PBSA 1413

UNDERSTANDING FINANCIAL
STATEMENTS
Assoc. Prof. Dr Nor Aiza Mohd Zamil
Contents of annual report
• Income statements/ P &L
Corporate • vision, mission, values account
information • background • Balance sheet
Financial • Statement of changes in
statements equity
• Statement of cash flows
• Notes to the FS
• corporate structure
Corporate • board of directors
profile
• management teams

• Directors’ report
• Statement by director
• statement of CG Others
Corporate • Statutory declaration
• audit committee report • Independent auditors’ report
governance
(CG) • statement of internal • Notice of AGM
control
Primary Financial Statements
• Primary financial statements answer basic questions
including:
• What is the company’s current financial status?
• What was the company’s operating results for the period?
• How did the company obtain and use cash during the
period?
Financial statements

Balance sheet
àAssets
àLiability
àEquity
The Balance Sheet
• Summary of the financial position of a company at a
particular date
• Assets: cash, accounts receivable, inventory, land,
buildings, equipment and intangible items
• Liabilities: accounts payable, notes payable and
mortgages payable
• Owners’ Equity: net assets after all obligations have
been satisfied
The Balance Sheet
• What are the resources of the company?
• What are the company’s existing obligations?
• What are the company’s net assets?
Accounting Equation
Assets = Liabilities + Owners’ Equity

Resources Sources of Funding

Resources Creditors’ Owners’

to use to claims claims
generate = against
+ against
revenues resources resources
 Sample Balance Sheet
Assets Liabilities
Cash $ 40 Accounts payable $ 50
Accounts receivable 100 Notes payable 150
Land 200 $200
Owners’ Equity
Total assets $340
Capital stock $100
Retained earnings 40
$140
Must Total liabilities
Equal and owners’ equity $340
 Classified and Comparative
Balance Sheets
• They distinguish between:
• Current and long-term assets
• Current and long-term liabilities

• Listed in decreasing order of liquidity

• Comparative so financial statement users can
identify significant changes over time. They have
more than one year on the Balance Sheet.
 Balance Sheet Limitations
ŒAssets recorded at historical value
Only recognizes assets that can be expressed in monetary terms
ŽOwners’ equity is usually less than the company’s market value
Financial statements

Income statement
àTurnover – revenue
àGross profit
àOperating cost
àProfit from operation
 The Income Statement
• Shows the results of a company’s operations over a
period of time.
• What goods were sold or services performed that
provided revenue for the company?
• What costs were incurred in normal operations to
generate these revenues?
• What are the earnings or company profit?
The Income Statement
Revenues
• Assets (cash or AR) created through business
operations
Expenses
• Assets (cash or AP) consumed through business
operations
Net Income or (Net Loss)
• Revenues - Expenses
 The Example Company
Income Statement
For the Years Ended December 31, 2018 and 2019

2018 2019
Revenues:
Sales $100 $ 85
Other revenue 30 15
Total revenues $130 $100

Expenses:
Cost of goods sold $ 62 $ 58
Operating & admin. 16 12
Income tax 20 18
Total expenses $ 98 $ 88

Net Income $ 32 $ 12
 Statement of Retained Earnings

Beginning retained earnings An additional financial

statement that identifies
+ Net income changes in retained earnings
from one accounting period
– Dividends paid
to the next.
= Ending retained earnings

Dividends result in:

Net income results in: Decrease in net assets
Increase in net assets Decrease in retained
Increase in retained earnings earnings
Increase in owners’ equity Decrease in owners’ equity
Financial statements

Statement of changes in equity

àNew issuance
àDividends
àChanges in the Premium accounts
àChanges in the Capital Reserve accounts
àChanges in the Distributable profits
 Difference between P+L and
comprehensive income
• Income Statement: profit and loss items.
• Statement of Comprehensive income: This statement starts with the profit or loss as
calculated under Income statement and contains components of other
comprehensive income. Simply this statement contains such line items which are
not recognized in profit or loss and if disclosed under Income Statement then it
might mislead users of financial statements as they may consider them as regular
line items.
• The components of other comprehensive income include:
• changes in revaluation surplus (see IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets);
• actuarial gains and losses on defined benefit plans
• gains and losses arising from translating the financial statements of a foreign operation
• gains and losses from investments in equity instruments measured at fair value through other
comprehensive income
• the effective portion of gains and losses on hedging instruments in a cash flow hedge (see IAS 39).
 Statement of Changes in Equity
§ shows all changes in owner’s equity for a period of time.
§ provide readers with the useful information on how the capital or fund of an entity is
utilized and used.
§ shows the movements of equity and accumulated earnings and losses, the readers
can depict on where the company’s equity came from and where did it go.
§ It includes:
• a) profit or loss for the period;
• b) each item of income and expense for the period that is recognized directly in
equity, and the total of those items;
• c) total income and expense for the period (calculated as the sum of (a) and (b)),
showing separately the total amounts attributable to equity holders of the parent
and to minority interest; and
• d) for each component of equity, the effects of changes in accounting policies
and corrections of errors recognized in accordance with IAS 8.
 Statement of Changes in Equity
• The following amounts may also be presented on the face of the
statement of changes in equity, or they may be presented in the
notes: [IAS 1.97]
• (a) capital transactions with owners;
• (b) the balance of accumulated profits at the beginning and at the
end of the period, and the movements for the period; and
• (c) a reconciliation between the carrying amount of each class of
equity capital, share premium and each reserve at the beginning
and at the end of the period, disclosing each movement.
Financial statements
Cash flow statement
àCash in flows
àCash outflows
àNet cash flow profit
àDividend and interest paid
àRepayment of loans
 Statement of Cash Flows
• Reports the amount of cash collected and paid out by a company in
operating, investing and financing activities for a period of time.
• How did the company receive cash?
• How did the company use its cash?
• Complementary to the income statement.
• Indicates ability of a company to generate income in the future.
Statement of Cash Flows
Cash inflows
• Sell goods or services
• Sell other assets or by borrowing
• Receive cash from investments by owners

