Elements and Principles | Sahithyan's Notes

Elements of Financial Statements

Income
Increases in assets, or decreases in liabilities, that increase equity, excluding contributions from equity holders.
Expense
Decreases in assets, or increases in liabilities, that decrease equity, excluding distributions to equity holders.
Assets
A present economic resource controlled by the entity as a result of past events, where the resource is a right with potential to produce economic benefits.
Liabilities
A present obligation of the entity to transfer an economic resource as a result of past events.
Equity
The residual interest in the assets of the entity after deducting all its liabilities.

\text{Assets} = \text{Liabilities} + \text{Equity}

For each account type, an increase is recorded as a debit or credit as follows:

\text{Assets} + \text{Expenses} = \text{Capital} + \text{Income} + \text{Liability}

Derived progressively:

$\text{Assets} = \text{Capital}$
The owner’s capital is what funds the entity’s assets.
$\text{Assets} = \text{Capital} + \text{Liability}$
Assets can also be funded by external obligations, not just capital.
$\text{Assets} = \text{Capital} + \text{Profit} + \text{Liability}$
Profit earned by the entity adds to the capital funding its assets.
$\text{Assets} = \text{Capital} + (\text{Income} - \text{Expenses}) + \text{Liability}$
Profit is expanded into its components: income earned less expenses incurred.
$\text{Assets} + \text{Expenses} = \text{Capital} + \text{Income} + \text{Liability}$
Expenses are moved to the left side, giving the extended accounting equation.