIFRSmaterialappearingasthefinalLearningObjectiveineachchapter.

ItisimportanttorememberthatpubliclyaccountableenterprisesmustfollowIFRS.Otherfor-profitenterprisescanfolloweitherASPEorcanchoosetofollowIFRS.Forexample,acompanyplanningtotradeitssharesonastockexchangeinthefuturemightchoosetofollowIFRSearlierforasmoothtransition.

Both IFRS and ASPE are prepared under the authority of the AccountingStandardsBoardandarepublishedaspartoftheCanadianInstituteofCharteredAccountants(CICA)Handbook.Thesestandardsareverydetailedandcomplete,andasyoubecomemoreknowledgeableinaccounting,youwillneedtobecomefamiliarwithmanyofthem.

ItisinterestingtonotethatbothIFRSandASPEare“principles-based.”Thismeansthatstandardscannotpossiblybedevelopedforeveryaccountingtransac-tionacompanywillencounter,sotheaccountantmustuseprofessionaljudgmentin somecircumstances.Professional judgment is anacquired skill—youneedagoodknowledgeofaccountingstandardsandmanyyearsofexperienceinorder

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toexercisesoundprofessionaljudgment.However,itisimportanttonotethatthestartingpointinacquiringprofessionaljudgmentisasolidunderstandingoftheconceptsofaccounting.

IntheHandbook,theintroductiontoboththeASPEandIFRSsectionsdiscussfinancial statement concepts in some detail. These are the concepts on whichASPEandIFRSarebased.Consequently,wewillnowintroducesomeofthemoreimportantfundamentalconceptsinaccounting.

Framework for Financial ReportingFundamental accounting concepts form the basis of how accounting should bedoneandreportedtousers.Exhibit1–6providesahierarchyoffinancialstatementconcepts.Thisistheframeworkforfinancialreporting.Asthepyramidshapeindi-cates,thefinancialreportsissuedbyacompanyaretheendproductdesignedtosatisfythefinancial-informationneedsofvarioususergroups,andtheyarebuiltonastrongfoundationofaccountingprinciples.Let’slookmorecloselyateachlevel.

A Hierarchy of Financial-Statement ConceptsExhibit 1–6

Recognition and Measurement Criteria, and Constraints

Considerations Principles Constraints Economic Entity Recognition Criteria Cost/BenefitGoing Concern Revenue MaterialityStable Monetary Unit Expense Measurement Cost Other bases (used in limited circumstances) Disclosure

Elements of Financial Statements

Assets Liabilities Equity Revenue and Gains and Expenses Losses

Qualitative Characteristics ofAccounting Information

Relevance ReliabilityComparability Understandability

Objective of Financial Reporting

Communicate useful information to users

LEVEL

1.

2.

3.

4.

Level 1:Exhibit1–6showsthattheprimaryobjectiveoffinancialstatementsistocommunicateinformationthatisusefultoinvestors,creditors,andotherusersinmakinginvestmentdecisionsorassessingthesuccessofacompany.Whatdoesthismean?Ideally,thefinancialinformationprovidedshouldallowaninterestedusertomakedecisionsaboutitsongoingfinancialrelationshipwithanorganization.

Level 2:Thequalitativecharacteristicsofusefulfinancialinformationidentifythetypesofinformationthatarelikelytobethemostusefultothevarioususersoffinancial reports, whichare existingandpotential investors, lenders, andothercreditors. The four characteristics identified are understandability, relevance,reliability,andcomparability.

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• Theinformationmustbeunderstandabletousersiftheyaretobeabletouseit.• Relevantfinancialinformationiscapableofmakingadifferenceinthedecisions

made by users. To be relevant, the information must allow users to predictfutureoutcomesorprovide feedbackaboutpreviousmanagementdecisions,or both.

• Financialinformationisonlyusefulifitisreliable.Informationisreliablewhenitaccuratelyrepresentstheimpactofthetransactionsthataresummarizedinthefinancialstatements,andisfreeoferrorandbias.

• Thecomparabilitycharacteristicfocusesontherelationshipbetweentwopiecesofinformationratherthanaparticularpieceofinformation.Itenablesuserstoidentifysimilaritiesanddifferencesbetweentheinformationprovidedbytwosetsoffinancialstatements.

Let’s take a moment to understand the role of these characteristics. Assumethatyouhavedecidedthatyouwouldliketoinvestsomeofyoursavingsinthesharesofacompany.Howwouldyoudecideonacompanyto invest in?Yourstartingpointwouldlikelybethefinancialstatements.Youarehopingthat thefinancialstatementsarereliable(thattheinformationreportedaccuratelyreflectsthetransactionsofthecompany)andthattheinformationisrelevant(itprovidesinformationuponwhichyoucanbaseyourinvestmentdecision).Youmightwanttomeasuretheresultsofthecompanyagainstitsresultsinpreviousyearsoryoumightliketocomparetheresultsofonecompanyagainsttheresultsofanothercompanyinthesameindustry(comparability).

Ifthesecharacteristicsareinplace, itmakesyourinvestmentdecisionalittleeasier.Certainlythereisotherinformationthatyoumaywanttostudybeforeyoumakeyourdecision,butthefinancialstatementsareagoodstartingpoint.

Level 3:Elements of financial statementsarethebasiccategoriesofitemsportrayedonthefinancialstatementstomeettheobjectivesoutlinedinLevel1.Wewilllearnmoreabouttheseitemslaterinthischapter.

Level 4:Thisleveloutlinessomebasicconsiderations,principles,andconstraintsthataccountantsrelyuponwhenproducingthefinancialinformationrequiredtosatisfytheneedsofusersoutlinedinLevel1.Theeconomicentity,goingconcern,andstablemonetaryunitconsiderationsarebasicassumptionsusedinbothASPEandIFRS.

Inaccounting,anentityisanorganizationorasectionofanorganizationthatstands apart from other organizations and individuals as a separate economicunit.Eachentityisaccountedforseparately.Thisappliesinsituationswhereyoukeepyourbusiness’saccountingseparatefromyourpersonalaccountingsothatyoucanevaluatethesuccessofyourbusiness.Italsoappliesinsituationswherecompanieskeepeachdepartment’saccountingseparatefromalltheotherdepart-mentstoassessandevaluatetheperformanceofeachdepartment.Resultsforeachdepartmentcanthenbecombinedtocreateresultsforthewholeorganization.

Whenaccountantsrecordfinancialinformation,theyassumethattheentityonwhichtheyarereportingisgoingtobeinbusinessfortheforeseeablefuture.Thisgoing-concern assumptionisimportantbecauseitimpactsthewaywemeasurecertaintransactions.Forexample,awarehousecosting$100,000maybevaluabletoacompanybecauseitexpectstouseitforthenexttenyears,sothecompanyrecordsthecostofthewarehouseasthe$100,000itpaid.However,ifthecompanywasforcedtosellthewarehousetomorrowbecauseitwasgoingoutofbusiness,itmightonlybeabletoget$50,000foritbecauseitisforcedtoacceptwhateverpriceitcangetforthewarehouse.Inthissituation,thecostofthewarehouseshouldbe$50,000.Thegoing-concernassumptionallowsthecompanytorecordthe$100,000costofthewarehousewhenitispurchased.Wewilldiscussthisassumptionasnecessaryinfuturechapters.

InCanada,accountantsrecordtransactionsindollarsbecausethedollaristhemeasureweusewhenwemakepurchasesandsales.However,unlikeothermea-sureslikeakilometeroratonne,thevalueofadollarcanchangeovertime.Arise

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inthegenerallevelofpricesiscalledinflation.Duringinflation,adollarwillpur-chaselessmilk,lesstoothpaste,andlessofothergoodsovertime.Whenpricesarerelativelystable—whenthereislittleinflation—thepurchasingpowerofmoneyisalsostable.Whenthedollar’spurchasingpowerisrelativelystable,thestable monetary unit assumptionallowsaccountantstoignoretheeffectofinflationintheaccountingrecords.Itallowsaccountantstoaddandsubtractdollaramountsforactivitiesthathappenedatdifferenttimes.

Toproducethefinancialinformationthatusersneed,accountantsmustfollowrecognition criteriaandprinciples tomeasureanddisclose (or report) financialinformation, as shown in Level 4 of Exhibit 1–6. Recognition is the process ofincludinganiteminthefinancialstatementsofacompany.Howdoesanaccoun-tantdecidewhenanitemshouldberecognizedinthefinancialstatements?ThecriteriafordeterminingwhenanitemshouldberecognizedareexaminedlaterinthischapterandinmoredetailinChapter3.

Measurement is the process of determining the amount at which an item isrecognized in the financial statements. There are a number of bases on whichanamountcanbemeasured.Financialstatementsarepreparedprimarilyusingthehistorical-costbasisofmeasurement,commonlycalledthecost principle.Thecost principle of measurementstatesthatacquiredassetsandservicesshouldberecordedattheiractualcost(alsocalledhistorical cost).Eventhoughthepurchasermaybelievethepricepaidisabargain,theitemisrecordedatthepriceactuallypaidandnotatthe“expected”cost.

The cost principle of measurement also holds that the accounting recordsshouldcontinuereportingthehistoricalcostofanassetforaslongasthebusinessholdstheasset.Why?Becausecostisareliablemeasure.

Otherbasesofmeasurementcanbeusedbutonlyinlimitedcircumstances.Inparticularcircumstances,wemayusereplacementcost,realizablevalue,orpres-entvalue.Theseotherbasesofmeasurementwillbediscussedonlyasneededinfuturechapters.

Level 4 inExhibit 1–6also includes twoconstraints that accountantsmustconsiderwhentheyareproducingfinancialinformation.Thefirstconstraintisthat thebenefitsof the informationproducedshouldexceedthecostsofpro-ducingtheinformation.Thesecondconstraintismateriality.Apieceofinfor-mationismaterialifitwouldaffectadecisionmaker’sdecision.Materialityisnotdefinedinthestandardsbutisamatteroftheinformationpreparer’sjudg-ment.Forexample,informationaboutinventoryisimportanttousersofRonaHardware’s financial statements, since a change in inventory could change adecisionmaker’sdecisionaboutinvestinginRonaorsellingproductstoRona.Thus,suchinformationwouldbeprovidedtodecisionmakers.However,infor-mationabout theoffice suppliesatRonawouldnot likelychange the invest-mentdecisionofaRonafinancial-statementuser,sodetailsofsuchinformationarenotprovided.

Exhibit 1–6 summarizes thekeypoints for recordingand reporting financialinformation:Foranyfinancialtransactionorsituation,theGAAPinLevel4areused as guidelines for classifying the transaction’s financial data into the stan-dard financial-statementelementsshown inLevel3. If theseelementsmeet theLevel-2qualitativecharacteristicsofaccountinginformation,theyarecombinedinto financial statements that meet the Level-1 objective of reporting financialinformationusefulforusers.FinancialinformationcanbereportedtousersusingeitherASPEorIFRS,dependingonwhetherthecompanyisapubliclyaccountableenterprise(mustuseIFRS)ornot(canuseASPEorIFRS).

This course will expose you to the generally accepted methods of account-ing.Webegin thediscussionofGAAP in this sectionand introduceadditionalassumptionsandprinciplesasneededthroughoutthebook.Throughoutthetext,wewilllinktheaccountinginthatchaptertotheframeworkforfinancialreport-ing using Why It’s Done This Way boxes. The hierarchy of financial statementconceptsformingtheframeworkforfinancialreportingfromExhibit1–6isshownonthebackinsidecoverofthistextbookforeasyreference.

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the Accounting Equation

Financial statements tell us how a business is performing and where it stands.Theyarethefinalproductoftheaccountingprocess.Buthowdowearriveattheitemsandamountsthatmakeupthefinancialstatements?Themostbasictooloftheaccountantistheaccounting equation.Itmeasurestheresourcesofabusinessandtheclaimstothoseresources.

Assets and LiabilitiesAssetsareeconomicresourcescontrolledbyanentitythatareexpectedtobenefitthebusinessinthefuture.Cash,officesupplies,merchandiseinventory,furniture,land,andbuildingsareexamplesofassets.

Claimstothoseassetscomefromtwosources.Liabilitiesaredebtsthatarepay-abletooutsiders.Theseoutsidepartiesarecalledcreditors.Forexample,acreditorwhohaslentmoneytoabusinesshasaclaim—alegalright—toapartoftheassetsuntil the business pays the debt. Many liabilities have the word payable in theirtitles.Examples includeAccountsPayable,NotesPayable,andSalariesPayable.Insiderclaimstothebusinessassetsareowners’claimscalledowner’s equityorcapital.Anowner’s claim to someof theentity’sassetsbeginswhen theownerinvestsinthebusiness.

TheaccountingequationinExhibit1–7showshowassets,liabilities,andown-er’sequityarerelated.Assetsappearontheleftsideoftheequation.Thelegalandeconomicclaimsagainsttheassets—theliabilitiesandowner’sequity—appearontherightsideoftheequation.AsExhibit1–7shows,the two sides must be equal:

Economic Resources Claims to Economic Resources(Outsiders) (Insiders)

Assets 5 Liabilities 1 Owner’s Equity

Owner’s EquityOwner’s equityistheamountofanentity’sassetsthatremainsaftertheliabilitiesaresubtracted.Forthisreason,owner’sequityisoftenreferredtoasnet assets,andtheaccountingequationcanbewrittentoshowthis:


10. Explainwhyfinancialinformationmustbebothrelevantandreliable.

11. Supposeyouareconsideringthepurchaseoflandforfutureexpansion.Thesellerisasking$200,000forlandthatcosther$100,000.Anappraisalshowsthelandhasavalueof$180,000.Youfirstoffer$160,000.Thesellercounterofferswith$190,000.Finally,youandtheselleragreeonapriceof$185,000.Whatdollaramountforthislandisreportedonyourfinancialstatements?Whichaccountingconsiderationorprincipleguidesyouranswer?

12. Supposeyouownacompanythatdeliversnewspapers.Thecompanyownstwotrucksthatareusedfordeliveringthepapers.Youhavedecidedthatyouneedanewcarformainlypersonalpurposesbutyouwantthecompanytobuyitforyou.Isthisappropriate?Nametheconsiderationorprinciplethatmustbeconsidered.


JUST CHECKING

LO 5Howdobusinesstransactionsaffecttheaccountingrecordsofacompany?

IFRS

Exhibit 1–7

The Accounting Equation

Assets �

Assets

Liabilities�

Owner’sEquity

Owner’sEquity

Liabilities

Increasesincasharenotalwaysrevenues.Cashalsoincreaseswhenacompanyborrowsmoney,butborrowingmoneycreatesaliability—notarevenue.Revenueresultsfromrenderingaserviceorsellingaproduct,notnecessarilyfromthereceiptofcash.

KEY POINTS

MyAccountingLab

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Thepurposeofbusinessistoincreaseowner’sequitythroughrevenues,whichare amounts earned by delivering goods or services to customers. Revenuesincrease owner’s equity because they increase the business’s assets but not itsliabilities.Asaresult,theowner’sshareofbusinessassetsincreases.Examplesofrevenue includesales revenue fromsellinggoods, service revenue fromsellingservices, interest revenue fromsavingmoney inabank, anddividend revenuefrominvestinginsharesofstock.Exhibit1–8showsthatownerinvestmentsandrevenuesincreasetheowner’sequityofthebusiness.

Exhibit1–8alsoshows thatownerwithdrawalsandexpensesdecreaseown-er’sequity.Owner withdrawals are thoseamountsor resources removed fromthebusinessbytheowner.Withdrawalsaretheoppositeofownerinvestments.Expenses are decreases in owner’s equity that occur from using or consumingassetsorincreasingliabilitiesinthecourseofdeliveringgoodsandservicestocus-tomers.Expensesarethecostofdoingbusinessandaretheoppositeofrevenues.Expensesincludethecostofofficerent;interestpayments;salariesofemployees;insurance;advertisements;propertytaxes;utilitypaymentsforwater;electricity;gas;andsoforth.

AccountnamesfordifferenttypesofbusinessesaregiveninAppendixBattheendofthisbook.

Transactions that Increase and Decrease Owner’s EquityExhibit 1–8

INCREASEOWNER’S EQUITY

DECREASE

Owner Investmentsin the Business

Revenues

Owner Withdrawalsfrom the Business

Expenses

Decreasesincasharenotalwaysexpenses.Cashdecreaseswhenlandispurchased,forexample,butthepurchasealsoincreasestheassetLand,whichisnotanexpense.Expensesresultfromusinggoodsorservicesinthecourseofearningrevenue,notnecessarilyfromthepaymentof cash.

