1. XII.1 Learning objectives – chapter 12 1. Understand the purpose of the income statement, and know how revenues/expenses are presented in the annual accounts. (self study) 2. Distinguish between the capital movements (entries booked directly to Owners´ Equity ) and entries, which are booked in equity via the income statement (“comprehensive income” or not?) 3. Concepts related to presentations of the share capital in different share classes due to differences in owners´ rights. (self study) 4. Basics about the composition of Owners´ Equity including the various reserves in Owners´Equity and the effect of these reserves 5. Own shares (treasury stocks) 6. Result carried forward and payment of profits. (partly self study) Copyright  2000 by Harcourt Inc. All rights reserved.

2. XII.2 Figure 12.1 Sources of profit Result of recurring (“main”) operating activity Result of recurring (“main”) operating activity Result of ended/ ending ordinary operating activity Result of ended/ ending ordinary operating activity Results of special activity, e.g. large sales of fixed assets. (shall be specified ) Results of special activity, e.g. large sales of fixed assets. (shall be specified ) Extraordinary profits/losses, e.g. losses in relation to catastrophe of nature Extraordinary profits/losses, e.g. losses in relation to catastrophe of nature Recurring Nonrecurring activity activity Operating Close activity/ event Operating remote activity/ event Copyright  2000 by Harcourt Inc. All rights reserved.

3. XII.3 The annual result The purpose of the income statement is to specify the annual result, so that the accounting reader can monitor company activities and make better estimates of future results and cash flows Copyright  2000 by Harcourt Inc. All rights reserved.

4. XII.4 Unrealized gains/losses on account of changes in the market values IAS has (inspired by the FAS’es) in recent years required that financial assets and also some financial obligations are booked at the market value in the financial statements The Danish Company Accounts Act from 2001 requires valuation of the derivatives (financial instruments) and most financial assets (all financial assets except bonds held to maturity) and those financial obligations, which are “traded”, are valued at marked price/fair value Copyright  2000 by Harcourt Inc. All rights reserved.

5. XII.5 Unrealized profits/losses due to changes in the market value When an asset (/liability) is valued at the market value, and this is different from its cost price valuation, the change of value is called an “unrealized profit/loss”. The word “unrealized” means changes in value, which has not been “confirmed” by a transaction (the company has not received money/a claim of money from the third party) Asset, appreciation.xxx Unrealized gains. xxx Copyright  2000 by Harcourt Inc. All rights reserved. How are unrealized gains/losses to be booked? (in the income statement or direct on the share capital)

6. XII.6 Unrealized profits/losses due to changes in the market value The accounting treatment of the unrealized gains/losses depends on the accounting rules for the type of asset/liability in question. In Denmark the main rule is, that unrealized profits from operating activity cannot be recognized in the income statement, while unrealized losses must be recognized in the income statement. The exceptions: –Unrealized losses or recalculation of foreign subsidiaries from foreign currency to DKK (directly to O.E.) –Change in accounting policies (directly to O.E.) –Property investment companies´ increases in valuations of property ( included in the profit and loss account, but not allowed to result in dividends payment to the owners due to special reserves requirements (reserve requirements like those for “equity method revenues” which result from use of the equity method – a method explained in detail later on) Copyright  2000 by Harcourt Inc. All rights reserved.

7. XII.7 Financial inventories ÅRL demands many financial assets and some financial obligations to be valued at the market price, and that the price changes of those assets/liabilities are included in the income statement – without any related reserve requirements for owners´equity (=>gains can be paid out as dividends to owners) Unclear how many financial assets/obligations are subject to fair value valuation – does not comprise claims/obligations which are kept to maturity

8. XII.8 “Comprehensive income ” FASB has put forward as an ideal income model, that all value movements are included in an income statement in 3 successive steps: 1.Earnings, 2. Net income, 3. Comprehensive income. In Europe: Earnings (called profit or loss/income for the year) + a statement that species all changes in owners´equity (including the the change resulting from income for the year) The tendency in recent years has been to move in the direction of the “total model” for the income statement ( “the all-inclusive view”), by which all changes in owners´equity – except those from payment of dividends and owners´payments by the company´s issue of new shares, are booked via the income statement. – (Accompanied, however, by requirements for reserves for unrealized profits => these profits are also included in income, but they cannot be the basis of dividend payments) Copyright  2000 by Harcourt Inc. All rights reserved.

9. XII.9 Share capital according to announcement I. Company capital (called up share capital) II. Capital premium account (share premium account) III. Revaluation reserve IV. Other reserves 1. Reserve for net revaluations according to the equity method 2. Reserve for own capital (own shares) 3. Reserve for the net revaluations of property investment assets 4. Reserve for the net revaluations of biological assets 5. Other legal reserves 6. Reserves provided for by the articles of association 7. Other reserves V. Transferred gains or losses (Suggested dividends) Copyright  2000 by Harcourt Inc. All rights reserved.

10. XII.10 Share capital versus foreign capital According to the balance sheet equality assets have two financing sources, i.e. creditors (liabilities) and owners (owners´equity). Characteristics for creditors - owners´equity respectively: –Obligations to creditors are typically a fixed amount. Furthermore the creditors’ requirements come before the owners’ requirements, if a company closes down. –In contrast, the company´s obligation to its owners is a “residual obligation” to pay dividends (if possible) and - by the the close down of the company - to pay to the owners whatever is left after that the creditors’ requirements have been met. There is no upper limit for payments that the owners can receive from the company in the course of time, whereas the owners’ risk is limited to the invested amount in the company if the company limited liability company. –REMEMBER: The owners´equity is a “derived measure” of net assets and has no substance itself (and “reserves” are certainly not funds that can be used for payments). Copyright  2000 by Harcourt Inc. All rights reserved.

