FA – Preparing Basic Financial

Statements
Contents
Producing year-end accounts:..................................................................................................... 2
Statement of financial position: .............................................................................................. 3
Statement of chnages in equity:.............................................................................................. 6
Statement of profit or loss: ..................................................................................................... 8
Statement of profit or loss and other comprehesive income: .............................................. 11
Disclosure Notes........................................................................................................................ 13
Purpose of disclosure notes: ................................................................................................. 13
Disclosures for non-current assets: ....................................................................................... 13
Events after the Reporting Period............................................................................................. 24
DEFINITION ............................................................................................................................ 24
adjusting events:.................................................................................................................... 24
NON-adjusting events:........................................................................................................... 25
Statement of Cash Flows ........................................................................................................... 26
Profit vs. cash flow:................................................................................................................ 26
Statement of Cash Flow (Illustration) ....................................................................................... 34
Company’s statement of financial position as at 31st May 20X5 and 31 May 20X6: ............ 35
Company’s statement of profit or loss for the year-ended 31st May 20X6: ......................... 38
Preparing company’s statement of cash flows from data provided: .................................... 39
Incomplete Records .................................................................................................................. 48
Methods of finding missing figures: ...................................................................................... 48

1
Producing year-end accounts:
All companies need to produce financial statements in accordance with IAS 1. The
requirements are to produce:

1. A statement of financial position;

2. A statement of profit or loss;

3. A statement of profit or loss and other comprehensive income;

4. A statement of changes in equity;

5. A statement of cash flows;

6. Notes to the accounts.

To be able to produce year-end accounts we must go through the following steps:

1. Record all transactions in the appropriate ledgers, following double-entry principles and
making use of the books of prime entry;

2. Close-off/balance-off the ledgers;

3. Prepare the trial balance;

4. Update the trial balance with any year-end adjustments;

5. Produce the final year-end financial statements based on the updated trial balance.

There are numerous year-end adjustments that may be required:

 To record the closing inventory;

 To calculate the depreciation charge for the year;

 To deal with any disposals or revaluations of assets during the year;

 To account for accrued and prepaid expenses and income;

 To write-off irrecoverable debts and make an allowance for doubtful debts;

 To calculate the tax liability and expense;

 To record any provisions and contingent liabilities

2
Statement of financial position:

Layout of a typical statement of financial position is:

XYZ Ltd. Statement of Financial Position as at 31/12/X6

$’000 $’000
Non-Current Assets
Property, Plant and Equipment X
Investments X
Intangibles X
X
Current Assets
Inventory X
Receivables X
Prepayment X
X
Total Assets AA
Equity
Ordinary Share Capital X
Irredeemable Preference Shares X
Reserves X
X
Liabilities
Loans X
Trade Payables X
Tax Payables X
X
Total Equity and Liabilities AA

The first thing you will notice is that the statement has a title. This is extremely important as it
tells the reader which company’s accounts they are reading and at what date the figures are
being reported.

3
Assets:

The top half of the statement deals with all of the assets within the company, non-current
assets to start with followed by the current assets.

Non-current assets:

You will notice that non-current assets are broken down into:

1. Tangible non-current assets (such as property, plant and equipment, investments);

2. Intangible non-current assets.

All of these will be shown on the face of the statement of financial position at their carrying
values at the year-end

Current assets:

The current assets are listed out based on their level of liquidity, the least liquid being inventory
as this takes time to sell and then convert to cash. This order is prescribed by IAS 1 and must be
followed whenever producing statements of financial position. A few things should be noted at
this stage:

 Firstly, the inventory being recorded here is the closing inventory, the trial balance will
show the opening inventory so be careful with this and ensure you include the correct
figure.

 Secondly, the receivables figure needs to be adjusted for any irrecoverable debts not yet
accounted for and also reduced by the closing balance on the allowance for doubtful
debts.

 Finally, you will notice that there is a prepayments figure within current assets which
needs to include any money paid out during the year towards next year’s expenses (this
figure will also be used to reduce the expense shown on the statement of profit or loss).

4
Once we have all of the non-current and current assets listed out we can then calculate a
figure for total assets.

Equity and liabilities:

The bottom half of the statement of financial position deals with the equity and liabilities in
the company:

Equity:

The first section deals with all aspects of equity within the business, this usually includes:

 Ordinary shares;

 Irredeemable preference shares;

 Reserves.

The closing year-end figures for each of these can be gathered from the statement of changes
in equity.

Liabilities:

The liabilities, like assets, are broken down into non-current liabilities and current liabilities.

Non-current liabilities relate to any liabilities that are due for repayment in more than 12
months’ time, so typically this will only include loans or debentures.

Current liabilities are all liabilities due within 12 months and will include:

 Trade payables;

 Accruals;

 Overdrafts;

 Tax payable;

 Any loans due to be repaid within 12months of the accounting date.

Once all equity and liabilities are recorded we can then total these up to find the total equity
and liabilities figure. You will notice that this figure AA equals the total assets figure in the top
half of the statement of financial position. This, of course, is in line with the accounting
equation that states that assets equal equity (or capital) plus liabilities.

