01.financial Statement Analysis

AFU 07309: FINANCIAL
STATEMENTS ANALYSIS
TOPIC : DEMAND AND SUPPLY OF FINANCIAL
INFORMATION
PREPARED BY @ MR.ABDALLAH S. MTANGANAKI

{*Msc.BF, *CPA-T, Bch.BF}
LEARNING OUTCOME
❑ Explain the purpose of financial statements.

❑ Evaluate the quality of financial statements using
different models.
❑ Identify users of accounting information and the kind of
information they need.
❑ Analyze the reporting behavior of the firm.
mtanganakiabdallah@gmail.com 11/12/2023 2
FINANCIAL STATEMENTS;
➢ are the basic and formal annual reports through which the corporate
management communicates financial information to its owners and various
other external parties which include investors, tax authorities, government,
employees, etc.
➢ Financial Statements refer to the balance sheet (position statement) as at the

end of accounting period, the statement of profit or loss and other
comprehensive income, the cash flow statement and the statement of change in
owners equity.
➢ .
Other names
OBJECTIVE OF FINANCIAL STATEMENTS
 Financial statements are the basic sources of information to the shareholders and other external parties
for understanding the profitability and financial position of any business concern. They provide
information about the results of the business concern during a specified period of time in terms of assets
and liabilities, which provide the basis for taking decisions.
 The objective of financial statements is to provide financial information about the reporting entity that
is useful to existing and potential investors, lenders and other creditors in making decisions about
providing resources to the entity.
 These users need information about The economic resources of the entity, the claims against the entity ,
and Changes in the entity’s economic resources and claims
 Thus, the primary objective of financial statements is to provide financial information that assist
the users in their decision-making
Importance of financial statements
1.To provide information about economic resources and obligations of a

business:
they are prepared to provide adequate, reliable and periodical information about
economic resources and obligations of a firm to investors and other external
parties who have limited authority, ability or resources to obtain information.
2.To provide information about the earning capacity of the business:
They are to provide useful financial information which can gainfully be utilized to
predict, compare and evaluate the business firm’s earning capacity.
3.To provide information about cash flows:
They are to provide information useful to investors and creditors for predicting,
comparing and evaluating, potential cash flows in terms of amount, timing and
related uncertainties.
4.To judge effectiveness of management:
They supply information useful for judging management’s ability to utilize the
resources of a business effectively.
5. Information about activities of business affecting the society:
They have to report the activities of the business organization affecting the society,
which can be determined and measured which are important in its social
environment.
QUALITATIVE CHARACTERISTICS OF USEFUL
FINANCIAL INFORMATION
➢ Qualitative characteristics are attributes that make financial information useful to
users.
➢ The characteristics are classified into;-
1. fundamental characteristics.
2. enhancing qualitative characteristics.
➢ Conceptual framework for financial reporting distinguishes between fundamental

and enhancing qualitative characteristics for analysis purposes. Fundamental
qualitative characteristics distinguish useful financial reporting information from
information that is not useful or misleading. Enhancing qualitative characteristics
distinguish more useful information from less useful information.
➢ The two fundamental qualitative characteristics are:
• Relevance: Relevant information has predictive value or confirmatory value,

or both, It is capable of making a difference in the decisions made by users.
The relevance of information is affected by its nature and its materiality.
• Faithful representation: Information must be complete, neutral and free from

error (replacing 'reliability').
➢ Financial reports represent economic phenomena in words and numbers. To be

useful, financial information must not only represent relevant phenomena but
must faithfully represent the phenomena that it purports to represent.
A complete, depiction includes all information necessary for a user to understand the
phenomenon being depicted, including all necessary descriptions and explanations.
A neutral ,depiction is without bias in the selection or presentation of financial information. This
means that information must not be manipulated in any way in order to influence the decisions of
users.
Free from error, means there are no errors or omissions in the description of the phenomenon and
no errors made in the process by which the financial information was produced. It does not mean
that no inaccuracies can arise, particularly where estimates have to be made.
Materiality, Information is material if omitting it or misstating it could influence decisions that

users make on the basis of financial information about a specific reporting entity. (Conceptual
Framework)
➢ The Enhancing Qualitative Characteristics are;-
• Comparability
– Information about a reporting entity is more useful if it can be compared with similar
information about other entities and with similar information about the same entity for
another period or another date.
– Consistency, although related to comparability, is not the same. Consistency refers to

