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Accounting and Finance for Managers

Financial Accounting and Reporting

Lesson Description
This lesson explains about corporate financial reporting. On the
completion of this lesson, the student will be able obtain
knowledge on the preparation and presentation of key financial
statements, analysis and interpretation of them.

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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What is Corporate Reporting?


Corporate financial reporting reflects not only the companys financial
statements but also outline the importance of financial data. It also reflects
on the application of financial policy. The true financial position of the
company will be reflected through a good financial reporting system. It helps
the management to detect any critical issues the company is encountered
with. As a result, the decision taken will be more effective.
The system of preparing corporate financial reports is generally known as
corporate financial reporting. These reports include Income statement.
Statement of financial position, statement of cashflow, statement of retained
earning etc. Usually, these reports are prepared monthly, quarterly or
annually.

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Businesses Need to Prepare Financial Statements


The main reason to prepare financial statements is to satisfy people with an interest on
companys financial performance. These could include:
Owners: Interested in business profitability and how well it is being run.
Managers: Interested in the companys financial situation to understand how to plan
and manage the business effectively in the future.
Banks: Banks would see whether the businesses can afford the loan repayments and
overdrafts.
Employees: Interested in the companys financial position and the impact it has on
jobs and wages.
Suppliers and Customers: Assess the financial stability of the business to ensure it
enables to make payments/ supply goods as needed.

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The elements of the financial statements


To report a businesss financial position and performance, financial statements need
to summarise five key elements as follows:
1. Assets:
An asset is a resource under the control of an entity due to past events, through
which future economic benefits are expected to flow to the business. For instance,
a business premises owned by the company which is being used for production and
ultimately assist to generate revenue is classified as an asset.
2. Liabilities:

An obligation to transfer economic benefits due to past transactions or events is


known as a liability. For instance, an unpaid tax obligation is a liability.
Source: Kaplan Financial Knowledge Bank (2012)
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The elements of the financial statements contd


3. Equity: This is the residual interest in a business and represents what is left
when the business is wound up, all the assets sold and all the outstanding
liabilities paid. It is effectively what is paid back to the owners (shareholders)
when the business ceases to trade.

4. Income: This is the recognition of the inflow of economic benefit to the entity
in the reporting period. This can be achieved, e.g. by earning sales revenue or
through the increase in value of an asset.
5. Expenses: This is the recognition of the outflow of economic benefit from an
entity in the reporting period. This can be achieved, e.g. by purchasing goods or
services off another entity or through the reduction in value of an asset.
Source: Kaplan Financial Knowledge Bank (2012)

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Categorisation of Assets
Assets

NON CURRENT ASSETS


Any tangible or intangible asset
acquired on a long-term basis to
be used in providing a service to
the business.
Not held for resale in the normal
course of trading. e.g: Land &
buildings, Motor vehicles

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CURRENT ASSETS
Assets which are expected to be
realised during the normal course of
business trading are current assets.
Disclosed in the statement of
financial position with the least
liquid item first (usually inventory,
Receivables, Cash in hand)

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Categorisation of Liabilities
LIABILITIES
Liabilities are business
obligations to outside parties

NON-CURRENT LIABILITIES
Long term liabilities are
payable after an year of the
reporting date.
e.g. Long term loan

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CURRENT LIABILITIES
These are payable within 12
months of the reporting date.
e.g. Payables, Bank overdraft,
Short term loans

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The Components of a Set of Financial Statements


The statement of Financial Position:
Assets, liabilities and equity balances of the business are summarised in this
statement at the end of the reporting period. Earlier this was called the
balance sheet.
The statement of Comprehensive Income:
This statement summarises the revenues earned and expenses incurred by
the business throughout the entire reporting period. Earlier this was called the
profit & loss account.

The statement of Changes in Equity:


The movement in equity balances (share capital, share premium, revaluation
reserve and retained earnings) from the beginning of the reporting period to
the end is summarised in this statement.
Source: Kaplan Financial Knowledge Bank (2012)
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The statement of Cash Flows:

This statement includes cash inflows and outflows of actual receipts


and payments during the reporting period.
The Notes:

These comprise the accounting policies disclosures and any other


disclosures required to enable to the shareholders to make informed
decisions about the business.

