Chapter 2 Financial Statements

2.1 Introduction
The basis for financial planning, analysis and decision making is the financial information. Financial information is needed to predict, compare and evaluate the firm’s earning ability. It is also required to aid in economic decision-makinginvestment and financial decision making. The financial information of an enterprise is contained in the financial statements. A firm communicates financial information to the users through financial statements and reports. Financial statements contain summarized information of the firm’s financial affairs, organized systematically. They are the means to presents the firm’s financial situations to the users. Preparation of the financial statements is the responsibility of the top management. As these statements are used by investors and financial analysts to examine the firm’s performance in order to make investment decisions, they should be prepared very carefully contain as much information as possible. Managers, shareholders, creditors and others interested groups seeks answers to the following questions about firms: 1. What is the financial position of the firm at a given point of time? 2. How has the firm performed financially over a given period of time? 3. What have been the sources and uses of cash over a given period of time? To answer the above questions, the accountant prepares two statements, these two basis financial statements prepared for the purpose of external reporting to owners, investors and creditors. 1. Balance sheet or Statement of Financial Position 2. Profit and Loss Accounts or Income Statement The balance sheet shows the financial positions (or conditions) of the firm at a given point of time. It provides a snapshot and may be regarded as a static picture. The profit and loss account reflects the performance of the firm over a period of time. In addition to the above two statements, a cash flow statement is also prepared which shows the inflows and outflows of cash from operating, investing and financing activities and it shows displays the sources and used of cash during the period.


Financial statements are often an important sources of information for financial decisions. These financial statements are contained in a company annual’s report. A typical annual report also includes the chairman’s speech, the director’s report, the auditor’s report and accounting policy changes. For internal management purpose, i.e. planning and controlling, much more information than that contained in the published financial statements is needed. Therefore, the financial accounting information is presented in different and report in such a way as to serve the internal needs of the management.

2.2 Objective of Financial Statements
Financial statements are prepared from the accounting records maintained by the firm. The objectives of the financial statements are: 1. Resources and obligations: to provide reliable information about economic resources and obligations of a business enterprise. 2. Changes in the net resources: to provide reliable information about change in net resources (resources mines obligations) of an enterprise that results from the profit-directed and other activities. 3. Earning potential: to provide financial information that assists in estimating the earnings potential of the enterprise. 4. Full disclosure: To disclose, to the extent possible, other information related to the financial statement that is relevant to statement users. Annual Report The annual report of a company provides a lot of useful information. 1. 2. 3. 4. 5. 6. 7. 1. Statement of the Chairman Report of the board of Directors, Auditor’s report, Balance Sheet and Profit and Loss account, Schedule of accounting , Schedule of accounting policies and Financial statement of subsidiaries. Chairman’s Statement: It is an important source of information on a company’s internal and external environment, challenge of competition, major changes, future opportunities and direction. The chairman’s statement also contains information on a company’s mission, objectives, products, organization philosophy etc. 2. Report of the board of Directors: Directors’ report provides a summary of profit made and appropriate by the company and other relevant information



5. 6.

such as industrial relations, investments, financing, reorganization, appointment of auditors and directors etc. Auditors’ Report: Auditors’ report to shareholders verifies whether the balance sheet and profit and loss account provide a true and fair view of the state of a company’s affairs. Auditors should obtain all necessary information and explanation and ensure that proper books of accounts as required by law have been prepared by the company. They bring out any deviation or distortion to the notice of the shareholders. Accounting polices: Companies adopt different accounting policies for preparing their balance sheet and profit and loss account. Annual reports incorporate major accounting policies as well as changes made in current year. Balance Sheet: Balance sheet shows the financial condition of a business at a given point of time. Profit and Loss Account: Profit and loss account presents the summary of revenue, expenses and net income (or net loss) of a firm.

2.3 Need for Analysis of Financial Statements
The users of the financial statements like shareholders, employees, customers, general public and lenders want to know different things from the financial statements. Employees are interested in profitability of the business so that they can get bonus, shareholders are interested in growth so that the value of their shares goes up. Lenders are interested in knowing the capability of the company to pay back the principle amount of loan along with interest. Customers are interested in the product pricing and quality. As it is, the financial statements do not provide the readymade answer or all these questions. They need to be analyzed properly keeping this objective in view. The analysis of the financial statements, therefore, is aimed at ascertaining financial weaknesses and strength of the company in terms of its activity, liquidity, solvency and profitability.

2.4 Significance of Financial analysis
1. Investors: Both potential future investors and existing investors are interested in the analysis of the financial statements. The present investors want to decide whether they should hold the securities of the company or they should sell them. On the other hand investors want to know whether they should invest in the shares of the company or not. 2. Creditor: They want to know the liquidity position of the company. Their concern is whether the company will be able to pay them or not. They try to focus on liquidity ratio.


3. Lenders: The long term lenders want to know whether the company is earning enough profits to able to pay interest to them regularly and also the principle amount will be paid them as and when due. They are also interested to know as to know as to how the money, lent by them, has been used by the company. It is good if the company invests the long term funds in Fixed Assets and Working Capital. 4. Management: The management always wants to ensure that the financial stability is maintained. From time to the management wants to judge its short and long term solvency, and efficiency in utilization of available resources. It wants to know the return on investment or profit margin on the sales. This information helps the management in decision making and planning. For any analysis we need (i) Subject matter and (ii) Tools to work on the subject matter. Financial statement i.e. Balance Sheet and Income Statement are the subject matter or raw material for conducting an analysis. The financial statements have to be analyzed in order to reach some conclusion. These statements merely contain absolute figure pertaining to assets, liabilities, revenues earned and expenses incurred. As it is, they do not reveal anything about earning capacity, the extant to which the resources have been utilized and liquidity and solvency position. In order to make an opinion on these issues, the Balance Sheet and Profit and Loss Account have to be analyzed systematically and conclusion have to be drawn to take proper decisions.

2.5 Management Discussion and Analysis of Performance
This part of document is describes the concepts on which the Board relied in recommending standards for Management's Discussion and Analysis (MD&A) to be included in general purpose federal financial reports (GPFFR). Concepts Statements are not authoritative in the sense that they do not establish standards or principles. Preparers may find them useful, but these concepts are not "prescribed guidelines" for required supplementary information as discussed in of the Codification of Statements on Auditing Standards published by the American Institute of Certified Public Accountants. No standards or prescribed guidelines for MD&A are presented in this statement of concepts. MD&A is an important vehicle for (1) communicating managers' insights about the reporting entity, (2) increasing the understandability and usefulness of the GPFFR, and (3) providing accessible information about the entity and its operations, service levels, successes, challenges, and future. Some federal agencies also refer to MD&A as the "overview." The basic concept that underlies the standards for MD&A is:


Each general purpose federal financial report (GPFFR) should include a section devoted to management's discussion and analysis (MD&A). It should address the reporting entity's performance measures, financial statements, systems and controls, compliance with laws and regulations, and actions taken or planned to address problems. The discussion and analysis of these subjects may be based partly on information contained in reports other than the GPFFR. MD&A also should address significant events, conditions, trends and contingencies that may affect future operations. A separate document titled Standards for Management's Discussion and Analysis presents the standards for MD&A. The standards for MD&A say that MD&A should address: -- the entity's mission and organizational structure; -- the entity's performance goals and results; -- the entity's financial statements; -- the entity's systems, controls, and legal compliance; and -- the possible future effects on the entity of existing, currently-known demands, risks, uncertainties, events, conditions and trends.

The term general purpose federal financial report, abbreviated "GPFFR," is used as a generic term to refer to the report that contains the entity's financial statements that are prepared pursuant to federal accounting principles.

Cowan University) The following accounting policies have been adopted in the preparation of the financial statements. These policies have been consistently applied to all the years presented, unless otherwise stated. General statement

The financial statements constitute a general purpose financial report which has been prepared in accordance with Australian Accounting Standards, Statements of Accounting Concepts and other authoritative pronouncements of the Australian Accounting Standards Board, and Urgent Issues Group (UIG) Consensus Views as applied by the Treasurer's Instructions. Several of these are modified by the Treasurer's Instructions to vary the application, disclosure, format and wording. The Financial Administration and Audit Act 1985 and the Treasurer's Instructions

are legislative provisions governing the preparation of financial statements and take precedence over Australian Accounting Standards, Statements of Accounting Concepts and other authoritative pronouncements of the Australian Accounting Standards Board, and UIG Consensus Views. The modifications are intended to fulfil the requirements of general application to the public sector, together with the need for greater disclosure and also to satisfy accountability requirements. If any such modification has a material or significant financial effect upon the reported results, details of that modification and where practicable, the resulting financial effect, are disclosed in individual notes to these financial statements. Reporting Entity The reporting entity is Edith Cowan University and its controlled entity; ECU Resources for Learning Ltd. Control is taken to exist where: • the entity is accountable to the University; • the University has a residual financial interest in the net assets of the entity; and • the University has the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.

