What Are Basic Accounting Statements

Financial accounting is categorized into four basic elements: assets, liabilities and owners’ equity, revenues, and expenses (each of which is explained below). Assets and expenses are represented by net debits, whereas liabilities, equity, and revenues are represented by net credits. The total amount of these debits and credits are commensurate at all times.

Balance Sheet

The balance sheet shows a company’s balances at a specific point in time, specifically including the company’s assets, liabilities, and owners’ equity.

• Assets: An asset represents a measurable amount for which the company expects to obtain a benefit or use in the future. Examples include equipment, inventory, prepaid expenses, and other amounts used to increase future revenues or reduce future expenditures. (For more information, see Assets.)
• Liabilities: A liability is an amount for which the company expects to have to satisfy a future obligation. Examples include accounts payable, long-term debt, accrued pension benefit obligations, and other amounts owed to external parties. (For more information, see Liabilities.)
• Owners’ equity: Owners’ equity represents the accumulated earnings of the com­pany plus capital contributions from owners, less dividends and any other payouts to owners. Owners’ equity is a residual amount, represented by the excess of total assets less liabilities. (For more information, see Owners’ equity.)

Income Statement

Whereas the balance statement is static (it measures certain balances at a specific point in time), the income statement is transitory: it shows the company’s operating performance for a specific year in terms of its net income or loss, as broken down by its revenues and expenses. (For more information, see Income and Expenses.)

• Revenues: Revenues represent income amounts, such as sales, commission income, service income, and other income amounts that relate to the company’s primary line of business.
• Cost of sales: Cost of sales decreases net income and represents the direct expendi­tures and allocated overhead costs incurred in preparing for sale the company’s primary product (the same product that comprises the company’s revenues).
• Expenses: Expenses decrease income and represent expenditures and allocated period costs of capital items, other than expenses already included in cost of sales. Examples of expense items include rent expense, depreciation, interest expense, and salary expense.
• Other income and expense items: These items represent amounts that increase or decrease the company’s net income but that are not directly related to the company’s primary line of business. Examples include interest income on excess cash, losses on asset sales, and other nonrecurring or unusual items.

Cash Flow Statement

The cash flow statement shows a detailed breakdown of the sources and uses of a company’s cash and cash equivalents over the accounting period. The cash flow statement reconciles to the company’s beginning and ending cash balances, as shown on the balance sheet.

Sections

The cash flow statement is separated into three sections, detailing net cash provided by (used by) operating activities, investing activities, and financing activities.

• Operating activities: Operating activities include all activities that go into the preparation of the company’s goods for sale (or, if a service business, into the preparation and support of its primary services). All activities not includable as investing or financing activities are included as operating activities.
• Investing activities: Investing activities include cash transactions related to ownership or lending of securities as well as handling the acquisition and disposal of long-term assets. Investing activities include such transactions as buying and selling depreciable assets and proceeds or repaying loans to other entities (if not classified as trading securities).
• Financing activities: Financing activities include repayment of creditors and bor­rowing or issuing of securities. These may include such transactions as buying back and selling company stock, issuing bonds, paying dividends, and borrowing from and repaying lenders.

Methods

There are two methods of presenting the cash flow statement. These methods differ in the way that they present cash flows from operating activities.

• Direct method: The direct method summarizes all cash receipts and disbursements, separated by individual operating category. The cash provided by (used by) each of these activities is presented in its gross amount, and these amounts are then aggregated to arrive at net cash provided by (used by) all operating activities.
• Indirect method: More commonly used, the indirect method adjusts a company’s net income to arrive at cash provided by (used by) operating activities. In making these adjustments, the company backs out (i.e., reverses) the effect of any noncash items that affected net income and adds in any noncash items that were not reflected in net income. Common reconciling items include (gains) losses on the sale of fixed assets, depreciation and amortization, foreign exchange (gains) losses, (increases) decreases in current asset accounts, and increases (decreases) in current liability accounts.

Statement of Changes in Owners’ Equity

A company presents in its financial statements the statement of changes in owners’ equity, which details changes in a company’s four primary equity accounts: capital stock, accumulated paid-in capital (APIC), minority interests, and retained earnings. (For more information, see Owners’ Equity.)