Lecture 3

Elements of Financial Statements

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 Objectives
• Build on and consolidate students knowledge of
financial statements, its contents and formats

• Gain an appreciation of the amount of

estimates/subjective judgements involved in the
preparation of financial statements.

• Gain an appreciation of the needs for notes to the

accounts.

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 Introduction
• The last two lectures and seminar have sought to
introduce basic financial accounting concepts

• Before moving on the next stage, it is useful to try

and consolidate our basic understanding of financial
statements, as there is no intention to go any deeper
than this in terms of accounts preparation techniques

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 ABC Ltd.
Income Statement for the Year Ended 31 July 2013
2013 2012
£’000 £’000
R Sales revenue 1,000 800
Less: Cost of sales (700) (600) COS
Gross profit 300 200
OI Add: Other income 10 10
Less: Operating expenses (200) (150) OE
Operating profit 110 60
Less: Interest expenses (20) (30) IE
Profit before taxation 90 30
Less: Income tax expense (30) (10) ITE
Profit after taxation 60 20 4
 ABC Ltd.
Statement of Financial Position as at 31 July 2015
2015 2014
£’000 £’000
Equity Non-current assets 2,000 1,500
an *
s Liabili d
Asset ties Current assets 1,400 1,000
* Total Assets 3,400 2,500

A=L+C *
Share capital 1,500 1,500
Reserves 500 100
Relevant items of * Total Equity 2,000 1,600
* assets, liabilities and
Current liabilities 900 600
equity are to list under *
each category. Non-current liabilities 500 300
* Total Liabilities 1,400 900

Total Equity and Liabilities 3,400 2,500

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 ABC Ltd.
Statement of Financial Position as at 31 July 2013
2013 2012
£’000 £’000
Non-current assets 2,000 1,500
*
Current assets 1,400 1,000
ssets Equity *
Net A Total Assets 3,400 2,500
Current liabilities 900 600
*
Non-current liabilities 500 300
A–L=C * Total Liabilities 1,400 900

* Relevant items of
assets, liabilities and Net Assets 2,000 1,600
equity are to list Equity
under each category. Share capital 1,500 1,500
* Reserves 500 100
* Total Equity 2,000 1,600
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 Practical Exercise/Example
• There is no better way to do this than through
actually attempting a practical example.

• So, attached is a case study involving CJS

Technologies plc.

• Attempt it individually or in pairs, and then we go

through together.

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Practical Exercise/ Example (cont’d)
• Useful approach:

• Start with the Income Statement

• Then Balance Sheet (or Statement of Financial

Position);

• Notes to the Accounts

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 Income Statement
• First identify all items that can be classified as
income

• Then go on the items that can be described as

‘expenses’ or ‘overheads’

• Finally, put them together in an Income Statement

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 Income Statement
Income Items : £

• Sales 950,600

• Other income 8,400

---------------------------------
959,000

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 Expenses/overheads
• Wages & salaries 75,900
• Rent, rates & ins 10,000
• Bad & doubtful debts 5,000
• Heat & light 8,000
• Bank charges & interest 4,700
• Audit & accountancy 10,500
• Interest on bank loan (W) 6,000
• Repairs & renewals 4,400
• Postage, stat& adv 5,400
• Research and development 32,100
• Directors remuneration 110,000
• Motor expenses 24,500
• Depreciation (W) 8,550
305,050 11
 Income Statement
• Are we now in a position to put the Income Statement
together ?

• No, not quite – one big item remains – cost of goods sold!
And where do we put it?

• Cost of goods sold

• First : An important principle in accounting is the
matching principle – income in the income statement
should be matched with cost of generating that income.
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 Income Statement
• Thus, if we have sold 100 units, we should include in the
Income Statement only the cost of the 100 units.

• The number of units we have sold and the number bought

will usually be different – because of closing and opening
inventories (stocks).

• So cost of good sold is famously given by the following

formula:

• Open. stocks + Purchases – Cl. Stocks = COS

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 Cost of Sales
How to calculate
Cost of Sales?

Cost of sales Cost of inventories sold.

= Opening Inventories on hand at the beginning

inventories of a period.
+ Purchases Inventories bought during a period.

