UNIT 3: FINANCIAL STATEMENTS – AN OVERVIEW

Financial Statements
Definition General purpose reports that provide financial information about the reporting entity’s [business] economic
resources [assets], claims against the entity [liabilities and owner’s equity], and changes in those
economic resources and claims [revenues, expenses, owner’s capital, owner’s drawings] that is useful to
primary users in making decisions relating to providing resources to the entity
Objective To provide financial information about the reporting entity’s assets, liabilities, equity, revenues, and
expenses that is useful to users of financial statements in assessing the prospects for future net cash inflows
to the reporting entity and in assessing management’s stewardship of the entity’s economic resources
(includes protecting the company’s assets against price changes and technological changes as well as
compliance with laws, regulations, and contracts)
Scope Financial information about the reporting entity
Reporting Specified period of time
period Information about transactions and other events that have occurred after the end of the reporting period is
provided if that information is necessary to meet the objective of financial statements
Perspective From the perspective of the reporting entity
Assumption Going-concern

Elements of Financial Statements

Conceptual Framework Element Definition or Description
Economic resource Asset A present economic resource controlled by the entity as a result of past events

Claim
Changes in
economic resources
and claims, reflecting
financial performance
Other changes in
economic resources
and claims
An economic resource is a right that has the potential to produce economic benefits
Liability A present obligation of the entity to transfer an economic resource
as a result of past events
Equity The residual interest in the assets of the entity after deducting all its liabilities
Income Increases in assets, or decreases in liabilities, that result in increases in
[Revenues] equity, other than those relating to contributions from holders of equity
claims
Expenses Decreases in assets, or increases in liabilities, that result in decreases in
equity, other than those relating to distributions to holders of equity claims
- Contributions from holder/s of equity claims, and distributions to them
- Exchanges of assets or liabilities that do not result in increases or decreases
in equity

3.1 Statement of Financial Position [Balance Sheet]

Definition A position statement that reports the financial condition (financial standing; financial strength) of an entity
at the end of the period and presents an organized list of assets, liabilities, and equity
Usefulness Provides information useful to assess the entity’s future cash flows, liquidity, and long-term solvency
Limitation - The entity's reported book value (assets minus liabilities) will not directly measure
the company’s market value (in a public corporation, this is current market price x number of shares issued)
- Many assets are measured at their historical costs rather than their fair values
- Many aspects of a company may represent valuable resources but are not recorded as assets
o Product knowledge
o Experienced management team
o Trained employees
o Loyal customer relationships

Forms
Report form Account form
Assets Assets Liabilities
Liabilities Owner's equity
Owner's equity
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Elements
ASSETS
A present economic resource controlled by the entity as a result of past events
• Economic resource – the right that has the potential to produce economic benefits
• Control – the present ability to direct the use of the economic resource and obtain the economic benefits that may flow
from it
o no other party controls that asset
o the right to deploy that asset in its activities
o ability to enforce legal rights on that asset

Current assets – assets that are

• expected to be realized (converted to cash) or intended to be sold or to be consumed within
the entity’s normal operating cycle*
• held primarily for the purpose of trading
• expected to be realized within twelve months after the reporting period
• cash or cash equivalent unless the asset is restricted from being exchanged or used to settle a liability
for at least twelve months after the reporting period

*Operating cycle 1 Use cash to acquire inventory ←←

– time between the acquisition of
assets for processing and their
realisation in cash or cash equivalents
* Where a company has no
clearly defined operating cycle,
the one-year convention is used.
↓ ↑
2 Prepare inventory for sale to customers
(Including the production process for manufacturing business)
↓ ↑
3 Deliver inventory to customer
↓ ↑
4 Collect cash from customer →→

Current assets are listed according to its liquidity, its nearness to cash.
1. Cash and cash equivalents
• Cash – cash on hand and in banks that is available for use in the operations of the business
• Cash equivalents – highly liquid investments that can be quickly converted into cash, not subject to significant risk of
changes in value, and must be held for the purpose of ‘meeting short-term cash commitments’
Examples include money market funds, such as:
o Investment in treasury bills (short-term debt instruments of government)
o Investment in commercial papers (short-term debt instruments of corporations)
o Investment in certificate of deposits (short-term debt instruments of banks)

