1 Objectives 2 Qualities 3 Three components of financial statements
3.1 Statement of cash flows 3.2 Statement of profit or loss (income statement or statement of operations) 3.3 Statement of financial position (balance sheet)
3.3.1 Statement of retained earnings (statement of changes in equity)
4 Basic concepts 5 Graphic definition 6 Versus cost accounting 7 Related qualification 8 See also 9 References 10 Further reading
To provide financial information about the reporting entity that is useful to existing and potential investors, lenders and other creditors in making decisions about providing resources to the entity.
2. According to the European
Capital maintenance is a competing objective of financial reporting.
Three components of financial statements
Statement of cash flows
The statement of cash flows considers the inputs and outputs in
concrete cash within a stated period. The general template of a cash
flow statement is as follows:
Example 2: in the beginning of June, WikiTables, a company that buys and resells tables, sold 2 tables. They'd originally bought the tables for $25 each, and sold them at a price of $50 per table. The first table was paid out in cash however the second one was bought in credit terms. WikiTables' cash flow statement for the month of June looks like this:
Important: the cash flow statement only considers the exchange of
actual cash, and ignores what the person in question owes or is owed.
Statement of profit or loss (income statement or statement of
The statement of profit or income statement reports the changes in
value of a company's accounts over a set period (most commonly one
fiscal year), and may compare the changes to changes in the same
accounts over the previous period. All changes are summarized on the
"bottom line" as net income, often reported as "net loss" when income
is less than zero.
The net profit or loss is determined by:
– cost of goods sold
– selling, general, administrative expenses (SGA)
– depreciation/ amortization
= earnings before interest and taxes (EBIT)
– interest and tax expenses
Statement of financial position (balance sheet)
The balance sheet is the financial statement showing a firm's assets,
liabilities and equity (capital) at a set point in time, usually the
end of the fiscal year reported on the accompanying income statement.
The total assets always equal the total combined liabilities and
equity in dollar amount. This statement best demonstrates the basic
accounting equation - Assets = Liabilities + Equity. The statement can
be used to help show the status of a company.
cash - physical money accounts receivable - revenues earned but not yet collected Merchandise inventory - consists of goods and services a firm currently owns until it ends up getting sold marketable securities - Stocks and bonds a firm has invested in other firms prepaid expenses - expenses paid for in advance for use during that year
Non-current assets include fixed or long-term assets and intangible assets:
fixed (long term) assets
property building equipment (such as factory machinery)
copyrights trademarks patents goodwill
trade accounts payable dividends payable employee salaries payable interest (e.g. on debt) payable
long term liabilities
mortgage notes payable bonds payable
Owner's equity, sometimes referred to as net assets, is represented differently depending on the type of business ownership. Business ownership can be in the form of a sole proprietorship, partnership, or a corporation. For a corporation, the owner's equity portion usually shows common stock, and retained earnings (earnings kept in the company). Retained earnings come from the retained earnings statement, prepared prior to the balance sheet. Statement of retained earnings (statement of changes in equity) This statement is additional to the three main statements described above. It shows how the distribution of income and transfer of dividends affects the wealth of shareholders in the company. The concept of retained earnings means profits of previous years that are accumulated till current period. Basic proforma for this statement is as follows: Retained earnings at the beginning of period + Net Income for the period - Dividends = Retained earnings at the end of period.  Basic concepts THE STABLE MEASURING ASSUMPTION One of the basic principles in accounting is “The Measuring Unit principle:
The unit of measure in accounting shall be the base money unit of the most relevant currency. This principle also assumes the unit of measure is stable; that is, changes in its general purchasing power are not considered sufficiently important to require adjustments to the basic financial statements.”
Historical Cost Accounting, i.e., financial capital maintenance in
nominal monetary units, is based on the stable measuring unit
assumption under which accountants simply assume that money, the
monetary unit of measure, is perfectly stable in real value for the
purpose of measuring (1) monetary items not inflation-indexed daily in
terms of the Daily CPI and (2) constant real value non-monetary items
not updated daily in terms of the Daily CPI during low and high
inflation and deflation.
UNITS OF CONSTANT PURCHASING POWER The stable monetary unit assumption
is not applied during hyperinflation.
producing general purpose financial statements producing information used by the management of a business entity for decision making, planning and performance evaluation producing financial statements for meeting regulatory requirements.
Objectives of Financial Accounting
Systematic recording of transactions: basic objective of accounting is
to systematically record the financial aspects of business
transactions (i.e. book-keeping). These recorded transactions are
later on classified and summarized logically for the preparation of
financial statements and for their analysis and interpretation.
Ascertainment of result of above recorded transactions: accountant
prepares profit and loss account to know the result of business
operations for a particular period of time. If expenses exceed revenue
then it is said that the business is running under loss. The profit
and loss account helps the management and different stakeholders in
taking rational decisions. For example, if business is not proved to
be remunerative or profitable, the cause of such a state of affairs
can be investigated by the management for taking remedial steps.
Ascertainment of the financial position of business: businessman is
not only interested in knowing the result of the business in terms of
profits or loss for a particular period but is also anxious to know
that what he owes (liability) to the outsiders and what he owns
(assets) on a certain date. To know this, accountant prepares a
financial position statement of assets and liabilities of the business
at a particular point of time and helps in ascertaining the financial
health of the business.
Providing information to the users for rational decision-making:
accounting as a ‘language of business’ communicates the financial
result of an enterprise to various stakeholders by means of financial
The accounting equation (Assets = Liabilities + Owners' Equity) and
financial statements are the main topics of financial accounting.
The trial balance, which is usually prepared using the double-entry
accounting system, forms the basis for preparing the financial
statements. All the figures in the trial balance are rearranged to
prepare a profit & loss statement and balance sheet. Accounting
standards determine the format for these accounts (SSAP, FRS, IFRS).
0 = Dr Assets Cr Owners' Equity
. / Cr Retained Earnings (profit) Cr Common
Crediting a credit Thus -------------------------> account increases its absolute value (balance) Debiting a debit
Debiting a credit Thus -------------------------> account decreases its absolute value (balance) Crediting a debit
When the same thing is done to an account as its normal balance it increases; when the opposite is done, it will decrease. Much like signs in math: two positive numbers are added and two negative numbers are also added. It is only when there is one positive and one negative (opposites) that you will subtract. Versus cost accounting See also: Cost accounting
Many professional accountancy qualifications cover the field of
financial accountancy, including Certified Public
Constant item purchasing power accounting
David Annand, Introduction to Financial Accounting, Athabasca
University, ISBN 978-0-9953266-4-4
v t e
Financial accounting Cost accounting
Revenue Cost of goods sold Operating expenses Capital expenditure Depreciation Gross profit Net profit