Financial Accounting Study Notes: Chapters 6–10 Key Topics and Exam Preparation

Chapter 6: Property, Plant, and Equipment, and Intangible Assets

Overview of Property, Plant, and Equipment (PP&E)

Property, Plant, and Equipment (PP&E) are long-term tangible assets used in the operations of a business. Only a small part of this chapter is covered here.

• Definition: PP&E includes assets such as land, buildings, machinery, and equipment.

• Depreciation: The allocation of the cost of tangible assets over their useful lives.

• Intangible Assets: Non-physical assets like patents, copyrights, and trademarks.

Example: A company purchases machinery for $50,000 with a useful life of 10 years. Annual depreciation using the straight-line method is:

$\text{Annual Depreciation} = \frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}}$

Additional info: Only a small part of this chapter is referenced; focus is on basic definitions and depreciation.

Chapter 7: Liabilities

Journal Entries for Liabilities

Liabilities represent obligations of a business to pay cash, transfer assets, or provide services in the future. Recording liabilities involves making journal entries.

• Current Liabilities: Obligations due within one year (e.g., accounts payable, short-term loans).

• Long-term Liabilities: Obligations due after one year (e.g., bonds payable, long-term loans).

• Journal Entry Example: When a company borrows $10,000 from a bank:

Journal Entry:

• Debit: Cash $10,000

• Credit: Notes Payable $10,000

Additional info: Focus is on journal entries related to liabilities.

Chapter 8: Shareholders' Equity

Common Questions and Concepts

Shareholders' equity represents the owners' claims on the assets of a corporation after liabilities are deducted.

• Components: Common stock, preferred stock, additional paid-in capital, retained earnings.

• Issuing Stock: When a company issues shares, it increases both cash and equity.

• Dividends: Distributions of earnings to shareholders reduce retained earnings.

Example: Issuing 1,000 shares of $1 par value common stock at $10 per share:

• Debit: Cash $10,000

• Credit: Common Stock $1,000

• Credit: Additional Paid-in Capital $9,000

Additional info: All questions are similar to those found in standard textbooks.

Chapter 9: The Statement of Cash Flows

Strengths and Weaknesses of the Statement of Cash Flows

The statement of cash flows provides information about a company's cash receipts and cash payments during a period.

• Strengths:

  • Shows actual cash generated and used by operating, investing, and financing activities.

  • Helps assess liquidity and financial flexibility.

• Weaknesses:

  • Does not show non-cash transactions.

  • Can be manipulated by timing of cash flows.

Example: Cash paid for equipment is shown as an investing outflow, while cash received from issuing shares is a financing inflow.

Chapter 10: Financial Statement Analysis

Key Ratios and Analysis

Financial statement analysis involves evaluating a company's financial statements to make informed business decisions. Ratios are a primary tool for this analysis.

• Net Income: Found on the income statement; represents total revenues minus total expenses.

• Current Assets: Assets expected to be converted to cash within one year (e.g., cash, accounts receivable, inventory).

• Analysis of Current Assets: Involves assessing liquidity and operational efficiency.

Common Financial Ratios

Ratio	Formula	Purpose
Current Ratio	$\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$	Measures short-term liquidity
Quick Ratio	$\text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}$	Measures immediate liquidity
Return on Equity (ROE)	$\text{ROE} = \frac{\text{Net Income}}{\text{Average Shareholders' Equity}}$	Measures profitability for shareholders
Debt-to-Equity Ratio	$\text{Debt-to-Equity} = \frac{\text{Total Liabilities}}{\text{Shareholders' Equity}}$	Measures financial leverage

• Calculating Ratios: Use values from the balance sheet and income statement to compute ratios for analysis.

Example: If a company has current assets of $50,000 and current liabilities of $25,000, the current ratio is:

$\text{Current Ratio} = \frac{50,000}{25,000} = 2.0$

Additional info: The biggest exam question focuses on ratios, their calculation, and interpretation.