Chapter 6 Financial Statements

Financial Information Analysis2 Copyright 2006 John Wiley & Sons Ltd Financial Statements as Financial Photographs

Financial Information Analysis3 Copyright 2006 John Wiley & Sons Ltd Consolidation Most large plc’s are business combinations i.e., various companies under one parent: wholly-owned subsidiaries partly-owned subsidiaries associates investee These combinations require consolidated (group) accounts to be prepared

Financial Information Analysis4 Copyright 2006 John Wiley & Sons Ltd Group a/cs Consolidated (Group) accounts comprise accounts of parent and: wholly-owned subsidiaries: incorporate fully partly-owned: incorporate fully, then identify minority interest share of profits and assets associates: include share of profits and net assets investee: show as investment and source of dividends See Chapter 11 for more detail

Financial Information Analysis5 Copyright 2006 John Wiley & Sons Ltd Format of financial statements Impact of EU Directives on presentation IAS 1, Presentation of Financial Statements, the principal standard for large plcs Overall principles: “Fair presentation” [NB: “True & Fair”] Compliance with IFRS must be stated Offsetting generally not allowed Each material class of item to be presented Basic accounting concepts continue

Financial Information Analysis6 Copyright 2006 John Wiley & Sons Ltd Financial Statements in AR Financial statements are core of AR Controlled by statute, standards, etc. Under IAS 1 financial statements include: balance sheet; income statement; cash flow statement; statement of changes in equity; notes to the accounts

Financial Information Analysis7 Copyright 2006 John Wiley & Sons Ltd Balance Sheet Format not rigid But, Assets and Liabilities must be divided between “current” and “non-current” “Current” if: Realisable within normal operating cycle, or Held primarily for trading purposes, or In form of cash (or a ‘cash equivalent’ item), or Expected to be realised with 12 months after B/S date Otherwise, B/S may follow any one of a number of structures

Financial Information Analysis8 Copyright 2006 John Wiley & Sons Ltd IAS 1 Format IAS 1 includes this example of B/S presentation Other formats acceptable – see Tesco B/S ASSETS Non-Current AssetsX Current AssetsX X LIABILITIES EquityX Non-Current LiabilitiesX Current LiabilitiesX X

Financial Information Analysis9 Copyright 2006 John Wiley & Sons Ltd B/S: minimum disclosure See p.175 for minimum disclosures based on IAS 1, para. 68. Additional line items allowed where necessary to “fairly present entity’s financial position” Following slides deal with some of the B/S items specified

Financial Information Analysis10 Copyright 2006 John Wiley & Sons Ltd Property, Plant & Equipment IAS 16: ‘Tangible assets held for use in production or supply of goods … for more than one period.’ Recognise at cost or revalued amount if future economic benefits expected to flow Cost includes all attributable costs Revaluation based on fair value Usually done by ‘class’ of asset Revaluation increases directly to Equity All subject to depreciation/impairment (IAS 36) Assets not to be carried at more than recoverable amount Detailed disclosures required in notes

Financial Information Analysis11 Copyright 2006 John Wiley & Sons Ltd Investment Property IAS 40: ‘land or buildings held to earn rentals or capital appreciation’ Cost or Fair Value model may be used Cost: Carry at cost less depreciation/impairment Fair value must also be disclosed Fair value: Any movements recognised in Income Statement

Financial Information Analysis12 Copyright 2006 John Wiley & Sons Ltd Intangible Assets IAS 38: ‘identifiable non-monetary assets without physical substance’ e.g.: intellectual capital, customer loyalty, etc To qualify, asset must be: ‘identifiable’ – separable ‘controlled’ – rights to future economic benefits Classify as ‘Indefinite’ life: subject to impairment tests ‘Finite’ life: can be valued using fair value and amortised Internally generated intangibles with demonstrable feasibility may now be recognised

Financial Information Analysis13 Copyright 2006 John Wiley & Sons Ltd Inventories IAS 2: Inventories shown in B/S at lower of Cost and Net Realisable Value (NRV) Determining cost can be problematic Raw materials, Work-in-Progress, Finished Goods FIFO, LIFO, Weighted Average Long-term contracts - % of completion (IAS11) Accounting policies in relation to Inventories must be disclosed

Financial Information Analysis14 Copyright 2006 John Wiley & Sons Ltd Provisions & Contingencies IAS 37: Provision recognised when: Entity has legal or constructive liability Outflow of resources probable Reliable estimate can be made Contingent Liabilities: more subjective and less certain that outflow will result e.g.: pending legal action against entity Disclose details by way of note

