Accounting analysis

Question 1

The Purpose of Financial Statements

Answer 1

Statement of Financial Position (IAS1) – Balance sheet
Income statement
Cash flow statement – Statement of cash flows (IAS1)
Additional reports
• Independent auditor’s report
• Notes to the accounts
• Shareholder information
• Reports to analyse corporate performance
- Strategic report
- Stakeholder review
- Financial review
- Directors remuneration

Question 2

Additional information

Answer 2

In addition to the statements opposite, companies may also produce:
• Statement of other comprehensive income
• Statement of changes in equity
• Comparative figures from the previous year’s financial statements
• Explanatory notes to accompany certain individual statements of financial position and profit and loss account items
• Disclosure of the company’s accounting policies

Question 3

Accounting standards

Answer 3

• The form and content of company financial statements are prescribed by laws and mandatory accounting standards

• Generally accepted accounting principles (GAAP)
• Often country specific

Question 4

International Accounting Standards Board (IASB)

Answer 4

• To achieve transparent and comparable financial statements to global accounting standards

• International financial reporting standards (IFRS)
• International accounting standards (IAS)

Question 5

Listing rules

Answer 5

• Many exchanges will require additional disclosure by traded companies
- Interim report

Question 6

The Accounting Equation

Answer 6

Assets = Equity + Liabilities

Non-current assets + Current assets = Capital + Reserves + Liabilities

Question 7

Non-current assets (fixed assets)

Answer 7

• Typically assets intended to be used by the business for more than one year
• Intangible non-current assets
- Expected to generate future revenue but have no physical substance
• Goodwill
• Trademarks
• Patents
• Tangible non-current assets
- Expected to generate future revenue and have physical substance
• Property, plant and equipment (PPE)
• Valued at net book value (NBV)
• Non-current asset investments
- Generally shares in other companies intended to be held for greater than one year

Question 8

Current assets

Answer 8

• Assets held for conversion into cash
• Inventory (stock)
- Raw materials
- Work-in-progress
- Finished goods
• Trade receivables (debtors)
- The amount the company is owed on the statement date
• Trade debtors
• Prepayments
• Cash

Inventory is valued prudently at the lower of cost and net realisable value.

Question 9

Share capital and share premium account

Answer 9

• Share capital
- Nominal value of total shares in issue
• Share premium
- Any excess above the nominal value raised on issue

Question 10

Reserves

Answer 10

• The amount belonging to shareholders that is retained by the company
• Revaluation reserve
- Created when a company revalues its assets from cost to market value
• Retained earnings (profit and loss reserve)
- Running total of retained earnings

Question 11

Liabilities

Answer 11

• Current liabilities
- Amount owed by the company and due for payment within one year
• Trade payables (creditors)
• Accruals
- Expenses not yet invoiced
• Non-current liabilities
- Amount owed by the company and due for payment after one year
• Long-term bank loans
• Bonds issued by the company
• Provisions
- E.g. Doubtful debt

Question 12

Depreciation

Answer 12

• Tangible non-current assets recorded on statement of financial position at net
book value (NBV)
• Annual depreciation charge
- Straight line method
• Freehold land
- Not depreciated

Question 13

IAS33:

Answer 13

Requires earnings per share ratio and diluted earnings per share to be shown at the foot of the income statement.

Question 14

Contents of Income Statement

Answer 14

• Income generated by a company from selling its goods and services
• Recognised at point of sale
• Recognition can be apportioned over several accounting periods for long term contracts

Question 15

Cost of sales (cost of goods sold)

Answer 15

Revenue (Turnover)
• Income generated by a company from selling its goods and services
• Recognised at point of sale
• Recognition can be apportioned over several accounting periods for long term contracts
Cost of sales (cost of goods sold)
• Costs directly associated with the cost of producing a product or service
Other operating costs
• More general costs of running a business
- Selling
- Distribution
- Administrative expenses
Operating profits
• Profit before interest and tax (PBIT)

Question 16

Capital vs. revenue expenditure

Answer 16

• Expenditure
- Money spent by the company
• Capital expenditure
- Money spent to buy non-current assets
- Reflected on the statement of financial position
• E.g. Purchase of property, purchase of plant and machinery
• Revenue expenditure
- Immediately impacts the income statement
• E.g. Wages, rent, professional fees

Question 17

Cash flow types

Answer 17

Free cash flow
The cash available after all expenses and reinvestments needed to maintain the operating capacity of the business have been made.
Enterprise cash flow (free cash flow to the firm)
• The free cash flow before considering payments made to any of the providers of finance to the firm (both debt and equity holders)
• Comparable cash flow irrespective of capital structure
Equity cash flow (free cash flow to equity)
• This is a measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment
• Includes all debts related cash flows

Question 18

Stuff on the cash flow statement

Answer 18

Operating activities (cash receipts and paid, income taxes paid, net cash from operating activities).
Investing activities (interest received, dividends received, proceeds on disposal of non-current assets, net cash used in investing activities)
Financing activities (equity dividends paid, repayment of debt, proceeds on issue of bonds or equities, bank loans raised, increase/decrease in bank overdrafts, net cash from financing activities, net increase/decrease in cash and cash equivalents.

Question 19

Profit v cash

Answer 19

Because of the difficulty in arriving at free cash flow from the cash flow statement, many users calculate a free cash flow figure from the income statement.
This is generally arrived at by taking the operating profit from the income statement, then making adjustments. For example:
• Non-cash expenses (such as depreciation) are added back to profits
• Any increase in current assets, or decrease in current liabilities, must be subtracted from profits
• Any decrease in current assets, or increase in current liabilities, must be added to profits

Question 20

Consolidating the accounts if the subsidiary is not entirely owned:

Answer 20

• 100% of the assets, liabilities, revenues and expenses of the subsidiary added
• Minority interest in shareholders’ funds on the statement of financial position
• Minority interest in the income statement after income tax expense