Elements and

Components of
Financial Statements
The Basic Accounting
Equation
Assets = Liabilities + Equity
– This is a mathematical equation
which must balance.
– If assets total P300 and liabilities
total P200, then equity must be
P100.
Asset, Liability and Equity
• Assets – are the economic resources you
control that have resulted from past events
and can provide you with economic benefits
• Liabilities – are your present obligations
that have resulted from past events and
can require you to give up economic
resources when settling them.
• Equity – is simply assets minus liabilities.
Other terms for equity are “capital”, “net
assets”, and “net worth”.
A transaction may do one of
several things:
• It may increase both the asset
side and the liabilities and
owners' equity side.
• It may decrease both the asset
side and the liabilities and
owners' equity side.
A transaction may do one of
several things:
• It may cause both an increase
and a decrease on the asset side.
• It may cause both an increase
and a decrease on the liabilities
and owners' equity side.
A transaction may do one of
several things:
• Regardless of what transaction
occurs, the accounting equation
must be in balance after the
transaction is analyzed.
Transaction Analysis
Transaction Analysis
Transaction Analysis
Transaction Analysis
Transaction Analysis
Transaction Analysis
Transaction Analysis
Transaction Analysis
Revenues and Expenses
• Revenues increase owners'
equity.
• Expenses decrease owners'
equity.
Revenues
• Revenues are inflows of assets (or
reductions in liabilities) in exchange
for providing goods and services to
customers.
– A retail store such as Wal-Mart earns
revenues by selling goods to customers.
– A CPA firm earns revenues by providing
services such as tax return preparation
or auditing.
Revenues
• Critically important point:
– Cash need not be received in order
for revenue to be recorded.
– Revenues are earned when a
company does what it is supposed
to do according to a contract.
Revenues
• Accounts receivable are
promises by a customer or client
to pay cash in the future.
Revenues
• A related concept concerns cash
received before a service is
performed or goods are delivered.
Consider the following
example:
• A magazine company receives
$24, which represents a year's
subscription.
• The subscriber, of course, pays in
advance.
Consider the following
example:
• The magazine company may not
record revenue because it has
not earned revenue yet.
Consider the following
example:
• To earn revenue, it must send the
subscriber one magazine a month
for twelve months.
Consider the following
example:
• It owes magazines to the
subscriber and thus has a liability
(called Unearned Revenue), not
revenue.
Consider the following
example:
• As magazines are sent, revenues
may be recorded.
Consider the following
example:
• Unearned revenues are usually
settled by the performance of a
service, unlike other liabilities
which are usually settled by the
payment of cash.
Revenues
Revenues
Expenses
• Expenses occur when resources
are consumed in order to
generate revenue.
• They are the cost of doing
business.
– Examples include rent, salaries and
wages, insurance, electricity,
utilities, and the like.
Expenses
Expenses
• A critically important point similar
to that for revenues holds true for
expenses.
– A business need not pay out cash in
order to have to record that an
expense has occurred.
Expenses
• A critically important point similar
to that for revenues holds true for
expenses.
– If a repairman comes to the
business to work on the air
conditioning system, then the
business has a repair expense even
though that work may be charged to
its account.
Expenses
• A critically important point similar
to that for revenues holds true for
expenses.
– The company will have a liability
which it will settle later with the
payment of cash.
Expenses
• The word "payable" is usually
used in a liability title.
Examples of Payables
• Notes payable—written
obligations.
• Accounts payable—unwritten
obligations that arise in the
normal operations of a business.
• Wages payable.
Examples of Payables
Sales of Inventory
• Sales of inventory contain both
revenue and expense
components.
Sales of Inventory
• A revenue transaction exists
because an asset has been
obtained and goods have been
provided to customers.
Sales of Inventory
• An expense transaction exists
because an asset has been
consumed to generate the
revenue.
Sales of Inventory
• The resulting expense is called
cost of goods sold.
Sales of Inventory
Adjustments to Accounts
• Several adjustments must be
made to accounting records at
the end of the accounting period.
Adjustments to Accounts
• A balance in an account may
need to be adjusted because of
the passage of time and the
occurrence of events in that time
period.
Adjustments to Accounts
• An amount may not have been
recorded in an account at all.
– The amount will have to be recorded
before the financial statements are
prepared so that all the information
will be correct.
Revenues and Expenses
• Remember that four transactions
affect owners' equity.
– Owner investments increase owners'
equity.
– Owner withdrawals decrease
owners' equity.
– Revenues increase owners' equity.
– Expenses decrease owners' equity.
Simple Balance Sheets and
Income Statements
• The end result of the accounting
process is the preparation of
financial statements.
The Balance Sheet
• The balance sheet shows a
firm's assets, liabilities, and
owner's equity at one point in
time.
– The date on the balance sheet will
be a single date, such as
December 31 or June 30.
The Income Statement
• The income statement
summarizes a firm's revenues
and expenses for a period of
time.
– The date on the income statement
will be a phrase such as, "For the
month ended July 31," or "For the
year ended December 31."
The Income Statement
• If revenues exceed expenses,
then the result is net income.
• If expenses exceed revenues,
then the result is a net loss.
The Income Statement
• Only revenues and expenses
appear on the income statement.
– Students sometimes think that cash
is a good thing and should appear
on the income statement.
– Cash is an asset and so will appear
on the balance sheet.
 Income Statement
For the Month Ended January 31, 2000
Revenues
Sales $ 4,000
Service
650
Total revenue 4,650
Expenses
Cost of goods sold 2,200
Rent 1,000
Salary 700
Depreciation 208
Interest 133
Utilities 120
Total expenses 4,361
Net income $ 289
The Statement of Owners'
Equity
• The statement of owners' equity
summarizes the changes that
took place in owners' equity
during the period under review.
The Statement of Owners'
Equity
• It will have the same date as does
the income statement.
• It shows results over a period of
time, not just at one point in time.
The Statement of Owners'
Equity
• The statement starts with the
beginning balance of owners'
equity and adds in any owner
investment and net income.
• If there are withdrawals, then
they are subtracted, as is a net
loss.
The Statement of Owners'
Equity
• A business will have either a net
income or a net loss, not both.
The Statement of Owners'
Equity
Relationship Between Balance
Sheet and Income Statement
• Changes in net income, owner
contributions, and owner
withdrawals, all of which affect
owners' equity, explain changes
in net assets.
 Basic Concepts of
Financial Accounting

End of Accounting
Basics