ACC100 chapter 1-3

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Introduction to accounting Chapter 1 - introduction to accounting What is a business? The activity of making, buying, or selling goods or providing services in exchange for money. Business sectors: Primary : where we grow and gather raw materials (potato farm, oil drilling). Secondary : where raw materials are turned into products (car manufacturing, frozen food factory). Tertiary: where goods and services are sold to consumers (restaurants, hairdressers). What is our focus? In this course our focus will be the tertiary sector, concentrating first on retailers and then on wholesalers. A retailer earns a profit by reselling goods or providing services to consumers (also called the public) in order to satisfy their wants and needs. A wholesaler buys large quantities of goods from manufacturers, warehouses them, and then resells them to retailers. Wholesalers do not sell to consumers (the public). Who cares about a business and why? Stakeholders care about a business. Stakeholders are individuals or groups who either affect the business or are affected by the actions of the business. All stakeholders have objectives , something they want from their relationship with the business. Stakeholders can be either internal or external. Internal stakeholders work for the business. Their objectives generally relate to their ability to keep their jobs, do their jobs more efficiently, get promoted, and get paid for their work. External stakeholders are outside of the business and their objectives generally relate to decisions they will make about money (also called resource allocation decisions) or about how the business can affect them, either positively or negatively. Internal Stakeholders: Stakeholder What They Want General Employee Earn high wages and keep their jobs

Marketing manager Effect of advertising (marketing campaigns) Company lawyer Ensure laws are followed Tax manager Ensure taxes are minimized and tax laws are followed Owners (or sole proprietor) Maximize profit, grow/expand the business External Stakeholders: Stakeholder What They Want Shareholders (of a corporation) Decide to invest or not invest, earn income from their investment Governments Ensure businesses pay taxes, employ more people, follow laws Customers Buy quality products at low prices, get the best warranties on products or services Suppliers Sell products/services to the business, get paid on time and in full Creditors (banks) Decide whether to lend money and how much, ensure business repays loan plus interest on time Society/Community Employ people from the community, improve the standard of living, run their businesses in an ethical manner, reduce/eliminate any negative environmental effects of their business practices, support local charities Why is it important to know about stakeholders and their objectives? The financial information a business provides is often the key information that external stakeholders use to make decisions. By better understanding the stakeholders and their objectives we can better understand the need for financial information and how important it is that stakeholders can depend on that information for their decision-making. Recap You now know that businesses are either in the primary, secondary, or tertiary sector. Many businesses can be in more than one sector – for example, Imperial Oil is in all three sectors: it

explores and drills for oil and gas, has refineries that create products from crude oil and gas, and also has service stations that sell those products to consumers. This book will focus on the tertiary sector; first retailers, then wholesalers. You also know that every business has stakeholders - individuals or groups that either affect a business or are affected by the decisions a business makes. Stakeholders have questions about the business they want answered so they can make decisions to help them meet their objectives. Stakeholders can be either internal or external to the business. What information do stakeholders use to answer their questions and make decisions? Companies record their business transactions in an accounting system: an information system that collects, groups, and communicates a business's financial position, including its financial health and profitability. Without accounting information, stakeholders would not be able to make many of the decisions that help them meet their objectives. Internal stakeholders have access to all the accounting information because they work in the business. They can use the accounting system to answer whatever questions they might have on a daily basis. External stakeholders do not have access to the business's accounting system because they are outside the business. Instead, they depend on the financial statements that businesses produce. Financial statements tell a business's story, what it does and how well it does it. They provide a business’s financial performance, its current financial position, and its cash flows. External stakeholders use the financial statements to analyze a business and answer questions, which allows them to make decisions and meet their objectives. What qualities must financial information have to make it useful for decision-making? We know that external stakeholders use financial information to make decisions that will help them meet their objectives. These decisions are often resource allocation decisions, meaning that their decisions often involve the stakeholder's money. For instance, a creditor might be deciding whether to give a loan to a business and an investor might be deciding whether or not to buy the business’s shares. Stakeholders can only make these kinds of decisions if the business provides them with the necessary financial information. Businesses are the preparers of the financial information, and stakeholders are the users. If you were a stakeholder making a decision, what qualities would you want the financial information to have? Would you want the information to be truthful? Comparable to other businesses so you can make a choice between them? Up-to-date information? In a format that is common to all businesses so you easily understand and compare it? All of these qualities are called qualitative characteristics: qualities that stakeholders want financial information to have so they can use the information for decision-making. Let’s look at each of the qualities that external stakeholders want. Quality: Description: Faithful Truthful, meaning it is complete, free of error, and neutral (unbiased). Relevant Applicable or pertinent to your decision-making, helps you predict the future and/or confirm decisions you made in the past.

