|SFAC 6 defines 10 elements of financial statements. These elements are the building blocks with which financial statements are constructedthe classes of items that financial statements comprise.33 They focus directly on items related to measuring performance and to reporting financial position. The definitions of these elements operationalize the resources, claims, and changes identified in the third objective of financial reporting in SFAC 1.34 The accrual accounting model actually is embodied in the element definitions. The FASB recognized that accrual accounting produces information that is more successful in predicting future cash flows than is cash flow accounting.|| (K)|
The 10 elements are: (1) assets, (2) liabilities, (3) equity, (4) investments by owners, (5) distributions to owners, (6) revenues, (7) expenses, (8) gains, (9) losses, and (10) comprehensive income.
|The 10 elements of financial statements defined in SFAC 6 describe financial position and periodic performance.|
You probably already know in general terms what most of these elements mean. But as you will see when they are discussed, it is helpful to have a deeper understanding of their meaning. You may recognize the first three elementsassets, liabilities, and equityas those that portray the financial position of an enterprise.
Assetsprobable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.
|Assets represent probable future economic benefits controlled by the enterprise.|
A key characteristic of this definition is that an asset represents probable future economic benefits. A receivable is an asset only if it is probable that future benefits will result, that cash will be collected. The controlled by aspect of the definition also is important. The employees of a company certainly represent future economic benefits to a company. However, they are not owned or controlled by the company and do not qualify as assets.
Liabilitiesprobable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. are probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.35
|Liabilities represent obligations to other entities.|
Most liabilities require the future payment of cash, the amount and timing of which are specified by a legally enforceable contract. Actually, though, a liability need not be payable in cash. Instead, it may require the company to transfer other assets or to provide services. For example, a warranty liability is created for the seller when a product is sold and the seller guarantees to fix or replace the product if it proves defective and it is probable that a material amount of product sold will, in fact, prove defective. A liability also need not be represented by a written agreement, nor be legally enforceable. For example, a company might choose to pay a terminated employees salary for a period of time after termination even though not legally required to do so. The commitment creates a liability at the date of termination.
Equityused when an investor can't control, but can significantly influence, the investee. or net assets, called shareholders equity or stockholders equitycalled shareholders' equity or stockholders' equity for a corporation; the residual interest in the assets of an entity that remains after deducting liabilities. for a corporation, is the residual interest in the assets of an entity that remains after deducting liabilities.
Assets and liabilities are measured directly; equity is not. Equity is simply a residual amount. The accounting equation illustrates financial position.
|Equity is a residual amount, the owners interest in assets after subtracting liabilities.|
For a corporation, equity arises primarily from two sources: (1) amounts invested by shareholders in the corporation and (2) amounts earned by the corporation on behalf of its shareholders. These two sources are reported as (1) paid-in capitalinvested capital consisting primarily of amounts invested by shareholders when they purchase shares of stock from the corporation. and (2) retained earningsamounts earned by the corporation on behalf of its shareholders and not (yet) distributed to them as dividends.. We discuss this classification of shareholders equity in more depth in Chapter 18.
The next two elements defined in SFAC 6 deal with changes in equity from owner transactions.
Investments by ownersincreases in equity resulting from transfers of resources (usually cash) to a company in exchange for ownership interest. are increases in equity resulting from transfers of resources (usually cash) to a company in exchange for ownership interest.
|Investments by owners and distributions to owners are transactions describing any owner contribution to and withdrawal from the company.|
A corporations issuance of ownership shares of stock in exchange for cash represents an investment by owners.
Distributions to ownersdecreases in equity resulting from transfers to owners. are decreases in equity resulting from transfers to owners.
A cash dividend paid by a corporation to its shareholders is the most common distribution to owners.
Revenues, gains, expenses, and losses describe changes in equity due to profit-generating transactions.
Revenuesinflows or other enhancements of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entity's ongoing major, or central, operations. are inflows or other enhancements of assets or settlements of liabilities from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major, or central, operations.
