The elements of balance sheet are assets, liabilities and equity. The elements of income statement are revenues and expenses.
Assets
Assets represent the items that have the potential to provide future economic benefits to an entity. Examples of assets include cash, marketable securities, accounts receivable, notes receivable, Inventory, land, buildings, equipment, goodwill and patents
Liabilities
Liabilities are the obligations of an entity to transfer economic resources to other entity in the future. Examples of liabilities include accounts payable, salaries payable, income taxes payable, borrowings and bonds payable.
Equity
Equity represents the residual interests in an entity as calculated by subtracting liabilities from assets. The amount of net assets, which is total assets minus total liabilities, represents the amount of equity that belongs to the owners of an entity. In the case of a corporation, whose owners are stockholders, owners’ equity is called as stockholders’ equity. Stockholders’ equity include the paid-in capital and retained earnings.
Revenues
Revenues represent the items that increase the equity of an entity, but not including the equity investments by stockholders and the items classified as other comprehensive income. Examples of revenues include sales revenue and services revenue.
Expenses
Expenses represent the items that decrease the equity of an entity, but not including the equity distributions to stockholders and the items classified as other comprehensive income. Examples of expenses include cost of goods sold, salaries expense, rent expense, insurance expense, advertising expense, utilities expense, interest expense and income taxes expense.
Review Questions
1. How is financial accounting information communicated to users?
Entities communicate financial accounting information to users in the form of financial statements and the notes to financial statements.
2. What are the financial statements prepared by an entity?
Balance sheet, income statement, statement of cash flows, statement of stockholders’ equity and statement of comprehensive income
3. Which information is provided by balance sheet?
Balance sheet provides the information about the financial position of an entity, by reporting assets, liabilities and equity.
4. What are the components of the balance sheet?
Assets, liabilities and equity
5. Which information is provided by income statement?
Income statement provides the information about revenues, expenses and net income.
6. What are the components of the income statement?
Revenues, expenses and net income
7. Which information is provided by the statement of cash flows?
Statement of cash flows provides the information about cash flows from operating, investing and financing activities
8. What are the components of the statement of cash flows?
Cash flows from operating activities, cash flows from investing activities and cash flows from financing activities
9. Which information is provided by the statement of stockholders’ equity?
Statement of stockholders’ equity provides the information about the components of stockholders’ equity, for beginning balances, increases and decreases during the period, and ending balances.
10. Which information is provided by the statement of comprehensive income?
Statement of comprehensive income presents the net income and the components of other comprehensive income.
11. What is an asset?
An asset represents an item that provides future economic benefits to an entity.
12. What are the examples of assets?
Cash, marketable securities, accounts receivable, notes receivable, Inventory, land, buildings, equipment, goodwill and patents
13. What is a liability?
A liability represents an obligation of an entity to transfer economic resources to other entity in the future.
14. What are the examples of liabilities?
Accounts payable, notes payable, salaries payable, income taxes payable, borrowings and bonds payable
15. What is equity?
Equity represents the residual claims to net assets of an entity. Net assets is the amount of assets remaining after subtracting liabilities. Equity belongs to the investors of an entity, such as stockholders.
16. How are revenues defined?
Revenues represent the increase in equity other than the investments by owners.
17. How are expenses defined?
Expenses represent the decrease in equity other than the distributions to owners.
18. How is Net Income calculated?
Net Income = Revenues – Expenses
19. How is Earnings per Share (EPS) calculated?
Earnings per Share = Net Income for common stockholders / Average number of common shares outstanding
Net income for common stockholders = Net income – Dividends to preferred stockholders
20. In which financial statement is net Income reported?
Net Income is reported in the Income Statement
21. To which account in the balance sheet is net Income added?
Net income is added to the Retained Earnings account
22. Other than net Income, which account affects the retained earnings balance?
The amount of dividends declared during the period decreases the retained Earnings account balance.
Ending retained earnings balance
= (A) + (B) – (C)
Where,
(A) = Beginning retained earnings balance
(B) = Net Income
(C) = Dividends
Exercise 1
Retained earnings at January 1, 20×1 = $200,000
Net income for 20×1 = $540,000
Dividends declared during 20×1 = $120,000
What is the amount of retained earnings at December 31, 20×1?
Retained Earnings at December 31, 20×1
= $200,000 + $540,000 – $120,000 = $620,000
Exercise 2
Retained earnings at January 1, 20×1 = $350,000
Revenues for 20×1 = $900,000
Expenses for 20×1 = $400,000
Dividends declared during 20×1 = $100,000
What is the amount of retained earnings at December 31, 20×1?
Retained Earnings at December 31, 20×1
= $350,000 + $900,000 – $400,000 – $100,000 = $750,000
Exercise 3
Retained earnings at December 31, 20×1 = $960,000
Net income for 20×1 = $650,000
Dividends declared during 20×1 = $140,000
What is the amount of retained earnings at January 1, 20×1?
Retained Earnings at January 1, 20×1
?? + $650,000 – $140,000 = $960,000
?? + $510,000 = $960,000
?? = $450,000