Lecture Notes: Chapter 1 – Financial Statements and Business Decisions
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
Introduction
Financial accounting provides critical information for decision-making by various
stakeholders, including investors, creditors, and managers. The four primary
financial statements—the income statement, balance sheet, statement of
retained earnings, and statement of cash flows—are the foundation of this
information. This chapter introduces these statements, explains how they work
together, outlines the roles and responsibilities of those involved in the financial
reporting process, and explains the importance of Generally Accepted
Accounting Principles (GAAP) in ensuring accurate and consistent reporting.
1. The Four Basic Financial Statements
Each of the four financial statements provides a unique perspective on a business’s
financial health and performance.
1.1 Income Statement
Purpose: Measures a company’s performance over a specific accounting period by
reporting revenues, expenses, and the resulting net income or loss.
Components:
Revenues: Earned from the sale of goods or services
Expenses: Costs incurred in earning those revenues
Net Income: Bottom line profit or loss for the period
Example:
A clothing retailer earns $200,000 in revenue and incurs $150,000 in expenses. Net
income = $50,000.
Users:
Investors analyze profitability and earnings trends.
Creditors assess the firm’s ability to repay debt.
Managers evaluate performance and plan improvements.
, 1.2 Statement of Retained Earnings (or Stockholders’ Equity)
Purpose: Explains changes in retained earnings during an accounting period.
This statement reflects the company’s decision to reinvest profits or distribute them
as dividends.
Example:
Beginning Retained Earnings = $100,000
Net Income = $25,000
Dividends = $5,000
Ending Retained Earnings = $120,000
Users:
Investors evaluate whether the company retains earnings for growth.
Managers assess dividend policies.
1.3 Balance Sheet
Purpose: Presents the financial position of the company at a specific point in
time by listing assets, liabilities, and equity.
Components:
Assets: Economic resources owned (cash, inventory, property)
Liabilities: Obligations owed to outsiders (loans, accounts payable)
Stockholders’ Equity: Owners’ claim after liabilities (common stock +
retained earnings)
Example:
Assets = $300,000; Liabilities = $120,000; Equity = $180,000
Users:
Creditors analyze the company’s solvency and leverage.
Investors assess financial health and asset management.
1.4 Statement of Cash Flows
Based on Financial Accounting, 11th Edition by Libby, Libby, and Hodge
Introduction
Financial accounting provides critical information for decision-making by various
stakeholders, including investors, creditors, and managers. The four primary
financial statements—the income statement, balance sheet, statement of
retained earnings, and statement of cash flows—are the foundation of this
information. This chapter introduces these statements, explains how they work
together, outlines the roles and responsibilities of those involved in the financial
reporting process, and explains the importance of Generally Accepted
Accounting Principles (GAAP) in ensuring accurate and consistent reporting.
1. The Four Basic Financial Statements
Each of the four financial statements provides a unique perspective on a business’s
financial health and performance.
1.1 Income Statement
Purpose: Measures a company’s performance over a specific accounting period by
reporting revenues, expenses, and the resulting net income or loss.
Components:
Revenues: Earned from the sale of goods or services
Expenses: Costs incurred in earning those revenues
Net Income: Bottom line profit or loss for the period
Example:
A clothing retailer earns $200,000 in revenue and incurs $150,000 in expenses. Net
income = $50,000.
Users:
Investors analyze profitability and earnings trends.
Creditors assess the firm’s ability to repay debt.
Managers evaluate performance and plan improvements.
, 1.2 Statement of Retained Earnings (or Stockholders’ Equity)
Purpose: Explains changes in retained earnings during an accounting period.
This statement reflects the company’s decision to reinvest profits or distribute them
as dividends.
Example:
Beginning Retained Earnings = $100,000
Net Income = $25,000
Dividends = $5,000
Ending Retained Earnings = $120,000
Users:
Investors evaluate whether the company retains earnings for growth.
Managers assess dividend policies.
1.3 Balance Sheet
Purpose: Presents the financial position of the company at a specific point in
time by listing assets, liabilities, and equity.
Components:
Assets: Economic resources owned (cash, inventory, property)
Liabilities: Obligations owed to outsiders (loans, accounts payable)
Stockholders’ Equity: Owners’ claim after liabilities (common stock +
retained earnings)
Example:
Assets = $300,000; Liabilities = $120,000; Equity = $180,000
Users:
Creditors analyze the company’s solvency and leverage.
Investors assess financial health and asset management.
1.4 Statement of Cash Flows