Basis of Preparation The financial report has been prepared in accordance with applicable Australian Accounting Standards which includes Australian equivalents to International Financial Reporting Standards, Urgent Issues Group Interpretations and other pronouncements of the Australian Accounting Standards Board. authoritative

The Balance Sheet and Income Statement have been prepared on an accrual basis and are in accordance with historical cost convention, modified by the revaluation of land and buildings which have been measured at fair value. The accounting policies applied in the preparation of the financial statements have been consistently applied throughout all periods presented except that AASB 132 and AASB 139 have been applied from 1 January 2005, with the option provided by AASB 1 paragraph 36A.


Assets and liabilities are recognised in the Balance Sheet when, and only when, it is probable that future economic benefits will flow and the amounts of the assets or liabilities can be reliably measured. Contingent liabilities and contingent assets are not recognised in the Balance Sheet, but are discussed in the relevant Notes to the Financial Statements. They may arise from uncertainty as to the existence of a liability or asset, or represent an existing liability or asset in respect of which settlement is not probable or the amount cannot be reliably measured. Where settlement becomes probable, a liability or asset is recognised. The consolidated financial report is presented in Australian dollars and all amounts are rounded to the nearest thousand dollars ($’000). The judgements that have been made in the process of applying accounting policies that have the most significant effect on the amounts recognised in the financial report are included at note 4. The key assumptions made concerning the future, and other key sources of estimation uncertainty at the reporting date that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are included at note 5. Basis of Accounting The consolidated financial statements have been prepared on the accrual basis of accounting using the historical cost convention, except for certain assets and liabilities which, as noted are measured at fair value. (a) Principles of consolidation Subsidiary The consolidated financial statements incorporate the financial statements of Edith Cowan University (the parent entity) and entities controlled by the University (its subsidiary) made up to 31 December each year. Control is achieved where the University has the power to govern the financial and operating policies of an investee entity so as to obtain benefits from its activities. A list of controlled entities appears in note 27. Consistent accounting policies have been employed in the preparation and presentation of the consolidated financial statements. The consolidated financial statements include the information and results of each controlled entity from the date on which the University obtains control and until such time as the University ceases to control such entities. Inter-company transactions, balances and unrealised gains on transactions between the University and controlled entities are eliminated in full on consolidation.

Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of the subsidiary have been changed on consolidation where necessary to ensure consistency with the accounting policies adopted by the University. (b) Grants and other Contributions Government Grants Grant contributions from the Commonwealth Government and Western Australia State Government for financial assistance for operational purposes are recognised as revenue when the University obtains control over the asset comprising the contributions. When the University does not have control of the contribution or does not have the right to receive the contribution or has not fulfilled grant conditions, the grant contribution is treated as deferred income. Grant contributions from the Commonwealth Government and Western Australia State Government for financial assistance for the acquisition of non-current assets are recognised as revenue when the University obtains control over the asset comprising the contributions. When the University does not have control of the contribution or does not have the right to receive the contribution or has not fulfilled grant conditions, the grant contribution is treated as deferred income. Sponsored Research Research funds provide the opportunity for graduate and undergraduate students to work with the faculty in research as part of their educational experience. Research grant contributions from various sources of sponsored research, including corporations, foundations, Commonwealth, State and local governments and research institutes are recognised as revenue when the University obtains control over the asset comprising the contributions. When the University does not have control of the contribution or does not have the right to receive the contribution or has not fulfilled grant conditions, the grant contribution is treated as deferred income. Donations Donations, gifts and other non-reciprocal contributions are recognised as revenue when the University obtains control over the assets comprising the contributions. Control is normally obtained upon their receipt. Endowment and Bequest Contributions The University receives restricted funds from donors who wish to fund specific programs or initiatives in the University. Endowments and bequests are invested to

create a source of income which is used for scholarships, research, prizes and special lecture programs. Endowment contributions are recognised as revenue when the University obtains control over the assets comprising the contributions. Control is normally obtained upon their receipt. (c) Revenue Recognition Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for goods and services provided in the normal course of business, net of discounts and Goods and Services Taxes (GST). Revenue is recognised as follows: Sale of Goods Revenue from sales of goods and disposal of other assets is recognised when goods are delivered and title has passed. Fees and Charges Revenue from fees and charges is recognised in the accounting period in which the services are rendered, by reference to completion of the specific transaction assessed on the basis of the actual service provided as a proportion of the total services to be provided. Revenue from students studying at the English language centre (ELICOS), is recognised on a cash basis. This is because students who have been offered an ELICOS course are issued with an invoice; payment of the invoice is a condition of acceptance. Interest Income Interest income is accrued on a time-proportion basis, by reference to the principal outstanding and at the effective interest rate applicable. Parking and Library Fines Revenue from parking and library fines is recognised on a cash basis, as the purpose of the fine is to act as a deterrent not strictly for raising revenue. Non-payment of these fines are not actively pursued. Royalty, Trademark and Licenses Income Royalties, trademark and licenses income is recognized on an accrual basis in accordance with the substance of the relevant agreements.


Gains Gains may be realized or unrealized. Realized gains are determined on a net basis as the difference between the sale proceeds received or receivable and the carrying amount of the non-current asset. Unrealized gains are determined on a net basis as the difference between the fair value and the carrying amount of an asset. The policies adopted for the recognition of significant categories of gains are as follows: Realized gains on disposal of non-current assets Gains arising on the disposal or retirement of a non-current asset are recognized when control of the asset and the significant risks and rewards of ownership have passed to the buyer. Net gains are included in revenue for the period in which they arise. Unrealised gains associated with investment property at fair value Gains arising from changes in the fair value of an investment property are included in revenue for the period in which they arise. (d) Expense Recognition Expenses are recognized when incurred and are reported in the year to which they relate. The policies adopted for the recognition of significant categories of expenses are as follows: Depreciation, amortization and impairment losses Depreciation of non-financial physical assets (excluding inventories) is provided on a straight-line basis at rates based on the expected useful lives of those assets. The expected useful lives for each class of depreciable asset are provided under property, plant and equipment. Amortization is provided on leasehold improvements, intangible assets and on assets held under finance leases and is calculated on a straight-line basis, generally over the expected useful lives on the same basis as owned assets. Impairment losses are recognized as an expense when an asset’s carrying amount exceeds its recoverable amount (unless it is related to a re-valued assets where the value changes are recognized directly in equity). Superannuation expense


The University receives Commonwealth Government superannuation supplementary funding for employer contributions of the Pension Scheme and Gold State Superannuation (GSS). These contributions where paid to state-administered GESB during the year. The University also receives Commonwealth Government general operating funding for employer contributions of the various UniSuper superannuation plans. The University includes the following elements in calculating a superannuation expense: (a) Defined benefit plan – change in the unfunded employer’s liability in respect of current employees who are members of the Pension Scheme and current employees who accrued a benefit on transfer from that Scheme to the Gold State Superannuation Scheme; and (b) Defined benefit plan – emerging cost in respect of current employees who are members of the Pension Scheme and current employees who accrued a benefit on transfer from that Scheme to the Gold State Superannuation Scheme; and (c) Defined contribution plan – employer contributions paid to the Gold State Superannuation Scheme and all of the Unisuper superannuation plans.

A revenue ‘Superannuation – deferred government contributions’ equivalent to (b) is recognised under Revenue in the Income Statement as emerging cost superannuation for which they are fully recouped by the Commonwealth superannuation supplementary grant. (d) Property, Plant and Equipment Land and buildings held for use in the production or supply of goods or services, for investment, and for administrative purposes, are stated in the Balance Sheet at their revalued amounts, being the fair value at the date of revaluation, determined from market-based evidence by appraisal undertaken by independent professional valuers, less any subsequent accumulated depreciation and subsequent accumulated recoverable amount write-down. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair values at the reporting date. Any revaluation increase arising on the revaluation of such land and buildings is credited to the asset revaluation reserve, except to the extent that it reverses a revaluation decrease for the same asset class previously recognized as an expense, in which case the increase is credited to the Income Statement to the extent of the decrease previously charged on a asset class basis. A decrease in carrying amount arising on the revaluation of such land and buildings is charged as an expense to the

extent that it exceeds the balance, if any, held in the asset revaluation reserve relating to a previous revaluation of that asset class. Depreciation on revalued assets is charged to the Income Statement. On the subsequent sale or retirement of a revalued asset, the attributable revaluation surplus remaining in the asset revaluation reserve is transferred directly to the Income Statement. Properties in the course of construction for production, rental or administrative purposes, or for purposes not yet determined, are carried at cost, less any recognized recoverable amount write down. Cost includes professional fees and, for qualifying assets, borrowing costs are capitalized. Depreciation of these assets, on the same basis as other property assets, commences when the assets are ready for their intended use. Fixtures and computer equipment are stated at cost less accumulated depreciation and any recognized recoverable amount write-down. Purchases of fixtures and computer equipment which individually cost less than $5,000 are expensed in the Income Statement in the year of acquisition. Depreciation is charged so as to write off the cost or valuation of assets, other than land and properties under construction, over their useful lives, using the straightline method. Expected useful lives for each class of depreciable asset are: Asset Category Life Land Buildings Computing equipment Other equipment furniture Motor vehicles Leased Motor vehicles Art Works Library Collections & Not depreciated 50 years 4 years 6 years 6 years 6 years Not depreciated Depreciated at 100% in the fourth year after acquisition


Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. Library Collections are stated at cost of the last three years’ acquisition of library books. In each year, that year’s cost of acquisition is added to the carrying value and the earliest year’s cost of acquisition within the carrying value is written off. Works of art are classified as heritage assets. These artifacts are protected and preserved for public exhibition, education, research and the furtherance of public service. They are neither disposed of for financial gain nor encumbered in any manner. Accordingly, such collections are capitalized, irrespective of value and are not depreciated as it is anticipated that they have indefinite useful lives. Their service potential has not, in any material sense, been consumed during the reporting period. Investment Property Investment property comprises land and buildings which are held to earn rentals and/or capital appreciation Initial recognition and measurement Investment property assets are initially recognized at cost. Subsequent measurement after recognition after recognition, the University uses the revaluation model for measurement of investment land and buildings. Land and buildings are carried at fair value and no depreciation is provided in respect of freehold land and building. The fair value of land has been determined on a continuing basis, determined from market-based evidence. Revaluations are performed with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair values at the reporting date. The last revaluation of investment land and buildings was conducted in December 2004 by an independent professional valuer. The gain arising from changes in the fair value of the investment property are included in the income statement for the period in which they arise. (e) Leases Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Assets held under finance leases are recognized as assets of the University at their fair value or, if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The corresponding liability to the lessor is

included in the Balance Sheet as a finance lease obligation. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income, unless they are directly attributable to qualifying assets, in which case they are capitalized. Rentals payable under operating leases are charged to expense on a straight-line basis over the term of the relevant lease. (f) Impairment The University is required to assess property, plant and equipment and intangible assets for any indication of impairment at each reporting date. Where there is an indication of impairment, the recoverable amount must be estimated. As the University is a not-for-profit entity, unless an asset has been identified as surplus asset, AASB 136 prescribes the recoverable amount is the higher of an asset’s fair value less selling costs and depreciated replacement cost. Consequently, the risk of impairment is generally limited to circumstances where an asset’s depreciation is materially understated or where the replacement cost is falling. The University reviews each relevant class of assets annually to verify that the accumulated depreciation/amortization reflects the level of consumption or expiration of asset’s future economic benefits and to evaluate any impairment risk from falling replacement costs. For assets identified as surplus assets, the recoverable amount is the higher of fair value less selling costs and the present value of future cash flows expected to be derived from the asset. (g) Cash For the purposes of the Cash flow Statement, cash includes cash assets and restricted cash assets. These include short-term deposits that are readily convertible to cash on hand and are subject to insignificant risk of changes in value. (h) Restricted Cash Endowment and bequest funds are classified as restricted cash assets. Endowment and bequest funds have been received from benefactors who, by the terms of their conveying instruments, have stipulated that the use of funds is limited in future years to the purposes designated by the benefactors. (i) Inventories Inventories are valued at the lower of cost and net realizable value. Cost comprises direct materials and where applicable, import duties, transport and handling costs

that have been incurred to bring the inventories to their present location and condition. Cost is calculated using the weighted average method. Net realizable value represents the estimated selling price less all estimated costs of completion and costs to be incurred in marketing, selling and distribution. (j) Receivables Accounts receivable include amounts due from students for tuition fees, housing and other enrolment related services and reimbursements due from sponsors of externally funded research. Accounts receivables are recognised at the amounts receivable as they are due for settlement no more than 30 days from the date of recognition. Accounts receivables do not carry any interest and are stated at their nominal value as reduced by appropriate allowances for estimated irrecoverable amounts. (k) Intangibles The University’s intangibles comprise externally acquired software for internal use and have been customised by ECU. These assets are carried at cost. Software is amortised on a straight-line basis over its anticipated useful life. The useful life of the University’s currently amortised software is 5 years. (l) Other financial assets Investments are recorded at their fair value. In the case of Investments that represent shares held in publicly listed companies – the fair value is measured at balance date as the last sale price quoted on the Australian Stock Exchange. (m) Payables Payables, including accruals not yet billed, are recognized when the University becomes obliged to make future payments as a result of a purchase of assets or services. Accounts payable are not interest bearing and are stated at their nominal value. (n) Interest bearing liabilities Interest-bearing loans and overdrafts are recorded as the proceeds received, net of direct issued costs. Finance charges, including premiums payable on settlement or redemption and direct issue costs, are accounted for on an accrual basis using the effective interest method and are added to the carrying amount of the instrument to the extent that they are not settled in the period in which they arise. (o) Employee Benefits Annual Leave

The liability for annual leave that will fall due within 12 months after the end of the reporting date is recognized in the provision for employee benefits and is measured at the undiscounted amounts expected to be paid. The liability for annual leave that will fall due more than 12 months after the end of the reporting date is recognised in the provision for employee benefits and is measured at the present value of amounts expected to be paid in the future in respect of services provided by employees up to the reporting date. Consideration is given, when assessing expected future payments, to expected future wage and salary levels including superannuation oncosts. Expected future payments are discounted using market yields at the reporting date on national government bonds with terms to maturity that match, as closely as possible, the estimated future cash flows. Long Service Leave The liability for long service leave that will fall due within 12 months after the end of the reporting date is recognized in the provision for employee benefits and is measured at the undiscounted amounts expected to be paid. The liability for long service leave that will fall due more than 12 months after the end of the reporting date is recognized in the provision for employee benefits and is measured at the present value of amounts expected to be paid in the future in respect of services provided by employees up to the reporting date. Consideration is given, when assessing expected future payments, to expected future wage and salary levels including superannuation on-costs. Expected future payments are discounted using market yields at the reporting date on national government bonds with terms to maturity that match, as closely as possible, the estimated future cash flows. Leave benefits are calculated at remuneration rates expected to be paid when liabilities are settled. A liability for long service leave is recognized after an employee has completed four years of service. An actuarial assessment of long service leave undertaken in-house in 2005 and determined that the liability measured using the short-hand method was not materially different from the liability measured using the present value of expected future payments. All unconditional long service leave is classified as a current liability. Provisions – Other Employee On-Costs Employee on-costs, including workers’ compensation insurance and payroll tax, are not employee benefits and are recognized as liabilities and expenses when the employee benefits to which they relate has occurred. Employee on-costs are not included as part of the University’s ‘Employee benefits expense’ and the related liability is included in Employee on-costs provision. Other Compensated Absences


Employees accrue and accumulate sick leave and study leave in accordance with University policies. It is the policy of the University to recognise the cost of sick leave and study leave when paid. Employees who leave University employment are not entitled to be paid for accrued sick leave or study leave. Therefore, no liability is shown in the financial statements. Superannuation The University contributes to the GESB Pension Scheme, GESB Gold State Superannuation Scheme and various UniSuper superannuation schemes on behalf of its employees. The contributions made to these schemes by the University, and emerging costs from unfunded schemes, are expensed in the Income Statement. Refer to Note 26 for details relating to the individual schemes. GESB Scheme Information Pension Scheme members receive pension benefits on retirement, death or invalidity. The Fund Share of the pension benefit, which is based on the member’s contributions plus investment earnings, may be commuted to a lump sum benefit. The State Share of the pension benefit, which is employer financed, cannot be commuted to a lump sum benefit. Some former Pension Scheme members have transferred to the Gold State Scheme. In respect of their transferred benefit the members receive a lump sum benefit at retirement, death or invalidity which is related to their salary during their employment and indexed during any deferral period after leaving public sector employment. (p) Foreign currency translation and Hedges Transactions in currencies other than Australian dollars are recorded at the rates of exchange prevailing on the dates of the transactions. At each reporting date, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rates prevailing on the reporting date. Nonmonetary assets and liabilities carried at fair value that are denominated in foreign currencies are translated at the rates prevailing at the date when the fair value was determined. Gains and losses arising on retranslation are included in the Income Statement for the period. In order to hedge its exposure to certain foreign exchange risks, the University enters into forward contracts and options. (q) Joint ventures Joint Venture Operations


The University participates in a number of joint venture operations. The University uses its own property, plant and equipment and incurs its own expenses and liabilities. The joint venture agreements provide that ventures will fund the costs of the joint venture in specific proportions and the revenue generated from the activity is pooled and distributed based on the level of contribution by each venturer. Joint Venture Entities The University has no material interest in joint venture entities and does not include any amounts in the financial statements for its interest in joint venture entities. (r) Desegregation Information The University has determined reportable segment information on the basis of business segments and geographical segments. A business segment is a group of assets and operations engaged in providing products or services that are subject to risks and returns that are different from those of other business segments. A geographic segment is engaged in providing services within a particular economic environment that are subject to risks and returns that are different from those of segments operating in other economic environments. The University and its subsidiary have two reportable business segments consisting of higher education and technical and further education (TAFE). The higher education segment is an aggregation of operations that deliver progressive university degree programs for the modern workplace and focus on the service professions. The TAFE segment primarily delivers nationally accredited flexible training solutions designed to meet the varied needs of businesses and individuals activities. Geographically, these activities are conducted and operated predominantly in Australia. Off-shore activities are analyzed as a separate geographical segment. Segment revenues, expenses, assets and liabilities are allocated to business and geographic segments on the basis of direct attribution and reasonable estimates of usage. Income tax has not been included in assets and liabilities. (s) Special reserves The special reserve represents restricted funds, whose use is limited in future years to the purposes designated by the benefactors, donors or sponsors such as research financial assistance, scholarships and capital equipment replacement. No funds are currently held in special reserves at the reporting date.


