Learning Area 5 Chapter 8 Financial Statements

 Explain the purpose of and be able to prepare a simple:  Income statement  Balance sheet  Statement of changes in equity  Cash flow statement (understand & interpret)  Understand how to apply the accounting concepts (page 2) Objectives

 Two parts  Assets (everything owned by business)  How these assets were financed (Equity and liabilities)  “Snapshot” of events at a point in time  Balance sheet equation: Assets = Equity + Liabilities  Balance sheet per p4 (know format!!!) 1. Statement of financial position p3

 Asset is a resource or inflow of economic benefits  Non-current asset = fixed assets (property)  Current assets = debtors / cash / inventory  Non-current asset usually long economic lives (>= 12 months)  Tangible assets:  Touch  Examples: Vehicles, Machinery, Property  Measured: Cost – accumulated depreciation  Revaluation of property…, still depreciated  Not all depreciate in value i.e. land has infinite life (revalue) 1.1 Non-current assets p5

 Intangible assets:  Assets that cannot be touched  Example: Goodwill = Sale price of company A – Net book value of company A (net book value: total assets – total liabilities = equity)  Research and development cost  Concessions, patents – right over product or discovery  Trade marks, brand names – MacDonald's  However IAS 38 claims …. “internally generated not an asset” 1.1 Non-current assets p6

 Investments  Interest in other companies: shares, loans, debentures etc.  Measured: Market value, (refer cost concept chapter 7 – see why we did the accounting concepts??!!! ) 1.1 Non-current assets p7

Cash and items convertible into cash in the normal course of business (< 12 months)  Inventories  Stock: Raw materials, Work-in-progress, consumables, finished goods  Measured: Lower of cost and net realisable value 1.2 Current assets p7

 Trade receivables (Debtors)  Amounts owed by customers  Measured: ‘Cost’ – Provision for doubtful debts… Take into account possible losses due non-payment  Other current assets  E.g. Short term investments in money market fund or fixed deposit (less than 1 year) 1.2 Current assets p8

 Amount contributed by the shareholders (Share capital and share premium) and earned by the shareholders (Retained earnings / reserves)  Assets – liabilities = Equity  Comprises:  Share capital  Reserves:  Share premium  Revaluation reserve (example property revalued)  Retained earnings 1.3 Equity p8

Liability = Finance by third parties, therefore amounts payable / owed to third party Net current assets (working capital) = CA – CL  Indicate the liquidity of the business 1.4 Liabilities p9

Current liabilities (< 12 months)  Trade payables (creditors) Measured: face value (cost)  Short-term borrowings (overdraft) Measured: amount actually overdrawn  Current portion of long-term borrowings Portion repayable within one year (< 12 months)  Current tax payable 1.4 Liabilities p9

Non current liabilities  Due >12 months  Long-term borrowings  Medium-term loans, hire purchase liability and finance leases  Long-term provisions  Estimated liabilities  Provision for claims incurred but not yet reported (IBNR)  Contingent liabilities  Potential liability, not likely: Disclose per Notes 1.4 Liabilities p10

Question 8.4 Solution Blank.docx Question 8.4 Solution.docx Question 8.4 p11

 Income statement – part of statement of comprehensive income… revenue until profit after tax  Other comprehensive income – only “gains on revaluation” part is examinable  Income statement:  Insight into activities and profits  Over a period of time (12 months)  P13 (know format by hard!!!) 2. Statement of comprehensive income p12

 Revenue can be sales / income from services rendered turnover sales  Also called turnover or sales realisation concept  Recognised when earned in accordance with realisation concept 2.1 Revenue p13

contributed to producing the goods sold Can be raw materials, components, wages & salaries - contributed to producing the goods sold  Include opening inventory, exclude closing inventory matching concept  According to the matching concept  Example  Purchases: R30 000, Opening inventory R5 000 and Closing inventory R Calculate Cost of Sales: 2.2 Cost of Sales p14

Distribution costs Costs associated with sales, distribution and advertising Example: Delivery vehicle Administrative expenses Wages & salaries, directors’ remuneration Not strictly related to production…Indirect costs (“overheads”) Distribution costs & Administrative expenses

Finance income  Income from Investments e.g. rent from property, interest, dividends Finance Costs  Interest payments on loans  Why disclose? Finance income & Finance cost