use of the same methods for the same items, either from period to period within a
reporting entity or in a single period across entities.
– Comparability is the goal; consistency helps to achieve that goal.
➢ The Enhancing Qualitative Characteristics are;-
• Understandability
– Financial reports are prepared for users who have a reasonable knowledge of business and economic
activities and who review and analyze the information diligently.
– Classifying, characterizing and presenting information clearly and concisely make it understandable.
• Verifiability
– knowledgeable and independent observers could reach consensus, but not necessarily complete
agreement, that a depiction is a faithful representation .
• Timeliness
– having information available to decision makers in time to be capable of influencing their decisions.
TEST YOUR BRAIN!
➢ NO.1
Maxi Nzengeli plc has recorded the value of a property at Tshs100 million until
last year. This year the company revalued the property and recorded it at Tshs150
million. Another effect of the increase in value was given by adding Tshs50
million to the reserves account. This adjustment was not disclosed anywhere in the
financial statements.
Do the statements satisfy the understandability criterion?
TEST YOUR BRAIN!
➢ No, the financial statements do not satisfy the understandability criterion. The
value of the property has increased by a material amount. So, the users of the
statements will not have a clear understanding as to what led to the increase in
the value of the property.
NOTE!
MATERIALITY : Information is material if omitting it or misstating it could
influence decisions that users make on the basis of financial information about a
specific reporting entity. (Conceptual Framework)
➢ Materiality means relative importance, Material items are important items that the
users of the financial statements must know.
➢ Materiality requires that only those items which have a bearing on the
determination of financial position and computation of profit and loss during the
accounting period should be recorded and disclosed in the financial statements
TEST YOUR BRAIN!
➢ NO.2
5 January 20X3, Wakishua ltd filed a lawsuit on Papatu ltd due to damages for
breach of contract. The claim was for Tshs500 million. Wakishua ltd prepares its
financial statements on 31 December every year. The lawsuit with Papatu ltd is
still pending on 31 December 20X3.
Should Wakishua ltd include this claim amount in the financial statements?
TEST YOUR BRAIN!
➢ No, Wakishua ltd should not include this claim in its financial statements
because it would not be reliable, as it is unknown at the time of preparation of
the financial statements, whether Papatu ltd will be found to be liable or not.
However, disclosure in the notes is desirable though not necessary..
BASIS OF ACCOUNTING
➢ 1. ACCRUAL BASIS
• According to IAS 1 Preparation and Presentation of Financial Statements, an entity shall

prepare its financial statements, except for cash flow information, using the accrual basis of
accounting. It means that when the financial statements are prepared, the transactions and
events are recognized as and when they are earned or incurred (and not as and when money is
received or paid) and recorded in the financial statements of the periods to which they relate.
• IAS 1 further specifies that under accrual basis, the elements of financial statements i.e.
assets, liabilities, equity, income and expenses are recognized when they satisfy the definition
and recognition criteria for those elements in the framework.
• Accrual basis accounting matches revenues to the time period in which they are earned and
matches expenses to the time period in which they are incurred. While it is more complex
than cash basis accounting, it provides much more information about the business.
BASIS OF ACCOUNTING
➢ Example on Accrual Basis :
Njaa kali ltd company purchased goods on 5 December 20X2 but paid the supplier on 8
February 20X3. Here, Njaa kali ltd company became the owner of the goods on 5 December
20X2 even though the payment was made later. Hence the purchase transaction should be
recorded on 5 December 20X2
BASIS OF ACCOUNTING
➢ ACCRUAL BASIS : RECOGNITION CRITERIA
BASIS OF ACCOUNTING
➢ 2. CASH BASIS
• The cash basis of accounting is not permitted by IFRSs / IASs. Only the cash flow statements
are prepared using the measurement base of cash. Smaller companies that haven't formally
incorporated and most sole proprietors use cash-basis accounting because the system is easier
for them to use on their own, meaning they don't have to hire a large accounting staff.
• Under cash basis of accounting, expenses are recorded when expenses are actually paid and
revenue is recorded when cash is actually received. The primary focus is on the amount of
cash in the bank, and the secondary focus is on making sure all bills are paid. Little effort is
made to match revenues to the time period in which they are earned, or to match expenses to
the time period in which they are incurred.
• The cash basis may be used, however, for small unincorporated entities, for example clubs
and societies.
TEST YOUR BRAIN!
➢ QUESTION : PAWAMABULA LTD CO. buys 100 tables for Tshs50,000 each in the month
of April 20X2. The purchase is made for cash. During April, 30 tables are sold for cash at
Tshs70,000 each. Calculate profit or loss.
a) Using Accrual basis
b) Using Cash basis
TEST YOUR BRAIN!
SOLUTION 01
•BY USING CASH BASIS
Details Tsh Tsh2