(t) Taxation The controlled entity, E.C.U. Resources for Learning Ltd. (ECURL) trading as Steps Professional Development, is subject to income tax in Australia under the Income Tax Assessment Act 1997. Authority has been granted to ECURL to adopt a calendar tax year. The overseas branches are subject to income tax relating to income and expenditure items attributable to permanent establishments in the UK and the US. The taxation expense represents the sum of tax currently payable and is measured at 31 December each year. Taxable profit differs from net profit as reported in the Income Statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The liability for current tax is calculated using tax rates that have been enacted by the reporting date. (u) Deferred Tax The University adopts an income statement liability method to account for expected income tax consequences inherent in the financial statements. The provision for deferred income tax liability and the deferred tax assets includes the tax effect (at current tax rates) of differences between income and expense items recognised in different accounting periods for book and tax purposes. The benefit arising from estimated carry-forward tax losses, has also been recorded as a deferred tax asset only where realization of the asset is considered to be virtually certain. The carrying amount of deferred tax assets is reviewed at each reporting date and reduced to the extent that it is no longer virtually certain that sufficient taxable profits will be available to allow all or part of the asset to be recovered. (v) Comparative figures Comparative figures have been restated on the AIFRS basis except for financial instruments information which has been prepared under the previous AGAAP Accounting Standard AAS 33 as permitted by AASB 1.36A. The transition to AIFRS for data prepared under AASB 132 and AASB 139 will be 1 January 2005. (w) Rounding Amounts in the financial statements have been rounded to the nearest thousand dollars.


2.7 Generally Accepted Accounting Principles – GAAP
Generally Accepted Accounting Principles (GAAP) is the standard framework of guidelines for financial accounting. It includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements. Financial accounting information must be assembled and reported objectively. Third-parties who must rely on such information have a right to be assured that the data are free from bias and inconsistency, whether deliberate or not. For this reason, financial accounting relies on certain standards or guides that are called "General Accepted Accounting Principles" (GAAP). Principles also derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor/ Certified Public Accountant must indicate to the reader whether or not the information contained within the statements complies with GAAP. Basic objective Financial reporting should provide information that is:
• • •

Useful to present to potential investors and creditors and other users in making rational investment, credit, and other financial decisions. Helpful to present to potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts. About economic resources, the claims to those resources, and the changes in them.

Fundamental qualities To be useful and helpful to users, financial statements must be:

Relevant: relevant information makes a difference in a decision. It also helps users make predictions about past, present and future events (it has predictive value). Relevant information helps users confirm or correct prior expectations (it has feedback value). It must also be available on time, that is before decisions are made. Reliable: reliable information is verifiable (when independent auditors using the same methods get similar results), neutral (free from bias), and demonstrate representational faithfulness (what really happened or existed). Comparable: information must be measured and reported in a similar manner for different enterprises (allows financial statements to be compared between different companies). Consistent: the same accounting methods should be applied from period to period and all changes in methods should be well explained and justified.

Basic concepts To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints. Assumptions

Economic Entity Assumption assumes that the business is separate from its owners or other businesses. Revenues and expenses should be kept separate from personal expenses. This applies even for partnerships and sole proprietorships. as corporates they are considered separate legal entities Going Concern Assumption assumes that the business will be in operation for a long time. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain is this assumption not applicable. Monetary Unit Assumption assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation. Periodic Reporting Assumption assumes that the business operations can be recorded and separated into different periods (most common periods are months, quarters and years). This is required for comparison between present and past performance.


The historical cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values. The revenue recognition principle requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting. The matching principle. Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost can be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle. The full disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be

enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information. Constraints
• •

• •

Cost-benefit relationship states that the benefit of providing the financial information should also be weighed against the cost of providing it. Materiality states that the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual. Industry practices states that accounting procedures should follow industry practices. Conservatism states that when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

Principle of regularity Regularity can be defined as conformity to enforced rules and laws. Principle of sincerity According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status. Principle of the permanence of methods This principle aims at allowing the coherence and comparison of the financial information published by the company. Principle of non-compensation One should show the full details of the financial information and not seek to compensate a debt with an asset, revenue with an expense, etc. Principle of prudence This principle aims at showing the reality "as is”: one should not try to make things look prettier than they are. Typically, revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable. Principle of continuity When stating financial information, one should assume that the business will not be interrupted. This principle is mitigating the previous one about prudence: assets do


not have to be accounted at their disposable value, but it is accepted that they are at their historical value. Principle of periodicity Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire time-span and not counted for entirely on the date of the transaction. The common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information. GAAP are imposed on companies so that investors have a minimum level of consistency in the financial statements they use when analyzing companies for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification and outstanding share measurements. Companies are expected to follow GAAP rules when reporting their financial data via financial statements. If a financial statement is not prepared using GAAP principles, be very wary! That said, keep in mind that GAAP is only a set of standards. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP, you still need to scrutinize its financial statements.

OPERATING EXPENSES Consolidated Revenue Fund operating expenses are presented in the Estimates and the Supplement to the Estimates on the basis of a group account classification system. Each group account represents a broad category of expenses and is comprised of several specific components termed standard objects of expense. These specific components are presented in the Supplement to the Estimates, and are then aggregated into the group account totals shown in the Estimates. This group account classification system is described below. SALARIES AND BENEFITS Base Salaries — includes the cost of the base salaries, overtime pay and lump sum payments for all permanent and temporary direct employees of the government. Supplementary Salary Costs — includes the cost of extra pay for certain types of work such as shift differentials, premiums and allowances.


Employee Benefits — includes the cost of employer contributions to employee benefit plans and pensions. Other benefits paid by the employer such as relocation and transfer expenses are also included. Legislative Salaries and Indemnities — includes the cost of the annual M.L.A. indemnity and supplementary salaries as authorized under Section 4 of the Legislative Assembly Allowances and Pension Act. Salaries for the Executive Council and Officers of the Legislature are also included. OPERATING COSTS Boards, Commissions and Courts — Fees and Expenses — includes fees paid to board and commission members, juries and witnesses, and related travel and out-ofpocket expenses. Public Servant Travel — includes travel expenses of government employees and officials on government business including prescribed allowances. Professional Services — includes fees and expenses for professional services rendered directly to government for: the provision of goods and services in the delivery of government programs; the provision of goods or services that are required by statute or legislation and are billed directly to the government; and the provision of goods or services that will assist in the development of policy and/or programs or improve/change the delivery of programs, such as management consulting services. Information Systems — Operating — includes all contract fees and costs related to data, voice, image and text processing operations and services such as data and word processing, data communications charges, supplies, repairs, maintenance and short-term rentals of information processing equipment. Office and Business Expenses — includes supplies and services required for the operation of offices. Advertising and Publications — includes costs associated with non-statutory advertising and general publications. Statutory Advertising and Publications — includes costs associated with special notices and publications required by statute and regulations. Utilities, Materials, and Supplies — includes the cost of services such as the supply of water and electricity, materials and supplies required for normal operation of government services and food for institutions. Operating Equipment and Vehicles — includes the costs associated with the repair and maintenance of government vehicles, and operating machinery and equipment.

