DUST OF SNOW_BY ROBERT FROST_EDITED BY_ TANMOY MISHRA
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.
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.
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.
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