PDF 3 Published financial statements of limited companies

[Pages:38]3 Published financial statements of limited companies

this chapter covers...

In this chapter we focus on the published financial statements of limited companies and look at: n the purpose and components of financial statements n the format of published financial statements n dealing with dividends in the financial statements n interpretation of the auditors' report n the accounting policies followed by a particular company n bonus issues and rights issues of shares Towards the end of the chapter (page 78) we see how a trial balance for a company is converted into the layout of published financial statements.

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INTRODUCTION

All limited companies have shareholders. Each shareholder owns a part of the company and, although they do not take part in the day-to-day running of the company (unless they are also directors), they are entitled to know the financial results of the company. Every limited company, whether public or private, is required by law to produce financial statements, which are also available for anyone to inspect if they so wish. We need to distinguish between the statutory accounts and the annual report and accounts. The statutory accounts are required to be produced under company law, and a copy is filed with the Registrar of Companies where it is available for public inspection. The annual report and accounts ? often referred to as the corporate report ? is available to every shareholder and contains: n statement of profit or loss and other comprehensive income n statement of financial position n statement of cash flows n statement of changes in equity n notes to the financial statements, including a statement of the company's

accounting policies n directors' report n auditors' report

DUTIes aND ResPONsIBILITIes OF DIReCTORs

The directors of a limited company are elected by the shareholders to manage the company on their behalf. The directors are put in a position of trust by the shareholders to be responsible for the stewardship of the company's financial information. The directors of a limited company have a duty to ensure that the provisions of the Companies Acts which relate to accounting records and statements are followed. The main provisions of the Acts are that: n a company's accounting records must:

? show and explain the company's transactions ? disclose with reasonable accuracy at any time the financial position of

the company

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? enable the directors to ensure that the company's statements of profit or loss and other comprehensive income and financial position give a true and fair view of the company's financial position

n a company's accounting records must contain: ? day-to-day entries of money received and paid, together with details of the transactions ? a record of the company's assets and liabilities ? details of inventories held at the end of the year

n a company's financial statements must be prepared in accordance with the Companies Act and with either UK accounting standards or international financial reporting standards (note that, in this book, we will study only financial statements which comply with IFRSs)

n the directors must report annually to the shareholders on the way they have run the company on behalf of the shareholders

Every company director has a responsibility to ensure that the statutory accounts are produced and filed with the Registrar of Companies within a set time. The filing deadlines after the end of the accounting period are: n nine months for a private limited company n six months for a public limited company

There are penalties (fines) for late filing and, if the financial statements are too late, a company can be struck off the companies register.

The annual financial statements must be approved by the company's board of directors and the copy of the statement of financial position filed with the Registrar of Companies must be signed by one of the directors on behalf of the board. The directors must prepare a directors' report ? this must be approved by the board and the copy to be filed with the Registrar of Companies signed on behalf of the board by a director (or the company secretary). The statutory accounts must be laid before the company at the annual general meeting, and they must be circulated beforehand to shareholders, debenture holders and any other persons entitled to attend the meeting.

Ias 1 ? PReseNTaTION OF FINaNCIaL sTaTeMeNTs

The objective of this accounting standard is to set out how financial statements should be presented to ensure comparability with previous accounting periods and with other entities. The standard states that `the objective of financial statements is to provide information about the

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financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions'. Note that this definition is very similar to that stated in the Conceptual Framework for Financial Reporting ? see the definition given on page 7 of this book. Financial statements also show the results of management's stewardship of the resources entrusted to it. The statements provide information about an entity's: n assets n liabilities n equity n income and expenses, including gains and losses n contributions by, and distributions to, owners in their capacity as owners n cash flows Such information ? along with other information in the notes ? assists users of financial statements in assessing the entity's future cash flows.

complete set of financial statements IAS 1 states that a complete set of financial statements comprises: n statement of financial position n statement of profit or loss and other comprehensive income n statement of changes in equity n statement of cash flows n accounting policies and explanatory notes n comparative information for the preceding period Note that IAS 1 states that: n all of the financial statements are to be given equal prominence n the statement of profit or loss and other comprehensive income can be

presented ? either as a single statement ? or as a profit or loss section, immediately followed by a separate

statement of comprehensive income

overall considerations The financial statements must present fairly the financial position, financial performance, and cash flows of an entity. The application of international financial reporting standards ? supported by appropriate additional

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disclosures ? is presumed to result in financial statements that achieve a fair presentation. IAS 1 requires that an entity whose financial statements comply with the standards should make an explicit and unreserved statement of such compliance in the notes.