5
NOTE: The statement of financial position is a snapshot on a particular date of all of the assets
owned and all of the liabilities owing at that date. We are not reporting on the movements
within assets and liabilities just simply the relevant closing balances at the period or year end.

Statement of chnages in equity:

Layout of a typical statement of changes in equity is:

XYZ Ltd. Statement of Changes in Equity for the year-ended 31/12/X6

Ordinary Irredeemable
Share Retained Revaluation
Share Preference Total
Premium Earnings Reserve
Capital Shares
($’000)
($’000) ($’000) ($’000)
($’000) ($’000)

At 31/12/15 X X X X X X

Public issue X X X X

Rights issue X X X

Bonus issue X (X) -

Revaluation X X

Profit X X

Dividends (X) (X)

At 31/12/16 X X X X X X

This statement provides us with the closing balances for the equity section of the statement of
financial position. As you can see the statement of changes in equity shows how the opening
balance on each reserve has changed to arrive at the closing balance. As with the statement of
financial position we must ensure that the statement of changes in equity has a title (as shown
here), this statement shows changes in the various figures, covering a period of time (the year
ended 31st of December 20X6 in this case).

6
Opening balances:

Each account within the equity section of the statement of financial position has a column and
for each we start with the opening balance which will be the figures seen on the statement of
financial position for last year.

Movements during the year:

We then detail any movements within the accounts. For the share capital, irredeemable
preference share and share premium accounts this will include share issues during the year
whether they have been issued through a public issue, rights issue or bonus issue. Notice that
the total column shows a zero balance with regard to the bonus issue, as we are simply moving
funds from one reserve to another.

With regards to the revaluation reserve we need to show the increase or decrease in the
reserve as a result of any revaluations of non-current assets during the year. And the retained
earnings reserve will increase by the net profit for the period and decrease by the value of any
dividends paid out during the year.

Closing balances:

The closing balance figures on the bottom line of the table will then feed into the equity section
of the statement of financial position.

7
Statement of profit or loss:

Layout of a typical statement of profit or loss is:

XYZ Ltd. Statement of Profit or Loss for the year-ended 31/12/X6

$’000

Revenue X

Cost of Sales (X)

Gross Profit X

Distribution Costs (X)

Administration Costs (X)

Profit from Operations X

Investments Income X

Finance Costs (X)

Profit before Tax X

Tax Expense (X)

Net Profit for the Period X

Now that we have covered all aspects of assets and liabilities we need to think about reporting
our income and expenses which is achieved through the statement of profit or loss. Again, it is
extremely important that we give the statement a title so that the reader knows what they are
looking at. As we are reporting on all of the income earned and all of the expenses incurred for
the full accounting period, the title for the statement of profit or loss will always state the
period in question (here, we are reporting on the year ended 31st of December 20X6).

8
Gross profit:

The top half of the statement of profit or loss takes the income or revenue earned in the period
and deducts from this the cost of sales for the period to arrive at gross profit.

Cost of sales:

Cost of sales is calculated as:

$’000

Opening inventory X

Add: Purchases X

Less: Purchase returns (returns outwards) (X)

Add: Carriage inwards X

Less: Closing inventory (X)

Cost of sales X

NOTE:

 In company accounts we DO NOT show the calculations performed to arrive at cost of

sales (the above calculation is shown in the notes to the financial statements).

 Any returns inwards (that is returns from customers) are deducted from gross sales
revenue before recording revenue on the statement of profit or loss.

Profit from operations:

Once we have arrived at gross profit we then need to deduct:

 Distribution expenses (including carriage outwards and other selling costs);

 Administrative expenses (such as wages for office staff, and rent/depreciation of the
admin office).

This takes us down to profit from operations, in other words the profit we have made by
running our business on a day to day basis (buying, making and selling goods or services).

9
Profit before tax:

Next, we then need to add on any investment income (i.e. interest or dividends received) we
have received, and deduct costs relating to financing (i.e. interest or dividends paid) our
business. This will give us profit before tax.

Net profit for the period:

We finally need to deduct the tax charge for the year from profit before tax to arrive at the net
profit for the period.

NOTE: One important point to note is that all of the income and expenses need to be recorded
on an accruals basis so make sure you increase or decrease income and expense figures
accordingly if there is any accrued or prepaid income or expenses at the year-end. Remember
that the accruals and prepayments themselves will be recorded on the statement of financial
position within current liabilities and current assets respectively (if they relate to expenses as is
most often the case).

10
Statement of profit or loss and other comprehesive income:

Layout of a typical statement of profit or loss and other comprehensive income is:

XYZ Ltd. Statement of Profit or Loss and Other Comprehensive Income

for the year-ended 31/12/X6

$’000

Revenue X

Cost of Sales (X)

Gross Profit X

Distribution Costs (X)

Administration Costs (X)

Profit from Operations X

Investments Income X

Finance Costs (X)

Profit before Tax X

Tax Expense (X)

Net Profit for the Period X

Other Comprehensive Income

Unrealised Gain/Loss X/(X)

Total Comprehensive Income for the Year X/(X)

This statement is exactly the same as the statement of profit or loss down to the line ‘net profit
for the period’ but we now add on an extra section for the other comprehensive income.

