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Sub chapter 6 financial statement
Learning Objectives
•Understand the need for having accounting system both for
internal and external purpose

•Understand the accounting equation

•Distinguish between debits and credits

•Understand what a balance sheet illustrates about a company

•Know how an income statement is put together

•Able to read and interpret accounts, accounting reports and
financial statements,

•Conduct ratio analysis of financial performance of an entity
(profitability, financial conditions, efficiency).
Sub-chapter 5: Outline
 Basic accounting framework
 Definition of Financial Statements
 What does Financial statements consist of?
     Balance Sheet
     Income Statement
     Cash flow Statement
 Application and preparation of financial Statement
 Financial ratios
 Issues relating to Financial Statements and the analysis.
Nature of accounting
 Financial statements are necessary sources of information about
  companies for a wide variety of users. Users includes company
  management teams, investors, creditors, governmental agencies and
  the Internal Revenue Service.
 Users of financial statement information do not necessarily need to
  know everything about accounting to use the information in basic
  statements
 Accounting is defined as the provision of information of financial
  nature to interested parties for the purpose of assisting in their
  decision making.
 2 types of accounting:
    Financial Accounting

    Management Accounting
What is in accounting?
•   What Information:
    •   Financial position – assets & liabilities
    •   Cash flow
    •   Profitability
    •   Comparison
    •   Aspect of decision making includes;


                  Who                  Why require info? - Decision
    •    Management                e.g. to produce or not, to sell?
    •    Employees                 Possibility of more bonus?
    •    Investor                  To invest in the company?
    •    Public                    Co spent to protect environment?
    •    Government                Change law to increase tax?
Financial vs Management Accounting
    Criteria /              Financial                     Management
   Accounting
Nature           Geared towards the            Providing relevant
                 preparation of information    information to the needs of
                 for external users/decision   internal users/decision
                 makers                        makers (i.e. management) at
                                               various level.
Purposes         Decision making               Decision making
                 Meeting legal
                 requirements
Users            External                      Internal
Detail           Less detailed                 More detailed
Standard         Subject to Accounting         No standard, as long as meet
                 Standards                     the requirement of users /
                                               management
Basic accounting concept and principles
1. Accounting entity – any accounting system and consequently its accounting
    reports is concerned with the life of one particular entity (e.g. company,
    partnership, group of companies). Different entities can be distinguished
    by;
      Ownership and/or control – public or private, partnership
      Size – Groups of companies, big or small company
      Reason of existence – profit or non profit making
      Type of activity – trading, manufacturing, services

2.   Accounting transactions - the recording of economic events.

3. Accounting principles
     Double entry
     Accrual concept (to capture all costs relevant to a period even not billed
      yet)
     Matching principle (match income and related expenses in an
      accounting period)
Accounting transactions




                                                                                                                 External Decision Makers
 Economic Environment




                                      Internal Data               Internal decision makers
                                        collection
                          External
                              data                                                                 Information
                         collection        Data           Processing             Information

                        Observation                   Accounting Information
                        & selection


Examples:
Sales of spare parts,                            Classify, compute and       Financial                     Government,
Purchase of machineries,                         summarise (Manual or       statements                      investors,
Pay staff salaries                              computerised accounting                                      auditors
Pay tax           Accounting                            system)        Management
                 transactions
 Extract from: Management for Engineers, 3rd edition, Edited by Danny Samsom, 2001 Prentice Hall
Financial statements are prepared from numerous
 accounting entries



    Accounting entries                Trial Balance               Financial Statement

                            Accounts        Debit         Credit
                                            (RM)          (RM)    • Income Statement
Purchase a building:
                           Building       2,000,000               • Cash flow Statement
Dr Building A/C 2,000,000
Cr Creditors A/C 2,000,000 Creditor                     2,000,000
                                                                  • Balance Sheet

Sales receipt:             Bank           300,000
Dr Bank A/C      300,000
                           Sales                        300,000
Cr Sales A/C     300,000


                           Total          Total debit   Total credit


                                   The financial statements are prepared from the Trial Balance
Accounts balances from Trial Balance are transferred to Income
Statement & Balance Sheet
               Accounts                    Debit (RM) Credit (RM) Income Statement   Balance Sheet
Capital                                                   20 000                         Yes
Drawings                                        2 500                                    Yes
Sales                                                    100 000
Stocks as at 1 January 2009:
   Finished goods (at cost)                     6 200                                    Yes
   Work in progress (at prime cost)             3 500                                    Yes
   Raw materials                                5 000                                    Yes
Purchases of raw materials                     14 400                   Yes
Wages                                          22 100                   Yes
Office salaries                                17 800                   Yes
General expenses                                4 120                   Yes
Heat and light                                  2,300                   Yes
Insurance                                         980                   Yes
Bad debts                                         550                   Yes
Discount received                                          1 800        Yes
Carriage outwards                                 290                   Yes
Direct expenses                                   820                   Yes
   Non-current assets at cost: Plant & M       24 800                                    Yes
                          Motor vehicles       14 340
    Accumulated depreciation:Plant & M                     4 000        Yes              Yes
                          Motor vehicles                   2 000
Cash                                           8 200                                     Yes
Debtors and creditors                          7 800       8 900                         Yes
Total                                        136 700     136 700
Financial Reports
The 3 main reports is known as Financial Statements
1. Income Statement
     –   A statement of operation performance / profitability

2.   Balance Sheet
     –   A statement of financial position of an entity at a specific date

3.   Cash flow Statement
     – A statement of changes in financial position (i.e. how fund in the
         company is sourced and used)

Audited Accounts:
    Nature
    Prepared for whom?
    Report by whom?
Legal requirement

 Companies Act, 1965 requires all registered companies to submit annual audited
  financial statements prepared in accordance to approved accounting standard, to
  Companies Commission of Malaysia (Suruhanjaya Syarikat Malaysia)

 With changes in reporting environment, corporate governance and globalisation
  economies, there is a move towards presenting high quality financial information
  which is international comparable.

