ELEMENTS OF FINANCIAL STATEMENTS

FINANCIAL POSITION – BALANCE SHEET

In simple terms, assets are valuable resources owned by the entity.
Per Framework:
ASSET is a resource controlled by the enterprise as a result of past events and from which future
economic benefits are expected to flow to the enterprise.
The future economic benefits embodied in an asset may flow to the enterprise in a number of
ways. The parts of the definition of an asset can be explained further.
 CONTROLLED BY THE ENTERPRISE – control is the ability to obtain the economic
benefits and to restrict the access of others (e.g. an entity being the sole user of its plant
and equipment, or by selling idle assets)
 PAST EVENTS – The event must be past before an asset can arise. For example,
equipment will only become an asset when there is the right to demand delivery or
access to the asset’s potential. Dependent on the terms of the contract, this may be on
acceptance of the order or on delivery.
 FUTURE ECONOMIC BENEFITS – These are evidenced by the prospective receipt of cash.
This could be cash itself, an account receivable or any item which may be sold.
Although, for example, a factory may not be sold (on a going concern basis) for it houses
the manufacturing facility for the goods. When these goods are sold, the economic
benefit resulting from the use of the factory is realized as cash.
For example, an asset may be:
 Used singly or in combination with other assets in the production of goods or
services to be sold by the enterprise.
 Exchanged for other assets
 Used to settle a liability; or
 Distributed to the owners of the enterprise

ASSET include cash, cash equivalents, notes receivable, accounts receivable, inventories,
prepaid expenses, property, plant and equipment, investments, intangible assets and other
assets.

LIABILITIES are obligations of the entity to outside parties who have furnished resources.
Per Framework, LIABILITY is a present obligation of the enterprise arising from past events, the
settlement of which is expected to result in an outflow from the enterprise of resources embodying
economic benefits. The parts of the definition of a liability can be explained further.
 OBLIGATIONS – These may be legal or not. For example, the year-end tax liability
relates to the year’s (i.e. past) events but in law this liability does not arise until it is
assessed some time later.
 TRANSFER ECONOMIC BENEFITS – This could be a transfer of cash, or other property,
the provision of a service or the refraining from activities which would otherwise be
profitable.
  PAST TRANSACTIONS OR EVENTS – refer to discussion in assets.
 COMPLEMENTARY NATURE OF ASSETS AND LIABILITIES – As should be evident from
the above, assets and liabilities are seen as mirror images of each other.

Settlement of a present obligation may occur in a number of ways, for example, by:
 Payment of cash
 Transfer of other assets
 Provision of services
 Replacement of that obligation with another obligation
 Conversion of the obligation to equity
LIABILITIES include notes payable, accounts payable, accrued/expenses liabilities, unearned
revenues, mortgage payable, bonds payable and other debts of the enterprise.

EQUITY – is the residual interest in the assets of the enterprise after deducting all its liabilities.
Equity may pertain to any of the following depending on the form of business organization.
 In a sole proprietorship, there is only one owner’s equity account because there is only
one owner.
 In a partnership, an owner’s equity account exists for each partner.
 In a corporation, owner’s equity or stockholders’ equity consists of share capital,
retained earnings and reserves representing appropriations of retained earnings among
others.

PERFORMANCE
 Income is increases 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.
The definition of income encompasses both revenue and gains.
Revenue arises in the course of the ordinary activities of an enterprise and is referred t
by a variety of different names including sales, fees, interest, dividends, royalties, and
rent.
Gains represent other items that meet the definition of income and may, or may not,
arise in the course of the ordinary activities of an enterprise. Gains represent increases
in economic benefits and as such are no different in nature from revenue. Hence, they
are not regarded as constituting a separate element.
Expenses are decreases in economic benefits during the accounting period in the form
of outflows or depletions of assets or incurrence of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants.
The definition of expenses encompasses losses as well as those expenses that arise in
the course of the ordinary activities of the enterprise. There are various classes of
expenses but they are generally classified as cost of services rendered or goods sold,
distribution or selling expenses, administrative expenses or other operating expenses.
 Losses represent other items that meet the definition of expenses and may or may not,
arise in the course of the ordinary activities of an enterprise. Losses represent
decreases in economic benefits and as such are no different in nature from other
expenses. Hence, they are not regarded as a separate element in this framework.

STATEMENT OF FINANCIAL POSITION

ASSETS classified in to two:
1. CURRENT ASSET
A. It expects to realize the assets, or intends to sell or consume it, in its normal
operating cycle
B. It holds asset primarily for the purpose of trading
C. It expects to realize the asset within twelve months after the reporting period
D. The asset is cash or a cash equivalents (as defined in PAS No. 7) unless the asset
is restricted from being exchanged or used to settle a liability for at least twelve
months after the reporting period.
All other assets should be classified as non-current 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 identified,
it is assumed to be twelve months.

