Financial statements are the important reports of the entity that provide the entity’s financial information at a specific period of time to be used by many stakeholders such as management, employees, the board of directors investors, shareholders, customers, suppliers, bankers, and other related stakeholders.
These statements are prepared as the requirement of management, owners, shareholders, governments, and other related authority organizations.
The completed set of financial statements contain five statements and five elements. Here are the five statements:
- Statement of Financial Position or Balance Sheet,
- Statement of Financial Performance, or Income Statement,
- Statement of Change in Equity,
- Statement of Cash flow, and
- Noted to Financial Statements
Elements of Financial Statements:
The above financial statements build-up by five key elements of financial statements. For example, in Balance Sheet, there are three main elements contain on it such as Assets, Liabilities, and Equities.
In the income statement, there are two key elements contain on it such as revenues and expenses. All of these elements are clearly defined and explained in the IASB’s Framework.
These Financial Statements contain five main elements of the entity’s financial information, and these five elements of financial statements are:
- Revenues, and
The official definition of assets are defined by IASB’s Framework for preparation and presentation of financial statements are the resources control by the entity as the result of past events and from which the future economic benefits are expected to flow the entity.
For example, the account receivable is the asset of the entity.
Right here could mean the right to use or control the physical assets or the intellectual property or it could be linked to the other entity’s obligation to pay or transfer the assets to the entity.
In the accounting equation, assets are calculated by the accumulation of equity and liabilities.
Here are examples of assets:
- Computer equipment
- Cash in bank
- Cash on hand
- Cash advance
- Petty cash
- Account receivables
- Prepaid expenses
- And other assets that meet the definition of assets above.
In general, assets are classified into two types based on the company’s policies and in accordance with international accounting standards.
The first class of assets is the current asset which refers to short-term assets and these kinds of assets are not depreciated. The movement or usages of them are directly charged to the income statement.
For example, the usages of inventories are charged as operating expenses or costs of goods sold in the income statement. Some of the current assets are justed move from one accounting item to another.
For example, accounts receivable are moved to cash in bank or cash on hand when the entity collects the payment from customers.
Current assets generally have a useful life in less than 12 months from the ending date of the reporting period. It is assumed that the entity could use or convert the current assets into cash in less than 12 months.
In case, the portion of assets will be converted or collected in less than 12 months and other assets have more than 12 months, then the portion that has more than 12 months should be recorded or classified as non-current assets.
The second types of assets are fixed assets. These kinds of assets normally refer to assets that use more than one year and with large amounts as well as are not for trading or holders for price appreciation.
In other words, fixed assets are the resources based on nature are converted into cash or cash equivalent in more than one year accounting period.
It is based on the company’s policies to recognize which amount should be classed as current assets and which amount should go to fixed assets. Yet, the policies should be aligned with current practice or market as well as reflected the real economic value.
Fixed assets are decreasing value from period to period because of their usages or because of impairment of their economic value.
Depreciation and impairment of fixed assets are charged into the income statement and they report cumulatively in the contra account to fixed assets in the balance sheet which is called accumulated depreciation.
Assets of the entity at the specific period can be calculated by the accumulation of liabilities and equities or total current assets plus total fixed assets.
The official definition of liabilities define by IASB’s Framework for preparation and presentation of financial statements are the present obligations arising from the past events, the settlement of which is expected to result in an outflow from entity resources embodying economic benefit.
Here are examples of Liabilities in Financial Statements:
- Bank Loan
- Interest payable
- Tax payable
- Account payable
- Noted payable
- Borrowing from parent company
- Intercompany account payable
- Salary payable
Liabilities are classified into two different types: Current liabilities and Non-current Liabilities. Current Liabilities refer to the kind of liabilities that expected to settle within 12 months after the reporting date.
For example salaries payable are classed as current liabilities because they are expected to pay to an employee in the following month.
Non-current liabilities refer to liabilities that expected to settle in more than 12 months. For example, a long term loan from the bank that the term of payments is more than 12 are classed as non-current liabilities. Liabilities records only in the balance sheet and they are considered as the second element of financial statements.
Liabilities can be calculated by eliminating the total equities from total assets or accumulation of total current liabilities and total long-term liabilities.
Equity is officially defined by IASB’s Framework for preparation and presentation of financial statements, is the residual interest in the assets of the entity after deducting all its liabilities.
Example: By solving the above definition, Equities = Assets – Liabilities. A good example of Equity is Ordinary Shares Capital and Retained Earnings. That means equity increase or decrease depending on the movement of assets and liabilities.
For example, if assets are increasing and the liabilities are stable, then equities will increase. However, if assets are stable and liabilities are increased, the equity will decrease.
The items that records in equity are:
- Share capital
- Retain earning or retain losses
- Revaluation gain
- Dividends payment
The official definition of revenues defined by IASB’s Framework for preparation and presentation of financial statement is increase in the economic benefits during the accounting period in the form of inflows or enhancements of assets or decrease of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
The example of revenues is sales revenues from selling of goods or rendering of services, interest incomes from banks deposits, as well as a dividend received from equity investments.
In the income statement, income sometimes called sales revenues or Revenues. These are referred to like the same things.
Revenues in the income statement are records all together for both the revenues from the selling of entity main products or services ( principle activities) as well as revenues that entity generate from the entity’s non-activities.
There are two accounting principles use to record and recognize revenues in the income statement. First, it uses a cash basis, and second, it uses an accrual basis.
Cash basis, revenues or income is recognised at the time cash is received or collected while accrual basis, revenue or income is recogsized at the time risks and rewards are transferred from sellers to buyers or the control over the products or services are handover from the seller to the buyer.
Expenses: Operating Expenses or Administration Expenses
The official definition of Expenses defined by IASB’s Framework for preparation and presentation of financial statement is decreased in economic benefits during the accounting period in the form of outflows or depreciation of assets or incurred of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
Expenses here refer to the expenses that occur for daily operational costs. Those expenses are:
- Cost of goods sold
- Salaries expenses
- Interest Expenses
- Tax expenses
- Utility expenses
- Transportation Cost
- Marketing Expenses
- Rental Expenses
- Repair and maintenance
- Internet Fee
- Telephone fee
Expenses are records as operational costs in the income statement in the period they have occurred.
Well, sometimes they called period cost including the cost of goods sold and administrative cost. Actually, these expenses are different from capital expenditures which are paid for purchasing fixed assets.
The above are the five main elements of financial statements that you could find in the income statement and balance sheet.
Assets are resources own by the entity, liabilities are an obligation that the entity owes to others, equities are the difference of assets and liabilities.
Revenues are the sales of goods or services, and finally, expenses are the operating costs of the entity.
These five elements of financial statements could produce five types of financial statements for the entity’s stakeholders using.
Written by Sinra