financial reporting and analysis slidess

financial reporting

1. © Copyright 2010 John Wiley & Sons Ltd
By John Dunn
[email protected]
ISBN: 978-0-470-69503-6
www.wileyeurope.com/college/dunn

2. Chapter 1
Published accounts
© Copyright 2010 John Wiley & Sons Ltd

3. Some basic “reminders”
•The basic skills from first year are the starting
point for any intermediate course.
•This session will help you to brush up on those
skills.
© Copyright 2010 John Wiley & Sons Ltd

4. The balance sheet equation
•Businesses control assets
•The finance required to control assets must
have been invested by the owners or lenders
•If we list assets, owners’ equity and loans then
the following always holds true:
assets = capital + liabilities
© Copyright 2010 John Wiley & Sons Ltd

5. In practice,
•The balance sheet equation always hold true
because the bookkeeping records reflect
changes in the business in a selective manner.
•Changes usually arise because of transactions.
•Very rarely, changes arise because of
accounting adjustments
© Copyright 2010 John Wiley & Sons Ltd

6. Double entry bookkeeping
Every ‘balance’ (asset, liability,
capital, income, expense) can be
tracked using a page in a book.
•Page a.k.a. “account”
•Book a.k.a. “ledger”
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7. Account balances can only:
•increase
or
•decrease
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8. Types of account
•Assets
•Expenses
–An increase on this side
will be matched by a
corresponding
decrease
•Liabilities
•Capital
•Income
–or an increase on this
side
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9. By convention:
•Each account is ruled down the middle
•The left hand side is called the ‘debit’ side
•The right hand side is called the ‘credit’ side
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10. By convention:
•Increases in assets or expenses are shown on
the ‘debit’ side of their accounts.
•Decreases in assets or expenses are shown on
the ‘credit’ side.
•Capital, liabilities and income are the
opposites of the above.
© Copyright 2010 John Wiley & Sons Ltd

11. The rules of double entry:
IncreaseDecrease
Asset
Expense
DEBIT CREDIT
Liability
Capital
Income
CREDITDEBIT
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12. Example:
•Smith invests £1,000 cash in order to start a
business
•The business borrows £2,000 from the bank
•The business purchases £500 of office
equipment for cash
•The business returns £200 of the equipment
for a cash refund
© Copyright 2010 John Wiley & Sons Ltd

13. Journal entries
•Every debit has a corresponding credit (and
vice versa)
•Think through the easiest part of the entry
first
•Include ‘audit’ information:
–the name of the corresponding a/c
–other references (e.g. to vouchers)
–the date
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14. Example:
•Jones invested £5,000 cash in a business
Debit Bank £5,000
Credit Capital £5,000
Being investment by owner

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15. •The business purchased a vehicle costing
£6,000
–£2,000 cash
–£4,000 on credit
Debit Vehicles £6,000
Credit Bank £2,000
Credit Lender £4,000
Being purchase of vehicle
© Copyright 2010 John Wiley & Sons Ltd

16. Balancing off accounts:
•Bookkeeping is not an end in itself
•It is necessary to extract the net totals from
accounts in order to arrive at:
–Current (book) values for assets, liabilities and
capital
–Totals to date for income and expenses
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17. E.G.
1/1/X4Capital 4,0003/1/X4Equipment 1,000
5/1/X4Loan 7,00012/1/X4Wages 2,500
21/1/X4Insurance 1,100
31/1/X4Bal c/d 6,400
11,000 11,000
1/2/X4Bal b/d 6,400
Bank
© Copyright 2010 John Wiley & Sons Ltd

18. N.B.
•These principles still apply to computerised
bookkeeping packages
•Computers like to print out ‘T’ accounts as
columnar tables
•Columnar tables are more difficult to work
with when you are setting out odd workings
and so they are best avoided in class.
© Copyright 2010 John Wiley & Sons Ltd

19. The asset of inventory
•Receipts of inventory tend to be valued in
either of two ways:
–Purchases @ cost
–Returns from customers @ selling price
•The same problem arises with issues:
–Sales @ selling price
–Returns to suppliers @ cost
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20. •For convenience, the ledger should contain at
least four inventory accounts:
–sales
–purchases
–returns inward
–returns outward
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21. •These accounts cannot keep track of the book
value of inventory on hand or the value
consumed.
•Most businesses have regular ‘inventory
counts’.
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22. The cost of stock consumed =
Opening inventory
+ Purchases
Returns outward
Closing inventory

