Module 2
Module 2
Module 2
Learning Outcomes
By the end of this module, you will be able to:
1. Recognize economic events and explain the accounting implications for these events.
2. Identify potential users of financial information.
3. Describe the purpose of Generally Accepted Accounting Principles (GAAP) including ASPE and
IFRS
4. Describe the key components of three main financial statements (Income Statement, Statement
of Owner's Equity, Balance Sheet) and how they inter-relate.
5. Use the accounting equation to capture economic events.
In your HR career, it's not likely that you will be required to maintain accounting records or prepare
accounting statements, however, it is likely that you will be looking at your company's financial
statements on a regular basis. We want you to have a general idea of what they're all about so that you
can participate with knowledge and confidence.
Economic event – An event that can be described in monetary terms (i.e. with dollars and cents).
Communicates – Using formal financial statements: Income Statement and Balance Sheets.
Users – There are both internal and external users of financial information.
A. Attending lectures
B. Paying tuition
C. Borrowing loan
D. Purchasing textbooks
E. Selecting courses
So if an activity doesn't fit the definition of an economic event, we can't capture it within our accounting
records.
At the end of the accounting period, financial statements will be prepared to summarize and
communicate this information to interested users.
In general, larger companies will set monthly accounting periods while smaller companies may choose
to report only once per year. Regardless of size, all businesses are required to produce financial
statements at least once per year.
Don't worry if you don't know what journals and ledgers and trial balances are. We'll get into those in
more detail in a few more modules.
The main tools for communicating are financial statements. There are 3 common financial statements
that are used:
• Statement of Cash Flows – Shows where our cash came from and what we did with it.
• Income Statement – Tells us if we are making a profit.
• Balance Sheet – Shows what we own and what we owe.
Don't worry too much about understanding these statements right now. We'll get into the details later.
For now, you need to understand that these statements are how we communicate.
• Internal users
• External users
Internal Users
Employed by the company and need information to answer questions such as:
External Users
Investors (or future investors), creditors, government and customer Need information to answer
questions such as:
A. Banks
B. Employees
C. Unions
D. Investors
E. Managers
F. Government or Regulatory Agencies
Answer:
Learning Activity
Following are descriptions of different business organizations. Identify each as Proprietorship,
Partnership or Corporation.
1. BioWind Company has one owner, Barb Smith, who is personally liable for the debts of the
business.
2. Ownership of Foxton Landscaping is divided into 1,000 shares.
3. Nancy Levens and Frank Kerr own a courier service. Both Levens and Kerr are personally liable
for the debts of the business.
4. Tiny Technologies has two owners and pays its own income taxes.
5. Mital Consulting does not have a separate legal existence apart from the one person who owns
it. Upon the death of the owner, the consulting business will cease to exist.
Answer:
1. Proprietorship
2. Corporation
3. Partnership
4. Corporation
5. Proprietorship
Accounting Rules
If all of these people are going to use our financial statements to make important decisions, they need
to know that the information is reliable and accurate.
To assist with this task, the accounting profession has developed standards to ensure that everyone is
following the same rules. These standards are referred to as Generally Accepted Accounting Principles
(G.A.A.P.)
Depending on the type of business, Canadian companies must follow either A.S.P.E. or I.F.R.S:
• Companies that are publicly traded on the stock exchange must follow the international
standards (I.F.R.S.).
• Private companies where the stock is not publicly traded can choose to follow either I.F.R.S. or
A.S.P.E.
Accounting rules and theories can get complicated quickly! All you need to understand is that there are
different rules for different countries with a common set of international rules that some companies
must follow. All of these different sets of standards can be referred to as Generally Accepted
Accounting Principles (G.A.A.P.).
Assumptions
• Going Concern Assumption: Assumes that a business will continue to operate into the
foreseeable future and the business's assets are required for this continued operation. Because
the business assets are required for continued operations, these assets are not for sale.
• Economic Entity Assumption: The business and all business related transactions must be
treated separately and distinctly from the owner(s).
• Monetary Unit Assumption: Only events resulting in transactions that can be expressed as
money will be recorded. Such events are recorded in the currency of the business entity's
country (i.e. Dollars, Pounds, Yuan, Yen, Pesos, Euros).