Source: Kaplan Financial Knowledge Bank (2012)

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The Qualitative Characteristics of Financial


Information
To make financial statements useful to the business stakeholders, they need to
embody certain qualitative characteristics. They are:
1. Relevance:
If information has the ability to influence the economic decisions of the users and is
provided on time to influence those decisions then such information is considered to
be relevant.
2. Reliability:

If information is reliable, then it should have been a faithful representation, free from
material misstatements, neutral, complete and prudent.

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3. Comparability:
It should be possible for users to compare financial information relating to the
entity over time and against other business entities. To this end accounting
treatments should be applied consistently from year to year and should be
disclosed in the financial statements.
4. Understandability:
This means that the financial statement users can understand them. The
assumption is that these users have a reasonable knowledge of business and
economic activity. Even so, the information must be understood by the audience to
be of any use.

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Other Important Accounting Concepts


The Business Entity Concept:
This accounting principle means that the financial accounting information presented
in the financial statements relates only to the business activities and not to the owner.
From an accounting perspective, the business is treated as being separate from its
owners.
The Accruals Concept:
This means that transactions are recorded when revenues are earned and when
expenses are incurred only. As per this concept, there is no regard to the timing of the
cash payment or receipt.

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The Going Concern Concept


Financial statements are prepared on the basis that the entity will continue to
trade for the foreseeable future. (i.e. it has neither the need nor the intention to
liquidate or significantly curtail its operations.)

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The Income Statement


This statement summarises the income earned and expenses incurred during the financial
period.
XYZ Group
Income Statement for the year ended 31 December XXXX
$

Revenue
(-) Cost of sales
Gross profit
(-) Distribution costs
Administrative expenses
Profit from operations
+ Investment income
(-) Finance costs
Profit before tax
(-) Tax expenses
Net profit for the period

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xx
(x)
xx
(x)
(x)
xx
x
(x)
xx
(x)
xx

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The Statement of Comprehensive Income

This is an extension of the income statement. This is used because certain


business gains during the year are not actually realised gains. A good example is
the revaluation of assets. In this situation, the gain is not realised until it being
sold and obtained cash. Hence, revaluation only reflects a hypothetical gain if it
had been profitable.

Due to this reason, it shouldnt be included in the net profit for the period
which reflects profits earned through realised sales. Instead, the unrealised
gains are added to the income statement.

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Statement of Comprehensive Contd


Statement of comprehensive income for XYZ for the year ended 31 December XXXX
$
Revenue

xx

(-) Cost of sales

(x)

Gross profit

xx

(-) Distribution costs

(x)

Administrative expenses

(x)

Profit from operations

xx

+ Investment income

(-) Finance costs

(x)

Profit before tax

xx

(-) Tax expenses

(x)

Net profit for the period

xx

Other comprehensive income:


Gain/loss on property revaluation

Total comprehensive income for the year

xx

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Relationship between the Income Statement and


Statement of Financial Position
The link between the statement of financial position and income statement is shown
below:
Statement of Financial Position
at the start of the period

Income Statement

Statement of
Comprehensive Income

Profit/Loss

Cash in

Movement of cash to/from


shareholders

Cash out

Statement of Financial Position


at the end of the period

Source: Kaplan (2013/14)


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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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The Statement of Financial Position


This summarises the assets, liabilities and equity balances (i.e. the financial position of
the company) at the end of the accounting period.
IAS 1 requires assets and liabilities to be classified as either current or non-current.
Statement of financial position for XYZ at 31 December XXXX
$m

$m

Non-current assets
Property, plant and equipment

Investments

Intangibles

x
x

Current assets
Inventories

Trade and other receivables

Prepayments

Cash

x
x

Total assets

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xx

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The Statement of Financial Position Contd


Equity
Ordinary share capital

Irredeemable preference share capital

Share premium

Reserves
Retained earnings

x
x

Non-current liabilities
Loan notes

Current liabilities
Trade and other payables

Overdrafts

Tax payable

x
x

Total equity and liabilities

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Current Assets and Current Liabilities


The suggested statement of financial position format makes a distinction between
current and non-current assets and liabilities. IAS 1 sets down the rules to be applied
in making this distinction.
Current Assets
An asset should be classified as a current asset if it is:
Held primarily for trading purposes
Expected to be realised within 12 months; or
Cash or a cash equivalent (i.e. a short term investment, such as a 30 day bond).