11
Other comprehensive income:

Other comprehensive income relates to any unrealised gains generated in the period, we
cannot show these unrealised gains within the main body of the statement of profit or loss as
the profit has not yet been realised, but it is useful to show the readers of the accounts that
there are gains within the business that could be realised at some point in the future.

Revaluation gain/loss:

Typically, unrealised gains or losses will be any revaluations of non-current assets during the
period. In the case of a revaluation the non-current asset would need to be sold to in order to
realise the gain, and at that point there would be a profit on disposal to record in the statement
of profit or loss and the value of the revaluation of that asset would be removed from the
revaluation reserve.

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Disclosure Notes
Purpose of disclosure notes:

To disclose more information providing a description or a more detailed analysis of items which
are on the face of the financial statements. They are also give information about items not
included in the financial statement such as contingent liabilities or assets. In short the
disclosures give greater understanding to the users of those financial statements.

IAS 1 – Presentation of Financial Statements gives the overall requirement for the financial
statements. However, other standards outline more disclosure requirements specific to the
standard.

Disclosures for non-current assets:

IAS 16 covers property, plant and equipment, which are non-current tangible assets. Under IAS
16 the following must be disclosed for each class of property, plant and equipment:

 The basis for measuring carrying amount.

 The depreciation method used.

 The useful life or depreciation rate of the asset.

 The gross carrying amount and accumulated depreciation and impairment losses.

 A reconciliation of the carrying amount at the beginning and the end of the period. The
reconciliation should cover:

 Additions

 Disposals

 Acquisitions through business combinations

 Revaluation increases or decreases

 Impairment losses

 Reversals of impairment losses

 Depreciation

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  Net foreign exchange differences on translation

 Other movements

 Additional disclosures that may apply:

 Any restrictions on the assets title and any items pledged as security for
liabilities.

 Any expenditure on the construction of property, plant, and equipment during

the period.

 Contractual commitments to acquire property, plant, and equipment.

 Compensation from third parties for items of property, plant, and equipment
that were impaired or given up that is included in profit or loss in the year.

Disclosers for property, plant and equipment:

 The effective date of the revaluation;

 Whether an independent valuer was involved.

For each revalued class of property, the following must be disclosed:

 The carrying amount that would have been recognised had the assets been carried
under the cost model.

 The revaluation surplus, including changes during the period and any restrictions on the
distribution of the balance to the shareholders.

14
Sample disclosure under IAS 16 for ABC Inc. at 31st December 20X7:

ABC Inc.

Property, Plant and Equipment as at 31st December 20X7

Land and
Equipment Total
buildings
($) ($)
($)

Cost (A):

1st January 20X7 10,000 2,000 12,000

Additions - 3,000 3,000

Disposals (cost) - (500) (500)

31st December 20X7 10,000 4,500 14,500

Accumulated depreciation and

impairment (B):

1st January 20X7 - 1,000 1,000

Annual depreciation - 200 200

Impairment - 50 50

Disposals (accumulated depreciation) - (500) (500)

31st December 20X7 - 750 750

Carrying amount at 31st December 20X7

10,000 3,750 13,750
(A – B)

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Disclosure:

During 20X7 the Group noticed a significant decline in the efficiency of a piece of equipment
and carried out a review of its recoverable amount. The review led to the recognition of an
impairment loss of $500. The carrying amount of the Group’s equipment includes an amount
of $1,000 (20X6: $800) in respect of assets held under finance leases.

On 15th December 20X7 the directors resolved to dispose of a piece of equipment. The
machine’s carrying amount of $500 is included equipment at 31 st December 20X7, and trade
payables include the Group’s remaining obligation of $550 on the acquisition of this
equipment. Because the proceeds on disposal are expected to exceed the net carrying
amount of the asset and related liability, no impairment loss has been recognised.

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Disclosures for non-current intangible assets:

IAS 38 – Intangible Assets is the guiding standard for preparing a disclosure for intangible
assets. Examples of intangible assets include trade secrets, patents and computer technology.

Disclosure requirements:

For each class of intangible asset, the following must be disclosed:

 The useful life or amortisation rate;

 The amortisation method;

 The gross carrying amount;

 Accumulated amortisation and impairment losses;

 Line items in the income statement in which amortisation is included;

 A reconciliation of the carrying amount at the beginning and the end of the period
showing:

 Additions;

 Assets held for sale;

 Retirements and other disposals;

 Revaluations;

 Impairments;

 Reversals of impairments;

 Amortisation;

 Foreign exchange differences;

 Other changes.

 The basis for determining that an intangible has an indefinite life;

 A description and carrying amount of individually material intangible assets;

 Certain special disclosures about intangible assets acquired with government grants;

17
  Information about any intangible assets where title is restricted;

 Any contractual commitments to acquire intangible assets.

Further disclosures are required if:

 Intangible assets are carried at revalued amounts;

 The amount of research and development cost is recognised as an expense in the

period.

