CHAPTER 2

Financial Statements
 OUTCOMES

• Describe the objectives of financial

statements
• Name the 3 major components of financial
statements
• Identify and discuss the components of the
SFP & SPL
 OBJECTIVE OF FINANCIAL STATEMENTS

• Financial Position on a given date

• Economic resources available
• Assets, Liabilities & Equity

• Financial Performance for a specified period (Financial

Year)
• Ability to generate revenue by utilizing assets
• Profits & Losses

• Change in financial position for a certain period

(Financial Year)
• Operating, investment and financing activities
 WHY?

• Users of financial statements:

• Shareholders – existing and potential
• Management
• Providers of debt capital
• Government organisations
• Other stakeholders – customers,
suppliers, stock brokers, trade unions,
etc.
 REQUIREMENTS

• Understandable - logical
• Relevant (enable to evaluate historic, current and future
changes)
• Significant
• Timely
• Reliable
• Accurate
• Objective
• Comparable
• Standardised financial statements
• Financial statements according to accounting guidelines
(IFRS)
• Different guidelines or interpretations to report same item
STATEMENT OF FINANCIAL POSITION
STATEMENT OF FINANCIAL POSITION
(p.9)
 ASSET : NON-CURRENT

• Notice the order in which they are reflected

• Capital investment – applied to generate income
• PPE @ Carrying Value
• Cost
• Accumulated depreciation
• Intangible assets (non-physical but used to generate
turnover)
• Goodwill
• Patent rights
• Manufacturing licenses
• Trademarks
• Computer software
• NB: Difference amortization vs impairment
 ASSETS : NON-CURRENT

• Financial Assets
• Investments in associates
• > 20% < 50%
• > 50% ?
• Other share investments
• < 20%
• Cost
• Loans granted (Interest bearing)
 ASSETS : CURRENT

• Used for relatively short period < 1 year

• Can be converted into cash with relative ease

• Inventories (Required for operations)

• Trade Receivables (Credit sales)
• Other receivables
• Cash and cash equivalents
• Prepayments
• Short term financial assets
• Short term loans and investments
 EQUITY & LIABILITIES

• Forms of capital used to finance assets

• Equity
• Non-Current Liabilities
• Current Liabilities
EQUITY & LIABILITIES
 EQUITY
• Ordinary Shareholders Equity:

• Ordinary Share Capital

• Shareholder’s portion of ownership
• Decreases when there is a buy-back
• Non-distributable reserves
• Cannot be distributed as dividend
• Revaluation Reserve, Capital Redemption Reserve
• Distributable reserves
• Distributable to ordinary shareholders via dividend
• Retained Earnings, General Reserve
 EQUITY

• Preference Share Capital

• Preference right to dividend above the ordinary
shareholder
• Preference share dividends are paid before
ordinary dividends
• Different types :
• Redeemable/non-redeemable
• Cumulative
• Participating
• Convertible
 EQUITY

• Preference Share Capital (continued)

• Sometimes referred to as semi-debt capital
• Characteristics of debt and ordinary shares
• Accounting guidelines prescribe
• Redeemable preference shares treated as
debt
• Dividend seen as finance cost
• Financial Analyst – equity
• Shareholders’ Equity = Ordinary + Preference
Share Capital
 EQUITY: Non-controlling interest (p14)

• If company A owns > 50% of company B

• Classified as subsidiary
• Company A = parent company
• Company A & B financial statements
consolidated
• Assets, Liabilities are added together
• If Co A does not own 100% of Co B
• Part of the assets & liabilities in Co B owned by
outside shareholders
• We account for the minority shareholders’ part in
the non-controlling interest
 EQUITY: Non-controlling interest (p14)

Company A
Assets 925 Capital 1000
Investment in
Company B 75
1000 1000

Company B
Assets 100 Shares:
Owned by A 75
Owned by others 25
100 100
 EQUITY: Non-controlling interest (p14)

Consolidated : Company AB
Assets 1025 Capital 1000
Non-controlling
interest 25
1025 1025
 NON-CURRENT LIABILITIES

• Debt > 1 year

• Interest bearing borrowings
• Long term loans
• Mortgage Loans
• Debentures
• Deferred Tax (p15)
• Difference in treatment of items for tax and
accounting purposes
• NOT considered debt capital when
doing ratio analysis (Chapter 3)
 CURRENT LIABILITIES

• Short term debt = < 1 year

• Trade payables (credit purchases – terms 30-
90 days)
• Other payables (obligations not from normal
operations)
• Short term borrowings
• Bank overdraft
• Current portion of interest-bearing
borrowings (payable within 12 months)
• Current tax liabilities
• Dividends payable
STATEMENT OF PROFIT OR LOSS
 STATEMENT OF PROFIT OR LOSS

