CHAPTER 1 NOTES - INTRODUCTION TO ACCOUNTING
SECTION 1.1: WHAT IS ACCOUNTING?
Accounting is a system of dealing with the financial data of a business so as to provide useful information for decision making.
More specifically, accounting tells us what a company is worth (equity) on a particular date and how much profit or loss that company has earned (net income) over a specified period of time.
There are five main activities involved in accounting and/or bookkeeping:
Gathering financial information about the activities of a business
Collecting permanent records of financial information, e.g., receipts, purchase orders, invoices
Organizing financial information into more useful forms
Preparing reports and analyses of financial information to aid in decision-making
Otherwise establishing internal controls to promote accuracy and honesty among employees
SECTION 1.2: WHY STUDY ACCOUNTING?
Accounting in your personal life is an advantage as you are better able to prepare personal budgets and income tax returns with this knowledge. This understanding may also help you in your choice of personal investment strategies as your ability to read complicated corporate financial statements will allow you to better recognize the relative strengths and weaknesses of various business entities.
Accounting is also helpful as the owner of a small business. To be successful the entrepreneur must be able to make sound management decisions based on good financial information, i.e., amounts owed by customers, financing options, etc.
Finally, one day you may even choose to pursue a career as a professional accountant (CPA).
Working as a Chartered Professional Accountant (CPA) - Public vs Private Practice
Three formal accounting career designations once existed in Canada, namely Chartered Accountant (CA), Certified General Accountant (CGA) and Certified Management Accountant (CMA).
However, as you will read below in Section 1.5, talks have recently been completed throughout Canada to unite the three designations both nationally and provincially/territorially under a single new designation known as CPA or Chartered Professional Accountant (not to be confused with the CPA designation in the United States meaning Certified Public Accountant). In short then, all newly-licensed accountants in Canada today are classified as Chartered Professional Accountants.
Today, many professional accountants choose to practice as public accountants who serve the general public (i.e., multiple individual and commercial clients) for a pre-determined fee in much the same way a doctor or lawyer does. Public accountants either work as sole practitioners (alone), in small accounting firms (5-20 accountants) or in large financial services firms like the Big Four (KPMG, Deloitte, Ernst & Young, PWC).
The main function (or type of work) performed by public accountants is auditing: an independent, third-party auditor examines (audits) the books (financial records) and procedures of a particular company in order to express an opinion as to the accuracy, honesty, comprehensiveness and reliability of its financial statements (income statements, balance sheets, etc.)
Alternatively, professional accountants may choose a career as a private accountant working in various types of industries as an in-house employee of a particular firm. Working privately in industry may involve
(i) industrial accounting (employment in manufacturing-based firms such as Toyota and General Electric) or
(ii) institutional accounting (employment in service-based organizations such as government agencies or financial institutions like TD Bank) or
(iii) educational institutions (employment at colleges, universities and school boards) or
(iv) not-for-profit or non-profit organizations (employment at charities and NGOs).
Private or in-house accountants serve only their employer's accounting needs where typical workday hours are much better (M-F 9-5) but where compensation (salary and benefits) is typically lower.
Click here for a link to the CPA Canada website detailing the various career opportunities available to CPAs in Canada today.
Click here for a link to a discussion page prepared by the newest national professional accounting association, CPA Canada, on the merger of CA, CGA and CMA designations in Canada and the provinces/territories into a single designation known as CPA (Chartered Professional Accountant)
SECTION 1.3: CHARACTERISTICS OF BUSINESSES
Generally a business involves the manufacture and/or sale of products (tangible goods or intangible services) in order to earn a profit.
There are five main types of businesses based on what the business does or provides:
1) Service businesses sell services (intangible items for sale) to the public to earn a profit for the owners (e.g., law firm, dental clinic).
2) Merchandising businesses purchase finished goods (tangible items for sale) from suppliers and then resell them to the public at a higher price to earn a profit for the owners (e.g., clothing retailer, electronics wholesaler).
