Summary of the first 6 chapters of Financial Accounting 10th edition by Libby, Libby and Hodge. This book is used in the first year's course 'Financial Accounting' at Tilburg University.
Chapter 1
GAAP: Generally Accepted Accounting Principles Every country has its own GAAP. Different
accounting standards lead to different reported incomes.
- Owner/manager = founder of business who also functions as manager
- Creditors lend money for a specific period of time and gain by charging interest on the money
they lend.
- Investors buy ownership in the company in the form of stock, hoping to gain in two ways:
o Sell ownership interest in the future for more than they paid.
o Receive a portion of the company’s earnings in cash (dividends).
- Managers: internal decision makers; Stockholders and creditors: external decision makers
- Business activities:
o Financing activities: borrowing or paying back money to lenders and receiving
additional funds from stockholders or paying them dividends.
o Investing activities: buying or selling items such as plant and equipment used in the
production of beverages.
o Operating activities: the day to day process of purchasing raw tea and other
ingredients from suppliers, manufacturing beverages, delivering them to customers,
collecting cash from customers and paying suppliers.
The four basic financial statements:
1. Balance sheet: reports the economic resources it owns and the sources of financing those
resources.
2. Income statement: reports its ability to sell goods for more than their cost to produce and
sell.
3. Statement of stockholders’ equity: reports additional contributions from or payments to
investors and the amount of income the company reinvested for future growth.
4. Statement of cash flows: reports its ability to generate cash and how it was used.
- Assets = economic resources (e.g. cash, inventory, buildings)
- Liabilities = financing form creditors (e.g. amounts owed to suppliers, employees, banks)
- Stockholders equity = financing from stockholders (e.g. common stock, retained earnings)
Income statement
Revenues = expenses + net income
- Revenues: Cash and promises received from delivery of goods and services.
- Expenses: Resources used to earn period’s revenues.
- Net income: revenues earned minus expenses incurred
Income statement: reports the accountant’s primary measure of performance of a business, revenues
less expenses during the accounting period.
Stockholders’ equity
Beginning of the year retained earnings + net income - dividends
,Statement starts with the beginning balances in the stockholders’ equity accounts, lists the increases
and decreases, and reports the resulting ending balances.
Retained earnings are the amount of profit a company has left over after paying all its direct costs,
indirect costs, income taxes and dividends to shareholders.
Retained earnings + common stock = total equity
Total equity = assets - liabilities
Total equity – shareholders equity = retained earnings
Retained earnings = beginning retained earnings – net income - dividends
Statement of cash flows
- CFO: cashflows directly related to earning income.
- CFI: cashflows related to the acquisition or sale of the company’s plant and equipment and
investments.
- CFF: cashflows directly related to the financing of the enterprise itself.
1. Net income from the income statement results in an increase in ending retained earnings on
the statement of stockholders’ equity.
2. Ending retained earnings from the statement of stockholders’ equity is one of the two
components of stockholders' equity on the balance sheet.
3. The change in cash on the cash flow statement added to the beginning of the year balance in
cash equals the end of the year balance in cash on the balance sheet.
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