Introduction to Accounting

1. Introduction to Accounting

2. Purpose • To teach the basics of accounting to those students entering the MBA program at SSB who do not have any background in accounting. • To prepare all MBA students for the mandatory course, ACTG 5100 – Financial Accounting for Managers, by providing the fundamental concepts on which the course builds. Introduction to Accounting

3. Intended audience • All incoming MBA students at The Schulich School of Business. • In particular, this lecture is designed for those that have no previous education or training in accounting. • The intention is for this lecture to teach at the most basic level. • To teach the “alphabet” of accounting so that students can learn to speak in “full sentences” in the accounting (and other) courses at SSB. • Students with even minimal background may wish to skim or skip sections of the lecture. Introduction to Accounting

4. Agenda • Fundamental concepts • The Accounting Cycle • Financial statements • Comprehensive example Introduction to Accounting

5. Fundamental concepts What is accounting? • The language of business. • A means to communicate financial information. • A way to convey information about a business to users. Introduction to Accounting

6. Fundamental concepts Who uses accounting information? • Owners • Managers • Investors (including potential) • Analysts on their behalf • Creditors (including potential) • Government (tax assessment) • Regulators • Customers Introduction to Accounting

7. Fundamental concepts Accounting has two main divisions: • Financial accounting • Primarily prepared for users external to the company. • Revenues, earnings, assets, etc. • Management accounting • Primarily for internal purposes • Costing, budgeting, net present value, etc. • This lecture will focus only on financial accounting. Introduction to Accounting

8. Fundamental concepts There are several ways that cash gets into a company: • Investment by owners • Investment by creditors (loans) • Payments from customers. • Repayment of amounts loaned to other entities. • Return on investments (interest and dividend) • Proceeds from selling assets. Introduction to Accounting

9. Fundamental concepts These can be organized into three categories: Operations • Payments from customers • Refunds from suppliers Financing • Investment by owners • Investment by creditors (loans) Investing • Return on investments (interest and dividend) • Proceeds from selling assets • Repayment of amounts loaned to other entities Introduction to Accounting

10. Fundamental concepts Similarly, money going out of an entity can be categorized: Operations • Payments to suppliers • Refunds to customers Financing • Payment of dividends or capital to owners • Repayment of creditors Investing • Purchase of assets • Amounts invested in other entities (debt or equity) Introduction to Accounting

11. Fundamental concepts Financial accounting categorizes all transactions and events based on their substance. • It is very important that the substance of a transaction be accurately reflected by financial accounting because the users of the information are using it with the assumption that these categorizations are being made accurately. • If money invested by owners was reported as revenue, this would be counter to the fundamental definition of revenue (i.e. that it results from the operations of the company). • The separation of income and capital is a fundamental concept of financial accounting. Introduction to Accounting

12. Fundamental concepts • Entity concept • Going concern • Unit of measure • Periodic reporting Introduction to Accounting

13. Fundamental concepts Entity concept • There are three basic structures that a company can have in Canada: • Sole proprietorship • Partnership • Corporation • A sole proprietorship is not a legal entity separate from its owner • A partnership is not a legal entity separate from its owners • These are both sub-components of their owners/partners for legal purposes • A corporation is a separate legal entity • The entity concept for accounting does not simply follow the legal guidelines • A business can be a separate entity for accounting even if it is not one from a legal perspective Introduction to Accounting

14. Fundamental concepts Entity concept • It is essential that we know for which entity we are accounting because it will determine if and how events are recorded. • e.g. If Ms. Prop is the sole proprietor of a business called SP, there is one legal entity, Ms. Prop (SP is not a separate legal entity). • If we wish to account for SP, there will be events to account for that are non-events from a legal perspective • e.g. When Ms. Prop puts money into a separate account for the company. This is a non-event legally, but is an event to be accounted for from an accounting perspective. Introduction to Accounting

15. Fundamental concepts Going concern • It is assumed that an entity will complete its current plans, use its existing assets, and meet its obligations in the normal course of business. • This is an underlying concept necessary for many of the fundamental recording and reporting decisions that are made in accounting. Introduction to Accounting

16. Fundamental concepts Unit of measure • In order for accounting to present information that is useful, it must be able to express things in a common unit of measure. • The unit of measure in Canada is usually the Canadian dollar (or U.S. dollar). • It is not useful to tell users that an entity has 30 cars, a building, some land, some equipment, and that it sold 35,000 widgets in the year. • The unit of measure concept allows us to express all of these things in dollars. Introduction to Accounting

