The Black Sheep of the Family

Transcription

1 The Black Sheep of the Family Author: Dr. Ciaran Connolly, PhD, BSSc, MBA, FCA. Examiner: Professional 2 Advanced Financial Accounting. Introduction The presentation of financial statements is addressed in IAS 1 Presentation of Financial Statements, which applies to all general purpose financial statements prepared and presented in accordance with international accounting and financial reporting standards. The objective of IAS 1 is to prescribe the basis for the presentation of general purpose financial statements in order to ensure comparability with both the entity s financial statements of previous periods and with the financial statements of other entities. To achieve this objective, IAS 1 sets out overall requirements for: the presentation of financial statements; guidelines for their structure; and minimum requirements for their content. IAS 1 does not apply to interim financial statements prepared in accordance with IAS 34 Interim Financial Reporting. The Financial Statements Family Financial statements are a structured representation of the financial position and financial performance of an entity. The objective of general purpose financial statements is to provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. Financial statements also show the results of management s stewardship of the resources entrusted to it. To meet these objectives, financial statements provide information about an entity s: assets; liabilities; equity; income and expenses, including gains and assets; other changes in equity; and cash flows. This information, along with other information in the notes, assists users of financial statements in predicting an entity s future cash flows and, in particular, their timing and certainty. Financial Statements should be presented at least annually and should be issued on a timely basis to be useful to users. A complete of financial statements includes: 1. a balance sheet; 2. an income statement; 3. a statement of changes in equity showing either: - all changes in equity; or - changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders; 4. a cash flow statement; and 5. accounting policies and explanatory notes. IAS 1 presents a suggested format for a balance sheet, and permits the preparation of an income statement on either the function of expenditure (cost of sales method) or the nature of expenditure method. The choice between the two methods being made according to which most fairly presents the elements of the enterprise s performance. A pro forma format is provided for each method. The definition and disclosure of discontinued operations is dealt with in IFRS 5 Non-current Assets Held for Sale and Discontinued Operations, and the profit/loss for discontinued operations should be disclosed at the foot of the income statement or alternatively analysed in a separate column on the face of the income statement. The preparation and presentation of the 4 th component of financial statements, the cash flow statement, is addressed specifically in IAS 7 Cash Flow Statements.

2 IAS 1 also provides guidance on the structure of the accompanying notes to financial statements, the accounting policies and other required disclosures. Notes to the financial statements normally include narrative descriptions or more detailed analysis of items on the face of the financial statements, as well as additional information such as contingent liabilities and commitments. However, the frequently ignored and misunderstood member of the financial statements family is the statement of changes in equity. This 3 rd component is discussed in more detail below. Statement of Changes in Equity IAS 1 requires that certain information relating to equity be presented separately in a statement of changes in equity. An enterprise should present, as a separate component of its financial statements, a statement showing: the net profit or loss for the period; each item of income and expense, gain or loss that is recognised directly in equity (e.g. revaluation surplus on property, plant and equipment, or as required by other standards), and the total of these items; and The cumulative effect of changes in accounting policy and the correction of fundamental errors. The total income and expenses for the period must be analysed in the case of groups between amounts attributable to equity holders of the parent and amounts attributable to minority interest. In addition, an enterprise should present, either within this statement or in the notes: capital transactions with owners and distributions to owners; the balance of accumulated profit or loss at the beginning of the period and at the balance sheet date, and the movements for the period; and a reconciliation between the carrying amount of each class of equity capital, share premium and each reserve at the beginning and end of each period, separately disclosing the movement. The statement of changes in equity can be of benefit to users of financial statements in a number of ways. Changes in an enterprise s equity between two balance sheet dates reflect the increase or decrease in its net assets or wealth during the period. The statement of changes in equity highlights the way that shareholders funds have changed over a period, and also the gains and losses recognised in the financial statements in the period that have not been charged or credited to the income statement. This information is important as changes, excluding changes resulting from transactions with shareholders (e.g. capital injections and dividends), represent the total gains and losses generated by the enterprise in that period. Investors can use the information in the statement to understand how the financial position of the company has changed. This can help the investors to understand whether the performance of the company has been good or poor. Investors will also see gains and losses that are not recognised in the income statement. For example, the company could have been holding property that is increasing in value in the period, and this will be seen in the statement if the company has revalued in the period. Page 2 of 7

3 Lenders may use the information in the statement to help assess the financial position of the company with a view to lending to it. The recognition of revaluation gains in the statement may help a lender to decide whether a company has a sufficient asset base to give security to loans. While it can be argued that all the information that is in the statement of changes in equity is already available in other disclosures in the financial statements, the statement more clearly presents the information and therefore it is of benefit to users. IAS 1 recommends that a statement of changes in equity should accompany the balance sheet and income statement. Either of the following formats may be used. 1. Statement of changes in equity Opening balance Loss on property revaluation Valuation gain taken to equity Foreign exchange differences Net income recognised directly in equity Profit for period Total recognised income and expenses for period Dividends Issue of share capital... Closing balance Attributable to equity holders of the parent: Share Other Translation Retained Minority capital reserves reserves earnings Total interests Total m m m m m m m Page 3 of 7

