 Hello and welcome to the session in which we would look at the elements of financial statement. The elements of financial statements are part of the conceptual framework. In the prior session we looked at the objectives, the qualitative characteristics and the cost constraint and this is what we looked at in the prior session. Make sure you are familiar with this picture. Whether you are a CPA candidate or an accounting student, you really want to know those qualitative characteristics. What I suggest you do if you're studying for the exam, print this picture in a colorful and colors and put it in your room and keep looking at it on a constant basis. It will help you remember the fundamental characteristic and the enhancing characteristics and the components of the fundamental characteristics. This is what I suggest you do. Also, whether you are an accounting student or a CPA candidate, I strongly suggest you take a look at my website farhatlectures.com. 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Like this recording, share it with other, connect with me on Instagram, Facebook, Reddit, and Twitter. So in this session, we're going to be focusing on the elements of financial statements. In the next session, we would look at recognition, measurement, and disclosure. And all of this is within the FASB conceptual framework. So let's take a look at the elements that we're going to be discussing in this session. We're going to be looking at assets, liability, equity, investment by owners, distribution to owners, revenues, expenses, gains, and losses, and comprehensive income. And just by looking at this list, I hope you understand what I did. What I did is this. I listed those together because they go on the balance sheet. I listed investment by owners and distribution to owners. Those are usually on the retained earnings or stockholders' equity section. Revenue, expenses, gains, and losses, those are income statement account and comprehensive income. It can be considered a statement by its own. Then it feeds eventually through accumulated other comprehensive income into the balance sheet on the equity section of the balance sheet. So by the time you are done with this recording, you'll need to have a good understanding of what assets are, what liabilities are, what is equity, what are revenues, expenses, gain, losses, and comprehensive income. As an accounting student, you cannot survive without knowing the basic elements of financial statements, especially if you are a CPA candidate. So let's go ahead and get started starting with assets. What are assets? Simply put, assets are resources. In those resources, the company can own or they don't have to own as long as they control. That provide current and future benefit. And the most important thing to be an asset, it's going to provide future benefit as a result of past transactions. What do I mean by this? An asset is something that you have, you are in control of. You don't have to own it as long as you control it because you might own a building, but really the bank owns it because you have a mortgage on it, but you can use that building. Therefore, it's an asset. It's not going to provide only current benefit. It is providing current benefit, but that's not the case. It's going to provide future benefit because it has that future characteristic. It becomes an asset. And the assumption here is we're going to be in business forever. And that's why we have this future benefit assumption. What are some examples of assets? Well, let me tell you the best asset is called cash. And I hope you are all familiar with cash. Why? Because if you are in control of cash, you can do anything with it. You can pay your employees, buy assets, expand your business, so on and so forth. Inventory is an asset. You can sell the inventory and make a profit. Property, plant and equipment, building, intangible assets are obviously assets. Intangible assets are assets that lack physical resources. Those are all physical, I'm not resources, physical substance. It doesn't have a physical substance. Those are all examples of assets. Liabilities is the second element of financial statements. There are 10 of them. So this is one, liabilities two. What are liabilities? Simply put, liabilities, if I wanted to find them in one word, they're obligations or debt. And we are all familiar with obligation or debt. Of course we are. What is a debt? What is an obligation? It requires you to make a future sacrifice of assets. It asks you to kind of sacrifice an asset in the future and usually that asset is cash. Usually it doesn't have to be about 95 or 99% of the time you settle your liabilities with cash to settle the current liability. Liability is an obligation. So somehow right now you owe someone something. As a result of that, you have to sacrifice an asset in the future to settle that liability and that liability was generated as a past transaction. So what happened? So we have three, three time period. We have current, future and past. You might have a loan today and as a result, you have to pay this loan in the future and this loan is a result of past transaction. In the past, you borrowed money. As a result, you have a current loan and because you have a current loan, you have to pay it in the future. This is what a liability is. What are some examples of liabilities accounts payable? In the past, you purchased something in account which makes your liability current. In the future, you have to pay off that liability. Simply put, let me give you a quick journal entry. You purchased inventory on account. Then in the future, now you have a current, now you have an account payable. In the future, you have to settle the liability. You debit account, payable, you credit cash. Another form of liabilities are loans, notes, payable. Those are liabilities and other liabilities are accrued liabilities, liabilities for expenses that incurred but not yet paid. So all liabilities fit this definition. The third component of the third element is equity. Equity is also known as net assets or for personal, if you're looking at personal asset is net worth but usually we call it as net asset. And what is equity is simply the difference between your assets and your liabilities. Simply put, basically 1 minus 2. 