Ten Basic Elements of Financial Accounting

This post would help business executives, who are new to corporate financial accounting to 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.

1. Asset

Assets are resources controlled by an organization for the purpose of generating future economic benefits. In financial statements, assets are grouped based on the time it would take the organization to fully obtain the anticipated benefits.

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, resulting in an outflow of economic resources.

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 show a true picture of the capital contributed by owners and earnings generated by the entity from business activities.

4. Investment from owners

This is any transfer of resources to obtain an ownership interest in an entity. It results in an increase in 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 payment to the entity owners is 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 is 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/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/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:

1. Distributions to owners
2. 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 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 investing activities of an organisation.

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 writes about the four basic financial statements and the interplay of these ten basic elements.

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