Sources and References

Primary textbook — Introductory Accounting for Private and Public Companies (Top Hat interactive e-text, ISBN 978-1-77412-900-5). This text covers AFM 191 (private company focus, ASPE) and continues into AFM 182 (public company focus, IFRS).

Supplementary — Walter T. Harrison Jr., Charles T. Horngren, and C. William Thomas, Financial Accounting, 11th Edition (Pearson, 2022); Robert Libby, Patricia Libby, and Frank Hodge, Financial Accounting, 10th Edition (McGraw-Hill, 2020); Jerry Weygandt, Paul Kimmel, and Donald Kieso, Accounting Principles, 14th Edition (Wiley, 2022).

Online resources — CPA Canada Learning Resources; ASPE Handbook (CPA Canada, members access); Khan Academy Accounting & Financial Statements (open access).

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Chapter 1: The Conceptual Framework of Accounting

The Purpose of Accounting

Accounting is the language of business. Its primary purpose is to provide relevant financial information to decision-makers — owners, creditors, managers, employees, and regulators — who need it to make informed choices. For a private company, the most important users are typically the owner-manager and the company’s lenders (banks, credit unions, private lenders).

In Canada, private companies follow Accounting Standards for Private Enterprises (ASPE), set by the Accounting Standards Board (AcSB). Public companies use IFRS. AFM 191 focuses on ASPE; AFM 182 extends the analysis to IFRS.

The Conceptual Framework Under ASPE

The ASPE conceptual framework is built around:

Objective: To provide information useful to the primary users (owners and creditors) for making resource allocation decisions and assessing management stewardship.

Qualitative characteristics:

Characteristic	Meaning
Understandability	Information is comprehensible to users with a reasonable knowledge of business
Relevance	Information influences decisions (predictive value, feedback value, timeliness)
Reliability	Free from material error and bias; can be depended upon (verifiability, representational faithfulness, neutrality)
Comparability	Consistent application across periods and entities; enables meaningful comparison

The hierarchy of qualities: Relevance and reliability are the primary qualities. Understandability and comparability are secondary. The cost-benefit constraint applies throughout.

Underlying assumptions:

Recognition Criteria Under ASPE

An item is recognized in financial statements when:

1. It meets the definition of an asset, liability, revenue, or expense.
2. The item has a measurable cost or value with reliability.
3. Recognition is probable (likelihood of future economic benefit exceeding 50%).

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Chapter 2: The Accounting Cycle and Double-Entry Bookkeeping

The Accounting Equation

The foundation of double-entry accounting is the fundamental accounting equation:

\[ Assets = Liabilities + Owners'\ Equity \]

Every transaction affects at least two accounts and keeps this equation in balance. The equation can be expanded to show equity components:

\[ Assets = Liabilities + Contributed\ Capital + Retained\ Earnings \]\[ Assets = Liabilities + Contributed\ Capital + (Revenues - Expenses - Dividends) \]

Debits, Credits, and T-Accounts

The double-entry system records every transaction as a debit to one or more accounts and a credit to one or more accounts, with total debits always equaling total credits.

The normal balance (where the account naturally increases) follows from its accounting equation position:

Account Type	Normal Balance	Debit Effect	Credit Effect
Asset	Debit	Increase	Decrease
Liability	Credit	Decrease	Increase
Owners’ Equity	Credit	Decrease	Increase
Revenue	Credit	Decrease	Increase
Expense	Debit	Increase	Decrease
Dividends	Debit	Increase	Decrease

The Accounting Cycle

The accounting cycle is the sequence of steps from recording transactions to producing financial statements:

1. Analyze transactions — identify which accounts are affected and by how much.
2. Record journal entries — enter debits and credits in the general journal.
3. Post to the ledger — transfer entries to individual T-accounts in the general ledger.
4. Prepare an unadjusted trial balance — list all account balances; verify debits = credits.
5. Record adjusting entries — recognize revenues earned or expenses incurred but not yet recorded.
6. Prepare an adjusted trial balance.
7. Prepare financial statements (income statement → statement of changes in equity → balance sheet → cash flow statement).
8. Record and post closing entries — close temporary accounts (revenues, expenses, dividends) to retained earnings.
9. Prepare a post-closing trial balance.

Adjusting Entries

Adjusting entries are made at period-end to reflect accrual-basis accounting — recognizing revenues when earned and expenses when incurred, regardless of cash flow timing. The four types:

Accrued revenues: Revenue earned but not yet billed or received.