 Companies or reporting enterprise must adhere to the accounting standards and
  regulations set by;
    Bursa Malaysia, CCM, Securities Commission, MASB, and Bank Negara for
     financial institutions.

 Accounting Standards are issued by MASB after consultations with various
  parties.
MASB Financial Reporting Standards
 - extract
  Standards                           Title
 FRS 1        First-time Adoption of Financial Reporting Standards

 FRS 3        Business Combinations

 FRS 112      Inventories

 FRS 118      Revenue
 FRS 116      Property, Plant & Equipment

 FRS 107      Cash Flow Statements
Financial Statements

  Balance Sheet
  Income Statement
  Cash flow Statement
Basic Guidelines
 The Accounting Equation
                  Assets = Liabilities + Owners' Equity
 It is an essential notion in financial accounting which is derived
  from assets and claims on assets.
 Assets : what a company owns
  - equipment
  - buildings and
  - inventory.
 Claims on assets:
  - liabilities (what a company owes such as notes payable,
  trade accounts payable and bonds. )and
  - owners' equity (the claims of owners against the business.)
Debit & Credit
 For every transaction that is recorded in a business, there have to be
  two components that make up an entry—a debit and a credit (double
  entry) : whenever a "transaction" occurs
 Debit          - an increase in an asset item(liabilities and owners'
                         equity)
                - a decrease in a claim or expense item
 Credit        - an increase in a claim item
                - a decrease in an asset or revenue item.

Assets and Claims on Assets
 Example : A businesswoman uses her cash to buy a sawing
  machine for her business. Hence;
  1. Debit : equipment account (because an asset was increased)
  2. Credit : Cash account (due to payment made on purchase)
 Generally, debits are listed first and credits second.
 The dollar amount of the debit appears on the left and the dollar
  amount of the credit appears on the right.
                                            Debit                 Credit
             Debit   Credit
                                      Increases in Assets   Decreases in Assets
 Equipment   $XXX                     Decreases in Claims   Increases in Claims
 Cash                $XXX               Expense Items         Revenue Items
1. represent everything that has
                                                    value(cash, fixtures, intangibles)
                                                 2. 2. Subject to claims by the
                                                    creditors and the owners




                                                             1. Allow the owners to
                                                            seek a higher claim in the
                                                              assets because their
                                                             profits have increased.
                                                               increases the owner's
                                                                       equity




1. Represent contra revenues
2. Reduces the amount of profit to   Assets = Liabilities + Owners' Equity
   which an owner lays claim.        Debit = Credit
1. Balance Sheet (B/S)
•   B/S is a statement of financial position of an entity at a specific date.
       Wealth that an entity has over its resources, or financial size of the entity
       Financial structure, information on various type of resources / assets controlled by
        this entity
       Solvency, assessment of how well the entity can meet its liability (i.e. able to pay
        debt/loan)
       Capacity for adaption, assessment on how the entity can meet future challenges,
        e.g. economic down turn (e.g. enough cash to survive if there is no sales?)


 Equation: Assets (A) = Liabilities (L) + Equity (E)
 Assets include Current Assets (short term, within 12 months) and Non Current
  Assets (long term or fixed assets)
 Liabilities include Current Liabilities (short term, within 12 months) and Long
  term Liabilities (loan/ mortgage)
 Capital / Shareholders’ Equity include Paid up capital (Ordinary shares or
  Preference Shares), Retained Earnings and other Reserves.
Example - Balance sheet As at 31 December 2010
                                  RM’ 000     Remarks

  Non Current /Long term Asset

    Property, Plant & Equipment     330,690   Value of NCA in B/S is the net book value,
    Motor Vehicles                      500   which cost of NCA less the accumulated
    Buildings                        14,500   depreciation.
  Total Non Current Asset           345,690

  Current Assets

    Cash at bank                      2,000   Value of Accounts receivable is net of
    Accounts Receivable/debtors       3,200   provision of bad debt and bad debt written
    Materials stock/inventories         190   off. Inventories are reported in B/S at the
    Finished goods inventories          670   lower of cost or net realizable value.
    Prepaid expenses                    250
  Total Current Assets                6,310

  Total Assets                      352,000
Cont.
                                                     RM’ 000                              Remarks
Long term Liabilities
  Loans/ Debentures                                       200,000
  Mortgage                                                120,000
Total Long term Liabilities                               320,000
Shareholders’ equity
  Paid up capital, RM1 ordinary shares                      1,000     Shareholders’ equity may include
  Retained earnings                                        30,000     preference shares.
Total Shareholders’ equity                                351,000     Retained earnings is the balance after
                                                                      adding the net profit for the year.
Current Liabilities
  Accounts payable/ creditors                                  450
  Accrued expenses                                             200
  Income tax payable                                           350
Total Current Liabilities                                    1,000
Total Liabilities and equity                              352,000
•   Accrued expenses: Charges incurred but no invoice is received then these charges are referred to as accruals
    (they 'accrue' or increase in value). A typical example is interest payable on a loan where you have not yet received a
    bank statement. These items (or an estimate of their value) should still be included in the profit & loss account. When
    the real invoice is received, an adjustment can be made to correct the estimate. Accruals can also apply to the
    income side.
Or..




