The Elements of Financial Statements

THE ELEMENTS OF FINANCIAL STATEMENTS
 The following are the elements of financial statements:

a. Assets
b. Liabilities
c. Equity
d. Income
e. Expense
 These are the building blocks of financial statements hence they are called the elements of
financial statements. The elements are analogous to “words” which makes up a sentence your
appreciation and understanding of the element is a crucial factor in your ability to speak the
accounting language.
Classification of Elements
- The elements of the financial statements are classified into:
a. Elements of Financial Position
b. Elements of Financial Performance
ELEMENTS OF FINANCIAL POSITION (A. L. E.)

 These are the elements that are presented in the balance sheet or statement of financial
position. These are important in assessing business stability and financial condition.
ELEMENTS OF FINANCIAL PERFORMANCE (I. EX.)
 These are important in assessing profitability
 Presented in the income statement
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.
THE DUALITY PRINCIPLE

*Remember that when an element is recognized (i.e. recorded) it gives rise to the recognition of
another element. Contemporary accounting make use of double entry system. Under this system
changes on two elements are recorded every time a transaction is recorded.
ELEMENTS OF FINANCIAL POSITION

A. ASSET
 Asset is a resource controlled by the business as a result of past transactions and events and
from which future economic benefits are expected to flow to the business.
Recognition of assets
- An asset is recognized in the balance sheet when it is probable that the future economic
benefits will flow to the business and the asset has a cost or value that can be measured
reliably.
ELEMENTS OF AN ASSET
a. Assets are resources controlled by the enterprise
b. Assets are results of past transactions or events
c. Assets are expected to provide future economic benefits
d. Assets have cost or value that can be measured reliably
ASSETS ARE CONTROLLED BY THE ENTERPRISE
-Assets are resources, tangible or intangible, which are controlled by the business enterprise. Control
over a resource is usually evidenced by ownership or contractual right or by the ability of the enterprise
to restrict others from using it. In general, assets are properties owned by the business. Tangible means
physically seen and touchable.
Basically, assets are properties owned by the business such as;

1. Cash
2. Receivables
3. Supplies
4. Goods held for sale
5. Truck Machineries and Other Equipment
6. Prepaid expense
ASSETS ARE RESULTS OF PAST TRANSACTION AND EVENTS

-Assets are present and existing resources which are acquired by the enterprise through past events
such as past events may be any of the following modes of acquisition:
a. Purchase
b. Borrowing
c. Contributions from the owners of the enterprise
d. Donation from third parties
e. Construction
f. Accrual or accretion such as in the increase in value of improvements and properties
g. Procreation, such as in the birth of animal offspring
h. Generation such as in the increase in value of living plants.
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.
OUTFLOWS WITH NO FUTURE ECONOMIC BENEFITS

>Payments for something that has no future economic benefit to the enterprise beyond the current
accounting period are not assets but are expenses. Expenses are deducted against income and
presented in the income statement and not in the balance sheet.
>To qualify as an asset, the inflow of economic benefits in the expenditure must be probable which
means more likely not- a chance of more than 50%. If the realization of benefits is not probable, the
assets is not recognized in the accounting books. Hence, possible claims from third parties are not
recognized as assets. Possible is a 50-50% chance.
ASSETS HAVE COST OR VALUE THAT IS RELIABLY MEASURABLE

>Assets have value that is quantifiable. Normally, enterprise value assets at the monetary equivalent of
the consideration given in exchange. This is called cost or simply cost.
DUALITY EFFECT ON ASSET

Remember the following table:
A. An increase in asset of the business may This is recorded in accounting as:
either be:
a. An income earned Increase in asset and increase in income
b. A liability borrowed Increase in asset and increase in liability
c. A capital contributed by the business owner Increase in asset and increase in asset
d. An asset received exchange for another Decrease in asset and increase in asset
asset
B. A decrease in asset of the business may
either be:
a. A payment of expense Decrease in asset and increase in expense
b. A payment of liability Decrease in asset and decrease in liability
c. A returns of capital to the business owner Decrease in asset and decrease in capital
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.
DUALITY EFFECT ON LIABILITIES

A. An increase in liability of the business may This is recorded in accounting as:
either be:
a. An expense which accrued Increase in liability and increase in expense
b. An asset which is borrowed Increase in liability and increase in asset
c. A replacement to another liability Increase in liability and decrease in liability
A. A decrease in asset of the business may be Decrease in liability and decrease in asset.
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.
Under the proprietary theorem:

ASSETS-LIABILITIES=EQUITY
DUALITY EFFECT ON EQUITY

A. An increase in equity of the business may This is recorded in accounting as
either be:
a. An asset contributed by the owners Increase in equity and increase in asset
b. A liability converted to equity Increase in equity and increase in liability
A. A decrease in equity of the business is a Decrease in equity and decrease in asset

return of capital to the owners
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.
DUALITY EFFECT ON INCOME

The recording of income is usually accompanied by the recording of a/an:
a. Increase in asset
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
 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.
 Examples of depletion of assets:

a. Use of supplies
Supplies are used in the daily business operation of the enterprise. Used supplies are expired
costs and must be expensed.
b. Depreciation of Properties
c. Expiration of prepaid expenses
d. Uncollectibility of receivables
DUALITY EFFECT ON EXPENSE
An expense is usually accompanied by:
a. Decrease in asset
b. Increase in liability
SUMMARY OF CHANGES AFFECTING THE EQUITY OF THE BUSINESS
From transactions with

Owners of enterprise Customers or clients
Increase in equity Additional investments (not Income
income)
Decrease in equity Withdrawals of capital (not Expense
expense)
These are reported in the:
Statement of Change in Equity Income Statement
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.

The Elements of Financial Statements

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

The Elements of Financial Statements

Uploaded by

Copyright:

Available Formats

THE ELEMENTS OF FINANCIAL STATEMENTS

 The following are the elements of financial statements:

ELEMENTS OF FINANCIAL POSITION (A. L. E.)

THE DUALITY PRINCIPLE

ELEMENTS OF FINANCIAL POSITION

Basically, assets are properties owned by the business such as;

ASSETS ARE RESULTS OF PAST TRANSACTION AND EVENTS

OUTFLOWS WITH NO FUTURE ECONOMIC BENEFITS

ASSETS HAVE COST OR VALUE THAT IS RELIABLY MEASURABLE

DUALITY EFFECT ON ASSET

DUALITY EFFECT ON LIABILITIES

Under the proprietary theorem:

DUALITY EFFECT ON EQUITY

A. A decrease in equity of the business is a Decrease in equity and decrease in asset

DUALITY EFFECT ON INCOME

 Examples of depletion of assets:

SUMMARY OF CHANGES AFFECTING THE EQUITY OF THE BUSINESS

From transactions with

These are reported in the:

Statement of Change in Equity Income Statement

You might also like