1. 1 Accounting The Balance Sheet Liabilities

2. 2 Dr. Clive Vlieland-Boddy FCA FCCA MBA

3. 3 4 Fundamental Accounting Concepts again! Going Concern - That the business will continue and not be liquidated. Accruals (or Matching) - That income is matched with expenditure. You match the sale with the cost of that sale. Consistency - What you did last year you do this. Otherwise figures would be meaningless. Prudence - Caution is essential. Note “Prudence must prevail”

4. 4 What is a Balance Sheet It is like a photograph taken on a given date of the financial position of the company. ……”Click”…….

5. 5 What is a Balance Sheet FLASH

6. 6 The Accounting Equation The Assets = Liabilities + Shareholders (Owners) Equity. Assets = Liabilities & Equity

7. 7 A Balance Sheet….. Assets Current Non Current Investments Intangibles Liabilities Current Non Current Shareholders Equity Shares Retained Earnings

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9. 9 Liabilities Represent an obligation of the business arising from past events. The settlement of this is expected to result in an outflow from the recourses of the business having itself created economic benefit. If you will never have to write out a cheque or otherwise settle a claim then it is not a liability.

10. 10 Liabilities A liability is what its name says. It is a responsibility of the enterprise and is some form of debt. There are 2 essential categories of these. Current Liabilities - Non Current Liabilities -

11. 11 Current Liabilities Those that are to be settled within 12 months. E.g. Accounts Payable Bank overdraft. Dividends Payable Tax Payable Sundry Accruals Current Proportion of Long Term Loans

12. 12 Accounts Payable (Creditors) Most companies buy materials and supplies on credit paying for them weeks or even months later. Thus the accounts must show that there is a liability outstanding when the goods are received / Invoiced, until they are actually paid for.

13. 13 Dividends Payable The amount that is due to be paid as dividends to shareholders.

14. 14 Tax Payable Current Tax payable to the government.

15. 15 Tax & Deferred Tax Tax is divided into two categories. Tax that has to be paid to the government and tax that is delayed due to certain concessions or tax incentives. Tax that is payable to the government is shown as a current liabilities as this will have to be paid quickly. Deferred tax is a Non Current Liability as it is not payable for at least 12 months.

16. 16 Deferred Tax Tax that is not payable within 12 months.

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18. 18 Sundry Accruals In order to comply with the Matching Concept, it is necessary to make adjustments for items that have yet to be invoiced but are due and need to be matched with the year or accounting period to which they relate. Example: A company receives its 3 month telephone bill one week after the year end. The whole bill relates to the closed year. This would need to shown as an Accrual.

19. 19 Coffee Break 11.2.1 What would be your concerns if, having received the annual accounts for a company in which you have a significant investment, you note that it has very substantial bank balances and has made substantial profits, but has recommended only a small dividend?

20. 20 Non Current Liabilities Those that are due to be settled after one year. E.g. Loans with maturity more than 12 months away. Mortgages Deferred Tax

21. 21 Long Term Loans Loans repayable more than 12 months away are treated as Non Current Liabilities. Any portion repayable within 12 months will be shown as a current liability.

22. 22 Proportion of Loans repayable within 12 months Example: A Company has a bank loan of $100k repayable over the next 10 years by equal installments of $10k. Thus in Current Liabilities would be $10k and in Non Current Liabilities would be $90k.

23. 23 Dividends payable. Dividends which are due and payable within 12 moths are normally shown separately under current liabilities.

24. Accounting for Contingencies Contingent loss Probability of Occurrence Accounting Treatment HighReasonableRemote NoYes Disclose In Notes Accrue In B/S IgnoreDisclose In Notes Estimable? >50% <50% <20%

25. 25 Provisions More than 50% likely we will have to write out a cheque. Must show as a liability in the Balance Sheet. Examples:  Warranty  Bad Debts (Accounts Receivable that might well not pay)  Proposed Management Bonuses or Audit Fees.  Litigation where the outcome is likely to be adverse..

26. 26 Contingencies Possible obligation from past events not within the companies control. The present obligation may not have any financial effect or as yet not determinable. If a contingency is more that 50% likely to happen then it is a provision and needs to be included in the Balance Sheet.

27. 27 Contingencies - Accounting Treatment Should be disclosed in a note to the accounts. A description given even in the notes. Reasons for any uncertainty. Attempt to quantify.

28. 28 Pension Liabilities Most companies separate these out. If still there then should show as Non Current Liability except the amounts payable to retired staff within next 12 months which are shown as Current Liabilities.

29. 29 Shareholders Equity This is the capital that the owners have in the business. It represents their investment into the enterprise. It is sometimes know as Stockholders funds or just Equity.

30. 30 Share Capital & Reserves The companies capital structure is initially written down in its foundation documents called Memorandum & Articles of Association.