       Must balance
2. Income Statement
 Also known as Profit & Loss, statement of operations, or statement of
    income.
   It is prepared for a period (the month, quarter, year ended dd.mm.yy)
   Items in Income Statement include;
       Revenue
       Expenses (Operating expenses, General & Admin, Finance and includes
         accruals, i.e. expenses incurred for the period but has not received
         invoiced)
       Profit (gain) and losses for the period
       Earnings per share
   Matching principle – Revenue for the period is matched with expenses for
    the period.                       the bottom line of the income statement indicates a net loss (-ve) - a
                                       banker/lender/creditor may be hesitant to extend additional credit to
   Various concept of profit            the company. On the other hand, a company that has operated
       Gross profit                    profitably- the bottom line of the income statement indicates a net
                                     income (+ve) - demonstrated its ability to use borrowed and invested
       Net Profit                                          funds in a successful manner

       Profit before tax and Profit after tax
   Profit will increase owner’s equity/share of the company.
Revenue and expenses are posted to Income                                    Statement and
categories into different nature of expenses.
     Income Statement for year ended 31 December               RM’ 000                     Remarks
                                            2010
 Revenue                                                          30,000    - Income/cost of sales (direct cost)
 Cost of sales                                                  (15,000)    from main activities.
 Gross profit                                                     15,000
 Other income                                                       2,000   - Other income include rental
 Other operating expenses                                         (1,250)   /interest.
 Administration expenses                                            (600)   - General and admin expenses
                                                                            include salary, travel, repair etc.
 Operating profit                                                 15,150
 Finance costs                                                      (350)   - e.g. interest on loan, bank charges.
 Share of profit/(loss) from associates or jointly                    500   - Share of profit from non controlled
   controlled entities                                                      subsidiaries

 Profit before tax                                                15,300
 Income tax expense                                               (3,500)

 Profit for the year                                              11,800
   Attributable to: - Equity holders of the Company               11,300    Attributable is only relevant for
                     - Minority interests                            500    group’s income statement.

    Income Statement prepared for the management will have detailed information on the revenue and expenses,
     including the production cost per unit .
Or..
   Sales
                                   Income Statement
                        For the Five Months Ended May 31, 2010
                                                                         $100,000
   Cost of Goods Sold                                                      75,000
        Gross Profit                                                       25,000

   Operating Expenses
       Selling Expenses
                Advertising Expense                              2,000
                Commissions Expense                              5,000      7,000
       Administrative Expenses
                Office Supplies Expense                          3,500
                Office Equipment Expense                         2,500      6,000
       Total Operating Expenses                                            13,000

   Operating Income                                                        12,000

   Non-Operating or Other
        Interest Revenues                                                   5,000
        Gain on Sale of Investments                                         3,000
        Interest Expense                                                     (500)
        Loss from Lawsuit                                                  (1,500)
                 Total Non-Operating                                        6,000
   Net Income                                                            $ 18,000
Or..                          Income Statement in Contribution Margin Format
                                  For the Five Months Ended May 31, 2010

                                                                                       Product    Product
                                                                     Total               Line 1     Line 2


       Sales                                                      $100,000             $70,000    $30,000
       Variable Expenses
             Cost of Goods Sold                                      75,000             50,000     25,000
             Commissions Expense                                      5,000              5,000          0
                      Total Variable Expenses                        80,000             55,000     25,000


       Contribution Margin                                           20,000             15,000      5,000


       Fixed Expenses - Prod. Line                                    6,000               4,000     2,000
                    Subtotal                                         14,000              11,000     3,000


       Fixed Expenses - Common                                        2,000
       Operating Income                                             $12,000

                            Remember that this format is not acceptable for distribution
                          outside of the company—its accessibility should be limited to the
                            members of the company's management. In fact, this type of
                             income statement is usually covered as part of managerial
                                         accounting, not financial accounting
 Income Statement shows the profitability of a company during
  the time interval specified in its heading.
          "The Four Weeks Ended December 27, 2010"
    (The period of November 29 through December 27, 2010.)

 An important concept in understanding the income statement
  is Earnings Per Share (EPS). The EPS for a company is net
  income divided by the number of shares of common stock
  outstanding. It represents the bottom line for a company.

 Companies continually make decisions on how their bottom
  line will be impacted since shareholders in the company are
  concerned with how management decisions affect individual
  shareholder position
3. Cash flow Statement summarizes the major sources and
uses of funds for the accounting period

  Cash flow statement for year ended               RM’ 000      Remarks
  31 December 2010
 Cash flow from operating activities
 Cash receipts from customers                           9 950   Include funds from activities that
 Cash paid to suppliers and employees                 (7 800)   contribute to the profit of the co.
 Cash flows from operating activities                     200   The amount does not include
 Taxes paid                                             (430)   amount due from customers and
                                                                amount due to suppliers (i.e.
 Net cash from operating activities                     1,920
                                                                unpaid amount)

 Cash flow from investing activities
 Acquisition of subsidiary                               (50)
 Proceed from the sales of non-current                   850
    assets
 Purchase of property, plant and equipment            (2 980)
 Investment in associate                                (100)
 Dividend received from associate                          50
    companies
 Net cash used in investing activities                (2,230)