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Sample disclosure under IAS 38 for ABC Inc. at 31st December 20X7:

ABC Inc.

Intangible Assets as at 31st December 20X7

Software

($)

Cost (A):

1st January 20X7 10,000

Additions -

Disposals (cost) -

31st December 20X7 10,000

Accumulated amortisation and

impairment (B):

1st January 20X7 5,000

Annual amortisation 1,000

Impairment -

Disposals (accumulated depreciation) -

31st December 20X7 6,000

Carrying amount at 31st December 20X7

4,000
(A – B)

Disclosure:

The acquired intangible asset of ABC Inc. is software which is measured initially at cost and
amortised on a straight-line basis over their estimated useful lives, at 10% cost per annum.

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Disclosures for provisions, contingent liabilities and contingent assets:

IAS 37 gives guidance when disclosing Provisions, Contingent Liabilities and Assets.

Disclosures:

 Reconciliation for each class of provision as follows:

 Opening balance;

 Additions;

 Used (amounts charged against the provision);

 Unused amounts reversed;

 Unwinding of the discount, or changes in discount rate;

 Closing balance.

 For each class of provision, a brief description of:

 Nature;

 Timing;

 Uncertainties;

 Assumptions;

 Reimbursement (if any).

NOTE: For disclosures of provisions, contingent liabilities and contingent assets a prior year
reconciliation is NOT required.

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Sample disclosure under IAS 37 for Great Goods Inc. for the year ended 31st December 20X6:

Great Goods Inc.

Provisions as at 31st December 20X7

Opening provision 40,000

Movement (20,000)

Closing provision 20,000

Disclosure:

Great Goods Inc. offers its customers a one year warranty on all goods purchased. At the 31st
December 20X6 the directors believe that the cost of this warranty was $20,000. This was
based on the 20X6 sales figures.

Disclosure of events after the reporting period:

IAS 10 covers disclosing events after the reporting period.

Non-adjusting events:

Non-adjusting events should be disclosed if their non-disclosure would affect the ability of users
to make proper evaluations and decisions and their disclosure should have:

 The nature of the event;

 An estimate of its financial effect or a statement that a reasonable estimate of the effect
cannot be made.

Some other factors to consider are:

 The company should update disclosures that relate to conditions that existed at the end
of the reporting period to reflect any new information received after the reporting
period.

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  The companies must disclose the date the financial statements are authorised for issue
and who gave the authorisation.

 If the enterprise's owners can amend the financial statements after issuance, this must
be disclosed.

Sample disclosure under IAS 10 for ABC Inc. for the year ended 31 December 20X6:

Disclosure:

In January 20x7 the board of directors decided to discontinue the south branch as part of a
major re-structuring program to centralise operations. Staff has been included in the
restructuring process. This project will commence in 20X7 and will cost $3 million.

NOTE: In the financial statements of ABC Inc. for the year ended 31st December 20x6, any
disclosures relating to the south branch will need be updated in line with the new conditions.

Disclosure for inventory:

IAS 2 is the standard that guides us when disclosing inventory.

Inventory disclosure notes must show:

 The accounting policy for measuring the inventory value.

 The carrying amount of inventory.

 Classify inventory into categories such as work in progress, supplies or goods ready for
sale.

 Any write -offs in the period.

 Reversal of write-offs and the circumstances for the reversal.

 Details of inventories pledged as securities.

Sample disclosure from T Plc. for the year ended 2015:

Disclosure:

Inventories comprise goods and development properties held for resale. Inventories are valued
at the lower of cost and fair value less costs to sell using the weighted average cost basis.
Directly attributable costs and incomes (including applicable commercial income) are included in

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the cost of inventories. The break-up of the figure appearing as ‘inventories’ in the statement of
financial position is as follows:

Description 20X5 ($’000) 20X4

($’000)

Goods held for resale 2,000 3,000

Development properties 100 110

Total 2,100 3,110

Goods held for resale are net of $56,000 (20X4: $53,000) relating to residential income. These
residential income amounts will be recognised in cost of sales upon sale of those inventories.

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Events after the Reporting Period
DEFINITION

This topic area is covered by IAS 10, which explains that events after the reporting period are
events that happen after the end of the accounting period but before the accounts are finalised
and authorised for issue, and they can be classified as adjusting events or non-adjusting events.

Note: An event could be a transaction taking place, or new knowledge being obtained, or the
auditor discovering something during the audit process.

adjusting events:

An adjusting event is one where we need to go back and adjust the figures within the accounts
that are being produced. They arise when evidence is found after the reporting period relating
to conditions that existed before the end of the reporting period.
Any event that indicates that the going concern assumption is no longer valid will always be
classed as an adjusting event even if the conditions relating to the event did not exist before
the end of the accounting period and the year-end accounts should be prepared based on the
assumption that the business is no longer a going concern.

Examples:

Situation Adjustment

Settlement after reporting date about Dr Expense

events before date. Cr Liability

Dr Irrecoverable debt expense

Trade receivable has gone into liquidation.
Cr Trade receivables

Fraudulent activity has been identified

Depends on accounts affected
during the audit.