11. XII.11 Note requirements for the share capital in Denmark In Denmark there is the requirement the all companies subject to ÅRL must disclose ”a statement of the movements of the share capital” There are no format requirements for this statement, but a cross tabulation showing all owners´ equity components (cf. the specifications in the balance sheet format) and all “reasons” for changes in the equity (income, payment of dividends, revaluations etc.) in each of these components of equity will probably be typical layout of this statement. Furthermore, limited companies and private limited companies must disclosure detailed information in the notes of the financial statements, if there are different rights for different shareholders(the number of shares and their nominal value for each group of shareholders ). Limited companies must always disclose the number of shares and their nominal value. Copyright  2000 by Harcourt Inc. All rights reserved.

12. XII.12 Issue of share capital A possible financing source is the issue of new shares – by which the company receives cash and investor shares. The capital paid in by the shareholders by the company´s issue of shares is divided in two components of owners´ equity, the share capital and the premium account. Liquid funds (1000 shares at the price of 100) 100,000 Share capital 10,00010,000 (1000 shares at the price of DKK 10 each unit) Premium by emission 90,000 Copyright  2000 by Harcourt Inc. All rights reserved.

13. XII.13 Provisions of revaluation It is possible to revaluate inventories, tangible assets, and ownership rights ( e.g. shares”) in subsidiaries and associated companies CONDITIONS: The revaluation amount must be transferred directly to the “Revaluation reserve” in owners´equity (=>the revaluation is not allowed to be booked as income in the income statement!) The “Revaluation reserve” is a strictly “not-distributable” reserve (it cannot be reduced by dividend payouts nor be reduced by a net loss for the year), but the reserve has to be dissolved/reduced, if the revaluated asset is realized or is left out of the operations, or if the revaluation must be reduced. Revaluation reserves can never be booked as income, so a ”dissolution” of the the reserve by a sale of a revaluated asset must be transferred directly to another component (“reserve”) of owners´ equity.

14. XII.14 Reserves for net revaluations by use of the equity value method This reserve has to be used by a company holding ownership rights (shares etc.) in subordinated companies, if it (i.e. the “holding” company) applies the equity-method on these ownership rights in its subsidiaries/associated companies. Income from these ownership rights exceeding dividends received from these subordinated companies – be must be transferred from the income statement to the net revaluation reserve by the use of the equity method. (The equity-method is explained in more detail in relation to consolidated financial statements)

15. XII.15 Treasury shares Treasury shares are shares which have been bought back by the company itself In the USA (and in several other countries) treasury shares are not regarded as an asset of the company, but as a reduction of the capital for the owners, i.e. is treated as reduction in owners´ equity. Denmark: 2 possibilities 1: O.E.-regulation, (2) capitalization “ § 35 =>The company can recognize treasury shares as an asset and value them at cost price. If it does so, an amount corresponding to the cost price for the capital shares must be reclassified from the item »income brought forward« - or another of those reserves in owners´equity, which does not restrict payment of dividends - to the item »Reserve for treasury shares«. This reserve is strictly not-distributable (cannot be reduced by dividend payments or by a loss for the year). Copyright  2000 by Harcourt Inc. All rights reserved.

16. XII.16 Treasury shares By a subsequent sale of treasury shares: If the shares have not stated as an asset: No income statement recognition of losses/gains by sale (instead the sales price will increase O.E. - almost always “the profit and loss (brought forward) account” (since this reserve is also most often reduced by the company´s purchase of treasure shares) If the shares were recognized as an asset: losses/gains by sale are recognized as gain/loss in the income statement. Detailed information must be given in the notes to the financial statements on holdings, purchases, and sales of treasury shares. Copyright  2000 by Harcourt Inc. All rights reserved.

17. XII.17 Special reserves ”Reserve for the current value on investment assets ”- has to be used by the few investment activities, which value property at current values ”Reserve for current value for biological assets”- has to be used by the few investment activities, which value biological assets at current values (In both cases the reserve has to contain the amount, with which the assets have been valued in proportion to the equity method) ”Other legal reserves” and ”Reserves in accordance with the Regulations” are not used/seldom used in practice “Other reserves” in an residual reserve of O.E. which do not restrict dividend payout.

18. XII.18 Gains/losses carried forward Profits and losses (brought forward) are increased by the income of the year (according to the income statement) and are reduced by dividends (in Denmark typically by the dividends proposed by the company board, i. e. dividends that will be paid out after the financial statements have been finally approved, but it is extremely rare that proposed dividends are not the finally approved dividends). Proposed dividends can be included in O.E. (if the item is not stated as company debt). The proposed dividend will in that case probably be classified as a separate O.E. reserve called ”Proposed dividends for the accounting year”. Copyright  2000 by Harcourt Inc. All rights reserved.

19. XII.19 Corrections and changes in accounting practice Corrections of accounting estimates (e.g. losses on receivables)must to be booked in the income statement in the the year the year the error is found. Corrections of huge errors has to be made as an direct O.E. correction, however. Changes in net capital resulting from a change in accounting practice shall be shown as a correction of beginning O.E in the year of change