     Example Sapura Crest Petroleum Bhd (Pg. 77 - Sapura Crest FS 2010.pdf )
Cash flow Statement summarises the major sources and
uses of funds for the accounting period – cont’d

  Cash flow statement for year ended RM’ 000                 Remarks
          31 December 2010
 Cash flow from financing activities
 Proceeds from issue of share capital          800
 Proceed from issue of debentures/loans        200
 Dividend paid by holding company                0
 Dividend paid to minority shareholders      (320)
 Net cash inflow from financing activities     680

 Net increase in cash and cash equivalents    370

 Cash and cash equivalents at beginning of   1,630 Cash at beginning and at
 the year                                          end of the year should tally
 Cash and cash equivalents at end of the     2,000 with the Cash balances in
 year                                              B/S.
Notes to the Accounts
 Is part of the financial statements and being audited. Notes to the
  Accounts must be read together with the other financial statements.

 Some of the Notes are;
    Significant Accounting Policy
    Revenue
    Non Current Assets
    Inter related transaction
Interpretation of Financial Statements
Various methods available to analyse and interpret the financial
performance of a company
 The financial information by itself may meaningless. Thus, it is
  normal for users to perform further analysis on the financial
  information, for decision making.
    Eg.    Company    Net Profit (RM)   Sales (RM)   Profit margin (%)   Rating
               A      200,000           848,000               23.58
               B      300,000           1,252,000             23.96
               C      500,000           1,927,500             25.94



 In performing the analyses, management accountants can be
  more detailed in their analysis as they have more information
  available as compared to that of the financial accountants.
Various methods available to analyse and interpret the financial
performance of a company
 Some of analyses used are;
   Ratios
   Comparison with preceding periods (intra company)
   Trending
   Benchmark with other companies (inter company)
        Similar size
        Similar industry
        Similar economic conditions / economy


        When looking at ratios, need to consider the timing of transactions
         and date of accounts of the entities being compared.
Different Ratios are used for different assessments
    Profitability ratio is a measure of profitability
      Net profit ratio :             Net Profit divided by Net sales (%)
       Return on total assets :      Net Profit divided by Total assets (%)
       Return on capital employed: Net Profit / Average capital employed
       Return on shareholders equity:           Net Profit / Shareholders’ Equity (%)
       Earnings per share: (RM)      Net profit after interest, tax and preference
        dividend                                                        No. of ordinary
        shares issued

    Measures of resources used - Assessment of efficiency of assets used
     or utilised.
       Total assets turnover:                   Total sales / total assets
Different Ratios are used for different assessments –cont’d
  Liquidity ratio which measure financial conditions - Assessment of an
   entity’s ability to meet its commitment (e.g. to pay its creditors, loan)

      Current (or working capital) ratio:          Current assets / Current liabilities
                                                    (ratio should be more than 1)
      Quick Asset (or liquid) or acid test ratio:Current assets less Stock
                                                    Current liabilities
                                                    (ratio should be more than 0.5)
      Debt Equity ratio (leverage):                Liabilities / Owner’s Equity
           (High leverage company indicate higher risk in servicing debts)


  No matter how profitable a business is, if it is not adequately liquid, it may fail.
Different Ratios are used for different assessments –cont’d
  Efficiency ratio measure the efficiency of a business maintaining a
   specific level of inventories., or control over the level of inventories.
     Inventory turnover:                         Cost of Sales / Average inventory (of finished
               (Rate of inventories turnover)                                          goods)
     Eg.            Company           Cost of sales (RM)      Average inventory (RM)                Turnover
                          A           96,000                   (34+30)k /2                             3 times
                          B           96,000                  (46+50)k /2                              2 times
          A reduction in inventory turnover can mean that the business is slowing down. Piling up and
           unsold inventory may lead to liquidity issue.


     Accounts receivable/ Sales ratio: Accounts receivable/Credit Sales x 365
       days
           •     This measures the no. of days it takes for debtors to pay / collection. The lower the
                 number, the better collection and better for liquidity.
     Accounts Payable / Purchases ratio:                     Accounts Payable/ Purchases x 365
           •     This measures the no. of days it takes for the business to pay its creditors / credit term.
                 The higher the number the better as the business may use its available fund for other
                 purchase sand get longer credit free from its creditor.
Users of ratios
    Ratio categories                      Example of interested groups (internal & external)

Profitability               Shareholders, management, employees, creditors, competitors, potential
                            investors

Liquidity                   Shareholders, employees, creditors, competitors

Efficiency                  Shareholders, management, employees, potential purchasers and
                            competitors

Shareholders                Shareholders, potential investors

Capital structure           Shareholder, lenders, creditors, potential investors.



