Chapter 60- Interpretation of Financial Statements

Question 1

Two financial statements businesses must have

Answer 1

1. Statement of comprehensive income (profit and loss account), which shows the profit and loss for the year, then shows other items of comprehensive income such as gains made on currency transactions.
2. Statement of financial position (balance sheet), which shows the assets, liabilities and capital of the business.

Question 2

The statement of comprehensive income

Answer 2

Contains:

1. Cost of sales (cost of goods sold)
2. Revenue
3. Gross profit
4. Operating profit
5. Net profit before tax
6. Administrative expenses

Question 3

Stakeholder interest for SCI

Answer 3

The statement of comprehensive income can be used to help evaluate the performance of the business. Consequently, it is likely to be of interest to a range of stakeholders.

Shareholders: Naturally the owners of the business will be interested in the business’ performance. Shareholders are likely to be interested in the profit made by the business – particularly the profit for the year (net profit) after tax. This is an effective guide to the performance of the business., but by no means the only guide.

Managers and directors: Since managers and directors are responsible for running the business, they are likely to use key information In the statement of comprehensive income to monitor progress. For example, they might be setting annual target for growth in revenue for profit for the year (net profit).

Employees: If employees , or their representatives are seeking a wage increase, it may be helpful to have access to some of the information n the statement of comprehensive income when presenting a claim

Question 4

Statement of financial position

Answer 4

Contains:

• Assets
• Liabilities
• Capital

Question 5

Non-current assets

Answer 5

Any assets that are not expected to be sold within 12months. Long term resources of the business.

• Goodwill- intangible assets, not physical assets of the business. Amount business is worth above value of net assets e.g. goof reputation + likelihood customer will return.
• Other tangible assets- usually on PLC balance sheets e.g. brand names, copyrights, and trademarks.
• Property, plant + equipment- tangible assets that the business owns (physical) e.g. property, land, machinery + equipment.
• Investments- financial assets owned by the company e.g. shares held in other companies. Investments listed under non-current = not expected to be sold within 12 months.
• Investments listed under current assets = sold within 12 months.

Question 6

Current assets

Answer 6

Money owned that is expected to be paid back within 12months.
• Borrowings, any short term loans or bank overdrafts.

• Trade + other payables, trade creditors + other amounts
owned by the business to suppliers of goods, services +
utilities.

• Dividends payable, balance sheet prepared, company has decided how much it will pay to shareholders in dividends but has not yet been paid = ‘payable dividends’.
• Current tax liabilities, corporation tax, employees income tax and any other tax owned by the business that must be repaid within 12 months.

Question 7

Non-current liabilities

Answer 7

long term liabilities of a business, money owned for over 12 months.

• Other loans + borrowings, money owned that does not have to be repaid for at least 12 months.
• Retirement pension obligations, companies need to show any money owed to past employees in the form of pension obligations.
• Provisions, have to be made if company likely to incur expenditure in future. Such expenditure results from agreements or warranties.

Question 8

Current liabilities

Answer 8

Any money owed by the business that is expected to be repaid within 12 months is called a current liability

• Borrowings – any short-term loans or bank overdrafts taken out by the business.
• Trade or other payables – Trade creditors and other amounts owed by the business to suppliers of goods, services and utilities.
• Dividends payable – When the balance sheet is prepared, it is possible that the company has decided how much it will pay to shareholders in dividends.

Question 9

Net assets

Answer 9

The value of all assets – value of all liabilities = same value as shareholders’ equity at bottom of balance sheet.

Question 10

Equity

Answer 10

Bottom of balance sheet shows amount of money owed to shareholders + will contain share capital + reserves.

• Share capital, amount of money paid by shareholders for their shares when they were originally issued.
• Share premium account, shows the difference between the value of new shares issued by the company + their nominal value.
• Other reserves, any amounts owning to the shareholders not covered by other entries under equity.
• Retained earnings, same as retained profit. Amount of profit retained by the business to be used in future e.g. to fund investment projects.

Question 11

Stakeholder interest in statement of financial position

Answer 11

Shareholders: Shareholders might use the balance sheet to analyse the asset structure of the business. This shows how the funds raised by the business have been put to use.

Managers and directors: The balance sheet might be used by the management of a business. For example, it is important for senior managers to be aware of the firm’s financial position at any given point in time. It will need to monitor working capital levels to ensure that the business does not overspend.

Suppliers and creditors: Suppliers will be most interested in the solvency of the business. Suppliers are not likely to offer trade credit to a business that has only a limited amount of working capital.

Question 12

Finance Cost

Answer 12

Interest paid by a business on any borrowed money.

Question 13

Finance Income

Answer 13

Interest received by a business on any money held in deposit accounts