IAS 1 requires compliance with a number of accounting concepts (see also pages 20-21) and other considerations:

n going concern ? when an entity's financial statements are prepared in accordance with international financial reporting standards, the presumption is that the entity is a going concern, ie it will not cease to trade in the immediate future

n accrual basis of accounting ? financial statements, except for cash flow information, are prepared under the accruals concept, ie income and expenses are matched to the same accounting period

n materiality and aggregation ? each material class of similar items is to be presented separately in the financial statements, eg the classification of assets as non-current and current

n offsetting ? generally it is not permitted to set off assets and liabilities, or income and expenses against each other in order to show a net figure, eg cash at bank is not netted off against a bank overdraft

n frequency of reporting ? financial statements are prepared at least annually; however, when the reporting period changes, the financial statements will be for a period longer or shorter than one year and the entity must give the reason for the change and disclose that the amounts in the financial statements are not entirely comparable with those of previous periods

n comparative information ? a requirement to show the figures from previous periods for all amounts shown in the financial statements in order to help users of the statements

structure and content ? general principles

IAS 1 sets out the detailed disclosures to be shown on the face of the statement of profit or loss and other comprehensive income, statement of financial position, and statement of changes in equity. We shall be covering these later in this chapter.

There are some general principles that the standard requires. These include the identification of: n the financial statements, which are to be distinguished from other

information in the corporate report n the name of the reporting entity

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n whether the financial statements are for an individual entity or for a group (see Chapter 8)

n the period covered by the financial statements, eg for the year ended 31 December 20-6

n the currency of the financial statements, ?s, s, etc n the level of rounding used for money amounts, thousands, millions, etc

sTaTeMeNT OF PROFIT OR LOss aND OTheR COMPReheNsIve INCOMe

The published statement of profit or loss and other comprehensive income does not have to detail every single overhead or expense incurred by the company ? to do so would be to disclose important management information to competitors. Instead, the main items are summarised; however, IAS 1 requires that certain items must be detailed on the face of the statement, including: n revenue n finance costs n share of the profit or loss of associates (see Chapter 8) n tax expense n other comprehensive income for the year (eg the revaluation of property)

Further detail may be needed to give information relevant to an understanding of financial performance.

Note that items of income and expense are not to be presented as extraordinary items, either on the face of the income statement or in the notes. When items are material, their nature and amount is to be disclosed separately.

The statement of profit or loss and other comprehensive income shows the: n profit or loss n total other comprehensive income n comprehensive income for the year, ie the total of profit or loss and other

comprehensive income (which is taken to the statement of changes in equity ? see page 69)

Expenses in the statement of profit or loss and other comprehensive income must be analysed either by nature (raw materials, employee costs, depreciation, etc) or by function (cost of sales, distribution costs, administrative expenses, etc) ? depending on which provides the more

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XYZ PLC statement of profit or loss and other comprehensive income

for the year ended 31 December 20-9

Continuing operations Revenue Cost of sales Gross profit Distribution costs Administrative expenses Profit from operations Finance costs Profit before tax Tax Profit for the year from continuing operations

?000

30,000 ?16,000

14,000 ?5,000 ?4,000

5,000 ?1,000

4,000 ?1,500

2,500

Other comprehensive income for the year Gain on revaluation of property Total comprehensive income for the year

500 3,000

Notes: ? IAS 1 does not permit items of income and expense to be described as `extraordinary items'. ? All material items of income and expense are to be disclosed separately, either on the face of the

statement of profit or loss and other comprehensive income or in the notes ? examples include disposals of property, plant and equipment, disposals of investments, litigation settlements. ? In this example expenses are analysed by function ? cost of sales, distribution costs, administrative expenses, etc. This is the analysis usually used in AAT Assessments.

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reliable and relevant information. The analysis by nature is often appropriate for manufacturing companies, while the analysis by function is commonly used by trading companies. The example statement of comprehensive income of XYZ PLC on the next page (with sample figures) shows an analysis by function. Note that AAT Assessments usually assess analysis by function.

Much of the detail shown in the statement of profit or loss and other comprehensive income is summarised. For example:

n revenue incorporates the figures for sales and sales returns

n cost of sales includes opening inventories, purchases, purchases returns, carriage inwards and closing inventories

n distribution costs include warehouse costs, post and packing, delivery drivers' wages, running costs of vehicles, depreciation of vehicles, etc

n administrative expenses include office costs, rent and rates, heating and lighting, depreciation of office equipment, etc

It is suggested that you study a recent statement of profit or loss and other comprehensive income for a large public limited company. The web directory at the beginning of this book lists some sources but all large plcs will have their financial statements available through their websites ? search for `financial statements' or `investor centre'.

DeaLING WITh DIvIDeNDs IN FINaNCIaL sTaTeMeNTs

Dividends are distributions to the shareholders, who own the company, as a return on their investment. Many companies pay dividends twice a year ? an interim dividend, which is usually paid just over halfway through the financial year, and a final dividend which is paid early in the next financial year. The interim dividend is based on the profits reported by the company during the first half of the year, while the final dividend is based on the profits reported for the full year. The final dividend is proposed by the directors but has to be approved by shareholders at the Annual General Meeting of the company. Thus the financial calendar for a company with a financial year end of 31 December 20-9 might take a form as illustrated at the top of the next page.

Only the dividends paid during the year can be recorded in the financial statements (see IAS 10, Events after the Reporting Period, page 154). In the above example, the dividends paid in April 20-9 (final dividend for the

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