Q. How are the ratios useful to them?

When deciding what the ratios tells you, you need to consider below;
- What the norm in the industry?
- Is this company above or below norm?
- If so, can it be justified after an analysis of the nature of the business and its assets and liabilities?
Issues on ratio analysis

 Ratios can be misleading if not used and interpreted appropriately.
 Comparison of ratios for a company should be done with a similar
  companies, else the comparison can be meaningless (e.g. co with
  same accounting policy).
 The ratio may be applicable at that particular time and can be out
  dated if not used timely.
Advantages and disadvantages of ratios

             Advantages                                Disadvantages
Ratios are easily understood by all        Ratios merely indicate the areas of
users                                      weaknesses and strength but does not
                                           indicate the cause of such.
They are useful for comparison             Meaningful, only if used intelligently
Important ratios will bring focus on the   Ratio are relative figures, they do not
attention of management/investors          indicate the volume/size of the
                                           business.
Remedial actions could be taken on         Using ratio for comparison may not be
weaknesses revealed through ratio          meaningful if the accounting policy
analysis                                   adopted by businesses are not the
                                           same. (i.e. not comparing like with
                                           like)
Issues relating to Financial Statements
 Application and preparation of Financial Statement can be time
  consuming
 Audit requirement on financial statements of companies, additional
  costs to companies.
 Standards set by MASB are to ensure comparability of the accounts
  prepared with minimum information provided. Companies must
  prepare accounts in accordance to the accounting standards set by
  MASB, can be time consuming, requires skilled staff and costly.
Clarifications, Questions


                  •Any
                Questions
                up to this
                 point?
Thank you
References
 Wood, F. Sangster, A (2008). Business Accounting 1, 11th Edition, Prentice Hall
   (Pearson Education)
 Management for Engineers, 3rd edition, Edited by Danny Samson, Melbourne
   University, (2001), Prentice Hall
 Malaysian Accounting Standard Board - webpage
 Malaysian Institute of Accountants - webpage
 Security Commission, Malaysia - webpage
 Bursa Malaysia - webpage
 Glossary of Accounting Terms - http://www.accountz.com/glossary.html

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Sub chapter 6 financial statement