KEY POINTS

Accounting for Business transactions

Accountingisbasedontransactions,notopinionsordesires.Atransactionisanyeventthataffectsthefinancialpositionofthebusinessentityandcanbemeasuredreliably.Manyeventsmayaffecta company, includingelectionsandeconomicbooms.Accountantsdonotrecordtheeffectsof theseeventsbecause theycan-notbemeasuredreliably.Anaccountantrecordsastransactionsonlyeventswithdollaramountsthatcanbemeasuredreliably,suchaspurchasesandsalesofmer-chandise inventory,paymentof rent, andcollectionof cash fromcustomers. InExhibit1-1onpage5,transactionsarethemiddlestepintheflowofinformationinanaccountingsystem.

Toillustrateaccountingforbusinesstransactions,let’sgobacktoouropeningstoryandtracethetransactionsforLisaHunter’scompany,HunterEnvironmentalConsulting(HEC),inthefirstyearofherbusiness.Wewillconsider11eventsandanalyzeeachintermsofitseffectontheaccountingequationofHEC.Remember that the accounting equation must always remain in balance.Transactionanalysisistheessenceofaccounting.

Transaction 1: Starting the Business Hunterinvests$250,000ofhermoneytostartthebusiness.Specifically,shedeposits$250,000inabankaccountentitledHunterEnvironmentalServices.

Atransactionisaneventthatmustalwayssatisfythesetwoconditions:

1. Itaffectsthefinancialpositionofabusinessentity,and

2. Itcanbereliablyrecordedintheaccountingrecords.

KEY POINTS

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TheeffectofthistransactionontheaccountingequationoftheHECbusinessentityis

Assets 5

Liabilities 1 Owner’s EquityType of Owner’s

Equity Transaction

Cash Lisa Hunter, Capital

(1) +250,000 +250,000 Owner investment

Foreverytransaction,theamountontheleftsideoftheequationmustequalthe amount on the right side. The first transaction increases both the assets (inthis case, Cash) and the owner’s equity of the business (Lisa Hunter, Capital).Thetransactioninvolvesnoliabilitiesofthebusinessbecauseitcreatesnoobliga-tionforHECtopayanoutsideparty.TheAssetsandLiabilitieselementsoftheaccountingequationwillbeexpandedtoshowthespecificaccountsaffectedbyatransaction,butOwner’sEquitywillnotbeexpanded.Therefore,totherightofthetransaction,wewrite“ownerinvestment”tokeeptrackofthereasonfortheeffectonOwner’sEquity.

Transaction 2: Purchase of Land HEC purchases land for a future officelocation, paying $100,000. The effect of this transaction on the accountingequationis

Assets Liabilities 1 Owner’s EquityTypes of Owner’s

Equity Transaction

Cash 1 Land Lisa Hunter, Capital

Bal. 250,000 5 250,000(2) -100,000 + 100,000Bal. 150,000 100,000 250,000

250,000 250,000

The cash purchase of the land increases one asset, Land, and decreasesanotherasset,Cash,by the sameamount.After the transaction is completed,HEChascashof$150,000,landof$100,000,noliabilities,andowner’sequityof$250,000.

Transaction 3: Purchase of Office Supplies and Equipment HEC buys statio-neryandotheroffice supplies, agreeing topay$7,000within30days.Thistransaction increases both the assets and the liabilities of the company, asfollows:

Assets Liabilities 1 Owner’s Equity

Cash 1Office

Supplies 1 LandAccounts Payable 1

Lisa Hunter, Capital

Bal. 150,000 100,000 5 250,000(3) +7,000 +7,000Bal. 150,000 7,000 100,000 7,000 250,000

257,000 257,000

LEARNING TIPS

Notethatthesumsofbalances(whichweabbreviateBal.)onbothsidesoftheequationareequal.Thisequalitymustalwaysexist.

Learning Tips aresuggestionsforlearningorrememberingimportantconcepts.

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The asset affected is Office Supplies, and the liability is called an account payable. A payable is always a liability. Because HEC is obligated to pay $7,000in the futurebutsignsnoformalpromissorynote,werecordthe liabilityasanAccountPayable.(Ifapromissorynotehadbeensigned,wewouldhaverecordedtheliabilityasaNote Payable.)

Transaction 4: Earning of Service Revenue HECearnsservicerevenuebyprovid-ing environmental consulting services for clients. Assume the business earns$30,000andcollectsthisamountincash.TheeffectontheaccountingequationisanincreaseintheassetCashandanincreaseinLisaHunter,Capital,asfollows:

Assets Liabilities 1 Owner’s EquityType of Owner’s

Equity Transaction

Cash 1Office



Bal. 150,000 7,000 100,000 5 7,000 250,000Service revenue(4) +30,000 +30,000

Bal. 180,000 7,000 100,000 7,000 280,000

287,000 287,000

Arevenuetransactioncausesthebusinesstogrow,asshownbytheincreaseintotalassetsandinthesumoftotalliabilitiesplusowner’sequity.AcompanylikeRONAorCanadianTirethatsellsgoodstocustomers isamerchandisingbusi-ness.Itsrevenueiscalledsales revenue.Incontrast,HECperformsservicesforcli-ents.HEC’srevenueiscalledservice revenue.

Transaction 5: Earning of Service Revenue on Account HECperformsconsultingservicesforclientswhodonotpayimmediately.Inreturnfortheservices,HECissuesaninvoiceandtheclientswillpaythe$25,000amountwithinonemonth.ThisamountowedtoHECisanassettoHEC,anaccountreceivablebecausethebusinessexpectstocollectthecashinthefuture.Inaccounting,wesaythatHECperformedthisserviceon accountandearnedtherevenue.Performingtheservice,not collecting thecash,earns the revenue.This$25,000of service revenue isasrealan increase in thewealthofHEC’sbusinessas the$30,000of revenue thatwascollectedimmediatelyinTransaction4.HECrecordsanincreaseintheassetAccounts Receivable and an increase in Service Revenue, which increases LisaHunter,Capital,asfollows:


Equity Transaction

Cash 1Accounts

Receivable 1Office



Bal. 180,000 7,000 100,000 5 7,000 280,000Service revenue(5) +25,000 +25,000

Bal. 180,000 25,000 7,000 100,000 7,000 305,000

312,000 312,000

Transaction 6: Payment of Expenses Duringthemonth,HECpays$12,000incashexpenses:officerent,$4,000(HECpurchasedlandtobuildanofficeinthefuture(transaction 2), but the company is renting fully furnished office space in the

Allreceivablesareassets.Allpayablesareliabilities.

KEY POINTS

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meantime);employeesalaries,$6,500(forafull-timeassistantandajuniorconsul-tant);andtotalutilities,$1,500.Theeffectsontheaccountingequationare

Expenses have the opposite effect of revenues. Expenses cause the business toshrink,asshownbythedecreasedbalancesoftotalassetsandowner’sequity.

Eachexpenseshouldberecordedinaseparatetransaction.Here,forsimplic-ity,theexpensesarelistedtogether.Alternatively,wecouldrecordthecashpay-mentinasingleamountforthesumofthosethreeexpenses,$12,000($4,000+$6,500+$1,500).Ineithercase,the“balance”oftheequationholds,asweknowitmust.

Transaction 7: Payment on Account HECpays$5,000tothestorefromwhichitpur-chased$7,000worthofofficesuppliesinTransaction3.Inaccounting,wesaythatthebusinesspays$5,000on account.TheeffectontheaccountingequationisadecreaseintheassetCashandadecreaseintheliabilityAccountsPayableasfollows:


Cash 1Accounts

Receivable 1Office



Bal. 168,000 25,000 7,000 100,000 5 7,000 293,000

(7) - 5,000 -5,000

Bal. 163,000 25,000 7,000 100,000 2,000 293,000

295,000 295,000

The payment of cash on account has no effect on the asset Office Suppliesbecausethepaymentdoesnotincreaseordecreasethesuppliesavailabletothebusiness.Likewise, thepaymentonaccountdoesnotaffectexpenses.HECwaspayingoffaliability,notanexpense.

Transaction 8: Personal Transaction LisaHunterremodelsherhomeatacostof$30,000,payingcashfrompersonalfunds.ThiseventisnotatransactionofHEC.IthasnoeffectonHEC’sbusinessaffairsand,therefore,isnotrecordedbythebusi-ness.ItisatransactionoftheHunterpersonalentity,nottheHECbusinessentity.Wearefocusingnowsolelyonthebusinessentity,andthiseventdoesnotaffectit.Thistransactionillustratestheeconomic-entityconsideration.

Transaction 9: Collection on Account InTransaction5,HECperformedconsult-ing services for clients on account. The business now collects $15,000 from a


Equity Transaction

Cash 1Accounts

Receivable 1Office



Bal. 180,000 25,000 7,000 100,0005

7,000 305,000Rent expenseSalaries expenseUtilities expense

(6) -4,000 -4,000-6,500 -6,500-1,500 -1,500

Bal. 168,500 25,000 7,000 100,000 7,000 293,000

300,000 300,000

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client.Wesaythatitcollectsthecashon account.ItwillrecordanincreaseintheassetCashandadecreaseintheassetAccountsReceivable.Shoulditalsorecordanincreaseinservicerevenue?No,becauseHECalreadyrecordedtherevenuewhen it performed the service in Transaction 5. The effect on the accountingequationis


Cash 1Accounts

Receivable 1Office

Supplies LandAccounts Payable 1


Bal. 163,000 25,000 7,000 100,000 5 2,000 293,000(9) +15,000 -15,000Bal. 178,000 10,000 7,000 100,000 2,000 293,000

295,000 295,000

Totalassetsareunchangedfromtheprecedingtransaction’stotal.Why?BecauseHECmerelyexchangedoneassetforanother.

Transaction 10: Sale of Land Lisasells50%ofthelandpurchasedinTransaction2.Thesalepriceof$50,000isequaltoHEC’scostoftheland.HECsellsthelandandreceives$50,000cash,andtheeffectontheaccountingequationis

Assets Liabilities 1Owner’s Equity

Cash 1Accounts

Receivable 1Office



Bal. 178,000 10,000 7,000 100,000 5 2,000 293,000(10) + 50,000 - 50,000Bal. 228,000 10,000 7,000 50,000 2,000 293,000

295,000 295,000

Transaction 11: Withdrawing of Cash Lisawithdraws$6,000cashforherpersonaluse.Theeffectontheaccountingequationis


Equity Transaction

Cash 1Accounts

Receivable 1Office



Bal. 228,000 10,000 7,000 50,000 5 2,000 293,000Owner withdrawal- 6,000 -6,000

Bal. 222,000 10,000 7,000 50,000 2,000 287,000

289,000 2,89,000

Hunter’s withdrawal of $6,000 cash decreases the asset Cash and also theowner’sequityofthebusiness.

Owner withdrawals do not represent a business expense because the cash is used for the owner’s personal affairs unrelated to the business.Werecordthisdecreaseinowner’sequityasWithdrawalsorDrawings.Thedoubleunderlinesbeloweachcolumnindicateafinaltotalafterthelasttransaction.

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Exhibit 1–9 Analysis of Transactions of Hunter Environmental Consulting

Evaluating Business transactions

Exhibit1–9summarizesthe11precedingtransactions.PanelAoftheexhibitliststhedetailsofthetransactions,andPanelBpresentstheanalysis.Asyoustudytheexhibit,notethateverytransactionmaintainstheequalityoftheequation


MyAccountingLab

Accounting Cycle Tutorial

1. BalanceSheetAccountsandTransactionspages1–12

2. IncomeStatementAccountsandTransactionspages1–6

ThesereferencestoMyAccountingLabareremindersthatyoucanreviewthesetopicsusingtheAccountingCycleTutorialsonMyAccountingLab.

PANEL A: DETAILS OF TRANSACTIONS(1) Thebusinessrecordedthe$250,000cashinvestmentmadebyLisaHunter.(2) Paid$100,000cashforland.(3) Bought$7,000ofofficesuppliesonaccount.(4) Received$30,000cashfromclientsforservicerevenueearned.(5) Performedservicesforclientsonaccount,$25,000.(6) Paidcashexpenses:rent,$4,000;employeesalary,$6,500;utilities,$1,500.(7) Paid$5,000ontheaccountpayablecreatedinTransaction3.(8) RemodelledHunter’spersonalresidence.Thisisnotatransactionofthebusiness.(9) Collected$15,000ontheaccountreceivablecreatedinTransaction5.(10) Soldlandforcashequaltoitscostof$50,000.(11) Thebusinesspaid$6,000cashtoHunterasawithdrawal.

PANEL B: ANALYSIS OF TRANSACTIONS


Equity Transaction

Cash Accounts

Receivable Office

Supplies Land

Accounts Payable


(1) +250,000 +250,000 Owner investmentBal. 250,000 250,000(2) -100,000 +100,000Bal. 150,000 100,000 250,000(3) +7,000 +7,000Bal. 150,000 7,000 100,000 7,000 250,000(4) +30,000 +30,000 Service revenueBal. 180,000 7,000 100,000 7,000 280,000(5) +25,000 +25,000 Service revenueBal. 180,000 25,000 7,000 100,000 7,000 305,000(6) -4,000 5 -4,000 Rent expense

-6,500 -6,500 Salaries expense-1,500 -1,500 Utilities expense

Bal. 168,000 25,000 7,000 100,000 7,000 293,000(7) -5,000 -5,000Bal. 163,000 25,000 7,000 100,000 2,000 293,000(8) Notatransactionofthebusiness(9) +15,000 -15,000Bal. 178,000 10,000 7,000 100,000 2,000 293,000(10) +50,000 -50,000Bal. 228,000 10,000 7,000 50,000 2,000 293,000(11) -6,000 -6,000 Owner withdrawalBal. 222,000 10,000 7,000 50,000 2,000 287,000

289,000 289,000

1 1 11

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the Financial Statements

Once the analysis of the transactions is complete, what is the next step in theaccountingprocess?Howdoesabusinesspresenttheresultsofthetransactions?Wenowlookatthefinancial statements,whicharetheformalreportsofanentity’sfinancialinformation.Theprimaryfinancialstatementsarethe:

• Incomestatement• Statementofowner’sequity• Balancesheet• Cashflowstatement

Income Statement The income statementpresentsasummaryof therevenuesandexpensesofanentityforaspecificperiodoftime,suchasamonthorayear.The income statement, also called the statement of earnings or statement of operations,islikeavideooftheentity’soperations—amovingfinancialpictureofbusinessoperationsduringtheperiod.Theincomestatementholdsperhapsthemostimportantsinglepieceofinformationaboutabusiness—itsnet income or net loss.Businesspeopleruntheirbusinesseswiththeobjectiveofhavingmorerevenuesthanexpenses.Anexcessoftotalrevenuesovertotalexpensesiscallednet income,net earnings,ornet profit.Iftotalexpensesexceedtotalrevenues,theresultiscalledanet loss.

Statement of Owner’s Equity Thestatement of owner’s equitypresentsasum-maryofthechangesthatoccurredintheentity’sowner’s equityduringaspecificperiodoftime,suchasamonthorayear.

Increasesinowner’sequityarisefrom:

• Ownerinvestments• Netincome(revenuesexceedexpenses)

Decreasesinowner’sequityarisefrom:

• Ownerwithdrawals• Netloss(expensesexceedrevenues)

13. a. Iftheassetsofabusinessare$75,000andtheliabilitiestotal$65,000,howmuchistheowner’sequity?

b. Iftheowner’sequityinabusinessis$50,000andtheliabilitiesare$20,000,howmucharetheassets?

14. Indicatewhethereachaccountlistedbelowisa(n)asset(A),liability(L),owner’sequity(OE),revenue(R),orexpense(E)account.

AccountsReceivable _____

ComputerEquipment_____

S.Scott,Capital _____

RentExpense _____

Supplies _____

S.Scott,Withdrawals _____

JUST CHECKING

SalariesExpense _____

ConsultingServiceRevenue_____

Cash _____

NotesPayable _____

SuppliesExpense _____

AccountsPayable _____

15. Acustomerpaysadepositof$20,000toyourcompanyforaservicethatyouwill begin to provide six months from now. How do you account for thistransaction?


LO 6Prepareandevaluatethefinancialstatements

MyAccountingLab

IFRS

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Sticky Note

<AU/ED: Please advise if this is correct IFRS logo in last learning objective.>


Net income or net loss comes directly from the income statement. Ownerinvestmentsandwithdrawalsarecapitaltransactionsbetweenthebusinessanditsowner,sotheydonotaffecttheincomestatement.

Balance Sheet Thebalance sheetlistsalltheassets,liabilities,andowner’sequityofanentityasofaspecificdate,usuallytheendofamonthorayear.Thebalancesheetislikeasnapshotoftheentity.Forthisreason,itisalsocalledthestatement of financial position.

Cash Flow Statement The cash flow statement reports the cash coming in(cash receipts) and the cash going out (cash payments or disbursements) during aperiod.Businessactivities result inanet cash inflow (receiptsgreater thanpay-ments)oranetcashoutflow(paymentsgreaterthanreceipts).Thecashflowstate-mentshowsthenet increaseordecrease incashduringtheperiodandthecashbalanceattheendoftheperiod.WefocusonthecashflowstatementinChapter17.

