Transactions could arise out of business activities that can either be classified as operating activities, investing activities or financing activities. As we have already learnt in the last post on financial statement analysis, operating activities are the core activities of a company, investing activities pertain to buying and selling of assets and financing activities could be either raising fresh debt or equity or paring existing debt. How a transaction is classified depends upon the nature of the business. For example selling machinery could be an investing activity for a manufacturer of cricket bats, but it would be an operating activity for the manufacturer of the machinery.
Financial statement elements and accounts
Transactions are broadly grouped into financial statement elements, viz, assets, liabilities, owner’s equity, revenue and expenses. (You can read about the financial statement elements in the previous post on financial statement analysis.) Within the financial statement elements, accounts are individual records of each asset, liability, each component of owner’s equity, each revenue source and each type of expense. Accounts record the increase and decrease in each of the individual elements during the accounting period.
Contra accounts are accounts that offset or deduct the value of other accounts. For example, Depreciation account records the value reduced from Plant and Machinery account.
Types of accounts for classifying financial statement elements
The following are the different types of asset accounts;
Cash and cash equivalents
We all understand what cash is and that cash is always an asset. Cash equivalents are liquid securities with maturities of 90 days or less that can easily be converted into cash. Since they are easily convertible into cash they are called cash equivalents.
Account receivables are amounts due to us or receivable by us for services already rendered. For example, sales made on credit. Account receivables are often accompanied by contra account for bad debt expense.
Plant and machinery
Plant and machinery account is accompanied by a contract account for depreciation
Prepaid expenses are expenses for future periods that have been paid in advance and will be items on future income statements. They are classified as assets.
Assets like patents, copyrights, trademarks are intangible assets. It is obvious that they are called intangible assets as they are not tangible.
Deferred tax assets
When a company has overpaid taxes or paid taxes in advance in previous accounting period/s, it becomes an asset in the current accounting period as it reduces the current period’s tax bill.
Trading and investment securities are financial assets for a company
Assets can further be classified into current and non-current assets. Current assets are those which expected to be converted into cash within a year. For example, inventory, accounts receivables, cash and cash equivalents. Non- current assets are those that are expected to benefit the company over a long period of times. For example, plant and machinery and intangible assets.
The following are the different types of liabilities;
Accounts payable are amounts that are due by us for services already received.
Unearned revenue is the revenue earned for services yet to be delivered. It is classified as liability as services yet to be delivered are a liability to the company until they are delivered. Unearned revenue appears as revenue over future accounting periods as services are rendered.
Long term debt
Deferred tax liabilities
Deferred tax liabilities arise due to temporary differences between a company’s estimated tax payable and actual tax payable in the current year. Since the tax will be payable in future accounting periods and add to the future tax bill it is a liability to the company.
Reserves are amounts that are to be set aside and held as buffer to meet unexpected future liabilities. Reserves are to be maintained in the form of liquid assets. Since these assets are resources not available to the company they are classified as liabilities.
The following are the various accounts that make up owner’s equity;
Par value of common stock
Additional paid in capital
Proceeds from sale of common stock over and above the par value
Retained earnings are net earnings that have not been distributed as dividends and have been ploughed back into the company.
Other comprehensive income
Other comprehensive income is revenues, expenses, gains and losses that have been excluded from the income statement. They include unrealized gains and losses on investments and gains and losses from foreign currency translation. These items are listed on the income statement after net income.Read more about owner’s equity here.
Following are some of the revenue accounts;
Increases in asset values
Following are some of the expense accounts;
Cost of the goods sold
Is the cost of producing the goods
Selling, general and administrative expenses
Depreciation and amortization
These are classified as expenses as they signify using up of the assets.
Losses are reduction in the value of assets
Read the following posts for better understanding of revenue and expense recognition.
Thus listed above are some of the major accounts into which financial statement elements are sub classified. That brings us to the end of this post. I would love to hear your reactions to the post. Please feel free to contribute if anything more needs to be added.
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