Non-Capital Roads and Bridges — includes highway costs recovered from the BC Transportation Financing Authority, costs for minor enhancements to capitalized infrastructure, as well as non-highway road costs. Amortization — includes the amortization of the cost of capital assets and prepaid capital advances over their useful lives. Building Occupancy Charges — includes payments to the British Columbia Buildings Corporation or the private sector, for the rental and maintenance of buildings and office accommodation, including tenant improvements that do not meet the criteria for capitalization. GOVERNMENT TRANSFERS Transfers — Grants — includes discretionary grants to individuals, businesses, nonprofit associations and others, where there are no contractual requirements. Transfers — Entitlements/Agreements — includes payments and reimbursements under contract, formula driven agreement, shared cost or other agreement, statute or regulation, to individuals for defined benefits; or to individuals, public bodies and organizations for the provision of goods and/or services to the public. OTHER EXPENSES Transfers Between Votes and Special Accounts — includes transfers (payments) between a vote and a Special Account. Interest on the Public Debt — includes only interest payments on the direct provincial debt borrowed for government purposes. Other Expenses — includes expenses such as financing costs and valuation allowances and other expenses which cannot be reasonably allocated to another standard object of expense. INTERNAL RECOVERIES Recoveries Between Votes and Special Accounts — includes recoveries between a vote and a Special Account. Recoveries Within the Consolidated Revenue Fund — includes recoveries for the use of equipment or the provision of goods and services between ministries of the provincial government. Recoveries External to the Consolidated Revenue Fund — includes costs and amounts recovered from government corporations, other governments, and non-government


organizations; the offset for commissions paid for the collection of government revenues and accounts; and the write-off of uncollectible revenue related accounts. CAPITAL EXPENDITURES Consolidated Revenue Fund capital expenditures are presented on the basis of the category of asset acquired. The categorization of assets is described below. Land — includes the purchased or acquired value for parks and other recreation land and land directly associated with capitalized infrastructure (buildings, ferries and bridges); but does not include land held for resale. Land Improvement — includes the capital cost of improvements to dams and water management systems and recreation areas. Buildings — includes the purchase, construction or major improvement of buildings owned by the Consolidated Revenue Fund. Specialized Equipment — includes the purchase or capital lease cost of heavy equipment such as tractors, trailers and ambulances, as well as telecommunications relay towers and switching equipment. Office Furniture and Equipment — includes the cost or capital lease cost of office furniture and equipment. Vehicles — includes the purchase or capital lease cost of passenger, light truck and utility vehicles. Information Systems — includes the purchase or capital lease cost of mainframe and other systems hardware, software and related equipment. Tenant Improvements — includes the cost or capital lease cost of improvements to leased space. Roads — includes the capital costs for construction or major improvements of roads, highways and bridges. Other — includes capital expenditures which cannot be reasonably allocated to another standard object of expense.


2.9 Subject matter
1. Balance Sheet The balance sheet is a significant financial of a firm. In fact, it is called a fundamental accounting report. Other terms to describe this financial statement are statement of financial positions or position statement. As the name suggestions, the balance sheet provides information about the financial standing or position of a firm at a particular point of time, say as on March 31, 2006 (i.e. Balance sheet of L&T Limited as on March 31, 2006). The financial position of a firm as disclosed by the balance sheet refers to its recourses and obligations and the interest of its owners in the business. In operation terms, the balance sheet contains information in respects of assets, liabilities, and owners’ equity. The balance sheet shows the financial condition of a given point of time. As per the Company Act, the balance sheet of a company shall be in either the Account Form (Horizontal Form) or the Report Form (Vertical Form). The Report Form (Vertical Form is most commonly used by companies, but it is more convenient to explain the contents of the balance in the Account Form (Horizontal Form). Before discussing various account categories found on the balance sheet, we must know about some basic concepts underlying financial accounting.

Basic concepts underlying financial accounting The framework of financial accounting is based on several concepts which have received widespread, through not universal, acceptance by accountants. The important concepts have been briefly described below. 1. Entity Concept – For purposes of accounting, the business firm is regarded as a separate entity. Accounts are maintained for the entity as distinct from the persons who are connected with it. The accountant records transactions as they affect this entity and regards owners, creditors, suppliers, employees, customers and the government as parties transacting with this entity. 2. Money Measurement Concept – Accounting is concerned with only those facts are expressible in monetary terms. The yardstick provides a means by which heterogeneous elements, such as land, Plant and equipment, inventories, securities and goodwill may be expressed may be expressed in a common denominator. 3. Stable Monetary Unit Concept – An implicit assumption in accounting, as it is practiced, is that the monetary unit remains stable and values recorded at the time that events occur are not changed. Put differently, in the purchasing power of money are not considered. This principle has been challenged and

forceful arguments have been advanced for making adjustment for price level changes. Despite the great plausibility of these arguments, the practice of accounting is still based on the stable monetary unit assumption. 4. Going Concern Concept – Accounting is normally based on the premise that the business entity will remain a going concern for an indefinitely long period. 5. Cost Concept – Assets acquired by a business are generally recorded at their cost and this is used for all subsequent accounting purposes. For example, depreciation is charged on the basis of the original cost. It is evidence that this concept is related to the stable monetary unit concept. 6. Conservatism Concept – This concept modifies the cost concept in the case of current assets. It is usually stated as follows: “Anticipate no profit but provide for all possible losses”. In accordance with this concept, current assets are generally valued at cost or market value, whichever is lower. 7. Dual Aspect Concept – Regarded as the most distinctive and fundamental concept of accounting, the dual aspect concept provides the basis for accounting mechanics. Assets are resources owned by a firm. I) Fixed Assets and II) Current Assets Liabilities are the claims of various parties against the assets owned by a firm. I) Owners’ Equity represents the claims of the owners. II) Outside liabilities, on the other hand, reflect the claims of the creditors of the firm. Since the resources owned by the firm are equal to its liabilities the basic accounting identity is: ASSETS = LIABILITIES Now according to the dual aspect concept, each event has two aspects. These are such that the accounting identity is always preserved. 8. Accounting Period Concept – In order to know the results of business operations and financial position of the firm periodically, time is dividend into segments referred to as accounting period. Income is measured for these periods and the financial position is assessed at the end of an accounting period. 9. Accrual Concept – Income is measured by changes in the owners’ equity arising from the operations of the business. An increase in owners’ equity arising from the business operations is called revenue and a decrease an expenses. When revenues exceed expenses, the difference is known as income, when expenses exceed revenues the difference is called loss. 10. Realization Concept – According to the realization concept, revenue is deemed to be earned only when it is realized. When is revenue realized? It is normally deemed realized when goods are shipping or delivered to the customers, and not when a sales order is received or a contract signed or goods manufactured.

11. Matching – Once revenues for an accounting period are recognized, expenses incurred in generating these revenues are matched them. This ensures that sales and cost of goods sold in the income statements refer to the same products. Note that expenses are matched to revenues and not vice versa. Liabilities Liabilities defined very broadly represent what the business entity owes others. The Companies Act classified them as follows: • Share Capital • Reserves and Surplus • Secured Loans • Unsecured Loans • Current Liabilities and Provisions 1. Share Capital: This is divided into two types: equity capital and preference capital. The first represents the contribution of equity shareholders who are theoretical the owner to the firm. Equity capital, being risk capital, carries no fixed rate of dividend. Preference capital represents the contribution of preference shareholders and the dividend rate on it is fixed. 2. Reserves and Surplus: Reserves and surplus are profits which have been retained in the firm. There are two types of reserves: revenue and capital reserves. Revenue reserves represent accumulated retained earning from the profits of normal business operations. These are held in various forms: general reserve, investment allowance reserve, capital redemption reserves, dividend equalization reserve, and so on. Capital reserves arise out of gains which are not related to normal business operations. Examples of such gains are the premium on issue of shares or gain on revaluation of assets. Surplus is the balance in the profit and loss account which has not been appropriated to any particular reserve account. Note that reserves and surplus along with equity capital represents owners’ equity. 3. Secured Loans: These denote borrowing of the firm against which specific collateral have been provided. The important components of secured loans are: debentures, loans from financial institutions, and loans from commercial banks. 4. Unsecured Loans: These are the borrowings of the firm against which no specific security has been provided. The major components of unsecured loans are: fixed


deposit, loans and advances from promoters, inter-corporate borrowings, and unsecured loans from banks. 5. Current Liabilities and Provisions: Current liabilities and provisions, as per the classification under the Companies Act, consist of the amounts due to the suppliers of goods and services bought on credit, advance payments received, accrued expenses, unclaimed dividend, provisions for taxes, dividends, gratuity, pension, etc. Currents liabilities for managerial purposes (as distinct from their definition in the Companies Act) are obligation which are expected to mature in the next twelve months. So defined, they include the following: (i). Loans which are payable within one year from the date of balance sheet, (ii). Account payable (creditors) on account of goods and services purchased on credit for which payment has to be made within one year, (iii). Provisions for taxation, (iv). Accrual for wages, salaries, rentals, interest and other expenses (v). Advance payments received for goods and services to be suppliers in the future. Assets Broadly speaking, asserts represents resources which are of some value to the firm. They have been acquired at a specific monetary cost by the firm for the conduct of its operations. Assets are classified as follows under the companies Act: • Fixed assets • Investments • Current assets, loans and advances • Miscellaneous expenditures and losses 1. Fixed Assets: These assets have two characterizes: they are acquired for use over relatively long periods for carrying on the operations of the firm and they are ordinarily not meant for resale. Examples of fixed assets are land, buildings, plant, machinery, patents, and copy rights. 2. Investment: These are financial securities owned by the firm. Some investment represents long-term commitment of funds. (Usually these are the equity shares of other firms held for income and control purposes). Other investments are shortterm in nature and may rightly be classified under current assets for managerial purpose. (Under requirement of the Companies Act, however, short-term holding of