All other assets should be classified as non-current assets.


This definition allows inventory or receivables to qualify as current assets, even if
they may not be realised into cash within twelve months.

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Current Liabilities
The rules for current liabilities are similar to those for current assets.
A liability should be classified as a current liability if:
It is expected to be settled in the normal course of the enterprises operating
cycle
It is held primarily for the purpose of being traded
It is due to be settled within 12 months of the statement of financial position
date or
The company does not have an unconditional right to defer settlement for at
least 12 months after the statement of financial position date.

All other liabilities should be classified as non-current liabilities.

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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IAS 7 Statement of Cash Flow


The objectives of IAS 7 are to ensure that companies:
Report their cash generation and cash absorption for a period by highlighting the
significant components of cash flow in a way that facilitates comparison of the
cash flow performance of different businesses.
Provide information that assists in the assessment of their liquidity, solvency and
financial adaptability.
Format of a Statement of Cash flow
IAS 7 Statement of Cash flows requires companies to prepare a statement of cash
flows as part of their annual financial statements. The cash flow must be presented
using standard headings.

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Statement of Cash Flow


Statement of cash flow for the period ended 31 December XXX
$000

$000

Cash flows from operating activities


Cash generated from operations

Interest paid

(x)

Dividends paid

(x)

Income tax paid

(x)

Net cash from operating activities

Cash flows from investing activities


Purchase of property, plant and equipment

(x)

Proceeds of sale of equipment

Interest received

Dividends received

Net cash used in investing activities

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(x)

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Statement of Cash Flow Contd


Statement of cash flow for the period ended 31 December XXX
$000

$000

Cash flows from financing activities

Proceeds of issue of shares

Repayment of loans

(x)

Dividends paid

(x)

Net cash used in financing activities

(x)

Net increase in cash and cash equivalents

Cash and cash equivalents at the beginning of the period

Cash and cash equivalents at the end of the period

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Cash Generated from Operations


There are two methods of calculating cash from operations namely direct and indirect
method. The method used will depend upon the information provided.
Direct method:This method uses information contained in the company ledger
accounts to calculate the cash from operations figure as follows:
$

Cash sales

Cash received from receivables

x
x

Less:

Cash purchases

Cash paid to credit suppliers

Cash expenses

x
(x)

Cash generated from operations

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Inventory
At the end of the year, two basic adjustments are required to recognise opening &
closing inventories in the correct place.

1. Inventory brought forward from the previous year is assumed to have been used to
generate assets for sale. It must be removed from inventory assets and recognised
as an expense in the year.
Dr Opening inventory in costs of sales
Cr Inventory assets
2. The unused inventory at the end of the year is removed from purchase costs and
carried forward as an asset into the next year
Dr Inventory assets
Cr Closing inventory in cost of sales
Once these entries have been completed, the cost of sales account contains both
opening and closing inventory and the inventory ledger account shows the closing
inventory for the asset remaining at the end of the year.
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Valuation of Inventory
Inventory consists of:
Goods purchased for resale
Consumable stores (such as oil)
Raw materials and components (used in the production process)
Partly- finished goods (usually called work in progress- WIP)
Finished goods (which have been manufactured by the business)

IAS 2 Inventories
Inventory is included in the statement of financial position at:
COST
THE LOWER OF
NET REALISABLE VALUE

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Non- current Assets


Non-current assets are different from current assets because they:
Are long-term in nature
Are not normally acquired for resale purposes
Could be tangible or intangible
Are used to generate income directly or indirectly for a business
Are not normally highly liquid assets (i.e. not easily and quickly converted into cash
without a significant loss in value).
The cost of a non-current asset is any amount incurred to acquire the asset and bring it
into working condition. This includes capital expenditure costs such as:
Purchase price
Delivery costs
Legal fees
Subsequent expenditure which enhances the asset
Trials and tests
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Depreciation of Non-current Assets


IAS 16 Property, Plant and Equipment, defines depreciation as the measure of the
cost or revalued amount of the economic benefits of the tangible non-current asset
that has been consumed during the period.
Methods of calculating depreciation:
Straight LineDepreciation charge is the same each year as it is assumed that the benefit is
consumed evenly.
Depreciation charge= (Cost- Residual value)/ Useful life
Reducing BalanceA reducing amount of depreciation is charged each year. Hence, it assumes that more
benefit is consumed in earlier years.
Depreciation charge= X% x carrying value (CV)

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Research and Development Cost


Research Costs

All research expenditure should be written off in the income


statement as it is incurred. This is in compliance with the prudence
concept.
Research expenditure does not directly lead to future benefits.
Therefore, it is not possible to comply with the matching concept.
Any capital expenditure on research equipment should be capitalised
and depreciated as normal.