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Comparable Can compare the same business from year to year OR between two different businesses in the same industry. Verifiable Anyone looking at the information would determine similar amounts. Timely Information is provided quickly (as old information is less useful). Understandable Group and present information so it is clear and concise. Why is this important? In order to use information to make decisions it is important to understand the quality of that information (how trustworthy it is). If information does not have these qualitative characteristics then it may mislead the stakeholders, causing them to make wrong decisions. Look at the next "Check your understanding" to better understand why the quality of information provided is so important for decision-making. How are qualitative characteristics used to produce useful information? The qualitative characteristics are part of the standards (also called guidelines) accountants use to prepare financial information for external stakeholders. We know that information must be faithful, relevant, comparable, verifiable, timely, and understandable in order to be useful. It is sometimes difficult to apply these qualitative characteristics to the recording of financial transactions. As a result, the qualitative characteristics are used to develop assumptions that specify how accountants must record, measure, and report information. By following the qualitative characteristics and these assumptions, preparers of financial information ensure that financial information has the qualities that external shareholders need in order to use the information for decision-making. Assumption Description: Separate Entity Only the activities of the business are included in the business’s financial information. Unit-of-Measure All transactions must be reported using the same monetary unit. Usually this is the monetary unit of the country the business's head office is located in, even if the business has offices in many countries. Going Concern Businesses will continue their operations well into the future. Historic Cost All purchases will be recorded at the amount that was paid for them.

Time Period (Periodicity) Information is broken into artificial time periods such as a month, quarter or year, so that stakeholders can analyze and compare information to make decisions. Full Disclosure If something will affect the decisions of the external stakeholders, it must be reported. Why is this important? You saw from the example of the used car salesperson that it is impossible to make an informed decision unless the information provided can be trusted. When preparers use both the qualitative characteristics and the assumptions to record, measure, and report financial information, external stakeholders gain assurance that the information provided is useful for decision-making. How are the assumptions used? Previously in the chapter you saw how qualitative characteristics are used as a guide when recording and reporting the financial information of a business. Since the assumptions are based on the qualitative characteristics, and are used by preparers to correctly record, measure and report information, they also help preparers to ensure that the financial information has the qualities stakeholders need to make decisions. Putting it all together! The qualitative characteristics and underlying assumptions are part of generally accepted accounting principles, called GAAP (pronounced gap). Preparers of accounting information use GAAP as a guideline when preparing financial accounting information. The overall objective of GAAP is to provide financial information about a business that is useful to external stakeholders for decision-making. Chapter 2 - The accounting equation and transaction analysis How does financial data become financial information? Financial information is the end product of data processing. Once data has been categorized, analyzed, and formatted for presentation purposes it becomes information. What is financial information used for: useful for decision-making. What does the accounting system do? Is an information system that collects groups and communicates a businesses financial position including its financial health and profitability. What is the end result of a business's accounting system? The financial statements, they tell a businesses story, what it does, and how well it does it but What do we have to do in order to record the data? We use the accounting equation and its elements to record business activities.