Principles
• Historical Cost Principle: Economic or business transactions are always recorded using the
actual cost of the consideration transferred between the parties. Assets must always be
recorded at their historical (original) cost, regardless of the current perceived fair market value.
• Realization (Revenue Recognition) Principle: Revenue should be recorded (recognized) in the
accounting records in the period in which it is earned, not when the cash is received. Costs
should be recorded (recognized) in the accounting records in the period they are incurred, not
when the cash is paid.
• Matching Principle: Whenever possible, the costs incurred to generate revenue should be
matched with and recorded at the same time as the related revenue.
Activity
Match the assumption or principle with its correct definition.
1. The principle that assets must always be recorded at the original cost, regardless of the current
perceived fair market value (i.e. cost adjusted from inflation).
2. The assumption that the business will continue to operate into the future, and the business
assets are not being sold due to continuing operation.
3. The principle that the costs incurred to generate revenue is matched with and recorded the
same time as the related revenue.
4. The assumption that transactions that are expressed as money will be recorded on financial
statements.
5. The assumption that all business-related transactions must be treated separately and distinctly
from the owner(s).
6. The principle that revenue should be recorded in the period in which they are earned, not when
the cash is received. Costs should be recorded in the period in which they are incurred, not
when the cash is paid.
Answer:
Financial Statements
We've learned that the financial statements are an important tool for communicating a company's
economic events to its users. It's time now to dig a little deeper into three of the most important
financial statements.
1
For Sole Proprietorships, this is called “The Statement of Owners Equity”.
It is a snapshot of the resources (assets) and obligations (liabilities or debts) of the business, as well as
the owner's ownership of those resources, at a particular point in time (i.e. on November 30).
Examples of Assets:
• Cash
• Accounts Receivable
• Supplies
• Inventory for Resale
• Land or Buildings
• Office/Warehouse/Manufacturing Equipment
• Automobiles
Liabilities
Debts or obligations incurred as expenses or to purchase assets.
Examples of Liabilities:
• Bank Loan
• Unpaid Utility Bills
• Unpaid Rent
• Unpaid Taxes
• Unpaid Salary
• Unpaid Interest
Owner Equity
Represents the owner's ownership of assets (the difference between assets and liabilities).
• Owner's Capital
• Owner's Drawings
Essentially, the balance sheet will create a snapshot at one point in time of the company’s health. This is
not a picture of its performance over a period of time (more on that later). It only represents a listing of
all the tangible and intangible assets, debts and equities in the company - be it a sole proprietorship, a
corporation, or a partnership.
Activity
Categorize the following accounts as:
A. Assets
B. Liabilities
C. Owner’s Equity
Accounts:
1. Supplies
2. Cash
3. Bank loan
4. Capital
5. Utility bills
6. Taxes
7. Accounts receivable
8. Rent
9. Drawings
10. Inventory
11. Land
Answer:
1. Supplies – Assets
2. Cash – Assets
3. Bank loan – Liabilities
4. Capital – Liabilities
5. Utility bills – Liabilities
6. Taxes – Liabilities
7. Accounts receivable – Assets
8. Rent – Liabilities
9. Drawings – Owner’s Equity
10. Inventory - Assets
11. Land – Assets
What is the Income Statement?
It summarizes revenues and expenses for an entire accounting period (i.e. for the month of November.)
A. Revenue
B. Expenses
Transactions:
Answer:
• A business makes (or loses) money from the economic activities undertaken during the year.
This is reflected on the income statement (revenues minus expenses).
• This profit or loss is added to the opening balance equity balance along with any investments or
drawings to calculate the ending equity (Statement of Owner's Equity).
• This new equity figure is then reported on the Balance Sheet.
Example
Melville's Bike Repair
Income Statement
For the Year Ended December 31, 2018
Revenues
Repair Services $5,000
Expenses
Salaries Expense $1,000
Advertising Expense 500
Rent Expense 750
Total Expense 2,500
Net Income $2,750
Net income value appears in the Statement of Owner’s Equity:
Melville's Bike Repair
Statement of Owner’s Equity
For the Year Ended December 31, 2018
M. Smith, Capital, January 1,
2018 $5,000
Add:
Investments $0
Net Income 2,750 2,750
Less:
Owner’s Drawings 2,000
M. Smith, Capital, December
31, 2018 $5,750
M. Smith, Capital, December 31, 2018 appears in the Balance Sheet:
Learning Activity
Determine which financial statements each account belongs to:
A. Income Statement
B. Statement of Owner’s Equity
C. Balance Sheet
Hint: Use your textbook (Illustration 1-14) as a guide when sorting where each of these accounts belong
in the financial statements.