Dr Closing inventory (SPL)

Inventory has been sold for less than cost.
We need to ensure that the inventory is Cr Closing inventory (SFP)
valued at net realisable value.
(thereby increasing the cost of sales)

24
NON-adjusting events:

A non-adjusting event is one where evidence is found after the end of the reporting period that
relates to conditions that also arose after the reporting period. No adjustments to the previous
period’s accounts are needed.

Disclosure:

Any non-adjusting event that is material in nature and will affect the reader's understanding of
the accounts needs to be disclosed in the form of a note to the accounts. The disclosures
needed within the accounts for non-adjusting events are:

 The nature of the event;

 The financial impact of the event. If the financial impact is not known with certainty
then an estimate should be made based on all available information.

Examples:

Situation Treatment

A dividend for the previous period has been Not classed as a material event and as such no
declared after the end of the reporting period. disclosure is required.

The value of the inventory at the year-end was

There has been a flood after the end of the
reporting period that has damaged some of
the inventory that was held by the company at
the year-end.
recorded correctly as there was no damage to
the goods at that point in time so we do not
need to go back into the accounts and reduce
the closing inventory value but we will need to
disclose the financial impact of the flood if the
reduction in inventory value is material to the
year-end accounts.

Legal action has been taken out against the

company but it relates to an incident that Disclosure required if the expected financial
happened AFTER the end of the reporting loss is material.
period.

Disclosure required if impact is deemed

A plan to close a significant part of a business.
material.

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Statement of Cash Flows
Profit vs. cash flow:

Before we look at the statement of cash flows itself let’s first of all consider the difference
between profit and cash and why businesses should focus on cash. It is vital the businesses to
generate profit and turn that profit into cash. Without cash they cannot pay employees or
suppliers and ultimately the business will fail. The statement of cash flows helps the businesses
to monitor the cash. The fundamental differences among cash and profit are summarised
below:

Statement of profit and loss Statement of cash flows

 Calculated on accrual basis;  Shows the cash actually received from

customers;
 Shows income generated and
expenses incurred;  Shows the cash actually received from
investments;
 Adjusted for accrued income and
expenses;  Shows the cash actually paid for
expenses.
 Adjusted for prepaid income and
expenses.

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Statement of cash flows:

The general outlay of a statement of cash flow is as follows:

Company ABC Statement of Cash flows Year-ended XXXX

$’000 $’000

Cash flows from operating activities

Cash generated from operations X

Interest paid (X)

Taxes paid (X)

Net cash flows from operating activities X

Cash flows from investing activities

Purchases of non-current assets (X)

Proceeds from sales of non-current assets X

Interest received X

Dividends received X

Net cash used in investing activities (X)

Cash flows from financing activities

Proceeds from share issues X

Repayment of loans (X)

Dividends paid (X)

Net cash used in financing activities (X)

Net increase/(decrease) in cash and cash equivalents X

Cash and cash equivalents at the beginning of period X From last year’s SFP

Cash and cash equivalents at the end of the period X From this year’s SFP

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As it can be seen, the statement of cash flows is segregated into three segments, explained as
below:

1) Cash flows from operating activities:

This section comprises of two parts:

i) Cash generated from operations:

This figure relates to cash in and cash out in relation to day to day trading. There are 2 methods
that can be used to calculate the cash flows from operating activities:

a. Direct method:

Description $’000 $’000

Cash sales X

Cash received from receivables X

Total cash receipts X

Less:

Cash purchases X

Cash paid to credit suppliers X

Cash expenses X

Total cash payments (X)

Cash generated from operations XXX

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 b. Indirect method:

Description $’000
Profit before tax (net profit) X
Finance cost X
Investment income (X)
Depreciation charge X
Loss/(profit) on disposal of NCA X/(X)
(Increase)/decrease in inventory (X)/X
(Increase)/decrease in trade
(X)/X
receivables
(Increase)/decrease in trade payables X/(X)
Cash generated from operations XXX

ii) Interest and tax paid:

We need to adjust accrued figures included on the statement of profit or loss to find the cash
paid. There are 2 ways that this can be done:

Ledger account approach:

Debit Interest/tax payable account Credit

$ $

Accrual b/f X

Cash paid β Charge to P&L X

Accrual c/f X

X X

a) Formulaic approach:

Interest/tax paid = interest/tax charge + accrual b/f – accrual c/f

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 2) Cash flows from investing activities:

This section covers investments in non-current assets and other businesses. The only cash
outflow you are likely to see is the purchase of non-current assets. Cash flows in this section
will include (ledger account approach):

i) Interest received:

Debit Interest receivable account Credit

$ $

Interest receivable
X
b/f

Income on P&L X Cash received β

Interest receivable
X
c/f

X X

ii) Dividends received:

Figure will be the same as that stated on the statement of profit or loss as we do not include
accrued income in relation to dividends.