Name the financial reporting elements: assets, liabilities, equity, revenue, and expenses. What will I learn in this chapter (2)? 1. What are the financial reporting elements, who uses them, and what for? 2. What is the interrelationship between the reporting elements? 3. How can you use your knowledge of the elements to solve for unknown numbers? 4. How can you use the elements to record basic business transactions? Why is financial information important? As you can see from the example of Tees Inc., both the preparers of financial information and the external stakeholders, the users, have objectives. The owners of Tees Inc. want a loan and they need to provide financial information to get it. The bank, an external stakeholder, wants financial information so it can decide on the amount of the loan as well as whether the loan, plus interest, will be repaid by the business. Both parties need financial information to meet their objectives. How do businesses produce financial information that is useful? Businesses are involved in thousands of business activities every day. These activities, when recorded, result in financial data. The problem is that financial data is not financial information. What's the difference? Information is the end product of data processing. Once data has been categorized, analyzed, and formatted for presentation purposes it becomes information which can be used for decision-making. Let's look at an example to make this concept clearer. Ryerson University collects data on all students applying to Ryerson's programs. Ryerson has huge amounts of raw data including name, address, date of birth, age, gender, nationality, high school attended, high school courses taken, grades received in every high school course, etc. Ryerson also has all that information, and more, for students who are presently enrolled in programs as well as for all students who have graduated. This data is useless for decision- making unless it's processed. Once processed (categorized, analyzed, and formatted), the data becomes information that can be used for decision-making. For instance, the information could indicate that students from specific high schools or students with both calculus and advanced functions are more likely to graduate from Ryerson's Business Management program. The data, once categorized, analyzed, and formatted for presentation purposes, becomes information that can be used to make decisions, such as adjusting future entrance requirements to improve student pass rates. In business, the process of changing financial data into financial information is carried out by the accounting system: an information system that collects, groups, and communicates a business's financial position, including its financial health and profitability. The end result of a business's accounting system is financial information in the form of financial statements. Financial statements tell a business's story, what it does and how well it does it. They provide a business’s financial performance, its current financial position, and its cash flows. External stakeholders use the financial statements to analyze a business and answer questions, which allow them to make decisions and meet their objectives. But we're getting ahead of ourselves. How do businesses use accounting systems to turn financial data into financial information so that financial statements can be produced? They use GAAP : generally accepted accounting principles.

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How does GAAP help turn financial data into financial information? Remember that for data to be useful it must first be categorized or grouped. GAAP specifies (identify, spell out) the categories, called elements , that all business activities are divided into. These elements are then used to produce financial information and, eventually, the financial statements which external stakeholders analyze to make decisions. What is the purpose of the financial reporting elements? These elements are used when recording business activities. Business activities are grouped, so that we can eventually produce financial statements that will be used by external stakeholders to make resource- allocation decisions. List the five financial reporting elements. Assets, liabilities, equity, revenue, and expenses. What is the definition of the element assets? Assets are owned, provide future economic benefit (assets will be used either directly or indirectly to help the business, used to produce a good or provide a service or pay down debt), and they are due to past events (transfer of ownership and transfer was a past event). What is the definition of the element liabilities? Liabilities are owed to third parties (obligation to individuals or groups outside the business), will be settled in the future (give up of cash, goods, or services), and are due to past events (only happens after you borrow money). What is the definition of the element equity? List the two items that make up the element equity and define them. Equity is equal to the wealth that is due to the owners of the business. Made up of two items. First, equity is the capita l provided by the owners. Second, equity is the profit that the business generates and keeps in the business. Retained earnings: the profit kept or retained in the business for future expansion. To summarize equity is the capital invested by the owners, plus the profit, less dividends retained by the business. Equity is owed to the owners of a business by the business. Equity - capital + retained earrings owed to the owners. How is equity, your wealth position, calculated? Assets - liabilities = equity. What is the definition of the element revenues? Is the income that a business earns. Only two ways to earn revenue: businesses either provide a good or service. Revenue must be earned (must have done the job). Revenues can only be recognized when the business has finished their job, provided the service, or delivered the good. What is the definition of the element of expenses? What expenses would you expect a courier business such as Federal Express (FedEx) to have? Expenses are the costs of the resources that are used, consumed, or incurred to help generate revenue. Costs or expenses must be matched to the revenue they help to generate. Revenues - expenses = profit Retained earnings = profit - dividends Equity = owner's capital + retained earnings

