Characteristics of Equity

Characteristics of Equity

Equity is basically residual interest of equity holder in the company. In other words we can say that Equity is remaining investment of the equity holder in the company. This investment is calculated as net asset i.e. asset- liabilities.

Important Characteristics of Equity

Following are some important characteristics of equity

1.   Accumulated Investment balance

Equity is basically a residual interest of equity holder. In other word we can say that equity is accumulated balance of investment of equity holder. Thus equity is initial investment plus accumulated retained earnings.

2.   Equity is not Fixed

As equity is an accumulated balance of investor investment, thus it changes year to year. Net income increases the equity, where a net loss reduces the equity. Thus performance of the company has direct linkage with equity.

3.   Equity Formula

Equity can be calculated with simple formula paid up capital plus accumulated retained earnings. Equity may also be calculated as net asset i.e. assets – liabilities.

4.   Equity Calculation

Equity can be calculated from the statement of financial position. If the company assets are 300 million and its liabilities are 200 million, then its equity would be 100 million i.e. asset minus liabilities.

5.   Items of Equity

Typically following items form part of equity.

a.    Paid up capital.

b.    Retained earnings.

c.    Revaluation surplus.

d.    Share premium account.

e.    Changes in accounting policies.

f.     Correction of error.

g.    Other items directly recognized in equity.

6.   Statement in Changes in equity

As name suggests that this statement shows the changes occur during the year in equity. These changes typically explain in term of changes in paid up capital, retained earnings, revolution surplus and share premium account.

This statement is divided into three sections i.e. opening balance, changed during the year and closing balances of above mentioned heads. A simple statement of changes equity has been given for understanding.

	Share Capital	Retained Earning	Share premium	Total
Opening	10,000	5,000	20,000	35,000
During Year	5,000	2,000	3,000	10,000
Closing	15,000	7,000	23,000	45,000

List of important characteristics of equity

Some important characteristics of equity are listed below

a.    Equity is residual interest of equity holder.

b.    Equity can be calculated as net asset.

c.    Equity is not fixed.

d.    Income increases the equity, while an expense reduces equity.

Characteristics of Expenses

Characteristics of Expenses

Expenses are incurred to finance day to day operations of the entity and these expenses reduce the equity. Expenses are costs incurred to generate profits. Thus we can say that expenses are cost of doing business.

Important Characteristics of Expenses

Some important characteristic of expenses have been explained below.

1.   Support operations

Expenses are incurred to run day to day operations of the entity. This is the most important characteristic or function of the expenses. Thus Expenses is one of the most important factors for the existence of the business.

2.   Generate profit

Another important characteristic of expense is profit generation. For example the cost of sales being as expense is incurred to generate revenue and profit. Production & selling both are technically not possible without incurring expenditure.

3.   Statement of Comprehensive Income

Expenses are shown in statement of comprehensive income. Expenses are shown in the first part of statement of comprehensive income, other part of comprehensive income deals financial items of special nature like gain on disposal of income.

4.   Reduce Equity

An expense reduces the equity of the entity. In practice accounting, expenses are not directly charged to equity, rather it is first charged to income statement and then net income is charged to equity. Thus net income reduces the equity.

5.   Equity Holder Distribution

Distribution to equity holder like dividend is not considered expense of the company. Similarly the contribution of equity holder does not consider the income of the company or entity. Thus both distribution and contribution to the equity does not form part of income statement.

6.   Capital & Revenue Expenditure

Expenses can be classified into capital and revenue expenses. Those expenses that provide short term benefit are called revenue expenses like salary , rent, etc, while those expenses which benefit is to be exhausted/received in long run are called capital expenses like purchase of machinery etc.

7.   Break Down Expenses

Typically the expenses can be break down into following main classes. Each of this class may have different type of function. This classification is also known as break down by function.

a.    Marketing & Selling Expenses

b.    Cost of sales expenses

c.    Factory overhead expenses.

d.    Finance Expenses

Expenses may also be classified in term of their nature.

a.    Deprecation.

b.    Material Expenses.

c.    Employee’s salary.

