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CHAPTER 2

FINANCIAL STATEMENTS

Chapter outline

Introduction
The objectives of financial statements
Who are the users of financial statements?
Requirements for financial statements
The standardisation of financial statements
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Conclusion

Learning outcomes
By the end of this chapter, you should be able to:
Discuss the objectives and requirements of financial
statements
Identify the users of financial statements
Identify the components included in the main types of
financial statements
Distinguish between the three main types of financial
statements
Describe the formats of a statement of financial
position, statement of comprehensive income and
statement of cash flows.

Introduction
Companies provide annual report at end of
financial year
Annual report provides analysts with
information
Includes a set of financial statements:
Statement of financial position
Statement of comprehensive income
Statement of cash flows

Indicates financial performance and position of


company for analysis and comparison

The objectives of financial


statements
Main objective:
Provide summary of financial position
Financial performance
Change in financial position

Financial position
Influenced by economic resources and the capital
structure used to finance these resources
Evaluated by focusing on assets, liabilities and
shareholders equity included in the statement of
financial position

The objectives of financial


statements (cont.)
Financial performance
Companys ability to generate income with its
available assets
Evaluated by focusing on the revenue and expenses
provided in the statement of comprehensive income

Change in financial position


Depends on the investment, financing and operating
activities during the year
The statement of cash flows provides a summary of
these activities

Users of financial statements


Stakeholders:
Shareholders Evaluate existing and expected
performance
Management Planning and control
Providers of debt capital Evaluate capital structure
and ability to pay interest
Government SARS, economic statistics
Other stakeholders Employees, clients, customers,
suppliers, competitors

Requirements for financial


statements
Understandable
Relevant
Significance
Timeliness

Accurate and objective


Comparable

The standardisation of financial


statements
Financial statements need to be comparable
Statements of companies may not be comparable
as a result of different accounting guidelines
SA companies converted to IFRS; comparison to
previous years where other accounting guidelines
were used may be problematic

Solution
Standardise published financial statements
Facilitates comparison between companies & over
time
Simplifies the calculation of financial ratios

Statement of financial position


Summary of a firms financial position at a
specific point in time

Statement of financial position


Current
assets

Non-current
assets

Ordinary
shares
Reserves
Preference
shares
Non-controlling
interest
Current liabilities

Non-current
liabilities

Assets
Capital investment - apply assets to generate
revenue
Two types of assets:
Non-current
Current

Distinction based on how the assets are


applied, as well as the period of time over
which they will be applied

Non-current assets
PPE at cost price
Usually indicated at original purchase price of items

Accumulated depreciation
Accumulate depreciation provided on PPE in the
statement of comprehensive income

PPE at carrying value


Cost minus accumulated depreciation

Assets under construction


Asset not yet completed; no depreciation provided

Non-current assets
Intangible assets
Goodwill
Other intangible assets (software, licences)

Investment in associate
Owns 20% - 50% of shares in another company

Other long-term assets


Loans granted
Share investments < 20%

Deferred tax assets


Difference in accounting and tax treatment

Current assets
Inventories
Required for operations of a company

Trade and other receivables


Credit sales still outstanding
Short-term outstanding amounts

Short-term financial assets


Financial assets with lifetime of less than a year

Cash and cash equivalents


Other short-term assets
Assets for sale

Total equity
Breakdown of different forms of equity capital
to finance companys assets
Includes all capital provided by different
shareholders
Important to distinguish between contributions
of different types of shareholders

Components of total equity


Share capital
Proceeds from sale of ordinary shares to
shareholders

Reserves
Share-based payments
Share repurchases

Retained earnings
Accumulation of retained profits reinvested

Preference share capital


Proceeds from the sale of preference shares

Components of total equity


Shareholders equity
Total capital invested by all shareholders

Non-controlling interest
Financial statements of subsidiary companies
included

Liabilities
Breakdown of the different forms of debt capital
Two types of liabilities:
Non-current liabilities
Current liabilities

