ELEMENTS OF FINANCIAL STATEMENTS

 Assets, liability and equity – relate to reporting entity’s financial position

 Income and expenses – relate to reporting entity’s financial performance
ELEMENT DEFINITION OR DESCRIPTION

ASSET A present economic resource controlled by the entity as a result of past

events. Potential to produce economic benefits
LIABILITY Present obligation of the entity

EQUITY Assets – liability

INCOME Increases in assets, decreases in liability, that result in increases in

equity.

EXPENSES Decreases in assets, increases in liability, that result in decreases in

equity.

FINANCIAL POSITION
Asset
An economic resource is a right that has the potential to produce economic benefits.
There are three aspects of these definitions: right; potential to produce economic
benefits; and control
Rights
(a) Rights that correspond to obligation to another party
 Rights to receive cash
 Rights to receive goods and services
 Rights to exchange economic resources with another party on favorable
terms
(b) Rights that do not correspond to obligation to another party
 Rights over physical objects e.g. property, plant and equipment,
inventories
 Rights to use intellectual property
Potential to produce economic benefits
(a) Receive contractual cash flows or another economic resource
(b) Exchange economic resources with another party in favorable terms
(c) Produce cash inflows or avoid cash outflows
(d) Receive cash or another economic resources by selling the economic resource
(e) Extinguish liabilities by transferring the economic resource
Controls
 To direct the use of economic resource and obtain the economic benefits.
 To prevent other parties from directing the use of the economic resource and
from obtaining the economic benefits.
Liability
For a liability to exist, three criteria must all be satisfied:
(a) The entity has an obligation
(b) The obligation is to transfer an economic resource
(c) The obligation is the present obligation that exists as a result of past events
An obligation is a duty or responsibility that an entity has no practical ability to avoid.
Always owed to another party or parties
Obligations to transfer an economic resource include for example:
(a) Obligations to pay cash
(b) Obligations to deliver goods or provide services
(c) Obligations to exchange economic resources with another party on unfavorable
terms
(d) Obligations to transfer an economic resource if a specified uncertain future event
occurs
(e) Obligations to issue a financial instrument.
Equity
Equity may pertain to any of the following depending on the form of business
organization
 Sole proprietorship only one owner’s equity account because there is only one
owner
 Partnership an owner’s equity account exist for each partner
 Corporation OE or SE consists of share capital, retained earnings and reserves,
representing appropriation of retained earnings among others.
FINANCIAL PERFORMANCE
Income Increases in assets, decreases in liability, that result in increases in equity.
Expenses Decreases in assets, increases in liability, that result in decreases in equity
Note:
Contributions from the holders of equity claims are NOT INCOME and distribution to
holders of equity claims are NOT EXPENSES.
THE ACCOUNT - basic summary device of accounting. Detailed record of the increases
and decreases, and balance of each element. The simplest form of account is “T”
account

Balance sheet (assets, liabilities and owner’s equity)

Income statement (income and expenses)

Account title

Debit side Credit side

THE ACCOUNTING EQUATION
ASSETS = LIABILITIES + OWNER’S EQUITY
DEBITS AND CREDITS – THE DOUBLE ENTRY SYSTEM
Accounting is based on a double entry system which means that the dual effects of a
business transaction is recorded.
 A debit side entry must have a corresponding credit side entry
 For every transaction there must be one or more acc. debited or credited
 Each trans. affects at least two accounts
 Total debits = total credits
Debit (Dr) – Debere Credit (Cr) – credere

BALANCE SHEET ACCOUNTS

ASSETS LIABILITIES AND OWNER’S EQUITY
DEBIT (+) CREDIT (-) DEBIT (-) CREDIT (+)
Increases decreases decreases increases
Normal balance normal balance

INCOME STATEMENT ACCOUNTS

Debit for decreases in owner’s credit for increases in owner’ equity
Equity
EXPENSES INCOME

DEBIT (+) CREDIT (-) DEBIT (-) CREDIT (+)

Increases decreases decreases increases
Normal balance Normal balance

ACCOUNTS

DEBIT CREDIT
Increases in increases in
Assets liabilities
Expenses owner’s capital
Withdrawal income

Decreases in decreases in
Liabilities assets
 Owner’s capital expenses
Income

NORMAL BALANCE OF AN ACCOUNT

normal balance of any account refers to the side of any account – debit or credit where
increases are recorded. AWE have debit normal balance. Liab, O.E, income have credit
normal balance.
Increases recorded by Normal Balance
Account category debit credit debit Credit
Assets
Liabilities
Owner’s Equity

Owner’s capital
Withdrawals
Income
Expenses

ACCOUNTING EVENTS AND TRANSACTIONS

Accounting event an economic occurrence that causes changes in an enterprise’s asset,
liabilities, and or equity. Events may be external (purchase of raw material from the
supplier) or internal (use of equipment for the production of goods or services).
Transaction a particular kind of event that involves the transfer of something of value
between two entities.

