The purpose of this brief paper is to identify four basic financial statements and the basis used for recording and journalizing business transactions. Finally, it discusses the usefulness of financial statements for various external users including investors and creditors.
There are four basic financial statements that companies usually prepare on a quarterly and annual basis. These include Statement of Financial Position (Balance Sheet), Statement of Comprehensive Income (Income Statement), Statement of Changes in Equity, and Statement of Cash Flows. The Balance Sheet provides details of the company’s assets, liabilities, and equity at a specific date of reporting. The Income Statement provides details of the company’s revenues and other income, cost of sales, operating expenses, net interest expense, tax, and other extraordinary items affecting the company’s earnings. It also provides values of Earnings per Share and the dividend decided by the company attributable to both ordinary and minority interest holders. Statement of Changes in Equity indicates changes in the value of the owner’s equity affected by changes in different other financial items. Statement of Cash Flow provides details of cash inflows and outflows from operating, investing, and financing investing activities which are added up or deducted from the company’s current cash position (Kimmel, Weygandt, & Kieso, 2009).
The basis for classifying the business transactions as debit and credit is based on the accounting equation which also forms the basis for the preparation of companies’ balance sheets.
Assets = Liabilities + Equity
The left hand side is the debit side whereas the right hand side of the above equation is the credit side. On the basis of this, it could be indicated that an increase in assets or a decrease in liabilities and owner’s equity is recorded on the debit side. On the other hand, a decrease in assets or an increase in liabilities and owner’s equity is recorded on the credit side. The process of classifying and recording of changes in assets and liabilities and owner’s equity is referred to as double entry system (Kimmel, Weygandt, & Kieso, 2009).
The process of recording financial transactions into a general ledger which is the first accounting document prepared by companies is referred to as journalizing of transactions. The financial transactions of the company are recorded in a journal which is a list of all transactions along with their respective debit and credit entries according to the chronological order in which events have taken place (Kimmel, Weygandt, & Kieso, 2009).
It is crucial for companies to provide access to the financial information which is not otherwise available to external users through certain form of reporting. This is achieved via publication of financial statements. Managers of business entities work for various stakeholders particularly investors who are interested in knowing how much return they are making on their investments in these companies and also there are other stakeholders such as creditors who will be interested in knowing whether the company is able to pay off its loans and meet its interest obligations associated with its debts (Kimmel, Weygandt, & Kieso, 2009). The usefulness of financial statements is sometimes limited to the knowledge and understanding of the users of such information. Therefore, over the years, there has been increasing emphasis on not just preparing and reporting financial statements on a periodical basis but also to provide detailed descriptive information related to the business decisions and operations which companies now include in their periodical publications.
Reference List
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2009). Financial accounting: Tools for business decision making. Hoboken, NJ: John Wiley & Sons.