17. Fundamental concepts Periodic reporting • Meaningful financial information about an entity can be provided for periods of time that are shorter than the life of an entity. • Because financial statements tell the users what the entity has and what they did to get it, the users want that information at different points in the entity’s life. • Most commonly, the reporting period is annual. All companies are required to file annual financial statements with their tax returns. • Other common reporting periods are monthly or quarterly. Introduction to Accounting

18. Fundamental concepts To review: • Entity concept • Going concern • Unit of measure • Periodic reporting Introduction to Accounting

19. The Accounting Cycle • Transaction or event occurs • Could simply be the passage of time. • Recorded in the Journal using a Journal Entry. • event is translated into accounting language. • Journal is posted to Ledger • the information from all the journal entries in the period is aggregated. • Ledger accounts are totalled. • Financial statements are prepared. Introduction to Accounting

20. The Accounting Cycle • Transaction or event occurs • Recorded in the Journal using a Journal Entry. • Journal is posted to Ledger • Ledger accounts are totalled. • Financial statements are prepared. • It is important to note that the decision-making of accounting occurs at step 2 – Journal entry. • Steps 3 – 5 are mechanical exercises. • Therefore, the decisions made when making the journal entry (i.e. translating to accounting language) are very important as they determine what will ultimately be presented on the financial statements. cont’d on next slide… Introduction to Accounting

21. The Accounting Cycle • The making of decisions about what journal entry should be made when a transaction or event occurs is the prominent theme of ACTG 5100. • It is commonly believed that these decisions are bound by strict rules that dictate what the journal entry should be. • In reality, this is not true. There are principles that can guide the decisions, but there are many circumstances for which there are not specific treatments prescribed and, therefore, the judgment of the preparers determines the treatment. • For the purposes of this lecture, we will look mostly at non-ambiguous situations. • Students will become very aware of the ambiguity in the real world in ACTG 5100 (and from reading the newspaper). Introduction to Accounting

22. Accounting Equation • Fundamental Accounting Equation: Assets = Liabilities + Owners’ Equity • This equation is always in balance • In order for this equation to remain in balance, double-entry bookkeeping is employed. • That is, the recording of every transaction or event must have at least two parts • Either an equal impact (increase or decrease) to both sides of the equation or equal and opposite impact to one side. • The recording of every transaction must keep this equation in balance Introduction to Accounting

23. Journal Entries All journal entries have two “sides”: • Debit and Credit • For every journal entry, the total debits must equal the total credits • This ensures that the fundamental accounting equation (A = L + OE) is always in balance. The basic journal entry: Debit Account name1 $amount Credit Account name2 $amount To record… Introduction to Accounting

24. Journal Entries • “Debit” and “Credit” are just accounting-speak for “increase” and “decrease” • “Debit” means “increase” for some elements and “decrease” for other elements. Likewise for “credit”. • For example, a company pays its $500 utility bill: • In English: the company has incurred an expense (the amount of expense has increased) and the amount of cash in the company has decreased. • An expense (Utilities) has increased • An asset (Cash) has decreased • In Journal entry: Debit Utility expense $500 Credit Cash $500 To record the payment of utility bill Introduction to Accounting

25. Journal Entries • How do we know whether to debit or credit? • Convention exists based on what element is being increased or decreased. • Each element “lives in” either debit or credit. If we want to increase something that “lives in” debit, we will debit it. • The convention works such that the fundamental equation (A = L + OE) is always kept in balance. Introduction to Accounting

26. Journal Entries • The Basic Accounting Elements: Introduction to Accounting

27. Journal Entries The Basic Accounting Elements: Asset • Has future benefit to the entity Liability • Obligation to transfer assets in the future Owners’ Equity • Owners’ interest in the company Revenue • Increase in economic resources resulting from normal operations of the company Expense • Decrease in economic resources resulting from normal operations of the company Introduction to Accounting

28. Journal Entries • The Basic Accounting Elements: Introduction to Accounting

29. Journal Entries • To increase an Asset or Expense: Debit • To increase a Liability, Revenue, or Owners’ Equity: Credit • To decrease an Asset or Expense: Credit • To decrease a Liability, Revenue, or Owners’ Equity: Debit Introduction to Accounting