TYPES AND EFFECTS OF TRANSACTIONS

1. Source of Assests (SA). An asset account increases and a corresponding claims (liab or
O.E) account increases.
2. Exchange of Assets (EA). One asset account increases and the other decreases.
3. Use of Assets (UA). An asset account decreases and a corresponding claims (liab. Or
equity) account decreases.
4. Exchange of Claims (EC). One claims (liab or OE) account increases and another claims
(liba or OE) account decreases.

The four (4) types of transaction above may be further expanded into nine (9) types of
effects as follows:

1. Increase in Assets = Increase in liab (SA)

2. Increase in Assets = increase in OE (SA)
3. Increase in one asset = decrease in other asset (EA)
4. Decrease in asset = decrease in liab (UA)
5. Decrease in asset = decrease in OE (UA)
6. Increase in liab = decrease in OE (EC)
7. Increase in OE = decrease in liab (EC)
8. Increase in one liab = decrease in another liab (EC)
9. Increase in OE = decrease in another OE (EC)
TYPICAL ACCOUNT TITLES USED
STATEMENT OF FINANCIAL POSITION
ASSETS

CURRENT ASSETS
(a). It expects to realize the asset or intends to sold or consume it in it's normal
operating cycle.
(b). It expects to realize the asset within 12 months after reporting period.
 Cash - any medium of exchange that a bank will accept for deposit at a face
value.
 Cash equivaliets - these are short term, highly liquid investments that are readily
convertible to known amounts of cash.
 Notes receivable - is a written pledge that the customer will pay the business a
fixed amount of money on a certain date.
 Accounts receivable - claims against customers arising from sale of service or
goods on credit.
 Inventory - represents raw materials, components, and finished products—is
included as current assets, but the consideration for this item may need some
careful thought.
 Prepaid expenses —which represent advance payments made by a company for
goods and services to be received in the future—are considered current assets.
Though they cannot be converted into cash, they are the payments which are
already taken care of.

NON-CURRENT ASSESTS

 Property, plant and equipment. Are tangible asset that are held by an Enterprise
for use in the production or supply of goods or sevices.
 Accumulated depreciation. It is a contract account that contains the sum of the
period of depreciation charges. The balance in this amount is deducted from the
cost of the related asset - equipment or buildings - to obtain book value.
 Intangible assets. Nometary asset without physical substance held for use in the
production.

LIABILITIES
A liability is current when
(a) it expects to settle in it's normal operating cycle.
(b) is to be settled within 12 months after the reporting period.

CURRENT LIABILITY

 ACCOUNTS PAYABLE. It is a 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. The business entity is the party who promises to pay the other
party a specified amount of money on a specified future date
 ACCRUED LIABILITIES. Amount owed to others for unpaid expenses. It incluedes
salaries payable, utilities payable, interest payable and taxes payable.
  UNEARNED REVENUES. When the business entity received payment before
providing it's customers with goods or services.
 CURRENT PORTION OF LONG TERM DEBT. Portions of mortgage notes, bonds,
and other long term indebtness.