Equity = owner's capital + revenue - expenses - dividends Assets - liabilities = equity Assets = liabilities + equity How do we apply our knowledge of the elements and equations to business activities? Recall that, in business, the process of changing financial data into financial information and then into financial statements is carried out by the accounting system. The first step in the accounting system is to collect and group the activities into the financial reporting elements and record them using the accounting equations. This is the first step in moving from financial data to financial information. Your current understanding of the financial reporting elements, their definitions, and the accounting equations is critical; however, you also have to understand another very important accounting concept: the double entry accounting system. What is the double entry accounting system? To explain this simply, let's go back to the basic accounting equation: Assets = Liabilities + Equity Note that this is a mathematical equation that includes an equal sign. Like all equations, any change must be reflected on both sides. We can demonstrate this using a simple example. Say you own 7 pens and 3 pencils. You therefore have the following equation: 10 = 7 + 3 You own all 10 writing tools so 10 on the left side is equal to your assets, what you own. The pens and pencils on the right-hand side must be kept separate. Why? Because, even though you use both pens and pencils to write with, they have different characteristics (like liabilities and equity - both are owed but one is to third parties, the other too owners!) If you added pens and pencils together and just showed 10 = 10 you would be misleading the stakeholders who use your information for decision-making (because pens and pencils have different characteristics!) Now, let's say you add 2 more pencils to your collection. What happens? (10 + 2) = 7 + (3+2) 12 = 7 + 5 Notice that we added in 2 pencils TWICE, making a double entry: 2 are added to what you own on the left side of the equal sign and 2 are added to the total pencils on the right side of the equal sign. This shows you now have more pencils and you own more writing tools in total, your assets. After adding 2 on both sides the equal sign is still true: 12 does equal 7 plus 5! This is a double entry system: you added the pencils in TWICE and showed different views of the same information! 20 The double entry accounting system is similar: everything is recorded twice AND the equation MUST

be kept in balance at all times. Even though this is a straightforward concept in math, using pencils and pens, it's complicated in accounting because we have elements into which activities must be grouped. We have to use the elements' definitions to determine which elements are affected. But it is similar in that every activity is recorded at least twice (although more complicated entries may affect multiple elements).

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Putting it all together! The overall objective of GAAP (what does that stand for again?) is to provide financial information about a business that is useful to stakeholders for decision-making. GAAP provides the qualitative characteristics and underlying assumptions which, when followed, help to make the financial information useful. But business activities are data, not information. Data must be grouped, analyzed, and formatted for presentation purposes before it becomes information which can be used for decision-making. GAAP stipulates the categories, called elements, that all business activities are divided into, changing financial data into financial information and, eventually, into financial statements. By knowing the elements, their definitions, and their interrelationships, we can begin recording business activities into the account system. The outcome of this system is financial information which is useful for decision-making. Going forward! Any accounting system should provide information that is ready for use by decision-makers; however, we saw that even with the expanded accounting equation there was still not enough information for decision-making purposes. In Chapter 3 you'll be introduced to accounts, common subgroups of financial reporting elements that are used to accumulate (gather) business activities. With the addition of accounts, the accounting system can be used to produce the financial statements that stakeholders use to better understand the business. This allows them to make decisions that will meet their objectives. Chapter 3 - Introduction to accounts: Why is financial information important? In order to manage your business, you need to use financial information to make decisions. When the information is not in a form that allows you to quickly evaluate your past activities, it is difficult to make decisions about the future. Using the expanded accounting equation gives you more information than the basic accounting equation; however, there is not enough information to help you make the decisions you need to make about future operations. How do businesses produce financial information that is useful for decision-making? The accounting system should provide information that is useful for decision-making. Even with the expanded accounting equation, there is still not enough information for decision-making purposes. For instance, you can't determine if there is enough cash to repay the loan from your parents without manual calculations. A good accounting system subdivides the financial reporting elements so that more detailed information is readily available. For example, an account called Cash under the element assets would track cash transactions so you would know your total cash at the end of the month immediately. Accounts are common subgroups of financial reporting elements that are used to accumulate (gather) business activities. Assets could be divided into Cash, Business Licence, Business Cards, and Office Supplies. Doing so would allow you, the owner, to better understand your business and make decisions (such as whether you have enough cash to pay off the loan from your parents!). By using accounts to subdivide financial reporting elements, the accounting system can also be used to produce financial statements. Financial statements tell a business's story, what it does and how well it does it. They provide a business’s financial performance, its current financial position, and its

