chapter
1 Financial Statements
and Business Decisions
Financial Accounting
10e
9e
Libby • Libby • Hodge
Copyright © 2020 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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What are we going to learn?
1. Some basic concepts
2. Four basic financial statements
3. GAAP and IFRS
Tips: this is an overview chapter; most content will be
elaborated in the near future
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Who are the principal players?
• Managers (may or may not be owners).
• Owners (stockholders) are investors. They may also be
managers. Owners invest money and/or other property in
a company for:
• Dividends
• Higher future stock prices
• Lenders (creditors). The lenders' potential return:
• To earn interest on the loan
• Suppliers and Customers.
• Whether the supplier has sufficient resources to meet future
demand.
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Business activities
 Operating activities
 Purchase parts from supplier, pay salaries to employee, sell
products to customers
e.g., Starbucks sold a grande Latte to you.
 Financing activities
 Borrow/pay back money from/to a bank
 pay dividends to owners
e.g., Starbucks borrowed $100 million from Bank of America (BOA)
 Investing activities
 Purchase or sell land, equipment
e.g., Starbucks purchased equipment and factories to in Malaysia to
roast coffee beans.
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The Accounting System
Accounting
The means by which
we measure and
describe the
economic activities of
a business AND
communicate these
results to interested
users.
Accounting is the
“language of business”.
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Financial Statements
 The four basic financial statements
 Balance sheet
 Income statement
 Statement of cash flows
 Statement of stockholder’s equity
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Tips:
• Focus on:
• Content: items reported on each statement
• Structure: the equation that shows how the elements
within each statement are organized and related
• Use: how the information is used by stockholders and
creditors to make decisions
• No need to memorize all the concepts for now.
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Balance Sheet
 Report the financial position of an accounting entity at a
particular point in time (snapshot).
 Assets: economic resources from past transactions
 Expect to provide future benefits.
 Initially measured at the total cost incurred to acquire it (historical
cost).
 Liabilities: debts or obligations from past transactions
 Represent future economic detriment.
 Financing provided by creditors.
 Stockholders’ equity
 Contributed Capital: amounts invested by the owners.
 Retained Earnings : accumulations of undistributed earnings.
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Example: Netflix
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The Basic Accounting Equation
Debt
Economic
Resources
Stockholder
Past Earnings
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Income Statement
• Report the accountant’s primary measure of
performance of a business for a period of time (fiscal
period).
• The Income Statement Equation:
• Alias:
• Statement of Operations; profit and loss (P&L) statement
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Income Statement
Name of the entity
Title of the statement
Accounting period
Unit of measure
Revenues are cash and
premises received from the
sale of goods or services to
customers.
Expenses are the resources
used up by the entity to
earn revenues during a
period.
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Example: Netflix
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Statement of Stockholders’ Equity
Elements of the Statement of
Stockholders’ Equity
Common Stock
Retained Earnings
Beginning Common Stock
Beginning Retained Earnings
+Stock Issuance
+Net Income
Ending Common Stock
−Dividends
Ending Retained Earnings
Statement of Retained Earnings
Name of the entity
Title of the statement
Accounting period
Unit of measure
The same as that reported
on the balance sheet
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Statement of Cash Flows
Elements of the Statement of Cash Flows
Cash Flows from Operating Activities
Cash Flows from Investing Activities
Cash Flows from Financing Activities
/
Note that each of the three cash flow
sources can be positive (net cash
inflow) or negative (net cash outflow)
Statement of Cash Flows
• This statement shows cash inflows (receipts) and cash
outflows (payments).
• Recall the three business activities we talked about:
• Cash flow from operating activities (CFO) - directly related
to normal business activities.
• Cash flow from investing activities (CFI) - acquisitions and
sales of plant and equipment, intangibles, and other
investment assets.
• Cash flow from financing activities (CFF) - involves dealings
with the company owners and lenders.
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Relationships Between Financial Statements.
Statement of Cash Flow
Cash from operations
Beginning Balance Sheet
Ending Balance Sheet
Cash from investing
Cash from financing
Assets
Cash
Other Assets
Net change in cash
Statement of retained earnings
Assets
Cash
Other Assets
Liabilities
Liabilities
Stockholder’s equity
Contributed Capital
Retained
earnings
B.B. of retained earnings
+ Net income
- Dividend
Ending balance of retained earnings
Stockholder’s equity
Contributed Capital
Retained
earnings
Income Statement
Revenues
- Expenses
Net income
Last period
Current period
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Dates of Financial Statements are Important!
• Balance sheet is “AS OF…” or “AT” a particular date,
sometimes called a “snapshot” in time.
• Income statement
• Statement of stockholders’ equity
• Statement of cash flows
These last three cover a period of time, and thus are
“FOR THE PERIOD ENDING”
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Generally Accepted Accounting Principles
The Securities and Exchange Commission (SEC)
has been given broad powers to determine
measurement rules for financial statements.
The SEC has worked closely with the accounting profession
to work out the detailed rules that have become known as GAAP.
Currently, the Financial Accounting Standards Board (FASB) is
recognized as the body to formulate GAAP.
International Perspective
Since 2002, there has been substantial movement toward the
adoption of International Financial Reporting Standards (IFRS).
Examples of jurisdictions requiring the use of IFRS:
• European Union
• Australia and New Zealand
• Hong Kong, India, Malaysia, South
Korea
• Israel and Turkey
• Brazil and Chile
• Canada and Mexico
Take-away of chapter 1
• What is the goal of business and who are the key
players?
• What is an accounting system?
• What are the four financial statements?
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