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 iii) Non-current asset purchase and proceeds:

To insert these figures, we will need to know data in relation to the cost account, the disposals
account and potentially the accumulated depreciation account:

Debit Non-current asset cost account Credit

$ $

Cost b/f X

Revaluation X Disposal – cost X

Purchases β Cost c/f X

X X

Debit Non-current asset disposal account Credit

$ $

Non-current asset Accumulated depreciation

X X
cost

Profit on disposal X Proceeds received β

X X

We can also use the carrying value account rather than cost account to calculate the value of
purchases of non-current assets:

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 Debit Non-current asset disposal account Credit

$ $

Opening
CV (cost – acc dep) b/f X Depreciation charge X  P&L
SPF 

Revaluatio
n reserve Revaluation at CV X Disposal at CV X


 Closing
Purchases β CV c/f X
SFP

X X

NOTE: The formulaic approach to calculate the proceeds from disposal is:

Proceeds = Carrying value + Profit on disposal

Proceeds = Carrying value – Loss on disposal

32
 3. Cash flows from financing activities:

This section includes cash flows relating to the way in which our business is financed, i.e. cash
flows relating to shares, loans and debentures. Cash flows will include:

i) Proceeds from share issues:

b/f ($’000) c/f ($’000)

Share capital X X

Share premium X X

A B

B – A = cash raised

ii) Proceeds from a new loan/debenture OR repayment of loan/debenture:

$’000

Loan c/f X

Less: Loan b/f (X)

Loan issued/(repaid) X/(X)

iii) Dividends paid:

Dividends paid = figure stated on SFP

Note: We DO NOT include interest paid in relation to the loan in this section as this has been
dealt with within the cash from operating activities section already.

33
Statement of Cash Flow (Illustration)
We will demonstrate the formats and calculations used when dealing with the statement of
cash flows by working with data of a hypothetical company called Abracadabra Ltd. The data
made available to us includes:

 Company’s statement of financial position as at 31st May 20X5;

 Company’s statement of financial position as at 31st May 20X6;

 Company’s statement of profit or loss for the year-ended 31 May 20X6.

34
Company’s statement of financial position as at 31st May 20X5 and 31 May
20X6:

20X6 ($’000) 20X5 ($’000)

Assets
Non-current assets 2,000 1,600
Accumulated depreciation -480 -400
1,520 1,200
Current assets
Inventory 60 50
Receivables 82 90
Dividends receivable 35 25
Cash 12 20
189 185
Total assets 1,709 1,385

Capital and reserves

Share capital 350 300
Share premium 260 230
Revaluation reserve 255 155
Retained earnings 239 185
1,104 870
Non-current liabilities
Loan 250 200
Current liabilities
Trade payables 65 85
Interest accruals 30 50
Tax payable 260 180
355 315
Total equity and liabilities 1,709 1,385

For the statement of cash flows we need to look at the movement in various figures within the
statement of financial position, so at this stage we can go ahead and calculate those changes:

35
In the asset section we can see that:

 The non-current assets have gone up from $1.6million to $2million, an increase of

$400,000;

 Inventory has risen from $50,000 to $60,000, an increase of $10,000;

 Trade receivables have dropped by $8,000 from $90,000 to $82,000.

In the equity section we can see that:

 The share capital account has increased by $50,000;

 Share premium has increased by $30,000;

 The revaluation reserve has increased by $100,000;

 Retained earnings have increased by $54,000.

Similarly, for liabilities:

 The long-term loan value has increased by $50,000;

 Trade payables have dropped by $20,000.

36
These changes can be put in table from as:

20X6 ($’000) 20X5 ($’000) Change ($’000)

Assets
Non-current assets 2,000 1,600 400
Accumulated depreciation -480 -400
1,520 1,200
Current assets
Inventory 60 50 10
Receivables 82 90 -8
Dividends receivable 35 25
Cash 12 20
189 185
Total assets 1,709 1,385

Capital and reserves

Share capital 350 300 50
Share premium 260 230 30
Revaluation reserve 255 155 100
Retained earnings 239 185 54
1,104 870
Non-current liabilities
Loan 250 200 50
Current liabilities
Trade payables 65 85 -20
Interest accruals 30 50
Tax payable 260 180
355 315
Total equity and liabilities 1,709 1,385

NOTE: Whenever you are looking at data for 2 periods of time it is always good to double-check
which year’s data is in which column as they can either be stated with the most recent year on
the left, as is the case here, or with the most recent year on the right. Clearly if you get the dates
the wrong way round the movement in figures will be the opposite of what has actually
happened and this will affect your final answer. So it is definitely worth stopping and checking
the dates before moving on.

37
Company’s statement of profit or loss for the year-ended 31st May 20X6:

$’000

Revenue 2,100

Cost of sales (980)

Gross profit 1,120

Distribution expenses (550)

Administration expenses (240)

Operating profit 330

Investment income

Interest 20

Dividends 25

Finance charge (80)

Profit before tax 295

Income tax (200)

Net profit for the year 95

NOTE: The asset disposal generated a profit of $21,000, the original cost was $56,000 and the
accumulated depreciation up to the date of disposal was $32,000.

38
Preparing company’s statement of cash flows from data provided:

As you remember, the statement is split into THREE SECTIONS:

1. The cash flows generated from operating activities (in other words the cash generated
by our day to day trading);

2. The cash flows generated from investing activities (this covers the purchase and
disposal of non-current assets and income generated from investments in other
businesses);

3. The cash flows generated from financing activities (so the cash flows relating to the
debt and equity used to finance our business).