31. 31 Shareholders Equity Limited Liability Companies require investors to provide capital. Initially in the form of shares and then by leaving their profits in the firm. These profits that are left in the firm are called retained earnings‏

32. 32 Different Types of Shares Common or Ordinary Shares - These are the real owners of the company ( Once you have 50% plus you own and control the company) Preference Shares - Basically a loan. Normally no voting rights.

33. 33 Authorised, Issued and Paid up Authorised is the number and amount that the Memorandum permits. This can be changed upwards, normally by application to the Court. Issued is the number of shares actually purchased. Paid up is the number actually paid for. Difference is that sometimes shares can remain unpaid.

34. 34 Shareholders Funds Retained Earnings The company will not normally pay all its profits to the shareholders as dividends. They will retain some to fund the activities and growth of the business. There profits not distributed are called “Retained Earnings”.

35. 35 Share Premium Shares sold by the company at a premium. The premium is collected here.

36. 36 Share Premium Where shares are say $1 each, often a company will sell them for say $1.50 or more. This premium is shown as a separate item in the Shareholders Equity.

37. 37 Revaluation Reserve NCA’s can be revalued. If they are, the increase should be recorded here. Note that under IFRS these reserves cannot be distributed as dividends.

38. 38 Capital Reserves These are revaluation reserves generated by re-valuing a Non Current Asset or the disposal of a Non Current Asset.

39. Treasury Stock Treasury Stock Corporation’s own stock that has been issued and reacquired. Reasons to reacquire own stock: –Limited investment opportunities. –To increase stock price. –To increase EPS. –To issue stock bonus to employees. –To prevent hostile takeover.

40. Accounting for Stock Transactions: Repurchase of Stock When common stock is repurchased, both assets (cash) and stockholders’ equity decrease by the purchase price. The reduction in stockholders’ equity is accomplished by increasing a contra- equity account called treasury stock.

41. 41 Treasury Stock Shares that the company has bought back. Many issues over how to show these in the financial statements. The balance represents the total that the enterprise has paid out to buy back shares.

42. 42 After Balance Sheet Events Activities occurring after the Balance Sheet date may or may not require adjustment or a note. Such events may be favourable or not. Either provide evidence of conditions that existed at the Balance Sheet date or indicate conditions that occurred after the Balance Sheet date but make a material effect to the possible future outcome.

43. 43 Off Balance Sheet Finance Examples Sale and lease back of a Non Current Asset or Fixed Asset along with its associated borrowings to a Special Purpose Vehicle (SPV) e.g. Enron!!! Buying loss making companies via a SPV until they become profitable.

44. 44 Creative Accounting This represents manipulating the figures for a desired result. Example: a company may try to improve the picture so as to inflate share price or gain beneficial loan arrangements. Alternatively, if tax was high, then possibly reducing profits so as to pay less tax. Often such adjustments are done at the year end by issuing invoices early or delaying until the next year.

45. Question? The following excerpt was taken from a recent financial statement of Cummins Engine Company: Loan agreements contain covenants which impose restrictions on the payment of dividends and distribution of stock, require maintenance of a 1.25:1 current ratio, and limit the amount of future borrowings. Why would a creditor such as a bank impose such restrictions when making a loan?

46. 46 Coffee Break 11.10.1 As a shareholder in a major telephone corporation, you note from the latest accounts that the levels of debt have been substantially reduced and that the previous auditors KPMG have been replaced by a small local firm called Will, Sighn & Run. What issues would you have for the next shareholders meeting?

47. 47 ABC Limited Balance Sheet as at 31st May 2006 Current Assets Accounts Receivable200,000 Inventories150,000 Bank Balance125,000 Total Current Assets475,000 Non Current Assets Plant & Equipment100,000 Less: Depreciation -50,000 Total Non Current Assets 50,000 Investments 25,000 Total Assets550,000 Current Liabilities Accounts Payable150,000 Tax Payable 50,000 Current Prop of Loan 25,000 Total Current Liabilities225,000 Non Current Liabilities Bank Loan250,000 Shareholders Funds Shares 25,000 Retained Earnings 50,000 Total Shareholders Funds 75,000 Total Liabs & Equity550,000

48. 48 Consolidated Balance Sheet Where you have a group of Companies, the parent will consolidate its subsidiaries into its own accounts. It will add all the groups assets and liabilities together. Minority Interest is the % that is not owned by the group.

49. Revision 49

50. What is an Asset? Must be owned or controlled by the enterprise. Must have some present or future value. If it fails one of these tow tests it is NOT and asset of the enterprise. 50

51. The 3 Main Current Assets

52. What is a Liability? Must represent a present or future responsibility from a past event. Will require settling at an expense to the business. (In other words it will have to write out a cheque) If it fails one of these two tests then it is not a liability. 52

53. Summary of Liabilities 53

54. Remember! The difference between Current & Non Current is the accounting cycle which is assumed to be less than12 months. 54

55. 55 Prepare for next class

56. Bye for now! I’m ready for some leisure time. Please ensure you Prepare for next session

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