3) Manufacturing businesses buy raw materials or parts, assemble/build them into finished goods, and then sell those finished goods to earn a profit for the owners (e.g., automotive plant, furniture factory).
4) Producing businesses extract natural resources from the earth and then convert them into a more usable/refined form before selling them to earn a profit for the owners (e.g., farming, fishing, mining, forestry, oil development).
5) Not-for-profit organizations carry on activities to meet social, charitable or cultural needs so as to assist as many persons as possible (e.g., religious institutions, human rights organizations, food banks) as opposed to producing or providing goods and services to earn a profit for the owners (for-profit organizations - see #1-4 above)
At the same time, there are five main legal forms of business ownership that determine the rights and responsibilities of the owners:
1) Sole proprietorship: A single owner, the sole proprietor, operates the firm alone and keeps all profits of the firm for him/herself. The sole proprietor possesses unlimited liability, meaning he/she is personally responsible for all of the debts of the firm. Put another way, the owner's personal assets (house, car, investments, etc.) may be used to satisfy the debts of his/her firm.
2) Partnership: Two or more owners, known as partners, share in both the control/operation/decision-making and profits of the firm. Like sole proprietors, partners also possess unlimited liability, both jointly and severally, meaning each partner is personally responsible for all of the debts of the firm (see above).
3) Private or Public Corporation: A special form of business in which ownership is represented by paper certificates (or electronic versions thereof) known as shares or stocks.
The owners of a corporation are known as shareholders or stockholders who, among other items, are responsible for electing the board of directors to manage the firm on their behalf.
All corporations must have at least one voting (common) share and at least one shareholder. Each voting share typically represents one vote an annual meeting of shareholders.
Most significantly though, the owners of a corporation possess limited liability, meaning the most they can lose in the business is their investment in the corporation (or the price of their purchased shares) - in other words, the shareholders are not personally responsible for the debts of the company.
Profits of the firm are sometimes distributed to the shareholders in the form of quarterly or annual dividends, e.g., 75 cents per share.
Corporations are easily identifiable in Canada by one of six terms that must legally appear at end of the corporate name, i.e., Limited, Incorporated, Corporation, Ltd., Inc., Corp. (And please note that the abbreviation Co. refers to Company and not Corporation.)
The shares of public corporations are traded openly on stock exchanges (e.g., TSX, NYSE, NASDAQ) while the shares of private corporations are not.
For an excellent summary of the pros and cons of sole proprietorships, partnerships and corporations, click here or click here.
And please note that today lawyers, accountants and other professionals in Canada are permitted to form professional corporations which offer some protection to their owners in terms of limiting personal liability for the debts of the firm.
4) Co-operative (co-op): A legally incorporated business owned and operated by group of individuals (often its employees and/or customers) for their own mutual benefit. Owners of co-ops are known as members. Each member receives one vote at annual meeting of owners. Examples of co-ops include Mountain Equipment Co-op (MEC), credit unions and trust companies, and even farms. Click here for more information about co-operatives.
5) Franchise: A right or license granted by a large business chain (franchisor) permitting an investor/owner (franchisee) to operate an outlet using the franchisor’s name, goods/services, experience, promotion and reputation in exchange for a one-time franchise fee, monthly royalty payments (fixed percentage of company revenues) and sometimes even marketing fees. As a hybrid organization though, a franchise operation must still be set up as either a sole proprietorship, partnership or corporation by the franchisee. Examples of popular franchises today include Tim Horton's and Subway.
SECTION 1.4: THE NATURE OF ACCOUNTING WORK
Accounting tasks can be divided into three categories:
(a) routine everyday activities occur nearly every day of the year (e.g., daily banking, recording transactions, processing invoices and orders)
(b) periodic/occasional activities occur at weekly/monthly/quarterly/annual intervals (e.g., preparing weekly payroll, preparing quarterly and/or annual financial reports, submitting annual income tax returns)
(c) miscellaneous activities occur at infrequent and unpredictable intervals (e.g., hiring and firing decisions, meetings with bank managers, executive meetings, professional association events).