Cash outflows
• Pay operating expenses
• Expand operations, repay loans
• Pay owners a return on investment
Match Classification of
Cash Flows
• Operating activities – Transactions and events that
enter into the determination of net income.
• Investing activities – Transactions and events that
involve the purchase and sale of securities,
property, plant, equipment, and other assets not
generally held for resale, and the making and
collecting of loans.
• Financing activities – Transactions and events
whereby resources and obtained from, or
repaid to, owners and creditors.
Operating Activities
Cash Inflow Cash Outflow
• Sale of goods or • Inventory payments
services • Interest payments
• Sale of investments • Wages
in trading securities
• Utilities, rent
• Interest revenue
• Taxes
• Dividend revenue
Investing Activities
Cash Inflow Cash Outflow
• Sale of plant assets • Purchase of plant assets
• Sale of securities, other • Purchase of securities,
than trading securities other than trading
securities
• Collection of principal
on loans • Making of loans to
other entities
Financing Activities
Cash Inflow Cash Outflow
• Issuance of own stock • Dividend payments
• Borrowing • Repaying principal on
borrowing
• Treasury stock
purchase
 Statement of Cash Flows
Operating Investing Financing
CASH Activities Activities Activities
INFLOWS

CASH
OUTFLOWS

Operating Investing Financing

Activities Activities Activities
Statement of Cash Flows Analysis

Operating Investing Financing General Explanation

Building up pile of cash,
1. + + + Possibly looking for
Acquisition

Operating cash flow being

2. + ─ — Used to buy fixed assets
And pay down debt

3. + + — Operating cash flow and sale of fixed assets

being used to pay down debt.

4. Operating cash flow and borrowed

+ ─ + money being used
to expand
 Statement of Cash Flows Analysis

Operating Investing Financing General Explanation

Operating cash flow problems covered by sale

5. ─ + + of fixed assets, borrowing and owner
contributions.

6. Rapid growth, short falls in operating cash

flow; purchase of fixed assets.
─ ─ +
Sale of fixed assets is financing operating cash
7. flow shortages.

─ + ─
Company is using reserves
to finance cash flow
8. ─ ─ ─ short falls.
 The Example Company
Statement of Cash Flows
December 31, 2019

Cash Flows From Operating Activities:

Receipts 48
Payments (43) 5

Cash Flows From Investing Activities:

Receipts 0
Payments (4) (4)

Cash Flows Used By Financing Activities:

Receipts 10
Payments (6) 4

Net Cash Flow 5

 Cash Flow Statement
Cash--Op. Act. $ 973,000
Cash--Inv. Act. (1,188,000)
Cash--Fin. Act. 245,000
Net increase $ 30,000
Beg. cash 80,000
End. cash $ 110,000 Balance
Sheet 31/12/19

Balance Sheet 31/12/18 Cash $ 110,000

Income Statement Other 4,975,000
Cash $ 80,000
Revenues $12,443,000 Total $5,085,000
Other 4,550,000
Expenses 11,578,400
Total $4,630,000
Net income $ 864,600 Liabilities $2,860,400
Cap. stock 1,000,000
Liabilities $2,970,000
1,224,600
Cap. stock 900,000 Stmt of Retained Earnings R/E
Total $5,085,000
R/E 760,000 R/E 31/12/18 $ 760,000
Total $4,630,000 Net income 864,600
Dividends (400,000)
R/E 31/12/19 $1,224,600
Cooking the books
“Every company in the country is fiddling its
profits. Every set of published accounts is based
on books which have been gently cooked or
completely roasted. The figures which are fed
twice a year to the investing public have all been
changed in order to protect the guilty. It is the
biggest con trick since the Trojan horse. . . In fact
this deception is all in perfectly good taste. It is
totally legitimate. It is creative
accounting.”
(Griffiths,1986:1)
 Creative Accounting
• Accounting practices that follow required laws and regulations, but
deviate from what those standards intend to accomplish.
Creative Accounting (2)
Opportunity for creative accounting:
1. Choice of accounting method
2. Bias estimates and prediction
3. Enter into artificial transaction
4. Timing of genuine transactions

(Amat et al. 1999)

Creative Accounting (3)

“Numbers don’t lie, people lie about numbers.”

Kevin Day
Creative Accounting (5)
• Choose between a policy of writing off development expenditure as it
occurs and amortising it over the life of the related project
• Estimation of an asset's useful life to calculate depreciation
• Arrangement is made to sell an asset to a bank then lease that asset
back for the rest of its useful life.
Creative Accounting (6)
• An investment of £1 million at historic cost which can easily be sold for
£3 million, being the current value.
• Managers are free to choose in which year they sell the investment and
so increase the profit in the accounts.
Top Glove Annual Report
https://www.bursamalaysia.com/trade/trading_resources/listing_d
irectory/main_market

Answer the following questions:

1. What are the contents of the annual reports
2. Where can you find the financial statements – name all the financial statements.
3. What is the difference between current assets and non-currents assets
4. What is the difference between current liabilities and non-current liabilities
5. What is your comment on Top Glove’s current performance. Why?