30. Journal Entries • Going back to the Fundamental Accounting Equation: Assets = Liabilities + Owners’ Equity Debit Credit Credit Introduction to Accounting

31. Journal Entries • What about the Income Statement elements (Revenue and Expense)? • They don’t appear in the fundamental accounting equation, so how does it stay in balance when they are debited or credited? • e.g. consultant sells services for $300 cash • In English: Cash (asset) increases $300 Revenue increases $300 • In Accounting: Debit Cash (Asset) $300 Credit Consulting Revenue $300 To record payment for consulting services rendered • Assets have increased. Liabilities and Owners’ Equity appear to be unchanged. • Is A = L + OE not true (i.e. out of balance)? Introduction to Accounting

32. Element structures • Assets • Liabilities • Owners’ equity Introduction to Accounting

33. Element structures • Assets • Current assets • Cash • Cash on hand • Bank accounts • CIBC • BMO • Accounts receivable • Accounts receivable – customer 1 • Accounts receivable – customer 2 • Inventory • Raw materials • Work in process • Finished goods • Product 1 • Product 2 Introduction to Accounting

34. Element structures • Assets • Current assets • Long-term assets • Buildings • Ontario buildings • Quebec buildings • Montreal building • Sherbrooke building • Vehicles • Cars • Trucks • Truck 1 • Truck 2 Introduction to Accounting

35. Element structures • Liabilities • Current liabilities • Accounts payable • Accrued liabilities • Long-term liabilities • Bank loans • Loan from RBC • Loan from Scotiabank • Notes payable • Bonds payable Introduction to Accounting

36. Element structures • Owners’ equity • Capital stock (direct investment) • Retained earnings (indirect investment) • Revenue • Expenses • (Dividends) • Although revenue and expenses are not sub-pieces of Retained earnings the way Current assets are a sub-piece of Total assets, for the purposes of understanding how they fit in to the equation, this representation is helpful. Introduction to Accounting

37. Element structures The balance sheet is a permanent statement • Its’ accounts accumulate information from the entity’s beginning. • The amounts presented on the balance sheet are aggregated from the entity’s beginning to the balance sheet date. The income statement is a temporary statement • Its’ accounts are temporary accounts • They accumulate information for a period and then are reset to zero to begin tracking information for the next period. • The amounts presented on the income statement are aggregated from the beginning of the period to the end of the period only. Introduction to Accounting

38. Element structures The Closing Entry • Whenever financial statements are to be prepared, the temporary (income statement) accounts must be “closed” to zero so that they can begin tracking data for the next period. • The amounts in the accounts at closing are transferred to Retained Earnings (so named because it is the earnings (net income) of the company that is retained in the company and not distributed to the owners). • We will see an example in the comprehensive example. Introduction to Accounting

39. Element structures The Closing Entry • The result of the closing entry is that all impacts on Revenue and Expenses (the temporary accounts) are indirectly impacts on Retained earnings (a permanent account). • That is how A = L + OE stays in balance. • The temporary accounts are sub-pieces of OE. Introduction to Accounting

40. Journal Entries • Going back to the Fundamental Accounting Equation: Introduction to Accounting

41. Financial Statements There are 4 statements in a standard set of financial statements • Balance Sheet • The “what do we have?” statement • Shows what the entity owns and owes (the difference being the owners’ residual interest) • Income Statement • The “what did we do?” statement • Shows the activity the entity undertook in its normal course of operations. • Statement of Retained Earnings • Shows the changes in Retained earnings in the year • Often shown at the bottom of the Income Statement • Statement of Cash Flows • Shows the sources and uses of cash in the year • Information is derived from the B/S and I/S and other Introduction to Accounting

42. Financial Statements Statement of Cash Flows • Contains information about how cash came into and left the entity in the period. • Does not contain new information • i.e. the SCF is derived from the Balance Sheet and Income Statement (with some supplementary information) • The SCF will not be covered in this lecture. It is covered in ACTG 5100. Introduction to Accounting

43. Financial Statements Introduction to Accounting

44. Financial Statements Introduction to Accounting

45. Loblaw Introduction to Accounting

46. Loblaw Introduction to Accounting

47. Loblaw Introduction to Accounting

48. Loblaw Introduction to Accounting To Balance Sheet

49. Loblaw From Statement of Retained Earnings Introduction to Accounting

50. Canadian Tire Introduction to Accounting