7/16/2024

Elements of Financial Statements

Element Definition or Description

Asset A present economic resource controlled by the entity as a
result of past events. 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 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.

Learning Objectives:
Definition of terms
At the end of the lesson, the student will be able to:

1. Define the elements of financial statement; Asset – is a resource controlled by the enterprise as a result of past events
2. Describe the account (simple T-Accounts) and its uses; and from which future economic benefits are expected to flow to the
3. Understand what is meant by the accounting equation and prove the validity of the enterprise. (old definition)
“mirror image” concept;
4. Understand what is meant by the double-entry system;
Asset – is a present economic resource controlled by the entity as a result
5. Explain how the double-entry system follows the rules of the accounting equation;
6. Define debits and credits; of past events. An economic resource is a right that has the potential to
7. Summarize the rules of debit and credit as applied to balance sheet and income produce economic benefits. (new definition, Conceptual Framework for
statement accounts. Financial Reporting, 2018)
8. Describe the nature of the typical account titles used in recording transactions;
9. Analyze and state the effects of business transactions on an entity’s assets, liabilities and
Assets includes cash, cash equivalents, notes receivable, inventories,
owner’s equity and record these effects in accounting equation from using the financial
transaction worksheet and the T-Accounts; and prepaid expenses, property, plant and equipment, investments, intangible
10.Distinguish between revenue and receipts. assets and other assets.
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Liabilities – is a present obligation of the enterprise arising

from past events, the settlement of which is expected to result Income encompasses both revenue and gains.
in an outflow from the enterprise of resources embodying
economic benefits. (old definition) Revenue arises in the course of ordinary activities of an
enterprises such as sales, fees, interest, dividends, royalties
Liabilities – is a present obligation of the entity to transfer an and rent.
economic resource as a result of past events. (new definition,
Conceptual Framework for Financial Reporting, 2018)
Gains represent other items that meet the definition of
Liabilities include notes payable, accounts payable, accrued income and may or may not, arise in the course of the ordinary
liabilities, unearned revenues, mortgage payable, bonds payable activities of an enterprise.
and other debts of enterprise.

Expenses are decreases in economic benefits during

Equity is the residual interest in the assets of the enterprise
the accounting period in the form of outflows or
after deducting all its liabilities.
depletions of assets or incurrences of liabilities that
Income is increase in economic benefits during the result in decreases in equity, other than those relating
accounting period in the form of inflows or enhancement of to distributions to equity participants.
assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity Losses represent other items that meet the definition
participants. of expenses and may or may not arise in the course of
ordinary activities of an enterprise.
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Debits and Credits – the Double-Entry System

The basic summary device of accounting is the account. The simplest
Accounting is based on a double-entry system which means that the dual
form of an account is known as the “ T-account”.
effects of a business transaction is recorded.

Account Title A debit side entry must have a corresponding credit side entry.
Left side or Right side or
Debit side Credit side For every transaction, there must be one or more accounts debited and
one or more accounts credited.

Each transaction affects at least two accounts.

The total debits for a transaction must always equal the total credits.

The most basic tool of accounting is the accounting equation.

Continuation....................
This equation presents the resources controlled by the enterprise, the present Debits and Credits – the Double-Entry System
obligations of the enterprise and the residual interest in the assets.
An account is debited when an amount is entered on the left side of the
It states that assets must always equal liabilities and owner’s equity.
account and credited when an amount is entered on the right side.
The basic accounting model or Accounting Equation is:
The abbreviations for debit and credit are Dr. (from the Latin debere) and
Assets = Liabilities + Owner’s Equity Cr. (from the Latin credere), respectively.
Note that the assets are on the left side of the equation opposite the liabilities and
The account type determines how increases or decreases in it are
owner’s equity. This explains why increases and decreases in assets are recorded in the
opposite manner (“mirror image”) as liabilities and owner’s equity are recorded. recorded. Increases in assets are recorded as debits, while decreases
in assets are recorded as credits. Conversely, increases in liabilities
The logic of debiting and crediting is related to the accounting equation. and owner’s are recorded by credits and decreases are entered as
debits.
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Continuation.................... Continuation...........
Debits and Credits – the Double-Entry System The rules on debit and credit

The rules of debit and credit for income and expense accounts are based Income Statements Accounts
on the relationship of these accounts to owner’s equity
Debit for Credit for
Income increases owner’s equity and expense decreases owner’s equity. decreases in Owner’s equity increases in Owner’s equity

Hence increases in income are recorded as credits and decreases as Expenses Income
debits.
Debit Credit Debit Credit
Increases in expenses are recorded as debits and decreases as credits. (+) (-) (-) (+)
Increases Decreases Decreases Increases
Normal Balance Normal Balance

The rules on debit and credit Continuation...........

