Basic Elements of Financial Statements

Financial Position. At timely intervals the business will scrutinize the

status of their assets, liabilities, and owner’s equity in a report called
balance sheet which is prepared to show the financial position of the firm on
a given date, such as the end of the month or a year. A balance sheet shows
the financial position of the business like its ability to convert its assets to
cash – liquidity, its ability to pay its currently maturing obligations –
solvency, as well as its ability to meet its long-term debts and withstand
financial difficulties – stability.

Asset is a resource controlled by the business as a result of past events and

from which future economic benefits are expected to flow to the enterprise.
In simple terms, assets are valuable resources owned by the business.

Liability is a present obligation of the business arising from past events, the
settlement of which is expected to result in an outflow from the business of
resources involving economic benefits. In other words, liabilities are
obligations of the business entity to outside parties who have furnished
resources.

Equity is the residual or left-over interest in the assets of the business after
deducting all its liabilities.

Financial Performance. When there is an excess of revenue over

expenses, the excess represents a profit. Profit is the reason why people risk
their money by investing it in a business. A business firm’s accounting
records does not only shows increases and decreases in assets, liabilities,
and owner’s equity but the detailed results of all transactions involving
revenue and expenses. This is reflected in the income statement. An
income statement shows the revenues and expenses of a business entity for
a period, such as a month, a quarter, semi-annually or yearly. It reports the
performance or results of operation of the business for a period.
Income is increases in economic benefits during the accounting period in
the form of inflows of assets or decreases of liabilities that result in increases
in equity, other than those relating to contributions from equity participants.

Revenue arises in the course of the ordinary activities of a business

enterprise and is referred to by a variety of different names including sales,
fees, interest, dividends, royalties, and rent.

Gains represent other items that meet the definition of income and may or
may not, arise in the course of the ordinary activities of the business.

Expenses are decreases in economic benefits during the accounting period

in the form of outflows or depletions of assets or incurrences of liabilities that
result in decreases in equity, other than those relating to distributions to
equity participants.

The definition of expenses embraces losses as well as those expenses arising

in the ordinary course of activities of the business. There are various classes
of expenses but are generally classified as cost of services rendered or cost
of goods sold, distribution cost or selling expenses, administrative expenses
or other operating expenses.

Losses represent items that meet the definition of expense and may or may
not, arise in the course of the ordinary activities of the business. Losses
represent decreases in economic benefits and as such are no different in
nature from other expenses. Hence they are not regarded as a separate
element.

Typical Account Titles

Current Assets

Cash. Currency on hand, money deposited in the bank, checks of

customers, money orders, treasury warrants, and bills of exchange.

Cash equivalents. These are short-term, highly liquid investments that are
readily convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value.

Notes receivable. A written pledge that the customer will pay the business
a fixed amount of money on a certain date such as a promissory note.

Accounts receivable. These are claims or collectibles against customers

arising from sale of goods on credit or for services rendered not immediately
paid by the customers.

Inventories. Goods or merchandise on hand or unsold at the start of a

period as well as at the end of a period and available for sale.

Prepaid expenses. Payment in advance for use of properties of other

persons or companies – prepaid rent, supplies to be used – supplies or
supplies on hand/inventory, and protection against loss, theft, fire or floods –
prepaid insurance.

Non-current Asset

Property, plant and equipment. These are tangible assets that are held
by the business for use in the production or supply of goods or services, for
rental to others, or for administrative purposes and which are expected to be
used beyond one year. Included are such items as land, building, machinery
and equipment, furniture and fixtures, and motor vehicles and equipment.

Accumulated Depreciation. Is a contra-asset account that contains the

sum of the periodic depreciation charges. The balance in this account is
deducted from the cost of the related asset – equipment or buildings – to
obtain the book value.

Intangible assets. These are identifiable, nonmonetary assets without

physical substance held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes. These include
goodwill, patents, copyrights, licenses, franchises, trademarks, brand names,
secret processes, subscription lists and non-competition agreements.

Current liabilities

Accounts payable. This account represents the reverse relationship of the

accounts receivable. By accepting the goods or services, the buyer agrees
to pay for them in the near future.

Notes payable. Amounts owed for services and goods used evidenced by a
promissory note issued by the business to the creditor.

Accrued liabilities. Amounts owed to others for unpaid expenses. This

account includes salaries payable, utilities payable, interest payable and
taxes payable.

Unearned revenues. When the business receives payment before

providing its customers with goods or services, the amounts received are
recorded in the unearned revenue account. When the goods or services are
provided to the customer, the unearned revenue is reduced and income is
recognized.

Current portion of long-term debt. These are portions of mortgage

notes, bonds and other long-term indebtedness which are to be paid within
one year from the balance sheet date.

Non-current liabilities

Mortgage payable. Money borrowed which requires the pledging of non-

current assets such as land and buildings as collateral.

Bonds payable. Business organizations often obtain substantial sums of

money from lenders to finance the acquisition of equipment and other
needed assets. They obtain these funds by issuing bonds. The bond is a
contract between the issuer and the lender specifying the terms of
repayment and the interest to be charged.

Owner’s equity

Capital. This account is used to record the original and additional

investments of the owner in the business entity. It is increased by the profit
earned during the year and decreased by a loss.