1. Accounts Payable
2. Accounts Receivable
3. J. Doe, Capital, September 1
4. Services
5. Owner’s Equity
6. Add: Investments, J. Doe
7. Assets
8. J. Doe, Capital, September 30
9. Total Assets
10. Less: Drawings
11. Total Expenses
12. September, 20, 2011
13. Rent
14. Liabilities
15. Salaries
16. Expenses
17. Revenue
18. Cash
19. Total Liabilities and Owner’s Equity
20. Total revenue
21. Net Income (less)
22. Total Liabilities
Answer:
Let's start right back at the beginning with something many of us can relate to - owning a house. Now,
most of us don't own a house outright, we have a mortgage. We own the house but we also owe the
bank for usually quite a large amount of the value of that house.
1. Let's say that I own a $500,000 house and that my mortgage is $400,000. I think it's common
terminology for me to say that I have $100,000 of equity built up in my house.
• House: $500,000
• Mortgage: $400,000
• Equity: $100,000
Now, the next time that I make a mortgage payment to my bank, my loan goes down and my
equity goes up just a little bit.
2. Let's say that my mortgage payment is $1,000 against the principle (plus some interest) So my
numbers now look like this:
• Mortgage: $399,000 – I now owe $1,000 less on my mortgage.
• Equity: $101,000 – I have increased my equity in my house by $1,000.
The value of my house hasn't changed, just the split between my equity and the bank loan.
3. Next, I need to buy some furniture and other things for my house so I go to the bank and get a
loan: $20,000 is put into my bank account:
• Cash: $20,000 – The bank has given me this cash to spend as I wish.
• Bank loan: $20,000 – I now owe the bank the value of the loan.
4. I use $5,000 of that cash to buy my furniture and $10,000 for a used car:
• Cash: $5,000 – I no longer have as much cash, but I do own some furniture and a car!
• Furniture: $5,000
• Car: $10,000
While we've just been working through some day to day activities and writing them down, I have been
writing them down in strategic places.
Balance Sheet
Assets Liabilities
House $500,000 Mortgage $399,000
Cash 5,000 Bank Loan 20,000
Furniture 5,000 Total Liabilities 419,000
Owner’s Equity
Car 10,000 Equity 101,000
Total Assets $520,000 Total Liabilities and Equity $520,000
None of the numbers have changed. The only difference is that I have wrapped my finances within the
framework of a balance sheet.
You can see that everything in the left column are things that I own. We might want to call those my
Assets. Top of the right column is all of the money that I owe, my Liabilities.
That equity that I built up in my house is in its own section called Equity: We've created a Balance Sheet!
So can you see that the balance sheet simply lists the things that I own (my Assets) and then describes
the proportion that has been paid for by me versus what I still owe the bank. If I add both of the two
pieces on the right, (what I paid for and what I still owe the bank), it should come to the full value of my
assets. My Assets = My Liabilities + My Equity.
This is called the Accounting Equation. And everything that we do in accounting has to have an end
result of this equation remaining in balance.
Finally, pay day has arrived and my work places $5,000 in my bank account! I immediately go out and
spend $1,000 on gas, groceries, cleaning supplies - all kinds of things for my house.
• Cash: $9,000 – My cash balance has increased $4,000 - $5,000 in pay less $1,000 spent.
• Groceries, gas and supplies: $1,000 – I don't want to add these purchases to my asset list as they
are consumables - I'm going to use them up right away; they'll be gone by the end of the month.
Have you noticed that my balance sheet doesn't balance anymore? The problem is that $4,000 I have
left over from my pay cheque. How are we going to recognize that extra money to make sure the
accounting equation balances?
If we call my pay my Revenue and my spending spree my Expenses, we can see that I have earned a Net
Income or Profit from my work of $4,000. Seems like an Income Statement!
Income Statement
Revenues 5,000 – my pay this week
Expenses 1,000 – the things I purchased with from my paycheque that I have
used up immediately.