Computersandsoftwareprogramshavehadasignificantimpactontheprepa-rationofthefinancialstatements.Financialstatementscanbeproducedinstanta-neouslyafterthedatafromthefinancialrecordsareenteredintothecomputer.Ofcourse,inmanualandcomputerizedaccountingsystems,anyerrorsthatoccurinthefinancialrecordswillbepassedontothefinancialstatements.Forthisreason,thepersonresponsibleforanalyzingtheaccountingdataiscriticaltotheaccuracyofthefinancialstatements.

Financial Statement HeadingsEachfinancialstatementhasaheading,whichgivesthreepiecesofdata:

• The proper name of the business (in our discussion, Hunter EnvironmentalConsulting)

• Thefullnameoftheparticularstatement• Thedateortimeperiodcoveredbythestatement

Abalancesheet takenat theendofyear2013wouldbedatedDecember31,2013.AbalancesheetpreparedattheendofMarch2014isdatedMarch31,2014.

Anincomestatementorastatementofowner’sequitycoveringayearendingonDecember31,2013,isdated“FortheYearEndedDecember31,2013.”Amonthlyincome statement or statement of owner’s equity for September 2014 has in itsheading “For the Month Ended September 30, 2014” or simply “For the MonthofSeptember2014.”Incomemustbeidentifiedwithaparticulartimeperiod.ThisisbecauseifDecember31,2013appearedintheheadingofthesestatements,youwouldnotknowwhetherthenetincomeamountwasgoodorbadunlessyouknewthetimeperiodcoveredbythestatements.Thenetincomeamountcouldbegoodifthetimeperiodwereoneday,butitcouldbebadifthetimeperiodwereoneyear.

relationships among the Financial Statements

Exhibit1–10onpage25illustratesallfourfinancialstatements.Theirdatacomefrom the transaction analysis in Exhibit 1–9. We are assuming the transactionsoccurredduringthemonthofApril2014.Studytheexhibitcarefully,becauseitshowstherelationshipsamongthefourfinancialstatements.

ObservethefollowinginExhibit1–10:

1. Theincome statementforthemonthendedApril30,2014,a. Reportsallrevenuesandallexpensesduringtheperiod.Expensesareoften

listedalphabetically,butcanalsobe listed indecreasingorderofamount,withthelargestexpensefirst.

b. Reportsnet incomeoftheperiodiftotalrevenuesexceedtotalexpenses,asinthecaseofHEC’soperationsforApril.Iftotalexpensesexceedtotalrevenues,anet lossisreportedinstead.

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Financial Statements of Hunter Environmental ConsultingExhibit 1–10

1

2

Statement of Owner’s EquityFor the Month Ended April 30, 2014

Lisa Hunter, capital, April 1, 2014................................................................ $ 0Add: Investment by owner............................................................................ 250,000

Net income for the month.................................................................... 43,000293,000

Less: Withdrawals by owner ......................................................................... (6,000)Lisa Hunter, capital, April 30, 2014.............................................................. $287,000

Cash Flow Statement*For the Month Ended April 30, 2014

Cash �ows from operating activitiesCash collections from customers** ................................ $ 45,000Cash payments to suppliers***....................................... $ (10,500)Cash payments to employees......................................... (6,500) (17,000)

000,82..............seitivitca gnitarepo morf wolfni hsac teNCash �ows from investing activities

Acquisition of land ......................................................... $(100,000)Proceeds from sale of land ............................................ 50,000

)000,05(...........seitivitca gnitsevni morf wolftuo hsac teNCash �ows from nancing activities

Investment by owner...................................................... $ 250,000Withdrawal by owner .................................................... (6,000)

000,442.............seitivitca gnicnanif morf wolfni hsac teNNet increase in cash ............................................................. $222,000

0.................................................4102 ,1 lirpA ,ecnalab hsaCCash balance, April 30, 2014............................................... $222,000

*Chapter 17 explains how to prepare this statement.**$30,000 + $15,000 = $45,000***$4,000 + $1,500 + $5,000 = $10,500

HUNTER ENVIRONMENTAL CONSULTING




Income Statement For the Month Ended April 30, 2014

Revenue:000,55$................................................................eunever ecivreS

Expenses:Rent expense .................................................................... $4,000Salary expense ................................................................. 6,500Utilities expense .............................................................. 1,500

000,12..............................................................sesnepxe latoT000,34$...........................................................................emocni teN

AssetsCash.......................................... $222,000Accounts receivable ............... 10,000O�ce supplies ........................ 7,000Land ......................................... 50,000

Total assets .............................. $289,000

LiabilitiesAccounts payable ................... $ 2,000

Owner’s EquityLisa Hunter, capital ............... 287,000

Total liabilities andowner’s equity.................. $289,000

Balance SheetApril 30, 2014

3

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2. Thestatement of owner’s equityforthemonthendedApril30,2014,a. Openswiththeowner’scapitalbalanceatthebeginningoftheperiod.b. Adds investment by the owner andaddsnet income (or subtractsnet loss, as

thecasemaybe).Netincome(ornetloss)comesdirectlyfromtheincomestatement(seearrow1inExhibit1–10).

c. Subtracts withdrawals by the owner. The parentheses around an amountindicateasubtraction.

d.Endswiththeowner’scapitalbalanceattheendoftheperiod.3. Thebalance sheetatApril30,2014,theendoftheperiod,

a. Reportsallassets,allliabilities,andowner’s equityofthebusinessattheendoftheperiod.

b. Reportsthattotalassetsequalthesumoftotal liabilitiesplustotalowner’sequity.

c. Reportstheowner’sendingcapitalbalance,takendirectlyfromthestatementofowner’sequity(seearrow2).

4. Thecash flow statementforthemonthendedApril30,2014,a. Reportscashflowsfromthreetypesofbusinessactivities(operating, investing,

and financing activities) during the month. Each category of cash-flow ac-tivities includes both cash receipts, which are positive amounts, and cashpayments, which are negative amounts (denoted by parentheses). Eachcategoryresultsinanetcashinfloworanetcashoutflowfortheperiod.WediscussthesecategoriesindetailinChapter17.

b. Reportsanetincreaseincash(oranetdecrease,asthecasemaybe)duringthe month and ends with the cash balance at April 30, 2014. This is theamountofcashtoreportonthebalancesheet(seearrow3).

16. Indicate whether each account listed below appears on the balance sheet (B),incomestatement (I), statementofowner’s equity (OE),or cash flowstatement(CF).Someitemsappearonmorethanonestatement.

AccountsReceivable _____

ComputerEquipment_____

S.Scott,Capital _____

RentExpense _____

Supplies _____

S.Scott,Withdrawals _____

JUST CHECKING

17. Study Exhibit 1–10, which gives the financial statements for Hunter Environ-mentalServices(HEC)atApril30,2014,theendofthefirstmonthofoperations.AnswerthesequestionsaboutHECtoevaluatethebusiness’sresults.a. What was the business’s result of operations for the month of April—a net

income(profit)oranetloss,andhowmuch?Whichfinancialstatementpro-videsthisinformation?

b. HowmuchownercapitaldidthecompanyhaveatthebeginningofApril?Atthe end of April? Identify all the items that changed owner’s capital duringthemonth,alongwiththeiramounts.Whichfinancialstatementprovidesthisinformation?

c. Howmuchcashdoesthecompanyhaveasitmovesintothenextmonth—thatis,May2014?Whichfinancialstatementprovidesthisinformation?

d. HowmuchdoclientsoweHECatApril30?Isthisanassetoraliabilityforthebusiness?Whatdoesthebusinesscallthisitem?

e. HowmuchdoesthebusinessoweoutsidersatApril30?Isthisanassetoraliabilityforthebusiness?Whatdoesthebusinesscallthisitem?


SalariesExpense _____

ConsultingServiceRevenue_____

Cash _____

NotesPayable _____

SuppliesExpense _____

AccountsPayable _____

MyAccountingLab

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As you review the details of each transaction, think of the names of the accounts that will be affected.

Summary problem for Your review

SamanthaTorresopensahomedesignbusinessinCalgary.Sheisthesoleownerof the proprietorship, which she names Torres Home Design. During the firstmonthofoperations,July2014,thefollowingtransactionsoccurred:

a. Torresinvests$80,000ofpersonalfundstostartthebusiness.b. Thebusinesspurchases,onaccount,officesuppliescosting$2,000.c. TorresHomeDesignpayscashof$56,000toacquireaparcelofland.Thebusi-

nessintendstousethelandasafuturebuildingsiteforitsbusinessoffice.d. Thebusinessprovidesservicesforclientsandreceivescashof$10,000.e. Thebusinesspays$1,500ontheaccountpayablecreatedinTransaction(b).f. Torrespays$6,500ofpersonalfundsforavacationforherfamily.g. Thebusinesspayscashexpensesforofficerent,$2,500,andutilities,$500.h. Thebusinessreturnstothesupplierofficesuppliesthatcost$300.Thewrong

supplieswereshipped.i. Torreswithdraws$3,000cashforpersonaluse.

Required

1. AnalyzetheprecedingtransactionsintermsoftheireffectsontheaccountingequationofTorresHomeDesign.UseExhibit1–9onpage22asaguidebutshowbalancesonlyafterthelasttransaction.

2. Preparetheincomestatement,statementofowner’sequity,andbalancesheetofTorresHomeDesignafterrecordingthetransactions.UseExhibit1–10onpage25asaguide.

SOLUTION1. PanelA:DetailsofTransactions

a.Torresinvested$80,000cashtostartthebusiness.b.Purchased$2,000inofficesuppliesonaccount.c. Paid$56,000toacquirelandasafuturebuildingsite.d.Earnedservicerevenueandreceivedcashof$10,000.e.Paid$1,500onaccount.f. Paidforapersonalvacation,whichisnotatransactionofthebusiness.g.Paidcashexpensesforrent,$2,500,andutilities,$500.h.Returnedofficesuppliesthatcost$300.i. Withdrew$3,000cashforpersonaluse.

Name: Torres Home DesignIndustry: Home design consultingFiscal Period: Month of July 2014

TheSummary Problem forYourReviewisanextensive,challengingreviewprob-lemthatpullstogetherthechapterconcepts.

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Assets

Office Cash 1 Supplies 1 Land

(a) +80,000(b) +2,000(c) - 56,000 + 56,000(d) + 10,000(e) - 1,500(f) Notabusinesstransaction(g) - 2,500

- 500(h) - 300(i) - 3,000Bal. 26,500 1,700 56,000

84,200

Liabilities

Owner’s Equity

Type of Owner’s Equity Transaction

Accounts Payable

Samantha Torres, Capital

+80,000 Owner investment+2,000

+10,000 Service revenue−1,500

- 2,500 Rent expense- 500 Utilities expense

− 300- 3,000 Owner withdrawal

200 84,000

84,200

Panel B: Analysis of Transactions

For each transac-tion, make sure the accounting equa-tion Assets = Liabilities + Owner’s Equity balances before going on to the next transaction.

2. Financial Statements of Torres Home Design

TORRES HOME DESIGN

Income Statement

For the Month Ended July 31, 2014

Revenue:

Servicerevenue $10,000

Expenses:

Rentexpense $2,500

Utilitiesexpense 500

Totalexpenses 3,000

NetIncome $ 7,000

TORRES HOME DESIGN

Statement of Owner’s Equity


SamanthaTorres,capital,July1,2014 $ 0

Add:Investmentbyowner 80,000

NetincomeforJuly 7,000

87,000

Less:Withdrawalbyowner 3,000

SamanthaTorres,capital,July31,2014 $84,000

=

1

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TORRES HOME DESIGN

Balance Sheet

July 31, 2014

Assets LiabilitiesCash $26,500 Accountspayable $200

Officesupplies 1,700

Owner’s EquityLand 56,000 SamanthaTorres,capital 84,000

Totalassets

$84,200

Totalliabilitiesand owner’sequity

$84,200

The title must include the name of the company, “Income Statement,” and the spe-cific period of time covered. It is critical that the time period be defined.Gather all the revenue and expense account names and amounts from Panel B. They appear in the Samantha Torres, Capital column.

• List the revenue account first.• List the expense accounts

next. Expenses are usually listed in alphabetical order.

The title must include the name of the company,“Statement of Owner’s Equity,” and the specific period of time covered. It is critical that the time period be defined.

The net income amount (or net loss amount) is transferred from the income statement.

The withdrawal amount is found in Panel B in the Saman-tha Torres, Capital column.

The title must include the name of the company, “Balance Sheet,” and the date of the bal-ance sheet. It shows the financial position on one specific date.

Gather all the asset and lia-bility accounts and Bal. amounts from Panel B. List assets first, then liabilities. The owner’s eq-uity amount is transferred from the statement of owner’s equity.

It is vital that Total Assets = Total Liabilities + Owner’s Equity

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Learning Objective 1: Define accounting, and describe the users of accounting information.

Define accounting, and describe the users of accounting information

• Accountingisaninformationsystemformeasuring,processing,andcommunicatingfinancialinformation.

• Asthe“languageofbusiness,”accountinghelpsawiderangeofusersmakebusinessdecisions.

• Examplesofusersincludeindividualinvestors,businesses,governmentagencies,andlenders.

MyAccountingLab Video:

Pg 5

Learning Objective 2: Explain why ethics and rules of conduct are crucial in accounting and business.

Explain why ethics and rules of conduct are crucial in accounting and business

• Ethicalconsiderationsaffectallareasofaccountingandbusiness.• Usersneedrelevantandreliableinformationaboutcompaniestomakedecisions.• TheprofessionalaccountinggroupsinCanadahavecodesofethicsandrulesofconductto

assuresocietythataccountantsbehaveethically


Pg 7

Learning Objective 3: Describe and discuss the forms of business organizations

Describe and discuss the forms of business organizations

• Thethreebasicformsofbusinessorganizationsarethe• proprietorship• partnership(alimited-liabilitypartnership,orLLP,isaspecialformofpartnership),and• corporation.

• AsummaryandcomparisonofthethreeformsaregiveninExhibit1–5onpage11.


Pg 9

Learning Objective 4: Explain the development of accounting standards, and describe the concepts and principles

Explain the development of accounting standards, and describe the concepts and principles

• Accountingconceptsguideaccountantsintheirwork.• Accountingconceptsthatprovidethebasisforaccountingstandardsforprivateenterprises

(ASPE)andinternationalfinancialreportingstandards(IFRS)aresummarizedinExhibit1–6:• Level1—Theprimaryobjectiveoffinancialstatementsistoprovideinformationthatis

usefulforusersintheirdecisionmaking.• Level2—Tobeuseful,theinformationmusthavethequalitativecharacteristicsofun-

derstandability,reliability,relevance,andcomparability.• Level3—TheLevel2characteristicsareachievedthroughtheuseofelementsto

categorizethefinancialinformation• Level4—TheLevel2characteristicsarealsoachievedbyfollowingtheguidelinesfor

recognitionandmeasurement.


Pg 11

Learning Objective 5: Describe and use the accounting equation to analyze business transactions

Describe and use the accounting equation to analyze business transactions

• Initsmostcommonform,theaccountingequationis

Assets = Liabilities + Owner'sEquity

• Atransactionisaneventthataffectsthefinancialpositionofanentityandcanbereliablyrecorded.

• Transactionsaffectabusiness’sassets,liabilities,andowner’sequity.Therefore,transac-tionsareoftenanalyzedintermsoftheireffectontheaccountingequation.


Pg 16

Summary

1

2

3

4

5

TheSummarygivesaconcisedescriptionofthematerialcoveredinthechapteralongwithpagereferences,soyoucanlinkbackintothechapterifyouwanttoreviewparticularmaterial.ItisorganizedbyLearningObjective.

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Learning Objective 6: Prepare and evaluate financial statements

Prepare and evaluate the financial statements

• Thefinancialstatementscommunicateinformationfordecisionmakingbyanentity’susers,includingmanagers,owners,andcreditors.

• Theincomestatement:• summarizestheentity’soperationsintermsofrevenuesearnedandexpensesincurred

duringaspecificperiodoftime.Totalrevenuesminustotalexpensesequalnetincome.• Thestatementofowner’sequityreportsthechangesinowner’sequityduringthe

period.• Thebalancesheetliststheentity’sassets,liabilities,andowner’sequityata

specific date.• Thecashflowstatementreportsthechangesincashduringtheperiod.

• Highnetincomeindicatessuccessinbusiness;anetlossindicatesalackofsuccessinbusiness.

Pg 23

MyAccountingLab Video: Relationships among the Financial Statements

MyAccountingLab Check Accounting Vocabulary on page 33 for all key terms used in Chapter 1 and the Glossary on page 000 for all key terms used in the textbook.

6

MyAccountingLab StudentPowerPointSlides

MyAccountingLab AudioChapterSummary

MyAccountingLab AvarietyofvideosaboutChapter1topics.