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23. The trial balance
•It is useful to summarise the various account
balances in the form of a table.
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24. DebitCredit
£000 £000
Administrative Expenses 325
Bank 88
Debenture Interest 7
Debenture Loans 150
Distribution Costs 185
Dividend Income 10
Dividends Paid 75
Fixtures and Fittings 120
Inventory at 31 December 20*2 340
Investments 150
Land and Buildings 595
Plant and Machinery 220
Purchases 970
Rent Income 90
Retained profit at 31 December 20X2 860
Sales 1,480
Share Capital 625
Trade payables 215
Trade receivables 355
3,430 3,430
Note:
The following trial balance was extracted from the books
of HGK, a wholesaler, at 31 December 20*3:
(1) Inventories were physically counted at 31 December
20*3 and valued at £420,000.
(2) The investments are to be treated as current assets.
© Copyright 2010 John Wiley & Sons Ltd

25. •What is the significance of the trial balance
‘balancing’ ?
•What is the significance of the TB total ?
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26. Preparing financial statements
•The objective of financial statements is to
provide information ... that is useful to a wide
range of users in making economic decisions.
IASB
•Figures from the bookkeeping records can be
rearranged to provide information about
–performance
–financial position
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27. Preparing accounting statements
from a trial balance
•This is largely a bookkeeping exercise
•Learn to work methodically
•DON’T PANIC !!
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28. HGK
Statement of comprehensive income
for the year ended 31 December 20X3
£000
Revenue 860
Cost of sales (890)
Gross profit (30)
Other income (note 1) 100
Distribution costs (185)
Administrative expenses (325)
Finance costs (7)
PROFIT FOR THE YEAR (447)
Other comprehensive income: -
TOTAL COMPREHENSIVE INCOME FOR THE YEAR(447)
HGK
Statement of changes in equity
for the year ended 31 December 20X3
Share
capital
Retained
profit
Total
equity
£000 £000 £000
Balance at 31 December 20X2 625 8601,485
Profit for year (447)(447)
Dividend (75) (75)
Balance at 31 December 20X3 625 338 963
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29. Gross profit
•The profit from trading activities, before
allowing for non-trading overheads (e.g. selling
costs or admin) and finance costs.
•Sales from primary trading activities is
compared with cost of sales:
–materials used in manufacturing
–bought in goods for resale
–manufacturing wages
–etc
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30. Net profit
•Gross profit + non-trading income and income
from investments - non-trading expenses and
finance charges.
•Net profit is added to owners’ capital
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31. HGK
Statement of financial position as at 31 December 20X3
£000
ASSETS
Non-current assets
Property, plant and equipment (note 2) 935
Current assets
Inventories 420
Trade receivables 355
Investments 150
Cash and cash equivalents 88
1,013
Total assets 1,948
EQUITY AND LIABILITIES
Equity
Share capital 625
Retained earnings 338
Total equity 963
Non-current liabilities
Debenture loans 150
Current liabilities
Trade and other payables 215
Total liabilities 365
Total equity and liabilities 1,328
© Copyright 2010 John Wiley & Sons Ltd

32. Non-current assets
•Used in the business in the long term
•Two records maintained:
–Non-current assets at cost or valuation
–depreciation to date
•Every year a proportion of cost or valuation is
written off
•This will be dealt with in more detail later in
the course
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33. Notes
(1) Other income
£000
Rent received 90
Dividend income 10
100
(2) Property, plant and equipment
£000
Land and Buildings 595
Plant and Machinery 220
Fixtures and Fittings 120
935
Workings
Cost of sales
Opening inventory 340
Purchases 970
Closing inventory (420)
890
© Copyright 2010 John Wiley & Sons Ltd

34. Notes and workings
•Notes provide additional information without
burdening the financial statements
themselves with undue detail
•Workings are intended to provide an audit
trail to the answer provided in an exam
© Copyright 2010 John Wiley & Sons Ltd

35. Basic mechanics
Read the question:
–what type of business is it ?
–what adjustments still have to be made to the figures
in the trial balance ?
–what items should be highlighted ?
Be proactive - don’t react to the question
–think about the point of the whole exercise
–look for the figures that you require - if you are trying
to reorganise the question to fit a “template” then you
don’t understand
© Copyright 2010 John Wiley & Sons Ltd

36. Practical tips:
Lots of paper:
–(1) Statement of comprehensive income / income statement
–(2) Balance sheet
–(3) Workings
– [(4) Notes - sometimes]
Check things off:
–Tick off the items in the TB and the notes as you go.
–Everything in the TB should be ticked once.
–Everything in the notes should be ticked twice (or not at all).
© Copyright 2010 John Wiley & Sons Ltd