financial securities also has to be shown under investment and not under current assets). 3. Current Assets, Loans and Advances: This category consists of cash and other resources which get converted into cash during the operating cycle of the firm. Current assets are held for a short period of time as against fixed assets which are held for relatively longer periods. The major components of currents assets are: cash, debtors (also called accounts receivable), inventories (also called stocks), loans, and advances and pre-paid expanses. Cash denotes funds readily disbursable by the firm. The bulk of it is usually in the form bank balance and rest in currency held by the firm. Debtors represent the amounts owned to the firm by the customers who have bought goods and services on credit. Debtors are shown in the balance sheet at the amount owned, less an allowance for bad debts. Inventories consists of raw materials, work-in-progress, finished goods, and stores and spares. They are usually reported at the lower of the cost or market value. Loans and advances are the amounts loaned to employees, advances given to suppliers and contractors, advanced tax paid, and deposits made with governmental and other agencies. They are shown at the actual amount. Pre-paid expenses are expenditure incurred for services to be rendered in the future. These are shown at the cost of unexpired services. 4. Miscellaneous Expenditure and Losses: This category consists of two: (i) miscellaneous expenditures and (ii) losses. Miscellaneous expenditure certain outlays such as preliminary expenses and pre-operations expenses which have not been written off. From the accounting point of view, a loss represents a decrease in owner’s equity. Hence, when a loss occurs, the owners’ equity should be reduced by that amount. However, as per company law requirements, the share capital (represents owner’ equity) cannot be reduced when loss occurs. So the share capital is kept intact on the left hand side (the liabilities side) of the balance sheet and the loss is shown on the right hand side (the assets side) of the balance sheet. Structure of the Balance Sheet as per Companies Act A. Account Form (Horizontal Form) Liabilities Assets Share capital Fixed Assets Reserves and Surplus Investments Secured loans Current Assets, Loans and Advances Unsecured Loans Current Assets Current liabilities and Provision Loans and Advances Current liabilities Miscellaneous Expenditure and losses Provision B Report Form( Vertical Form)

I Sources of Funds 1. Shareholders’ Funds (a) Share Capital (b) Reserves & Surplus 2. Loans Funds (a) Secured Loans (b) Unsecured Loans II Application of Funds 1. Fixed Assets 2. Investments 3. Current Assets, loans, Advances less: Current Liabilities and Provision Net Current Assets 4. Miscellaneous Expenditure and losses 2. Profit and Loss Accounts The second major statement of financial information is the profit and loss account (P/L Account). It is also known by several other titles such as income statement, statement of earning, statement of operations and profit and loss statement. While the balance sheet, as a stock/position statement, reveals the financial condition of a business at a particular point of time (date), the P/L account portrays, as a statement, the operations over/during a particular period of time. The period of time is an accounting period/year, April-March (i.e. Balance sheet of L&T Limited for the Year ending on March 31, 2006). Since the purpose of every business firm is to earn profit, the operations of a firm in given period of time will truly be reflected in the profit earned by it. Thus the income statement P/L account of a firm reports the result of operations in term of income/net profit by it. The statement is prepared annually by every company. It shows the profit earned or loss suffered by the company during the financial year. It discloses the true and fair view of the profitability of the company. The companies Act has prescribed a standard form for the balance sheet, but none for the P/L account. However, the Companies Act does requires that the information that the information provided should be adequate a true and fair picture of the operations of the company for the accounting period. The P/L account, like the balance sheet, may be presented in the account form or the report form. Typically, companies employ the report form. The report form statement may be a single-step statement or a multi-step statement. In a single-step statement, all revenue items are recorded first, then the expense items are finally the net profit is given.

While a single step profit and loss account aggregates all revenues and expanses, a multi-step profit and loss account provides disaggregated. Further, instead of showing only the final profit measures, viz. the profit after tax figure, it presents profit measurers as intermediate stages as well. The highlights in the P/L account are given below. • • • • • • • • • • • Revenues One group of items listed on the P/L account is revenue. It is defined as the income that accrues to the firm by the sale of goods/services/assets or by the supply of the firm’s resources to others. Alternatively, revenues mean the value that a firm receives from its customers. The value/income can arise from other sources: 1. sale of products/goods/services and 2. supply of firm’s resources to others Sales income:- The sales revenues equals net sales, that is, gross sales less (i) return and allowance, and (ii) sales discount. Gross sales are the total invoice price of the goods sold/services rendered plus the cash sales during the year. Sales return represents the sale value of goods that were returned by the customers. Sales discount is the amount of cash discount taken by customers for prompt payment. Use of Economic Resources Outside:- the second sources of revenue is obtained by investing a firm’s resources outside, and earning interest, rent, dividend, royalty, commission, fee, and so on. Expenses The cost of earning revenue is called expenses. An important item of expanses appearing in the P/L account is the cost of goods sold. Include in this expanse are material cost, labour cost and other manufacturing expanses such as fuel and power, repair, and maintenance, consumable stores, insurance of goods, and so on.

Net sales Cost of goods sold Gross Profit Operating expenses Operating Profit Non-Operating Surplus/deficit Profit before interest and tax Interest Profit before tax Tax Profit after tax

The general administrative expanses include salary, managerial remuneration, rent, rate and taxes, staff welfare expanses, and so on. Other items are self-explanatory. Net Income/Profit The difference between revenues and expanses is net profit. The profit and loss account may also show the appropriate of the net profits between dividends paid to the shareholders and retained earning/amount transferred to reserves and surplus. This last item is transferred to the balance sheet in the owner’s equity. Thus, it is a link, in a way, between the profit and loss account and the balance sheet. To conclude the two financial statements, namely, the balance sheet and profit and loss account of a business firm contain useful information. The balance sheet shows the sources from funds currently used to operate the business have been obtained, that is, liabilities and owners’ equity, and the type of property rights in which these funds are currently locked up, that is, assets. The profit and loss account represents the score-board of the performance of the firm in term of the profitability of its operations. Net sales are obtained as follows: Sales-Sales inwards-Excise duty Sales are the sum of the invoice price of goods sold and services rendered during the period. Sales inwards represent the invoice value of goods returned by the customers. Excise duty refers to the amount paid to the government. 1. Cost of goods: - is the sum of costs incurred for manufacturing the goods sold during the accounting period. It consists of direct material cost, labour cost, and factory overheads. It should be distinguished from the cost of production. The latter represents the cost of goods produced in the accounting year, not the cost of goods sold during the same period. 2. Gross profit: - is the difference between net sales and cost of cost of goods sold. Most companies show this amount as a separate item. Some companies, however, show all the expanses at one place without making gross profit a separate item. 3. Operating expanses: - consists of general administrative expanses, selling and distribution expenses, and depreciation. (Many accountants include depreciation under cost of goods sold as a manufacturing overhead rather than under operating expanses. This treatment is also quite reasonable). 4. Operating profit: - is difference between gross profit and operating expanses. As a measure of profit it reflects operating performance and is not affected by non-operating gains/losses, financial leverage, and tax factor. 5. Non-operating surplus: - represents gains arising from sources other than normal operations of the business. Its major components are income from

investment and gain from disposal of assets. Likewise, non-operating deficit losses from activities unrelated to the normal operations of the firm. 6. Profit before interest and taxes (PBIT): - is the sum of operating profit and non-operating surplus deficit. Referred to also as Earning before interest and taxes (EBIT), this represents a measure of profit which is not influenced by financial leverage and the tax factor. Hence, it is preeminently suitable for inter-firm comparison. 7. Interest: - is the expanses incurred for borrowed funds, such as term loans debentures, public deposits, and working capital advances. 8. Profit before tax (PBT): - is obtained by deducting interest from profit before interest and taxes. 9. Tax: - represents the income tax payable on the taxable profit of the year. 10. Profit after tax (PAT): - is the difference between the profit before tax and tax for the year. 11. Dividends: - represents the amount earmarked for distribution to shareholders. 12. Retaining earnings: - are the difference between profit after tax and dividends. Structure of the Profit and Loss accounts of Horizon Limited for the Year Ending on March 31, 2001 (Rs in Million) Items Net sales Cost of goods sold Stocks Wages and salaries Other manufacturing expanses Gross profit Operating expanses Depression General administration Selling Operating profit Non- operating surplus/deficit Profit before interest and tax (PBIT) Interest Profit before tax (PBT) Tax Profit after tax Dividends Retained earnings Per share data(in rupees) Earning per share Dividend per share 2001 701 552 421 68 63 149 60 30 12 14 89 89 21 68 34 34 28 6 2.27 1.87