Note:AllMyAccountingLabresourcesarefoundonlineunderChapterResources–MultimediaLibrary

CHAPTER REVIEw:

Testyourunderstandingwiththesemultiple-choiceSelf-Study Questions.Pagereferencesaregivenifyouneedreview,andtheanswersaregivenafterSelf-StudyQuestion12.

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Highlight

<AU/ED: To advise, this page reference will be updated once Glossary is paginated.>


1.c2.d3.c4.a5.b6.b7.c8.a9.b10.c11.b12.c

Answers to Self-Study Questions

SELF-STUDY QUESTIONSTestyourunderstandingofthechapterbymarkingthecor-rectanswerforeachofthefollowingquestions:

1. The organization that formulates generally acceptedaccountingprinciplesisthe(p.12)a. OntarioSecuritiesCommission(OSC)b. PublicAccountantsCouncilofCanadac. AccountingStandardsBoard(AcSB)d. CanadaRevenueAgency(CRA)

2. Whichofthefollowingformsofbusinessorganizationisan“artificialperson’’andmustobtainlegalapprovalfromthefederalgovernmentoraprovincetoconductbusiness?(p.10)a. Lawfirmb. Proprietorshipc. Partnershipd. Corporation

3. YouhavepurchasedsomeT-shirts for$6,000andcansellthemimmediatelyfor$8,000.Whataccountingcon-sideration, assumption, or characteristic governs theamountatwhichtorecordthegoodsyoupurchased?(p.15)a. Economic-entityconsiderationb. Reliabilitycharacteristicc. Costprincipled. Going-concernassumption

4. Theeconomicresourcesofabusinessarecalled(p.16)a. Assetsb. Liabilitiesc. Owner’sequityd. Accountspayable

5. Iftheassetsofabusinessare$200,000andtheliabilitiesare$90,000,howmuchistheowner’sequity?(p.16)a. $290,000b. $110,000c. $200,000d. $90,000

6. A business has assets of $160,000 and liabilities of$180,000.Howmuchisitsowner’sequity?(p.16)a. $0b. ($20,000)

c. $160,000d. $340,000

7. If theowner’s equity inabusiness is $70,000and theliabilitiesare$35,000,howmucharetheassets?(p.16)a. $35,000b. $70,000c. $105,000d. $35,000

8. Purchasingofficesuppliesonaccountwill(p.18)a. Increaseanassetandincreasealiabilityb. Increaseanassetandincreaseowner’sequityc. Increaseoneassetanddecreaseanotherassetd. Increaseanassetanddecreasealiability

9. Performingaserviceforacustomerorclientandreceiv-ingthecashimmediatelywill(p.19)a. Increaseoneassetanddecreaseanotherassetb. Increaseanassetandincreaseowner’sequityc. Decreaseanassetanddecreasealiabilityd. Increaseanassetandincreasealiability

10. Payinganaccountpayablewill(p.20)a. Increaseoneassetanddecreaseanotherassetb. Decreaseanassetanddecreaseowner’sequityc. Decreaseanassetanddecreasealiabilityd. Increaseanassetandincreasealiability

11. Thefinancialstatementthatsummarizesassets,liabili-ties,andowner’sequityiscalledthe(p.24)a. Cashflowstatementb. Balancesheetc. Incomestatementd. Statementofowner’sequity

12. The financial statements that are dated for a timeperiod(ratherthanforaspecificpointintime)arethe(pp.24–25)a. Balancesheetandincomestatementb. Balancesheetandstatementofowner’sequityc. Incomestatement,statementofowner’sequity,and

cashflowstatementd. Allfinancialstatementsaredatedforatimeperiod.

MyAccountingLab

CheckhowwellyouansweredtheSelf-StudyQuestions.

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Like many other subjects, accounting has a special vocabulary. It is important that you understand the following terms.

Account payable Aliabilitythatisbackedbythegeneralreputationandcreditstandingofthedebtor (p.19).

Account receivable Anasset,apromisetoreceivecashfromcustomerstowhomthebusinesshassoldgoodsorservices (p.19).Accounting Thesystemthatmeasuresbusinessactivities,processesthatinformationintoreportsandfinancialstatements,andcommunicatesthefindingstodecisionmakers (p.5).

Accounting equation Themostbasictoolofaccounting:Assets=Liabilities+Owner’sEquity(proprietorship)orAssets=Liabilities+Shareholders’Equity(corporation) (p.16).

Accounting Standards for Private Enterprises (ASPE) CreatedbytheAccountingStandardsBoard,guidelinesforreportingthefinancialresultsofnon-publiclyaccountableenterprisesinCanada (p.12).

Asset Aneconomicresourceabusinessownsthatisexpectedtobeofbenefitinthefuture (p.16).

Audit Theexaminationoffinancialstatementsbyoutsideaccountants,themostsignificantservicethatpublicaccountantsperform.Theconclusionofanauditistheaccountant’sprofessionalopinionaboutthefinancialstatements (p.7).

Balance sheet Listofanentity’sassets,liabilitiesandowner’sequity(proprietorship)orshareholders’equity(corporation)asofaspecificdate. Alsocalledthestatement of financial position (p.24).

Capital Anothernamefortheowner’sequityofabusiness (p.16).

Cash flow statement Reportscashreceiptsandcashpaymentsclassifiedaccordingtotheentity’smajoractivities:operating,investing,andfinancing (p.24).

Corporation Abusinessownedbyshareholdersthatbeginswhenthefederalgovernmentorprovin-cialgovernmentapprovesitsarticlesofincorpora-tion.Acorporationisalegalentity,an“artificialperson,”intheeyesofthelaw (p.10).

Cost principle of measurement Statesthatassetsandservicesarerecordedattheirpurchasecostandthattheaccountingrecordoftheassetcontinuestobebasedoncostratherthancurrentmarketvalue (p.15).

Entity Anorganizationorasectionofanorganizationthat,foraccountingpurposes,standsapartfromotherorganizationsandindividualsasaseparateeconomicunit.Thisisthemostbasicconceptinaccounting (p.14).

Expense Decreaseinowner’sequity(proprietor-ship)orshareholders’equity(corporation)thatoccursinthecourseofdeliveringgoodsorservicestocustomersorclients (p.17).

Financial accounting Thebranchofaccountingthatprovidesinformationtopeopleoutsidethebusiness (p.6).

Financial statements Businessdocumentsthatreportfinancialinformationaboutanentitytopersonsandorganizationsoutsidethebusiness (p.5).Generally accepted accounting principles (GAAP) Accountingguidelines,formulatedbytheAccountingStandardsBoard,thatgovernhowbusi-nessesreporttheirresultsinfinancialstatementstothepublic (p.11).

Going-concern assumption Accountants’assump-tionthatthebusinesswillcontinueoperatingintheforseeablefuture (p.14).

Income statement Listofanentity’srevenues,expenses,andnetincomeornetlossforaspecificperiod.Alsocalledthestatement of earningsorstatement of operations (p.23).

Inflation Ariseinthegenerallevelofprices(p.15).International Financial Reporting Standards (IFRS) CreatedbytheInternationalFederationofAccountants,guidelinesforreportingthefinan-cialresultsofpubliclyaccountableenterprisesandacceptedbyover110countriesintheworld.Canadaadoptedthesestandardsin2011forpubliclyaccountableenterprises (p.12).

Liability Aneconomicobligation(adebt)payabletoanindividualoranorganizationoutsidethebusi-ness (p.16).

Limited-liability partnership (LLP) Aformofpartnershipinwhicheachpartner’spersonalliabilityforthebusiness’sdebtsislimitedtoacertainamount (p.11).

Management accounting Thebranchofaccount-ingthatgeneratesinformationforinternaldecisionmakersofabusiness,suchastopexecutives (p.6).

Measurement Theprocessofdeterminingtheamountatwhichanitemisrecognizedinthefinancialstatements (p.15).Net earnings Anothernamefornetincomeornetprofit (p.23).

ACCOUNTING VOCABULARY MyAccountingLab

Accounting Vocabularylistsallthenewboldfacedtermsthatwereexplainedinthechapterwiththeirdefinitions.TheyarealsodefinedintheGlossary.Pagereferenceshelpyoutoreviewtheterms.

M01_HORN0096_01_SE_C01.indd 33 10/4/12 1:12 PM


Net income Excessoftotalrevenuesovertotalexpenses.Alsocallednet earningsornet profit (p.23).

Net loss Excessoftotalexpensesovertotalrev-enues (p.23).

Net profit Anothernamefornetincomeornetearnings (p.23).

Note payable Aliabilityevidencedbyawrittenpromisetomakeafuturepayment (p.19).

Owner’s equity Inaproprietorship,theclaimofanownerofabusinesstotheassetsofthebusiness.Alsocalledcapital (p.16).

Owner withdrawals Amountsremovedfromthebusinessbyanowner (p.17).

Partnership Anunincorporatedbusinesswithtwoormoreowners (p.10).

Proprietorship Anunincorporatedbusinesswithasingleowner (p.9).

Publicly accountable enterprise Acorporationthathasitssharestradedonastockexchangeorforwhichastrongpublicinterestexists (p.12).

Recognition Theprocessofincludinganiteminthefinancialstatementsofacompany (p.15).

Revenue Increaseinowner’sequity(proprietor-ship)orshareholders’equity(corporation)thatisearnedbydeliveringgoodsorservicestocustomersorclients (p.17).

Shareholder Apersonorcompanywhoownsoneormoresharesofstockinacorporation (p.10).

Stable monetary unit assumption Accountants’basisforignoringtheeffectofinflationandmakingnoadjustmentsforthechangingvalueofthedollar (p.15).

Statement of earnings Anothernamefortheincomestatement (p.23).

Statement of financial position Anothernameforthebalancesheet (p.24).

Statement of operations Anothernamefortheincomestatement.Alsocalledthestatement of earnings (p.23).

Statement of owner’s equity Summaryofthechangesinanentity’sowner’sequityduringaspecificperiod (p.23).

Transaction Aneventthataffectsthefinancialpositionofaparticularentityandmaybereliablyrecorded (p.17).

SIMILAR ACCOUNTING TERMSAccounting equation Assets = Liabilities + Owner’sEquityBalance Sheet StatementofFinancialPositionIncome Statement StatementofOperations;StatementofEarningsNet income Netearnings;Netprofit

Similar Accounting Terms arealinkbetweenthetermsusedinthisbookandsimilartermsyoumighthaveheardout-sideyouraccountingclassinthemediaoryourday-to-daybusinessdealings.

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QUESTIONS

Assignment Material

1. Distinguishbetweenaccountingandbookkeeping.

2. Identify five users of accounting information andexplainhowtheyuseit.

3. Nametwoimportanthistoricalreasonsforthedevel-opmentofaccounting.

4. Namethreeprofessionaldesignationsofaccountants.Alsogivetheirabbreviations.

5. What organization formulates generally acceptedaccounting principles? Is this organization a govern-mentagency?

6. Identify the owner(s) of a proprietorship, a partner-ship,andacorporation.

7. Whydoethicalstandardsexist inaccounting?Whichprofessional organizations direct their standardsmore toward independentauditors?Whichorganiza-tionsdirecttheirstandardsmoretowardmanagementaccountants?

8. Whyistheeconomic-entityassumptionsoimportanttoaccounting?

9. Givefourexamplesoftypesofaccountingentities.

10. Brieflydescribethereliabilitycharacteristic.

11. Whatroledoesthecostprincipleofmeasurementplayinaccounting?

12. If assets = liabilities + owner’s equity, then how canliabilitiesbeexpressed?

13. Explainthedifferencebetweenanaccountreceivableandanaccountpayable.

14. Whatroledotransactionsplayinaccounting?

15. Acompanyreportedmonthlyrevenuesof$92,000andexpensesof $96,400.What is the resultofoperationsforthemonth?

16. Giveamoredescriptivetitleforthebalancesheet.

17. Whatfeatureof thebalancesheetgivesthisfinancialstatementitsname?

18. Giveanothertitlefortheincomestatement.

19. Which financial statement is like a snapshot of theentityataspecifictime?Whichfinancialstatementislikeavideooftheentity’soperationduringaperiodof time?

20. What information does the statement of owner’sequityreport?

21. Give another term for the owner’s equity of aproprietorship.

22. What piece of information flows from the incomestatement to the statement of owner’s equity? Whatinformation flows from the statement of owner’sequitytothebalancesheet?Whatbalancesheetitemisexplainedbythecashflowstatement?

23. Why does it make sense that Canadian companieswhosesharesarepubliclytradedonstockexchangesin Canada follow international financial reportingstandardsinsteadofstandardsdevelopedforprivatecompaniesinCanada?

MakethegradewithMyAccountingLab:TheStarters,Exercises,andProblemsmarkedinred canbefoundonMyAccountingLab.Youcanpractisethemasoftenasyouwant,andmostfeaturestep-by-stepguidedinstructionstohelpyoufindtherightanswer.

MyAccountingLab

STARTERS

Starter 1–1 Ralph’sLandscapingServicehasbeenopenforoneyear,andRyanRalph,theowner,wantstoknowwhetherthebusinessearnedanetincomeoranet loss for the year. First, he must identify the revenues earned and theexpensesincurredduringtheyear.Whatarerevenuesandexpenses?

Starter 1–2 Suppose you need a bank loan to purchase lawn equipment for Ralph’sLandscapingService.Inevaluatingyourloanrequest,thebankerasksabouttheassetsandliabilitiesofyourbusiness.Inparticular,thebankerwantstoknowtheamountofthebusiness’sowner’sequity.

Required

1. Isthebankerconsideredaninternaloranexternaluseroffinancialinformation?2. Whichfinancialstatementwouldprovidethebestinformationtoanswerthe

banker’squestions?

1 5

Explainingrevenuesandexpenses

AbriefdescriptionandtheLearningObjectivescoveredappearbesideeachStarter,Exercise,andProblem.

1Usersoffinancialinformation

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Starter 1–3 LouiseLaytonplanstoopenLouise’sFloralDesigns.Sheisconsideringthevarioustypesofbusinessorganizationsandwishestoorganizeherbusinesswith unlimited life and limited liability features. Which type of businessorganizationwillmeetLouise’sneedsbest?

Starter 1–4 ErinChan is theproprietorofapropertymanagementcompanynear thecampusofalocaluniversity.Thebusinesshascashof$12,000andfurniturethatcost$24,000andhasamarketvalueof$30,000.Debtsincludeaccountspayable of $10,000. Chan’s personal home is valued at $400,000 and herpersonalbankaccountcontains$12,000.

Required

1. Considertheaccountingconceptsandprinciplesdiscussedinthechapter,anddefinetheprinciplethatbestmatcheseachofthefollowingsituations:

a. Chan’s personal assets are not recorded on the property management company’sbalancesheet.

b. Chanrecordsfurnitureatitscostof$24,000,notthemarketvalueof$30,000.c. Chandoesnotmakeadjustmentsforinflation.d. The account payable of $10,000 is documented by a statement from the furniture

companyshowingthepropertymanagementcompanystillowes$10,000onthefur-niture.Chan’s friend thinks thepropertymanagementcompanyshouldonlyoweabout$6,000.Theaccountpayableisrecordedat$10,000.

2. Howmuchistheowner’sequityofthepropertymanagementcompany?

Starter 1–5 LazyCreekKennelearnsservicerevenuebycaringforthepetsofcustom-ers. Lazy Creek’s main expense is the salary paid to an employee. Writetheaccountingequationfor(a)thereceiptof$500cashforservicerevenueearned,and(b)thepaymentof$1,500forsalaryexpense.

Starter 1–6 OutdoorAdventuresTravelrecordedrevenuesof$3,000earnedonaccountbyprovidingtravelserviceforclients.

Required

1. Howmucharethebusiness’scashandtotalassets,assumingthisistheonlytransaction?

2. Namethebusinessassetthatwasincreasedasaresultofthistransaction.

Starter 1–7 Matchtheassumption,principle,orconstraintdescriptionwiththeappro-priatetermbyplacinga,b,c,d,e,andfontheappropriateline.

a. Costprincipleofmeasurement

______ Benefitsoftheinformationpro-ducedbyanaccountingsystemmustbegreaterthanthecosts

b. Going-concernassumption

______ Amountsmaybeignorediftheeffectonadecisionmaker’sdecisionisnotsignificant

c. Stablemonetaryunitassumption

______ Transactionsarerecordedbasedonthecashamountreceivedorpaid

d. Economic-entityassumption

______ Transactionsareexpressedusingunitsofmoney

e. Cost/benefitconstraint

______ Assumesthatabusinessisgoingtocontinueoperationsindefinitely

f. Materialityconstraint ______ Businessmustkeepitsaccountingrecordsseparatefromitsowner’saccountingrecords

Starter 1–8 SupposeMayneIslandKayaksrentskayakstotourists.Thecompanypur-chased a storage building for the kayaks for $200,000 and financed thepurchasewitha loanof$120,000andaninvestmentbytheownerfortheremainder. Use the accounting equation to calculate the owner’s equityamount.

