GAAP Liabilities + Equity Equals Assets

GAAP requires firms to present financial information on a quarterly basis using four financial statements: balance sheet, income statement, statement of owner's equity, and statement of cash flows (Financial Statements, n.d.).

It describes a company's financial status at a specific period in time (Writer, 2011). A company's balance sheet is represented by the following equation:

Liabilities + Equity Equals Assets

Current assets are either current or fixed assets. Accounts receivable, cash, inventory, prepaid assets, and market securities are examples of current assets that are easily and swiftly convertible into cash. Fixed assets, recorded at historical costs, cannot be readily converted into cash and include land, equipment, and buildings.

Liabilities (either current or fixed) refer to the portion of business assets owed to creditors. Current liabilities are due within the next 12 months and include accounts payable, notes payable, taxes payable, etc. Long-term liabilities have maturity periods of more than a year and include bonds payable and mortgage payable.

Equity refers to residual claimants by the owners after paying all creditors.

The Income Statement

It shows periodic results (e.g. for one year) of an entity’s operations (Writer, 2011). The following equation represents the income statement:

Net Income = Revenue – Expenses + Gains - Losses

Revenues are inflows from sale or manufacture of a product, or provision of a service. Outflows incurred during the production of revenues are expenses. Gains and losses include capital gains and losses from natural disasters respectively.

Statement of Owners’ Equity, Also Known As Statement of Retained Earnings.

It explains the change in retained earnings between two balance sheets and is majorly influenced by dividends and income. The equation below shows the corporation’s equity equation:

Stockholders’ Equity = Common Stock +Premium on Common Stock + Preferred Stock + Premium on Preferred Stock + Retained Earnings.

The Statement of Cash Flow

Used to evaluate a firm’s ability to pay its bills for a given period and provides information regarding the source, use, and change in cash balance. The statement divides the cash sources and uses into operating, investing and financing activities (Writer, 2011). It uses information from the period’s income statement and the beginning and ending balances on the balance sheet of the period.

The Relationships between The Four GAAP Basic Statements

The income statement shows the net income or net loss of a company for a given period. This amount is added, if income, or subtracted, if a loss, from the retained earnings figure in the balance sheet thus altering the balance (Peavler, 2016). The net income figure is also used when determining cash flows from operating activities.

There exists a strong relationship between the balance sheet and the statement of cash flow since various line items contained in the balance sheet are also reflected as line items in the statement of cash flows (Peavler, 2016). A good example is a decrease in the loan amount that appears in the balance sheet on the liabilities section. The amount also appears on the statement of cash flows as a decrement under the finance section. Also, the cash balance on the ending financial statement appears in the statement of cash flows.

The statement of net income and balance sheet are related since the sale, disposition or purchase of an asset appears both in the income statement as either a gain or loss if any and on the balance sheet as an asset reduction or increment.

The above explanation confirms the strong relationship between financial statements of a firm. It is the reason why an investor, or any other interested party, is advised to examine the four financial statements when reviewing the performance of a company to obtain the accurate picture of its financial situation.

References

Financial Statements. (n.d.). Retrieved February 24, 2017, from http://www.quickmba.com/accounting/fin/statements/

Peavler, R. (2016, June 14). What Every Entrepreneur Should Know About Financial Statements. Retrieved February 24, 2017, from https://www.thebalance.com/the-relationship-between-the-financial-statements-3935894

Writer, L. G. (2011, September 18). The Basic Features of the Four Financial Statements & Their Interrelationships. Retrieved February 24, 2017, from http://smallbusiness.chron.com/basic-features-four-financial-statements-interrelationships-24250.html