Business Accounting 1

Chapter 10:
Financial statements of a limited company
On completion of this topic you should be able to
Explain the terms used in the financial statements of
limited companies
Understand the profit and loss account and balance sheet
for a limited company under UK GAAP and the income
statement and balance sheet under international GAAP
Independent study
Study Chapter 10
Download the annual report and accounts for Ted Baker
Plc from http://ft.ar.wilink.com and study the chairmans
statement, income statement and balance sheet
Progress test and practice question(s) as set
Business Accounting 2
The story so far ...
Financial reporting is the statutory disclosure of
information by limited liability entities
Must file their annual report and accounts at Companies
House and send a copy to all shareholders
Both UK GAAP and international GAAP are
underpinned by conceptual frameworks based on the
objective that general purpose financial statements
should be useful to users for economic decisions
Statement of Principles for Financial Reporting (ASB, 1999)
Framework for the Preparation and Presentation of
Financial Statements (IASB, 1989)
Business Accounting 3
The story so far ...
The obligation to disclose financial information only
applies to limited liability entities
24% of businesses in the UK are limited companies
<1% of these are public limited companies (SBS, 2005)
Differences in the sources of finance available to
limited liability entities compared to unincorporated
sole proprietorships and partnerships lead to
differences their financial structure
This leads to differences in the items shown in their
financial statements and the terminology used
Business Accounting 4
Similarities and differences in sources of finance
Sole proprietorships and
general partnerships
Limited liability entities
(public and private)
Capital Owners capital (savings, etc)
and retained profit
(Owner can draw on capital)
Share capital and reserves
(Shareholders receive
dividends)
Debt finance Medium/long-term loans (eg
mortgages, loans from banks,
business angels, family, friends)
Medium/long-term loans (eg
mortgages, loans from banks
Debentures and non-equity
shares
Asset-based
finance
Hire purchase, leasing, invoice
finance/factoring
Hire purchase, leasing,
invoice finance/factoring
Business Accounting 5
Differences in sources for limited liability entities
Capital
Known as equity finance and comprises ordinary shares
and reserves (include reserves of retained profit)
Ordinary shareholders (also known as equity holders)
receive dividends based on a variable percentage of profit
Debt finance also includes
Debentures, which are a widely used form of long-term loan
(usually secured on the assets) a fixed rate of interest
(lower than overdraft rate) and repayable at a fixed date
Non-equity shares (eg preference shares) with a fixed rate
of dividend (paid before dividends to ordinary shareholders)
Business Accounting 6
Types of share capital
Share capital is the equity finance received from
shareholders in exchange for ordinary shares
Authorized share capital is the maximum amount the
company can issue (in memorandum of association)
Issued share capital is the amount of authorized
share capital for which shareholders have subscribed
Called-up share capital fully paid is the amount where
payment has been requested and paid in full (with some
shares, part of the payment is deferred)
Called-up share capital not paid is the amount where
payment has been requested but not paid
Business Accounting 7
Exercise 1
Share capital
Note 21 to the 2006 accounts of Ted Baker Plc tells
us that the company has authorized share capital of
80,000,000 ordinary shares of 5p each
At 28 January 2006, 42,989,801 shares had been
issued, called up and paid for in full
Required
Calculate the called-up share capital fully paid
Business Accounting 8
Solution 1
Share capital
Called up share capital fully paid is:
42,989,801 shares 5p = 2,149,490
So Ted Baker has raised 2.15m in equity finance
from selling 43m ordinary shares on the stock
market
Public limited companies have a considerable
advantage in being able to raise capital on the stock
exchange compared to private limited companies
which cannot offer their shares publicly
Business Accounting 9
Adoption of international GAAP
The UK is in a state of transition as we begin to
adopt international GAAP and move towards EU
harmonization in the regulation of financial reporting
Since 2005, all group companies with a listing on an
EU stock exchange must use International Financial
Reporting Standards (IFRSs) for preparing their
statutory financial statements
In the UK, all other companies continue to use UK GAAP,
but it is likely that IFRSs will soon become applicable to
single entities and the IASB is also working on developing
an IFRS for SMEs
Business Accounting 10
Consolidated financial statements
A group company (parent + subsidiaries) prepares
consolidated financial statements
Consolidation is the process of adjusting and
combining financial information from the individual
financial statements of a parent undertaking and its
subsidiary undertakings to prepare consolidated
financial statements that present financial
information for the group as a single economic entity
(Collis and Hussey, 2007, pp. 172-3)
A full set of financial statements under UK GAAP differ
from those required under international GAAP ...