3 AFormsofbusinessorganizations

4

Applyingaccountingconceptsandprinciples

5Usingtheaccountingequation


5Analyzingtransactions

4

Describingaccountingconcepts,principles,andconstraints

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Starter 1–9 Apotentialcustomerisextremelyinterestedinrentinganumberofkayaksfrom Mayne Island Kayaks and emails his intention to rent kayaks in thesummer.Wouldanaccountantconsiderthiseventatransactiontoberecordedintheaccountingrecords?Explain.

Starter 1–10 What four main financial statements are provided in a company’s annualreport?Anexampleofacompany’s’annualreportisprovidedinAppendixAatthebackofthistextbook.

Starter 1–11LaurelWeddingPlannershasjustcompletedoperationsfortheyearendedDecember 31, 2014. This is the third year of operations for the company.Astheowner,youwanttoknowhowwellthecompanyperformedduringtheyear.Toaddressthisquestion,youhaveassembledthedatabelow.UsethesedatatopreparetheincomestatementofLaurelWeddingPlannersfortheyearendedDecember31,2014.

InsuranceExpense.............. $3,000 SalaryExpense..................... $50,000ServiceRevenue.................. 120,000 AccountsPayable................ 8,000SuppliesExpense................. 1,000 Supplies................................ 2,500RentExpense ..................... 18,000 Withdrawals........................ 40,000

Starter 1–12 ReviewtheincomestatementpreparedinStarter1-11.Evaluatetheresultsof2014operations forLaurelWeddingPlanners.Was itagoodyearorabadyear?Whyorwhynot?

EXERCISES

Exercise 1–1Matcheachofthefollowingaccountingtermswithitscorrectdefinition:

TERMS: DEFINITIONS:

1. Accountingequation

2. Asset

3. Balancesheet

4. Expense

5. Incomestatement

6. Liability

7. Netincome

8. Netloss

9. Revenue

10. Cashflowstatement

11. Statementofowner’sequity

A. Aneconomicresourcethatisexpectedtobeofbenefitinthefuture

B. Aneconomicobligation(adebt)payabletoanindividualoranorganizationoutsidethebusiness

C. ExcessoftotalexpensesovertotalrevenuesD. ExcessoftotalrevenuesovertotalexpensesE. Thebasictoolofaccounting,statedasAssets =

Liabilities + Owner’sEquityF. Decreaseinequitythatoccursfromusingassets

orincreasingliabilitiesinthecourseofdeliveringgoodsorservicestocustomers

G. Amountsearnedbydeliveringgoodsorservicestocustomers

H. Reportofcashreceiptsandcashpaymentsduringaperiod

I. Reportofanentity’sassets,liabilities,andowner’sequityasofaspecificdate

J. Reportofanentity’srevenues,expenses,andnetincomeornetlossforaperiodoftime

K. Report that shows the changes in owner’s equityforaperiodoftime

Exercise 1–2JimandAndreaKerslakewanttoopenarestaurant.Inneedofcash,theymeetwiththeirbankmanagerforaloan.Withlittleknowledgeoffinance,theKerslakesdon’tknowhowthelendingprocessworks.Explaintothemtheinformationprovidedtothebankbytheincomestatement(statementofoperations)andthebalancesheet(statementoffinancialposition).Indicatewhyalenderwouldrequirethisinformation.

Exercise 1–3PubliclyaccountableenterprisesinCanadamustuseinternationalfinancialreportingstan-dards (IFRS) in preparing their financial statements. Provide two reasons why Canadaswitchedtothesestandards.

5Definingtransactions

6Examplesoffinancialstatements

6Preparingtheincomestatement

Netincome,$48,000

6Evaluatingbusinessperformance

5 6Usingaccountingvocabulary

1 6

Usersoffinancialstatements,explainingtheincomestatementandthebalancesheet

Checkfiguresappearinthemarginwhenapplicabletohelpyoumake

sureyouare“ontrack.”

4

Reasonsforfollowinginternationalfinancialreportingstandards(IFRS)

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Exercise 1–4TheaccountingrecordsofChiangConsultingServicescontainthefollowingaccounts:

SuppliesExpense AccountsPayable

AccountsReceivable RentExpense

J.Chiang,Capital Cash

SalaryExpense J.Chiang,Withdrawals

ComputerEquipment Supplies

ConsultingServiceRevenue NotesPayable

Required

1. Indicatewhethereachaccountlistedisa(n)asset(A),liability(L),owner’sequity(OE),revenue(R),orexpense(E)account.

2. Indicatewhethereachaccountlistedappearsonthebalancesheet(B),incomestatement(I),statementofowner’sequity(SOE),orcashflowstatement(CF).Someaccountscanappearonmorethanonestatement.

Exercise 1–5Give an example of a business transaction that has each of the following effects on theaccountingequation:

a. Increasesanassetandincreasesaliability.

b. Increasesoneassetanddecreasesanotherasset.

c. Decreasesanassetanddecreasesowner’sequity.

d. Decreasesanassetanddecreasesaliability.

e. Increasesanassetandincreasesowner’sequity.

Exercise 1–6PeaceRiverEnterprises,abusinessownedbyAlanSidhu,experiencedthefollowingevents.Statewhethereachevent(1)increased,(2)decreased,or(3)hadnoeffectonthetotal assetsofthebusiness.Identifyanyspecificassetaffected.

a. Sidhuincreasedhiscashinvestmentinthebusiness.

b. Paidcashonaccountspayable.

c. Purchasedofficeequipment;signedanotepayableinpayment.

d. Performedserviceforacustomeronaccount.

e. Sidhuwithdrewcashforpersonalexpenses.

f. Receivedcashfromacustomeronaccountreceivable.

g. Sidhuusedpersonalfundstopurchaseaswimmingpoolforhishome.

h. Soldundesirablelandforapriceequaltothecostoftheland;receivedcash.

i. Borrowedmoneyfromthebank.

j. Cashpurchaseofdesirablelandforafuturebuildingsite.

Exercise 1–7Selectfinancialinformationforthreeproprietorshipsfollows:

Assets Liabilities Owner’s EquityEconomyCuts $? $120,000 $40,000

MarpoleDryCleaners 100,000 ? 50,000

DauphinGiftandCards 145,000 115,000 ?

5 6

Classifyingaccounts,workingwithfinancialstatements

5Businesstransactions

5Transactionanalysis

Characteristicsofaproprietorship,accounting

conceptsandprinciples,usingtheaccountingequation

3 4 5

MarpoleDryCleanersliabilities,$50,000

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Required

1. Computethemissingamountintheaccountingequationforeachentity.

2. Whichaccountingconceptorprinciple tellsus that thethreecompanieswillceasetoexistiftheownersdie?

Exercise 1–8JaniceThorpeownsGrindsCoffeeHouse,nearthecampusofWesternCommunityCollege.Thecompanyhascashof$18,000andfurniturethatcost$40,000.Debtsincludeaccountspayable of $7,000 and a $30,000 note payable. Write the accounting equation of GrindsCoffeeHouse.Whatistheowner’sequityofthecompany?

Exercise 1–9PrairieSnowremovalbegan2014withtotalassetsof$44,000andtotalliabilitiesof$18,000.Attheendof2014,thebusiness’stotalassetswere$50,000andtotalliabilitieswere$20,000.

Required

1. Didtheowner’sequityofPrairieSnowRemovalincreaseordecreaseduring2014?Byhowmuch?

2. Identifytwopossiblereasonsforthechangeinowner’sequityofPrairieSnowRemovalduringtheyear.

Exercise 1–10Indicatetheeffectsofthefollowingbusinesstransactionsontheaccountingequationofaproprietorship.Transactionaisansweredasaguide.

a. Received$50,000cashfromtheowner.

Answer:Increaseasset(Cash)

Increaseowner’sequity(Owner,Capital)

b. Paidthecurrentmonth’sofficerentof$4,000.

c. Paid$3,500cashtopurchaseofficesupplies.

d. Performedengineeringservicesforaclientonaccount,$6,000.

e. Purchasedonaccountofficefurnitureatacostof$5,000.

f. Receivedcashonaccount,$3,000.

g. Paidcashonaccount,$2,500.

h. Soldlandfor$50,000,whichwasthebusiness’scostoftheland.

i. Performedengineeringservicesforaclientandreceivedcashof$6,000.

Exercise 1–11GayleHayashi,M.D.,opensamedicalclinic.Duringherfirstmonthofoperation,January,theclinic,entitledHayashiMedicalClinic,experiencedthefollowingevents:

Jan. 6 Hayashiinvested$250,000intheclinicbyopeningabankaccountinthenameofHayashiMedicalClinic.

9 HayashiMedicalClinicpaidcashforlandcosting$150,000.Thereareplanstobuildaclinicontheland.Untilthen,thebusinesswillrentanoffice.

12 Theclinicpurchasedmedicalsuppliesfor$10,000onaccount.

15 OnJanuary15,HayashiMedicalClinicofficiallyopenedforbusiness.

15–31 Duringtherestofthemonth,theclinicearnedprofessionalfeesof$20,000andreceivedcashimmediately.

15–31 Theclinicpaidcashexpenses: employeesalaries,$5,000;office rent,$4,000;utilities,$500.

28 Theclinicsoldsuppliestoanotherclinicatcostfor$1,000.

31 Theclinicpaid$4,000ontheaccountfromJanuary12.


Owner’sequity$21,000

5 6

Usingtheaccountingequation,evaluatingbusinessperformance

1.Increaseinowner’sequity$4,000

5

Transactionanalysis

Excel Spreadsheet Template

5

Transactionanalysis,accountingequation

Totalassets$266,500

ThismarginnoteremindsyouthatanExceltemplateisavail-ableinMyAccountingLabtohelpyouanswerthisquestion.

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Required AnalyzetheeffectsoftheseeventsontheaccountingequationofHayashiMedicalClinic.UseaformatsimilartothatofExhibit1–9,PanelB,onpage22withhead-ingsfor:Cash;MedicalSupplies;Land;AccountsPayable;andGayleHayashi,Capital.

Exercise 1–12TheanalysisofthetransactionsthatOakdaleEquipmentRentalengagedinduringitsfirstmonthofoperationsfollows.Thebusinessbuyselectronicequipmentthatitrentsouttoearnrentalrevenue.Theownerofthebusiness,GaryOake,madeonlyoneinvestmenttostartthebusinessandmadenowithdrawalsfromOakdaleEquipmentRental.

Cash 1

Accounts Receivable 1

Rental Equipment 5

Accounts Payable 1

G. Oake, Capital

a. +50,000 + 50,000

b. + 1,000 + 1,000

c. +80,000 +80,000

d. + 1,000 + 1,000

e. -2,000 -2,000

f. +4,500 +4,500

g. +500 - 500

h. -5,000 –5,000

Required

1. DescribeeachtransactionofOakdaleEquipmentRental.

2. IfthesetransactionsfullydescribetheoperationsofOakdaleEquipmentRentalduringthemonth,whatwastheamountofnetincomeornetloss?

Exercise 1–13Presentedbeloware thebalancesof theassetsand liabilitiesofSummerlandConsultingServicesasofSeptember30,2014.Alsoincludedaretherevenueandexpenseaccountbal-ancesof thebusiness forSeptember.MeganHall, theowner, invested$60,000when thebusinesswasformed.

ConsultingService..............Revenue

$62,000 Computer...............Equipment

$80,000

AccountsReceivable........... 25,000 Supplies................... 5,000

AccountsPayable................ 16,000 NotePayable........... 50,000

SalaryExpense..................... 10,000 RentExpense.......... 4,000

M.Hall,Capital................... ? Cash......................... 5,000

Required

1. WhattypeofbusinessentityororganizationisSummerlandConsultingServices?Howcanyoutell?

2. PreparethebalancesheetofSummerlandConsultingServicesasofSeptember30,2014.

3. Whatdoesthebalancesheetreport—financialpositionoroperatingresults?Whichfinancialstatementreportstheotherinformation?

Exercise 1–14Examine Exhibit 1–9 on page 22. The exhibit summarizes the transactions of HunterEnvironmental Services for the month of April 2013. Suppose the business completedtransactions1to7andneededabankloanonApril21,2013.Thevice-presidentofthebankrequiresfinancialstatementstosupportallloanrequests.

5 6

Businessorganizations,transactions,netincome

2.Netincome$4,500

3 6

BBusinessorganization,balance

sheet

2.Totalassets$110,000

Preparingthefinancialstatements

Totalassets$295,0006

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Required Preparetheincomestatement,statementofowner’sequity,andbalancesheetthatHunterEnvironmentalServiceswouldpresenttothebankeronApril21,2013,aftercompletingthefirstseventransactions.Exhibit1–10,page25,showstheformatof thesefinancialstatements.

Exercise 1–15Theassets,liabilities,owner’sequity,revenueandexpensesofPhilpottCompany,apropri-etorship,havethefollowingfinalbalancesatDecember31,2015,theendofitsfirstyearofbusiness.Tostartthebusiness,BrianPhilpottinvested$90,000.

NotePayable............................. $50,000 OfficeFurniture............. $50,000

UtilitiesExpense....................... 18,000 RentExpense................. 48,000

AccountsPayable..................... 12,000 Cash................................ 15,000

B.Philpott,Capital................... 90,000 OfficeSupplies.............. 14,000

ServiceRevenue....................... 610,000 SalaryExpense.............. 430,000

AccountsReceivable................ 35,000 SalaryPayable............... 5,000

SuppliesExpense...................... 30,000 ResearchExpense.......... 27,000

Equipment................................. 100,000

Required

1. Prepare the incomestatementofPhilpottCompanyfor theyearendedDecember31,2015.WhatisPhilpottCompany’snetincomeornetlossfor2015?(Hint:Ignorebalancesheetitems.)


6

Incomestatementforapropri-etorship

1.Netincome$57,000

5 6

Transactionanalysis,accountingequation,financialstatements

Totalassets,$36,750

SERIAL EXERCISEThe Serial Exercise involves a company that will be revisited throughout relevant chapters in Volume 1 and Volume 2. It begins as a proprietorship in Volume 1, and then grows to a partnership and then a corporation in Volume 2.You can complete the Serial Exercises using MyAccountingLab.

Exercise 1–16Kerr Consulting began operations and completed the following transactions duringDecember2013.

Dec. 2 Received$30,000cashfromownerAlexKerr.Thebusinessgaveowner’sequityinthebusinesstoKerr.

2 PaidofficerentforthemonthofDecember,$3,000 3 PaidcashforaDellcomputer,$2,000.Thecomputerisexpectedtoremainin

serviceforfiveyears. 4 Purchasedofficefurnitureonaccount,$6,000.Thefurnitureisexpectedtolast

forfiveyears. 5 Purchasedsuppliesonaccount,$500. 9 Performedconsultingservicesforaclientonaccount,$2,000. 12 Paidutilityexpenses,$250. 18 Performedconsultingservicesforaclientandreceivedcashof$2,000 21 Received$2,000inadvanceforclientservicestobeperformedevenlyoverthe

next30days.(UsetheaccountUnearnedRevenueforthistransaction.) 22 Hired an office manager, on a part-time basis. She will be paid $2,000 per

month.Shestartedworkimmediately. 23 Paid$500forthesuppliespurchasedonDecember5. 28 Collected$1,500fromtheconsultingclientinvoicedonDecember9. 31 AlexKerrwithdrew$2,000forpersonaluse.


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CHALLENGE EXERCISES

Exercise 1–17Computethemissingamountsforeachofthefollowingbusinesses.

Fraser Co. Delta Co. Pine Co.

Beginning:

Assets............................................. $350,000 $300,000 $540,000

Liabilities....................................... 200,000 120,000 360,000

Ending:

Assets............................................. $500,000 $360,000 $?

Liabilities....................................... 250,000 160,000 480,000

Owner’s equity:

Investmentsbyowner.................. $? $0 $50,000

Withdrawalsbyowner................. 250,000 150,000 220,000

Income Statement:

Revenues.......................................Expenses........................................

$660,000460,000

$350,000?

$900,000675,000

Exercise 1–18MeritLogistics’balancesheetdataareshownbelow.

January 1, 2014 December 31, 2014

Totalassets $300,000 $420,000

Totalliabilities 260,000 340,000

Required

1. ComputetheamountofnetincomeornetlossforthecompanyduringtheyearendedDecember31,2014,iftheownerinvested$50,000inthebusinessandwithdrew$30,000duringtheyear.Showallcalculations.

2. Prepare the statement of owner’s equity for Sandy Merit, the owner of MeritLogistics, for the year ended December 31, 2014. Use the format shown inExhibit1–10onpage 25.

