Understanding Equity, Financial Statements, and Accounting Principles

Equity

Equity is the residual interest in the assets of a company after deducting all its liabilities. It represents the financing resources that are not borrowings.

Components of Equity:

• All contributions made by owners
• Reserves, share premiums & equity instruments
• Retained earnings, prior losses & profit/loss of the period
• Grants, subsidies, donations, and bequests received
• Valuation adjustments & hedging transactions

The Balance Sheet: A Fundamental Accounting Identity

The Balance Sheet represents the fundamental accounting equation:

USES OF FUNDS = SOURCES OF FUNDS

This equation highlights that a company's assets (uses of funds) are financed by either its liabilities or equity (sources of funds).

Static vs. Dynamic Vision of Financial Statements

While a static vision focuses on the economic and financial structure of a company at a specific point in time (e.g., year-end), a dynamic vision assesses its performance over a period (e.g., one year).

Dynamic Vision: Generation and Consumption of Resources

Generation of resources (revenues): Companies generate resources through business activities like selling products and providing services. Other revenue sources include finance income, commissions, and gains on non-current assets.

Revenues increase a company's equity during the reporting period, reflected as inflows or improvements in assets or outflows or extinguishment of liabilities. Reliable measurement of asset increases or liability decreases is crucial for revenue recognition.

Consumption of resources (expenses): Business activities also involve resource consumption. Common expenses include purchases, external services, and personnel costs. Other expenses encompass taxes, finance expenses, losses on non-current assets, depreciation, amortization, and impairment losses.

Expenses decrease equity during the reporting period, reflected as outflows or depletions of assets or the incurrence of liabilities. Accurate measurement of asset decreases or liability increases is essential for expense recognition.

The Income Statement: Capturing the Net Result

The Income Statement summarizes a company's financial performance over a specific period. It presents:

REVENUES - EXPENSES = NET INCOME

Net income, representing the period's profit, is then included as equity on the Balance Sheet.

The Accounting Conceptual Framework: Guiding Principles

The Accounting Conceptual Framework outlines the principles, standards, and conventions that govern financial accounting and reporting. It serves as a guide for preparing and presenting financial statements for external users.

Objectives of the Conceptual Framework:

• Ensure financial statements provide useful information about a company's economic and financial position and performance.
• Guide accountants, auditors, authorities, and professional bodies in resolving accounting issues.
• Promote consistency and comparability in accounting standards and regulations.

Requirements and Constraints in Accounting Information

The IASB Conceptual Framework emphasizes the qualitative characteristics of financial information, ensuring relevance, reliability, comparability, understandability, and faithful representation.

IASB Conceptual Framework - Qualitative Characteristics of Financial Information

The framework emphasizes the importance of these characteristics to ensure financial information is useful for decision-making.