8.   Recognition of Expenses

Expenses are recognized in book subject to fulfillment of following conditions

a.    Expenses satisfy the definition.

b.    Economic associated with expense will flow to organization.

c.    Expense can be measured reliably.

List of important Characteristics of Expenses

Some important characteristics of expenses are listed below

a.    Expenses are facilitates operations.

b.    Expenses facilitate income generation.

c.    Expenses provide long and long term benefit.

d.    An expense reduces the equity of the company.

e.    A distribution to equity holder is not an expense.

Characteristics of Income

Characteristics of Income

In this article, the characteristic of income has been explained. Income is the gross inflow of economic benefit, other than equity contribution, which would increase the equity.

Important Characteristics of income

Some important characteristics of income have been briefly explained below.

1.   Gross Inflow

Income is gross inflow of economic benefit like revenue.

2.   Increase the equity

Second important characteristic of income its impact on the equity. Income would increase the equity of the entity. It is important to note that income increase the equity, while expense reduces the equity. Thus it is more appropriate to say that net income would reduce the equity i.e. income minus expenses.

3.   Other the Contribution

Share holder contribution is not treated as income. It is important to note that such contribution will be directly added to equity.

4.   Recognition of income

Income must be recognized, when it would satisfy the following conditions.

a.    Satisfy the definition of income.

b.    Can be measure reliably.

c.    It is probable the economic benefit will flow to organization.

Above condition are general conditions for income or revenue recognition. However, IAS specifies specific condition/circumstance for revenue recognition from different industries like construction contracts, sales of goods, interest etc.

5.   Gross Income & Net income

There is a difference between gross income & net income. Gross income is gross inflow like revenue, while net income is net inflow calculated by deducting expenses from the gross inflow; example of net income is profit.

6.   Types of Income

a.    Revenue.

b.    Interest on deposit.

c.    Royalties.

d.    Dividend.

e.    Rental income.

Characteristics of Liability

Characteristics of Liability

Characteristics of liability may be expressed in term of present obligation of past event, settlement of liability, and recognition etc. These characteristics have been briefly explained below

    Important Characteristics of Liability

Following are the important characteristics of liability.

1.   Obligation of Past Event

Liability is a present obligation of a past event.  Thus a future event cannot give rise to a liability. This concept has been explained with an example , Goods purchased on credit give rise to a liability, because this is a present obligation of a past event, however future plan of purchases goods does not create liability, because there is no present obligation for a past event.

2.   Settlement of Liability

A liability can be settled in many ways like payment of cash , transfer of other asset, providing a service, replacement of liability , convert liability into equity i.e. share issue, liability can also be settled by writing of the liability i.e. writing of bad debts. 

3.   Recognition of Liability

Two important conditions need to be satisfied for liability recognition.

a.    An items fulfills the liability definition criteria.

b.    Amount of liability can be measured reliably.

4.   Current & Non Current Liabilities

Liabilities can be broadly classified into current & non current liabilities. Current liability is to be settled within one year like creditor, while non current liabilities are to be settled after one year like long term loan etc. The concept of current & non current liabilities have been explained in more details in my other article.

List of important Characteristics of liability

1.    Liability is present obligation of past event.

2.    Liability required future economic flow for settlement.

3.    Liability must be able to measure reliably.

Books of Accounts

Books of Accounts

In accounting there are only two main books of accounts i.e. Journal and Ledger. In this article these books of accounts have been explained in details. Books of accounts are used to record the financial transactions. 

It is important to note that trial balance & financial statement are reports generated from the books of accounts and thus not part form of books of accounts. However, we have also explained these reports in this article.