• Dr. Accounts Receivable / Cr. Revenue

Accrued expenses: Expense incurred but not yet paid.

• Dr. Expense / Cr. Accrued Liability (e.g., Salaries Payable)

Deferred revenues (unearned revenue): Cash received before revenue is earned.

• Dr. Unearned Revenue / Cr. Revenue (as service is provided)

Prepaid expenses: Cash paid before expense is incurred.

• Dr. Expense / Cr. Prepaid Expense (as benefit is consumed)

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Chapter 3: The Income Statement and Revenue Recognition

The Accrual Basis vs. Cash Basis

Under accrual accounting, revenues are recognized when earned (performance obligation satisfied) and expenses when incurred (regardless of cash payment timing). This gives a more accurate picture of economic activity than cash-basis accounting, which records only cash inflows and outflows.

Revenue Recognition Under ASPE

ASPE Section 3400 governs revenue recognition. Revenue from the sale of goods is recognized when:

• The significant risks and rewards of ownership have transferred to the buyer.
• The seller retains neither continuing managerial involvement nor effective control.
• The amount of revenue can be measured reliably.
• It is probable that economic benefits will flow to the seller.
• The costs incurred or to be incurred can be measured reliably.

Revenue from rendering services is recognized based on the stage of completion (percentage of completion method) when the outcome can be estimated reliably.

Income Statement Structure

A typical single-step income statement groups all revenues together and all expenses together:

Revenues                          $X
Less: Total Expenses             ($X)
Net Income                        $X

A multi-step income statement provides more detail:

Net Sales Revenue                 $X
Less: Cost of Goods Sold         ($X)
Gross Profit                      $X
Less: Operating Expenses         ($X)
    Selling expenses
    Administrative expenses
Operating Income                  $X
Other income / expenses           $X
Income Before Tax                 $X
Less: Income Tax Expense         ($X)
Net Income                        $X

Earnings per share (EPS) is disclosed for all income statement subtotals:

\[ EPS = \frac{Net\ Income - Preferred\ Dividends}{Weighted\ Average\ Common\ Shares\ Outstanding} \]

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Chapter 4: The Balance Sheet — Assets, Liabilities, and Equity

Current Assets

Cash and cash equivalents: Coins, bank balances, and short-term investments with original maturities of three months or less. Cash is the most liquid asset.

Accounts receivable: Amounts owed by customers for goods or services delivered on credit. Gross receivables are reduced by an allowance for doubtful accounts to arrive at the net realizable value — the amount expected to be collected.

The allowance is estimated using the aging schedule method (older receivables are more likely to default) or as a percentage of credit sales (income statement approach).

\[ Bad\ Debt\ Expense = \text{Estimated uncollectible amount for the period} \]

When a specific receivable is confirmed uncollectible: Dr. Allowance for Doubtful Accounts / Cr. Accounts Receivable.

Inventory: Goods held for sale. The cost of inventory includes purchase price plus freight-in, import duties, and handling. Cost of goods sold (COGS) is the cost of inventory sold during the period:

\[ COGS = Beginning\ Inventory + Purchases - Ending\ Inventory \]

Inventory costing methods under ASPE:

Method	Description	Impact in Rising Prices
First-In, First-Out (FIFO)	Earliest costs charged to COGS; most recent costs remain in inventory	Higher ending inventory; lower COGS; higher net income
Weighted Average Cost	Average cost of all units available applied to both COGS and ending inventory	Middle ground
Specific Identification	Each item tracked individually; actual cost matched to each unit sold	Precise; practical only for low-volume high-value items

Note: LIFO (last-in, first-out) is permitted under US GAAP but not under ASPE or IFRS.

Long-Term Assets

Property, Plant and Equipment (PP&E)

PP&E is initially recorded at cost (purchase price + all costs to bring the asset to its intended location and condition). Under ASPE, PP&E is subsequently carried at cost less accumulated depreciation less impairment losses (the cost model).

Depreciation allocates the cost of a long-lived asset over its useful life. ASPE does not mandate a specific method; the chosen method should best reflect the pattern in which the asset’s economic benefits are consumed.

