Topic 2 Part I

FINANCIAL STATEMENTS
Deegan Chapter 17
Leo et al Chapter 10
 Learning Objectives
Prepare financial statements in compliance
with disclosure requirements

1. Income Statement
2. Statement of Changes in Equity
3. Balance Sheet
 GENERAL PURPOSE
FINANCIAL REPORTING
(GPFR)

Objective
To provide information that is useful for
economic decision-making
Annual Reports
 1.a Financial Statements
Consist of
1. Income Statement
2. Statement of Changes in Equity
3. Balance Sheet
4. Cash Flow Statement
5. Notes to Financial Statements

Show figures for Current & Previous Period

 1.b Compliance
Regulation Entities covered
Accounting Specified reporting entities e.g.
Standards publicly accountable entities
banking & financial institutions
turnover or assets > $20
million
Companies Act All companies
SPSE Listing All listed companies
Rules
INCOME STATEMENT
2.a Disclosure Requirements (IAS 1)
On the face of the Statement

1. Revenue
2. Finance Costs
 i.e. Interest & costs related to
borrowing
3. Tax Expense
4. Profit (or Loss) after Tax
5. Share of Profit of associate companies
 2.b Revenue
Separate disclosure required for revenue
from

a. Sales
b. Services
c. Interest
d. Dividends
e. Royalties (for natural resources)
 2.c Classification of Expenses
Classification must be provided either on the
face or in the notes
 can be disclosed in 2 ways

1. By Nature i.e.
a. Employee Benefits
b. Depreciation
c. Raw Materials used in Production
 2.c Classification of Expenses
Alternatively

2. By Function e.g.
a. Cost of Goods Sold
b. Distribution
c. Marketing
d. Administration
Example 1
 Tavewa Ltd, Year ended 31.12.07
Sales revenue 600,000
Cost of sales 250,000
Advertising 15,000
Gain on sale of equipment 8,000
(carrying amount $58,000)
Selling commissions 25,000
Office expenses 30,000
Research costs written off 26,000
Interest expense 12,000
Tavewa Ltd, Year ended 31.12.07
Assume the company’s tax rate is 30%

Required
1. Calculate tax expense
2. Prepare an Income Statement, that
complies with IAS 1
 Classify expenses by function
 Tavewa Ltd
Income Statement
for the year ended 31 December 2007

Sales Revenue 600,000

Other Income Note 2 8,000
608,000
Cost of Sales (250,000)
Marketing Expenses Note 3 (40,000)
Administration Expenses (30,000)
Other Operating Expenses (26,000)
Operating Profit 262,000
 Tavewa Ltd
Income Statement
for the year ended 31 December 2007

Finance Costs (12,000)

Profit before Tax 250,000
Tax Expense (75,000)
Profit after Tax 175,000
 Tavewa Ltd
Notes to Financial Statements
for the year ended 31 December 2007
Note 2, Other Income
Gain on Sale of Land 8,000

Note 3, Marketing Expenses

Advertising 15,000
Selling Commissions 25,000
40,000
 2.d Companies Act
Additional disclosures required
Usually provided in the notes

1. Audit Fees
2. Directors’ Fees
3. Bad Debts
STATEMENT OF CHANGES
IN EQUITY
 3.a Disclosure Requirements
Share By category e.g. Ordinary, Preference
Capital Add issue of new shares
Subtract capital reduction/redemption
Retained Add Net Profit after tax
Earnings Add (subtract) transfers from (to)
Reserves
Subtract dividends declared/paid
Reserves By category e.g. ARR, General Reserve
Add Transfers to Reserves
Subtract transfer from Reserves
Opening & Closing Balance for all items
Example 2
 Adams Ltd, Year ended 30.06.06
Revenue 650,000
Operating Expenses 471,000
Borrowing Costs 9,000
Tax Rate = 30%
Share Capital (200,000 shares @ $1.50) 300,000
Retained Earnings 01.07.05 100,000
General Reserve 15,000
Interim Dividend of 6c per share
Transfer $10,000 of general reserve back to
retained earnings
Prepare a Statement of Changes in Equity
Adams Ltd – Statement of Changes in Equity
for the year ended 30 June 2006
Share Retained General Total
Capital Profits Reserve
Bal 01.07.05 300,000 100,000 15,000 415,000
Profit after 119,000 119,000
Tax
Dividend (12,000) (12,000)
Declared
Transfer from 10,000 (10,000) ----------
Reserve
Bal 30.06.06 300,000 217,000 5,000 522,000
BALANCE SHEET

