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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6 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 7
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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8 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 9
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 Solutions appear at the end of this chapter and on MyAccountingLab.
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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10 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 11
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 Solutions appear at the end of this chapter and on MyAccountingLab.
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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12 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 13
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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14 Part 1 TheBasicStructureofAccounting
• 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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Chapter 1 AccountingandtheBusinessEnvironment 15
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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16 Part 1 TheBasicStructureofAccounting
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:
Assets 2 Liabilities 5 Owner’s Equity
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 Solutions appear at the end of this chapter and on MyAccountingLab.
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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Chapter 1 AccountingandtheBusinessEnvironment 17
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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18 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 19
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
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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:
Assets Liabilities 1 Owner’s EquityType of Owner’s
Equity Transaction
Cash 1Accounts
Receivable 1Office
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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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20 Part 1 TheBasicStructureofAccounting
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:
Assets Liabilities 1 Owner’s Equity
Cash 1Accounts
Receivable 1Office
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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
Assets Liabilities 1 Owner’s EquityType of Owner’s
Equity Transaction
Cash 1Accounts
Receivable 1Office
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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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Chapter 1 AccountingandtheBusinessEnvironment 21
client.Wesaythatitcollectsthecashon account.ItwillrecordanincreaseintheassetCashandadecreaseintheassetAccountsReceivable.Shoulditalsorecordanincreaseinservicerevenue?No,becauseHECalreadyrecordedtherevenuewhen it performed the service in Transaction 5. The effect on the accountingequationis
Assets Liabilities 1 Owner’s Equity
Cash 1Accounts
Receivable 1Office
Supplies LandAccounts Payable 1
Lisa Hunter, Capital
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
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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
Assets Liabilities 1 Owner’s EquityType of Owner’s
Equity Transaction
Cash 1Accounts
Receivable 1Office
Supplies 1 LandAccounts Payable 1
Lisa Hunter, Capital
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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22 Part 1 TheBasicStructureofAccounting
Exhibit 1–9 Analysis of Transactions of Hunter Environmental Consulting
Evaluating Business transactions
Exhibit1–9summarizesthe11precedingtransactions.PanelAoftheexhibitliststhedetailsofthetransactions,andPanelBpresentstheanalysis.Asyoustudytheexhibit,notethateverytransactionmaintainstheequalityoftheequation
Assets 5 Liabilities 1 Owner’s Equity
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
Assets Liabilities 1 Owner’s EquityType of Owner’s
Equity Transaction
Cash Accounts
Receivable Office
Supplies Land
Accounts Payable
Lisa Hunter, Capital
(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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Chapter 1 AccountingandtheBusinessEnvironment 23
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?
Just Checking Solutions appear at the end of this chapter and on MyAccountingLab.
LO 6Prepareandevaluatethefinancialstatements
MyAccountingLab
IFRS
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24 Part 1 TheBasicStructureofAccounting
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.
M01_HORN0096_01_SE_C01.indd 24 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 25
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 = $10,500
HUNTER ENVIRONMENTAL CONSULTING
HUNTER ENVIRONMENTAL CONSULTING
HUNTER ENVIRONMENTAL CONSULTING
HUNTER ENVIRONMENTAL CONSULTING
Income Statement For the Month Ended April 30, 2014
Revenue:000,55$................................................................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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26 Part 1 TheBasicStructureofAccounting
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?
Just Checking Solutions appear at the end of this chapter and on MyAccountingLab.
SalariesExpense _____
ConsultingServiceRevenue_____
Cash _____
NotesPayable _____
SuppliesExpense _____
AccountsPayable _____
MyAccountingLab
M01_HORN0096_01_SE_C01.indd 26 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 27
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.
M01_HORN0096_01_SE_C01.indd 27 10/4/12 1:12 PM
28 Part 1 TheBasicStructureofAccounting
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
For the Month Ended July 31, 2014
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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Chapter 1 AccountingandtheBusinessEnvironment 29
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
M01_HORN0096_01_SE_C01.indd 29 10/4/12 1:12 PM
30 Part 1 TheBasicStructureofAccounting
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
MyAccountingLab Video:
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.
