International Accounting

(IFRS)
Chapter 3
Preparation and Regulation of
Financial Statements
(Published Accounts)

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | Eupener Str. 70 | 52066 AACHEN | [Link]
Have you ever wondered:

 What information is available in the Annual Report?

 Which parts of it are regulated and which are not?
 How published accounts for listed companies are
supposed to be presented?
 Why different Financial Statement formats exist and
whether there is any regulation dictating this?

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 2
Learning Objectives:

 Know and be able to apply the formats for published

accounts
 Understand and be able to prepare the related
workings for published accounts formats
 Discuss the adequacy of the disclosure
requirements

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 3
 The Annual Report

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 4

How is financial accounting information
communicated?
 Via the ANNUAL REPORT (also known as ‘the accounts’
or ‘the financial statements’).
 The Annual report actually contains more than the
financial statements
 Plus INTERIM information – semi-annual reports are
now fairly standard.
 Some companies produce quarterly reports and other
management updates which include financial
information.

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 5
Main users of financial information relating to a
business

Owners Customers Competitors

Employees
Managers and their
representatives

Business

Lenders Government

Investment Community
Suppliers
analysts representatives

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 6

The Annual Report

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 The annual report is the means by
which the directors are accountable
for their stewardship of the assets and
their handling of the company’s affairs
for the past year.

 It consists of:
 Narrative material (some of
which is regulated)
 Audited financial data

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 7

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 8
The Annual Report – Narrative material

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Narrative reporting
• At a glance (highlights)
• Chairman’s statement, Chief Executive’s review, strategy
and board overview
• Directors’ report (business review) (split into sections)*
• Remuneration report*
• Corporate Governance Report *
• Auditors’ report*
• Statement of directors’ responsibilities*

* Content regulated
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 9 9
Narrative material: in more detail

 Format will vary from company to company, usually with

statements from Chairman, CEO, possibly FD
 Will contain a business review, which will incorporate
an operating review, a corporate responsibility review
and a financial review
 Purpose is to:
 explain what has been achieved in the current year;
and
 assist existing and potential investors to make their
own predictions of cash flows of future years

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 10
Narrative material: forward-looking
statements

 Will incorporate aspects relating to the future:

 Prognosis e.g.
 directors expect sales to increase in the current
financial year, with even stronger growth in
earnings, provided no unforeseen events occur;
 Corporate strategy e.g.
 how to deal with any low profitability segments,
possible divestments or acquisitions.

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 11
Narrative material: Directors’ Report

Required items in this

section:  Statement about
 Principal activities employee involvement

 Business review  Number of employees

with disabilities
 Future developments
 Donations to charities
 R&D activities /political parties
 Post balance sheet events  Purchase of own shares
 Value of land and buildings  Information about
directors
 Policy on creditor
payment
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 12
Annual Report – Audited
Financial Statements

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | Eupener Str. 70 | 52066 AACHEN | [Link]
The Annual Report:
Criteria for information in Published Accounts

 Format complies with IAS 1 and statute

 Financial statements should present a fair view of profits and
assets and liabilities
 Accounting policies comply with IFRSs/statute
 IAS 1 requires compliance with fundamental accounting
principles:
 Accruals, materiality and aggregation, going concern,
consistency
 IAS 1 requires companies to disclose the accounting
policies adopted in determining the amounts shown in the
financial statements and to apply them consistently

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 14
The Financial Statements

According to IAS 1, a complete set of financial

statements comprises:
1. A statement of Financial Position (SoFP)
2. A statement of Comprehensive Income (SoCI)
3. A statement of Changes in Equity (SoCE)
4. A statement of Cash Flows (SoCF)
5. Notes

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IAS 1 – Presentation of Financial Statements

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The prescribed formats:
1. The Statement of Financial Position
The minimum information that must be presented on
the face of the BALANCE SHEET:
 Property, plant & equipment Trade and other payables

 Investment property Provisions

 Intangible assets Financial liabilities

 Financial assets Liabilities and assets for current

tax
 Investments accounted for using
Deferred tax liabilities and
the equity method
assets

Non controlling interests (within

 Inventories
equity)
 Trade and other receivables Issued share capital and
 Cash & cash equivalents reserves attributable to equity
holders of the parent 17
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 17
The prescribed formats:
1. The Statement of Financial Position (cont’d)

 IAS 1 does NOT prescribe the order and presentation of

the balance sheet!
 For example:
 Total Assets = Total equity & liabilities
 Assets – Liabilities = Net Assets = Equity
 Not a strict requirement, but suggested if relevant:
 Splitting assets & liabilities into current & non-
current
 Present assets & liabilities broadly in order of
liquidity

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 18
2. Statement of Comprehensive Income (SoCI)

 IAS 1 gives the requirements for the way in which

performance (and last year’s comparatives) are reported.
 Purpose: to present all income and expense recognised
in the period.