Straight-line depreciation:

\[ Annual\ Depreciation = \frac{Cost - Residual\ Value}{Useful\ Life} \]

Declining balance depreciation (double-declining balance, DDB):

\[ Annual\ Depreciation = Carrying\ Value \times \left(\frac{2}{Useful\ Life}\right) \]

This method front-loads depreciation and is used for assets that are most productive early in their lives. The DDB rate produces higher depreciation in early years, which reduces carrying value faster. When carrying value approaches residual value, the method often switches to straight-line.

Units-of-production depreciation: depreciation per unit = (Cost − Residual Value) / Total estimated units of production; annual depreciation = units produced × rate. Used for assets whose wear correlates with usage.

Intangible Assets

Intangible assets are identifiable non-monetary assets without physical substance (patents, trademarks, copyrights, franchises, customer lists). Under ASPE, intangibles with finite useful lives are amortised on a systematic basis; those with indefinite useful lives are not amortised but are tested for impairment annually.

Goodwill is recognized only in a business combination and represents the excess of the purchase price over the fair value of identifiable net assets acquired. Goodwill has an indefinite life and is not amortised under ASPE (tested for impairment annually at the reporting unit level).

Current Liabilities

Accounts payable: Amounts owed to suppliers for goods or services received on credit.

Accrued liabilities: Expenses incurred but not yet paid or invoiced (salaries payable, interest payable, taxes payable).

Unearned revenue: Cash received for services not yet rendered; represents an obligation to perform.

Current portion of long-term debt: The portion of long-term debt due within the next 12 months is reclassified as current.

Long-Term Liabilities

Long-term debt (bonds payable, term loans, mortgages): Debt with a maturity beyond one year. Recorded at the present value of future cash flows using the effective interest method:

• Interest expense = Carrying value at beginning of period × Market interest rate
• Cash payment = Face value × Coupon rate
• The difference between interest expense and cash payment adjusts the carrying value (amortization of discount or premium).

Owners’ Equity

For a corporation, owners’ equity consists of:

• Share capital (contributed capital): The amount received from shareholders for shares issued.
• Retained earnings: Accumulated net income since inception, less dividends declared.
• Accumulated other comprehensive income (AOCI): Gains and losses not included in net income (e.g., unrealized gains on certain financial instruments; remeasurements of defined-benefit pension plans).

Dividends declared reduce retained earnings. They are recognized as a liability (dividends payable) on the declaration date, not when paid.

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Chapter 5: The Cash Flow Statement

Purpose and Structure

The cash flow statement explains the change in cash during a period, reconciling the opening and closing cash balances shown on the balance sheet. It is an essential complement to the income statement because accrual-basis earnings can diverge significantly from cash flows.

The statement is divided into three sections:

Operating activities: Cash generated or used in running the business. The indirect method begins with net income and adjusts:

• Add back non-cash expenses (depreciation, amortization).
• Add increases in liabilities / Subtract decreases in liabilities (e.g., accounts payable).
• Subtract increases in assets / Add decreases in assets (e.g., accounts receivable, inventory).

Investing activities: Cash used to acquire or received from disposal of long-term assets and investments.

• Purchases of PP&E, intangibles, investments → cash outflows.
• Proceeds from sale of PP&E or investments → cash inflows.

Financing activities: Cash flows from transactions with providers of debt and equity capital.

• Proceeds from borrowing or share issuance → cash inflows.
• Repayment of debt, share repurchases, dividends paid → cash outflows.

Interpreting Cash Flow Patterns

A mature, profitable business typically shows: positive operating cash flow, negative investing cash flow (reinvesting for future growth), and variable financing cash flow. A growing business may have negative operating cash flow (as it builds working capital) alongside heavy investing outflows funded by positive financing activities.

Operating cash flow vs. net income: Persistent divergence (net income far exceeds CFO) may indicate aggressive revenue recognition or failure to collect receivables — a red flag for analysts.

Free cash flow = Operating CFO − Capital expenditures. Represents the cash available for debt repayment, dividends, or reinvestment after maintaining and expanding the asset base.

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Chapter 6: Financial Analysis of Private Companies

Ratio Analysis Framework

Financial ratios transform raw financial data into measures that enable assessment of performance, liquidity, solvency, and valuation. The value of ratios lies in comparison: to historical trends (the firm against itself), to industry benchmarks (the firm against peers), or to a reference standard.

Liquidity Ratios

\[ Current\ Ratio = \frac{Current\ Assets}{Current\ Liabilities} \]\[ Quick\ Ratio = \frac{Cash + Marketable\ Securities + Accounts\ Receivable}{Current\ Liabilities} \]

A current ratio below 1.0 means current liabilities exceed current assets — a potential liquidity concern. The quick ratio excludes inventory (which may not be quickly convertible to cash) for a more conservative measure.