BEYOND THE NUMBERS

Beyond the Numbers 1–1AsananalystforRoyalBank,itisyourjobtowriterecommendationstothebank’sloancommittee.VernonEngineeringCo., a clientof thebank,has submitted these summarydatatosupportthecompany’srequestfora$150,000loan:

Required

1. AnalyzetheeffectsofKerrConsulting’stransactionsontheaccountingequation.UsetheformatofExhibit1-9,PanelB,onpage22,andusetheseheadings:Cash;AccountsReceivable;Supplies;Equipment;Furniture;AccountsPayable;UnearnedRevenue;andAlexKerr,Capital.

InChapter2,wewillaccountforthesesametransactionsinadifferentway—astheaccount-ingisactuallyperformedinpractice.

5 6

Usingthefinancialstatements

2Netincome:FraserCo.$200,000DeltaCo.$170,000PineCo.$225,000

5 6

Usingtheaccountingequation,preparingthestatementof

owner’sequity

2.Netincome$20,000

1 6Analyzingaloanrequest

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Income Statement Data 2014 2013 2012

Totalrevenues $550,000 $490,000 $475,000

Totalexpenses 400,000 345,000 305,000

Netincome $150,000 $145,000 $170,000

Statement of Owner’s Equity Data 2014 2013 2012

Beginningcapital $230,000 $205,000 $215,000

Add:Netincome 150,000 145,000 170,000

$380,000 $350,000 $385,000

Less:Withdrawals (175,000) (120,000) (180,000)

Endingcapital $205,000 $230,000 $205,000

Balance Sheet Data 2014 2013 2012

Totalassets $450,000 $425,000 $375,000

Totalliabilities $245,000 $195,000 $170,000

Totalowner’sequity 205,000 230,000 205,000


$450,000 $425,000 $375,000

Required Analyzethesefinancialstatementdatatodecidewhetherthebankshouldlend$150,000toVernonEngineeringCo.Considerthetrendsinnet incomeandown-er’s equity, and the change in total liabilities in making your decision. Write a one-paragraphrecommendationtothebank’sloancommittee.

Beyond the Numbers 1–2ShiningStarCampconductssummercampsforchildrenwithphysicalchallenges.Becauseofthenatureof itsbusiness,ShiningStarCampexperiencesmanyunusualtransactions.Evaluateeachof thefollowingtransactions intermsof itseffectonShiningStarCamp’sincomestatementandbalancesheet.

a. Acampersufferedadentalinjurythatwasnotcoveredbyinsurance.ShiningStarCamppaid$1,000forthechild’sdentalcare.Howdoesthistransactionaffecttheincomestate-mentandthebalancesheet?

b. Onecamper’smotherisaphysician.ShiningStarCampallowsthischildtoattendcampin return for the mother’s serving part-time in the camp infirmary for the two-weekterm.Thestandardfeeforacamptermis$1,500.Thephysician’ssalaryforthispart-timeworkwouldbe$1,500.HowshouldShiningStarCampaccountforthisarrangement?

c. Lightningduringastormdamagedthecampdininghall.Thecosttorepairthedamagewillbe$5,000overandabovewhattheinsurancecompanywillpay.

ETHICAL ISSUES

Ethical Issue 1The following excerpt was taken from the President’s letter to the shareholders inCVTechnology’s2007AnnualReport:

Inthefallof2006,encouragedbyenthusiasmfromAmericanretailers,welaunchedCOLD-fX®intheU.S.InthefaceofunexpectedlyhighreturnratesfromU.S.retail-ers, we announced on April 11, 2007 that we would restate our financial results,duetoareconsiderationofthewayweapplyourrevenuerecognitionpolicy.Asaresultofourannouncement,SecuritiesCommissions inAlberta,BritishColumbia,andOntarioissuedinterimtradinghaltsonourshares.Afterrestatedfinancialswerereleased,tradinginthesharesresumedonJuly11,2007.

5

Transactionanalysis,effectsonfinancialstatements

M01_HORN0096_01_SE_C01.indd 43 10/4/12 1:12 PM


Required

1. Whyisitimportantthatthistypeofinformationbedisclosed?

2. Supposeyouarethechieffinancialofficer(CFO)responsibleforthefinancialstatementsofCVTechnologies.Whatethicalissueswouldyoufaceasyouconsiderwhattoreportinthe2007AnnualReport?

3. WhatarethenegativeconsequencestoCVTechnologiesofnottellingthetruth?WhatarethenegativeconsequencestoCVTechnologiesoftellingthetruth?

Ethical Issue 2TheboardofdirectorsofCloutierInc.ismeetingtodiscussthepastyear’sresultsbeforereleasingfinancialstatementstothepublic.Thediscussionincludesthisexchange:

SueCloutier, companypresident:“Well, thishasnotbeenagoodyear!Revenueisdownandexpensesareup—wayup.Ifwedon’tdosomefancystepping,we’llreportalossforthethirdyearinarow.IcantemporarilytransfersomelandthatIownintothecompany’sname,andthatwillbeefupourbalancesheet.Rob,canyoushave$500,000fromexpenses?Thenwecanprobablygetthebankloanthatweneed.”

RobSamuels, companychiefaccountant: “Sue,youareasking toomuch.Generallyacceptedaccountingprinciplesaredesignedtokeepthissortofthingfromhappening.”

Required

1. Whatisthefundamentalethicalissueinthissituation?

2. Discuss how Cloutier’s proposals violate generally accepted accounting principles.Identifythespecificconcept(s)orprinciple(s)involved.

PROBLEMS (GROUP A)

Problem 1–1AJon Conlin was a lawyer and partner in a large firm, a partnership, for five years aftergraduatingfromuniversity.Recently,heresignedhispositiontoopenhisownlegalprac-tice, which he operates as a proprietorship. The name of the new company is Conlin &Associates.

Conlinrecordedthefollowingeventsduringtheorganizingphaseofhisnewbusinessanditsfirstmonthofoperations.Someoftheeventswerepersonalanddidnotaffectthelegalpractice.Otherswerebusinesstransactionsandshouldbeaccountedforbythebusiness.

July 4 Conlinreceived$100,000cashfromhisformerpartnersinthefirmfromwhichheresigned.

5 Conlininvested$50,000cashinhisbusiness,Conlin&Associates. 5 ThebusinesspaidofficerentexpenseforthemonthofJuly,$3,000. 6 Thebusinesspaid$1,000cashforletterheadstationeryfortheoffice. 7 Thebusinesspurchasedoffice furnitureonaccountfor$7,000,promisingto

paywithinsixmonths. 10 Conlinsold2,000sharesofRoyalBankstock,whichhehadownedforseveral

years,receiving$25,000cashfromhisstockbroker. 11 Conlindepositedthe$25,000cashfromsaleoftheRoyalBanksharesinhis

personalbankaccount. 12 ArepresentativeofalargeconstructioncompanytelephonedConlinandtoldhim

ofthecompany’sintentiontotransferitslegalbusinesstoConlin&Associates. 29 Thebusinessprovidedlegalservicesforaclientandsubmittedthebillforser-

vices,$10,000.Thebusinessexpectedtocollectfromthisclientwithintwoweeks. 31 Conlinwithdrew$3,000cashfromthebusiness.

4 5

Entityconcept,transactionanalysis,accountingequation



MyAccountingLab

M01_HORN0096_01_SE_C01.indd 44 10/4/12 1:12 PM


Required

1. Classifyeachoftheprecedingeventsasoneofthefollowing(listeachdate,thenchoosea,b,orc):a. A business transaction to be accounted for by the business, Conlin &

Associates.b. A business-related event but not a transaction to be accounted for by

Conlin &Associates.c. ApersonaltransactionnottobeaccountedforbyConlin&Associates.

2. Analyze the effects of the above events on the accounting equation of Conlin &Associates.UseaformatsimilartoExhibit1-9,PanelB,onpage22.

Problem 1–2AShawnSteeleisarealtor.Hebuysandsellspropertiesonhisown,andhealsoearnscom-missionrevenueasarealestateagent.HeorganizedhisbusinessasasoleproprietorshiponNovember15,2013.ConsiderthefollowingfactsasofNovember30,2013:

a. Thebusinessowed$30,000onanotepayableforsomeundevelopedland.Thislandhadbeenacquiredbythebusinessforatotalpriceof$70,000.

b. Steele’sbusinesshadspent$15,000foraRe/MaxLtd.realestatefranchise,whichenti-tledhim to representhimself asaRe/Maxagent.Re/Max is anational affiliationofindependentrealestateagents.Thisfranchiseisabusinessasset.

c. Steele owed $250,000 on a personal mortgage on his personal residence, which heacquiredin2001foratotalpriceof$500,000.

d. Steelehad$25,000inhispersonalbankaccountand$9,000inhisbusinessbankaccount.

e. Steeleowed$1,000onapersonalchargeaccountwithTheBay.

f. Thebusinessacquiredbusinessfurniturefor$9,000onNovember25.Ofthisamount,thecompanyowed$3,000onaccountatNovember30.

g. Therealestateofficehad$500worthofofficesuppliesonhandonNovember30.

Required

1. Steeleisconcernedaboutliabilityexposure.Whichproprietorshipfeature,ifany,limitshispersonalliability?

2. Prepare the balance sheet of the real estate business of Shawn Steele, Realtor, atNovember30,2013.

3. Identifythepersonalitemsgivenintheprecedingfactsthatwouldnotbereportedinthefinancialrecordsofthebusiness.

Problem 1–3ATisdaleSupplierswasrecentlyformedasaproprietorship.Thebalanceofeachiteminthebusiness’saccountingequationisshownbelowforJune21andforeachoftheninefollow-ingbusinessdays.

Cash

Accounts Receivable

Supplies

Land

Accounts Payable

Owner’s Equity

June 21 $19,000 $9,000 $3,000 $18,000 $9,000 $40,000

22 26,000 9,000 3,000 18,000 9,000 47,000

23 16,000 9,000 3,000 28,000 9,000 47,000

24 16,000 9,000 7,000 28,000 13,000 47,000

25 12,000 9,000 7,000 28,000 9,000 47,000

26 15,000 6,000 7,000 28,000 9000 47,000

27 22,000 6,000 7,000 28,000 9,000 54,000

28 17,000 6,000 7,000 28,000 4,000 54,000

29 14,000 6,000 10,000 28,000 4,000 54,000

30 4,000 6,000 10,000 28,000 4,000 44,000

5

Businesstransactionsandanalysis

M01_HORN0096_01_SE_C01.indd 45 10/4/12 1:12 PM


Required Assuming that a single transaction took place on each day, describe brieflythe transaction thatwasmost likely tohaveoccurred.Beginwith June22andcompleteuptoJune30.Indicatewhichaccountswereaffectedandbywhatamount.Norevenueorexpensetransactionsoccurredonthesedates.

Problem 1–4A

Presented below are the amounts of (a) the assets and liabilities of Superior MarketingConsultantsasofDecember31,2014and(b)therevenuesandexpensesofthecompanyfortheyearendedDecember31,2014.Theitemsarelistedinalphabeticalorder.

AccountsPayable...................... $57,000 InsuranceExpense.................... $4,500

AccountsReceivable................. 36,000 InterestExpense........................ 15,000

AdvertisingExpense................. 48,500 Land............................................ 37,500

Building...................................... 300,000 NotePayable.............................. 195,000

Cash............................................. 15,000 SalaryExpense........................... 240,000

ComputerEquipment............... 165,000 SalaryPayable............................ 22,500

CourierExpense........................ 7,000 ServiceRevenue........................ 450,000

Furniture..................................... 45,000 Supplies...................................... 7,500

Theopeningbalanceofowner’sequitywas$300,000.Atyearend,afterthecalculationofnetincome,theowner,SusanWong,withdrew$103,500.

Required

1. Preparethebusiness’sincomestatementfortheyearendedDecember31,2014.

2. Preparethestatementofowner’sequityofthebusinessfortheyearendedDecember31,2014.

3. PreparethebalancesheetofthebusinessatDecember31,2014.

4. Answerthesequestionsaboutthebusiness:a. Wastheresultofoperationsfortheyearaprofitoraloss?Howmuchwasit?b. Didthebusiness’sowner’sequityincreaseordecreaseduringtheyear?Howwould

thisaffectthebusiness’sabilitytoborrowmoneyfromabankinthefuture?c. HowmuchintotaleconomicresourcesdoesthebusinesshaveatDecember31,2014,

asitmovesintothenewyear?Howmuchdoesthebusinessowe?Whatisthedollaramountoftheowner’sportionofthebusinessatDecember31,2014?

Problem 1–5A

ThebookkeeperofOliverServicesCo.,aproprietorship,preparedthebalancesheetofthecompanywhile theaccountantwas ill.Thebalancesheet isnotcorrect.Thebookkeeperknewthatthebalancesheetshouldbalance,sohe“pluggedin”theowner’sequityamountneededtoachieve thisbalance.Theowner’sequityamount,however, isnotcorrect.Allotheramountsareaccurateexceptthe“Totalassets”amount.

OLIVER SERVICES CO.

Balance Sheet


Assets LiabilitiesCash $70,000 Servicerevenue $220,000

Officesupplies 5,000 Notepayable 55,000

Land 130,000 Accountspayable 45,000

Advertisingexpense 10,000

Officefurniture 50,000

Accountsreceivable 75,000 Owner’sEquity

Rentexpense 22,000 J.Enderby,capital 42,000

Totalassets $362,000Totalliabilitiesand owner’sequity

$362,000


6

Incomestatement,statementofowner’sequity,balancesheet,

evaluatingbusinessperformance

1.Netincome$135,000

6

Balancesheetforaproprietorship


M01_HORN0096_01_SE_C01.indd 46 10/4/12 1:12 PM


Required

1. Prepare thecorrectedbalancesheet,anddate it correctly.Compute totalassets, totalliabilities,andowner’sequity.

2. ConsidertheoriginalbalancesheetaspresentedandthecorrectedbalancesheetyoupreparedforRequirement1.Did the totalassetspresented inyourcorrectedbalancesheetincrease,decrease,orstaythesamecomparedtotheoriginalbalancesheet?Why?

Problem 1–6AMaryReaneyistheproprietorofacareercounsellingandemployeesearchbusiness,ReanyPersonnelServices.Thefollowingamountssummarizethefinancialpositionofthebusi-nessonAugust31,2014: 5 6


2.Netincome$45,000

Assets

5

Liabilities

1

Owner’s Equity

Cash 1 Accounts Receivable

1 Supplies 1 Furniture and Computers

5 Accounts Payable

1 M. Reaney, Capital

Bal. 40,000 35,000 95,000 55,000 115,000

DuringSeptember2014thefollowingcompanytransactionsoccurred:

a. Reaneydeposited$80,000cashinthebusinessbankaccount.

b. Performedservicesforaclientandreceivedcashof$5,000.

c. PaidofftheAugust31,2013,balanceofaccountspayable.

d. Purchasedsuppliesonaccount,$6,000.

e. Collectedcashfromacustomeronaccount,$7,500.

f. Consultedonalargedownsizingbyamajorcorporationandbilledtheclientforser-vicesrendered,$48,000.

g. Recordedthefollowingbusinessexpensesforthemonth:(1) PaidofficerentforSeptember2013—$5,000.(2) Paidadvertising—$3,000.

h. Soldsuppliestoanotherbusinessfor$1,000cash,whichwasthecostofthesupplies.

i. Reaneywithdrew$8,000cash.

Required

1. Analyze the effects of the above transactions on the accounting equation of ReaneyPersonnelServices.AdapttheformatofExhibit1–9,PanelB,onpage22.

2. Prepare the income statement of Reaney Personnel Services for the month endedSeptember30,2014.Listexpensesindecreasingorderofamount.

3. Preparethebusiness’sstatementofowner’sequityforthemonthendedSeptember30,2014.

4. PreparethebalancesheetofReaneyPersonnelServicesatSeptember30,2014.

Problem 1–7ATannerGlasshadbeenoperatinghislawpracticeinMississaugaunderthenameTannerGlass,Lawyer,fortwoyearsandhadthefollowingbusinessassetsandliabilities(attheirhistoricalcosts)onApril30,2015:

Cash $45,000

AccountsReceivable 30,000

Supplies 2,000

FurnitureandComputers 75,000

AccountsPayable 20,000

4Accountingconcepts/principles

M01_HORN0096_01_SE_C01.indd 47 10/4/12 1:12 PM


ThefollowingbusinesstransactionstookplaceduringthemonthofMay2015:

May 1 Glassdeposited$30,000cashintothebusinessbankaccount. 3 Glasscompletedlegalworkforahomebuilder.Hechargedthebuilder$5,000,not

the$6,000theworkwasworth,inordertopromotebusinessfromthebuilder. 5 ThebusinessboughtfurniturefromAjaxFurniturefor$8,000,paying$2,000

cashandpromisingtopay$1,000permonthatthebeginningofeachmonthstartingJune1,2015, forsixmonths.Glasswouldliketoexpensetheentireamounttoreducenetincomefortaxreasons.

10 Thecompanysigneda lease to rentadditional spaceatacostof$2,000permonth.GlasswilloccupythepremiseseffectiveJune1,2015

18 DeterminingthatthebusinesswouldneedmorecashinJune,Glasswenttothebankandborrowed$20,000onapersonalloanandtransferredthemoneytothecompany.