4 2. Statement of recognised income and expenses Loss on property revaluation Valuation gain taken to equity Foreign exchange differences Net income recognised directly in equity Profit for period Total recognised income and expenses for period m m Attributable to: Equity holders of parent Minority interest If this second format is adopted, the notes to the financial statements must include a reconciliation of opening and closing balances of share capital, reserves and accumulated profit. Conclusion Comparative information should be disclosed for all amounts reported in the financial statements, unless an IFRS requires or permits otherwise. Enterprises are also encouraged to present outside the financial statements, a financial review by management which describes and explains the main features of the financial performance, financial position and principal uncertainties facing the business. For many of us, the move to international accounting and financial reporting standards has meant getting used to new terminology, principles and practices. While much of the change is arguably quite subtle and even superficial, from an examination perspective, two important changes are: Dividends paid are no longer included in the income statement: they are an appropriation and therefore should be taken through reserves. Proposed dividends are not accrued until approved by shareholders at the AGM in accordance with IAS 10 Events After the Balance Sheet Date; and Extraordinary items are banned and it is a decision for the company to highlight/separately disclose exceptional items. IAS 1 makes no reference to super exceptional items. Example: Statement of Changes in Equity KTE Limited (KTE) prepares its financial statements to 31 st December each year. Extracts from the balance sheet of KTE as at 31 st December 2005 were as follows: 1 ordinary shares 500,000 Share premium account 100,000 Revaluation reserve 200,000 Retained earnings 300,000 During the year ended 31 st December 2006, the following transactions occurred: 1 st February KTE paid a 25,000 dividend that had been declared and approved by shareholders in December Page 4 of 7

5 1 st April 5,000 1 ordinary shares at 20 per share were offered to the public. The shares were fully subscribed and issued on 1 st June On the same date, a further 5,000 1 ordinary shares were placed with major investors at 20 per share. 1 st May KTE decided to change its accounting policy for the treatment of borrowing costs that are directly attributable to the acquisition of property, plant and equipment. Previously, KTE had capitalised such costs but now wishes to treat these costs as an expense. The directors of KTE believe that the new policy is preferable because it results in a more transparent treatment of finance costs and is consistent with industry practice, therefore making KTE s financial statements more comparable. KTE had capitalised 40,000 borrowing costs up to 31 st December st July KTE paid an interim dividend of 30, st August A valuation of KTE s properties by a firm of chartered surveyors showed the following surpluses (ignore any deferred tax implications): Land - 50,000 Property - 25,000 1 st September KTE adopted a new international financial reporting standard early. The transitional liability on initial adoption was 80,000 more than the non current liability recognised under the previous accounting standard, and under the transitional arrangement should be recognised as a movement in retained earnings in st October KTE declared a one for ten bonus issue to existing shareholders, using the share premium account to create the bonus issue. 1 st November KTE repurchased 2,500 1 ordinary shares on the open market for 20 per share. The repurchase was accounted for by writing down share capital/share premium and retained earnings by an equal amount. 1 st December KTE made a rights issue of one for 20 at 15 per share. In early January 2007, the directors of KTE calculated that the company s profit after tax for the year ended 31 st December 2006 was 600,000 and proposed a final dividend of 75,000. Requirement Prepare the statement of changes in equity for KTE for the year ended 31 st December Page 5 of 7

6 KTE Statement of Changes in Equity for the Year Ended 31 st December 2006 Share Capital Share premium Revaluation Reserve Retained Earnings Total Balance at 1 st January , , , ,000 1,100,000 Gain on revaluation of land and buildings - - (w5) 75,000-75,000 Change in accounting policy (w3) (40,000) (40,000) Early adoption of IFRS (w6) (80,000) (80,000) Net income recognised directly in equity 500, , , ,000 1,055,000 Profit for year (w10) 600, ,000 Total recognised income and expenditure for the year 500, , , ,000 1,655,000 Interim dividend paid (w4) (30,000) (30,000) Issue of ordinary shares: (w2) 10,000 (w2) 190, ,000 (w7) 51,000 (w7) (51,000) (w9) 27,925 (w9) 390, ,875 Repurchase of ordinary shares (w8) (2,500) (w8) (22,500) - (w8) (25,000) (50,000) Closing balance at 31 st December , , , ,000 2,193,875

7 Workings (1) 1 st February 2006: Accounted for in Therefore no further adjustment in (2) 1 st April 2006: 10,000 shares issued at 20 per share. Therefore credit share capital 10,000 and share premium 190,000 (debit bank 200,000). (3) 1 st May 2006: Debit retained earnings 40,000 (credit property, plant and equipment 40,000). (4) 1 st July 2006: Debit retained earnings 30,000 (credit bank 30,000). (5) 1 st August 2006: Credit revaluation reserve 75,000 (debit land 50,000 and property 25,000). (6) 1 st September 2006: Debit retained earnings 80,000 (credit non current liabilities 80,000). (7) 1 st October 2006: 510,000 shares in issue. Therefore 51,000 new shares issued. Debit share premium 51,000 and credit share capital 51,000. (8) 1 st November 2006: Total cost of 50,000 (2,500 x 20). Therefore debit share capital 2,500, debit share premium 22,500 and debit retained earnings 25,000 (credit bank 50,000) (9) 1 st December 2006: 558,500 shares in issue. Therefore 27,925 new shares issued at 15 each. Credit share capital 27,925 and share premium 390,950 (debit bank 418,875). (10) Profit and dividends: Show profit for year of 600,000, but proposed dividends should not be recognised in Page 7 of 7