There are a number of workings that we need to perform to get the required figures for
statement of cash flows, from the provided statements of financial position and statement of
profit or loss:

1. Cash flows from operating activities:

This section can be further divided into three sections:

39
a) Cash generated from operations (working 1):

This is the first working we are going to look at and this is the most complicated
working. This working allows us to calculate the cash generated from operations that
feeds into the first section of the statement of cash flows. The starting point for this
calculation is the profit for the year. We then need to add back anything included within
that figure that is not a cash movement or that is seen elsewhere within the statement
of cash flows:

Indirect method:

$'000

Net profit 295

Finance charge 80

Investment income (45)

Profit on disposal of NCA (21)

Depreciation charge for year (see below) 112

Increase in inventory (10)

Decrease in receivables 8

Decrease in payables (20)

Cash generated from operating activities 399

40
 Calculation of depreciating charge for the period:

$'000

Accumulated depreciation b/f 400

Disposal (32)

Adjusted accumulated depreciation b/f 368

Accumulated depreciation c/f (480)

Depreciation charge for year (negative figure means a charge to P&L) (112)

NOTE:

Working capital adjustments include:

 Inventory has increased by $10,000 so we need to deduct this to show the cash leaving
our bank to buy more stock;

 Receivables have decreased by $8,000 so we add this on to show that we have

effectively collected in more cash;

 Payables have also decreased meaning that money has left our bank and been paid
across to our suppliers, so we also need to deduct this $20,000 outflow.

41
 b) Interest paid (working 2):

Please note that the figures that we report on the statement of profit or loss are accrued
figures so we need to use our understanding of accruals to work backwards and find the cash
actually paid out:

Dr Interest paid Cr

$’000 $’000

Accrual b/f 50

Cash PAID (β) 100 Finance charge 80

Accrual c/f 30

130 130

c) Tax paid (working 3):

The exact principle, as used for interest paid, can be used for this calculation as well.

Dr Tax paid Cr

$’000 $’000

Liability b/f 180

Cash PAID (β) 120 Tax payable 200

Liability c/f 260

380 380

42
NOTE:

Tax charge = Cash paid – Liability b/f + Liability c/f

Tax paid = Tax charge + Liability b/f – Liability c/f

After completing these three workings, we have now completed the first section of the
statement of cash flows and can calculate the net cash flow from operating activities:

$’000 $’000

Cash flows from operating activities

Cash generated from operations (W1) 399

Interest paid (W2) (100)

Tax paid (W3) (120)

Net cash from operating activities 179

2. Cash flows from investing activities:

Now that we are done with cash flows from operating activities, we are now going to move on
to the second section of the statement of cash flows, which is, cash generated from investing
activities. This section comprises of further three sections:

a) Proceeds from sale of non-current assets (working 4):

In order to find the proceeds we need to rearrange the formula that we would normally use to
calculate the profit on disposal:

Profit = Proceeds – Carrying value

Proceeds = Profit + Carrying value

Carrying value = Historic cost – Accumulated depreciation = $56,000 – $32,000 = $24,000

Proceeds = Profit + Carrying value = $21,000 + $24,000 = $45,000

43
 b) Purchase of non-current assets (working 5):

Here, we need to think about how much money has been a spent buying non-current asset:

$'000

Cost b/f 1,600

Disposal at cost (56)

Revaluation 100

Purchase (β) 356

Cost c/f 2,000

c) Interest and dividends received (working 6):

As there are no interest receivable figures on the statement of financial position we can assume
that the interest income showing on the statement of profit or loss is the actual amount
received and we can, therefore, post this directly to the statement of cash flows with no
calculation.

As for the dividends, we can see that there is a dividends receivable figure for both 20X5 and
for 20X6 so we need to adjust the accrued figure showing on the statement of profit or loss for
these:

Dr Dividends receivable Cr

$’000 $’000

Receivable b/f 25

Dividends receivable (SPL) 25 Cash RECEIVED (β) 15

Receivable c/f 35

50 50

We can now feed this into the statement of cash flows and calculate the net cash outflow from
investing activities:

44
 $’000 $’000

Cash flows from investing activities

Proceeds from sale of NCA (W4) 45

Purchase of NCA (W5) (356)

Interest received (as per SPL) 20

Dividends received (W6) 15

Net cash from investing activities (279)

3. Cash flows from investing activities:

We are now going to find the figures for the final section of the statement of cash flows, the
figures relating to cash flows from our financing activities. This section is again segregated into
three further sections:

a) Proceeds from share issue (working 7):

We have already established that both the share capital and the share premium accounts
increased from 20X5 to 20X6 so we need to combine these figures to find the total amount of
cash we have raised through this share issue:

Share capital Share premium

Total cash inflow
$’000 $’000

C/f 350 260

B/f (300) (230)

Change 50 30 80

45
 b) Loans:

We can see that there was a loan value of $200,000 at the end of 20X5 and the loan value is
now $250,000, so we have clearly raised more debt finance and we have received a further
$50,000 as a result.