 Choice of presentations:
 Single Statement OR
 a Double Statement that essentially splits the required
information into:
(1) profit and loss (i.e. an I/S) and
(2) a statement that starts with profit or loss and then adds
other comprehensive income.
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 19
What is meant by comprehensive income?

 Comprehensive Income
 recognises the gains and losses (both realised
and unrealised)
 that have increased or decreased the owners’
equity in the business.
 Such gains and losses arise, e.g. from
 the revaluation of non-current assets and from
other items (e.g. Financial Instruments, Employee
benefits).
 These are referred to as Other Comprehensive
Income.
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 20
The prescribed formats:
2. Statement of Comprehensive Income

Minimum information in the statement of comprehensive

income:
 Revenue
 Other comprehensive
 Finance costs income (OCI)
 Share of profit or loss of  Share of OCI from
associates/joint ventures associates and joint
 Tax expense ventures
 Post tax profit or loss  Total comprehensive
arising from discontinued income (split as profit or
operations/revaluation to loss)
fair value of relevant assets
 Profit or loss (split non-
controlling interests and
owners of parent)
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 21
The prescribed formats:
2. Statement of Comprehensive Income

 IAS 1 allows a choice of two formats for detailing

income and expenditure:
 Format 1: Vertical with costs analysed according to
function, e.g. Cost of sales, distribution costs and
administrative expenses
 Format 2: Vertical with costs analysed according to
nature, e.g. raw materials, employee benefits
expenses, operating expenses and depreciation
 We will be studying Format 1 only.
 The principle is to require sufficient detail for users
without listing large numbers of separate expenses
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 22
SoCI Format 1: costs analysed by function

 In order to arrive at its Operating Profit, a company

needs to classify all of its operating expenses into 1 of 4
categories:
 Cost of Sales
 Distribution and Selling Costs
 Administrative expenses
 Other operating expenses (or income)
 Finance Costs

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 23
COST OF SALES includes:

Direct costs: direct materials purchased; direct labour;

subcontracting costs.
Overheads: variable and fixed production overheads
Depreciation and amortisation:
 depreciation of non-current assets used in production
 depreciation of own work that has been capitalised
 impairment expense
Exceptional amounts written off inventory

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 24
Why “Cost of Sales” may not be comparable

Between companies or between the same company

over different years

Potential for different treatment of:

 Choice of depreciation method & estimates
 Methods
 Carrying values
 How inventory is valued
 FIFO/ LIFO / Weighted Average
 Management attitude to estimates
 Capability of system to produce information
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 25
The 3 other categories of operating
expenses
Distribution & Selling costs Administration expenses
 Warehousing  Administrative staff
 Promotion salaries
 Selling  Premises

 Transport  Professional fees e.g.

audit
 Trade receivable write-
downs

Other operating expense (income)

 Payments for licences

 Income from 3rd party use of PPE not used currently in

production
 Income from employees (e.g. canteen)
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 26
Activity: Classify the operating expense

1. Head office salaries

2. Salaries of staff involved in the
production
3. Warehouse insurance
4. Advertising costs
5. Accounting fees
6. Bad debts
7. Subcontracting costs related to
production

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 27
3. Statement of Changes in Equity (SoCE)

The Statement of Changes in Equity will show the

following items on the face of the statement:
 Comprehensive income
 for each component of equity, the effect of changes
in accounting policies and corrections of errors
recognised (IAS 8)
 Capital transactions with the owners (e.g.
dividends, share buybacks, increases from bonus,
rights or new cash issues)
 for each component of equity, a reconciliation
between the carrying amount at the beginning and
end of the period
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 28
 Example – Statement of Changes in Equity
Sainsbury’s Annual Report 2013

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 29
4. Statement of Cash Flows (SoCF)

IAS 7 requires
 “the provision of information about the historical changes
in cash and cash equivalents by means of a cash flow
statement which classifies cash flow during the period
from operating, investing and financing activities”
 Cash - Cash in hand and money available on demand –
bank deposits
 Cash equivalents – short term highly liquid investments
readily convertible to known amounts of cash and
subject to an insignificant risk of changes in value

Covered during Financial Accounting module!