Deegan Chapter 4
Leo et al Chapter 10
 4.a Classification
Assets & Liabilities can be classified in 2
ways

1. Either Current & Non-Current

2. or in order of liquidity
 If this provides more relevant &
reliable information e.g. financing
companies
 4.b Asset Classes & Disclosure
1. Property, Plant & Equipment
 Classified by main types
 State basis of measurement e.g. cost,
independent valuation
 Show Gross Amount, Accumulated
Depreciation & Net Book Value
 Reconciliation of carrying amount at start
& end of the period
Impairment Test
 4.b Asset Classes & Disclosure
2. Investment Property
 Held for rent or capital gain
 Fair value

3. Intangibles
 Classified by main types e.g. brand
names
 Show Gross Amount, Accumulated
Amortisation & Net Book Value
 4.b Asset Classes & Disclosure
4. Biological Assets
 e.g. livestock, plantations

5. Inventories
 Lower of cost or net realisable value
 Classified by main types
a. Raw Materials
b. WIP
c. Finished Goods
 4.b Asset Classes & Disclosure
6. Cash & Cash Equivalents

7. Financial Assets
a. Traded securities
b. Available for sale
c. Held to maturity
d. Loans & Receivables

8. Trade & Other Receivables

 Net of allowances for Doubtful Debts
 4.c Liability Classes
1. Trade & Other Payables

2. Provisions
 e.g. Employee Entitlements

3. Financial Liabilities

4. Current Tax Liability

5. Deferred Tax Liability

 4.d Classes of Equity
1. Minority Interest, presented within Equity

2. Capital, Reserves & Retained Earnings

 Details in Statement of Changes in
Equity
 4.e Disclosure
Not all classes apply to each company

Companies may disclose more detailed

information, but not less

General Rule
 Provide additional line items, headings &
sub-headings when such presentation is
necessary to present fairly the
enterprise’s financial performance &
position
 Topic 2 Part II
FINANCIAL STATEMENTS
Deegan Chapter 17
Leo et al Chapter 10
 Learning Objectives
Explain the correct accounting treatment for
changes in
1. accounting policies
2. accounting estimates

3. Conduct tests to determine the materiality

of errors, omissions & misstatements

4. Apply correct accounting treatment for

events after balance date
ACCOUNTING POLICIES
 1.a Definition
Specific accounting principles, bases or rules
 adopted by a company in preparing &
presenting its financial reports

1. May be prescribed by accounting standards

2. or specifically determined by the company
 1.b Disclosure
Note 1 must disclose

1. Compliance with Accounting Standards

2. Measurement Basis
 Going Concern
 Accrual
 Historical Cost
 1.b Disclosure
3. Description of other accounting policies e.g.
 Inventory
 Depreciation

4. Judgements made by management in the

process of applying accounting policies
 1.c Consistency
Generally, policies should be applied
consistently to ensure comparability

1. Over time
2. Between companies
 1.d Changes to Policies
Policies may be changed

1. If required by an accounting standard

 Standard indicates required disclosure
or
2. To improve relevance & reliability
 Applied retrospectively
 Adjust reported figures for prior periods
 Unless impracticable
 1.d Changes to Policies
Disclose

1. Nature of the change

2. How it improves relevance & reliability
3. Adjustment to each line time affected
 for current & previous periods
4. Statement that
 comparative figures have been restated
 or that restatement is impracticable
ACCOUNTING ESTIMATES
 2.a Definition
Certain items must be estimated
 Cannot be known in advance e.g. useful
life of assets, % of bad debts

May need to be revised

 Based on new information
 2.b Changes
1. Applied prospectively
 Adjust figures for current & future periods
 Disclose nature & amount of change