The rules on debit and credit

Accounts
Balance Sheet Accounts
Debit Credit
Assets Liabilities and Owner’s Equity Increases in Increases in
Assets Liabilities
Expenses Owner’s equity
Debit Credit Debit Credit
Income
(+) (-) (-) (+)
Increases Decreases Decreases Increases Decreases in Decreases in
Normal Balance Normal Balance Liabilities Assets
Owner’s Equity Expenses
Income
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Types and Effects of Transactions

Normal Balance of an Account 1. Source of Assets (SA)
o An asset account increases and a corresponding claims (liabilities or
The normal balance of any account refers to the side of the account – owner’s equity) account increases. Examples: 1). Purchase of supplies on
debit or credit – where increases are recorded account; 2) Sold goods on cash on delivery basis
2. Exchange of Assets (EA)
Account Category Increases Recorded by Normal Balance
o One asset account increases and another asset account decreases.
Debit Credit Debit Credit
Example: Acquired equipment for cash
Assets / / 3. Use of Assets (UA)
Liabilities / / o An asset account decreases and a corresponding claims (liabilities or
Owner’s Equity: equity) account decreases. Examples: 1). Settled accounts payable; 2)
Owner’s Capital / / paid salaries of employees
Withdrawals / / 4. Exchange of Claims (EC)
Income / / o One claims (liabilities or owner’s equity) account increases and another
Expenses / / claims (liabilities or owner’s equity) account decreases. Example: received
utilities bill but did not pay.

Accounting Events and Transactions The four types of transactions may be further expanded into the
following effects:
An accounting event is an economic occurrence that causes changes in 1. Increase in Assets = Increase in Liabilities (SA)
an enterprise’s assets, liabilities, and/or equity. 2. Increase in Assets = Increase in Owner’s Equity (SA)
3. Increase in one Asset = Decrease in another Asset (EA)
Events may be internal and external event. 4. Decrease in Assets = Decrease in Liabilities (UA)
5. Decrease in Assets = Decrease in Owner’s Equity (UA)
Transaction is a particular kind of event that involves the transfer of 6. Increase in Liabilities = Decrease in Owner’s Equity (EC)
something of value between two entities. 7. Increase in Owner’s Equity = Decrease in Liabilities (EC)
8. Increase in one Liability = Decrease in another Liability (EC)
Examples of transactions include: 9. Increase in one Owner’s Equity = Decrease in another Owner’s Equity
a) acquiring assets from owner(s) (EC)
b) Borrowing funds from creditors
c) Purchasing or selling goods and services
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Typical Account Titles Used Current Assets

Statement of Financial Position
Inventories – are assets which are (a) held for sale in the ordinary course of
Assets are classified into two: business; b) in the process of production for such sale; or (c) in the form of
1. Current assets materials or supplies to be consumed in the production process or in the
An entity shall classify assets as current when: rendering of services.
o It expects to realize the asset, or intends to sell or consume it, in its normal operating
cycle
Prepaid expenses - are expenses paid for by the business in advance.
o It holds the asset primarily for the purpose of trading
o It expects to realize that asset within twelve months after the reporting period; or
o The asset is cash or a cash equivalent unless the asset is restricted from being
exchanged or used to settle a liability for at least 12 months after the reporting period.
2. Noncurrent assets

Operating Cycle – is the time between the acquisition of assets for processing and their
realization in cash or cash equivalents. When the entity’s normal operating cycle is not clearly
identifiable, it is assumed to be 12 months.

Current Assets Noncurrent Assets

Cash – is any medium of exchange that a bank will accept for deposit at face Property, Plant and Equipment – are tangible assets that are held by an
value. It includes coins, currency, checks, money orders, bank deposits and enterprise for use in the production or supply of goods or services, or for rental to
drafts. others, or for administrative purposes and which are expected to be use during
more than one period. (land, building, machinery and equipment, furniture and
Cash equivalents – these are short-term, highly liquid investments that are fixtures, motor vehicles and equipment)
readily convertible to known amounts of cash and which are subject to an
insignificant risk of changes in value. Accumulated Depreciation – it is a contra account that contains the sum of the
periodic depreciation charges.
Notes Receivable – is a written pledge that the customer will pay the business a
fixed amount of money on a certain date. Intangible Assets - these are identifiable, nonmonetary assets without physical
substance held for use in the production or supply of goods or services, for rental
Accounts Receivable – are claims against customers arising from sale of to others, or for administrative purposes. (Goodwill, patents, copyrights, licenses,
services or goods on credit franchises, trademarks, brand names, secret processes, subscription lists and
non-competition agreements.)
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Liabilities
Current Liabilities
Liabilities are classified into two:
Unearned revenues – when the business entity receives payment before
1. Current liabilities providing its customers with goods or services, the amounts received are
An entity shall classify a liability as current when: recorded in the unearned revenue account (liability method). When the goods or
o It expects to settle the liability in its normal operating cycle; services are provided to the customer, the unearned revenue is reduced and
o It holds the liability for the purpose of trading; income is recognized.
o The liability is due to be settled within 12 months after the reporting
period; or Current Portion of Long-Term Debt - these are portions of mortgage notes,
o The entity does not have a unconditional right to defer settlement of the bonds and other long-term indebtedness which are to be paid within one year
liability for at least 12 months after the reporting period. from the balance sheet date.
2. Noncurrent liabilities

