Unit 4: Basic Financial Statements (Overview)

4.1 Types of Financial Statements

Financial Statements are structured representation of the financial policies of the

business transactions undertaken by a business entity showing the results of the
management’s stewardship of resources invested.

In simple terms, financial statements are reports made by accountants at the end of the
accounting period. It is in these reports where financial information are communicated to
the various users such as the public, government, creditors, employees, prospective
investors, etc.

The basic financial statements are:

a. Statement of Comprehensive Income (Income Statement)

This shows the “results of operations” for a given period of time. Results of
operations refer to the performance of the business. Through this, the users of
accounting information will be able to know how well the business is doing—
whether it is profitable or not. It may reflect NET INCOME or NET LOSS. Net
income results when total revenues exceed total expenses and net loss is the
result of the opposite case.

b. Statement of Financial Position (Balance Sheet)

This report shows the company’s financial condition by providing information

about the company’s assets (resources), liabilities (obligations), and capital
(equity) from the start up to the current accounting period. Through this
financial statement, users are able to know if the company has enough
resources to pay for its obligations.

c. Statement of Changes in Equity

This statement summarizes the changes in equity or capital for a given period
of time. This reflects the increases and decreases in the level of capital
through investments and profits, and/or withdrawals and losses.

d. Statement of Cash Flows

This financial statement focuses on the movement of CASH—its inflows and

outflows. Through the cash movement, the change in the beginning and ending
balances of cash can be seen in this report.

*There are more than four (4 ) financial statements but we will only tackle those listed above.

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4.2 Elements of Financial Statements

The elements of financial statements have already been mentioned in some parts of this
module but here are the details about them:

a. Assets

An asset is a resource controlled by the enterprise as a result of past

transactions and events and from which future economic benefits are
expected to flow to the enterprise. [F 4.4(a)- Conceptual Framework for Financial Reporting
2018]

Note that the benefits are going to flow “TO THE ENTERPRISE” and NOT “FROM
THE ENTERPRISE”. In other words, through assets there will be an INFLOW of
benefits.

If an item will not result in the inflow of economic benefits, such item is NOT an
asset. Meaning, not everything we spend on can actually give us future benefits;
hence those with no such benefits cannot be considered as assets.

Once an item can no longer provide future economic benefits, that item is NO
LONGER part of assets. This means that there are items that can initially be
classified as assets but will subsequently be out of the group when they can no
longer provide benefits to the business.

Examples:

*If you buy a new furniture for your shop, it will be considered as an asset. This
is so because the furniture is expected to be used in the future.

*You pay IN ADVANCE for a 6-month rental of the commercial space you occupy.
The rental you paid for in advance is considered an asset because you are
entitled to occupy that space not just for the current period but also for the next
few months.

*You deposited your money in the bank. The amount you deposited is
considered to be your asset since you have the right to claim it for future use.

*You rode on a taxi and paid the driver for the fare. The money you paid to the
driver is NOT part of assets because after the ride, you cannot expect to have
future benefits anymore. Your next ride isn’t for free so the money you paid is
only good for that one ride.

b. Liabilities

A liability is a present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow from the entity of resources
embodying economic benefits. [F 4.4(b)- Conceptual Framework for Financial Reporting 2018]

Liabilities represent the claims of the creditors over the enterprise’s assets or the
financial obligations of the business to its creditors.

Contrary to assets, liabilities result in an outflow of benefits from the business.

Not all liabilities are to be settled using money. Some can be paid through services
and other means.
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 Examples:

*You have used electricity and water for your shop, received the bill, but haven't
paid for such. This gives you a liability because an obligation to pay the
concerned agency arises.

*You received an advance payment from your clients for your services to be
rendered next month. You have an obligation to render your service to your
client on the following month. So while you haven’t rendered the service yet,
your liability will continue to exist.

*You own an apartment building that you rent out to tenants. One of the tenants
paid you in ADVANCE for 5 months. From the time you received the advance
payment, your liability arises since the tenant will be entitled to occupy the
apartment for the next 5 months. So while the 5-month stay is not yet exhausted,
you still have an obligation.

c. Capital/Equity

This represents the residual interest in the assets of the business after deducting all
of its liabilities. Capital is increased through additional investments of the
owner and income of the business. It is reduced by expenses, losses and
withdrawals.

d. Income

Income is an increase in economic benefits during the accounting period in the

form of inflows or enhancements of assets or decreases of liabilities that
result in increases in equity, other than those relating to contributions from equity
participants (IASB Framework). Income is also from the proceeds of services
rendered or proceeds from the sale of merchandise.

Examples:

*You are a professional barber and you have already rendered services to your
clients. In this case, you have already earned an income since you have
already rendered your service/s. (recall the revenue recognition principle)

*You are into merchandising business and you have sold several items to
customers. Since the items have been sold, you have already earned an income.
(recall the revenue recognition principle)

e. Expenses

Expenses are decreases in economic benefits during the accounting period in the
form of outflows or depletion of assets or incurrences of liabilities that result in
decreases in equity, other than those relating to distributions to equity
participants. [F 4.25(b)- Conceptual Framework for Financial Reporting 2018]

Expenses represent the cost of operations incurred by the company in generating

income.

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Expenses may also represent the cost of an asset used by the company in the
conduct of business. This simply means that when an asset is fully exhausted
and can no longer provide future benefits to the entity, such value is already
treated as expense.

Examples:

*You bought a prepaid load worth ₱5,000 for business use. At the time the
prepaid load was acquired, it can be considered an ASSET because it can be used
for several days or weeks (remember the future benefit). However, when they are
already consumed/ used they become part of EXPENSE. This is a clear example
of an item that is previously recognized as an asset but becomes an expense at
a later period.

*You hired a technician to fix some damaged facilities in your shop. The service
fee is considered as your expense and is treated as income of the technician.

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Summary of topic/section

The table below shows the different financial statements and their contents.

Contents Income Statement Balance Sheet Changes in Equity Cash Flows

Income ✓
Expenses ✓
Assets ✓
Liabilities ✓
Capital/Equity ✓
Cash inflows and outflows ✓
Increase or decrease in Capital ✓

The table below shows the basic description of the elements of financial statements.

Elements of Brief Description

Financial Statement

Assets * Resources controlled by the company

* Result of past transactions/events
* Represents inflow of future economic benefits

Liabilities * Obligations
* Result of past transactions/events
* Its settlement will result in an outflow of benefit

Capital/ Equity * Residual Interest after deducting liabilities

from assets
* Increased by additional investments and income
* Decreased by withdrawals, expenses and losses

Income * Earned from sale of goods or services

Expenses * Cost of operation

* Cost of assets used

The asset of one party is the liability of the other party. Similarly,
the income of one is the expense of the other.

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