Event Technology & Finance Lecture

Financial statements from the accounting equation & Ensuring the quality of financial statements

Jonathan Sibleyj.sibley@leedsmet.ac.uk

Event Technology & FinanceToday we will be focusing on the following topics,

1. Chapter 3: Financial statements from the accounting equation: p. 51 – 73

2. Chapter 4: Ensuring the quality of financial statements: p. 74 – 105

Weetman, P (2013), Financial Accounting, An Introduction, Sixth Edition, Pearson, Harlow, England

Financial statements from the accounting equation

CHAPTER 3

Weetman, P (2013), Financial Accounting, An Introduction, Sixth Edition, Pearson, Harlow, England

Primary Financial Statement Purpose...to report the…

Balance Sheet (A statement of financial position)

Financial position of an entity at a specific time

Profit and Loss Account(Income statement)

Performance of an entity over a specified time

Cash Flow (Statement of Cash Flows)

Financial adaptability of an entity for a period of time

Financial StatementsThere are three main financial statements which are used for different purposes when presenting financial information.

The Purpose of Financial Statements

Owners and long-term lenders regarded as primary users but all potential users are interested in financial performance and financial position of the reporting entity.

Reference: Week 1 Lecture

The Balance Sheet:“A financial statement which

summarises a companies assets, liabilities and ownership interest at a specific point in time. These three segments show what the company owns and owes as well as the amount invested by the owner”

How to use a balance sheet to assess the financial position of an entity… The Accounting Equation

Assets – Liabilities = Ownership Interest

Assets Liabilities Ownership Interest

£100,000 £75,000 £25,000

A balance sheet includes all of the elements of the accounting equation and demonstrates the financial position of a company by highlighting the relationship between what is owned how much is owed and how much is owned by the owners. A change in any of these segments will have an impact on the other in order to maintain balance.

How to use a balance sheet to assess the financial position of an entity…

Assets Liabilities Ownership Interest (Equity)

The Structure of a Balance Sheet

FIXED ASSETS

CURRENT ASSETS

CURRENT LIABILITIES

LONG-TERM LIABILITIES

Capital at start of year plus/minusCapital contributed or withdrawn plus

Profit of the period

The Structure of a Balance Sheet

£100,000 £20,000

£10,000 £70,000

£40,000

Fixed Assets Current Assets

Current Liabilities Long-term liabilities

Capital/Ownership Interest/Equity

Profit and Loss Account

“A financial statement that measures a company's financial performance over a specific accounting period.”

• Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities.

• It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year.

Profit and Loss Account (Income statement)

Revenue – Expenses = Profit

Revenue(Income)

Expenses(Expenditure)

Profit

£200,000 £110,000 £90,000

Statement of Cash Flows

“shows the amount of cash generated and used by a company in a given period. Cash flow can be attributed to a specific project, or to a business as a whole. Cash flow can be used as an indication of a company's financial strength”

Statement of Cash Flows

Cash Inflows – Cash Outflows = Change in Cash & Similar Liquid Assets

Cash Inflows

Cash Outflows

Change in Cash & Similar Liquid Assets

£500,000 £300,000 £200,000

Profit does not always equal cash

Working capital

• Some sales are made on credit where customers pay later.

• Some purchases are made on credit where pay suppliers later.

• Cash is used to buy inventory (stock) which is sold later.

• Cash is used to buy more current assets.

• Cash is used to buy other investments

• Cash is used to repay loans.

• Cash is raised from issuing shares.

• Cash is raised from borrowing.

Profit does not always equal cash

Subdivisions of Cash Flow• Operating activities:

Provision of services, and the manufacturing, buying and selling of goods for resale.

• Investing activities:

Buying and selling fixed assets for long-term purposes.

• Financing activities:

Raising and repaying the long-term finance (loans) of the business.

Practical illustrations

See Mason (2013) for illustrations/examples in Chapter 3 for:

1. Statement of financial position.

2. Income statement.

3. Statement of cash flows.

4. Comparison of profit & loss and cash flow.

Ensuring the quality of financial statements

CHAPTER 4

Weetman, P (2013), Financial Accounting, An Introduction, Sixth Edition, Pearson, Harlow, England

Qualitative characteristicsUnderstandability

• The significance of the information can be perceived by the user.

Relevance

• Information that has the ability to influence decisions.

Reliability

• Information that is a complete and faithful representation.

Comparability

• Similarities and differences can be discerned and evaluated.

Qualitative characteristics

Relevance and ReliabilityRelevant• Information should be relevant to the decision

making needs of the user• Enabling the user to make predictions about future

trends (Predictive value)• As well as confirming or correcting past decisions

(Confirmatory value)

Reliable• Free from material error• Faithful representation• Neutral• Complete• Prudent

Measurement principles

There are 4 measurement principles:

1. Going concern

2. Accruals

3. Consistency

4. PrudenceNB: Going Concern and Accruals: Discuss these definitions within your workshop.

Consistency• Use similar policies from one year to

next or explain reason for and effect of change.

Prudence – see later.

Measurement principles

Materiality• Threshold for considering an item. Would a

user’s decision change if the information were omitted or misstated?

For example:

• An error of £10m in an expense item when overall profit £500m is not material as this is only 2% of profit.

• Whereas an error of £10m in an expense item when the overall profit is £20m is material as this is 50% of profit.

Prudence

The inclusion of a degree of caution in accounting judgements under conditions of uncertainty.

For example:• The undertaking of an Inventory (stock) Valuation and the uncertainty caused if that stock is not yet sold.

PrudenceAvoid• Overstatement of assets• Understatement of liabilities• Because both of these will lead to

overstatement of profit.