c) Dividends paid (working 8):

This figure can be found by looking at the increase in retained earnings from 20X5 to 20X6
together with the profit generated for the year:

$'000

Opening retained earnings 185

Profit for the year 95

Dividends PAID (β) (41)

Closing retained earnings 239

If we feed these workings into the statement of cash flows we can see that the total net cash
generated from financing activities is $89,000:

$’000 $’000

Cash flows from financing activities

Proceeds of share issue (W7) 80

Proceeds from loan issue (250 – 200) 50

Dividends paid (W8) (41)

Net cash from financing activities 89

46
Statement of cash flows:

All we need to do now is add up the figures from the three sections of the statement of cash
flows to give us the net decrease in cash over the year (this is $8,000):

Abracadabra Ltd. Statement of Cash Flow for the year ended 31st May 20X6

$’000 $’000

Cash flows from operating activities

Cash generated from operations (W1) 399

Interest paid (W2) (100)

Tax paid (W3) (120)

Net cash from operating activities 179

Cash flows from investing activities

Proceeds from sale of NCA (W4) 45

Purchase of NCA (W5) (356)

Interest received (as per SPL) 20

Dividends received (W6) 15

Net cash from investing activities (279)

Cash flows from financing activities

Proceeds of share issue (W7) 80

Proceeds from loan issue (250 – 200) 50

Dividends paid (W8) (41)

Net cash from financing activities 89

Net decrease in cash and cash equivalents (8)

Cash at beginning of period 20

Cash at end of period 12

47
Incomplete Records
Methods of finding missing figures:

1. Accounting equations;

2. Ledgers;

3. Bank/cash summaries;

4. Accruals and prepayments;

5. Markup and margin.

1. Accounting equation:

Basic principle: Assets = Liabilities + Equity (Capital)

Note: Capital and equity mean the same thing, however capital relates to a sole trader and
equity relates to a company.

Detailed version: Closing share capital + Retained earnings + Other reserves + Liabilities

Equity

Notes:

Retained earnings = Net profit – Dividends

Dividends = Dividends paid + Dividends due to be paid

Application:

Finding net profit:

1. Find retained earnings as a balancing figure rearranging the accounting equation;

2. Find net profit using retained earnings from para 1 and dividends.

Finding share capital introduced:

48
 1. Find closing share capital as a balancing figure rearranging the accounting equation;

2. Find opening share capital from the last year SFP;

3. Find share capital introduced by deducting opening from closing share capital.

2. Ledgers:

Finding credit sales using receivables ledger control account (or any other figure
rearranging the data in control account):

DR Receivables ledger control account CR

Narrative $ Narrative $

Bank
SFP  Balance b/f X Cash received X 
ledger

Discount
allowed
Credit sales β Discount allowed X 
ledger
or SPL

Bank
 Refund X Contra X  PLCA
ledger

Balance c/f X  SFP

X X

Notes:

Total sales = Credit sales (β) + Cash sales (from bank ledger)

Any numbers not provided assumed to be zero

Finding payments to suppliers using payables ledger control account (or any other figure
rearranging the data in control account):

49
 DR Payables ledger control account CR

Narrative $ Narrative $

Discount
received
 Discounts received X Balance b/f X  SFP
ledger
or SPL

Payments to Purchases
β Credit purchases X 
suppliers day book

Bank
RLCA  Contra X Refunds X 
ledger

SFP  Balance c/f X

X X

Notes:

Total purchases = Credit purchases + Cash purchases (from bank ledger)

Any numbers not provided assumed to be zero

50
What figures can be found from ledgers?

 Credit sales

Receivables ledger control  Discounts allowed

account  Money received from credit customers

 Refunds

 Credit purchases

Payables ledger control  Discounts received

account  Money paid to credit suppliers

 Refunds

 Cash sales
Cash ledger
 Theft from the till

 Drawings

 Dividends paid
Bank ledger
 Theft of money

 Expenses paid

3. Bank/Cash summaries:

 Reconstruct inflows and outflows from cash book and/or bank statement;

 Use bank reconciliation to support records;

 Use alongside ledgers.

51
4. Accruals and prepayments:

Methods of finding missing expense/income figures using accruals and prepayments:

 Ledgers:

Dr Expense Cr

$ $

Paid during the year X Accrual b/f X

Accrual c/f X Expense for the year β

X X

 Formula:

Expense = Amount paid in year – Accrual b/f + Accrual c/f

OR

Expense = Amount paid in year + Prepayment b/f – Prepayment c/f

5. Margin and markup:

Methods of finding missing sales and cost of sales or gross profit figures:

 Markup – based on cost of sales:

a. Gross profit = CoS x %

b. Sales = CoS + %

c. Gross profit = Sales – CoS

 Margin – based on sales:

a. Gross profit = Sales x %

b. CoS = Sales – %

52
 c. Gross profit = Sales – CoS

Calculating purchases:

Purchases = CoS + Closing inventory – Opening inventory

Calculating inventory:

Closing inventory = Opening inventory + Purchases – CoS

53