3.1. Financial Statement Elements and Accounts

#cfa-level-1 #reading-23-financial-reporting-mechanics

Within the financial statement elements, accounts are subclassifications. Accounts are individual records of increases and decreases in a specific asset, liability, component of owners’ equity, revenue, or expense. For financial statements, amounts recorded in every individual account are summarized and grouped appropriately within a financial statement element. Exhibit 2 provides a listing of common accounts. These accounts will be described throughout this reading or in following readings. Unlike the financial statement elements, there is no standard set of accounts applicable to all companies. Although almost every company has certain accounts, such as cash, each company specifies the accounts in its accounting system based on its particular needs and circumstances. For example, a company in the restaurant business may not be involved in trading securities and, therefore, may not need an account to record such an activity. Furthermore, each company names its accounts based on its business. A company in the restaurant business might have an asset account for each of its ovens, with the accounts named “Oven-1” and “Oven-2.” In its financial statements, these accounts would likely be grouped within long-term assets as a single line item called “Property, plant, and equipment.”

A company’s challenge is to establish accounts and account groupings that provide meaningful summarization of voluminous data but retain enough detail to facilitate decision making and preparation of the financial statements. The actual accounts used in a company’s accounting system will be set forth in a chart of accounts. Generally, the chart of accounts is far more detailed than the information presented in financial statements.

Certain accounts are used to offset other accounts. For example, a common asset account is accounts receivable, also known as “trade accounts receivable” or “trade receivables.” A company uses this account to record the amounts it is owed by its customers. In other words, sales made on credit are reflected in accounts receivable. In connection with its receivables, a company often expects some amount of uncollectible accounts and, therefore, records an estimate of the amount that may not be collected. The estimated uncollectible amount is recorded in an account called allowance for bad debts. Because the effect of the allowance for bad debts account is to reduce the balance of the company’s accounts receivable, it is known as a “contra asset account.” Any account that is offset or deducted from another account is called a “contra account.” Common contra accounts include allowance for bad debts (an offset to accounts receivable for the amount of accounts receivable that are estimated to be uncollectible), accumulated depreciation (an offset to property, plant, and equipment reflecting the amount of the cost of property, plant, and equipment that has been allocated to current and previous accounting periods), and sales returns and allowances (an offset to revenue reflecting any cash refunds, credits on account, and discounts from sales prices given to customers who purchased defective or unsatisfactory items).

Exhibit 2. Common Accounts
  • Cash and cash equivalents

  • Accounts receivable, trade receivables

  • Prepaid expenses

  • Inventory

  • Property, plant, and equipment

  • Investment property

  • Intangible assets (patents, trademarks, licenses, copyright, goodwill)

  • Financial assets, trading securities, investment securities

  • Investments accounted for by the equity method

  • Current and deferred tax assets

  • [for banks, Loans (receivable)]

  • Accounts payable, trade payables

  • Provisions or accrued liabilities

  • Financial liabilities

  • Current and deferred tax liabilities

  • Reserves

  • Unearned revenue

  • Debt payable

  • Bonds (payable)

  • [for banks, Deposits]

Owners’ Equity
  • Capital, such as common stock par value

  • Additional paid-in capital

  • Retained earnings

  • Other comprehensive income

  • Minority interest

  • Revenue, sales

  • Gains

  • Investment income (e.g., interest and dividends)

  • Cost of goods sold

  • Selling, general, and administrative expenses “SG&A” (e.g., rent, utilities, salaries, advertising)

  • Depreciation and amortization

  • Interest expense

  • Tax expense

  • Losses

For presentation purposes, assets are sometimes categorized as “current” or “non-current.” For example, Tesco (a large European retailer) presents the following major asset accounts in its 2006 financial reports:

Non-current assets:

  • Intangible assets including goodwill;

  • Property, plant, and equipment;

  • Investment property;

  • Investments in joint ventures and associates.

Current assets:

  • Inventories;

  • Trade and other receivables;

  • Cash and cash equivalents.

Non-current assets are assets that are expected to benefit the company over an extended period of time (usually more than one year). For Tesco, these include the following: intangible assets, such as goodwill;3 property, plant, and equipment used in operations (e.g., land and buildings); other property held for investment, and investments in the securities of other companies.

Current assets are those that are expected to be consumed or converted into cash in the near future, typically one year or less. Inventory is the unsold units of product on hand (sometimes referred to as inventory stock). Trade receivables (also referred to as commercial receivables, or simply accounts receivable) are amounts customers owe the company for products that have been sold as well as amounts that may be due from suppliers (such as for returns of merchandise). Other receivables represent amounts owed to the company from parties other than customers. Cash refers to cash on hand (e.g., petty cash and cash not yet deposited to the bank) and in the bank. Cash equivalents are very liquid short-term investments, usually maturing in 90 days or less. The presentation of assets as current or non-current will vary from industry to industry and from country to country. Some industries present current assets first, whereas others list non-current assets first. This is discussed further in later readings.


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