Business Accounting 11
Full set of financial statements under UK and
international GAAP compared
UK GAAP International GAAP
Balance sheet Balance sheet
Profit and loss account Income statement
Statement of total recognized
gains and losses
Statement of changes
in equity
Cash flow statement Cash flow statement

Both require notes to the financial statements (see Note 1 in
the accounts of Ted Baker Plc, which gives a summary of
significant accounting policies)
Business Accounting 12
Greater emphasis on financial position
International GAAP places greater emphasis on the
measurement of financial position than UK GAAP
The objective of financial statements is to provide
information about the financial position [ie the balance
sheet], performance [ie the income statement] and changes
in financial position [ie the statement of changes in equity
and the cash flow statement] (IASB, 1989, paras. 22-23)
IAS 1, Presentation of Financial Statements requires
certain headings, line items and subtotals if they are
relevant to the users understanding, but a number of
presentations are acceptable
Business Accounting 13
Balance sheet - main headings under IAS 1
(see Ted Bakers accounts as an example of presentation)
Assets
Non-current assets (ie fixed assets)
Current assets (Note: Stock is called inventories and trade
debtors are called trade receivables)
Liabilities
Current liabilities (ie amounts due 1 year) (Note: Trade
creditors are called trade payables)
Non-current liabilities (ie amounts due > 1 year)
(Total assets - Total liabilities = Net assets)
Equity (ie capital and reserves)
Share capital
Other reserves
Retained earnings (Resulting total matches net assets above)
Business Accounting 14
Balance sheet - key definitions (IASB, 1989, para. 25)
An asset is a resource controlled by the enterprise as a
result of past events and from which future economic
benefits are expected to flow to the enterprise
A liability is a present obligation of the enterprise
resulting from past events, the settlement of which is
expected to result in an outflow from the enterprise of
resources embodying economic benefits
Equity is the residual interest in the assets of the
enterprise after deducting all its liabilities
In other words, Assets - Liabilities = Equity
Equity = Share capital + Reserves
Business Accounting 15
Income statement - main headings under IAS 1
(See Ted Bakers accounts as an example of presentation)
Revenue (ie sales revenue or turnover)
Expenses (a deduction analysed by nature as we did for
sole traders, or by function as in Ted Bakers accounts eg
distribution, administration and finance expenses)
Profit before tax
Income tax expense (a deduction)
Profit for the period
Attributable to: (breakdown between parent & subsidiaries)
Equity holders of the parent company
Minority interests (negative figure indicates a loss)
(Resulting total matches profit for the period above)
Business Accounting 16
Income statement - key definitions (IASB, 1989, para. 70)
Income is increases in economic benefits during the
accounting period in the form of inflow or enhancements
of assets or decreases in liabilities that result in
increases in equity, other than those relating to
contributions from equity participants (ie not equity
finance)
Expenses are decreases in economic benefits during
the accounting period in the form of outflows or
depletions of assets or occurrences of liabilities that
result in decreases in equity, other than those relating to
distributions to equity participants (ie not dividends)
Business Accounting 17
Earnings per share (EPS)
All the profit made by the company belongs to the
ordinary shareholders, but normally only part is paid
to them as dividends (the remainder is retained in a
reserve to help the company grow)
So, the dividend per share represents only part of an
shareholders earnings
Earnings per share (EPS) measures the total
earnings and is based on the profit for the period
attributable to ordinary shareholders
Disclosure is a requirement under both UK GAAP and
international GAAP
Business Accounting 18
Basic and diluted EPS
IAS 33, Earnings per share (revised) requires
disclosure of both basic EPS and diluted EPS
Basic EPS is calculated as
Profit attributable ordinary shareholders
Average number of ordinary shares issued
Diluted EPS is similar, except it includes additional shares
that might be issued as a result of future obligations (eg
share options), which makes the denominator a larger
figure, hence diluting the EPS
Basic and diluted EPS are shown in pence at the
foot of the income statement
Business Accounting 19
Exercise 2
Basic earnings per share (EPS)
Note 9 to the 2006 accounts of Ted Baker Plc tells
us that the profit for the period attributable to the
ordinary shareholders for the year ended 28 January
2006 was 12,919,000 and the company had issued
an average of 42,236,880 ordinary shares
Required
Calculate the basic EPS in pence using the following
formula:
Profit attributable to ordinary shareholders
Average number of ordinary shares issued
Business Accounting 20
Solution 2
Basic earnings per share (EPS)
Basic EPS:
Profit attributable to ordinary shareholders
Average number of ordinary shares issued
= 12,919,000
42,236,880
= 0.3058701
= 30.6p
Companies using UK GAAP must also disclose
basic and diluted EPS
Required by FRS 22, Earnings per share which replaced
FRS 14, Earnings per share
Business Accounting 21
Conclusions
The UK is in a state of transition as we move
towards using IFRSs
The set of 4 financial statements required by international
GAAP differ from those under UK GAAP
Chapter 10 describes both sets, but we have focused on
the income statement and the balance sheet that large
companies publishing consolidated accounts must prepare
using IFRSs, as these are widely analysed by users
Bring a copy of the income statement and balance
sheet for Ted Baker Plc to the next lecture