2. Quite different from correction of errors

ERRORS IN PRIOR PERIODS
 3.a Treatment

Once discovered, the error must be corrected

retrospectively
 Adjust comparative figures
 P&L items relating to more than 1 year
before current period must be adjusted
against opening retained profits
 3.b Disclosure
1. Nature of the error

2. For each previous period presented

 Amount of the correction for each line
MATERIALITY
 3.c Definition
Information is material if its omission,
misstatement or non-disclosure
 Individually or collectively

has the potential to influence users’ decisions

 or affects discharge of accountability by
management
 3.d General Decision Rules
>= 10% Material
<= 5 % Not material
5% - 10% Management must apply judgement
Consider entity as a whole
Base Varies for each financial statement
 3.e Exceptions
Items affecting the following are always deemed
to be material
a. related parties
b. expansion (industry or geographic)
c. risk of breaching debt covenant
 3.f Bases
Income 1. Profit or Loss
Statement 2. Or appropriate category of income
or expense
Balance 1. Equity
Sheet 2. Or appropriate class of asset or
liability
Cash Flow Net cash flow for operating, investing
or financing activities (as appropriate)

For Income Statement & Cash Flow, either

current period or average can be used
Example

Materiality
 Case 1
Creditors’ invoices (valued at $30,000) relating
to goods delivered in December 2007 have
not been recorded

Accounts affected (perpetual inventory system)

 Inventory
 Accounts Payable
 Case 1
Error Base $ %
$30,000 Inventories 420,000 7.1
Payables (current) 300,000 10.0
Result Material, since error > 10%
Requires adjustment

Dr Inventory 30,000
Cr Accounts Payable 30,000
 Case 2
Sales invoices (valued at $40,000) raised by
Ranadi branch for the last week of
December 2007 have not been processed.
 The cost of the goods was $15,000

Accounts affected
 Accounts Receivable
 Sales
 Inventory
 Cost of Goods Sold
 Case 2
Error Base $ %
$40,000 Profit 400,000 10.0
Receivables (current) 500,000 8.0
$15,000 Profit 400,000 3.8
Inventory 420,000 3.6
Result Material, since error > 10%
Requires adjustment
 Case 3
Depreciation was incorrectly calculated and is
currently overstated by $10,000

Accounts affected
 Depreciation
 Asset (Accumulated Depreciation)
 Case 3
Error Base $ %
$10,000 Profit 400,000 2.5
Equity 850,000 1.2
Result Not Material, since error < 5%
No adjustment required
 Case 4
The allowance for doubtful debts does not
include accounts owing from a customer
who went bankrupt shortly after reporting
date.
The customer’s balance outstanding is $30,000

Accounts affected
 Bad Debts Expense
 Accounts Receivable
 Case 4
Error Base $ %
$30,000 Profit 400,000 7.5
Receivables (current) 500,000 6.0
Result May be material.
Requires professional judgement.
EVENTS AFTER BALANCE
DATE
 4.a Definition
Events that occur between

Authorisation
Balance Date Date
End of financial When financial
period statements are
signed
 4.b Terms
2 Types 1. Adjusting Events
(require changes to statements)
2. Non-adjusting
disclosed in notes
Adjusting Provide evidence of conditions that
already existed at balance date
e.g. Insolvency of customer
Non- Indicate conditions that arose after
adjusting the reporting period e.g. flood or fire
 Example

Events after Balance Date

 Case 1
Summary Date of accident 17 Jan 2015
Does not affect financial
position of the company at 31
December 20014

Classification Type 2 error (non-adjusting)

Treatment Disclose details of the

accident & estimated financial
impact (in the notes)
 Case 2
Summary Cash paid on 29 Dec 2015.
Net was in transit at 31 Dec
2015 (included in assets).
Inspection provides new
evidence of actual state of the
net at balance date.
Classification Type 1 error (adjusting)
Treatment Dr Receivable $450,000
Cr Net/PP&E $450,000
 Case 3

Type Lawsuit is a consequence of the

2 cyclone, which occurred after balance
date
 Case 4
Summary 30% was provided for at
balance date.
Liquidator provides new
evidence of actual state of the
account at balance date.
Classification Type 1 error (adjusting)
Treatment Dr B/Debts Exp. $125,000
Cr A/c Receivable $125,000
$250,000 x (70%-20%)
End