Principal Financial Statements • The end product of the financial accounting process is a set of reports that are called financial statements. Principal financial statements are 1. Profit and Loss Account 2. Balance Sheet 3. Statement of Changes in Financial Position
Profit and Loss Account • Also known as Income Statement • Shows net profit or net income of an entity for a period of time. • Net profit or income is the difference between revenues and expenses. • It indicates how successful a business enterprise has been in achieving its profit goal for a given span of time.
It also gives the sources and amount of revenues earned and the different types and amount of expenses. • Net profit indicates an enterprise’s accomplishments (revenues) in relation to the efforts required (expenses) in pursuing its operation activities. • When expenses exceed revenues for a period, a business enterprise incurs loss.
Balance Sheet • Shows financial position of business on a certain date. • It indicates the investing and financing activities of a business enterprise at a point of time and shows firms assets, liabilities and equity capital usually at the close of the last day of the month or a year.
Assets are economic resources and provide future benefits to a firm such as cash, inventories, building, plant, goodwill, patent etc. • Liabilities are outsiders claims on the assets of a business enterprise such as creditors, accounts payable, salaries payable, income tax payable, debentures. • Liabilities include shareholders equity as well which is in terms of ordinary shares, preference shares, retained earnings.
Shareholders equity is the shareholders or owners claim on the assets of the firm. • The shareholders claims are only residual, i.e. they have claim on the assets of the company only after all creditors claims have been met.
Statement of Changes in Financial Position (SCFP) • It shows where the financial resources (funds) have come from (sources) and where they have gone (users). • It is generally prepared on working capital basis and cash basis. • Working capital based SCFP explains increase or decrease in working capital for a specified period of time. It reports
Amount of changes in working capital associated with the operation activities of a firm. • Long term financing or other sources that cause an increase in the working capital. • Long term investment activities or other uses that cause a reduction in the working capital.
Cash basis SCFP, commonly known as CASH FLOW STATEMENT, summarize the flow of cash in and out of the firm over a period of time. • It focuses on various items which bring out changes in sources of an organization at a specified moment of time.
Basic Accounting Equation or Model • Frame work of financial statements rests on important and basic relationship, referred to as basic or fundamental accounting equation or basic accounting model. • This basic equation is expressed by the balance sheet equation and therefore is known as the Balance Sheet Equation also.
The Balance sheet equation indicates that Sources of Funds = Uses of Funds Or Equities = Assets Or Proprietor’s Equity (Capital)+ Outside Liability= Assets
Effects of Financial Transaction On Accounting Equation • Every business transaction can be analyzed by its effect on the balance sheet. • A business transaction results into a change in all or any of the components of the equation. Whatever may be the change, the Accounting Equation remains in balance.
Different types of business transactions may result into a maximum of nine possible effect combinations on the components of Accounting equation. They are • Increase in one asset; decrease in another asset. • Increase in one liability; decrease in another liability. • Increase in one item of proprietor’s equity; decrease in another item of proprietor’s equity.
Increase in one item of proprietor’s equity; decrease in liability. • Increase in liability; decrease in proprietor’s equity. • Increase in asset; increase in proprietor’s equity. • Increase in asset; increase in liability. • Decrease in asset; decrease in liability. • Decrease in asset; decrease in proprietor’s equity.
Transaction Analysis • Determining the effect of a business transaction on assets, liabilities and equities of the accounting equation is called transaction analysis. • It shows increases and decreases in assets, liabilities or proprietor’s equity of a business entity. • Where the effects are presented in an account form, they are shown by a simultaneous debit or credit in the relevant accounts of assets, liabilities and/or equities.