Closing Inventories on hand at the end

- inventories of a period.
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 Cost of goods sold
In CJS’s case :
• Opening inventories 0
• Add : Purchases 750,100

750,100
• Less : Closing inventories *150,000
• COST OF GOODS SOLD 600,100
(or Cost of Sales)
* As a wee aside: How would we value the stock at year end?
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 Income Statement
• We are now in a position to put the Income Statement together.

• At its simplest, it is simply :Total Income minus Total

Expenses to give a Profit or Loss.

In the case of CJS: £

• Total Income 959,000
• Total expenses (600,100 + 305,050) 905,150
• Profit before tax 53,850

This is of limited use/meaningfulness

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 Alternatively, show everything :
INCOME : £ £
Sales 950,600
Less : Cost of Sales:
Opening stock 0
Purchases 750,100
750,100
Less : Closing stock (150,000)
Cost of Sales
600,100
Gross Profit
350,500
Other Income:
Bank interest received 17
8,400
 Alternatively, show everything :
Less: Expenses/Overheads:
• Wages & salaries 75,900
• Rent, rates & ins 10,000
• Bad & doubtful debts 5,000
• Heat & light 8,000
• Bank charges & interest 4,700
• Audit & accountancy 10,500
• Interest on bank interest 6,000
• Repairs & renewals 4,400
• Postage, stationery & advertising 5,400
• Research and development 32,100
• Directors remuneration 110,000
• Motor expenses 24,500
• Depreciation 8,550
305,050
Net Profit Before Tax 53,850
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 CJS TECHNOLOGIES : Income Statement
for the year ended 31 July 2012 (Std format)
• Turnover 950,600
• Cost of Sales 600,100
• Gross Profit 350,500
• Administrative expenses (299,050)
• Other Income 8,400
• Operating Profit 59,850
• Net Interest payable (6,000)
• Profit before tax 53,850
• Taxation (6,000)
• Profit after tax for year 47,850
• Dividends (10,000)
• Retained profit for year 37,850
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 CJS Technologies: Balance Sheet as at 31 July 2010
(not common in UK)
Fixed Assets: £ Capital and Reserves: £
Tangible Assets 110,450 Share Capital 100,000
Reserves 37,850

Non-Current Liabilities :
Current Assets : Bank loan 60,000
Stocks 150,000
Trade debtors 50,700 Current Liabilities :
Other debtors 15,300 Bank overdraft 27,400
Cash in hand 10,400 Trade creditors 66,600
226,400 Other creditors 45,000

TOTALS 336,850 TOTALS 336,850

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CJS Technologies: Balance Sheet at 31 July 2010 (std
format)
Fixed Assets: Notes £ £
Tangible Assets 1 110,450
Current Assets :
Inventories 150,000
Trade receivables 50,700
Other debtors 15,300
Cash in hand 10,400
226,400
Current Liabilities 2 (139,000)
Net Current Assets 87,400
197,850
Non-Current Liabilities 3 (60,000)
137,850
Capital & Reserves:
Share capital 4 100,000
Reserves 5 37,850
137,850 21
 Workings:
1. Fixed Assets/Depreciation :
• Off Buildings - £80,000 0
• Motor Vehicles - £15,000 x 25% RB = £3,750
• Office Equip - £24,000 x 20% RB = £4,800
• Total cost/depn £ 119,000 = £8,550
NBV = 119,000 – 8,550
= 110,450

2. Interest on bank loan : 60,000 x 10% = 6,000

3. Administrative expenses :
Total expenses 305,050
Less : Interest on bank loan (6,000)
299,050 22
 Workings (cont’d)
4. Current liabilities £
• Bank overdraft 27,400
• Trade creditors 66,600
• Other creditors 10,400
• VAT payable 12,600
• Corporation tax payable 6,000
• Dividends payable 10,000
• Loan interest accrued 6,000
• TOTAL 139,000

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 Importance of Notes to the Accounts
• For this exercise, each person free to select
depreciation method and policy deemed most
appropriate.

• Also true in practice in UK. Each business /

company free to select depreciation method
and policy most appropriate to their
circumstances.

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 Notes to the accounts
• To help readers of the financial statements it is important
to include a note

• In this case, the RB Method used – with rates of 20% on

OE, and 25% on MV’s

• This however is just one example. In practice, so many

items in the financial statements require further
information.

• Hence the long list of Notes to the Accounts.

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 Next Week:
• We look at assessing financial performance
using ratios and other techniques.

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Thank You

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