Distinction based on the period over which the


debt capital is obtained

Non-current liabilities
Long-term debt capital
Interest-bearing borrowings
Long-term loans
Mortgages
Debentures

Post-retirement obligations
Deferred tax liabilities

Current liabilities
Short-term debt capital
Trade and other payables
Outstanding amount on credit purchases
Other short-term obligations

Short-term debt
Loans redeemed in the next financial year

Current liabilities

Short-term financial liabilities


Tax payable to SARS
Bank overdraft
Other current liabilities
Liabilities in disposal groups, short-term provisions,
short-term deferred income

Statement of comprehensive
income
Summary of financial performance for the
financial year matching income and expenses
Income:

Turnover
Operating income
Investment income
Non-recurring income
Other

Statement of comprehensive
income (cont.)
Expenses:

Cost of sales
Operating expenses
Non-recurring expenses
Finance cost
Taxation
Non-controlling interest
Preference dividends
Ordinary dividends

Statement of comprehensive
income (cont.)

EXPENSES
INCOME

RETAINED
PROFIT

2009

2008

(R million)

(R million)

Turnover

137 836

129 943

Cost of sales and services rendered

(88 508)

(74 634)

49 328

55 309

1 021

635

(25 681)

(22 128)

24 666

33 816

2 060

989

Finance cost

(1 917)

(1 145)

Profit before tax

24 809

33 660

(10 480)

(10 129)

14 329

23 531

(67)

(1 111)

(614)

(3)

Attributable earnings

13 648

22 417

Ordinary dividends

(7 193)

(5 766)

6455

16651

Gross profit

Other operating income


Operating expenses
Operating profit
Investment income

Tax
Profit after tax
Non-controlling interest
Preference share dividends

Retained earnings (for the year)

Statement of comprehensive
income components
Turnover
Income received for products or services rendered
by the company during the financial year

Cost of sales and services rendered


All costs directly incurred to generate turnover
Purchases of inventory, transport costs, customs,
etc. incurred to deliver products to customers

Gross profit
Turnover minus cost of sales
Profit generated by sales activities of company

Statement of comprehensive
income components
Other operating income
Income items not part of the sales activities of the
company, but which are generated as part of the
operating activities

Operating expenses
Expenses incurred to support primary activities
Includes depreciation, employee costs, research
and development, operating lease charges, etc

Operating profit
Profit resulting from primary activities of business
Excludes income items not part of the businesss
normal activities

Statement of comprehensive
income components
Investment income
Income generated by financial investments
Dividends & interest received

Finance cost
Interest paid on debt financing

Profit before tax


Tax
Tax calculated on the profit before tax

Profit after tax

Statement of comprehensive
income components
Non-controlling interest
Portion of profit that belongs to non-controlling
interest shareholders

Preference share dividends


Dividends paid to preference shareholders
Preference above ordinary dividends

Attributable earnings
Portion of profit left after all expenses have been
allocated
Important to the ordinary shareholders: amount
available for ordinary dividend payments

Statement of comprehensive
income components
Ordinary share dividends
Total amount paid to ordinary shareholders in the
form of dividends

Retained earnings
Portion of profit not paid out as dividends to
shareholders but reinvested
Transferred to reserves of business and used to
finance businesss activities
Earnings still belongs to shareholders included as
part of shareholders equity

Statement of cash flows


Summary of a firms cash flows for the financial
year
Three major categories:
Cash from operating activities
Cash from investing activities
Cash from financing activities

Statement of cash flows


CASH AT
BEGINNING
OF YEAR

CASH FROM
OPERATING
ACTIVITIES

+/-

MOVEMENT IN
CASH DURING
THE YEAR

CASH FROM
INVESTING
ACTIVITIES

+/-

CASH AT END
OF YEAR

CASH FROM
FINANCING
ACTIVITIES

Statement of cash flows


2009

2008

(R million)

(R million)

Cash received from customers

144 963

123 452

Cash paid to suppliers and employees

(96 776)

(88 712)

Cash generated by operating activities

48 187

34 740

2 264

957

(2 168)

(2 405)

(10 252)

(9 572)