Current Liabilities Noncurrent Liabilities

Accounts payable – represents the reverse relationship of the accounts Mortgage payable – this account records long-term debt of the business entity
receivable. By accepting the goods or services, the buyer agrees to pay for them for which the business entity has pledged certain assets as security to the
in the near future. creditor. In the event that the debt payments are not made, the creditor can
foreclose or cause the mortgaged asset to be sold to enable the entity to settle the
Notes payables – is like a note receivable but in reverse sense. In the case of a claim.
note payable, the business entity is the maker of the note; that is, the business
entity is the party who promises to pay the other party a specified amount of Bonds payable – often substantial sums of money from lenders to finance the
money on a specified future date. acquisition of equipment and other needed assets. They obtain these funds by
issuing bonds. The bond is a contract between the issuer and the lender
Accrued liabilities – amounts owed to others for unpaid expenses. This account specifying the terms of repayment and the interest to be charged.
includes salaries payable, utilities payable, interest payable and taxes payable.
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Owner’s Equity Income Statement

Capital - (from the Latin capitalis, meaning “property”). This account is used to Expenses:
record the original and additional investments of the owner of the business
entity. It is increased by the amount of profit earned during the year or is Salaries or Wages Expense - includes all payments as a result of an employer-
decreased by a loss. Cash or other assets that the owner may withdraw from the employee relationship
business ultimately reduce it. This account title bears the name of the owner.
Telecommunications, Electricity, Fuel and Water Expenses - expenses
Withdrawals – when the owner of a business entity withdraws cash or other related to use of telecommunications facilities, consumption of electricity, fuel
assets such are recorded in the drawing or withdrawal account rather than and water.
directly reducing the owner’s equity account.
Rent Expenses – expenses for space, equipment or other asset rentals
Income Summary – it is a temporary used at the end of the accounting period to
close income and expenses. This account shows the profit or loss for the period Supplies expenses – expense of using supplies in the conduct of daily business.
before closing to the capital account.

Income Statement Income Statement

Income: Expenses:

Service income - revenues earned by performing services for a customer or Insurance expense – portion of premiums paid in insurance coverage which has
client expired

Sales - revenues earned as a result of sale of merchandise Depreciation expense – portion of the cost of a tangible asset allocated or
charged as expense during the accounting period.
Expenses:
Uncollectible Accounts expense - the amount of receivables estimated to be
Cost of sales - cost incurred to purchase or to produce the products sold to doubtful of collection and charged as expense during an accounting period.
customers during the period; also called cost of goods sold.
Interest expense - and expense related to use of borrowed funds
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Distinction between Revenues and Receipts

Accounting for Business Transactions
The table shows various types of sales transactions and classifies the effects of
Business transaction - is the occurrence of an event or a condition that affects each on cash receipts and sales revenues for “this year”:
financial position and can be reliably recorded.
This Year
Transaction Amount Cash receipts Sales revenues
Financial Transaction Worksheet
1. Cash sales made this P200,000 P200,000 P200,000
year
Every financial transaction can be analyzed or expressed in terms of its effects on
2. Credit sales made 300,000 300,000 0
the accounting equation. The financial transaction worksheet will be analyzed by
last year; cash received
means of a financial transaction worksheet which is a form used to analyze this year
increases and decreases in the assets, liabilities or owner’s equity of a business 3. Credit sales made 400,000 400,000 400,000
entity. this year; cash received
this year
4. Credit sales made 100,000 0 100,000
this year; cash to be
received next year

Thank
Use of T-Accounts

Analyzing and recording transactions using the accounting equation is useful in

conveying a basic understanding of how transactions affect the business.
However, it is not an efficient approach once the number of accounts involved
increases. Double entry system provides a formal system of classification and

you!!!
recording business transactions.