What Are the Elements of Financial Statements?

Financial statements are a primary method for a company to communicate its financial health and performance to external parties like investors, creditors, and regulatory agencies. To ensure consistency and comparability, these statements are built from a set of components known as “elements.”

The Financial Accounting Standards Board (FASB) defines these elements in its Statements of Financial Accounting Concepts, providing a shared framework for financial reporting. The elements are the building blocks used to construct financial statements, representing a company’s resources, the claims against those resources, and the events that cause them to change. Understanding these components is the first step in interpreting a company’s overall financial picture.

Elements of Financial Position

The elements of financial position describe a company’s economic condition at a specific moment. These three elements—assets, liabilities, and equity—are presented on the Balance Sheet, which acts as a financial snapshot. Together they form the basis of the company’s financial structure.

Assets are the resources a company owns that are expected to provide future economic value. Common examples include cash, an inventory of goods waiting to be sold, and a company’s equipment or buildings. These items are considered assets because they are used in daily operations to pay bills or generate income.

Liabilities represent a present obligation to transfer an economic benefit, meaning they are the debts and obligations owed to outside parties. A common example is a bank loan, which requires the company to make future cash payments. Other examples include accounts payable, which is money owed to suppliers, and wages payable to employees for work they have performed.

Equity is the residual interest in a company’s assets that remains after deducting all of its liabilities. It represents the ownership interest in the company and is sometimes called net assets. If a company were to sell all of its assets and pay off all its liabilities, the amount left over would be its equity, reflecting the portion of resources claimed by its owners.

Elements of Financial Performance

While the elements of financial position provide a snapshot, the elements of financial performance describe financial activities over a specific period, such as a quarter or year. These elements are reported on the Income Statement and show how a company generated profits or incurred losses. They focus on the transactions that changed the company’s equity during the period.

Revenues are inflows of assets from a company’s primary business activities, which are the central operations like producing goods or rendering services. For a retail company, revenue comes from the sale of its products, while a consulting firm generates revenue from service fees. These transactions increase a company’s assets, such as cash or accounts receivable.

Expenses are the costs incurred in the process of generating revenue. They represent outflows or the use of assets related to the company’s main operations. A common expense is the cost of goods sold, which is the direct cost of producing products, while other examples include employee salaries, rent, and utility costs.

Gains are increases in a company’s equity from transactions outside of its primary business operations, often called peripheral transactions. The distinction from revenue is that gains do not come from the core activities of the business. For instance, if a manufacturing company sells old equipment for a price higher than its recorded value, the resulting profit is a gain.

Losses are the opposite of gains, representing decreases in equity from peripheral or incidental transactions. Like gains, they are separate from the expenses incurred in the main course of business. An example of a loss is if a company’s warehouse is damaged in a fire, or if it sells a long-term investment for less than what was originally paid.

Elements of Changes in Equity

Certain transactions directly affect a company’s equity but are not related to its operational performance. These elements involve direct transactions between the company and its owners and are detailed in the Statement of Stockholders’ Equity. They represent changes in the ownership interest from capital contributions or withdrawals.

Investments by owners are increases in a company’s equity that result from owners transferring something of value, like cash, to the business. In exchange, the owners receive or increase their ownership stake in the company. The most common example is when a corporation issues and sells shares of its stock to investors, which increases the company’s assets and its equity.

Distributions to owners are decreases in a company’s equity resulting from the transfer of assets from the company back to its owners. These transactions reduce the owners’ claims on the company’s net assets. The most common form of a distribution is the payment of dividends to shareholders, which reduces the company’s cash and its equity.

How the Elements Interconnect

The elements of financial statements do not exist in isolation; they are linked through a relationship that governs all accounting. This connection ensures that the financial statements articulate with one another, providing a cohesive view of a company’s financial health and performance. The entire system is built upon a single equation.

This relationship is expressed through the accounting equation: Assets = Liabilities + Equity. This equation is the foundation of the Balance Sheet and must always remain in balance. It shows that a company’s resources (assets) are financed by either debt (liabilities) or owner contributions (equity), and every transaction affects at least two elements to maintain the balance.

The elements of financial performance, reported on the Income Statement, directly link to the Balance Sheet through the equity section. The result of the Income Statement is net income, calculated as Revenues plus Gains minus Expenses and Losses. This net income figure represents the increase or decrease in a company’s net assets from its activities, with a profit increasing equity and a loss decreasing it.

For example, a new company starts by receiving $50,000 in cash from its owners in exchange for stock. Its assets (cash) increase by $50,000, and its equity (investments by owners) increases by $50,000, keeping the equation in balance. In its first month, the company earns $10,000 in cash revenue from services, which increases assets (cash) by $10,000 and, through net income, increases equity by $10,000. The company’s assets are now $60,000, and its total equity is $60,000, demonstrating the link between performance and financial position.