 As calculated per tax notes (do later in May)  Why not Profit x 28%?  Depreciation vs Capital allowances  Provision for doubtful debts  Prohibited expenses and losses  Assessed losses from previous years Tax expense p15

 Gross profit = Revenue – Cost of Sales  Operating profit = Profit before finance costs and income  Net profit before tax = Operating profit adjusted for finance cost and income Categories of profit p16

 EPS = Earnings attributable to ordinary shareholders / number of ordinary shares  Earnings attributable to ordinary shareholders:  If no preference shares: Profit after tax  If pref shares: Profit after tax – dividends payable to pref shareholders Earnings per share p16

Revaluation of non-current assets – Effect:  Non-current asset Increase  Revaluation reserve increase  Increase reflect as ‘gain on revaluation’ in the other comprehensive income  Example: Land: Cost = R , Revalued to R Revaluation of assets held as an investment  “gains from investments” per other comprehensive income Other comprehensive income – Revaluation (p17)

 Downward revaluation:  Expense in the income statement unless it reverse a previous upward revaluation surplus  Asset sold:  Realised gain/loss: Income statement Other comprehensive income – Revaluation (p19)

 Solution 8.6.docx Solution 8.6.docx Question 8.6

 Question 8.1 p6 Intangible assets  Question 8.3 p11 Classification: Balance sheet  Work through Question 8.5 p14 Cost of Sales and Question 8.6 p19 Income Statement again Homework

The purpose of the cash flow statement is to show cash movements and liquidity of company Gives insight to the following:  Why did bank balance not increase /decrease in correlation with profitability?  Can company generate sufficient cash?  What did company do with loan taken out during the year? 3. Cash Flow Statement (p20)

Cash vs Profit  Income statement recognises depreciation and credit sales which is not a flow of funds  Cash flow statement ignores the accruals concept 3. Cash Flow Statement (p21)

ProfitCash Purchase non- current asset for cash -Decrease Increase depreciation charge Decrease- Revaluation of inventory (upward) Increase- Paying tax-Decrease Paying dividends-Decrease Question 8.8 (p22)

ProfitCash Selling goods on credit (above cost price) Increase- Purchase of raw material on credit Lower- Issue of loan capital or new shares for cash -Increase Selling an investment (zero capital gain) -Increase Question 8.8 (p22)

3 Sections:  CF from operating activities – reconciles profit before tax to cash from operating activities  CF from investing activities – disposal and acquisition of long term assets and investment income  CF from financing activities – changes in size of equity and loans (share issues, repayment of loans etc.) Cash flow statement: Structure (p24)

Net cash generated from operating activities (p25) Operating profit Adjustments for: - Depreciation - Decrease/(Increase) in inventory level - Decrease/(Increase) in trade and other receivables - Increase/(decrease) in trade and other payables Cash generated from operations Tax and interest to be deducted for ‘Net cash generated from operations’ (7 000) (1 500) (9 400)

Investing & Financing Activities  Investing activities  Buy or sell fixed assets (property and plant)  Interest or dividends from investments  “Liquid assets” such as short-term investments in securities  Financing Activities  Dividends to shareholders  Cashflows arising: o repayment of loans o new borrowing o issue of shares

Solution Q8.10.docx Question 8.10 HOMEWORK

 Reconciles all equity accounts’ opening balances to closing balances  Example p28 Example - Statement of changes in equity.docxExample - Statement of changes in equity.docx  Dividends  What is dividends?  Proposed by directors on annual general meeting Statement of changes in equity p28

Notes will cover:  Detailed disclosures and explanatory information  Accounting policies  Post balance sheet events  …true and fair view of the position of the company Notes to the accounts p30

Be able to:  Explain the importance of each statement, and explain the different elements on the statements  Compile the various statements  Explain the difference between profit and cash What to expect in a test/exam…

 Question 8.7 & 8.9 & 8.10 Cash flow statement  Question 8.11 Statement of changes in equity Solution 8.11 Changes in equity.docx HOMEWORK

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 Date:  Date:Friday 7 March 2014  Time :  Time :16:00  Total :  Total : 40 marks  Duration:  Duration:1 hour  Venue:  Venue: Centenary 1 & 2  Scope:  Scope:Chapters 1; 2; 7; 8 and 9 (Learning areas: 1; 2; 4; 5 and 6) Semester test 1