The framework

The elements of financial statements

Everything in the statements is one of five elements.

Draft: not yet reviewed by a teacher

Why it exists

For different companies to show the same thing the same way, they need shared definitions. These decide whether an item is recognised at all and where it goes: the statement of financial position or the statement of profit or loss.

Key rules

An asset is an economic resource controlled by the entity as a result of past events. A resource is a right that can produce economic benefits.
A liability is a "present obligation" of the entity to transfer an economic resource as a result of past events.
Equity is the residual interest in the assets after deducting all liabilities.
Income is an increase in assets or decrease in liabilities that increases equity, other than contributions from owners.
Expenses are decreases in assets or increases in liabilities that reduce equity, other than distributions to owners.
Assets, liabilities and equity appear in the statement of financial position; income and expenses in the statement of profit or loss.

Examples

A café on Fountain Square, 31 December:

Assets: coffee machine 8,000, cash 2,500, owed by a catering client 700 = 11,200
Liabilities: coffee supplier 1,900, bank loan 4,000 = 5,900
Equity: 11,200 − 5,900 = 5,300
Income 30,000, expenses 24,600: profit 5,400

The five elements in one example

How it works

The key words are "control" (not ownership), "past event" and "obligation". A company controls a van it leases under a contract, even though it does not own it. A purchase it has only decided on is not yet a liability: there is no past event.

Income and expenses are defined through changes in assets and liabilities, which ties them to the statement of financial position.

Traps

Taught in the course

Key rules

An asset is an economic resource controlled by the entity as a result of past events. A resource is a right that can produce economic benefits.

A liability is a "present obligation" of the entity to transfer an economic resource as a result of past events.

Equity is the residual interest in the assets after deducting all liabilities.

Income is an increase in assets or decrease in liabilities that increases equity, other than contributions from owners.

Expenses are decreases in assets or increases in liabilities that reduce equity, other than distributions to owners.

Assets, liabilities and equity appear in the statement of financial position; income and expenses in the statement of profit or loss.

How it works

Income and expenses are defined through changes in assets and liabilities, which ties them to the statement of financial position.

Traps