2. Trade and other receivables

• Trade receivable / Accounts receivable – receivable resulting from a company’s normal trade, that is,
providing services or selling goods on account [on credit; on charge account; on open-account credit]
• Notes receivable – receivable with a written promissory note from another party from a company’s normal trade,
usually requiring an additional receipt of explicit interest
• Other receivables
o Advances to employees – advances by the company to employees
o Loans receivable – loans given by by the company to individuals and other entities
o Accrued revenue – revenue already earned, but not yet received (recorded as part of adjusting entries at period-end)

3. Inventory – encompass goods that are

• purchased and held for resale
o merchandise purchased by a retailer and held for resale [Merchandise Inventory]
o land and other property held for resale
• raw materials and factory supplies awaiting use in the production process
• work in progress being produced by the entity
• finished goods produced

4. Prepaid expense [Deferred expense] – expense paid in advance, thus creating benefits, but not yet used
o includes office supplies

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Non-current assets – residual by definition, an entity shall classify all other assets as non-current.
1. Property, plant, and equipment – tangible items that
• are held for use in the production or supply of goods or services, for rental to others (except for land and
building), or for administrative purposes
• are expected to be used during more than one period
o Land o Vehicles o Office equipment
o Land improvements o Furniture and o Bearer plants
o Building fixtures
o Machinery o Fittings

Note: There are other non-current assets, but for FDNACCT, only Property, Plant, and Equipment items are discussed.

LIABILITIES
A present obligation of the entity to transfer an economic resource as a result of past events
• Obligation – a duty or responsibility that an entity has no practical ability to avoid and
owed to another party/parties
o person o a group of people / o society at large
o another entity a group of entities
• Transfer an economic resource
o pay cash
o deliver goods or provide services
o exchange economic resources with another party on unfavourable terms (E.g., Forwards; Options)
o transfer an economic resource if a specified uncertain future event occurs
o Issue a financial instrument if that financial instrument will oblige the entity to transfer an economic recourse
• Result of past events
o the entity has already obtained economic benefits or taken an action
o the entity will or may have to transfer an economic resource that it would not otherwise
have had to transfer

Current liabilities – liabilities that

• are expected to be settled in the entity’s normal operating cycle
• are owed primarily for the purpose of trading
• are due to be settled within twelve months after the reporting period
• do not have the right at the end of the reporting period to defer settlement of the liability for at least twelve
months after the reporting period

1. Trade and other payables

• Trade payable / Accounts payable – payable resulting from a company’s normal trade, that is, buying assets and
goods on account [on credit; on charge account; on open-account credit]
• Notes payable – payable with a written promise to pay cash at some future date (legal IOUs), usually requiring an
additional payment of explicit interest
• Other payables
o Accrued expense – expense already used, but not yet paid (recorded as part of adjusting entries at period-end)

2. Loans payable - current portion – a portion of long-term Loans Payable that is payable within the next year

3. Unearned revenue [Deferred revenue] – revenue received in advance, but not yet earned

Non-Current liabilities – residual by definition, an entity shall classify all other liabilities that are not current as non-
current

1. Loans payable - noncurrent portion – long-term Loans Payable that is not yet due within the next year

2. Long-term notes payable – long-term promissory notes that is not yet due within the next year

3. Mortgage payable – long-term promissory note secured by an asset whose title is pledged to the lender
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Deferrals and Accruals
Prepaid expense expense paid in advance not yet used ASSET
[Deferred expense]
Unearned revenue revenue received in advance not yet earned LIABILITY
[Deferred revenue] paid by providing service
Accrued revenue revenue already earned not yet received ASSET
Accrued expense expense already used not yet paid LIABILITY

OWNER’S EQUITY
The residual interest in the assets of the entity after deducting all its liabilities
Owner’s financial interest in a business
Net worth