Financial Information Analysis15 Copyright 2006 John Wiley & Sons Ltd Financial Assets & Liabilities IAS 39: recognition and measurment Recognise on B/S including underlying instruments etc (e.g. derivatives) Measure initially at ‘fair value’ (usually = cost) Subsequent measurement: Non- trading Loans etc – amortised cost Held-to-maturity investments – amortised cost Derivatives etc – fair value; changes to Income Statement Other – fair value; changes to equity Instruments used for hedging – ‘hedge accounting’ Changes recognised in Income Statement Significant additional disclosures

Financial Information Analysis16 Copyright 2006 John Wiley & Sons Ltd Financial Assets & Liabilities IAS 32: Disclosure & Presentation Intended to address Off-Balance Sheet issues Requires that financial istruments be classified on the basis of substance if obliged to make future transfer = Liability otherwise = Equity Significant disclosure requirements: Fair value Risk exposure

Financial Information Analysis17 Copyright 2006 John Wiley & Sons Ltd Capital and Reserves Share Capital: Authorised: indicated in Memo of Association Issued: element of Authorised offered to public Allotted: allocated to purchasers Called-up: payment demanded by company Fully paid: amount of called-up that has been paid Share values: Nominal (Par): arbitrary initial value, e.g., £1 Issue price: amount at which available to public share premium: excess of issue price over par value Market price: price commanded on open market

Financial Information Analysis18 Copyright 2006 John Wiley & Sons Ltd Capital and Reserves Reserves arise from retention of profits or events such as issue of shares at a premium Distributable reserves: can be used to fund dividends or other distributions Undistributable Reserves: Share Premium: excess of issue price over par Revaluation Reserve: increase in asset value Capital Redemption Reserve Reserves nominated in Memo of Association IAS 1 imposes significant disclosure requirements

Financial Information Analysis19 Copyright 2006 John Wiley & Sons Ltd Income Statement (IS) IAS 1 imposes certain minimum required headings: Revenue Finance costs Share of profits from associates and joint ventures Tax expense Allocation of profit between Minority Interest and Equity Dividends recognised as distributions during period must also be disclosed Additional items may be required for purposes of ‘fair presentation’ Where material, income and expense should be disclosed separately

Financial Information Analysis20 Copyright 2006 John Wiley & Sons Ltd Income Statement (IS) Expenses can be analysed by: Nature: materials, staff costs, etc., or Function: cost of sales, administration, etc. Choice will impact IS structure IFRS 5 requires that results of Discontinued Operations be shown on face of IS Problems of definition of income, etc calls for ‘Comprehensive Income’ like US

Financial Information Analysis21 Copyright 2006 John Wiley & Sons Ltd Statement of Changes in Equity Replaces Statement of Total Recognised Gains and Losses Intended to track and disclose changes to Equity IAS 1 requires disclosure of: Profit or loss for period Income and expense recognised in Equity Impact of changes in Accounting Policy on Equity Capital transactions with owners Opening and closing reconciliations

Financial Information Analysis22 Copyright 2006 John Wiley & Sons Ltd Cash Flow Statement (CFS) CFS allows an assessment of ability to generate and apply cash (or cash equivalents) Reflects critical role of cash in commercial life IAS 7 requires presentation under three headings: Operating – principal trading activity Investing – e.g. acquisitions, dividends received Financing – cash movements relating to Equity or borrowings Additional information should be disclosed by way of notes

Financial Information Analysis23 Copyright 2006 John Wiley & Sons Ltd Notes to Financial Statements Integral part of reporting process Cross-referenced to primary statement Disclose: Basis of preparation Additional information, often in narrative form Typically, AR has separate section dealing with Accounting Policies (IAS 8) Outlines policies, judgements, etc, used Prior period adjustments made by restating comparative prior period amounts

Financial Information Analysis24 Copyright 2006 John Wiley & Sons Ltd Post-Balance Sheet Events Arise because AR issued after year-end IAS 10 envisages two categories: Adjusting events: ‘provide additional evidence of conditions existing at balance sheet date’ e.g., confirmation of amount of a bad debt  record in period under review Non-adjusting events: ‘concern conditions which did not exist at balance sheet date’ e.g., acquisition of subsidiary after balance sheet date  where material, disclose by way of note Dividends proposed or declared after year end now viewed as contingent liability Disclose by way of note

Financial Information Analysis25 Copyright 2006 John Wiley & Sons Ltd Summary Financial statement presentation heavily regulated Increasing emphasis on greater disclosure and supplementary information in notes Continuing change likely in future due to: changing reporting culture new technologies and media Fair value represents significant change