CHAPTER 3: ACCOUNTING EQUATION AND FINANCIAL STATEMENTS

The basic accounting equation is the direct result of the entity concept.

ASSETS = EQUITY + LIABILITIES

 Owner provides capital/equity.

 Business can make use of loans as additional funding.

Equity can be divided into:

 Capital contributions
 Income
 Capital withdrawals
 Expenses

Therefore:

ASSETS = (CAPITAL CONTRIBUTIONS + INCOME – EXPENSES – CAPITAL WITHDRAWALS) +

LIABILITIES

Accounting equation will always balance due to the double-entry system.

Objective of financial statements:

 Provide information on financial performance and cash flow of an entity.
 Useful for making economic decisions.
 Also shows the results of management’s stewardship of the entity’s resources.
 Period for which financial statements have to be prepared: financial/accounting period.
 Financial period for internal reporting: 1 month
 For external reporting: 12 months, normally inline with the tax year.

Components of financial statements:

1. Balance sheet (statement of financial position)
2. Income statement (statement of comprehensive income)
3. Statement of changes in equity
4. Statement of cash flows
5. Notes to financial statements.

1)Balance sheet
 Presents the financial position of an entity at a specific point in time, the last day of the
financial year.
 Financial position: wealth or ability of an entity at a specific point in time.
 As well as breakdown of individuals that have an interest there-in.
Layout of balance sheet:
Assets = Equity + Liabilities
2)Income statement
 Presents the financial results of an entity for a specific financial period.
 Financial results: gains or losses that contribute towards an improvement or decline in the
financial performance.

3)Statement of changes in equity

 Reconciliation of equity at the beginning of the financial year with equity at the end of the
financial year.

4)Statement of cash flows

 Provides information on the ability of the entity to produce cash and cash equivalents and
the demand of the entity to utilize that cash flow.
 Entity presents its cash flow from operating, investment and finance activities.