The Accounting Fives

by Chad Thompson

files/pages/blog/blog-images/Other/5Ball.jpgA few months ago, I posted an article titled "Internal Controls and the Five Senses." More recently, I discussed the five methods used to project sales when performing an income loss evaluation. Two fives. A coincidence? Maybe not; as it turns out, five is quite popular in accounting. This is a strange observation since five is an odd number and accounting is all about symmetry and balance.

After the five senses of internal controls and five methods for projecting sales, the other five that comes to mind is the five components to a set of financial statements: balance sheet, income statement, cash flow statement, retained earnings statement and disclosures.

Speaking of financial statements, CPAs are the only licensed professionals allowed to express an authoritative opinion on them. They express this opinion by first conducting an audit. When a CPA performs an audit, he or she is validating a number of assertions inherent in the financial statements. How many assertions, you ask? Five, of course! The five financial statement assertions are listed below:

  1. Existence or occurrence - Transactions reflected in the accounting records have actually occurred and assets reflected on the balance sheet actually exist.
  2. Completeness - The financial statements include all material transactions.
  3. Rights and obligations - The company has actual rights to its assets and is obligated for the balance sheet liabilities.
  4. Valuation - All items are properly valued (historical cost, lower of cost or market, net realizable value, etc.).
  5. Presentation/disclosure - The financial statements are presented properly and include all relevant and required disclosures.

The five assertions are drilled into every auditor's head. Every auditor was once an auditing student. As students, we learned the auditing procedures. Since there were so many auditing procedures, someone along the way created a clever acronym to package them - FIVE CARROTS. Another five! In case you are wondering, the acronym stands for: Footing/crossfooting, Inquiry, Vouching, Examination, Confirmation, Analytical procedures, Reconciliation, Recalculation, Observation, Tracing and Subsequent event review.

The occurrence of fives is interesting, so I considered this phenomenon further. While the five financial statement components, five assertions and the five-based acronym are an impressive string of fives, I thought there must be something bigger. So I looked back to the basis for all of accounting. The accounting equation: Assets = Liabilities + Equity. But that's only three components. Or is it?

Equity is a multilayered component. It includes contributed capital and earned capital. But even if we split equity into two pieces, that still just leaves four components to the accounting equation. Well, to make the equation clearer, equity needs another split. Earned capital is a nebulous sounding term. In essence, it represents profits. And even those who are not accountants know that profits represents the difference between sales and expenses. I have now laid out the world of accounting: assets, liabilities,contributed capital, sales and expenses. Thus, the accounting equation in its purest form is: Assets = Liabilities + Contributed Capital + Sales - Expenses. There you have it; while hidden from the untrained eye, the accounting equation actually does have five components!

I think I'm on to something with these fives. I'm beginning to think the "high-five" might have been started by a group of accountants after they performed the profession's first closing of the books. At this point, it might be worth googling!

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