Lesson 6: Elements of Financial Accounting
In this lesson, we will cover the nine elements of financial accounting. We
will learn how dividends fit into accounting concepts, and the application of
each element in financial statements. We will finish by giving some examples of
financial elements.
At first glance, it may be overwhelming to think of all of the different
accounts involved in financial accounting. Don't let this sea of concepts worry
you, as we will be reviewing each element in depth over the course of this
financial accounting class. The more practice, concepts and examples that you
review; the easier it will be to memorize the financial accounting elements.
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In this lesson I will guide you in
helping to
make sense of all of the elements including assets, liabilities, equity,
revenues, expenses, gains, losses and other comprehensive income (OCI).
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You will apply these concepts both in real life and in your accounting course
work as they are the basic building blocks of financial accounting. These items
are summarized and reported on financial statements in order to communicate the
performance of the business.
Essentially, every transaction can be linked to one of these elements. When you
are preparing records, you will likely be dealing with at least one of the
financial accounting elements. If you compare them to the amino acids that
build up the human body, these elements are the concepts that serve as the
building blocks of financial accounting. The first three elements portray the
current financial position of the business and are recorded on the balance sheet.
If you look at the simple example of a balance sheet above, you will find
assets, liabilities and owners' equity. These elements are the fundamental
factors behind what a business owns (assets), what obligations they are
responsible for (liabilities) and the retained value (equity).
Let's take a moment to
briefly explain each concept on the balance statement as we will be doing a
deeper dive into assets, liabilities and equity in the next few lessons.
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Assets are items owned by the business that
add value and often serve a vital role in their continued success. Examples on
the balance sheet include cash, inventory and equipment.
Liabilities are obligations to
transfer something of value which is recorded through notes payable on the
balance sheet. Other forms of liabilities include interest payable, warranty
liability and unearned revenue.
Equity is the owners value that
is retained after liabilities are
paid. The balance sheet lists equity from the original investment along with
retained earnings.
The next three elements including revenues, gains and
losses are
recorded on the income statement. Looking at the sample example income
statement above, lets define each element.
â€¢ Revenues represent income that
is earned through the sale of the business' products or services.
â€¢ Gains account for an increase in
the company's position through a secondary source such as selling assets or
investing.
â€¢ Expenses are the widest ranging category and can be related to
costs including sales commissions, supplies, advertising and much more.
â€¢ Losses are
virtually the opposite of gains as they involve the company losing money
through secondary activities such a losing a lawsuit.
We will get into more detail on the concept of other comprehensive income (OCI)
in a future lesson. Basically, OCI is the unrealized version of revenues,
gains, expenses and losses. This means the transaction can be quantified but it
has not been completed yet.
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Examples include unrealized gains or losses from
assets listed for sale, foreign currency transactions, discontinued operations
and pension plans.
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Take a look at the example above. The red circle indicates where the OCI value
is recorded on the comprehensive income statement.
Dividends are often considered a ninth element,
as it is an important concept of financial accounting that
records the distribution of a corporations earnings to
it's shareholders. The dividends paid out are
recorded on the retained earnings statement. See the example above. The
dividends section is circled in red.