CHAPTER 2: FINANCIAL STATEMENTS

The accounting equation: Assets = Liabilities + Equity  (Economic Resources = Claims).

An asset is a resource that gives benefit to its owner. An enterprise should consider a resource as an asset if
it a) Controls the resource, b) Resource can give benefits.
Tangible assets are things like plants, machinery etc. Intangible assets are things like IP, trademarks,
copyrights etc. Financial assets are mortgage loans, bonds etc.
A liability is an obligation that requires to be settled by giving up assets. Generally, requires payment of
cash. Some liabilities such as bonds payable or trade payable are in precise amounts whereas salaries, IT
payable and others are varying in nature.
Equity is net assets. The equity of businesses increases through investment from owners and profits earned
from company operations and decreases through distribution of dividends and losses from operations.
The equity of a company is called shareholder’s equity. It comprises of share capital, securities premium,
and retained earnings.
Retained Earnings represent the profit kept in the business.
Share capital is the contribution of shareholders towards company capital.
Securities premium is the excess of shareholders’ contribution over share capital.
Equities would change in the following cases: 1) Firm earns revenue 2) Incurs an expense 3) Pays
dividend 4) Receives capital from or returns capital to the owner.
There are 4 major financial statements:
1. Balance Sheet: It shows the financial position at a point in time.
2. P&L Statement: Reports the financial performance in a given period.
3. Statement of changes in equity: Explains how equity has changed as a result of the profit, dividends,
return of capital and other transactions in a period.
4. Cash Flow statement: Summarizes cash inflow and outflow resulting from operating, investing, and
financing activities in a period.
The balance Sheet has 3 sections: Assets, Liabilities and Equity. They follow permanency. This means, that
permanent things or close to permanent things are listed first in the BS.
Assets consist of 1) Non-Current Assets: Kept for use in the company’s business and not for conversion into
cash as part of the operations. These include long-term assets such as tangible assets (Property, plant and
equipment), intangible assets (Goodwill, sub-contracting rights, IP), Financial Assets (T/R, loans and long-
term investments), Deferred Tax assets (Result from differences between accounting profit and taxable
profit to be realized in the future).
2) Current Assets: Regularly converted to cash (within 12 months). Examples are inventories, short-term
investments and loans.

Non-current liability is payable after 12 months of BS date. These include financial liabilities (obligations to
pay borrowings), provisions (Estimated employee benefits), and deferred tax benefits.
Current Liabilities are payable as part of operations within one year of BS date. Consists of financial
liabilities (T/P, Bills/P and security deposits/P), Provisions, and current tax liabilities.
Statement of Profit and Loss: Has 3 sections, Income, Expenses and Profit.
Income consists of revenue from operations (Through sale of goods/services) and other income (Return on
investments, dividends, and other non-operating income).
Expenses include cost of materials consumed, employee costs, finance costs, depreciation and amortization
expenses and other expenses.
Statement of changes in equity: Describes changes in equity including share capital and retained earnings.
Equity share capital is increased by issuance of additional shares and decreased by share buyback.
Retained Earnings is increased by profits and decreased by loss and distribution of dividends.
Other comprehensive income changes as a result of gains and losses.

Statement of Cash Flows: Has 3 sections: 1) Operating Activities 2) Investing 3) Financing.