NON-CURRENT LIABILITIES
Mortgage payable – the account records long-term debt of the business entity for which
the business entity has pledged certain assets as security to the creditor. In the event
that the debt payments are not made for the creditor can foreclose or cause the
mortgage asset to be sold to enable the entity to settle the claim.
Bonds payable – business organization often obtain substantial sums of money from
lenders to finance the acquisition of equipment and other needed assets.
Owner’s Equity
Capital (from the latin capitalis, meaning “property”). Used to record the original and
additional investments of the owner of the business entity.
Withdrawals when the business entity withdraws cash or other assets such are
recorded in the drawing or withdrawal account rather than directly reducing the
owner’s equity account.
Income summary a temporary account use at the end of the accounting period to close
income and expenses. This account shows the profit loss for the period before closing to
the capital account.
Income statement
INCOME
Service Income are 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 to produce products sold to customers
during the period.
Salaries and wages expense includes all the payments as a result of an employer-
employee, relationship such as salaries or wages, 13th month pay, cost of living
allowances and other related benefits.
Telecommunications, electricity, fuel and water expense/utility expense
Rent expense expense for space, equipment or other asset rentals.
Supplies expense expense of using supplies (e.g. office supplies) in the conduct of daily
business.
Insurance expense portion of premiums paid on insurance coverage.
Depreciation expense the portion of the cost of a tangible asset (e.g. buildings and
equipment) 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 use of borrowed funds.
 ACCOUNTING FOR BUSINESS TRANSACTIONS
Business Transaction – is the occurrence of an event or a condition that affects financial
position and can be reliably recorded.
Financial transaction worksheet
Every financial transaction can be analyzed or express in terms of its effects on the
accounting equation.
ESSENCE OF FINANCIAL STATEMENTS.
The financial statements are the means by which the information is accumulated and
processed in financial accounting is periodically communicated to the users.
COMPLETE SET OF FINANCIAL STATEMENTS
1. A statement of financial position at the end of the period
2. A statement of financial performance for the period
3. A statement of changes in equity for the period
4. A statement of cash flows for the period
5. Notes, comprising a summary of significant accounting policies and other explanatory
information
6. A statement of financial position as the beginning of the earliest comparative period
when an entity applies an accounting policy retrospectively.
 Statement of financial position (or balance sheet) list all assets, liabilities and
equity of an entity as at a specific date.
 Statement of financial performance (or income statement) presents the
summary of the revenues and expenses of an entity for a specific period.
 Statement of changes in equity present summary of changes in capital such as
investments, profit loss, and withdrawals during a specific period.
 Statements of cash flows reports the amounts of cash received and disbursed
during the period.
ACCOUNTING POLICIES are the specific principles bases, conventions, rules and
practices adopted by an enterprise in preparing and presenting financial statements.
PREPARING THE FINANCIAL STATEMENTS (step 6)
once the worksheet is completed, it is easy to prepare the financial statements for the
account balances has been extended to the appropriate income statements and balance
sheet columns.
STATEMENT OF FINANCIAL PERFORMANCE
An entity can present all items of income and expense recognized in a period in a single
statement of comprehensive income, or in two statements; a statement displaying
components of profit or loss (separate income statement) and a second statement
beginning with profit or loss and displaying components of other comprehensive
income.
STATEMENMT OF CHANGES IN EQUITY
The statement of changes in equity summarizes the changes that occurred in owners’
equity. This statement is now required statement (per Revised Philippine Accounting
Standards (PAS) No. 1). Changes in an enterprise’s equity between two balance sheet
dates reflect the increase or decrease in its net assets during the period.
In the case of sole proprietorship, increases in owner’s equity arise from additional
investments by the owner and profit during the period. Decreases results from the
withdrawals by the owner and from loss for the period. The beginning balance and
additional investments are taken from the owner’s capital account in the general ledger.
STATEMENT OF FINANCIAL POSITION (balance sheet)
Is a statement the shows the financial position or condition of an entity by listing the
assets, liability and owner’s equity as at a specific date.
 LIQUIDITY – refers to the availability of cash in the near future after taking
account of the financial commitments over this period.
 FINANCIAL FLEXIBILITY – the ability to take effective action to alter the amounts
and timings of cash flow so that it can respond to unexpected needs and
opportunities.
 SOLVENCY – refers to the availability of cash over the longer term to meet
financial commitments as they fall due.
FORMAT
REPORT FORMAT – vertical sequence
ACCOUNT FORMAT – list the asset on the left and the liabilities and owner’s equity on
the right side.
CLASSIFICATION
 Assets are classified and presented in decreasing order of liquidity; cash is the
most liquid. Assets that are least likely to be converted to cash are listed last.
 Liabilities are generally classified and presented based on the time of maturity
such that obligations which are currently due are listed first.
STATEMENT OF CASH FLOWS
provides information about the cash receipts and cash payments of an entity during a
period. It is a formal statement that classifies cash receipts (inflows) and cash payments
(outflows) into operating, investing and financing activities.
Cash flows from operating activities
Direct method the entity’s net cash provided by (used in) operating activities are
obtained by adding the individual operating cash inflows and then subtracting the
individual operating cash outflows
Indirect method derives the net cash (used in) operating activities by adjusting profit for
income and expense items not resulting from cash transactions. The adjustment begins
with profit followed by the addition of expenses and charges (e.g. depreciation) that did
not entail cash payments.
Cash inflows

 Receipts from sale of goods and performance of services.

 Receipts from royalties, fees, commissions and other revenues.
cash outflows
  Payments to suppliers of goods and services
 Payments to employees
 Payments for taxes
 Payments for interest expense
 Payments for other operating expenses
cash flows from investing activities
investing activities includes making and collecting loans; acquiring and disposing of
investments in debt or equity securities; and obtaining and selling of property and
equipment and other productive assets.
Cash inflows
 Receipts from sale of property and equipment
 Receipts from sale of investments in debt or equity securities
 Receipts from collection on notes receivable
Cash outflows
 Payments to acquire property and equipment
 Payments to acquire debt or equity securities
 Payments to make loans to others generally in the form of notes receivable
Cash flows from financing activities
Financing activities includes obtaining resources from owners and creditors.
Cash inflows
 Receipts from investments by owners
 Receipts from insurance of notes payable
Cash outflows
 Payments to owner in the form of withdrawals
 Payments to settle notes payable.