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Research and Development Cost


Development Costs
Development expenditure must be capitalised as an intangible asset provided it
meets below criteria:
- Separate project
- Expenditure identifiable and reliably measured
- Commercially viable
- Technically feasible
- Overall profitability
- Resources available to complete
If the above criteria are not met, development expenditure must be written off to
the income statement as it is incurred.
Once such expenditure has been treated as an expense, it cannot be reinstated as
an asset.

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Substance over Form


Substance over form is an accounting concept and is a particular concern under
Generally Accepted Accounting Principles (GAAP).

It states that economic substance of transactions and events must be recorded in


the financial statements rather than the legal form simply to present a true and fair
view of the entity affairs.
Main point is that a transaction shouldnt be recorded in a manner to hide the true
intent of it that would mislead readers of company financial statements.

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial instruments

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Capital Instruments
A capital instrument is any contract that gives rise to a financial asset of one entity and
a financial liability or equity instrument of another entity. They are the securities used
to obtain equity or loan capital for a company.
FINANCIAL
LIABILITIES

FINANCIAL
ASSETS
FINANCIAL
INSTRUMENTS
EQUITY CAPITAL

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DEBT

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Financial Asset
An asset that is:
-cash
-a contractual right to receive cash or another financial asset from another entity
-a contractual right to exchange financial assets/liabilities with another entity under
conditions that are potentially favourable .
-an equity instrument of another entity.
e.g. Trade receivables, options, investment in equity shares

Financial Liability
It is any liability that is a contractual obligation:
-to deliver cash or another financial asset to another entity, or
-to exchange financial instruments with another entity under conditions that are
potentially unfavourable, or
-that will or may be settled in the entitys own equity instruments
e.g. Trade payables, Debenture loans, Redeemable preference shares

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Topics:

What is corporate reporting?

The elements of the financial statements

The components of a set of financial statements

The qualitative characteristics of financial information

The Income Statement

The statement of Comprehensive Income

The statement of Financial position

Statement of Cash flows

Capital instruments

Interpreting financial information

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Interpreting Financial Information


Profitability Ratios:
Gross profit margin= Gross Profit
Sales Revenue

X 100

Operating profit margin= Profit Before Interest and Tax (PBIT) X 100
Sales Revenue
ROCE= Operating Profit
X 100
Capital Employed
Net Asset Turnover=
Sales Revenue
Capital Employed (Net assets)

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Interpreting Financial Information Contd


Liquidity & Efficiency ratios:
Current Ratio: Current Assets
Current Liabilities

:1

Quick ratio= Current Assets Inventory


Current Liabilities

Inventory Turnover Period= Inventory


COS

:1

x 365 days

Receivables Collection Period= Trade receivables


Credit Sales

x 365 days

Payables payment period= Trade Payables x 365 days


Credit Purchases

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Interpreting Financial Information Contd


Financial Position:
Debt/ Equity Ratio= Long term debt
Equity
Interest Cover=

PBIT
Interest Payable

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Limitations of Ratio Analysis


Ratios based on historical cost accounts do not give a true picture of year to
year trends. Sometimes, an increase in profit may not be a true increase, due
to inflationary effects.
Financial statements only reflect those activities which can be expressed in
monetary terms. They do not give a complete picture of the business activities.
The application of accounting policies in the preparation of financial statements
must be understood when attempting to interpret financial ratios.
Ratios must not be used as the sole test of efficiency. Concentration on ratios by
managers may inhibit the incentive to grow and expand, to the detriment of the
long-term interests of the company.
A few simple ratios do not provide an automatic means of running a company.
Business problems usually involve complex patterns which cannot be solved
solely by the use of ratios.

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Thank You

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