What are the main components of financial reporting?

The following points highlight the four main components of financial statements. The main components are 1. Balance Sheet 2. Income Statement 3. Statement of Changes in Owners’ Equity 4. Statement of Changes in Financial Position.

Financial Statements Component # 1. Balance Sheet:

The American Institute of Certified Public Accountants defines Balance Sheet as, “A tabular statement of summary of balances (debits and credits) carried forward’ after an actual and constructive closing of books of account and kept according to principles of accounting.'” The purpose of the balance sheet is to show the resources that the company has, i.e., its assets, and from where those resources come from, i.e. its liabilities and investments by owners and outsiders.

The balance sheet is one of the important statements depicting the financial strength of the concern. It shows on the one hand the properties that it utilizes and on other hand the sources of those properties. The balance sheet shows all the assets owned by the concern and all the liabilities and claims it owes to owners and outsiders. The balance sheet is prepared on a particular date.

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The right hand side shows properties and assets. Normally there is no particular sequence for showing various assets and liabilities. The Companies Act, 1956 has prescribed a particular form for showing assets and liabilities in the balance sheet for companies registered under this act. These companies are also required to give figures for the previous year along with the current year’s figures.

Financial Statements Component # 2. Income Statement (Or Profit and Loss Account):

Income statement is prepared to determine the operational position of the concern. It is a statement of revenues earned and the expenses incurred for earning that revenue. If there is excess of revenues over expenditures it will show a profit and if the expenditures are more than the income then there will be a loss. The income statement is prepared for a particular period, generally a year. When income statement is prepared for the year ending on 31st December 2011 then all revenues and expenditures falling due in that year will be taken into account irrespective of their receipt or payment.

The income statement may be prepared in the form of a Manufacturing Account to find out the cost of production, in the form of Trading Account to determine gross profit or gross loss, in the form of a Profit and Loss Account to determine net profit or net loss. A statement of Retained Earnings may also be prepared to show the distribution of profits.

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Financial Statements Component # 3. Statement of Changes in Owners’ Equity (Or Retained Earnings):

The term ‘owners equity’ refers to the claims of the owners of the business (shareholders) against the assets of the firm.

It consists of two elements:

(i) Paid -up share capital, i.e. the initial amount of funds invested by the shareholders; and

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(ii) Retained earnings/ reserves and surplus representing undistributed profits

The statement of changes in owners’ equity simply shows the beginning balance of each owner’s equity account, the reasons for increases and decreases in each, and its ending balance. However, in most cases, the only owner’s equity account that changes significantly is Retained Earnings and hence the statement of changes in owners’ equity becomes merely a statement of retained earnings.

A statement of retained earnings is also known as Profit and Loss Appropriation Account or Income Disposal Statement. As the name suggests it shows appropriations of earnings. The previous sear’s balance is first brought forward. The net profit during the current year is added to this balance.

On the debit side, appropriations like interim dividend paid, proposed dividend on preference and equity share capital, amounts transferred to debenture redemption fund, capital redemption funds, general reserve, etc. are shown. The balance in this account will show the amount of profit retained in hand and carried forward. The appropriations cannot be more than the profits so this account will not have a debit balance. There cannot be appropriations without profits.

Financial Statements Component # 4. Statement of Changes in Financial Position:

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The basic financial statements, i.e., the balance sheet and the profit and loss account or income statement of a business reveal the net effect of the various transactions on the operational and financial position of the company. The balance sheet gives a static view of the resource of a business and the uses to which these resources have been put at a certain point of time.

The profit and loss account in a general way, indicates the resources provided by operations. But there are many transactions that do not operate through profit and loss account. Thus, for a better understanding another statement called statement of changes in financial position has to be prepared to show the changes in assets and liabilities from the end of one period to the end of another point of time. The objective of this statement is to show the movement of funds (working capital or cash) during a particular period.

The statement of changes in financial position may take any of the following two forms:

(a) Funds Flow Statement:

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The funds flow statement is designed to analyze the changes in the financial condition of a business enterprise between two periods. The word ‘Fund’ is used to denote working capital. This statement will show the sources from which the funds are received and the uses to which these have been put. This statement enables the management to have an idea about the sources of funds and their uses for various purposes. This statement helps the management in policy formulation and performance appraisal.

(b) Cash Flow Statement:

A statement of changes in the financial position of a firm on cash basis is called Cash Flow Statement. It summarizes the causes of changes in cash position of a business enterprise between dates of two balances sheets. This statement is very much similar to the statement of changes in working capital, i.e., funds flow statement. A cash flow statement focuses attention on cash changes only it describes the sources of cash and its uses.

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