Lecture 3

The elements of financial statements

–Assets,
 Liabilities,
 Equity,
 Income and expenses

The presentation of financial statements

–Statement of financial performance
•Profit and loss account
*STROGL (or Statement of Changes in Equity)
–Balance sheet
 Cash Flow Statement
Definitions: Assets
‘rights or other access to future economic benefits controlled by an entity as a result
of past transactions or events’

Note: ownership normally conveys rights of access, but it is not a prerequisite; contractual rights
(leases, licences, copyright etc) can give rise to assets.
Control also involves being able to prevent other parties using your assets/receiving benefits.

Future benefits:
often interpreted as giving rise to future cash flows
future benefits which cannot be evidenced are not assets
(e.g. large advertising campaign may give benefits for a long time, but it is not an asset as cannot
prove that benefits will continue.)

Past transactions or events

The method by which we can establish that control has been achieved (concept of objectivity).
Cannot recognise an asset unless it is capable of ‘reliable measurement’
Definitions: Liabilities
‘obligations of an entity to transfer economic benefits as a result of past transactions
of events’

Note the ‘mirroring’ of the definition of an asset

Obligations are usually legal (enforceable), but may be ‘constructive’

e.g. voluntary environmental costs – carbon offset payments or high-street store will
exchange/refund clothing ‘if it makes your bum look big’

Normally the transfer of economic benefits will be future cash payments (can have barter
transactions).

Liabilities are generally transaction based:

*Receiving goods or services (invoice)
*Borrowing money (loan agreement)

Past transactions or events

- similar meaning to that of assets
The balance sheet and accounting equations
Having defined assets and liabilities we can now formulate the balance
sheet equation:

Assets – Liabilities = Ownership interests (or equity)

This can be refined to give the accounting equation:

Profit = capital c/f - capital b/f - capital introduced + drawings

Intuitively:
opening net assets are increased by net profit and further capital introduced
and reduced by any drawing (or dividends)
Users and their Needs
Investors: present and prospective
–Hold or sell shares
 Income/returns (dividends) and their growth
 Risk/security/stability of investment
 Efficiency of management (re-appoint directors)
–Secondary issues: ethical/green investments

Lenders: banks loan providers

–Can company pay interest and capital on loan
 Cash flow statement important
 Imposition of charges on assets/covenants
–Problem of ‘off balance sheet finance’
–
Employees (and representatives – trade unions)
–Secure employment
 Levels of remuneration (pensions)
 Promotion prospects
–Job satisfaction (staff turnover rates?)

Management
–Achieving stewardship function
 Safeguarding the company's assets
 Managing the business efficiently
 Satisfying fiduciary (trust) relationship

Government (local and national)

*Corporation tax
*Income tax from employees
*VAT from consumers
*Business rates
Allocation of resources
*Distribution of grants or incentives
National statistics
*Exports
*Inflation

Business Contact Groups

Suppliers (creditors), customers and competitors

Public
Interaction with local economy/environment