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 30
5. Notes to the Financial Statements

The notes section contains notes:

 Setting out Accounting policies
 Giving greater detail of the make up of B/S items
 E.g. Inventory, non-current asset make-up
 Giving additional information to assist the prediction of
future cash flows
 E.g. Capital commitments, future commitments,
contingent liabilities

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 31
5. Notes to the Financial Statements (cont’d)

 Related party transactions

 E.g Direct or indirect (through an intermediary) control
 IAS 24 requirements – disclosure of the relationship and of
the nature of any transactions
 Other information of interest to other stakeholders
 E.g Staff costs and numbers

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 32
 Preparation of Published
Accounts

Practical session involving

a worked example
(Valencia handout)

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | Eupener Str. 70 | 52066 AACHEN | [Link]
Preparation of published accounts

 We will use the question Valencia to illustrate the

preparation of a Statement of Comprehensive Income
and a Statement of Financial Position as required by
IAS 1.

 The aim is that you should be able to:

 prepare a set of accounts that conform to the
prescribed formats; and
 understand how a company arrives at the figures
that appear in the published financial statements.

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 34
Step-wise Approach

We will follow a progressive step-wise approach to the

preparation of published accounts:

 Step 1: Internal Income Statement from the trial

balance data
 Step 2: Statement of Comprehensive Income (with
costs analysed by function – Format 1).
 Step 3 (if required): Statement of changes in Equity
 Step 4: Statement of Financial Position

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 35
Step1: Internal Income Statement
from Trial Balance

€ €
Sales 345,000
Less: Op. inventory 43,125
Purchases 258,750
Cl. Inventory (25,875)
Cost of Sales (276,000)
Gross Profit 69,000

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 36
Less Expenses

€000
Salaries (18055+5175) 23,230
Motor expenses 9,200
Depreciation (see next slide) 5,175
Insurance 3,450
Post /phone 1,840
Audit Fees 1,150
Director’s remuneration 1,150
Light and power 920
Repairs (2760 – 2300) 460
Hire charges 300
Miscellaneous (sundries) 275
Total 47,150

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 37
Depreciation Charge for the Year

Buildings 2% Straight Line

2% x 57500 = 1,150
Equipment 10% Reducing balance
10% * (14950 – 3450) = 1,150
Vehicles 25% Reducing balance
25%* (20700 – 9200) = 2,875

Total depreciation = 5,175

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 38
 Profit

€
Gross Profit 69,000
Less Expenses (47,150)
Operating profit 21,850
Finance costs (1150+ 6325) (7,475)
Profit Before Tax 14,375
Tax (5,750)
Profit for the year 8,625
Dividends (1,725)
Profit transferred to reserves 6,900

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 39
 Step 2: Statement of Comprehensive Income
(according to function)
 The previous slides show what you are familiar with – the
income statement in an internal format
 Now we need to redraft into one of the prescribed
legal formats from IAS 1

We need to:
 Reallocate cost of sales and expenses according to
Function (choice of function or nature - we are just
looking at function)
 Disclose further specific information in notes to the
accounts

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 40
Expenses allocation

 Expenses are allocated to:

 Cost of sales
 Distribution costs
 Administration expenses
 Some expenses may have to be apportioned to
more than one classification

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 41
Expenses allocation

 The company will have to make some decisions and

assumptions to make the allocation. These vary
between companies:
 For example, floor space is frequently used to
apportion certain expenses such as rent, or
depreciation of buildings
 ALWAYS SHOW YOUR WORKINGS!!!!

