Question

“Financial statements are a structured representation of the financial position and financial
performance of an entity. The objective of financial statements is to provide information
about the financial position, financial performance and cash flows of an entity that is useful
to a wide range of users in making economic decisions.”
AASB 101 Presentation of Financial Statements

Question:
In your own words, define the various elements of financial statements and discuss how they
contribute to the objective of providing information for users to making decisions.

Answer 1

AASB 101 Presentation of Financial Statements

"The objective of this standard is to prescribe the basis for the presentation of general purpose financial statements to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities."

Financial statements include-

1. Statement of financial position - Statement of financial position or balance sheet shows the company's capital, assets, liabilities, and owners equity at a given point of time.

2. Statement of comprehensive income - Statement of income or profit and loss statement shows the revenue and expenses of a company for the period.

3. Statement of cash flows - Statement of cash flows indicates the inflow and outflow of cash during the period that is it shows the receipts and payments of cash from operating, financing and investing activities of the company.

Financial statements show the assets, liabilities, equity, income and expenses including gains and losses, cash flows and other changes in equity.

Financial statement includes a set of statement of financial position as at the end of the period, statement of comprehensive income for the period and statement of cash flows for the period.

Elements of financial statements-

1. Assets- Assets are financially owned phenomena which drives the storage value in terms of money. They are accounting records at the asset side of the balance sheet. It is an item of economic value which is expected to give benefit in future. Assets can be classified into-

A. Tangible Assets- Tangible asset means physical asset. Tangible assets can be seen, touched, felt, etc. Example- physical asset like machinery, plant, furniture, etc.

B. Intangible asset- Intangible assets are assets which do not have a physical existence. Intangible assets cannot be seen, touched, felt, etc. Example- Goodwill, Patent, etc.

C. Fixed Assets- Fixed assets are those assets which are purchased for long term use and which provides benefit for a longer period. Example- Machinery, Furniture, Building, etc.

D. Current Assets- Current assets are those assets which can be easily converted into cash and generally absorbed in one accounting period.

2. Liabilities- Liabilities is what a company owes to the owners and outsiders. Liabilities can be classified into-

A. Current liabilities- Current liabilities are the liabilities which has to be paid during the current financial year. Example creditors, bills payable, etc.

B. Non-current liabilities- Non-current liabilities are the company's long term liability that is not due within a year. Example debentures, bonds, long term loans etc.

3. Equity- Equity is simply the amount of capital contributed by the owners. It is the value attributable to the owners of the business. It is the difference between assets and liabilities.

4. Revenue- Revenue is the income which the business our company generates from its normal business activities or operations usually from the sale of goods and services to customers. Increase in revenue increases the owner's equity.

5. Gains- Gains is an increase in owner's equity from transactions not related to normal business operations. Example- A chocolate company may make a gain by selling machinery at a price higher than the book value.

6. Expenses- Expenses is outflow of cash done with the purpose to generate revenue. For example, the company incurs expenses on selling and distribution activities.

7. Losses- Losses is decrease in owner's equity from transactions not related to normal business operations. Example chocolate company suffers a loss by selling a machinery at a price lower than the book value.

Benefits of elements of financial statements

1. Statement of financial position - Statement of financial position is an essential element of financial statement as it indicates the financial position of a company at a particular point of time. It reveals a true and fair financial status of a company. It also provides information like owners equity, liabilities of a company, Investments made by the company etc.

2. Statement of comprehensive income- Statement of comprehensive income is another essentials statement of financial statement which indicates the income and expense of a company during a given period of time. It shows whether the company is having a profit or loss at the end of the period.

3. Statement of cash flows- Statement of cash flows shows the inflow and outflow of cash during a given period of time. It shows the total cash receipts and payments from operating, investing, and financing activities of a company. It shows whether the company is having adequate cash balance or not. Statement of cash flow help in knowing the liquidity / actual cash position of the company.

Benefits of financial statements

It provides a clear insight into the financial position of a company.

Financial statements prevents irrelevant expenditures and thus increases savings and help the company to deploy funds into valuable and profitable Investments.

The elements of financial statements like loss, gain, liabilities etc help the company in making prudent decisions. Thus the elements of financial statement act as a decision-making tool.

The elements of financial statement reveals the profits, liabilities, losses, etc and thus help in proper strategic decision making.

The elements of financial statements are expressed in ratios in ratio analysis. Ratio analysis is a very important tool for the companies to evaluate its financial position and performance and also investors can use the ratio analysis to make decisions whether to invest or not.