cash flows. Both internal and external stakeholders use the financial statements to analyze a business and answer questions, which allow them to make decisions and meet their objectives. So, what should you name your lawn care business? 3 steps: ● Select what name you want. ● Decide what you want the name to say. ● Check that the name is available. The 7 categories of names: Eponymous Embroidering the vision and beliefs of their founders (Disney, Tesla). Are okay if you're feeling lazy or have a big ego. Descriptive Tells exactly what the company does (Home Depot, American Airlines). Can be mouthful and are much harder to own and protect Acronymic Shorthand versions of descriptive names (KFC, HSBC). Can be strategic (like KFC instead of saying fried chicken). Suggestive Real words with meanings like UBER and SLACK which suggest attributes or benefits to the company. Limited words in the dictionary. Composite names like Facebook are created by gluing two words together and can be memorable. Can invent names but they can sound bad or unmarketable. Associative Work by reflecting imagery meaning back to the brand (Amazon, Redbull). Non-english Samsung (3 stars in Korean) or Lego (play well in Danish). Abstract Have no intrinsic meaning but instead rely on the power of phonetics to create really powerful brand names (Rolex, Kodak). Are there any other important considerations when naming a business? Yes, there are a few more things you'll want to consider. 1. You want to be able to use the name of your business as your domain name on the internet, preferably using .com (the most searched domain extension). If you name your lawn care business Lawn Care by David, the domain name would be lawncarebydavid.com, which is long and difficult to type. The best domain names are short, don't have any hyphens, and are one, two, or three-word summaries of what the business is about. For instance, nutrilawn.com, the domain name for nutri-lawn®, tells you right away that they care about feeding your lawn! 2. Once you've decided on a few different names (3-5 gives you choice) check out domain name registration companies (for example, Register.com, Namecheap.com, or GoDaddy.com) to see if the domains are available. Domain names are leased (rented) for a maximum of 10 years and cost between $5.99 and $25.99, plus HST, per year.

3. If you are selling yourself (like an author or a public speaker) consider using your own name as your business and domain name. Your name is your brand so using it is the best way to build that brand. Account names: Account name Financial reporting element and partial definition Bank loan payable Liability . Businesses did not receive a good or service instead they received money from a lender (or creditor). Must be paid by maturity date. Borrow money: + pay off money: - Accounts receivable Asset . Businesses legal right to collect cash from a customer in the future. Sells on account: + collects cash: - Sales revenue Revenue . If the business provides goods. Delivered: + returned: - Prepaid expense Asset . Not an expense, it's an asset that will become an expense in the future. Examples include prepaid insurance, rent, and advertising. Pay for something in advance: + when you receive it: - Income tax payable Liability . Equipment Asset . Receive: + use up: - Supplies expense Expense . Accounts payable Liability . When a business buys a good or service in the past, but has not paid for it yet. More specific accounts include salaries, wages, rent, income tax, interest payable. Buy on account (or credit): + pay off: - Patent (intangible asset) Asset : legal right that a business has that will benefit them in the future. Receive: + use up: - Service revenue Revenue . Used when the business is a service business and provides services. Service provided: + refunded: - Owners capital Equity . The amount the owner invests when they start the business. Rare for it to decrease. Receive investment: + Retained earnings Equity . Earnings or profit that will be retained in the business for future development and growth. Profit generated: + dividends paid: - Advertising expense Expense. Interest payable Liability. Office supplies Asset . Receive: + use up: - Deferred (unearned) revenue Liability . Is what a customer pays the business now, but they get nothing in return. Instead they will get something in the future.