  • 2. Learning Objectives •Understand the need for having accounting system both for internal and external purpose •Understand the accounting equation •Distinguish between debits and credits •Understand what a balance sheet illustrates about a company •Know how an income statement is put together •Able to read and interpret accounts, accounting reports and financial statements, •Conduct ratio analysis of financial performance of an entity (profitability, financial conditions, efficiency).
  • 3. Sub-chapter 5: Outline  Basic accounting framework  Definition of Financial Statements  What does Financial statements consist of?  Balance Sheet  Income Statement  Cash flow Statement  Application and preparation of financial Statement  Financial ratios  Issues relating to Financial Statements and the analysis.
  • 4. Nature of accounting  Financial statements are necessary sources of information about companies for a wide variety of users. Users includes company management teams, investors, creditors, governmental agencies and the Internal Revenue Service.  Users of financial statement information do not necessarily need to know everything about accounting to use the information in basic statements  Accounting is defined as the provision of information of financial nature to interested parties for the purpose of assisting in their decision making.  2 types of accounting:  Financial Accounting  Management Accounting
  • 5. What is in accounting? • What Information: • Financial position – assets & liabilities • Cash flow • Profitability • Comparison • Aspect of decision making includes; Who Why require info? - Decision • Management e.g. to produce or not, to sell? • Employees Possibility of more bonus? • Investor To invest in the company? • Public Co spent to protect environment? • Government Change law to increase tax?
  • 6. Financial vs Management Accounting Criteria / Financial Management Accounting Nature Geared towards the Providing relevant preparation of information information to the needs of for external users/decision internal users/decision makers makers (i.e. management) at various level. Purposes Decision making Decision making Meeting legal requirements Users External Internal Detail Less detailed More detailed Standard Subject to Accounting No standard, as long as meet Standards the requirement of users / management
  • 7. Basic accounting concept and principles 1. Accounting entity – any accounting system and consequently its accounting reports is concerned with the life of one particular entity (e.g. company, partnership, group of companies). Different entities can be distinguished by;  Ownership and/or control – public or private, partnership  Size – Groups of companies, big or small company  Reason of existence – profit or non profit making  Type of activity – trading, manufacturing, services 2. Accounting transactions - the recording of economic events. 3. Accounting principles  Double entry  Accrual concept (to capture all costs relevant to a period even not billed yet)  Matching principle (match income and related expenses in an accounting period)
  • 8. Accounting transactions External Decision Makers Economic Environment Internal Data Internal decision makers collection External data Information collection Data Processing Information Observation Accounting Information & selection Examples: Sales of spare parts, Classify, compute and Financial Government, Purchase of machineries, summarise (Manual or statements investors, Pay staff salaries computerised accounting auditors Pay tax Accounting system) Management transactions Extract from: Management for Engineers, 3rd edition, Edited by Danny Samsom, 2001 Prentice Hall
  • 9. Financial statements are prepared from numerous accounting entries Accounting entries Trial Balance Financial Statement Accounts Debit Credit (RM) (RM) • Income Statement Purchase a building: Building 2,000,000 • Cash flow Statement Dr Building A/C 2,000,000 Cr Creditors A/C 2,000,000 Creditor 2,000,000 • Balance Sheet Sales receipt: Bank 300,000 Dr Bank A/C 300,000 Sales 300,000 Cr Sales A/C 300,000 Total Total debit Total credit The financial statements are prepared from the Trial Balance
  • 10. Accounts balances from Trial Balance are transferred to Income Statement & Balance Sheet Accounts Debit (RM) Credit (RM) Income Statement Balance Sheet Capital 20 000 Yes Drawings 2 500 Yes Sales 100 000 Stocks as at 1 January 2009: Finished goods (at cost) 6 200 Yes Work in progress (at prime cost) 3 500 Yes Raw materials 5 000 Yes Purchases of raw materials 14 400 Yes Wages 22 100 Yes Office salaries 17 800 Yes General expenses 4 120 Yes Heat and light 2,300 Yes Insurance 980 Yes Bad debts 550 Yes Discount received 1 800 Yes Carriage outwards 290 Yes Direct expenses 820 Yes Non-current assets at cost: Plant & M 24 800 Yes Motor vehicles 14 340 Accumulated depreciation:Plant & M 4 000 Yes Yes Motor vehicles 2 000 Cash 8 200 Yes Debtors and creditors 7 800 8 900 Yes Total 136 700 136 700
  • 11. Financial Reports The 3 main reports is known as Financial Statements 1. Income Statement – A statement of operation performance / profitability 2. Balance Sheet – A statement of financial position of an entity at a specific date 3. Cash flow Statement – A statement of changes in financial position (i.e. how fund in the company is sourced and used) Audited Accounts:  Nature  Prepared for whom?  Report by whom?
  • 12. Legal requirement  Companies Act, 1965 requires all registered companies to submit annual audited financial statements prepared in accordance to approved accounting standard, to Companies Commission of Malaysia (Suruhanjaya Syarikat Malaysia)  With changes in reporting environment, corporate governance and globalisation economies, there is a move towards presenting high quality financial information which is international comparable.  Companies or reporting enterprise must adhere to the accounting standards and regulations set by;  Bursa Malaysia, CCM, Securities Commission, MASB, and Bank Negara for financial institutions.  Accounting Standards are issued by MASB after consultations with various parties.
  • 13. MASB Financial Reporting Standards - extract Standards Title FRS 1 First-time Adoption of Financial Reporting Standards FRS 3 Business Combinations FRS 112 Inventories FRS 118 Revenue FRS 116 Property, Plant & Equipment FRS 107 Cash Flow Statements
  • 14. Financial Statements  Balance Sheet  Income Statement  Cash flow Statement
  • 15. Basic Guidelines  The Accounting Equation Assets = Liabilities + Owners' Equity  It is an essential notion in financial accounting which is derived from assets and claims on assets.  Assets : what a company owns - equipment - buildings and - inventory.  Claims on assets: - liabilities (what a company owes such as notes payable, trade accounts payable and bonds. )and - owners' equity (the claims of owners against the business.)
  • 16. Debit & Credit  For every transaction that is recorded in a business, there have to be two components that make up an entry—a debit and a credit (double entry) : whenever a "transaction" occurs  Debit - an increase in an asset item(liabilities and owners' equity) - a decrease in a claim or expense item  Credit - an increase in a claim item - a decrease in an asset or revenue item. Assets and Claims on Assets  Example : A businesswoman uses her cash to buy a sawing machine for her business. Hence; 1. Debit : equipment account (because an asset was increased) 2. Credit : Cash account (due to payment made on purchase)  Generally, debits are listed first and credits second.  The dollar amount of the debit appears on the left and the dollar amount of the credit appears on the right. Debit Credit Debit Credit Increases in Assets Decreases in Assets Equipment $XXX Decreases in Claims Increases in Claims Cash $XXX Expense Items Revenue Items
