Elements of Financial Statements
When a transaction occurs, it affects one or more aspects of financial statements which are called elements of financial statements. The analysis of the transactions is carried out to decide which one or more elements needs updating as a result of the transaction. There are five elements of financial statements;
- Capital/Equity
- Assets
- Liabilities
- Income
- Expense
These elements can also be called head of accounts as usually each element would have many accounts under it. Let’s explore each of these elements one by one.
Assets
Assets are presented in Statement of Financial Position (Balance Sheet) showing the total book value of the assets which are owned and controlled by the business. It is worth noting that book value may be different (in some cases significantly) from the market value of the assets.
The following definition has been given by the accounting framework issued by the accounting regulatory body “International Accounting Standards Board (IASB)”,
“An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.”
Examples of assets are;
- Land and buildings
- Plant and equipment
- Fixture and fittings
- Machines and Motor Vehicles
- Investments
- Cash
- Stock
- Receivables
The above are obvious resources which businesses use to operate and make sales and profit (economic benefits) from their use (by a right to control or ownership). This right to use/ control or ownership was acquired as a result of past event (a transaction). As these assets are tangibles (can be seen and touched), it is easy to verify their existence and ownership.
However, there are some assets which cannot be seen or touched, for examples,
- Goodwill
- brand name
- patents
- technical know-how
- advanced production processes
are all examples of Intangible Assets.
Each element of financial statement is a head of accounts and under “Assets” headings there can be many accounts. For example, each building, machine, car, van would need to have a separate account to record and update the transactions related to these assets. This can result in 100s and sometime 1000s of accounts under each head of accounts. These accounts, However, are summarised and grouped into the few main categories mentioned above before preparing financial statements. We will discuss these in more details when analysing the financial statements. However, Assets can be sub- categorised into two sub-headings;
- Non-Current Assets (Also Called fixed assets)
- Current Assets
Non-Current Assets (Fixed Assets).
These are assets which business intends to keep for longer than 1 year. The time frame is 1 year as financial statements are prepared for 12 month (usually) and the purpose of this classification is to inform the reader of the short-term and long-term position and intentions of the business. This section contains long life assets like land and buildings, plant and equipment, fixture and fittings, machines, motor vehicles. Apart from these many big companies are now investing in other companies for longer term to enjoy their success and benefit from their growth and innovative ideas and products. For example, alphabets Inc. (Google) has invested in SpaceX.
Non-Current Assets are presented in Statement of Financial Position (Balance Sheet). However, a part of these assets is expensed in Income Statement as an expense which is called Depreciation or Amortisation. This concept will be discussed later in this chapter in “Expense” section.
Current Assets
These are assets which can be converted into cash in the short-term i.e. within 12 months. Cash in hand or in the bank, Accounts Receivables (credit sales) and Inventory are the main assets in this section. Many companies invest in short-term deposits in the bank to earn some interest on spare cash which might be needed in future so cannot be invested for longer term. These investments fall under current assets and the interest earned but not received is included here as “other receivables.
This article is written by Raja Mizan who is a senior lecturer in accounting & finance in a UK university. He is an ACCA member and also runs his own accountancy practice RMR Accountants & Business Advisors.