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Receive cash: + provide goods or services: - Salaries payable Liability. Wages expense Expense. Cash Asset . Receive cash: + give away cash: - How would LawnKare record the leasing of the domain name? On May 1 you pay for the domain name with your business credit card, $16.99 plus HST, on GoDaddy.com. You will pay off the business expenses from the credit card when you receive the bill at the end of the month. What did LawnKare get? An asset as the fee covers the domain name for 1 year, from May 1, 2021, to April 30, 2022. LawnKare owns the domain name (legal right to use it) for that period of time, it will benefit the business in the future because it can use it, and it is due to a past transaction. Assets increase by $19.20 (16.99 * 1.13%). The account you would use to record this asset is Prepaid Expense. This account sounds like an expense account (after all, it has the word expense in it!) but it is never an expense. Why? Because, as noted above, it meets the definition of an asset: it is owned, has future benefit, and is due to a past transaction. So why does this account have the word expense in it? As you use the domain name the value of the asset will decrease (1/12 every month). That use will cause the asset to become an expense (remember the definition of expense is something used, consumed, or incurred to generate revenue). That's why it's called Prepaid Expense: it is an asset that you pay for in advance and, over time, it will become an expense in the future, as the business uses the asset up. What did LawnKare give away? An "I owe you" (IOU), a promise to pay the credit card company in the future. Note that you don't owe GoDaddy.com because they received their money immediately from the credit card company. LawnKare owes the credit card company cash in the future due to a past purchase, which meets the definition of a liability. The account you would use to record this liability is Accounts Payable. Accounts payable is used when you purchase something from someone (a supplier) and you owe the supplier cash in the future. The credit card company actually supplied you with cash (they paid GoDaddy.com on your behalf) and you owe them cash in the future to settle this debt. Let's record this in the expanded accounting equation using these account names. Assets Liabilities Equity Owner's Capital Retained Earnings Profit Dividends Revenue Expenses

Prepaid Expense Accounts Payable +19.20 +19.20 How would LawnKare record the other services they receive from GoDaddy.com? On May 1st you also sign up for GoDaddy.com's website builder and hosting services. It costs $7.99 per month, plus HST, payable on the first day of every month. You set up an automatic monthly charge to the credit card and make the first payment on May 1st. What did LawnKare get? The use of a website and hosting for 1 month. This is an asset for the month of May but you expense the amount instead. Why? Because by the end of the month you will have used up all of the assets. If you record it as a Prepaid Expense on May 1st you would have to move it to an expense account on May 31st. That would mean doing 2 entries this month, 31 days apart. That is not efficient or necessary for decision-making. Instead, you record it immediately as an expense because you know, by the end of the month, it will be an expense. So, what is the name of the expense account that you will use for the website and hosting? The naming of expense accounts is based on what a business wants to know about its costs. The more detailed the information the better it is for decision-making but too much detail would be overwhelming. Every business has to decide on the expense accounts they want to use. In this case, in order to know what the website is costing you over time, you create an expense account called Website Expenses. This will allow you to compare the cost of the website to the number of hits to the website. This information will allow you to decide, in the future, if the website is helping your business generate revenue. What did LawnKare give away? As with the domain name, it gave away an IOU, a promise to pay the credit card company cash in the future. We again use Accounts Payable to record the cash that is owed in the future to a supplier. Let's record the business activity using the expanded accounting equation and these account names. Assets Liabilities Equity Owner's Capital Retained Earnings Profit Dividends Revenue Expenses Prepaid Expense Accounts Payable Website Expenses