Assets – liabilities = Capital (incl. profit)

• If you overstate the value of an asset how does the equation balance?

• Answer: Create profit.• If you decrease the cost of a liability. How does

the equation balance? • Answer: Create profit.

Regulation

Financial statements

• Information that is useful to a wide range of users.

Annual reports

• Mixture of regulated and non-regulated contents. Regulated section is audited.

RegulationInternational Accounting Standards (IAS) Regulation• Overrides national company law.

• Requires all listed groups to prepare financial statements using the International Financial Reporting Standards (IFRS).

UK Company law• Requires true and fair view.

• Accounting rules apply to companies not following IAS Regulation.

• Contains other rules for management and the auditing of a company.

RegulationFinancial Reporting Council• Authorised by UK government to make

arrangements for accounting standards, auditing standards, oversight of professional bodies and firms, enforcement of standards.

UK Accounting Standards Board• Independent standard-setting body.• Sets accounting standards for use in UK (by

companies not applying the IAS Regulation).

Regulation

Auditing Practices Board• Sets auditing standards (based on

International Standards on Auditing) and a code of ethics for auditors.

Professional Oversight Board • Has oversight of professional bodies

and accountancy firms.

Regulation

Financial Reporting Review Panel

• Monitors compliance with true and fair view.

• May ask companies to correct wrong accounts.

Accountancy and Actuarial Discipline Board

• Investigates complaints against accountants and applies penalties.

Regulation

Committee on Corporate Governance

• Sets Code on Corporate Governance for directors running a company.

Financial Services Authority (will change in future to a new body/bodies)

• Regulates market for shares.• Has accounting rules for fair market.

RegulationAuditors

• Report to shareholders.

• Use auditing standards.

• Give opinion on true and fair view from financial statements.

Tax system

• Companies pay corporation tax.

• Taxable profit is based on accounting profit but with additional rules, for example, depreciation rates fixed.

Is regulation necessary?

For regulation

• Supply and demand do not meet unless a regulator intervenes.

• Stakeholders may lose confidence, or may need protection.

• Scandals result where there is inadequate regulation.

Is regulation necessary?

Against regulation

• Market forces ensure information flow.

• Lenders will ensure they have good information for reassurance.

• Costs may exceed benefits.

Look at key figures in highlighted statements.

1. Sales

2. Gross profit

3. Profit before tax

4. Profit after tax

• Trends in key figures

Reviewing published financial statements

Reviewing published financial statements

• What kinds of assets are held?

• What kind of liabilities are held?

(Notes on the Balance Sheet)

• What is the cash flow?

• Inflow or outflow?

Financial Statement Terminology

• Balance Sheet• Asset• Liability• Fixed Asset • Current Asset• Limited Liability• Long-Term Liability• Ownership Interest

• Relevance• Reliability• Measurement

Principles• Materiality• Prudence• IAS Regulation• Working Capital• Capital

You Tube:• What is a Balance sheet? http://youtu.be/

ixCPM5HznRU• What is a Profit & Loss Statement?

http://youtu.be/ulpX3jX_UT0

Further Sources of InformationThe following resources are

available to view on YouTube only: Click on the links within the slides to view alternatively cut and paste the links into a web browser.

Reference: Weetman, P (2013), Financial Accounting, An Introduction, Sixth Edition, Pearson, Harlow, England p. 51 - 105

CHAPTERS 3 & 4

Jonathan Sibleyj.sibley@leedsmet.ac.uk

www.slideshare.net/Jonathan_Sibley

Asset:

Assets are subdivided into:1. Fixed assets 2. Current assets

“Resources available to the business”

Liability:

Liabilities are subdivided into:1. Current liabilities (due within one year) 2. Long-term liabilities (due after one year).

“The obligations of the business to persons other than the owner”

Ownership Interest:

• The owner(s) typically provide the capital with which the business is started, this capital is used to purchase assets and the payment of liabilities.

• Ownership Interest may also be subdivided to show the capital contributed or withdrawn and the profit for the period.

• Ownership Interest is the residual claim after liabilities to 3rd parties have been paid

“an interest of the owner in the assets of the business”

Fixed Asset:“A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be consumed or converted into cash any sooner than at least one year's time”

Current Asset:“A balance sheet account that represents the value of all assets that are reasonably expected to be converted into cash within one year in the normal course of business”

Current Liabilities:“A company's debts or obligations that are due within one year. Current liabilities appear on the company's balance sheet and include short term debt, accounts payable, accrued liabilities and other debts.”

Long-term Liabilities:“In accounting, a section of the balance sheet that lists obligations of the company that become due more than one year into the future. Long-term liabilities include items like debentures, loans, deferred tax liabilities and pension obligations.”

Capital:“Capital” can mean many things. In general, it refers to financial resources available for use. Companies and societies with more capital are better off than those with less capital”

Revenue:“The amount of money that a company actually receives during a specific period. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income.”

Expenses:“The economic costs that a business incurs through its operations to earn revenue. In order to maximize profits, businesses must attempt to reduce expenses without also cutting into revenues. Because expenses are such an important indicator of a business's operations, there are specific accounting rules on expense recognition.”

Liquid Assets:“An asset that can be converted into cash quickly and with minimal impact to the price received. Liquid assets are generally regarded in the same light as cash because their prices are relatively stable when they are sold on the open market”

Working Capital:A measure of both a company's efficiency and its short-term financial health, which indicates whether a company has enough short term assets to cover its short term debt.

Current Assets – Current Liabilities = Working Capital

Operating Activities:Operating Activity:“An activity that directly affects an organization's cash inflows and outflows, and determines its net income”

Non Operating Activity: “An expense incurred by activities not relating to the core operations of the business”