  • 17. 1. represent everything that has value(cash, fixtures, intangibles) 2. 2. Subject to claims by the creditors and the owners 1. Allow the owners to seek a higher claim in the assets because their profits have increased. increases the owner's equity 1. Represent contra revenues 2. Reduces the amount of profit to Assets = Liabilities + Owners' Equity which an owner lays claim. Debit = Credit
  • 18. 1. Balance Sheet (B/S) • B/S is a statement of financial position of an entity at a specific date.  Wealth that an entity has over its resources, or financial size of the entity  Financial structure, information on various type of resources / assets controlled by this entity  Solvency, assessment of how well the entity can meet its liability (i.e. able to pay debt/loan)  Capacity for adaption, assessment on how the entity can meet future challenges, e.g. economic down turn (e.g. enough cash to survive if there is no sales?)  Equation: Assets (A) = Liabilities (L) + Equity (E)  Assets include Current Assets (short term, within 12 months) and Non Current Assets (long term or fixed assets)  Liabilities include Current Liabilities (short term, within 12 months) and Long term Liabilities (loan/ mortgage)  Capital / Shareholders’ Equity include Paid up capital (Ordinary shares or Preference Shares), Retained Earnings and other Reserves.
  • 19. Example - Balance sheet As at 31 December 2010 RM’ 000 Remarks Non Current /Long term Asset Property, Plant & Equipment 330,690 Value of NCA in B/S is the net book value, Motor Vehicles 500 which cost of NCA less the accumulated Buildings 14,500 depreciation. Total Non Current Asset 345,690 Current Assets Cash at bank 2,000 Value of Accounts receivable is net of Accounts Receivable/debtors 3,200 provision of bad debt and bad debt written Materials stock/inventories 190 off. Inventories are reported in B/S at the Finished goods inventories 670 lower of cost or net realizable value. Prepaid expenses 250 Total Current Assets 6,310 Total Assets 352,000
  • 20. Cont. RM’ 000 Remarks Long term Liabilities Loans/ Debentures 200,000 Mortgage 120,000 Total Long term Liabilities 320,000 Shareholders’ equity Paid up capital, RM1 ordinary shares 1,000 Shareholders’ equity may include Retained earnings 30,000 preference shares. Total Shareholders’ equity 351,000 Retained earnings is the balance after adding the net profit for the year. Current Liabilities Accounts payable/ creditors 450 Accrued expenses 200 Income tax payable 350 Total Current Liabilities 1,000 Total Liabilities and equity 352,000 • Accrued expenses: Charges incurred but no invoice is received then these charges are referred to as accruals (they 'accrue' or increase in value). A typical example is interest payable on a loan where you have not yet received a bank statement. These items (or an estimate of their value) should still be included in the profit & loss account. When the real invoice is received, an adjustment can be made to correct the estimate. Accruals can also apply to the income side.
  • 21. Or.. Must balance
  • 22. 2. Income Statement  Also known as Profit & Loss, statement of operations, or statement of income.  It is prepared for a period (the month, quarter, year ended dd.mm.yy)  Items in Income Statement include;  Revenue  Expenses (Operating expenses, General & Admin, Finance and includes accruals, i.e. expenses incurred for the period but has not received invoiced)  Profit (gain) and losses for the period  Earnings per share  Matching principle – Revenue for the period is matched with expenses for the period. the bottom line of the income statement indicates a net loss (-ve) - a banker/lender/creditor may be hesitant to extend additional credit to  Various concept of profit the company. On the other hand, a company that has operated  Gross profit profitably- the bottom line of the income statement indicates a net income (+ve) - demonstrated its ability to use borrowed and invested  Net Profit funds in a successful manner  Profit before tax and Profit after tax  Profit will increase owner’s equity/share of the company.
  • 23. Revenue and expenses are posted to Income Statement and categories into different nature of expenses. Income Statement for year ended 31 December RM’ 000 Remarks 2010 Revenue 30,000 - Income/cost of sales (direct cost) Cost of sales (15,000) from main activities. Gross profit 15,000 Other income 2,000 - Other income include rental Other operating expenses (1,250) /interest. Administration expenses (600) - General and admin expenses include salary, travel, repair etc. Operating profit 15,150 Finance costs (350) - e.g. interest on loan, bank charges. Share of profit/(loss) from associates or jointly 500 - Share of profit from non controlled controlled entities subsidiaries Profit before tax 15,300 Income tax expense (3,500) Profit for the year 11,800 Attributable to: - Equity holders of the Company 11,300 Attributable is only relevant for - Minority interests 500 group’s income statement.  Income Statement prepared for the management will have detailed information on the revenue and expenses, including the production cost per unit .
  • 24. Or.. Sales Income Statement For the Five Months Ended May 31, 2010 $100,000 Cost of Goods Sold 75,000 Gross Profit 25,000 Operating Expenses Selling Expenses Advertising Expense 2,000 Commissions Expense 5,000 7,000 Administrative Expenses Office Supplies Expense 3,500 Office Equipment Expense 2,500 6,000 Total Operating Expenses 13,000 Operating Income 12,000 Non-Operating or Other Interest Revenues 5,000 Gain on Sale of Investments 3,000 Interest Expense (500) Loss from Lawsuit (1,500) Total Non-Operating 6,000 Net Income $ 18,000
  • 25. Or.. Income Statement in Contribution Margin Format For the Five Months Ended May 31, 2010 Product Product Total Line 1 Line 2 Sales $100,000 $70,000 $30,000 Variable Expenses Cost of Goods Sold 75,000 50,000 25,000 Commissions Expense 5,000 5,000 0 Total Variable Expenses 80,000 55,000 25,000 Contribution Margin 20,000 15,000 5,000 Fixed Expenses - Prod. Line 6,000 4,000 2,000 Subtotal 14,000 11,000 3,000 Fixed Expenses - Common 2,000 Operating Income $12,000 Remember that this format is not acceptable for distribution outside of the company—its accessibility should be limited to the members of the company's management. In fact, this type of income statement is usually covered as part of managerial accounting, not financial accounting
  • 26.  Income Statement shows the profitability of a company during the time interval specified in its heading. "The Four Weeks Ended December 27, 2010" (The period of November 29 through December 27, 2010.)  An important concept in understanding the income statement is Earnings Per Share (EPS). The EPS for a company is net income divided by the number of shares of common stock outstanding. It represents the bottom line for a company.  Companies continually make decisions on how their bottom line will be impacted since shareholders in the company are concerned with how management decisions affect individual shareholder position