Assets – Liabilities = Owner’s Equity

BASIC ACCOUNTING EQUATION

Resources = Claims on resources

Assets = Liabilities + Owner’s Equity

A = L + OE

3.2 Statement of Profit & Loss [Income Statement; Statement of Operations]

Definition A change statement that summarizes the profit-generating transactions that changes the owner’s equity
for the period and reports an entity’s financial performance, that is, its net profit or net loss, for the period
Usefulness Provides information useful to assess the entity’s profitability, return on owner’s investment,
its operations and various functions and predicting future expenses and cash outflows

Forms
Nature of expense method
• Classifies expenses within profit or loss according to their nature
Function of expense method
• Classifies expenses by their function within the entity
o Cost of sales – cost of providing service / cost of goods sold
o Distribution costs – expenses related to selling and distributing the goods to the customers
o Administrative costs – expenses related to the general administration of the business
o Finance costs – interest expense

Elements
INCOME [REVENUES]
• Earnings of an entity
• Inflow of resources resulting from services provided or goods sold to customers
• Increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to
contributions from holders of equity claims
o Service revenue / Professional fees – revenue from services provided to clients
o Sales revenue – revenue from sale of goods to customers
o Other income – revenue from sources other than the main line of business
§ Interest income
§ Rent income
§ Commissions income
§ Income from investments
§ Gain on sale of plant, property, equipment item

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EXPENSES
• Outflow of resources incurred for generating revenues
• Decreases in assets, or increases in liabilities, that result in decreases in equity, other than those relating to
distributions to holders of equity claims
o Delivery expense o Employee benefits
o Insurance expense o Taxes & licenses expense
o Interest expense o Transportation & travel expense
o Marketing expense o Utilities expense
(advertising, promotion) o Miscellaneous expenses /
o Office supplies expense Other expenses / Sundry expenses
o Professional fees o Bad debts expense*
(accounting, audit, legal) o Doubtful debts expense*
o Rent expense o Depreciation expense*
o Repair & maintenance expense *recorded as part of adjusting entries at
o Representation & entertainment expense period-end
o Salaries & wages expense

3.3 Statement of Changes in Owner’s Equity

Definition A change statement that discloses the events that caused the owner’s equity to change for the period
Usefulness Provides information useful to understand the transactions with owners in their capacity as owners,
showing separately contributions by and distributions to owners

Items affecting equity

• Income [revenues] and expenses
• Contributions [investment] by owner
Owner’s capital – financial investment of the owner
o Cash
o Other assets
§ Recorded at its fair market value at the time of investment
• Distributions to [withdrawal by] owner
Owner’s drawings – temporary withdrawal of the profit of the business
---
Capital
• Capital / Owner’s capital – financial investment of the owner
• Capital employed – the long-term source of financing, which includes both the capital of the owner and
non-current liabilities
• Working capital – refers to net current assets (Current assets minus Current liabilities)
• Capital expenditures – expenditures for purchase of non-current assets
• Capital budgeting – the process of investment appraisal
---

EXPANDED ACCOUNTING EQUATION

Resources = Claims on resources

Owner’s Equity
Assets = Liabilities +
Changes
Drawings Capital
Expenses Revenues

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3.4 Statement of Cash Flows
Definition A change statement disclosing the events that caused cash to change for the period
Usefulness Provides information useful to assess the entity’s ability to generate cash and cash equivalents
and to utilize those cash flows
To be discussed in detail when Chapter 24 is discussed

3.5 Preparing financial statements with accompanying notes (service business)

Notes to Financial Statements

The notes shall:
• present information about the basis of preparation of the financial statements and the specific accounting policies
used
• disclose the information required by IFRSs that is not presented elsewhere in the financial statements
• provide information that is not presented elsewhere in the financial statements, but is relevant to an understanding
of any of them

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REFERENCES
• IFRS Foundation (2003, December). IAS 10 - Events after the Reporting Period
• IFRS Foundation (2018, March). Conceptual Framework for Financial Reporting.
• IFRS Foundation (2020, July). IAS 1 - Presentation of Financial Statements.
• Price, J., Haddock, M., & Farina, M., (2021). College Accounting, 16th edition. McGraw-Hill Education.
• Spiceland, Sepe, Thomas, Tan, Low, Low (2019), Intermediate Accounting Global Edition (2nd Edition), McGraw- Hill Education (Asia).

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