Financial Statement

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Accounting mainly involves analyzing, interpretation and reporting of business transaction records. Accounting provides information for decision making to the management. The purpose of accounting is to maintain proper control of finances of an organization. In other words, accounting is an information system whose purpose is to provide essential information about business financial activities. It is primarily involves design of record keeping system, summarized reports based on the recorded data and eventually interpretation of the reports. (Duane and Charles 1991; Martin & Fernando 2002).

Four basic financial statements are:

Balance sheet:

This records assets and liabilities as well as owner’s equity of a business entity. Assets include current assets such as cash, debtors, securities, and prepayments. Long term assets include land, machineries, plants, and furniture. On the T account liabilities are recorded on the right hand side. They include current liabilities and long term liabilities and owners equity.


Current assets:                                                 Current liabilities:

Cash                            xx                                Accounts payable        xx

Accounts receivable    xx                                Long term liabilities:

Marketable securities  xx                                loans                            xx

Inventory                    xx                                bonds payable             xx

Prepayments                xx                               total liabilities              xx

Total current assets     xx                                owner’s equity                        xx

Long term assets:                                            retained earnings         xx

Land                            xx                                total owner’s equity    xx

Plant and equipment   xx                                total liabilities              xx

Machinery                   xx

Total long term assets xx

Other assets:

Goodwill                     xx

Intangible assets          xx

Total other assets        xx

Total assets                  xx

The income statement

This records revenue and expenses of a business entity for a specific period of time usually one year. Gross profit which is obtained after deducting COGS from the sales. Income before tax is obtained after deducting operating costs from gross profit. After deducting income tax from EBT, net income is obtained.


Cost of sales                                        xx                    sales                 xx

Gross profit                                         xx

Operating expenses                                                     gross profit b/f xx

Wages                         xx

Insurance                     xx

Depreciation                xx

Repairs                        xx

Interest                                    xx

Advertising                 xx

Income before income tax      xx

Income tax

Net income                  xx

Xx                                           Xx

Statement of owner’s equity

This report changes in owner’s equity for specified period. Owner’s equity b/f represents owner’s equity as per last financial year, adding new investment (shares) to this, less withdrawals; one obtains owner equity for the year in consideration

Owners’ equity b/f                              xx

New investment                                  xx

Net income                                          xx

Withdrawals                                        (xx)

Owner equity                                      xx

Statement of cash flows:

This records inflows and outflows of cash and cash equivalents. It shows changes in the financial position on cash basis.  Cash equivalent represent assets that are convertible to cash within or less than three months


Opening balance                                 xx                    cash outflows

Add cash inflows                                                        purchase of fixed assets          xx

Cash from operations  xx                                preference shares redemption xx

Sales of fixed asset     xx                                loan repayment                        xx

Income from sale                                            dividend, tax payment                        xx

of fixed assets             xx                                                                                xx

Share capita                 xx                                closing balance                        xx

Non trading income    xx

Total                            xx                                                                                xx


Financial statement preparation:

The first step towards preparing financial statement is recording the transactions in the journals. Then the accountant will prepare ledger accounts for every item e.g. machinery, wages, furniture, cash accounts and so on. It is from these ledgers data to prepare the basic financial statement is derived from.

The relationships

Net income/loss reported in income statement forms part of owner’s equity items. If net loss results, it is deducted, if net income results then it is added (in the owner’s equity statement). Owner’s equity as at end of trading period from the owner’s equity statement is recorded in the balance sheet as owner’s capital. Net cash reported in the cash flow statement is the cash reported in the balance sheet (Carl etal 2008)

Users of financial Statement

Financial statements are very useful to managers, investors, creditors, and employees. Managers need to know performance of the business in terms of profit, costs, liquidity, and solvency status so as they appropriately plan and make decisions for future. These statements also help them in budgeting and forecasting the performance. Investors are concerned about maximization of their wealth. These statements show the dividends and other incomes rewarded. They can use the statements to judge potential earnings from the firm. Creditors offer credit facilities to a business. They use these statements to evaluate a business liquidity and solvency status so as they may be able to know ability of a business to meet its short term and long term liabilities. Employees are also concerned to know the performance of their employer. Good performance means continuation of their employment while poor performance is a threat to their employment. (Bhabatosh 2005)

Objectives of financial reporting

Financial reporting is to provide information for decision making. It is also help in forecasting, budgeting, control. Financial reporting determines financial position of a business entity. It also shows income earned. Financial reporting is meant to be used by both internal and external users.

Accounting principles, assumptions and constraints

Accounting principles includes: cost principle; which state that assets and liabilities should be reported at acquisition cost rather than market cost, Revenue principle; state that revenue should be recorded when goods pass into the possession of the buyer (when realizable or earned. Revenue should not be anticipated), matching principle; state that expenses should be matched with revenues accruing from a certain transaction, Disclosure principle; state that, any information that may affect decision making should be disclosed. (Jerry etal 2004).

Assumptions includes: Going concern; a business entity is assumed to be continuing with operations indefinitely, Business entity; this state that business and the owners are separate entities, Time period; operations of a business entity can be divided into time periods, Monetary unit assumption; a stable currency as unit of account  is assumed. (Jerry etal 2004).


Constraints includes: Objectivity principle; financial statement should be objective based on evidence, Materiality principle; any item that is likely to influence decision of the financial accounts user should be included, Consistency principle; accounting principles should be used be consistently. (Jerry etal 2004).

Accounting equation;

The accounting equation is: assets =liabilities + owners’ liabilities. Business transaction leading to increase in assets will affect assets side. However this has to be funded by either owners or creditors. Meaning that, the equation will always be balanced.


Accounting reporting purpose is to provide information for decision making. Accounting standards by both international and national accounting bodies should be adhered to in financial reporting. Basic financial statements are balance sheet, cash flow statement, owners’ equity statement, and income statement. These statements are very useful to both internal and external users as far as decision making is concerned.