Revenue ( 30 x Tsh 70,000) 2,100,000
less: Cost of sales:
( 100 x Tsh50,000) -5,000,000
LOSS -2,900,000
•BY USING ACCRUAL BASIS
Details Tsh Tsh2

Revenue (30 x Tsh 70,000) 2,100,000
Less: Cost of sales
Purchases (100 x Tsh 50,000) 5,000,000
less: Closing stock (70 x Tsh 50,000) -3,500,000 -1,500,000
PROFIT 600000
MORE EXAMPLE ON ACCRUAL VS CASH!
➢ Toms Ltd made sales worth Tshs2 million in the month of July 20X2 on credit basis.
Half of the price is paid upfront by the customer (i.e. Tshs1 million) and the rest is
promised to be paid in October. Let us understand the reporting of this transaction under
accrual basis and cash basis:
➢ Accrual basis : this basis, sales revenue of Tshs2 million will be recorded and Tshs1
million will be reported as receivable from the customer.
➢ Cash basis : Under this basis, sales revenue of Tshs1 million will be recorded as only
Tshs1 million was received from the customer in cash. No receivables will arise, as under
cash basis, the accounting entry is recorded only when cash flow occurs. The remaining
sales of Tshs1 million will be recorded in October when the customer pays.
BASIS OF ACCOUNTING
➢ 3.GOING CONCERN BASIS
• Under going concern, it is assumed that the entity will continue to operate for the foreseeable
future and it has neither the intention nor the necessity of liquidation or of curtailing the scale
of the operations materially. While preparing the financial statements, management should
make an assessment of the company‘s going concern status.
• If the management assesses that the going concern status of the company will not be
maintained during the foreseeable future, then the financial statements would be prepared on a
different basis (named as the break up basis).
• The going concern concept assumes that an entity;- (i) will continue its operations for at least
the next 12 months, (ii) does not have any intention or need to close down its operations ,(iii)
does not have any intention or need to curtail materially, the scale of its operations
BASIS OF ACCOUNTING
➢ 4. BREAK-UP BASIS
• Break-up basis A generally acceptable alternative authoritative basis other than the going
basis is the break-up basis or the liquidation basis‖. In certain situations when going concern
assumption is no longer valid, financial statements may have to be re-drafted on a break-up
basis.
• Under the break-up or the liquidation basis, all assets are stated at the lower of carrying value
and their estimated realizable amounts and provision is made for any further estimated
liabilities. All assets and liabilities are classified as current.
• Break-up basis of accounting is adopted when a company has either the necessity or the
intention to enter into a scheme of arrangement with its payables; or be placed into
administrative receivership or liquidation.
CONSISTENCY CONCEPT
➢ Consistency means the financial statements should be prepared in the same manner
period after period. (According to IAS 1 Presentation of Financial Statements)
➢ According to this concept, the policy once adopted in one accounting period should be
consistently followed in the subsequent accounting periods.
➢ Example, Until 2012 NDOIGE Plc followed the reducing balance method (RBM) for
charging depreciation on assets. However, in 2013 the company calculated depreciation
according to the straight line method (SLM). Here ICC Plc has not followed the
principle of consistency.
BUSINESS ENTITY CONCEPT
USERS OF FINANCIAL STATEMENT
➢ Owners / shareholders and potential investors
➢ Management
➢ Providers of finance e.g. banks or other financial institutions
➢ Suppliers and customers
➢ Employees
➢ Government
➢ Financial analysts, stock brokers, financial journalists
➢ Tax authorities
OWNERS / SHAREHOLDERS AND POTENTIAL
INVESTORS
➢ The primary users of an organization's financial statements are its owners / shareholders. This is because
owners / shareholders have provided the capital that makes it possible for an organization to begin its
operations. Naturally they want as much information and detail as possible in order to determine if their
investment is not only safe but also growing. As a general rule of thumb, if the owners are satisfied with
the contents of an organization's financial statements, then other groups also feel comfortable.
➢ The information that owners / shareholders are interested in include, how their capital has been utilized,
the number and type of assets the organization owns, the level of debt the organization has taken on, how
profitable the operations of the organization are, and whether the financial condition and performance of
the organization is improving or deteriorating over time
➢ Potential investors would also be interested in the above information as this information would help
them decide if they could become the new owners / shareholders of the business. In addition, they will
use the financial statements to assess whether the organization represents a viable investment option.
MANAGEMENT
➢ Management will use the financial statements of the organization as a kind of “report
card” of their decisions / activities throughout the year. This is because the financial
statements reflect how profitable (or unprofitable) these decisions or activities have been
for the organization.
PROVIDERS OF FINANCE
➢ Payables such as banks and other financial institutions typically provide the funding an organization
needs to carry on its operations and / or expand its business. As a result, they need to ascertain
whether the organization has the ability to repay its debts. As a result, they turn to the organization's
financial statements to determine the general trends followed by the organization in terms of sales,
profits, past scale of operations and cash flows.
➢ The specific information they seek from the organization's financial statements include
i. how profitable the organization has been
ii. whether the company will continue to operate in the coming years, or is it likely that it will go out
of business
iii. whether the operations of the organization have generated sufficient cash flow to satisfy their debt
repayments, going forward
iv. the value of the assets the organization may have pledged as security / collateral
SUPPLIERS AND CUSTOMERS
➢ Trade relations are the relations between the suppliers and customers of an
organization ,they will use these statements to determine the financial condition and
performance of the business in order to find out whether the organization will be able
to pay for the goods / services it orders from them.
➢ Customers are typically less interested in the financial statements of an organization