CURRENT ASSETS
 CASH – cash is any medium of exchange that a bank will accept for deposit
at face value. It includes coins, currency, checks, money orders, bank
deposits and drafts.
 CASH AND CASH EQUIVALENTS – these are short –term, highly liquid
investments that are readily convertible to known amounts of cash and
which are subject to an insignificant risk of changes in value.
 NOTES RECEIVABLE – a note receivable is a written pledge that the
customer will pay the business a fixed amount of money on a certain date.
 ACCOUNTS RECEIVABLE – these are claims against customers arising from
sale of services or goods on credit. This type of receivable offers less
security that a promissory note.
 INVENTORIES – these are assets which are (a) held for sale in ordinary
course of business; (b) in the process of production for such sale; (c) in the
form of materials or supplies to be consumed in the production process or
in the rendering of services.
 PREPAID EXPENSES – these are expenses paid for by the business in
advance. It is an asset because the business avoids having to pay cash in the
future for a specific expense. These include insurance and rent. These
prepaid items represent future economic benefits – assets – until the time
 these start to contribute to the earning process, these, then, become
expenses.
NON-CURRENT ASSETS
 PROPERTY, PLAN AND EQUIPMENT – these are tangible assets that are
held by an enterprise for use in the production or supply of goods or
services, or for rental to others, or for administrative purposes and
which are expected to be used during more than one period. Included
are such items as land, building, machinery and equipment, furniture
and fixtures, motor vehicles and equipment.
 ACCUMULATED DEPRECIATION – It is a contra account that contains
the sum of the periodic depreciation charges. The balance in this
account is deducted from the cost of the related asset – equipment or
buildings – to obtain book value.
 INTANGIBLE ASSETS – these are identifiable, nonmonetary assets
without physical substance held for use in the production or supply of
goods or services, for rental to others, or for administrative purposes.
These include goodwill, patents, copyrights, licenses, franchises,
trademarks, brand names, secret processes, subscription lists and non-
competition agreements.

LIABILITIES
Per PAS 1 (PHILIPPINE ACCOUNTING STANDARDS 1) an entity shall classify a liability as current
when:
A. It expects to settle the liability in its normal operating cycle;
B. It holds the liability primarily for the purpose of trading
C. The liability is due to be settled within twelve months after the reporting period
D. The entity does not have an unconditional right to defer settlement of the liability
for at least twelve months after the reporting period
All other liabilities should be classified as non-current liabilities:

CURRENT LIABILITIES
 ACCOUNTS PAYABLE – This account represents the reverse relationship of the
accounts receivable. By accepting the goods or services, the buyer agrees to
pay for them in the near future.
 NOTES PAYABLE – A note payable is like a note receivable but in a reverse
sense. In the case of a 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 money on a specified future date.
 ACCRUED LIABILITIES – Amounts owed to others for unpaid expenses. This
account includes salaries payable, utilities payable, interest payable and taxes
payable.
  UNEARNED REVENUES – When the business entity receives payment before
providing its customers with goods or services, the amounts received are
recorded in the unearned revenue account (liability method). When the goods
or services are provided to the customer, the unearned revenue is reduced and
income is recognized.
 CURRENT PORTION OF LONG-TERM DEBT – These are portions of mortgage
notes, bonds and long-term indebtedness which are to be paid within one year
from the balance sheet.

NON-CURRENT LIABILITIES
 MORTGAGE PAYABLE – this account records long-term debt of the business
entity for which the business entity has pledged certain assets as security to
the creditor. In the event that the debt payments are not made, the
creditor can foreclosed or cause the mortgaged asset to be sold to enable
the entity to settle the claim.
 BONDS PAYABLE – business organizations often obtain substantial sums of
money from lenders to finance the 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 specifying the terms of
repayment and the interest to be charged.

OWNER’S EQUITY
 CAPITAL (from latin capitalis, meaning “property”). This account is used to
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
decreased by a loss. Cash or other assets that the owner may withdraw from the
business ultimately reduce it.
This account title bears the name of the owner.
 WITHDRAWALS – When the owner of a business entity withdraws cash or other
assets, such are recorded in the drawing or withdrawal account rather than
directly reducing the owner’s equity account.
 INCOME SUMMARY – It is a temporary account used at the end of the
accounting period to close income and expenses. This account shows the profit
or loss for the period before closing to the capital account.

INCOME STATEMENT
INCOME
 SERVICE INCOME – Revenues earned by performing services for a customer or clients
for example accounting services by a CPA firm, laundry services by a laundry shop.
 SALES – Revenues earned as a result of sale of merchandise; for example, sale of
building materials by a construction supplies firm.
EXPENSES
 COST OF SALES – The cost incurred to purchase or to produce the products sold to
customers during the period; also called cost of goods sold.
 SALARIES OR WAGES EXPENSE – Includes all payments as a result of an employer-
employee relationship such as salaries or wages, 13 th month pay, cost of living
allowances and other related benefits.
 TELECOMMUNICATIONS, ELECTRICITY, FUEL AND WATER EXPENSES – Expenses related
to use of telecommunications facilities, consumption of electricity, fuel and water.
 RENT EXPENSE – expense for space, equipment or other asset rentals.
 SUPPLIES EXPENSE – expense using supplies (e.g. office supplies) in the conduct of daily
business.
 INSURANCE EXPENSE – portion of premiums paid on insurance coverage (e.g. on motor
vehicle, health, life, fire, typhoon or flood) which has expired.
 DEPRECIATION EXPENSE – The portion of the cost of a tangible asset (e.g. buildings and
equipment) allocated or charged as expense during an accounting period.
 UNCOLLECTIBLE ACCOUNTS EXPENSE – the amount of receivables estimated to be
doubtful of collection and charged as expense during an accounting period.
 INTEREST EXPENSE – an expense related to use of borrowed funds.