Manual & Computerized Books of Accounts

In manual system, Books of accounts are maintained manually by accountant, While in computerized environment books of accounts are automatically maintained or updated by accounting software. In computerized environment books of accounts are automatically updated by accounting software . In computerized environment   Accountant works is only to enter accurate amount in accurate heads of accounts and remaining tasks are performed by the accounting software.

1.   General Journal:

In first place the transactions are recorded in the General Journal. In Journal transactions are recorded in chronological order (Date wise). Transactions are recorded with the help of debit & credit rules. There are two basic rules for double entry system i.e. Every transaction  have two aspects i.e. (Debit & Credit) and debit aspect is always equal to credit aspect. Some important characteristics of General journal are listed below

1.    Journal is a primary book or book of original entry.

2.    Two aspects of a transaction is recorded i.e. Debit & Credit.

3.    Entries are recorded in chronological order.

4.   Special journal are used for high volume of transactions in large organizations. 

Special journal have been explained in my other article.

2.   General Ledger:

A register or book which contains all accounts is known as General Ledger. It is important note that, when there is no special journal, then all account are maintained in General ledger, and there is no need of total account.

However, when special journal are maintained, then individual account of creditor and customer are not part of general ledger, instead the total accounts for debtors and creditor, purchases, sales are maintained and individual accounts of debtor and creditors are maintained as memorandum account.

3.   Trial Balance:

Closing balance of General ledger is extracted in the form of trial balance. Trial  balance being a report can be extracted any time from the general ledger . Trial balance provides a foundation for the preparation of financial statement. It is to be noted that trial balance extracted from General ledger may require some adjustment for doubtful debt, prepaid expenses, accruals , depreciation and accounts are prepared from the adjusted trial balance.

1.    Trial balance extracted from General Ledger.

2.    Trial balance is summary of closing balances of General Ledger.

3.    Trial balance is a report, which is extracted from General Ledger.

4.    Trial balance may required  adjustment  (Depreciation ,accruals etc)
5.  Financial statements are prepared from adjusted trial balance.

4.   Financial Statements:

Financial statement is prepared from the trial balance extracted from the General ledger. Like trial balance, financial statements are also reports and can be prepared any time; however, financial statement are prepared at least once in the financial year. Financial statements contain statement of financial position, statement of comprehensive income, statement of cash flows, and statement of changes in equity and notes to the financial statements.

Financial Accounting Stakeholders

Financial Accounting Stakeholders

Financial accounting stakeholders are those people, who are interested in financial statements of the organization. Different stakeholders requires these statements for different needs. Some stakeholders need financial statements for economic decision making, while other requires them for compilation purposes.

In this article we would explain the information needs of different stakeholders. Some stakeholders are more interested in financial performance component, while others focuses on financial position component, and some users are interested in both financial position and financial performance component.

1.   Investor & Shareholders:

Investor can be classified into two categories i.e. current investor and prospective investor. Current investor is interested in financial statements to know the return and growth of their investments , while prospective investor wants to plan their future investments on the bases of financial statement information.  

2.   Creditors & Financial Institutions:

Creditors on one hand want early recovery of their due amount and on other hand are interested to have long term business relationship with organization. Thus creditors are more interested in financial position and cash flow statements. These statements clearly reflect organization Financial strength and ability to pay. Financial institutions also want to know about the financial stability of the organization before approving the loan.

3.   Employees & Trade Union:

Employees are also stakeholder of financial statements. They want to predict the possible increase in their salaries and possible announcement of bonus. Financial performance and liquidity position may give them some idea about the possibilities of salary increments. Trade unions also frame their demands in accordance with the financial performance of the company. 

4.   Government:

Another important stakeholder is Government. The Government is obviously interested in financial statement to levy and recover the tax from the organization. Government may also need financial statements for compilation of the national economic data.

List of Stakeholders

a.    Investor for investment decision & investment return information.

b.    Employees for possible salary increments & bonuses information.

c.    Creditor for timely/early recovery of the credit amount.

d.    Government to levy tax and compilation of national data.