Net Income 4,000
My profit is money that I worked hard for and now have available to use later. I've built up some more
Equity in my life! So let’s transfer that profit into my Equity so that I can use it later:
Balance Sheet
Assets Liabilities
House $500,000 Mortgage $399,000
Cash 5,000 Bank Loan 20,000
Furniture 5,000 Total Liabilities 419,000
Owner’s Equity
Car 10,000 Equity 105,000
Total Assets $520,000 Total Liabilities and Equity $520,000
My equity has increased by $4,000 - the money I had leftover from my paycheque.
We can now expand our basic accounting equation to include revenues and expenses (and other
changes to our equity).
And that, in a nutshell, is everything there is to know about the Accounting Equation and Financial
Statements. In a business environment, we have a few different names and accounts, but the basic idea
doesn't change.
Learning Activity
Now it's your turn: For the following events, see if you can figure out how the accounting equation
changes. Begin with a chart as follows:
Equity
Assets Liabilities Revenues (+) Expenses (−) Investments (+) Drawings (−)
Situations:
1. Received $500 for services provided.
2. Paid $300 of operating expenses.
3. Invested $1,000 cash in the business.
4. Owner withdrew $400 cash.
5. Purchased $600 in equipment in exchange for a note payable. Loyalist User: A note payable is
like an IOU - we will pay the vendor later.
Answer:
Equity
Assets Liabilities Revenues (+) Expenses (−) Investments (+) Drawings (−)
500 500
(300) (300)
Equity
Assets Liabilities Revenues (+) Expenses (−) Investments (+) Drawings (−)
1,000 1,000
(400) (1400)
600 600
1,400 600 500 (300) 1,000 (400)
Assets = Liabilities + Revenues (+) − Expenses (-) + Investments (+) − Drawings (-)
We balance!
1. Accounts Receivable
2. Wages Expense
3. Salaries Payable
4. Equipment
5. Supplies
6. Service Revenue
7. Notes Payable
8. Owners Drawings
Answer:
1. Accounts Receivable – A
2. Wages Expense – OE
3. Salaries Payable – L
4. Equipment – A
5. Supplies – A
6. Service Revenue – OE
7. Notes Payable – L
8. Owners Drawings – OE
Now that we have learned some typical account names, let's practice analyzing some more transactions
using account names.
Learning Activity 2
Below are 4 economic events. Match one of the basic transaction analyses to each event.
Transaction Analysis:
1. Cash increased by $9,000 and the owner's capital account increased by $9,000
2. Cash is decreased by $4,000 and the Rent Expense is increased by $4,000
3. Supplies is increased by $1,000 and the liability, Accounts Payable is increased by $1,000
4. Accounts Receivable is increased by $900 and Service Revenue is increased by $900
Economic Events:
Answers:
1. Cash increased by $9,000 and the owner's capital account increased by $9,000 – Owner invests
cash in business
2. Cash is decreased by $4,000 and the Rent Expense is increased by $4,000 – Paid cash for rent
3. Supplies is increased by $1,000 and the liability, Accounts Payable is increased by $1,000 –
Supplies are purchased on account
4. Accounts Receivable is increased by $900 and Service Revenue is increased by $900 – Company
provides service on account
Practice Activities
Please see the Course Timeline posted on Blackboard for your homework questions for this module.
• All homework questions come from the end of the chapter in your textbook.
• Answers to the multiple choice questions can be found at the end of the chapter.
• Solutions for selected questions and exercises are posted on Blackboard under "Practice
Problems"
We've covered a lot of material in a very short amount of time. The best thing for you to do to help with
retaining it is to do some practice questions on your own! Don't just read through them. Sit down with
a paper and pencil and work through each one! If you have any questions, be sure to post on the
Discussion board.
Summary
In this module, we have explored:
Module Checklist
You have now completed all of the modules and activities for week 2. Check off each item below to
confirm you have successfully completed all items in the module.
• I have completed the learning activities in all assigned modules for week 2 (see Timeline for
details).
• I have completed the assigned practice problems from the textbook.
• I have posted any questions that I have on the Discussion Board in Blackboard.
• I have checked the Announcements and the Discussion Board on Blackboard for any tips and
tricks for this week.
• I have completed and submitted the graded assignment for this week (See Timeline for details)
Now that you know a bit about financial statements and how financial transactions affect them, it's time
to move on to learn the recording process in detail.