Lecture 1Corporate Reporting & Finance

External Financial Reporting

By the end of this lecture and related work you should:

• Understand the objective of external financial reporting and know about users and their needs

• Know in outline what is in a set of financial statements• Be able to explain the accounting equation and to construct a simple

statement of financial position• Understand the qualitative characteristics of financial information

Learning outcomes

To provide financial information about the reporting entity to users of the financial statements that is useful in making decisions about providing resources to the entity, as well as other financial decisions

Primary purposeof external financialreporting:

The objective of external financial reporting

Decision making

Users of financial statements

Source: Kaplan, ACCA F3, page 8 (2015)

Different types of business organisation and their user groups

Sole trader

Partnership

Limited company -

unlisted

Limited company -

listed

Management, lenders, government (HMRC)

Management, lenders, government (HMRC)

Investors, management, suppliers, customers, lenders, government (HMRC), competitors

Investors, management, suppliers, customers, lenders, government (HMRC), competitors, the

public

Financial statements• Statement of profit or loss – presents results of the business for a period of

account, usually one year• Statement of financial position – presents the position of a business at a

given point in time, usually the year end• Statement of changes in equity – presents movements in owners’ capital for

a period of account, usually one year• Statement of cash flows – presents movements in cash flows for a period of

account, usually for one year

Financial statements (continued)

ALSO:

• Disclosure notes• Directors’ report (for companies)• Auditor’s report (if applicable)• Other information, e.g. Five-year summary

Example: Pearson plc

Most recent annual financial statements: 31 December 2014

https://www.pearson.com/ar2014.html#sec5

Example: Pearson plc (continued)Financial summary information about sales:

Accounting regulatory framework

International standards and regulation• International financial reporting standards (IASB – International Financial Standards board)

• EU legislation

National standards and regulation• UK Generally Accepted Accounting Practice (UK GAAP)• Companies Act, 2006• UK Corporate Governance Code

Accounting basicsFinancial statements comprise five key elements:

• ASSETS – A resource controlled by a business

• LIABILITIES – An obligation to transfer economic benefit

• EQUITY – The residual interest in the business – capital that is due to be returned to the owners when the business ceases

• INCOME – The inflow of economic benefit within an accounting period

• EXPENSES – The outflow of economic benefit within an accounting period

How financial statements work

INCOMELESS

EXPENSES=PROFIT

• Statement of profit or loss • Statement of financial position

ASSETSLESS

LIABILITIES=EQUITYINCREASES

The accounting equation

- = = +

ASSETS LIABILITIES EQUITY

ASSETS LIABILITIES EQUITY

Example – Jeff (1)

Jeff Bright starts a sole trader business on 1 January 2015 with £10,000 that he has been left in a will.

• Jeff opens a bank account - ‘Jeff – trading as Bright Printers’ and deposits £10,000

There are two sides to the transaction from the point of view of the business:• ASSETS increase by £10,000• EQUITY (also known as CAPITAL) increases by £10,000

The business entity concept

Jeff is a sole trader – his business trades as ‘Bright Printers’

Legally, the business is not a separate entityBUT

THE BUSINESS ENTITY CONCEPT

means that Jeff is regarded as separate from his business

Example – Jeff (2)Here is Jeff’s statement of financial position after the first transaction:

ASSETS = EQUITY (there are no liabilities)

£

ASSETS 10,000

EQUITY (CAPITAL) 10,000

Example – Jeff (3)On 2 January 2015 Jeff buys a computer for £2,000 The business bank account is reduced by £2,000, but Jeff’s business hasacquired a new asset for £2,000, so the total of assets is still £10,000:

Computer £2,000Bank account £8,000

£10,000

BUT: the computer will be used in the business for more than one accounting period so it is classified as a NON-CURRENT ASSET

Example – Jeff (4)Here is Jeff’s statement of financial position after the second transaction:

£

ASSETS NON-CURRENT ASSETS 2,000 CURRENT ASSETS 8,000

10,000

EQUITY (CAPITAL) 10,000

Example – Jeff (5)

On 3 January 2015 Jeff buys office supplies for £100.

The supplier allows him credit terms of 30 days – this means that Jeff’s business will have to pay £100 in 30 days’ time. The office supplies are a CURRENT ASSET of £100 (they will probably be used up within a year), but there is an equal liability of £100.

Example – Jeff (6)Here is Jeff’s statement of financial position after the third transaction:

£

ASSETS NON-CURRENT ASSETS 2,000 CURRENT ASSETS (8,000 + 100) 8,100

10,100

EQUITY (CAPITAL) 10,000LIABILITIES CURRENT LIABILITIES 100

10,100

Qualitative characteristics of financial statements

The IASB Conceptual Framework:FUNDAMENTAL characteristics• Relevance• Faithful representationENHANCING characteristics• Comparability• Verifiability• Timeliness• Understandability