MyAccountingLab Video:
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.
MyAccountingLab Video:
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.
MyAccountingLab Video:
Pg 16
Summary
1
2
3
4
5
TheSummarygivesaconcisedescriptionofthematerialcoveredinthechapteralongwithpagereferences,soyoucanlinkbackintothechapterifyouwanttoreviewparticularmaterial.ItisorganizedbyLearningObjective.
M01_HORN0096_01_SE_C01.indd 30 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 31
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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32 Part 1 TheBasicStructureofAccounting
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.
M01_HORN0096_01_SE_C01.indd 32 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 33
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.
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34 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 35
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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36 Part 1 TheBasicStructureofAccounting
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
5Usingtheaccountingequation
5Analyzingtransactions
4
Describingaccountingconcepts,principles,andconstraints
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Chapter 1 AccountingandtheBusinessEnvironment 37
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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38 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 39
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.
5Usingtheaccountingequation
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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40 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 41
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.)
Excel Spreadsheet Template
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.
Chapter 1 AccountingandtheBusinessEnvironment 41
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42 Part 1 TheBasicStructureofAccounting
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
M01_HORN0096_01_SE_C01.indd 42 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 43
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
Totalliabilitiesand owner’sequity
$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
44 Part 1 TheBasicStructureofAccounting
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
2.Totalassets$61,000
MakethegradewithMyAccountingLab:TheStarters,Exercises,andProblemsmarkedinred canbefoundonMyAccountingLab.Youcanpractisethemasoftenasyouwant,andmostfeaturestep-by-stepguidedinstructionstohelpyoufindtherightanswer.
MyAccountingLab
M01_HORN0096_01_SE_C01.indd 44 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 45
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
46 Part 1 TheBasicStructureofAccounting
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
For the Month Ended July 31, 2013
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
Excel Spreadsheet Template
6
Incomestatement,statementofowner’sequity,balancesheet,
evaluatingbusinessperformance
1.Netincome$135,000
6
Balancesheetforaproprietorship
1.Totalassets$330,000
M01_HORN0096_01_SE_C01.indd 46 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 47
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
Transactionanalysis,accountingequation,financialstatements
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
48 Part 1 TheBasicStructureofAccounting
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
Chapter 1 AccountingandtheBusinessEnvironment 49
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
MakethegradewithMyAccountingLab:TheStarters,Exercises,andProblemsmarkedinred canbefoundonMyAccountingLab.Youcanpractisethemasoftenasyouwant,andmostfeaturestep-by-stepguidedinstructionstohelpyoufindtherightanswer.
MyAccountingLab
M01_HORN0096_01_SE_C01.indd 49 10/4/12 1:12 PM
50 Part 1 TheBasicStructureofAccounting
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
Excel Spreadsheet Template
5
Incomestatement,statementofowner’sequity,balancesheet
M01_HORN0096_01_SE_C01.indd 50 10/4/12 1:12 PM
Chapter 1 AccountingandtheBusinessEnvironment 51
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
Totalassets $108,000Totalliabilitiesand owner’sequity
$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
52 Part 1 TheBasicStructureofAccounting
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
Transactionanalysis,accountingequation,financialstatements
4Accountingconcepts/principles
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Chapter 1 AccountingandtheBusinessEnvironment 53
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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54 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 55
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
Totalliabilitiesand owner’sequity
$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
Totalassets $723,000Totalliabilitiesand owner’sequity
$723,000
*Theinvestmentsof$600,000canbesoldtodayfor$750,000.
Required
1. Basedsolelyonthesebalancesheets,whichentitywouldyoubemorecomfortablelendingmoneyto?Explainfully,citingspecificitemsandamountsfromthebalancesheets.
2. Inadditiontothebalancesheetdata,whatotherfinancialstatementinformationwouldyourequire?Bespecific.
1 6
Usingfinancialstatementstoevaluatearequestforaloan
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56 Part 1 TheBasicStructureofAccounting
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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Chapter 1 AccountingandtheBusinessEnvironment 57
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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