+19.20 +19.20 +9.03 +9.03 Is the accounting equation still in balance? Note that this transaction LOOKS like the accounting equation is not in balance because, for this transaction, it looks like Assets $0 = Liabilities $9 + Expenses $9 or $0 = $18!! As noted in Chapter 2 you need to flow expenses up into equity to see if the equation balances. Expenses decrease Profit, which decreases Retained Earnings, and therefore decrease Equity. The equation IS in balance because Assets $0 = Liabilities $9 - Equity $9, which also equals $0. Remember that expenses and dividends have a negative effect on equity. Is every business activity recorded in the accounting system? A business may be involved in many business activities but not all of them are recorded in the accounting records. An event is a business activity of importance to a business. What is necessary for an event to be recorded in the accounting system? If the event is measurable (we have a dollar value) and realized (the exchange has already happened) then it is recorded in the accounting system. This is called a transaction , which is an event that is measurable and realized. So, if an event is measurable and realized it is a transaction and will be recorded in the accounting system. If an event is measurable but not realized OR realized but not measurable, then it is an event but NOT a transaction. Events are never recorded in the accounting system. Here’s another way to think about it. A transaction involves an exchange between two parties. Usually goods or services go one way, and cash goes the other way. If EITHER party has done his part, then BOTH must record the transaction. If NEITHER party has done anything, then the agreement to make the exchange is still an event and does not have to be recorded. Note that either the goods/services or the cash can change hands first – a transaction does not have to involve cash. Quite often, the goods/services change hands first and the cash later. That’s how receivables and payables happen! Let's do an example to make it clearer. You want to sign up for a gmail.com account using LawnKare but someone already owns that email account. Instead, you sign up for lawnkare@hotmail.com. What did LawnKare get? The use of an email account, which it has a legal right to use and also has future benefit, all due to a past activity. That's an asset. What did LawnKare give away? Nothing because the email account is free. There is no dollar value attached to this business activity so it is an event but not a transaction. When a business has an event, it does not record an entry into the accounting system. Remember that every business activity is either an event (measurable OR realized but not both so it is NEVER recorded) or a transaction (recorded because it is both measurable AND realized).

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What accounts should LawnKare use when they purchase a business licence? On May 2 you register the name, LawnKare, at Service Ontario for $60 using a credit card. Is this an event or a transaction? It's a transaction because it is measurable ($60) and realized. What did LawnKare get? The business got a licence to run the business for 5 years, something it owns which it will use in the future and is due to a past activity. Assets increase by $60. The cost of a licence is capitalized , meaning the cost is recorded as an asset because it has future benefit for the company. When an asset will last a long time (over the long term) it is called a long-lived asset . Long-lived assets are divided into tangible assets (physical assets such as land or buildings) and intangible assets (non-physical assets which represent legal rights, such as a licence, trademark or brand name). One type of intangible asset is a licensing right , which is the permission to use something (ability to run a business) for a specific period of time (5 years). We'll record the licensing costs as a long-term asset account named Business Licence . What did LawnKare give away? As with the domain name and web hosting service, it gave away an IOU, a promise to pay the credit card company cash in the future. We again use Accounts Payable to record this business activity. Assets Liabilities Equity Owner's Capital Retained Earnings Profit Dividends Revenue Expenses Prepaid Expense Busines s Licence Accounts Payable Website Expenses +19.20 +19.20 +9.03 +9.03 NO ENTRY +60 +60 What accounts should LawnKare use for the cost of website development? Your friend, who has a website design business, designs your website for $300. The website is designed to allow customers to book lawn care appointments and pay using PayPal. You pay your friend cash for the design of your website and expect to continue to use this website for the next 3 years. What did LawnKare get? The business got a website designed, something owned