1 minus 2, 1 is assets, minus 2 is liabilities. So it's assets, minus liabilities will give us equity and it's easier to use numbers. Let's assume we have 100 dollar an asset minus 40 dollars of liabilities. It means our equity is 60 dollars. What does that mean? It means this is the residual what's left after you pay off your liabilities. Remember, you have to pay off your liabilities. So let's assume the company liquidate just to illustrate the point. They pay off all their liabilities and let's assume that's the market 40 dollars for the liabilities. What's left is equity and that's good. If you have a positive equity, it's good. It means something left. The company is worth 60 dollars. That's what the equity is. So after you pay off all your liabilities, that's what's left. Although you have 100 dollar and assets, assets not what matters. What matters is how much left after you pay off your liabilities? In this situation 60 and this is what equity is, the difference between assets and liabilities. Now we need to talk about equity later on. There's a one-fold chapter about equity but this is the basic idea of equity. Another element of financial statements is something called investment by owners. What are the investment by owners? As the word suggests, a transfer of assets, usually cash but it can be something other than cash, from investors, owners or shareholders, basically owners of the company to the entity. So simply put, when the owner, when the investor, when someone likes the company, what they do, they invest cash in that company. As a result, there was an increase of equity. So this investment by owner increases the equity of the company because what you are doing, let's assume you invested 10 dollars in this company. Well, if you invest 10 dollars, you're going to increase their assets by 10 dollars. As a result, the equity will increase by 10 dollars. Therefore, you will have assets of 110. Your liabilities will stay the same and now your equity is 70. So notice how this 10 dollar investment increases the equity of the business, the equity of the business. So this is, you need to understand that it increases equity, equal to 70 and now my pen is not working properly. That's fine. I'm going to try to use the mouse to write 70 but this is, just know that there are 70 dollars there. Now, distribution to owners, basically the opposite of investment by owners. What do I mean the opposite? Simply put, you can invest in the company. Also, you can take that money out. You can withdraw of assets by investors, owners, and shareholders. What happened as a result of these withdrawals? The equity of the business goes down. The equity of the business goes down. Think of these two as the opposite of each other. Think of these two as the opposite of each other. So let's go back here and write 70. Now, if the owners wants to take five dollars out, if they decided to withdraw five dollars, what they have to do, they have to minus five dollars. Okay, they will deduct five dollars and five dollars is deducted from equity. So they will have 105 dollars an asset minus 40 equal to 65 in equity. So it's the opposite. One increases equity, the other decreases equity. Let's take a look at the remaining five elements of financial statements starting with revenues. What are revenues? Revenues are increases in asset or a reduction in liability. Usually, when you generate revenue, what happens is you will increase your assets. How do you increase your assets? You either receive cash or a promise to receive the cash, which is an account receivable or a reduction in liability. If you owe someone something and you did some service for them, they will forgive you. They would reduce your liability. So revenues is when you deliver goods and services from the company's ongoing central or major upper. And when you do so, you increase equity. Why? Because you're increasing cash, you're increasing account receivable. What are some examples of revenues? Different companies will have different sources of revenues. For example, most companies will have sales revenue. They sell something. Some companies, they provide a service. Like, for example, your university, their revenue is called tuition revenue. They also have revenues from the government as well or grants from the government. That's another source of revenue. But usually it's the tuition. It's what they do. They service you. For example, Google, one of the revenues is advertising revenue. YouTube, one of the revenues is advertising revenues. So different companies will have different sorts of revenues. And what do revenues do? They increase equity. They increase equity. Now, expenses are decreases in assets or increases in liabilities. Think of expenses are the opposite, although there's no such thing as the opposite of revenues. But if you look at the definition itself, it looks like the opposite decreases in assets or increases in liabilities, which is the opposite of what we said about revenue as a result of what as a result of incurring cost. Now to run a business, you have to incur cost, various types of cost, utilities cost, you have to pay taxes, you have to pay rent, you have to pay insurance, you have to pay your employees wages, you have to pay for supplies, you have to pay for your inventory. So you have many expenses to run the business on a day-to-day operation. So those costs, they are called expenses. So this is the sixth element we said revenue is six, expenses are seven. Okay, that's those are elements of financial statements. Then we have something called gains. This is element number eight. And what are gains? Gains are increases in assets or a reduction in liabilities. Hold on a second. This statement sounds like revenues, increases in assets and a reduction in