Breaking Down Financial Statement Items

In one of my first posts I went through the accounting equation

giving a little snippet of each group. Now is the time that auditors in practice should resume resolving review notes or email your senior to ask why they choose a sample size of 7 for the entire population of revenue transactions. *Sampling is something we will work on later.

JARGON! FSA's or Financial Statement Areas/Financial Statement Assertions. Right now it means the different line items on the financial statements of a company. Cash, Inventory, Notes Payable, Common Stock are all FSA's. FSA's are classified as either Assets, Liabilities or Owners Equity (stockholder equity, shareholders equity and owners equity are all the same thing).

Assets: Generally these FSA's represent financial claim to both tangible or intangible items. Tangible being things you can touch and hold like cash and inventory. Intangible assets are things like patents, copyrights and the infamous goodwill which only exist on paper.
You really need to look a little deeper at assets. Somethings can start as assets but become liabilities if problems come up. To be classified as an asset it requires three things: expected to provide future economic benefit, tangible or intangible item that is measurable and is the result of an underlying transaction. In other words an asset needs to give value you need to be able to measure that value and it needs to come from an outside source. This is why things like internally created intellectual property are not considered assets. Without an underlying transaction it is not possible to fairly and accurately measure their real value.

Liabilities: Basically the opposite of assets. They are financial items that represent another entities claim to a companies assets. They are amounts the company will have to pay out in the future. The same three conditions also need to be met, expected future economic payable amount, measurable, and resulting from an underlying transaction. One issue that comes up is when you have to disclose  a liability, for example a lawsuit. At what point do you have to disclose or report an amount that may be payable should you loose a pending lawsuit? One requirement is that the amount be estimable (which is accountant speak for measurable within a range). There is financial value is disclosing a possible loss on a lawsuit if you have no idea what you might have to pay. In that case the amount you might have to pay has not met the conditions of being a liability and is not disclosed on the financial statements, although it may be disclosed in note that accompany the financial statements.

Owners Equity: This is what is left over. If Assets = Liabilities + Owners Equity then Assets - Liabilities = Owners Equity. This is how the company has funded their purchases and what they have done with excess earnings or losses. This category encompasses FSA's like Dividends (payments to owners), Retained Earnings/Losses, Common Stock, Additional Paid in Capital (APIC) and several others. Important to remember is that this is the residual equity of the firm. In theory if a company has to close its doors it would use assets to satisfy liabilities and this is what would be left over, because it is hard to get book value for most assets reality is usually much different.

Keep in mind that while there are generally accepted names for most accounts there are very few if any naming requirements. Cash could be called cash and cash equivalents and could have cash and highly liquid financial instruments under either name. Accounts payable could be called trade accounts payable or just payables. In the world of US GAAP and our thousands of rules, people find loop holes or flexibility and sometimes use them just to use them.