The Elements of Financial Statements
The Elements of Financial Statements
RECOGNITION
The process of incorporating in the balance sheet or income statement an item that meets the
definition of an element of financial statements.
Also called recording.
DERECOGNITION
Removal of an element in the Financial Statement when it ceases to be an element.
NOT ASSETS:
The following are not assets of the business:
1. Employees
Employees are valuable to the business but they are not properties of the business.
2. Properties held in trust
The business does not own these properties. The business is only a trustee to these properties.
3. Consigned goods held
The business does not own these goods. These goods owned by a consignor for whom the business
acts as agent to sell the goods to customers.
4. Ordered goods
Ordered goods which are not yet received are not owned by the business until they are delivered to
the enterprise.
5. Building to be constructed
The building does not yet exist.
6. Future Income
Income in cash or in kind which will be received and earned in future accounting periods is not an
asset because it is not yet owned.
>This must be differentiated with accrued income. It must be noted that is already earned but it is to be
collected in the future is an asset. Accrued income is an asset.
ASSETS ARE EXPECTED TO PROVIDE FUTURE ECONOMIC BENEFITS
> Assets are resources that provide future economic benefits to the enterprise.
RECOGNITION OF ASSETS
The recording of an asset in the accounting books may be coupled by:
a. Recognition of income
b. Recognition of liability
c. Recognition of equity
DECOGNITION OF ASSETS
Assets are derecognized or removed from the book if they cease to be assets. The removal of an asset in
the accounting books may also be coupled by:
a. Recognition of expense
b. Derecognition of a liability
c. Derecognition of equity
LIABILITY
>Liability is a present debt of the business arising from past events, the settlement of which is expected
to result in an outflow of assets from the business.
ELEMENTS OF A LIABILITY
a. A liability is a present obligation
b. A liability requires a future outflow of resources
c. A liability arises from past event
>The past event creates a liability is usually a purchase passage of time or accrual of expense.
RECOGNITION OF LIABILITY
The recording of a liability in the accounting books is usually coupled by either:
a. Recognition of expense
b. Recognition of assets
DERECOGNITION OF LIABILITY
The removal of a liability in the accounting books is usually coupled by the Derecognition of an asset.
EQUITY
Equity means the capital or the wealth of the owner in the business enterprise. It is the residual interest
of the owner/owners of the enterprise in the assets of the enterprise after deducting all its liabilities
from its assets.
INCOME
Income is an increase in asset or a decrease in liability that result in an increase of equity other
than contributions from the owner/s of the enterprise.
ELEMENTS OF INCOME
1. Income is an Increase in equity resulting from:
a. Increase in asset
b. Decrease in liability
2. Not a capital infusion by the owners of the business.
*Income is an increase in wealth that arises from transactions with customers or clients. The increase in
wealth (equity) of the business arising from transactions with owners of the enterprise is not income but
additional capital investment or infusion.
Types of Income:
Revenue from the sale of goods or services in the normal course of business.
Other income from secondary sources such as interest or dividends received from investments.
Gains from selling assets of the business other than goods that are normally held for sale.
*The term revenue means income earned in the normal course of operations. Revenue arises from the
principal or primary business activities. In the statement of financial performance or income statement,
revenue and other income are reported as separate items.
Types of Revenue:
a. From the sales of goods held for sale – This is called sales revenue or simply sales.
b. From sales of services – This is called as service revenue or simply fees.
*Gains arise from the sale of goods or properties which are not usually intended for sale in the normal
course of business such as supplies, machineries, building, land, equipment and investments.
EXPENSE
>Expenses are decrease in asset in the form of outflows or depletion of assets or incurrences of liabilities
that results in decrease in equity, other than those relating to returns of capital or income to owner/s of
the enterprise.
ELEMENTS OF AN EXPENSE
a. Expenses is a decrease in equity
b. Decrease in liability
Expenses are generally costs of generating incomes for the business or costs of maintaining or
sustaining the business, hence they are deducted against income.
Decreases in the capital arising from transactions with the business owner/s are not expenses
but capital withdrawals. Capital withdrawals are deductible directly to capital not against
income.
*Transactions that do not decrease equity are not expenses such as the following:
Payment of liability Asset and liability decrease, equity is unaffected
Purchase of assets for cash An asset decreases, another asset(cash) increase, no
effect in equity
Purchase of asset for credit An asset increases, liability increases, no effect in equity
NATURE OF EXPENSE
An expense is either a:
1. Period Expenditures – a payment or an obligation to pay during the period for something that
has no future economic benefits.
2. Depletion of the assets – an expiration of an asset cause by usage or passage of time.
3. Loss - a value lost without consideration received.
*Period expenditure
Remember that payments for capital expenditure are assets. Payments which are period
expenditures such as, but not limited to, salaries, interest, utilities, and rent are expenses.
*Depletion of assets
Certain assets are used or are consumed in the course of business operations while others
expires as time goes by. When assets deplete, they are recognized and recorded as expense.
POINTS TO REMEMBER:
1. Expenses are first deducted from the income in the Income statement. The net amount (profit
or loss) is transferred to the Statement of Changes in Equity.
2. A net income adds up to capital. A net loss reduces capital.
3. Additional investments are not income but are added directly to capital. Withdrawals of
capital are not expenses but are deducted against capital.