Financial Statesment

What do we already know about financial statements (FS)?
FS are intended for external users.
FS contain summarised information.
FS reflect the company's past.
FS are prepared on a regular basis.
FS are required by law.
FS are prepared in accordance with GAAP.

The objective of general purpose FS is
to provide information about
the financial position,
financial performance,
and cash flows of an entity
that is useful to a wide range of users in making economic decisions.

Set of financial statements
1) a statement of financial position (balance sheet)
2) a statement of comprehensive income (income statement / profit and loss account)
3) a statement of cash flows
4) a statement of changes in equity
5) explanatory notes

Assumptions
Accruals basis. The effects of transactions and other events are recognised when they occur (and not when cash is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.
Going concern. The entity is normally viewed as continuing its operation for the foreseeable future: the entity has neither the intention nor the necessity of liquidation or of curtailing materially the scale of its operations.

Qualitative characteristics
Fundamental characteristics
Relevance. Information influences the economic decisions of users and has predicative and confirmatory value.
Faithful presentation. Information must be complete, neutral and free from error.
Other characteristics
Comparability
Understandability
Timeliness

The Balance Sheet
The Statement of Financial Position (SOFP)

The Balance Sheet
ASSETS
The fundamental accounting equation:
Assets = Liabilities + Equity (Owners' capital)

What is an asset?
something that we own
cash
furniture
vehicles
inventory
equipment
land

Definition of an asset (IAS)
“A resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity”.
The definition has three important characteristics:
Future economic benefits
Control (ownership)
Transaction to acquire has taken place

ASSETS

Assets are NOT manna from heaven!
Sources / Claims on assets
Owners
Creditors
A company's assets can be financed through borrowing (liabilities) or by paying the owners' money (equity)
ASSETS

What is a liability?
something that we owe
to banks
to staff
to the government
to suppliers

The definition of a liability (IAS)
“An obligation of an entity to transfer economic benefits as a result of past transactions and events”.
The definition has three important characteristics:
1. Obligation (something that we cannot avoid)
2. Transfer of economic benefits
3. Result of past transactions and events

LIABILITIES

OWNERS' CAPITAL (EQUITY)
something that belongs to the entity`s owners
It includes:
- contributed capital (share capital)
- retained profits (earnings)

Bringing it all together...
THE BALANCE SHEET
This balance sheet is prepared in an INCREASING order of liquidity.
LIQUIDITY

Bringing it all together...
THE BALANCE SHEET
This balance sheet is prepared in a DECREASING order of liquidity.
LIQUIDITY

A balance sheet is a snapshot of a company at a moment in time .
It shows the company's financial position (assets, liabilities and equity) as of a particular (reporting) date.

Mechel's balance sheet (prepared under the RAS))

Consolidated balance sheets for L'oreal (prepared under the IFRS)

No matter what transactions a company enters into
the equation
assets = liabilities + capital
is ALWAYS true!

Explain how the transactions will affect the balance sheet:
Transaction 1
Costas has decided to set up in business selling football shirts from a stall in a market place. He begins by putting $3,000 in a bank account for the business.
Cash 3,000
Capital contributed 3,000
3,000
3,000

Transaction 2
Costas then obtains a 5-year loan of $4,000 from his brother.
Cash 3,000
Capital contributed 3,000
3,000
3,000
Loan 4,000
+ 4,000
+ 4,000
+ 4,000

Transaction 3
Costas then purchases a market stall and pays $2,000 in cash.
Cash 7,000
Capital contributed 3,000
7,000
7,000
Loan 4,000
Fixed assets 2,000
-
-2,000

Transaction 4
Costas now buys some football shirts for $1,800 on credit.
Cash 5,000
Capital contributed 3,000
7,000
7,000
Loan 4,000
Fixed assets 2,000
-
Inventory 1,800
Accounts payable 1,800
+1,800
+1,800

Transaction 5
Costas now sells 50% of its shirts (cost $900) for $1,200 in cash.
Cash 5,000
Capital contributed 3,000
8,800
8,800
Loan 4,000
Fixed assets 2,000
-
Inventory 1,800
Accounts payable 1,800
- 900
+ 1,200
Profit 300
+ 300
+ 300

Things to remember...
Internally generated intangibles (expertise of the staff, the reputation of the business) are NOT normally recognised as assets in the balance sheet.
Net assets of a company (total assets — total liabilities) can be different from the value placed by the company's buyers.