they deal with. This is because normally their relationship with the organization ends
once the sale of goods / services has been made. However customers who have an on-
going relationship with an organization will be interested in the financial statements to
determine if the organization will continue to operate for the coming years.
➢ EMPLOYEES
Employees of an organization are interested in the financial condition and performance of

an organization because that is the source of their salaries. In addition, organizations that
are performing poorly or are in a weak financial position are unlikely to offer much scope
for promotions, career development etc. Employees can figure out their career prospects
from the financial statements.
➢ GOVERNMENT
Financial statements of organizations serve as a source of data for the government when it
is compiling national economic statistics such as the country’s GDP (Gross Domestic
Product). This helps the government in taking different policy decisions.
➢ FINANCIAL ANALYSTS, STOCK BROKERS, FINANCIAL JOURNALISTS
This group of users study the financial statements of organizations to determine their
financial condition and performance. They also use these statements as a basis from
which they make predictions regarding the future financial condition and performance of
the organization. Depending upon their predictions, they then advise their clients
(potential investors) on whether to invest in a particular organization or not.
➢ TAX AUTHORITIES
Tax authorities use the financial statements to determine tax amounts. Income shown by
the statement of profit or loss is used as the starting point for calculating taxable income.
Revenue and purchase figures are used to determine VAT liability
REPORTING BEHAVIOUR OF THE FIRM
➢
THE END

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AFU 07309: FINANCIAL

PREPARED BY @ MR.ABDALLAH S. MTANGANAKI

❑ Explain the purpose of financial statements.

➢ Financial Statements refer to the balance sheet (position statement) as at the

1.To provide information about economic resources and obligations of a

2.To provide information about the earning capacity of the business:

3.To provide information about cash flows:

4.To judge effectiveness of management:

➢ The characteristics are classified into;-

2. enhancing qualitative characteristics.

➢ Conceptual framework for financial reporting distinguishes between fundamental

• Relevance: Relevant information has predictive value or confirmatory value,

• Faithful representation: Information must be complete, neutral and free from

➢ Financial reports represent economic phenomena in words and numbers. To be

Materiality, Information is material if omitting it or misstating it could influence decisions that

– Consistency, although related to comparability, is not the same. Consistency refers to

– Comparability is the goal; consistency helps to achieve that goal.

Do the statements satisfy the understandability criterion?

However, disclosure in the notes is desirable though not necessary..

• According to IAS 1 Preparation and Presentation of Financial Statements, an entity shall

a) Using Accrual basis

b) Using Cash basis

Details Tsh Tsh2

Details Tsh Tsh2

➢ Providers of finance e.g. banks or other financial institutions

➢ Suppliers and customers

➢ Financial analysts, stock brokers, financial journalists

i. how profitable the organization has been

➢ Customers are typically less interested in the financial statements of an organization

Employees of an organization are interested in the financial condition and performance of

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