Accounting functions typically occur in cycles. Accounting and financial activities are performed, measured and reported within equal periods of time known as fiscal periods which are usually either one year (the maximum allowable period under the law) or one quarter (i.e., three months) in length.
The accounting cycle is the recurring set of accounting procedures carried out over the course of each fiscal period, one period after another. Some activities occur every day, some once a week, month or quarter, and some once a year.
SECTION 1.5: BECOMING A PROFESSIONAL ACCOUNTANT IN CANADA
As previously stated, talks were recently completed to merge the three existing accounting designations in Canada and the individual provinces/territories into a single new designation known as Chartered Professional Accountant (CPA) to be overseen by the newest national professional accounting association known as Chartered Professional Accountants of Canada (CPA Canada). (And remember, the CPA designation in the United States refers to the title Certified Public Accountant.)
National (CPA Canada) and provincial/territorial (e.g., CPA Ontario) professional accounting associations are responsible for regulating the activities of accountants in Canada, although strictly speaking, the accounting profession is provincially/territorially regulated in this country.
Please note that in order to become a licensed CPA in Canada, each of these associations requires its members to complete
(a) university bachelor's degree in any subject area that includes a number of specified business-related courses (e.g., economics, accounting, finance, statistics, law, etc.) that serve as prerequisites for the PEP (see below)
(b) 30 months of practical work experience within an approved accounting workplace at the same time as...
(c) six-module specialized training course with final evaluations known as the Professional Education Program (PEP) and
(d) standardized three-day exam known as the Common Final Examination (CFE)
Click here for a link to the CPA Ontario website containing a summary of the mandatory requirements to become a CPA in Ontario.
SECTION 1.6: ROLES AND FUNCTIONS IN ACCOUNTING
Bookkeepers: Bookkeepers perform clerical work and are mostly concerned with routine day-to-day matters of the firm. Bookkeepers ensure transactions are properly recorded and supporting documents are present and correct. Bookkeepers record accounting entries in the books of the business and balance the ledger as necessary. Bookkeepers perform payroll calculations and prepare staff paycheques and employment records. Bookkeepers carry out routine banking transactions.
Please note that the term bookkeeper has recently been replaced by the term accounting clerk.
Accountants: Accountants are responsible for maintaining accounting systems, interpreting data produced by accounting systems, preparing analyses (reports and summaries) based on the output of accounting systems, assisting in the making of business decisions, and supervising the work of all accounting employees.
Most significantly though, accountants ensure that the rules of proper accounting, once known in this country as Canadian Generally Accepted Accounting Principles (GAAPs), are being followed.
Please note though that in Canada, GAAPs were recently replaced by International Financial Reporting Standards (IFRS) for public corporations and financial institutions and by Accounting Standards for Private Enterprises (ASPE) for private corporations, partnerships and sole proprietorships, all of which is summarized here.
International standards of proper accounting procedures ensure consistency from one national jurisdiction to another in terms of reporting company financial data - in other words, allowing for "apples to apples" comparisons.
SECTION 1.7: HOW ACCOUNTANTS USE ACCOUNTING SOFTWARE TODAY
Computers and specialized accounting software are ideal for use in accounting environments. Accountants and bookkeepers who use these products properly are able to effectively meet the demands of their careers. All national and provincial/territorial accounting associations recognize the impact of technology on the profession.
Different businesses use different software so accounting students should be familiar with a variety of applications, e.g., QuickBooks, Freshbooks, Sage 50, Wave Accounting, Xero. MS Excel and Google Sheets spreadsheets are also useful in limited circumstances.
These applications save time and costs by allowing accountants and bookkeepers to maintain and/or create financial statements (balance sheets and income statements) and other accounting records quickly and easily. Ultimately though, computers and computer software are simply tools used by accountants and related professionals in their work and so they will never replace basic accounting skills.