A key characteristic is that revenues are inflows. The enterprise is acquiring something in exchange for providing goods and services to customers. Also, providing these goods and services represents a major operation of the enterprise.
|Revenues are gross inflows resulting from providing goods or services to customers.|
On the other hand, if selling the item is not part of the central operations of the business but instead is only an incidental result of those operations, the inflow of assets would produce a gain rather than a revenue.
Gainsincreases in equity from peripheral, or incidental, transactions of an entity. are increases in equity from peripheral, or incidental, transactions of an entity.
FedEx earns revenue by providing a service, delivering packages, to its customers. If FedEx sold a piece of machinery used to deliver packages for an amount greater than its book value (original cost less depreciation recorded up to the date of sale), a gain would result. Gains are net inflows, the difference between the amount received and book value. Revenues are gross inflows, measured as the amount received or to be received for the goods or services without regard to the cost of providing the goods or services.
Expensesoutflows or other using up of assets or incurrences of liabilities during a period from delivering or producing good, rendering services, or other activities that constitute the entity's ongoing major, or central, operations. are outflows or other using up of assets or incurrences of liabilities during a period from delivering or producing goods, rendering services, or other activities that constitute the entitys ongoing major, or central, operations.
|Expenses are gross outflows incurred in generating revenues.|
A key characteristic is that expenses represent outflows of resources incurred in the process of generating revenues.
Lossesdecreases in equity arising from peripheral, or incidental, transactions of the entity. represent decreases in equity arising from peripheral, or incidental, transactions of an entity.
If FedEx sold that piece of machinery used to deliver packages for less than its book value, a loss would result. So, losses are the opposite of gainsthey are net outflows rather than net inflows. They differ from expenses by being net rather than gross outflows and by being peripheral, or incidental, transactions rather than major, or central, operations. Revenues plus gains less expenses and losses for a period equals net incomeincome statement bottom line. or net lossincome statement bottom line., the so-called bottom line of the income statement.36
You should note that the definitions of these nine elements are in basic agreement with those used in practice. But, SFAC 6 also introduced a new term, the 10th element, called comprehensive income.
Comprehensive incometraditional net income plus other nonowner changes in equity. is the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
|Comprehensive income often does not equal net income.|
Under present GAAP, net income as reported in the income statement often doesnt equal comprehensive income. The difference is the treatment of certain changes in assets and liabilities not included in the determination of net income for the period in which they are recognized but instead reported collectively as a separate component of shareholders equity in the balance sheet called accumulated other comprehensive income. For example, in your study of investments in Chapter 12, you will learn that for certain types of investments valued at fair values in the balance sheet, the changes in those values are not included in net income but rather in a separate component of shareholders equity. Comprehensive income is discussed in Chapter 4.
In the FedEx Corporation financial statements in Appendix B, the income statement for the most recent fiscal year reports net income of $838 million. The balance sheet for the most recent fiscal year shows accumulated other comprehensive income of $(46 million), and the statement of changes in stockholders investment and comprehensive income provides the details of the change in this figure from the prior year.
Brief-Exercises BE1-3, BE1-4, BE1-5, BE1-6
Exercises E1-5, E1-6, E1-7, E1-8, E1-9, E1-11, E1-12, E1-13, E1-14
Communication Case 1-5
Judgment Case 1-8, 1-9, 1-10
Real World Case 1-13
33 Elements of Financial Statements, Statement of Financial Accounting Concepts No. 6 (Stamford, Conn.: FASB, 1985), par. 5.
35 In 2000, the FASB issued an exposure draft proposing a revision to the Concept Statement No. 6 definition of a liability. The proposed amendment would expand the definition to also include as liabilities certain obligations that require or permit settlement by issuance of the issuers equity shares and that do not establish an ownership interest. At the time this text was written, a final pronouncement had not been issued.
36 Some companies use the term net earnings instead of net income. If earnings are negative, the term used is net loss.