which will be used in the future to help run the business (because it allows for the booking of appointments and payments by customers) and is due to a past event. Assets increase by $300. Like the business licence, the costs of developing a website are capitalized , meaning the cost is recorded as an asset because it has future benefit for the company. The cost of website development is also an intangible asset because it is not a physical good but a legal right. This long-lived intangible asset is called a technology asset . Technology assets include website development and some software purchases. We'll record the website development costs in a long-term asset account called Website Design . What did LawnKare give up? LawnKare gave away cash, which we already know is an asset. In this case the asset will decrease because, now that $300 has been given to the website supplier, that cash is no longer owned by the business and therefore no longer has any future benefit. The account Cash, an asset, decreases by $300. Let's record this in the expanded accounting equation using these account names. Assets Liabilities Equity Owner' s Capital Retained Earnings Profit Divide nds Reven ue Expens es Ca sh Prep aid Expe nse Busin ess Licen ce Web site Desi gn Acco unts Paya ble Loan Paya ble Own er's Capit al Webs ite Expe nses +19.20 +19.20 +9.03 +9.03 NO ENTRY +60 +60 +500 +500 +1,50 0 +1,500 -300 +300

Trans # Description Account name, element, and indicator Account name, element, and indicator 1 Provided services to a customer on account (for credit). Accounts receivable, Assets, + Service revenue, Revenue, + 2 Paid cash for a 1-year insurance policy. Prepaid Insurance, Assets, + Cash, Assets, - 3 Paid an employee for the work they had completed. Cash, Assets, - Salary Expense, Expenses, + 4 Received payment from a customer for services which had already been billed (invoiced) last month. Cash, Assets, + Accounts Receivable, Assets, - 5 Purchased equipment in exchange for cash. The equipment will be used in the future. Equipment, Assets, + Cash, Assets, - 6 Purchased office supplies on account. Office Supplies, Assets, + Accounts Payable, Liabilities, + 7 Borrowed money from the bank. Cash, Assets, + Note Payable, Liabilities, + 8 Paid for a cell phone used during last month. Cash, Assets, - Telephone Expense, Expenses, + 9 Received cash in advance from a customer. You will provide the services next month. Cash, Assets, + Deferred Revenue, Liabilities, + 10 Paid interest on a bank loan that has been outstanding for a month. Cash, Assets, - Interest Expense, Expenses, + 11 Hired a new employee who will start next month. This is an event, not a transaction!

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12 You have not paid income taxes yet but you earned revenue so you owe them. Your tax rate is 17% of your profit. Income Tax Payable, Liabilities, + Income Tax Expense, Expenses, + Did you use a positive indicator for the expenses or a negative? Explain your choice. · The indicator for expenses was a positive · This is because expenses are increasing (meaning the expenses are getting larger) · When the expense is flows up into the expanded accounting equation the negative sign in front of the expense calculation (Revenues - Expenses = Profit) will result in a negative effect on profit, retained earnings, and equity How would your answers change if you were recording these transactions into the basic accounting equation? What would change and why? · All of the expense accounts would have a NEGATIVE indicator · That is because the effect of expenses is to increase the expense element, decrease profit, decrease retained earnings, and therefore decrease equity · For that reason, the effect on equity is negative Putting it all together! The overall objective of GAAP is to provide financial information about a business that is useful to stakeholders for decision-making. By using the elements in Chapter 2 you discovered that recording information allows you to better understand your business so you can make decisions. You also discovered that information recorded using only the accounting equation, even the expanded accounting equation, is not enough for decision-making. By using accounts, which further subdivides the elements, you are better able to determine things like your cash position at the end of the year or how much you owe in loans. This provides better information for you to make decisions as you move forward with your business. Going forward! Stakeholders, including owners, need to see the accounting information in a format that can be easily understood. Using the account names, businesses can record transactions and create the financial statements. Financial statements tell a business's story, what it does and how well it does it. They provide a business’s financial performance (income statement), its current financial position (balance sheet), and its cash flows (statement of cash flows). Both internal and external stakeholders can use the financial statements to analyze a business and answer questions, which allow them to make decisions and meet their objectives.

ACC100 chapter 1-3

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