Ten Basic Elements of Financial Accounting
This post would help business executives who are new to corporate financial accounting learn the ten basic elements in less than an hour. These ten basic elements of accounting are the building blocks of financial records and statements prepared by accountants for entities.
- Asset
An asset is a resource that can generate future economic benefits for the organization that controls it. In the financial statements, assets are grouped based on the time it would take the organization to fully obtain the anticipated benefits.
| S/N | Category | Time expected to convert to cash | Example |
| 1 | Current Asset | Within 12-months | Inventory held by a trading company for resale |
| 2 | Non-current Asset | More than 12-months | Office building owned or controlled by a non-real estate entity |
In financial analysis, assets can be categorized based on their income-generating capacity: income-generating and non-income-generating assets. This analysis enables an organization to identify areas of improvement.
2. Liability
A liability is an outstanding obligation of an entity because of past events that result in an outflow of economic resources.
| S/N | Category | Time expected for settlement | Example |
| 1 | Current Liabilities | Within 12-months | Accounts payables |
| 2 | Non-current Liabilities | More than 12-months | Debentures issued by an entity |
To better manage an entity’s obligations, liabilities can also be categorized into risk funds/interest-bearing liabilities and non-risk funds/non-interest-bearing liabilities. The entity can prioritize the repayment of risk and interest-bearing liabilities to maximize its financial strength and performance.
3. Owner’s Equity
The residual economic value of an entity after settling all its present obligations is called equity. This is the leftover economic resources (controlled or owned by the entity) after settling all liabilities.
Before assessing the performance of the owners’ equity, group the owners’ equity into contributed and earned capital. This classification would provide a more accurate picture of the capital invested by owners as well as the earnings earned by the firm through business activity.
4. Investment from owners
This is any transfer of resources to obtain an ownership interest in an entity. It results in an increase in the owner’s equity. It is commonly referred to as capital, as it basically describes any owner’s contribution to the firm. An example is ordinary shares.
5. Distributions to owners
Dividend payments to the entity owners are an example of distribution to owners. It is a transfer of economic resources to the owners of the entity. The remaining profits after distribution to owners are called retained earnings.
6. Revenue
Revenue is an income (increase in economic benefit) from the ordinary activities of an entity arising from the transfer of goods or services to the customer. It is generated from the operating activities of an entity.
Depending on the nature of an entity, examples include sales, dividends, fees, royalties, and service charges.
7. Expenses
Expenses result in the outflow or decline of economic resources arising from the ordinary activities of an entity. Expenses could include salaries, office rent, consulting fees, and advertisement costs.
Kindly note that the following are not considered expenses:
- Distributions to owners
- Losses
Expenses are incurred to generate revenue.
8. Gains
Gains are income from activities that are not part of an entity’s ordinary business. Gains arise from the investing activities of an entity.
For instance, if a manufacturing company disposes of a manufacturing plant, the income from the sale could result in a gain or loss.
9. Losses
Losses are expenses (decrease in economic benefit) that do not arise during the normal business of an organization. Losses result from the investing activities of an organization.
10. Comprehensive income
Comprehensive income includes net income and unrealized income earned by an entity. The purpose of comprehensive income is to capture all operating and financial events that affect the interests of third parties in an entity.
In the next blog post, I will write about the four basic financial statements and the interplay of these ten basic elements.
