AF2101 Intermediate Financial Accounting 1

1 LECTURE 3 – Slide deck of pre-recorded conten

Preparation and Regulation of

Financial Statements
(Published Accounts)

Dr Danielle Lyssimachou
 Have you ever wondered:
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 What information is available in the Annual Report?

 Which parts of it are regulated and which are not?

 How published accounts for listed companies are

supposed to be presented?
 Why different Financial Statement formats exist and
whether there is any regulation dictating this?
 Learning Objectives:
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 Know and be able to apply the formats for

published accounts

 Understand and be able to prepare the related

workings for published accounts formats

 Discuss the adequacy of the disclosure

requirements
4 The Annual Report
 How is financial accounting information
communicated?
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• Via the ANNUAL REPORT (also known as ‘the

accounts’ or ‘the financial statements’).
• The Annual report actually contains more than the
financial statements

• Plus INTERIM information – semi-annual reports

are now fairly standard.
• Some companies produce quarterly reports and other
management updates which include financial
information.
Main users of financial information relating to a business

Owners Customers Competitors

Employees
Managers and their
representatives

Business

Lenders Government

Investment Community
Suppliers representatives
analysts

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 The Annual Report
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 The annual report is the means

by which the directors are
accountable for their stewardship
of the assets and their handling of
the company’s affairs for the past
year.
 It consists of:
 Narrative material (some of
which is regulated)
 Audited financial data
8
 The Annual Report – Narrative
9
material
Narrative reporting
• At a glance (highlights)
• Chairman’s statement, Chief Executive’s review, strategy and
board overview
• Directors’ report (business review) (split into sections)*
• Remuneration report*
• Corporate Governance Report *
• Auditors’ report*
• Statement of directors’ responsibilities*

* Content regulated 9
 Narrative material: in more detail
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 Format will vary from company to company, usually

with statements from Chairman, CEO, possibly FD
 Will contain a business review, which will
incorporate an operating review, a corporate
responsibility review and a financial review
 Purpose is to:
 explain what has been achieved in the current year; and
 assist existing and potential investors to make their own
predictions of cash flows of future years
 Narrative material: forward-looking
statements
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 Will incorporate aspects relating to the future:

 Prognosis e.g.
 directors expect sales to increase in the current financial
year, with even stronger growth in earnings, provided no
unforeseen events occur;
 Corporate strategy e.g.
 how to deal with any low profitability segments,
possible divestments or acquisitions.
 Narrative material: Directors’ Report
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 Required items in this

section:
 Statement about
employee involvement
 Principal activities
 Number of employees
 Business review with disabilities
 Future developments  Donations to charities
 R&D activities /political parties
 Post balance sheet  Purchase of own shares
events  Information about
 Value of land and directors
buildings  Policy on creditor
payment
 Annual Report – Audited Financial
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Statements
 The Annual Report:
Criteria for information in Published
14 Accounts
 Format complies with IAS 1 and statute
 Financial statements should present a fair view
of profits and assets and liabilities
 Accounting policies comply with IFRSs/statute
 IAS 1 requires compliance with fundamental accounting
principles:
 Accruals, materiality and aggregation, going concern,
consistency
 IAS 1 requires companies to disclose the accounting
policies adopted in determining the amounts shown in
the financial statements and to apply them consistently
 The Financial Statements
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According to IAS 1, a complete set of financial

statements comprises:
1.A statement of Financial Position (SoFP)
2.A statement of Comprehensive Income (SoCI)

3.A statement of Changes in Equity (SoCE)

4.A statement of Cash Flows (SoCF)

5.Notes (comprising a summary of significant accounting

policies and other explanatory information)
 IAS 1 – Presentation of Financial
Statements
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 The prescribed formats:
1. The Statement of Financial Position
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The minimum information that

must be presented on the face of  Trade and other payables
the BALANCE SHEET:
 Provisions
 Financial liabilities
 Property, plant & equipment
 Liabilities and assets for
 Investment property current tax
 Intangible assets  Deferred tax liabilities and
 Financial assets assets
 Investments accounted for
using the equity method  Non controlling interests
(within equity)
 Inventories  Issued share capital and
 Trade and other receivables reserves attributable to equity
 Cash & cash equivalents holders of the parent
 The prescribed formats:
1. The Statement of Financial Position (cont)
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 IAS 1 does NOT prescribe the order and

presentation of the balance sheet!
 For example:
 Total Assets = Total equity & liabilities
 Assets – Liabilities = Net Assets = Equity

 Not a strict requirement, but suggested if relevant:

 Splitting assets & liabilities into current & non-current
 Present assets & liabilities broadly in order of liquidity
 2. Statement of Comprehensive Income
(SoCI)
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 IAS 1 gives the requirements for the way in which

performance (and last year’s comparatives) are reported.
 Purpose: to present all income and expense recognised
in the period.

