THE ELEMENTS OF FINANCIAL STATEMENTS

• Introduction
  The objective of financial reporting is to provide useful information. In order to be useful information must be understandable. A large company enters into thousands of transactions so in order for users to be able to understand the impact of these they must be summarised in some way.
  Financial statements group transactions into broad classes according to their economic characteristics. These broad classes are called the elements of financial statements.
  ·          The elements directly related to the measurement of financial position in the statement of financial position are assets, liabilities and equity.
  ·          The elements directly related to the measurement of performance in the statement of comprehensive income are income and expenses.
  
  
  1.      Assets
  
  
  An asset is defined as:
  ·          a resource controlled by the entity;
  ·          as a result of past events; and
  ·          from which future economic benefits are expected to flow to the entity.
  
  
  Resource controlled by the entity
  Control is the ability to obtain economic benefits from the asset, and to restrict the ability of others to obtain the same benefits from the same item.
  An entity usually uses assets to produce goods or services to meet the needs of its customers, and because customers are willing to pay for the goods and services, this contributes to the cash flow of the entity. Cash itself is an asset because of its command over other resources.
  Many assets have a physical form, but this is not an essential requirement for the existence of an asset.
  The result of past events
  Assets result from past transactions or other past events. An asset is not created by any transaction that is expected to occur in the future but has not yet happened. For example, an intention to buy inventory does not create an asset.
  
  
  Expected future economic benefits
  An asset should be expected to provide future economic benefits to the entity.
  Providing future economic benefits can be defined as contributing, directly or indirectly, to the flow of cash (and cash equivalents) into the entity.
  
  
  2.      Liabilities
  A liability is defined as:
  ·          a present obligation of an entity
  ·          arising from past events
  ·          the settlement of which is expected to result in an outflow of resources that embody economic benefits.
  
  
  Present obligation
  A liability is an obligation that already exists. An obligation may be legally enforceable as a result of a binding contract or a statutory requirement, such as a legal obligation to pay a supplier for goods purchased.
  Obligations may also arise from normal business practise, or a desire to maintain good customer relations or the desire to act in a fair way. For example, an entity might undertake to rectify faulty goods for customers, even if these are now outside their warranty period. This undertaking creates an obligation, even though it is not legally enforceable by the customers of the entity.
  
  
  Past transactions or events
  A liability arises out of a past transaction or event. For example, a trade payable arises out of the past purchase of goods or services, and an obligation to repay a bank loan arises out of past borrowing.
  
  
  Future outflow of economic resources
  The settlement of a liability should result in an outflow of resources that embody economic benefits. This usually involves the payment of cash or transfer of other assets. A liability is measured by the value of these resources that will be paid or transferred.
  Some liabilities can be measured only with a substantial amount of estimation.
  These may be called provisions.
  
  
  
  
  3.      Equity
  Equity is the residual interest in an entity after the value of all its liabilities has been deducted from the value of all its assets. It is a ‘balance sheet value’ of the entity’s net assets. It does not represent in any way the market value of the equity.
  Equity of companies may be sub-classified into share capital, retained profits and other reserves.
  
  
  4.      Income
  Financial performance is measured by profit or loss. Profit is measured as income less expenses. Income includes both revenue and gains.
  ·         Revenue is income arising in the course of the ordinary activities of the entity. It includes sales revenue, fee income, royalties’ income, rental income and income from investments (interest and dividends).
  ·         Gains include gains on the disposal of non-current assets. Realised gains are often reported in the financial statements net of related expenses. They might arise in the normal course of business activities. Gains might also be unrealised. Unrealised gains occur whenever an asset is revalued upwards, but is not disposed of. For example, an unrealised gain occurs when marketable securities owned by the entity are revalued upwards.
  
  
  
  
  5.      Expenses
  Expenses include:
  ·         Expenses arising in the normal course of activities, such as the cost of sales and other operating costs, including depreciation of non-current assets. Expenses result in the outflow of assets (such as cash or finished goods inventory) or the depletion of assets (for example, the depreciation of non-current assets).
  ·         Losses include for example, the loss on disposal of a non-current asset, and losses arising from damage due to fire or flooding. Losses are usually reported as net of related income. Losses might also be unrealised.
  Unrealised losses occur when an asset is revalued downwards, but is not disposed of. For example, and unrealised loss occurs when marketable securities owned by the entity are revalued downwards.
  
  
  
  
  6.      Measurement of assets and other elements
  Assets, liabilities, income and expenses can be measured in the following ways according to circumstances:
  ·         Historical cost. This is the actual amount of cash paid or received. For example, the historical cost of an item of equipment is the amount that it cost to buy (at some time in the past).
  ·         Current cost. Assets might be valued at the amount that would have to be paid to obtain an equivalent current asset ‘now’. For example, if a company owns shares in another company, these assets might be valued at their current market value. Similarly, a company that owns a building might choose to value the building at its current market value, not the amount that it originally cost.
  ·         q Realisable value or settlement value. Assets might be valued at the amount that would be obtained if they were disposed of now (in an orderly disposal).
  ·         Present value. This is a current value equivalent of an amount that will be receivable or payable at a future time.
  The most common method of measurement is historical cost, but the other methods of measurement are also used in certain cases.