Market per share Book value per share 3. Cash flow statement

21.00 17.46

A cash flow statement is a financial report that shows incoming and outgoing money during a particular period (often monthly or quarterly). The statement shows how changes in balance sheet and income accounts affected cash and cash equivalents and breaks the analysis down according to operating, investing, and financing activities. As an analytical tool the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. People and groups interested in cash flow statements include:
• • • •

Accounting personnel, who need to know whether the organization will be able to cover payroll and other immediate expenses Potential lenders/creditors, who want a clear picture of a company's ability to repay Potential investors who need to judge whether the company is financially sound Potential employees or contractors who need to know whether the company will be able to afford compensation

The cash flow statement may be prepared on the basis of actual or estimated data. In the later case, it is termed as “Projected Cash Flow Statement”, which is synonymous with the term ‘Cash Budget’. The cash flow statement is a statement depicting change in cash position from one period to another. The cash flow statement explains the reasons for inflows or outflows of cash, as the case may be. It also helps management in making plans for the immediate future. A Projected Cash Flow Statement or the Cash Budget will be help the management in ascertaining how much cash will be available to meet obligations to trade creditors, to pay bank loans and to pay dividend to the shareholders. A proper planning of the cash recourses will enable the management to have cash available whenever needed and put it to some profitable or productive use in case there is surplus cash available. The change in the cash position from one period to another is computed by taking into account ‘Sources’ and ‘Applications’ of cash. The Structure of the CFS


The cash flow statement is distinct from the income statement and balance sheet because it does not include the amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. Cash flow is determined by looking at three components by which cash enters and leaves a company: core operations, investing and financing, Operations Measuring the cash inflows and outflows caused by core business operations, the operations component of cash flow reflects how much cash is generated from a company's products or services. Generally, changes made in cash, accounts receivable, depreciation, inventory and accounts payable are reflected in cash from operations. Cash flow is calculated by making certain adjustments to net income by adding or subtracting differences in revenue, expenses and credit transactions (appearing on the balance sheet and income statement) resulting from transactions that occur from one period to the next. These adjustments are made because non-cash items are calculated into net income (income statement) and total assets and liabilities (balance sheet). So, because not all transactions involve actual cash items, many items have to be reevaluated when calculating cash flow from operations. For example, depreciation is not really a cash expense; it is an amount that is deducted from the total value of an asset that has previously been accounted for. That is why it is added back into net sales for calculating cash flow. The only time income from an asset is accounted for in CFS calculations is when the asset is sold. Changes in accounts receivable on the balance sheet from one accounting period to the next must also be reflected in cash flow. If accounts receivable decrease, this implies that more cash has entered the company from customers paying off their credit accounts - the amount by which AR has decreased is then added to net sales. If accounts receivable increase from one accounting period to the next, the amount of the increase must be deducted from net sales because, although the amounts represented in AR are revenue, they are not cash. An increase in inventory, on the other hand, signals that a company has spent more money to purchase more raw materials. If the inventory was paid with cash, the increase in the value of inventory is deducted from net sales. A decrease in inventory would be added to net sales. If inventory was purchased on credit, an increase in


accounts payable would occur on the balance sheet, and the amount of the increase from one year to the other would be deducted from net sales. The same logic holds true for taxes payable, salaries payable and prepaid insurance. If something has been paid off, then the difference in the value owed from one year to the next has to be subtracted from net income. If there is an amount that is still owed, then any differences will have to be added to net earnings. Investing Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets such as marketable securities. However, when a company divests of an asset, the transaction is considered "cash in" for calculating cash from investing. Financing Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a bond to the public, the company receives cash financing. However, when interest is paid to bondholders, the company is reducing its cash. Analyzing an Example of a CFS


From this CFS, we can see that the cash flow for FY 2003 was $1,492,000. The bulk of the positive cash flow stems from cash earned from operations, which is a good sign for investors. It means that core operations are generating business and that there is enough money to buy new inventory. The purchasing of new equipment shows that the company has cash to invest in inventory for growth. Finally, the amount of cash available to the company should ease investors' minds regarding the notes payable, as cash is plentiful to cover that future loan expense. Of course, not all cash flow statements look this healthy, exhibiting a positive cash flow. But a negative cash flow should not automatically raise a red flag without some further analysis. Sometimes, a negative cash flow is a result of a company's decision to expand its business at a certain point in time, which in fact would be a good thing for the future. This is why analyzing changes in cash flow from one period to the next gives the investor a better idea of how the company is performing, and whether or not a company may be on the brink of bankruptcy or success. Balance Sheet as at 31st March, 2006

As At 31st March, 2006 (Rs. in Crores) I. SOURCES OF FUNDS

As At 31st March, 2005 (Rs. in Crores)

1. Shareholders' Funds a)Capital b)Share Capital Suspense c)Reserves & Surplus 2. Loan Funds a)Secured Loans 33.67 88.69 375.52 248.22 1.21

8685.96 9061.48 7646.18 7895.61


b)Unsecured Loans 3. Deferred Tax - Net Total II. APPLICATION OF FUNDS 1.Fixed Assets a)Gross Block b)Less: Depreciation c)Net Block d)Capital Work-in-Progress 2.Investments 3.Current Assets, Loans and Advances a)Inventories b)Sundry Debtors c)Cash and Bank Balances d)Other Current Assets e)Loans and Advances


119.73 324.76 9505.97


245.36 376.09 8517.06

6227.17 2065.44 4161.73 243.40 4405.13 3517.01

5746.27 1795.51 3950.76 186.15 4136.91 3874.68

2636.29 547.96 855.82 146.80 975.03 5161.90

2002.99 527.76 55.66 142.52 810.36 3539.29

Less : 4.Current Liabilities and Provisions a)Liabilities 2189.03 1925.64



1389.04 3578.07

1108.18 3033.82 1583.83 9505.97 505.47 8517.06

Net Current Assets Total

Profit & Loss Account for the year ended 31st March, 2006

For the year ended 31st March, 2006

For the year ended 31st March, 2005





Gross Sales



Less: Excise Duties and Taxes on Sales of Products and Services.



Net Sales [after considering provision for Taxes of Rs. Nil (2005 - 214.75 Crores); also see Schedule 19(i)]


52 7639.45

Other Income

286.08 10076.61

235.81 7875.26

II. OTHER EXPENDITURE Raw Materials etc. Manufacturing, Selling etc. Expenses Depreciation 3983.23 2491.85 332.34 6807.42 III. PROFIT Profit before Taxation and Exceptional items Provision for Taxation Profit after Taxation before Exceptional items Exceptional items (net of tax) Profit after Taxation Profit brought forward 3269.19 988.82 2280.37 (45.02) 2235.65 611.41 2846.76 Release from Hotel Foreign Exchange Earnings Reserve 2673.07 836.00 1837.07 354.33 2191.40 387.84 2579.24 15.14 2769.55 2119.77 312.87 5202.19


Available for appropriation



IV. APPROPRIATIONS General Reserve Proposed Dividend Income Tax on Proposed Dividend [Including Rs. 0.02 Crore (2005 - Rs. 1.27 Crores) for earlier years] Profit Carried Forward 1150.00 995.12 139.58 1100.00 773.25 109.72

562.06 2846.76

611.41 2594.38

Earnings Per Share (Face Value Rs. 1.00 each) On Profit after Taxation before Exceptional items Basic Diluted On Profit after Taxation Basic Diluted
Cash Flow Statement for the year ended 31st March, 2006
(Figures for the previous year have been rearranged to conform with the revised presentation)

Rs. 6.08 Rs. 6.05

Rs. 4.91 Rs. 4.91

Rs. 5.96 Rs. 5.93

Rs. 5.85 Rs. 5.85


For the year ended 31st March, 2006 (Rs. in Crores) A. NET PROFIT BEFORE TAX AND EXCEPTIONAL ITEMS ADJUSTMENTS FOR : Depreciation Interest etc. (Net) Income from Long Term Investments Income from Current Investments Fixed Assets - Loss on Sale/Write off - Net (Profit)/Loss on Sale of Current Investments - Net Excess of Cost over Fair Value of Current Investments Unrealised Loss on Exchange -Net Write off of Long Term Investment Liability no longer required written back 332.34 2.83 (8.69) (155.47) 19.63 (3.43) 12.76 3269.1 9

For the year ended 31st March, 2005 (Rs. in Crores) 2673.07

312.87 5.91 (27.04) (119.72) 1.89 0.34 -

0.01 (7.38) 192.60

0.04 0.05 (15.39) 158.95


3461.7 9





(633.30) 328.79 (465.02 ) 2996.7 7 (999.22 ) 1997.5 5 (67.87)