25 Glasspurchasedapaintingforhishomefromoneofhisclients.Hepaidforthe$3,000purchasewithhispersonalcreditcard.

28 Glass withdrew $5,000 from the business. He used $2,000 of the money torepayaportionoftheloanarrangedonMay18.

31 Thebusinessdidlegalworkwithavalueof$10,000forApexComputersLtd.Apexpaidfortheworkbygivingthecompanycomputerequipmentwithasellingpriceof$12,000.

Required Identifytheaccountingcharacteristic,assumption,orprinciplethatwouldbeapplicabletoeachofthetransactionsanddiscusstheeffectsitwouldhaveonthefinancialstatementsofTannerGlass,Lawyer.

Problem 1–8ATerraceBoardRentalswasstartedonJanuary1,2013,byRyanTerracewithaninvestmentof$50,000cash.Thecompanyrentsoutsnowboardsandrelatedgearfromasmallstore.Duringthefirst11months,Terracemadeadditionalinvestmentsof$20,000andborrowed$40,000fromthebank.Hedidnotwithdrawanyfunds.Thebalancesheetaccounts,exclud-ingTerrace’scapitalaccount,atNovember30,2013,areasfollows:

Cash.................................................................... $45,000

AccountsReceivable........................................ 15,000

RentalGear........................................................ 32,000

RentalSnowboards.......................................... 48,000

StoreEquipment............................................... 30,000

AccountsPayable............................................. 12,000

NotePayable..................................................... 40,000

ThefollowingtransactionstookplaceduringthemonthofDecember2013:

Dec. 1 Thebusinesspaid$5,000forthemonth’srentonthestorespace. 4 Thebusinesssignedaone-yearleasefortherentalofadditionalstorespaceat

acostof$4,000permonth.TheleaseiseffectiveJanuary1.Thebusinesswillpaythefirstmonth’srentinJanuary.

6 Rentalrevenuesfortheweekwere:Gear,$4,000;Boards,$10,000.75%ofthefeeswerepaidincashandtherestonaccount.

10 ThebusinesspaidtheaccountspayablefromNovember30,2013. 12 Thebusinesspurchasedgearfor$20,000andboardsfor$40,000,allonaccount. 13 Rentalrevenuesfortheweekwere:Gear,$7,000;Boards,$14,000.Allthefees

werepaidincash. 15 ThecompanyreceivedpaymentfortheaccountsreceivableowingatNovem-

ber30,2013. 18 Thecompanypurchasedstoreequipmentfor$10,000bypaying$3,000cash

withthebalanceduein60days. 20 Rentalrevenuesfortheweekwere:Gear,$8,000;Boards,$14,000.Halfthefees

werepaidincashandhalfonaccount. 21 Terracewithdrew$7,000. 24 ThecompanypaidthebalanceowingforthepurchasesmadeonDecember12. 27 Rentalrevenuesfortheweekwere:Gear,$6,000;Boards,$10,000.Allthefees

werepaidincash.

Accountingconcepts/principles,transactionanalysis,accountingequation,financialstatements,

evaluation

4 5 6

3.Netincome$54,000

M01_HORN0096_01_SE_C01.indd 48 10/4/12 1:12 PM


27 ThecompanyreceivedpaymentforrentalfeesonaccountfromDecember6. 31 ThecompanypaiditsemployeesforthemonthofDecember.Thetotalwages

expensewas$10,000. 31 TerracepaidtheutilitybillforthemonthofDecember,whichwas$4,000.

Required

1. WhatisthetotalnetincomeearnedbythebusinessovertheperiodofJanuary1,2013toNovember30,2013?

2. Analyze theeffectsof theDecember2013 transactionson theaccountingequationofTerraceBoardRentals.IncludetheaccountbalancesfromNovember30,2013.

3. Prepare the income statement for Terrace Board Rentals for the month endedDecember 31,2013.

4. Preparethestatementofowner’sequityforTerraceBoardRentalsforthemonthendedDecember31,2013.

5. PreparethebalancesheetforTerraceBoardRentalsatDecember31,2013.

6. Terracehasexpressedconcernthatalthoughthebusinessseemstobeprofitableandgrow-ing,heconstantlyseemstobeinvestingadditionalmoneyintoitandhasbeenunabletomakeanywithdrawalsfortheworkhehasputintoit.Prepareareplytohisconcerns.

PROBLEMS (GROUP B)

Problem 1–1BLinda McLean is an architect and was a partner with a large firm, a partnership, for10 yearsaftergraduating fromuniversity.Recently she resignedherposition toopenherownarchitectureoffice,whichsheoperatesasaproprietorship.ThenameofthenewentityisMcLeanDesign.

McLeanrecordedthefollowingeventsduringtheorganizingphaseofhernewbusi-nessanditsfirstmonthofoperations.Someoftheeventswerepersonalanddidnotaffectthepracticeofarchitecture.Otherswerebusinesstransactionsandshouldbeaccountedforbythebusiness.

July 1 McLeansold1,000sharesofCanadianTirestock,whichshehadownedforseveralyears,receiving$60,000cashfromherstockbroker.

2 McLeandepositedthe$60,000cashfromthesaleoftheCanadianTiresharesintoherpersonalbankaccount.

3 McLeanreceived$100,000cashfromherformerpartners inthearchitecturefirmfromwhichsheresigned.

5 McLeandeposited$80,000intoabankaccountinthenameofMcLeanDesign. 5 McLeanDesignpaidofficerentforthemonthofJuly,$4,000. 6 ArepresentativeofalargerealestatecompanytelephonedLindaMcLeanand

toldherofthecompany’sintentiontotransferitsdesignbusinesstoherbusi-ness,McLeanDesign.

7 McLeanDesignpaid$3,000cashforofficesupplies,includingletterheadandstationery.

9 McLeanDesignpurchasedofficefurnitureonaccountfor$10,000,promisingtopayinthreemonths.

23 McLeanDesign finisheddesignwork foraclientandsubmitted thebill fordesignservices,$12,000.Itexpectstocollectfromthisclientwithinonemonth.

31 McLeanwithdrew$5,000forpersonaluse.

Required

1. Classifyeachoftheprecedingeventsasoneofthefollowing(listeachdateandthenchoosea,b,orc):a. Abusinesstransactiontobeaccountedforbythebusiness,McLeanDesign.b. Abusiness-relatedeventbutnotatransactiontobeaccountedforbyMcLeanDesign.c. ApersonaltransactionnottobeaccountedforbyMcLeanDesign.

4 5

Entityconcept,transactionanalysis,accountingequation


MyAccountingLab

M01_HORN0096_01_SE_C01.indd 49 10/4/12 1:12 PM


2. AnalyzetheeffectsoftheaboveeventsontheaccountingequationofMcLeanDesign.UseaformatsimilartoExhibit1–9,PanelB,onpage22.

Problem 1–2BLupitaGoodwinisarealtor.Shebuysandsellspropertiesonherown,andshealsoearnscommissionrevenueasarealestateagent.Sheinvested$70,000onMarch10,2014,inthebusiness,LupitaGoodwinRealty.ConsiderthefollowingfactsasofMarch31,2014:

a. Goodwinhad$10,000inherpersonalbankaccountand$90,000inthebusinessbankaccount.

b. Therealestateofficehad$6,000ofofficesuppliesonhandonMarch31,2014.

c. LupitaGoodwinRealtyhadspent$25,000foraRoyalLapagefranchise,whichentitledthecompanytorepresentitselfasaRoyalLapagememberfirm.Thisfranchiseisabusinessasset.

d. Thecompanyowed$130,000onanotepayable forsomeundeveloped landthathadbeenacquiredbythecompanyforatotalpriceof$165,000.

e. Goodwinowed$185,000onapersonalmortgageonherpersonalresidence,whichsheacquiredin2001foratotalpriceof$320,000.

f. Goodwinowed$2,000onapersonalchargeaccountwithSears.

g. The company acquired business furniture for $18,000 on March 26. Of this amount,LupitaGoodwinRealtyowed$14,000onaccountatMarch31,2014.

Required

1. Goodwin is concernedabout liabilityexposure.Whichproprietorship feature, ifany,limitsherpersonalliability?

2. Prepare the balance sheet of the real estate business of Lupita Goodwin Realty atMarch31,2014.

3. Identifythepersonalitemsgivenintheprecedingfactsthatwouldnotbereportedonthebalancesheetofthebusiness.

Problem 1–3BRecently,KateCameronformedamanagementaccountingpracticeasaproprietorship.ThebalanceofeachitemintheproprietorshipaccountingequationfollowsforNovember16andforeachoftheeightfollowingbusinessdays.

CashAccounts

ReceivableOffice

Supplies FurnitureAccounts Payable

Owner’s Equity

Nov.16 $6,000 $10,000 $1,000 $8,000 $6,000 $19,000

17 7,000 9,000 1,000 8,000 6,000 19,000

18 6,000 9,000 1,000 8,000 5,000 19,000

19 6,000 9,000 1,500 8,000 5,500 19,000

20 8,000 9,000 1,500 8,000 5,500 21,000

23 7,000 9,000 1,500 8,000 4,500 21,000

24 9,000 9,000 1,500 6,000 4,500 21,000

25 8,500 9,000 2,000 6,000 4,500 21,000

26 7,500 9,000 2,000 6,000 4,500 20,000

Required Assumingthatasingletransactiontookplaceoneachday,describebrieflythetransactionthatwasmostlikelytohaveoccurred.BeginwithNovember17andcompleteuptoNovember26.Indicatewhichaccountswereaffectedandbywhatamount.Assumethatnorevenueorexpensetransactionsoccurredonthesedates.

Problem 1–4BTheamountsof(a)theassetsandliabilitiesofHaradaOfficeCleaningasofDecember31,2014,and(b)therevenuesandexpensesofthecompanyfortheyearendedonDecember31,2014,appearbelow.Theitemsarelistedinalphabeticalorder.

4 6Balancesheet,entityconcept

5

Businesstransactionsandanalysis


5

Incomestatement,statementofowner’sequity,balancesheet

M01_HORN0096_01_SE_C01.indd 50 10/4/12 1:12 PM


AccountsPayable $40,000 Land $100,000

AccountsReceivable 50,000 NotesPayable 200,000

Building 350,000 PropertyTaxExpense 10,000

Cash 25,000 RepairsExpense 30,000

Equipment 110,000 SalaryExpense 280,000

InterestExpense 14,000 ServiceRevenue 650,000

InterestPayable 3,000 Supplies 10,000

Furniture 18,000 UtilitiesExpense 25,000

Thebeginningamountofowner’sequitywas$200,000.Duringtheyear,theowner,YoshiHarada,withdrew$71,000.

Required

1. PreparetheincomestatementofHaradaOfficeCleaningfortheyearendedDecember31,2014.

2. Preparethestatementofowner’sequityofthebusinessfortheyearendedDecember31,2014.

3. PreparethebalancesheetofthebusinessatDecember31,2014.

4. AnswerthesequestionsaboutHaradaOfficeCleaning.a. Wastheresultofoperationsfortheyearaprofitoraloss?Howmuchwasit?b. Didthebusiness’sowner’sequityincreaseordecreaseduringtheyear?Howwould

thisaffectthebusiness’sabilitytoborrowmoneyfromabankinthefuture?c. HowmuchintotaleconomicresourcesdoesthecompanyhaveatDecember31,2014,

asitmovesintothenewyear?Howmuchdoesthecompanyowe?Whatisthedollaramountoftheowner’sportionofthebusinessatDecember31,2014?

Problem 1–5BThebookkeeperofMcBrideInsuranceAgencypreparedthebalancesheetofthecompanywhiletheaccountantwasill.Thebalancesheetcontainserrors.Inparticular,thebookkeeperknewthatthebalancesheetshouldbalance,soshe“pluggedin”theowner’sequityamountneeded to achieve this balance. The owner’s equity amount, however, is not correct. Allotheramountsareaccurateexceptthe“Totalassets”amount.

McBRIDE INSURANCE AGENCY

Balance Sheet

For the Month Ended October 31, 2014

Assets LiabilitiesCash $24,000 Premiumrevenue $53,000

Insuranceexpense 2,000 Accountspayable 23,000

Rentexpense 6,000 Notepayable 40,000

Salaryexpense 8,000

Officefurniture 20,000

Accountsreceivable 22,000 Owner’sEquity

Utilitiesexpense 2,000 C.McBride,capital (8,000)

Notesreceivable 24,000


$108,000

Required

1. Preparethecorrectedbalancesheet,anddateitcorrectly.Computetotalassets,totalliabilities,andowner’sequity.

2. IdentifytheaccountslistedabovethatshouldnotbepresentedonthebalancesheetandstatewhyyouexcludedthemfromthecorrectedbalancesheetyoupreparedforRequirement1.

6Balancesheet

M01_HORN0096_01_SE_C01.indd 51 10/4/12 1:12 PM


Problem 1–6BMirandaSykesoperatesaninteriordesignstudiocalledSykesDesignStudio.Thefollow-ingamountssummarizethefinancialpositionofthebusinessonApril30,2014:

Assets

5

Liabilities

1

Owner’s Equity

Cash

1

Accounts Receivable

1

Supplies

1

Land

5

Accounts Payable

1

M. Sykes, Capital

Bal. 27,000 26,000 102,000 33,000 122,000

DuringMay2014,thecompanydidthefollowing:

a. Sykesreceived$20,000asagiftanddepositedthecashinthebusinessbankaccount.

b. Paidthebeginningbalanceofaccountspayable.

c. Performedservicesforaclientandreceivedcashof$5,000.

d. Collectedcashfromacustomeronaccount,$4.000.

e. Purchasedsuppliesonaccount,$3,000.

f. Consultedontheinteriordesignofamajorofficebuildingandbilledtheclientforser-vicesrendered,$16,000.

g. Recordedthefollowingbusinessexpensesforthemonth:(1)PaidofficerentforMay2014—$6,000.(2)Paidadvertising—$4,000.

h. Sold supplies to another interior designer for $1,000 cash, which was the cost of thesupplies.

i. Sykeswithdrew$7,000cashforpersonaluse.

Required

1. AnalyzetheeffectsoftheabovetransactionsontheaccountingequationofSykesDesignStudio.AdapttheformatofExhibit1–9,PanelB,onpage22.

2. PreparetheincomestatementofSykesDesignStudioforthemonthendedMay31,2014.Listexpensesindecreasingorderofamount.

3. Preparethestatementofowner’sequityofSykesDesignStudioforthemonthendedMay31,2014.

4. PreparethebalancesheetofSykesDesignStudioatMay31,2014.

Problem 1–7BJohn Chang has been operating a plumbing business as a proprietorship (John ChangPlumbing)forfouryearsandhadthefollowingbusinessassetsandliabilities(attheirhis-toricalcosts)onMay31,2015:

Cash............................................................ $60,000

AccountsReceivable................................ 30,000

ShopSupplies........................................... 10,000

ShopEquipment....................................... 80,000

AccountsPayable..................................... 33,000

ThefollowingeventstookplaceduringthemonthofJune2015:

June 1 John’sbrotherretiredandsoldhisequipmenttoJohnfor$30,000.Theequip-menthadcost$50,000andhadareplacementcostof$38,000.

3 Thebusinessdidsomeplumbingrepairsforacustomer.Thebusinesswouldnormallyhavecharged$1,500forthework,buthadagreedtodoitfor$1,000cashinordertoencouragemorebusinessfromthecustomer.

10 Thebusinesssignedaleasetorentadditionalshopspaceforthebusinessatacostof$3,000permonth.ThebusinesswilloccupythepremiseseffectiveJuly1,2015.

5 6


4Accountingconcepts/principles

M01_HORN0096_01_SE_C01.indd 52 10/4/12 1:12 PM


18 Findinghewaslowoncash,Johnwenttothebankandborrowed$8,000onapersonalloan.

22 ThevalueofJohn’sequipmenthasdoubled.Johndoesnotunderstandwhyaccountantsignoretheeffectofinflationintheaccountingrecords.

28 Johnwithdrew$12,000fromthebusinessandused$7,000torepaytheper-sonalbankloanofJune18.

Required Identify the accounting assumption, principle, or characteristic that wouldbeapplicabletoeachoftheevents,anddiscusstheeffectsitwouldhaveonthefinancialstatementsofJohnChangPlumbing.