Withdrawals. Amount of cash and other assets taken by the owner from
the business for his personal use. This is deducted from the capital account.

Income summary. It is a temporary account used at the end of the

accounting period to close income and expenses. This account reflects the
profit or loss for the period before closing to the capital account.

Income

Service income. Revenues earned by performing services for a customer

or client.

Sales. Revenues earned as a result of sale of merchandise.

Expenses

Cost of sales. The cost incurred to purchase or produce the products to be

sold to customers during the period.

Salaries and wages expense. Includes all payments as a result of an

employer-employee relationship such as salaries and wages, 13 th month pay,
cost of living allowances and other related benefits.

Utilities expense. Expenses related to the use of telecommunication

facilities, consumption of electricity, fuel and water.
Rent expense. Expense for space, equipment or other asset rentals.
Supplies expense. Expense of using supplies in the conduct of daily
business.
Insurance expense. Portions of premiums paid on insurance coverage
(e.g. on motor vehicle, health, life, fire, typhoon or flood) which has expired.
Depreciation expense. The portion of the cost of a tangible asset allocated
or charged as expense during an accounting period.
Uncollectible accounts expense. The amount of receivables estimated to
be doubtful of collection and charged as expense during an accounting
period.
Interest expense. An expense related to the use of borrowed funds.

The Accounting Equation.

Financial statements are the final products of the accounting process and
tells us how a business is performing. But how do we arrive at the items and
amounts that make up these statements? The most basic accounting tool is
the accounting equation. This equation presents the resources controlled by
the business, its present obligations and residual interest in the assets. It
states that assets must always equal liabilities and owner’s equity. These
relationship is expressed as the accounting equation:

ASSETS = LIABILITIES + OWNER’S EQUITY

Business Transactions

A business transaction is an exchange of goods or services for a

specific sum of money. It also refers to any activity, event or condition that
must be recorded. Every transaction has a two-fold effect on the assets,
liabilities and capital. In every transaction, the money value received is
equal to the money value parted with or given out. This is referred to as the
double entry bookkeeping. Meaning, in every transaction there is a debit and
a credit element. For every debit element there is a corresponding credit
element which are both equal in amount.

Note that assets are on the left side of the equation opposite the liabilities
and owner’s equity. This explains why increases and decreases in assets are
recorded in the opposite manner as liabilities and owner’s equity are
recorded. The equation also explains why liabilities and owner’s equity
follow the same rules of debit and credit.

The logic of debiting and crediting is related to the accounting equation.

Transactions may require additions to both sides, subtractions from both
sides, or an addition and subtraction on the same side but in all cases the
equality must be maintained.
Financial Transaction Worksheet

Every transaction can be analyzed or expressed in terms of its effects on

the accounting equation. The financial transactions will be analyzed by
means of a financial transaction worksheet which is a form used to analyze
increases and decreases in assets, liabilities or owner’s equity of a business.

Illustration:

Transactions for September 20____ Analysis

a. A. Santos invested cash in the A & S Value received by the business, Cash
Laundry Shop, P20,000 P20,000 = Value given out, Capital
P20,000
b. Bought various supplies for cash
P2,500 Value received, supplies worth, P2,500 =
Value given out, Cash of P2,500
c. Paid rent for a space to be used for
the business, P3,000 Value received, Rent expense, P3,000 =
Value given out, Cash paid for P3,000
d. Bought typewriter for P15,000
paying P5,000 and the balance Value received, equipment of P15,000=
on account value given out , Cash of P5,000 and
account payable of P10,000

e. Services rendered to cash Value received, cash of P6,500 = value

customers, P6,500 given out, service income of P6,500

f. Services to customers who promised Value received, accts receivable, P7,500

to pay later (on account) P7,500 = value given out, service income,
P7,500
g. Santos took cash of P2,000 to pay
for his personal expenses Value received, drawing of P2,000 =
value given out, cash of P2,000
h. Partial payment of account in letter
d., P5,000 (typewriter) Value received, accts payable of P5,000
= value given out, cash of P5,000
i. Received cash for customer’s
account in letter f., P3,000 Value received, cash of P3,000 = value
given out, accts receivable, P3,000
j. Paid for the services of the helpers,
P2,500 Value received, services of helpers
(salary expense) worth P2,500 = value
given out, cash of P2,500
Analysis of transactions in terms of increase and/or decrease in assets,
liabilities and capital:
Transaction Analysis
A --- increase in assets (cash) = increase in capital
-
B --- increase in assets (supplies) = decrease in asset (cash)
-
C --- decrease in capital (rent expense) = decrease in asset cash)
-
D --- increase in asset (equipment) = decrease in asset (cash) &
- Increase in liability (accts
payable)
E --- increase in asset (cash) = increase in capital (Service
- income)
F --- increase in asset (accts. = increase in capital (Service
- receivable) income)
G --- decrease in capital (drawing) = decrease in asset (cash)
-
H --- decrease in liability (accts. = decrease in asset (cash)
- payable)
I --- increase in asset (cash) = decrease in asset (accts rec’ble)
-
J --- decrease in capital (Salaries Exp.) = decrease in asset (cash)
-