(506.09) 418.11 (197.05)

Trade Payables



Income Tax Paid


Cash Flow before Exceptional items


Exceptional items paid/received [see Schedule 19(i)]



1929.6 8


B. CASH FLOW FROM INVESTING ACTIVITIES : Purchase of Fixed Assets Sale of Fixed Assets Purchase of Business (see Note 2 below) (709.19) 5.89 (38.83) (32734.10 ) 33215.54 (517.20) 21.51 (38.83) (24462.88 ) 23446.79 (3.01) 0.05 27.04

Purchase of Current Investments

Sale/Redemption of Current Investments Purchase of Long Term Investments Sale of Long Term Investments Income from Long Term Investments Received



Income from Current Investments Received Interest Received Refund of Deposits towards Property Options Loans Given Loans Realised

20.92 7.92 46.50 (55.24) 56.91 (175.31 )

22.17 16.76 77.01 (186.34) 157.98 (1438.95 )


C. CASH FLOW FROM FINANCING ACTIVITIES : Proceeds from issue of Share Capital Proceeds from Long Term Borrowings Net increase / (decrease) in Cash/Export Credit Facilities and other Short Term Loan Interest etc. Paid Dividends Paid Income Tax on Dividend Paid NET CASH FLOW USED IN FINANCING ACTIVITIES NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS OPENING CASH AND CASH EQUIVALENTS 65.95 17.01 (142.64) 37.32 11.31 113.12

(16.28) (769.78) (108.47) (954.21 ) 800.16

(18.68) (494.65) (65.51) (417.09)



34.00 26.50





CASH AND CASH EQUIVALENTS COMPRISE : Cash and Bank Balances 855.82 55.66

Notes :
1. Cash and cash equivalents include Rs. Nil (2005 - Rs. 26.50 Crores) of erstwhile ITC Hotels Limited and Ansal Hotels Limited taken over on amalgamation. 2. Purchase consideration of Rs.232.99 Crores (net of liability of Rs.15.03 Crores towards sales tax deferment loans assumed) on acquisition of business in 2004, payable to M/s BILT Industrial Packaging Company Limited. Cash paid [Including Rs.38.83 Crores (2005 Rs.38.83 Crores) during the year as per scheme of repayment] Balance Payable



116.49 116.50

77.66 155.33

For analysis of these financial statements, the following tools are used:1. Ration analysis 2. Cash Flow Statement 3. Statement of Change in Financial Position on Working Capital basis and Cash basis 4. Comparative Statement and, 5. Common size Statement.


2.10 Statement of Change in Financial Position (SCFP)
The balance sheet and income statement are traditional basic financial statement of business enterprises. While they do furnish useful financial data regarding its operations, a serious limitation of these statements is that they do not provide information regarding changes in the firm’s financial position during a particular period of time. In operational terms, they fail responsible to answer questions such as: What have been factors responsible for the difference in owner’s equity, assets and liabilities of the firm at two dates of consecutive balance sheet? • What have been the premier financing and investment activities of the firm during this period? • How long-term sources been adequate to finance fixed assets purchase? • Does the firm possess adequate working capital and cash? • Why did the firm not pay dividends in spite of adequate profits? • How much funds have been generated from operations/operating activities? • How much funds have been generated (or spent) from (or on) investment and financing activities? • Has the liquidity position of the firm improved? The SCFP overcomes these limitations of basic financial statements. In other words, the SCFP throws light on the above aspects which are of considerable interest to the financial managers and outside investors. Meaning of SCFP The SCFP is a statement of flows, that is, it measures the changes that taken place in the financial position of a firm between two balance sheet dates. It summarizes the sources from which funds have been obtained and the uses to which they have been applied. As a statement of sources and uses of funds, drawing on the information contained in the basic financial statement, it shows the source of funds and application of funds during the period. The changes in financial position could be related to several different concepts of funds. The two most common usages of the term funds are cash and working capital. Viewed in this sense. The SCFP would explain the change in cash or working capital. Accordingly, there are two statements, that is, statement of changes in cash (popularly called cash statement) and statement of changes in words capital (popularly known as sources and uses statements or funds flow statements). SCFP-Working Capital basis

The net working capital (NWC) of a firm is the amount by which its current assets (CA) exceed its current liabilities, (CL). The magnitude of working capital is a measure of the safety margin that exists for the protection of short-term creditors. Working capital may also be viewed as funds available for acquisition of noncurrent assets/fixed assets as well as to repay non-current liabilities/ long-term liabilities. Any transaction that results in an increase in working capital is a source of WC; any transaction that causes a decrease in WC is an application of WC. Some transactions merely change the form of working capital, without altering the amount of working capital; such items neither constitute a source nor the use of working capital. General Rules Let us formulate some general rules to ascertain transaction give rise to a use of working capital and which do not. This exercise is useful for the preparation of the funds flow statement. Symbolically, WC=CA-CL From the above, the following may be deduced: 1. Transactions affecting WC: (a) An increase in CA (without affecting CL) causes an increase in WC. – Issue of equity shares causes an increase in cash (CA) and increases in non-current liability (NCL). (b) A decrease in CA (without affecting CL) causes a decrease in WC. – Purchase of non-current assets (NCA) causes decrease in cash (CA) and increase in (NCA). © An increase in CL (without affecting CA) causes a decrease in WC. – Bank overdraft to repay long-term loans causes an increase in CL and decrease in NCL. (d) A decrease in CL (without affecting CA) causes an increase in WC. – Bank overdraft paid by issue of debentures causes a decrease in bank overdraft (CL) and an increase in NCL. 2. Transactions not affecting WC: (e) A simultaneous increase in CA and CL does not affect WC. – Purchase of inventories on credit causes an increase in inventory (CA) and an increase in creditors (CL).


(f) A simultaneous decrease in CA and CL does not affect WC. – Payment of creditors in cash (CA) and decrease in creditors (CL). (g) A simultaneous increase/decrease in NCA and NCL does not affect WC. – Purchase of machine by issue of debentures causes an increase in NCA and an increase in debentures (NCL). A close examination of the above rules and illustrations that a transaction which gives rise to a source or use of working capital should affect both the current account (CA or CL), and the non-current account (NCA or NCL) simultaneously. However, if a transaction occurs where either only current accounts [as shown in rules (e) and (f)] are affected, working capital is not changed. Likewise, if both noncurrent assets (g) are affected as a result of the transaction, it does not bring about any change in working capital. The major sources and uses of working capital are 1. Sources of Working Capital o Funds from business operations o Other incomes o Sales of non-current assets o Long-Term borrowings o Issue of additional equity capital or preferences shares capital 2. Uses of Working Capital o o o o SCFP-Cash basis The statement of change in financial position based on working capital is of immense use in long-range financial planning. The long-term financing and investment activities are specifically portrayed. The net working capital requirements (in one lump sum amount) are shown as a residual figure. However, the working capital concept may conceal or exclude too much. It treats increase in inventories and accounts receivable as equivalent to increase in cash. Likewise, an increase in accounts payable and accrued expenses are treated as equivalent to an increase in bank overdraft. This is not a correct treatment. In fact, accrued expanses like wages and salaries may become payable in next 10 days or so; sundry creditors bills may fall due for payment during the next one month, whereas bank overdraft may be for a longer period of, say, three months or even more. Similarly, inventories

Loses from business operations Purchase of non-current assets Redemption of debentures and/or preference shares Dividends to shareholders

and accounts receivable undergo a transformation before they become money assets (cash). It is possible that there is sufficient net working capital as revealed by the statement of changes in financial position and yet the firm may be unable to meet its current liabilities as and when they fall due. It may be due to a sizeable piling up of inventories and an increase in debtors caused by a slow-down in collections. The firm’s failure to meet its short-term commitments, in spite of its sound long-range financial position and adequate profitability, may plunge it into technical insolvency. Therefore, in making plans for the more immediate future (short-range financial position), the management is vitally concerned with a statement of cash flows which provides more detailed information. Such a statement is useful for the management to assess its ability to meet obligations to trade creditors, to pay bank loans, to pay interest to debenture holders and dividend to the shareholders. Furthermore, the projected cash flow statement prepared month-wise or so (which are constructed like the funds statement) can be useful in presenting information of excess cash in some months and shortage of cash in others. By making available such information in advances, the statement of cash flows enables the management to revise its plans. In the months when cash receipts are expected to be greater than cash payment, bank overdraft can be repaid, short-term government securities can be purchased, and cash discount can be availed of and so on. Likewise, in the months when cash payments are expected to exceed receipts, the firm would be required to arrange for bank overdraft or sell its marketable securities. In essence, cash flow statements are SCFP on the basis of funds defined as cashequivalent. In short, cash flow statement summaries sources of cash inflow and uses of outflows of the firm during a particular period of time.


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