Activity (Efficiency) Ratios

\[ Inventory\ Turnover = \frac{COGS}{Average\ Inventory} \quad Days\ in\ Inventory = \frac{365}{Inventory\ Turnover} \]\[ Receivables\ Turnover = \frac{Credit\ Sales}{Average\ Accounts\ Receivable} \quad DSO = \frac{365}{Receivables\ Turnover} \]\[ Payables\ Turnover = \frac{COGS}{Average\ Accounts\ Payable} \quad DPO = \frac{365}{Payables\ Turnover} \]

Cash Conversion Cycle = DIO + DSO − DPO. A shorter cycle means cash is tied up in operations for fewer days — generally better liquidity.

Profitability Ratios

\[ Gross\ Margin = \frac{Gross\ Profit}{Revenue} \]\[ Operating\ Margin = \frac{Operating\ Income}{Revenue} \]\[ Net\ Profit\ Margin = \frac{Net\ Income}{Revenue} \]\[ Return\ on\ Assets\ (ROA) = \frac{Net\ Income}{Average\ Total\ Assets} \]\[ Return\ on\ Equity\ (ROE) = \frac{Net\ Income}{Average\ Shareholders'\ Equity} \]

Leverage (Solvency) Ratios

\[ Debt-to-Assets = \frac{Total\ Liabilities}{Total\ Assets} \]\[ Debt-to-Equity = \frac{Total\ Liabilities}{Shareholders'\ Equity} \]\[ Interest\ Coverage\ Ratio = \frac{EBIT}{Interest\ Expense} \]

An interest coverage ratio below 2.0x is often considered a warning signal by lenders; covenants in loan agreements frequently require maintenance of a minimum coverage ratio.

Limitations of Ratio Analysis

Ratios are derived from historical cost financial statements that may not reflect current economic values. They are only meaningful in context — an “ideal” ratio differs by industry (a grocery chain turns inventory far more rapidly than a furniture manufacturer). Accounting policies (depreciation method, inventory valuation) affect comparability across firms. Ratios are backward-looking; investors care about future performance.

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Chapter 7: Introduction to Managerial Accounting for Private Companies

Cost Concepts

Understanding costs is essential for planning, pricing, and decision-making. Costs are classified along multiple dimensions:

By behaviour relative to activity level:

By traceability to cost objects:

• Direct costs: Can be traced specifically to a cost object (product, department) with economic feasibility. Direct materials and direct labour are typically direct costs.
• Indirect (overhead) costs: Cannot be traced directly; must be allocated. Manufacturing overhead (factory rent, utilities, supervisory salaries) is indirect relative to individual products.

By relevance to decisions:

• Sunk costs: Already incurred; irrelevant to future decisions.
• Opportunity costs: Forgone alternatives; always relevant.
• Differential (incremental) costs: The difference in costs between two alternatives; relevant.

Cost-Volume-Profit Analysis

CVP analysis examines the relationship between revenues, costs, and profit to answer questions such as: How many units must we sell to break even? What profit will we earn at a given volume? How sensitive is profit to changes in selling price, variable cost, or fixed cost?

Contribution margin (CM) = Revenue − Variable Costs. Contribution margin represents the amount each unit sold contributes toward covering fixed costs and generating profit.

\[ CM\ per\ unit = Selling\ Price - Variable\ Cost\ per\ Unit \]\[ CM\ Ratio = \frac{CM\ per\ Unit}{Selling\ Price} = \frac{Total\ CM}{Total\ Revenue} \]

Break-even point — the level of sales at which profit = 0 (total revenue = total costs):

\[ Break-even\ (units) = \frac{Fixed\ Costs}{CM\ per\ Unit} \]\[ Break-even\ (revenue) = \frac{Fixed\ Costs}{CM\ Ratio} \]

Target profit analysis — the sales required to achieve a specific profit level:

\[ Target\ Sales\ (units) = \frac{Fixed\ Costs + Target\ Profit}{CM\ per\ Unit} \]

Margin of safety is the excess of actual (or budgeted) sales above break-even. It indicates how much sales can fall before the firm starts losing money:

\[ Margin\ of\ Safety = Actual\ Sales - Break-even\ Sales \]\[ Margin\ of\ Safety\ \% = \frac{Margin\ of\ Safety}{Actual\ Sales} \]

Product Costing Systems

Job-order costing accumulates costs by individual job or customer order. Used in custom manufacturing (construction, printing, professional services). Each job has its own cost record (job cost sheet) that tracks:

• Direct materials requisitioned
• Direct labour hours and wages
• Manufacturing overhead applied (using a predetermined overhead rate)

\[ Predetermined\ Overhead\ Rate = \frac{Budgeted\ Total\ Overhead}{Budgeted\ Allocation\ Base} \]

Common allocation bases: direct labour hours, machine hours, direct materials cost.