 Choice of presentations:
 Single Statement OR
 a Double Statement that essentially splits the required
information into:
 (1) profit and loss (i.e. an I/S) and
 (2) a statement that starts with profit or loss and then adds other
comprehensive income.
 What is meant by Comprehensive
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Income?

Total Comprehensive Income recognises the gains and

losses, both realised and unrealised, that have increased
or decreased the owners’ equity in the business.

Such gains and losses arise, e.g. from the revaluation of

non-current assets and from other items (e.g. Financial
Instruments, Employee benefits). These are referred to as
Other Comprehensive Income.
 The prescribed formats:
2. Statement of Comprehensive Income
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Minimum information in the statement of comprehensive

income:
 Revenue  Other comprehensive
 Finance costs
income (OCI)
 Share of profit or loss of
associates/joint ventures
 Share of OCI from
 Tax expense
associates and joint
ventures
 Post tax profit or loss arising from
discontinued  Total comprehensive
operations/revaluation to fair value income (split as profit or
of relevant assets loss)
 Profit or loss (split non-controlling
interests and owners of parent)
 The prescribed formats:
2. Statement of Comprehensive Income (cont)
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 IAS 1 allows a choice of two formats for detailing

income and expenditure:
 Format 1: Vertical with costs analysed according to function,
e.g. Cost of sales, distribution costs and administrative
expenses
 Format 2: Vertical with costs analysed according to nature,
e.g. raw materials, employee benefits expenses, operating
expenses and depreciation

 We will be studying Format 1 only.

 The principle is to require sufficient detail for users without
listing large numbers of separate expenses
 SoCI Format 1: costs analysed by
function
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In order to arrive at its Operating Profit, a company

needs to classify all of its operating expenses into 1
of 4 categories:

1.Cost of Sales
2.Distribution and Selling Costs

3.Administrative expenses

4.Other operating expenses (or income)

 COST OF SALES includes:
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 Direct costs: direct materials purchased; direct labour;

subcontracting costs.
 Overheads: variable and fixed production overheads
 Depreciation and amortisation:
 depreciation of non-current assets used in production
 depreciation of own work that has been capitalised
 impairment expense

 Exceptional amounts written off inventory

Why “Cost of Sales” may not be comparable
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 Between companies or between the same company

over different years
 Potential for different treatment of:
 Choice of depreciation method & estimates
 Methods
 Carrying values
 How inventory is valued
 FIFO/ LIFO / Weighted Average
 Management attitude to estimates
 Capability of system to produce information
 The 3 other categories of operating
expenses
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Distribution & Selling costs Administration expenses

 Warehousing  Administrative staff salaries

 Premises
 Promotion
 Professional fees e.g. audit
 Selling
 Trade receivable write-downs
 Transport

Other operating expense (income)

 Payments for licences

 Income from 3rd party use of PPE not

used currently in production

 Income from employees (e.g.

canteen)
 Activity: Classify the operating expense
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1. Head office salaries

2. Salaries of staff
involved in the
production
3. Warehouse insurance
4. Advertising costs
5. Accounting fees
6. Bad debts
7. Subcontracting costs
related to production
 3. Statement of Changes in Equity
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(SoCE)
The Statement of Changes in Equity will show the following
items on the face of the statement:
 Comprehensive income
 for each component of equity, the effect of changes in
accounting policies and corrections of errors recognised (IAS
8)
 Capital transactions with the owners (e.g. dividends, share
buybacks, increases from bonus, rights or new cash issues)
 for each component of equity, a reconciliation between the
carrying amount at the beginning and end of the period
 Example – Statement of Changes in Equity
Sainsbury’s Annual Report 2013
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 The statement of changes in equity will show the following

items on the face of the statement:
 total recognised income and expense for the period,
showing separately the total amounts attributable to equity holders
of the parent and to non-controlling interests
 for each component of equity, the effect of changes in accounting
policies and corrections of errors recognised (IAS 8)
 the amounts of transactions with equity holders in their capacity as
equity holders, showing separately contributions by and
distributions to equity holders
 for each component of equity, a reconciliation between the
carrying amount at the beginning and end of the period
 4. Statement of Cash Flows (SoCF)
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 IAS 7 requires
“the provision of information about the historical changes in
cash and cash equivalents by means of a cash flow statement
which classifies cash flow during the period from operating,
investing and financing activities”
 Cash - Cash in hand and money available on demand – bank
deposits
 Cash equivalents – short term highly liquid investments
readily convertible to known amounts of cash and subject to
an insignificant risk of changes in value

Covered during Year 1 Accounting module!

 5. Notes to the Financial Statements
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The notes section contains notes:

 Setting out Accounting policies
Giving greater detail of the make up of B/S items

 E.g. Inventory, non-current asset make-up

Giving additional information to assist the prediction of future cash

flows
 E.g. Capital commitments, future commitments, contingent liabilities

Related party transactions

 E.g Direct or indirect (through an intermediary) control

 IAS 24 requirements – disclosure of the relationship and of the
nature of any transactions
Other information of interest to other stakeholders

 E.g Staff costs and numbers