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Financial Accounting Exam Review
Chapter 1: The Purpose and Use of Financial Statements
What is Accounting?
1. Accounting is the language of business. It is the information system organizations use to measure
business activities.
2. Accounting helps process data into results and communicates those results to key decision-
makers.
3. Accounting identifies and records the economic events (financial transactions) within an
organization. Organizations then create financial statements using the financial transactions they
collected and recorded to communicate the results to interested users.
4. Accounting can be used for both companies and individuals – companies want to see how they
are performing in any given year, but you can also apply it to your life to track your earnings and
expenses.
What are Financial Statements?
1. The financial statements aim to provide a picture of the financial position and performance of a
business.
2. Financial accounting focuses on preparing financial statements for external users to help them
make decisions. External users are not involved in the day-to-day business.
3. Internal users are the ones who prepare those financial statements. Internal users must act
ethically for the financial statements to have value to the external users.
Internal Users:
- Finance/Accounting Dept. – The ones making financial statements! Marketing & HR Department
External Users:
- Investors: They decide on investing or buying/selling shares of a company
- Lenders: They want to know if they will be repaid
- Governments: They want to know if they are paying taxes appropriately, or using loans correctly
- Customers, employees, labour unions
What are GAAP (Generally Accepted Accounting Principles)?
- The basis on which general-purpose financial statements are created, and a broad set of
principles.
- International Financial Reporting Framework (IFRS) versus Account Standards for Private
Enterprises (ASPE)
- Used to make the financial statements comparable!
- Makes sure internal users are acting ethically!
- Helps external users have the ability to understand how the company is doing compared to others
in the industry & allows them to feel “good” about making decisions based on the financial
statements
,What is the Income Statement (Statement of Income)?
- The statement of income reports the success or failure of the company’s operations for a
period/fiscal year (usually a year) Jan 1 to Dec 31 OR Nov 1 to Oct 31 (any 12 months)
1. Revenue is the income earned from the sale of goods or services (sales, service revenue, interest
revenue, rental revenue)
2. Expenses are the cost incurred to be able to run your business and earn revenue (COGS, rent
expense, income tax expense)
3. Net Income is calculated: Revenues – Expenses
- Investors are interested in a company’s past income because these numbers provide information
that may help predict future income.
- Income is required to generate cash to fund growth, repay debt, and pay dividends so this
statement shows how profitable the company was in the last fiscal year.
- Creditors want to be repaid in the future they typically don’t lend to companies who are not
making income!
,What is the Statement of Changes in Equity?
- Reports the changes in each component of shareholders’ equity during a time (usually a year).
- The statement of changes in equity starts with the account balances at the beginning of the
period (year) and ends with the account balances at the end of the period (year)
1. Share Capital/Common Shares = the amounts contributed ($$) by the shareholders (owners) in
exchange for shares in the company.
2. Retained Earnings represent the total amounts of net income that have been retained in the
corporation with fewer dividends.
- In other words, the income that has been accumulated in the corporation has fewer dividends to
shareholders since the company was incorporated/started.
What might external users be deciding based on this information?
- Dividends that were paid out and Commons shares were issued during the year
, What is the Statement of Financial Position (Balance Sheet)?
- The balance sheet reports assets and claims to those assets at a specific point in time (the end of
the fiscal period).
- It provides a “snapshot photo” of a moment in time. It will show the balances ($$) of each account
– Assets, liabilities and Shareholders’ Equity for a specific date.
- The accounting equation states that the assets must be equal to the liabilities and SE – Everything
must always balance – hence the name! ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY
1. Assets – What you Own: Resources a company owns or controls that will provide future benefit
the s to the company
2. Liabilities – What we Owe to someone else: Claims of lenders – Obligations that are a result of a
past transaction
3. Shareholders’ Equity – What the company is worth: Claims of shareholders – Comes from the
statement of changes in equity – it is the ending balances in the retained earnings and common
shares
- Lenders and other creditors could look at the company and analyze if they will be repaid (and how
many liabilities the company already has)
- Investor interest in looking at the number of assets compared to liabilities
The accounting equation ALWAYS balances no matter what. Let’s look at some examples:
- Shareholder’s invested $500 into the company
- + Cash (Asset) & + C/S (SE)
- The Company used $200 of the cash to purchase
equipment
– Cash (Asset) & + Equipment (Asset)
- The Company purchased a building by taking out a
mortgage
+ Buildings (Asset) & + Mortgage Payable (Liability)
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