Cash available from operating activities

38 031

23 720

Dividends paid

(7 193)

(5 766)

Cash retained from operating activities

30 838

17 954

Finance income received


Finance expenses paid
Tax paid

Statement of cash flows

Additions to assets under construction


Additions to other intangible assets
Non-current assets sold
Acquisitions of businesses
Disposal of businesses
Purchases of investments
Proceeds from sale of investments
Other cash flows from investing activities

2009
(R million)
(13 047)
(126)
697
(30)
3 486
(89)
7
(917)

Cash flow from investing activities

(12 518)

2008
(R million)
(8 671)
(17)
184
(431)
693
(42)
0
(393)

(10 844)

Statement of cash flows

Share capital issued


Share capital repurchased
Proceeds from long-term debt
Repayments of long-term debt
Proceeds from short-term debt
Repayments of short-term debt
Other

2009
2008
(R million) (R million)
1 189
475
(1 114)
(7 300)
5 575
3 806
(4 820)
(4 588)
280
1 942
(2 091)
(2 292)
(212)
(458)

Cash flow from financing activities

(1 193)

Translation effect of foreign operations


Increase/(decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the year

Cash and cash equivalents at the end of the year

(870)
16 257
4 335

20 592

(8 415)
(448)
(981)
6 088

4 335

Cash flow from operating activities


Cash generated from normal operating
activities of the company
Cash received from customers
Cash amount that customers paid for products sold
and services rendered

Cash generated by operating activities


Cash received from customers minus cash paid to
suppliers and employees

Cash flow from operating


activities (cont.)
Finance income received on investments
Finance expenses paid on interest-bearing
debt capital
Tax paid in cash
Cash available from operating activities
Indicates if sufficient cash flow was generated to
afford a dividend payment
Negative value: indicates that cash dividend can
only be afforded if cash is obtained elsewhere

Cash flow from operating


activities (cont.)
Dividends paid
Cash payment of preference and ordinary dividends

Cash retained from operating activities


Negative operating cash flow no surplus cash flow
available to invest in replacement and expansion of
assets
Additional cash has to be generated from financing
activities or company may have to sell assets to
finance cash deficit
Consistent failure to generate positive cash flow can
be seen as indicator of serious financial problems

Cash flow from investing activities


Additions to PPE, to assets under construction
& to other intangible assets
Cash incurred to purchase additional assets

Non-current assets sold


Cash proceeds from sale of non-current assets

Acquisitions of businesses & disposal of


businesses
Cash effect of acquiring & selling business units

Proceeds from sale of investments and


purchases of investments
Cash result of increases & decreases in investment

Cash flow from financing activities


New share capital issued
Cash inflow

Share capital repurchased


Cash outflow

New long-term debt obtained


Cash inflow
Repayments of long-term debt
Cash outflow

Proceeds from short-term debt and repayments


of short-term debt
Cash inflows and outflows respectively

Conclusion
The main objectives of financial statements are to
provide information about the financial position,
financial performance and changes in the financial
performance of a company.

The users of financial statements include the existing


and potential shareholders; providers of debt capital;
the management of the company; government; and
other stakeholders.
The requirements for financial statements are that they
should be understandable, relevant, accurate, objective
and comparable.

Conclusion (cont.)
It is sometimes necessary to standardise the published
financial statements of a company to ensure that they
are comparable with other companies, and over time.
The statement of financial position provides a summary
of a companys financial position on a specific date.
The statement consists of two parts: the asset side,
and the equity and liabilities side. The asset part
provides an indication of the specific assets that the
company owns. The equity and liability part contains
the different sources of capital used to finance these
assets.

Conclusion (cont.)
The statement of comprehensive income provides a
summary of a companys financial performance over a
period of time. Within a statement of comprehensive
income the turnover generated during the financial year
is allocated to the different stakeholders up to a point
where only retained earnings are left.
The statement of cash flows provides a summary of a
businesss ability to generate cash and the application
of cash (i.e. how the cash is used). A distinction is
made between the cash results of operating, investing
and financing activities.