liabilities. It sounds the same. However, as a result from peripheral or incidental transaction, what does that mean? Remember, revenues is something that the company does every day to generate revenues like sell burgers. If you're McDonald's, they sell burgers. That's the revenue. Now McDonald's, every once in a while, they might sell an old warehouse. They have a warehouse somewhere and they no longer need it. So they will sell the warehouse. And as a result, they might incur again. They might experience again from that sale. So they purchase the warehouse for the sake of simplicity. Let's assume a land because I don't want to involve depreciation. Let's assume they have a piece of land somewhere. They bought that piece of land. They thought they're going to build a McDonald on that land and they paid for it $100,000. But they end up not building that McDonald. So that's how much they paid for it. Now they sold it. The prices went up. They sold it for 150. As a result, they have a gain of $50,000. We don't call this revenue. We call it a gain. And the reason is because it's not part of their operation. It's not part of their central major operation because McDonald's sell burgers. Now we also could have losses. Losses are decreases in assets or increases in liabilities. If you look at it, it's very similar. It's very similar to what? It's very similar to expenses. But those decreases in assets or increases in liabilities are the result of peripheral transaction. Let's go back to that piece of land. Let's assume they can only sell the land for $75,000 rather than $150,000. The prices of the land in that area went down. And maybe that's why they're not putting up that new McDonald. The area is going down. Or maybe not. Maybe McDonald's strive on if the area is not good. Maybe it's not a healthy food. They can open a new place, regardless. That's beside the point. Now they have a loss of $25,000. Losses are number nine, element nine. I mean, I'm just calling them nine. They're not really nine. But what I want to tell you, six, seven, eight, and nine, when you net them out, so revenues minus expenses plus gains minus losses will give us net income. So six, seven, eight, and nine revenue minus expenses plus gains because gains increase income minus losses will give us net income. So that's important. So those are the net income or income statement element. If you net them, they'll give us net income or a net loss. If we have more expenses and losses than gains and revenues, we have a net loss. But I'm going to be positive and we're going to say we have a net income. So those are the, this is the ninth element. The last element is called comprehensive income. It's called comprehensive income. And let me go ahead and tell you what comprehensive income is. Comprehensive income starts with net income. I just told you what net income is. Net income is six, seven, eight, and nine. So all of these, all of these plus any changes in equity plus any changes in equity other than owner sources. What are the owner sources? Owner sources, we saw them on the prior slide. Owner sources are investment by owners and distribution by owners. So if you like, if we looked at the elements again, if we look at the prior slide here, remember we had investment by owners and distribution by owners, those two here. Okay. So comprehensive income, execute those two. It looks at everything that deals with equity, that changes equity, except those two. So net income plus any changes other than owner sources. That will include something called unrealized gain and losses on hedge derivatives, financial instruments. You don't have to worry about this now, but don't worry, you're going to have to learn it later. What are those unrealized gain and losses on hedge or derivatives instrument and foreign currency transactions gain and losses. Those are the two things I can think of, but there could be other, other transactions that goes into comprehensive income. Why do we have comprehensive income? The reason why we have comprehensive income because there are certain transactions, whether they are gains and losses. Remember, we have gains and losses up here, but sometimes we could have something called unrealized gain and losses, but we don't want them to be on the income statement. We want them to, we want them to affect equity, but we don't want them to go on the income statement. Therefore, what we do is we put them in comprehensive income, in comprehensive income, eventually closed to equity. So eventually they will end up on the balance sheet in equity, but they don't go through the income statement, which is they don't go through six, seven, eight, and nine. They go through the equity directly. Why? Because we don't think it's a good idea to take them through income. Let's take a look at an example to see how these, this concepts might be tested, whether on the CPA exam or in your intermediate accounting course, which of the following account is recorded and the statement of financial position, which is the balance sheet. So which account is a balance sheet account? And hopefully, you know, the balance sheet accounts are assets, liabilities, and equity. So expenses is an income statement account, revenues is an income statement accounts, and gains are income statement account. Those are income statement account. This is the balance sheet account. Remember equity is assets minus liabilities will give us equity. If you want to look at additional questions, please take a look at my website, farhatlectures.com. Again, I don't replace your CPA review course. What I do is I'm a supplemental material. I can help you understand the material better, which in turn will help you on the exam day. Don't shortchange yourself. The CPA exam is a lifetime investment. Invest in yourself. Take it seriously. And it will pay dividend down the road. Also, I do have resources for other college, college and university courses. Take a look at my website, take a look at my catalog. It might help you. Good luck. Stay safe and study hard.