Process costing accumulates costs by department or process over a period, then divides by units produced to compute a per-unit cost. Used in continuous manufacturing (chemicals, food processing, oil refining) where identical or similar products flow continuously.

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Chapter 8: Budgeting and Financial Planning

The Budgeting Process

A budget is a formal quantitative expression of management’s plan for a future period. Budgets serve multiple functions: planning (forcing managers to think ahead), coordination (aligning departmental plans), communication (cascading goals through the organization), motivation (providing targets), and control (providing a benchmark against which to measure actual performance).

The master budget integrates all functional budgets into a comprehensive plan:

Operating budgets:

1. Sales budget (the starting point — projected unit sales and revenue)
2. Production budget (units to be produced = sales + desired ending inventory − beginning inventory)
3. Direct materials budget
4. Direct labour budget
5. Manufacturing overhead budget
6. Cost of goods sold budget
7. Selling and administrative expense budget
8. Budgeted income statement

Financial budgets: 9. Capital expenditures budget 10. Cash budget 11. Budgeted balance sheet

The Cash Budget

The cash budget ensures the firm has sufficient liquidity. It typically covers the coming quarter month-by-month:

Beginning cash balance                          $X
Add: Cash receipts (from collections)           $X
  Total cash available                          $X
Less: Cash disbursements:
  Materials purchases                          ($X)
  Labour payments                              ($X)
  Overhead payments                            ($X)
  Selling & administrative                     ($X)
  Capital expenditures                         ($X)
  Debt repayments / interest                   ($X)
  Total disbursements                          ($X)
Ending cash balance before financing            $X
Financing: borrowing / (repayment)              $X
Ending cash balance                             $X

Receipts from customers lag sales because of credit terms. If all sales are on 30-day credit terms, December sales are collected in January, etc.

Variance Analysis

After the period, variance analysis compares actual results to budget to identify where performance deviated from plan and why.

Sales price variance = (Actual price − Budgeted price) × Actual units sold.

Sales volume variance = (Actual units − Budgeted units) × Budgeted CM per unit.

Spending variances for costs: Compare actual cost to flexible budget cost (the cost that should have been incurred at the actual volume achieved).

Variances are labeled favorable (F) if they increase profit relative to budget (revenue above budget, costs below budget) and unfavorable (U) otherwise. Variance analysis does not explain why deviations occurred — that requires management investigation. It is a diagnostic tool that directs attention, not a verdict.

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Chapter 9: Introduction to Ethics and Professional Judgment in Accounting

The Role of Professional Judgment

Accounting is not purely mechanical. Many standards require estimates and judgments:

• Useful life of a depreciable asset
• Residual value of PP&E
• Allowance for doubtful accounts
• Valuation of inventory at the lower of cost and net realizable value
• Whether a lease is a finance lease or operating lease
• Recognition of contingent liabilities

Professional judgment is exercised within the constraints of GAAP, but the range of defensible judgments can be wide. The key test is whether the chosen accounting treatment faithfully represents the underlying economic reality.

Accounting Ethics and Integrity

The accounting and finance professions are built on public trust. When that trust is violated — through earnings management, fraudulent financial reporting, or conflicts of interest — the consequences are severe (corporate collapses, investor losses, criminal prosecution).

Earnings management — using accounting discretion to influence reported earnings toward a desired target — exists on a spectrum from aggressive but legitimate to outright fraud. Warning signs include:

• Revenues growing much faster than cash collected from customers.
• Frequent use of large, one-time charges (restructuring) that conveniently manage earnings expectations.
• Changes in accounting policies without clear business rationale.
• Significant unexplained growth in accounts receivable or inventory relative to sales.

The ethical framework for accountants in Canada is provided by CPA Canada’s Code of Professional Conduct, which identifies fundamental principles: integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour. These principles should guide every professional judgment made in practice.