  • 27. 3. Cash flow Statement summarizes the major sources and uses of funds for the accounting period Cash flow statement for year ended RM’ 000 Remarks 31 December 2010 Cash flow from operating activities Cash receipts from customers 9 950 Include funds from activities that Cash paid to suppliers and employees (7 800) contribute to the profit of the co. Cash flows from operating activities 200 The amount does not include Taxes paid (430) amount due from customers and amount due to suppliers (i.e. Net cash from operating activities 1,920 unpaid amount) Cash flow from investing activities Acquisition of subsidiary (50) Proceed from the sales of non-current 850 assets Purchase of property, plant and equipment (2 980) Investment in associate (100) Dividend received from associate 50 companies Net cash used in investing activities (2,230)  Example Sapura Crest Petroleum Bhd (Pg. 77 - Sapura Crest FS 2010.pdf )
  • 28. Cash flow Statement summarises the major sources and uses of funds for the accounting period – cont’d Cash flow statement for year ended RM’ 000 Remarks 31 December 2010 Cash flow from financing activities Proceeds from issue of share capital 800 Proceed from issue of debentures/loans 200 Dividend paid by holding company 0 Dividend paid to minority shareholders (320) Net cash inflow from financing activities 680 Net increase in cash and cash equivalents 370 Cash and cash equivalents at beginning of 1,630 Cash at beginning and at the year end of the year should tally Cash and cash equivalents at end of the 2,000 with the Cash balances in year B/S.
  • 29. Notes to the Accounts  Is part of the financial statements and being audited. Notes to the Accounts must be read together with the other financial statements.  Some of the Notes are;  Significant Accounting Policy  Revenue  Non Current Assets  Inter related transaction
  • 31. Various methods available to analyse and interpret the financial performance of a company  The financial information by itself may meaningless. Thus, it is normal for users to perform further analysis on the financial information, for decision making. Eg. Company Net Profit (RM) Sales (RM) Profit margin (%) Rating A 200,000 848,000 23.58 B 300,000 1,252,000 23.96 C 500,000 1,927,500 25.94  In performing the analyses, management accountants can be more detailed in their analysis as they have more information available as compared to that of the financial accountants.
  • 32. Various methods available to analyse and interpret the financial performance of a company  Some of analyses used are;  Ratios  Comparison with preceding periods (intra company)  Trending  Benchmark with other companies (inter company)  Similar size  Similar industry  Similar economic conditions / economy  When looking at ratios, need to consider the timing of transactions and date of accounts of the entities being compared.
  • 33. Different Ratios are used for different assessments  Profitability ratio is a measure of profitability  Net profit ratio : Net Profit divided by Net sales (%)  Return on total assets : Net Profit divided by Total assets (%)  Return on capital employed: Net Profit / Average capital employed  Return on shareholders equity: Net Profit / Shareholders’ Equity (%)  Earnings per share: (RM) Net profit after interest, tax and preference dividend No. of ordinary shares issued  Measures of resources used - Assessment of efficiency of assets used or utilised.  Total assets turnover: Total sales / total assets
  • 34. Different Ratios are used for different assessments –cont’d  Liquidity ratio which measure financial conditions - Assessment of an entity’s ability to meet its commitment (e.g. to pay its creditors, loan)  Current (or working capital) ratio: Current assets / Current liabilities (ratio should be more than 1)  Quick Asset (or liquid) or acid test ratio:Current assets less Stock Current liabilities (ratio should be more than 0.5)  Debt Equity ratio (leverage): Liabilities / Owner’s Equity  (High leverage company indicate higher risk in servicing debts)  No matter how profitable a business is, if it is not adequately liquid, it may fail.
  • 35. Different Ratios are used for different assessments –cont’d  Efficiency ratio measure the efficiency of a business maintaining a specific level of inventories., or control over the level of inventories.  Inventory turnover: Cost of Sales / Average inventory (of finished (Rate of inventories turnover) goods) Eg. Company Cost of sales (RM) Average inventory (RM) Turnover A 96,000 (34+30)k /2 3 times B 96,000 (46+50)k /2 2 times  A reduction in inventory turnover can mean that the business is slowing down. Piling up and unsold inventory may lead to liquidity issue.  Accounts receivable/ Sales ratio: Accounts receivable/Credit Sales x 365 days • This measures the no. of days it takes for debtors to pay / collection. The lower the number, the better collection and better for liquidity.  Accounts Payable / Purchases ratio: Accounts Payable/ Purchases x 365 • This measures the no. of days it takes for the business to pay its creditors / credit term. The higher the number the better as the business may use its available fund for other purchase sand get longer credit free from its creditor.
  • 36. Users of ratios Ratio categories Example of interested groups (internal & external) Profitability Shareholders, management, employees, creditors, competitors, potential investors Liquidity Shareholders, employees, creditors, competitors Efficiency Shareholders, management, employees, potential purchasers and competitors Shareholders Shareholders, potential investors Capital structure Shareholder, lenders, creditors, potential investors. Q. How are the ratios useful to them? When deciding what the ratios tells you, you need to consider below; - What the norm in the industry? - Is this company above or below norm? - If so, can it be justified after an analysis of the nature of the business and its assets and liabilities?
  • 37. Issues on ratio analysis  Ratios can be misleading if not used and interpreted appropriately.  Comparison of ratios for a company should be done with a similar companies, else the comparison can be meaningless (e.g. co with same accounting policy).  The ratio may be applicable at that particular time and can be out dated if not used timely.
  • 38. Advantages and disadvantages of ratios Advantages Disadvantages Ratios are easily understood by all Ratios merely indicate the areas of users weaknesses and strength but does not indicate the cause of such. They are useful for comparison Meaningful, only if used intelligently Important ratios will bring focus on the Ratio are relative figures, they do not attention of management/investors indicate the volume/size of the business. Remedial actions could be taken on Using ratio for comparison may not be weaknesses revealed through ratio meaningful if the accounting policy analysis adopted by businesses are not the same. (i.e. not comparing like with like)
  • 39. Issues relating to Financial Statements  Application and preparation of Financial Statement can be time consuming  Audit requirement on financial statements of companies, additional costs to companies.  Standards set by MASB are to ensure comparability of the accounts prepared with minimum information provided. Companies must prepare accounts in accordance to the accounting standards set by MASB, can be time consuming, requires skilled staff and costly.
  • 40. Clarifications, Questions •Any Questions up to this point?
  • 42. References  Wood, F. Sangster, A (2008). Business Accounting 1, 11th Edition, Prentice Hall (Pearson Education)  Management for Engineers, 3rd edition, Edited by Danny Samson, Melbourne University, (2001), Prentice Hall  Malaysian Accounting Standard Board - webpage  Malaysian Institute of Accountants - webpage  Security Commission, Malaysia - webpage  Bursa Malaysia - webpage  Glossary of Accounting Terms - http://www.accountz.com/glossary.html