Problem 1–8BWilson Marketing Consulting, a proprietorship owned by Lin Wilson, was started onJanuary1,2013,withaninvestmentof$50,000cash.Thecompanypreparesmarketingplansforclients.Ithasbeenoperatingforoneyear.Businesswasquiteslowinthefirstyearofoperationsbuthassteadilyincreased.Wilsonhasmadeadditionalinvestmentsof$30,000buthasnotmadeanywithdrawals.ThegeneralledgershowedthefollowingbalancesasofDecember31,2013:

Cash................................................................. $25,000

AccountsReceivable..................................... 30,000

Software.......................................................... 21,000

OfficeFurniture............................................. 15,000

ComputerEquipment................................... 32,000

AccountsPayable.......................................... 18,000

L.Wilson,Capital.......................................... 105,000

ThefollowingtransactionstookplaceduringthemonthofJanuary2014:

Jan. 2 Wilsoninvested$20,000inthebusiness. 2 Thebusinesspaid$4,000forthemonth’srentontheofficespace. 4 Thebusinesssignedaleasefortherentalofadditionalofficespaceatacostof

$3,500permonth.TheleaseiseffectiveFebruary1.Thebusinesswillpaythefirstmonth’srentinFebruary.

6 ThebusinessdevelopedasystemsdesignforBantingLtd.andreceived$10,000nowplusadditional$7,000paymentstobereceivedonthe15thofthemonthforthenextthreemonths.

10 Thebusinesspaid$1,000toacourierservice. 12 WilsonsignedanagreementtoprovidedesignworktoSmithInc.for$15,000

tobepaiduponcompletionofthework. 14 Thecompanypurchased$5,000ofsoftwarethatwillberequiredfortheSmith

assignment.Thecompanypaid$3,000andpromisedtopaythebalancebytheendofthemonth.

15 Thecompanyreceived$7,000asthemonthlypaymentfromBantingLtd.fromJanuary6.

18 The companypurchasedcomputerequipment for$10,000bypaying$4,000cashwiththebalanceduein60days.

23 ThecompanycompletedanetworkdesignforSalemLtd.,whichpromisedtopay$12,000bytheendofthemonth.

29 ThecompanypaidthebalanceowingforthesoftwarepurchasedonJanuary14. 31 EmployeesofWilsonMarketingConsultingarepaidattheendofeachmonth.

ThetotalwagesexpenseforJanuarywere$10,000. 31 WilsonMarketingConsultingpaidtheutilitiesexpenseforJanuary,$1,000. 31 LinWilsonwithdrew$5,000forpersonaluse.

Required

1. WhatisthetotalnetincomeearnedbythebusinessovertheperiodofJanuary1,2013,toDecember31,2013?

2. AnalyzetheeffectsoftheJanuary2014transactionsontheaccountingequationofWilsonMarketingConsulting.BesuretoincludetheaccountbalancesfromDecember31,2013.

4 5 6

Accountingconcepts/principles,transactionanalysis,accountingequation,financialstatements,evaluation

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3. PreparetheincomestatementforWilsonMarketingConsultingforthemonthendedJanuary31,2014.

4. Prepare the statement of owner’s equity for Wilson Marketing Consulting for themonthendedJanuary31,2014.

5. PreparethebalancesheetforWilsonMarketingConsultingatJanuary31,2014.

6. LinWilsonhasexpressedconcernthatalthoughthebusinessseemstobeprofitableandgrowing,sheconstantlyseemstobeinvestingadditionalmoneyintoitandhasbeenunabletomakeanywithdrawalsfortheworkshehasputintoit.Prepareareplytoherconcerns.

CHALLENGE PROBLEMS

Problem 1–1CThegoing-concernassumption isbecomingan increasingsourceof concern forusersoffinancialstatements.Thereareinstancesofcompaniesfilingforbankruptcyseveralmonthsafter issuing their annual audited financial statements. The question is: Why didn’t thefinancialstatementspredicttheproblem?

Afriendhasjustarrivedonyourdoorstep;yourealizesheisveryangry.Aftercalmingherdown,youaskwhattheproblemis.Shetellsyouthatshehadinherited$40,000fromanuncleandinvestedthemoneyinthecommonsharesofOutdoorSportsEquipmentCorp.(OSEC).ShehadcarefullyexaminedOSEC’s financial statements for the latestyearendandhadconcludedthatthecompanywasfinanciallysound.Thismorning,shehadreadinthelocalpaperthatthecompanyhadgonebankruptandherinvestmentwasworthless.SheasksyouwhythefinancialstatementsvaluedtheassetsatvaluesthatareinexcessofthosetheTrusteeinBankruptcyexpectstorealizefromliquidatingtheassets.Whyhavetheassetssuddenlylostsomuchofthevaluetheyhadsixmonthsago?

Required Explaintoyourfriendwhyassetsarevaluedonagoing-concernbasisinthefinancialstatementsandwhytheyareusuallyworthlesswhenthecompanygoesoutofbusiness.Useinventoryandaccountsreceivableasexamples.

Problem 1–2CYouandthreefriendshavedecidedtogointothelandscapebusinessforthesummertoearnmoneytopayforyourschoolinginthefall.Yourfirststepwastosignupcustomerstosatisfyyourselvesthatthebusinesshadthepotentialtobeprofitable.Next,youplannedtogotothebanktoborrowmoneytobuytheequipmentyouwouldneed.

After considerable effort, your group obtained contracts from customers for200 residences for the summer. One of your partners wants to prepare a balance sheetshowingthevalueofthecontractsasanasset.Sheissurethatyouwillhavenotroublewithborrowingthenecessaryfundsfromthebankonthebasisoftheproposedbalancesheet.

Required Explaintoyourfriendwhythecommitments(signedcontracts)fromcustom-erscannotberecognizedasassets.Whatsuggestionsdoyouhavethatmightassistyourgroupinborrowingthenecessaryfunds?

4

Understandingthegoingconcernassumption

5

Accountingforbusinesstransactions

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Extending Your Knowledge

DECISION PROBLEMS

Decision Problem 1Twobusinesses,Tyler’sBicycleCentreandRyan’sCatering,havesoughtbusiness loansfromyou.Todecidewhethertomaketheloans,youhaverequestedtheirbalancesheets.

TYLER’S BICYCLE CENTRE

Balance Sheet

December 31, 2014

Assets LiabilitiesCash $27,000 Accountspayable $ 36,000

Accountsreceivable 42,000 Notespayable 354,000

Merchandiseinventory 55,000 Totalliabilities 390,000

Storesupplies 2,000

Furnitureandfixtures 26,000 Owner’s EquityBuilding 246,000 T.Jones,capital 230,000

Land 222,000

Totalassets

$620,000


$620,000

RYAN’S CATERING

Balance Sheet

December 31, 2014

Assets LiabilitiesCash $ 30,000 Accountspayable $9,000

Accountsreceivable 12,000 Notepayable 204,000

Officesupplies 6,000 Totalliabilities 213,000

Inventory 60,000

Officefurniture 15,000 Owner’s Equity

Investments* 600,000 R.Smith,capital 510,000


$723,000

*Theinvestmentsof$600,000canbesoldtodayfor$750,000.

Required

1. Basedsolelyonthesebalancesheets,whichentitywouldyoubemorecomfortablelendingmoneyto?Explainfully,citingspecificitemsandamountsfromthebalancesheets.

2. Inadditiontothebalancesheetdata,whatotherfinancialstatementinformationwouldyourequire?Bespecific.

1 6

Usingfinancialstatementstoevaluatearequestforaloan

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Decision Problem 2Afriendlearnsthatyouaretakinganaccountingcourse.Knowingthatyoudonotplanacareerinaccounting,thefriendaskswhyyouare“wastingyourtime.’’Explaintothefriend:

1. Whyyouaretakingthecourse.

2. Howaccountinginformationisusedorwillbeused:a. Inyourpersonallife.b. Inthebusinesslifeofyourfriend,whoplanstobeafarmer.c. Inthebusinesslifeofanotherfriend,whoplansacareerinsales.

FINANCIAL STATEMENT CASES

TheseandsimilarcasesinlaterchaptersfocusonthefinancialstatementsoftworealCanadiancompanies—GildanActivewearIncandRainmakerEntertainmentInc.GildanActivewearInc.(Gildan)isaglobalmarketerofandthelargestNorth-Americanmanufacturerofbasicapparel,particularly blank t-shirts, sports shirts, and fleece that are then screenprinted with logosby othercompanies.Gildanisalsotheworld’slargestsupplierofsport,casual,anddresssockstocustomersintheUnitedStates.HeadquarteredinMontréal,Gildanhas300,000 employeesworldwide, with manufacturing facilities in South America and the Caribbean Basin,and plans to grow in Asia and Europe. Rainmaker Entertainment Inc. (Rainmaker) is amulti-faceted animation studio and is one of Canada’s largest producers of computer-generated(CG)animation.Rainmakerdevelopsitsownprojectsandalsoproducesfull-lengthDVDsforothertopNorthAmericancompanies.ThecompanyisheadquarteredinVancouver.Asyoustudyeachfinancialstatementproblemusingthesetwocompanies,youwillgraduallybuildtheconfidencetounderstandanduseactualfinancialstatements.

Financial Statement Case 1RefertotheGildanfinancialstatementslocatedinAppendixAattheendofthisbook.Thereare two things to notice in the overall presentation of the financial statements. First, allamountsarereportedinthousandsofdollars.Second,Gildanhasa52-weekfiscalyear.Mostcompanies’financialstatementsarestatedatamonthend,butmanyretailandmerchandis-ingcompanies(companiesthatsellproductsratherthanservices)choosetousea52-weekyearinstead.Consequently,thefiscalyearendchangesfromyeartoyear.InGildan’scase,theyearendwasOctober2in2011andOctober3in2010.

Required

1. HowmuchcashandcashequivalentsdidGildanhaveatOctober2,2011?

2. WhatweretotalassetsatOctober2,2011?AtOctober3,2010?

3. Write the company’s accounting equation at October 2, 2011, by filling in the dollaramounts:

Assets 5 Liabilities 1 Shareholders’ Equity

4. IdentifytotalrevenuefortheyearendedOctober2,2011.DothesamefortheyearendedOctober3,2010.Didrevenueincreaseordecreaseinfiscal2011?

5. HowmuchnetincomeornetlossdidGildanexperiencefortheyearendedOctober2,2011?Was2011agoodyearorbadyearcomparedto2010?

Financial Statement Case 2

RefertotheRainmakerfinancialstatementslocatedonMyAccountingLab.

Required

1. HowmuchtradeandotheraccountsreceivabledidRainmakerhaveatDecember31,2011?

2. WhatweretotalassetsatDecember31,2011?AtDecember31,2010?

3. Writethecompany’saccountingequationatDecember31,2011,byfillinginthedollaramounts:

Assets 5 Liabilities 1 Shareholders’ Equity

4. IdentifytotalsalesrevenuefortheyearendedDecember31,2011,andtheyearendedDecember31,2010.Didrevenueincreaseordecreaseduring2011?

5. How much net income or net loss did Rainmaker experience for the year endedDecember31,2011?Was2011agoodyearorbadyearcomparedto2010?

1 5 6Usingaccountinginformation

6

Identifyingitemsfromacompany’sfinancialstatements

5.October31,2008,netincome$102,019thousand

6

Identifyingitemsfromacompany’sfinancialstatements

5.Dec.31,2008,netloss($11,673thousand)

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1. Accountingistheinformationsystemthatmeasuresbusinessfinancialactivities,processesthatinformationintoreports,andcommunicatestheresultstodecisionmakers.

2. Individualsuseaccountinginday-to-dayaffairs.Businessesuseaccountinginformationtosetgoalsfortheirorganiza-tion.Investorsneedaccountinginformationtoevaluatetheirinvestmentsorpotentialinvestments.Creditorscouldusefinancialinformationtoevaluatetheirongoingrelationshipwithacompany.

3. Financialaccountingcommunicatesfinancialinformationaboutacompanytointeresteduserswhoareexternaltothecompany(investors,creditors,andregulators,forexample).Managementaccountingisabranchofaccountingthatisusedwithinacom-panytohelpmakebetterfuture-orienteddecisions.

4. Anauditisafinancialexamination.Itisperformedbyanindependentaccountantsothatoutsideusersofthefinancialstatementscanhaveconfidencethattheinformationprovidedinthefinancialstatementsismateriallycorrectandthattheinformationisfreefromanybiasoftheowners.

5. Professionalaccountantswhoprepareandauditfinancialstatementshaveanobligationtoupholdthepublictrust.Inotherwords,membersoftheinvestingpublicarerelyingonthecapabilitiesandethicsofprofessionalaccountantstoensurethatthefinancialinformationaccuratelyportraysthefinancialpositionofthecompany.Therulesofprofessionalconductensurethataccountantswillbehaveinaprofession-allyresponsiblemanner.

6. TheStudentPolicies,Bylaws,andCodesofConductofacollegeoruniversityexisttoencouragestudentstobehaveinanethicalmanner.

7. Aproprietorshiphasasingleowner.Legally,thebusinessisanextensionoftheindividual.Separateaccountingrecordsarekeptfortheproprietorship.Apartnershipjoinstwoormoreindividualstogetherasco-owners.Eachownerisapartner.Accountingtreatsthepartnershipasaseparateorganizationdistinctfromthepersonalaffairsofeachpartner.Fromalegalperspective,apartnershipisequivalenttoaproprietorship.

8. Acorporationisaseparatelegalentity,ownedbysharehold-ers.Theshareholdersownsharesinthecompany.Thus,unlikeproprietorshipsorpartnerships,thecorporationisnotanextensionoftheownerbutaseparatecompany,withdifferentlegalobligations.

9. Oneadvantageofthecorporateformofownershipcomparedtotheproprietorshipformis,inmostinstances,itiseasierforashareholdertoselltheshares(theinvestment)inacorpora-tionthantoselltheinvestmentinapartnershiporproprietor-ship.Asecondadvantageistheshareholdersofacorporationhavelimitedlegalliability,whilethelegalliabilityofapropri-etorshipextendstotheowner.

10. Relevantinformationinfluencesdecisions,andisusefulformakingpredictionsandforevaluatingpastperformance.Reliableinformationisfreefromerrorandthebiasofaparticu-larviewpoint;itisinagreementwiththeunderlyingeventsandtransactions.Ifyouthinkabouttheobjectiveoffinancialreport-ing,thefinancialstatementsmustbebothrelevantandreliableinordertocommunicateusefulinformationtointerestedusers.

11. ThemeasurementcriteriainLevel4(seeExhibit1-6)tellsusthatthehistoricalcostbasisofmeasurementshouldbeused.Thistransactionwouldberecognizedattheamountofcashpaidfortheland.Youpaid$185,000fortheland.Therefore,$185,000isthecosttoreportonyourfinancialstatements.

12. Ifthecarisnotgoingtobeusedforbusinesspurposes,thecarshouldbethepersonalresponsibilityoftheowner.Theeconomic-entityassumptionmeansthatassetsofthebusinessshouldnotbemixedwiththeassetsoftheownertoensurethattheresultsofthebusinesscanbeidentifiedandanalyzedaccurately.

13. Toanswerbothquestions,usetheaccountingequation:a. Assets 2 Liabilities 5 Owner’s Equity $75,000 - $65,000 = $10,000b. Assets 5 Liabilities 1 Owner’s Equity $70,000 = $20,000 + $50,000

14. Indicatewhethereachaccountlistedbelowisa(n)asset(A),liability(L),owner’sequity(OE),revenue(R),orexpense(E)account.

AccountsReceivableA

ComputerEquipmentA

S.Scott,CapitalOE

RentExpenseE

SuppliesA

S.Scott,WithdrawalsOE

SalaryExpenseE

ConsultingServiceRevenueR

CashA

NotesPayableL

SuppliesExpenseE

AccountsPayableL

15. Thinkabouttheaccountingequation.Thereceiptofthecashwillincreasetheassetsby$20,000.Whatabouttheothersideoftheaccountingequation?Thecompanycannotjustifyrecordingtheamountasaservicerevenue(anincreaseinowner’sequity)becausethe$20,000hasnotyetbeenearnedWhatwouldhappenifthecompanydoesn’tcompletetheservice?Itislikelythatthecompanywouldhavetoreturnthemoneytothecustomer.Thus,thecompanyshouldrecordtheamountasaliabilityuntilitearnsthe$20,000,sinceitowestheservicetothecustomer.

16. AccountsReceivableB

ComputerEquipmentB

S.Scott,CapitalB,OE

RentexpenseI

SuppliesB

S.Scott,WithdrawalsB,OE

SalaryExpenseI

ConsultingServiceRevenue I

CashB,CF

NotesPayableB

SuppliesExpenseI

AccountsPayableB

17. a. Netincome = $43,000.Theincomestatementprovidesthisinformation.

b. Fromthestatementofowner’sequity: Beginningownercapital = $0;Endingownercapital =

$287,000 Increases:Investmentbyowner = $250,000;Netincome

forthemonth = $43,000 Decrease:Withdrawalbyowner = $6,000 c. Cash = $222,000.Thebalancesheetorcashflowstatement

providesthisinformation. d. Clientsowethebusiness$10,000,whichisanassetcalled

AccountsReceivable. e. Thebusinessowesoutsiders$2,000,whichisaliability

calledAccountsPayable.

JUST CHECKING Solutions for Chapter 1

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