• Revenue
• Deduct: Cost of Sales (direct costs + transport,
etc.)
• (Opening Inventories + Purchases – Closing
Inventories)
• = Gross Profit
• Deduct: Operating Expenses (support primary
operating activities)
• Distribution costs
• Marketing and selling
• Admin costs
• = Operating Profit
STATEMENT OF PROFIT OR LOSS

• Add: Investment Income (dividends &

interest)
• Add: Other non-recurring profits/gains
• Deduct: Other non-recurring losses
• Deduct: Finance Costs (interest)
• = Profit Before Tax
• Deduct: Income Tax expense
• = Profit after tax
• Deduct: Non-controlling interest*
• Deduct: Preference share dividends
• = Attributable earnings
 STATEMENT OF PROFIT OR LOSS

• = Attributable earnings
• Deduct: Transfers to reserves*
• Deduct: Ordinary dividends
• Add/Deduct: Extraordinary Items*
• = Retained earnings (for the year)

• Retained Earnings(SFP) (Distributable Reserve –

Equity)
• Cumulative retained earnings/losses from beginning
• Opening balance + movement for current year =
Closing balance
 Statement of cash flows

• Breakdown of the sources and application of cash

• Components
• Cash from operating activities
• Normal operating activities
• Cash flow from investing activities
• Cash generated/spent on investment in assets or
investments (capital & financial)
• Cash flow from financing activities
• Where did the cash come from?

• SFP (p9 Table 1); SPL(p17 Table 2); SCF (p21 Table 3)
• Additional information (p20)
 Operating activities

• Start with EBIT (earnings before interest and tax) in SPL

• Add back : non-cash transactions

• i.e. Accounting entries that represent an expense or
income but not a cash flow ,e.g.
• Depreciation,
• amortisation of intangibles,
• impairment of goodwill,
• gain/loss with sale of PPE/Investment
• Deduct: investment income (dealt with later in SCF)
Changes in net working capital: : in general - did cash
flow into or out of the business?

20X1 20X0 

Inventories 1 750 2 100 350 Asset , cash IN

Trade receivables 2 000 1400 (600) Asset , cash OUT

Prepayments 900 900 0

Trade payables 850 800 50 Liability , cash IN

• Inflow = 350 + 50 = 400; Outflow = 600;
• Net change =
 Cash from operating activities

• Deduct : Finance Cost Paid (SPL)

• Deduct : Income Tax paid (calculation)
• = NET CASH GENERATED BY OPERATING
ACTIVITIES
 Income Tax Paid

Opening balance (Current tax liabilities) 450

Opening balance (Deferred tax liabilities) 300
Plus:
Income tax expense in SPL 1 400
= Total Amount Owed 2 150
Minus:
Closing balance (Current tax liabilities) (300)
Closing balance (Deferred tax liabilities) (500)
= Amount Paid 1 350
 Cash flow from investment activities

• Show the gross cash flow

• Gross proceeds with sale of assets (usually in
additional info)
• Gross purchase price of new PPE (more
complicated) – 3 step process
• Gross purchase price/proceeds with purchase/sale
of intangible assets
• Gross purchase price/proceeds with purchase/sale
of investments
 Purchase price of PPE

3 Accounts affected:
PPE @ Cost Accumulated
6 000 Depreciation 3 200
Open balance (SFP) 4 Open balance (SFP) 1 500
+ Purchases 950
10 + Depreciation (SPL) 4 700
Available 950 Available (100)
(950)
- PPE sold - PPE sold 4 600
10
Close balance (SFP) Close balance (SFP)
000
PPE Sold
Cost price (asset sold) 950
- Acc. Depreciation (100)
Carrying value 850
- Loss PPE (350)
Proceeds 500
Other investing activities:
• Consider movement from year to year on SFP of :
• Intangible assets
• Proceeds
• Payments
• Share investments
• Proceeds
• Payments
• Loans granted
• Proceeds
• Payments
 Cash flow from financing activities

• Where did the cash to finance operations

come from?
• Evaluate SFP items:
• Ordinary shares
• New shares issued?= inflow
• Shares bought back?= outflow
• Preference shares
• New shares issued?= inflow
• Redeemed?= outflow
Dividends paid
Opening balance (Dividends Payable) (SFP) 250
+ Dividends declared (SPL) (Ord + Pref) [50 + 800] 850
Total owed 1 100
- Closing balance (Dividends Payable) (SFP) (400)
Amount paid
 Cash flow from financing activities

• Non-controlling interest
• 2 line items
• Movement in non-controlling interest account
on SFP
• Profit attributable to non-controlling interest
holders
 CASH AND CASH EQUIVALENTS

• Add together the totals of the 3 components:

= Increase/(Decrease) in cash and cash

equivalents
+ Net cash and cash equivalents at beginning of year
(SFP)
• cash, bank accounts, marketable securities and
bank overdrafts
= Net cash and cash equivalents at end of year
(SFP)