Business entities communicate economic information about their activities to the public through four financial statements:Primary means of communicating the financial information of an organization to the external users. The four general-purpose financial statements are the income statement, statement of changes in equity, balance sheet, and statement of cash flows.² (1) an income statement, (2) a statement of changes in equity, (3) a balance sheet, and (4) a statement of cash flows.

The information reported in financial statements is organized into categories known as elementsPrimary components of financial statements including assets, liabilities, equity, contributions, revenue, expenses, distributions, and net income.. Eight financial statement elements are discussed in this chapter: assets, liabilities, equity, contributed capital, revenue, expenses, distributions, and net income. The other two elements, gains and losses, are discussed in a later chapter. In practice, the business world uses various titles to identify several of the financial statement elements. For example, business people use net income, net earnings, and net profit interchangeably to describe the same element. Contributed capital may be called common stock and equity may be called stockholders’ equity, owner’s capital, and partners’ equity. Furthermore, the transfer of assets from a business to its owners may be called distributions, withdrawals, or dividends. Think of accounting as a language. Different terms can describe the same business event.

Answers to  The Curious Accountant

Anyone who owns stock in McDonald’s owns a part of the company. McDonald’s has many owners. In contrast, nobody actually owns the American Red Cross (ARC). The ARC has a board of directors that is responsible for overseeing its operations, but the board is not its owner.

Ultimately, the purpose of a business entity is to increase the wealth of its owners. To this end, it “spends money to make money.” The expense that McDonald’s incurs for advertising is a cost incurred in the hope that it will generate revenues when it sells hamburgers. The financial statements of a business show, among other things, whether and how the company made a profit during the current year.

The ARC is a not-for-profit entity. It operates to provide services to society at large, not to make a profit. It cannot increase the wealth of its owners, because it has no owners. When the ARC spends money to assist flood victims, it does not spend this money in the expectation that it will generate revenues. The revenues of the ARC come from contributors who wish to support efforts related to assisting disaster victims. Because the ARC does not spend money to make money, it has no reason to prepare an income statement like that of McDonald’s.

Not-for-profit entities do prepare financial statements that are similar in appearance to those of commercial enterprises. The financial statements of not-for-profit entities are called the statement of financial position, the statement of activities, and the cash flow statement.