CFO Service Finance & Accounting

Key Elements of Financial Statements

Financial Statements are used for indicating the financial performance and business activities via written accounting reports. These are prepared by the management of the company for a certain time period, which is usually a financial year. Examples Elements of financial statements are

• Cash Flow Statement,
• Income Statement,
• Balance sheet, etc.

The chief aim of preparation of financial statements is to keep the owners, shareholders, management, government, and other interested parties informed of the actual financial standing of the company.

Financial statements are integral to every business as they reflect the performance of the organization at any point of time. It is, therefore, important that the financial statements are prepared very carefully by collecting all the relevant data. Any omission or mistake in the financial statements can mislead the management into taking wrong financial decisions for the organization.

What Forms Complete Set of Financial Statements?

A complete set of financial statements for a financial year would include the following five statements:

• Balance Sheet- which is a statement of financial position of the company
• Income Statement – which is the statement of financial performance of the company
• Cash Flow Statement
• Statement of Changes in Equity (reflecting increase or decrease in assets)
• Relevant notes to financial statements

Every organization is required to maintain these financial statements at the end of every financial year. The laws pertaining to submission and presentation of these financial statements differ for public and private entities. 

What are the Key Elements of Financial Statements?

The financial statements are prepared on the basis of detailed information on the following five elements:

• Assets
• Liabilities
• Equity
• Income
• Expenses

Let us now try to explain them in detail:

1. Assets

 As per the 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.” Some vital points in regards to an asset are as follows:

• It is not necessarily a physical item.
• It may not be actually owned by the entity. The benefit from it may be derived as long as it is under the control of the entity.
• The entity must exercise sufficient control over the asset to enjoy its benefits.
• For an item to be considered as an asset, it must yield future economic benefits. In case, the value of an asset for a certain financial period becomes nil, the same shall not be considered to be an asset.
• The cost and value of an asset should be assessable.

Examples of Assets – Goodwill, Patents, Accounts Receivable, Inventory, Land, Cash in bank, Cash in hand, Prepaid Expenses and such other items that meet the definition of assets.

2. Liabilities

These are the legal obligations of an entity for paying to another organization or individual. The settlement of liabilities results in decrease in its financial resources. Liabilities are of two types:

Current Liabilities: These are the obligations that are expected to get settled within 12 months of their creation date.

Non-Current Liabilities: These are the obligations that get settled in more than 12 months from the date of their creation.

Examples of Liabilities – Bank Loan, Overdraft, Tax Payable, Interest Payable, Salary Payable, etc.

   3. Equity

As per IASB, “equity is the residual interest in the assets of the entity after deducting all its liabilities.” In simple words, equity is the excess of aggregate assets over aggregate liabilities, for a financial year. Hence, an increase or decrease in equity is dependent upon the movement of assets and liabilities of the organization in the financial year.

Equity = Assets-Liabilities

Items that form a part of equity are:

• Share Capital
• Retained Earnings/Loss
• Payment of dividends
• Revaluation Gain/Loss

4. Income (Revenue)

An entity is said to have generated income if any of the following two happen:

• There is an overall increase in the economic benefits for a financial period. The increase may be in the form of cash inflow or increase in assets.
• Reduction in the total liabilities of the entity, thereby increasing the equity.

Accounting principles used for recording income:

Cash Basis: The income is recognized and recorded when it is actually received in cash by the entity.

Accrual Basis: The income is recognized and recorded when it becomes accrued to the organization and may be actually received by the entity at a later date.

The entity has to uniformly follow an accounting principle for a financial year.

Examples of Income: Sales, income generated from services rendered, interest from bank deposits, dividend received from investments, etc.

5. Expenses

An entity is said to have incurred expenses if any of the following two happen:

• Reduction in economic benefits during the accounting period via cash outflow
• Decrease in assets

Besides the above two, expenses shall also include the expenditure incurred on items like wages paid, expenses that occur in the normal course of business and other losses that usually do not occur in the ordinary course of business.

Expenses are recorded in the Profit and Loss account in accordance with the revenue generated. An expense will automatically be created in the Profit and Loss account when an assets value becomes nil and no future economic benefits are expected from it.

Expenditure can be of following two types:

Capital Expenditure: It is incurred in relation to fixed assets, that are expected to yield economic benefits for a long period of time.

Revenue Expenditure: This expenditure is in relation to particular revenue transactions or operating periods. These usually include expenses related to wear and tear of fixed assets.

Examples of Expenses: Depreciation, Marketing expenses, Interest expenses, Transportation costs, Repairs and maintenance, Utilities expenses, etc.

Conclusion

Financial Statements are integral to any organization and it is pertinent that they are prepared and maintained in an efficient manner by complying with all the applicable laws. Any misrepresentation or deliberate vital omission is considered to be a crime under the laws of India. Hence, it is necessary that the correct financial statements are presented to the interested parties. Activities such as tax evasion on the basis of misrepresentation of accounts should be completely refrained from.

For any further assistance on preparation of financial statement, accounting principles or recording of financial elements, contact us at www.enterslice.com.

Also Read:
Financial Reporting Services in India
Why Accurate Financial Statements Are Critical for Businesses?