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 42
W1- Salaries and Wages Allocation

Total before Costs of Distribution Administration

reallocation sales Costs costs
€000 €000 €000 €000

Factory staff 11,500 11,500

Inspectors 575 575
Warehouse
staff 4,600 4,600
Accounts
dep’t 575 575
Drivers 3,680 3,680
Salespersons'
salaries 2,300 2,300
23,230 12,075 10,580 575
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 43
W2- Allocation of Depreciation

Total before Costs of Distribution Administration

reallocation sales Costs costs
€000 €000 €000 €000
Freehold
buildings 1,150 575 287.5 287.5

Equipment 1,150 575 287.5 287.5

Motor vehicles 2,875 2,875

5,175 1,150 3,450 575

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 44
W3- Expenses allocated on basis of space
occupied

Total Cost of Sales Distrib’n Admin

€000 €000 €000 €000

Insurance 3,450 1,725 862.5 862.5

Post etc 1,840 920 460 460
Lighting 920 460 230 230
Repairs 460 230 115 115
Hire 300 150 75 75
Misc 275 137.5 68.75 68.75

Total 7,245 3,622.5 1,811.25 1,811.25

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 45
Other expenses

Motor expenses
 Common sense indicates these are allocated to
distribution
Audit fees
 these are always allocated to admin
Directors’ remuneration
 In this case, additional information assumes that
half of time is on production and half on admin

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 46
Summary of expenses allocated

Cost of Sales Distrib’n Admin

€000 €000 €000

Cost of sales 276,000

Salaries & wages 12,075 10,580 575
Motor expenses 9,200
Depreciation 1,150 3,450 575
Allocated on
space 3,622.5 1,811.25 1,811.25
Audit fees 1,150
Directors’ pay 575 575

Total 293,422.5 25,041.25 4,686.25

© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 47

Statement of Comprehensive Income (by
function) for year ended 31 December 2011
€000
Turnover 345,000.00
Cost of sales 293,422.50
Gross profit 51,577.50
Distribution and selling costs 25,041.25
Administrative expenses 4,686.25
Operating profit 21,850.00
Finance costs 7,475.00
Profit on ordinary activities before tax 14,375.00
Tax 5,750.00
Profit for the year 8,625.00

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 48
Minimum required information on the face of
the Statement of Comprehensive Income

Turnover (sales)
Finance costs
Tax
Profit for the year
That’s it!
Note what is NOT required

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Information disclosed by way of note

Usual practice is to have a note referenced to the profit

on ordinary activities before tax.
For Valencia the note as below with additional information
regarding the loss on the inventory:
Profit on ordinary activities before tax is stated after
charging:
€000
Depreciation and amortisation 5,175
Directors’ remuneration 1,150
Audit fee 1,150
Exceptional loss on inventory 1,000
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 50
Step 3: Statement of changes in Equity
for year ended 31st December 2011

Retained
Share capital earnings Total
€000 €000 €000
Balance as at 1
January 2011 17,250 57,500 €74,750
Changes in
equity for 2011:
Dividends paid (1,725) (1,725)
Total
comprehensive
income for the
year 8,625 8,625
17,250 64,400 81,650
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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 51
Step 4: Preparation of the
Statement of Financial Position as at 31.12.11

 Prepare the note for Movement on Property, Plant and

Equipment, where cost, depreciation and net book
value must all be shown

 Do this before preparing the Statement of Financial

Position

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 52
Note X: Property, plant and equipment

Freehold Equipment Motor Vehicles

Property €000 €000 €000 Total €000
Cost 115,000 14,950 20,700 150,650
At 1.1.11
Additions
Disposals
At 31.12.11 115,000 14.950 20,700 150,650

Accum.
Depreciation
At 1.1.11 3,450 9,200 12,650
Charge for 1,150 1,150 2,875 5,175
Year
At 31.12.11 1,150 4,600 12,075 17,825

NBV 31.12.11 113,850 10,350 8,625 132,825

NBV 31.12.10 115,000 11,500 11,500 138,000 53
© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 53
Statement of Financial Position as at 31.12.11

€000 €000
Non-current assets
Property, plant and equipment Note X 132,825
Current assets
Inventory 25,875
Receivables 28,750
Cash at bank and in hand 4,600
Prepayments 2,300 61,525

Total Assets 194,350

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 54
Statement of Financial Position as at 31.12.11
(cont)
€000 €000
Equity
Share capital 17,250
Retained earnings 64,400 81,650

Non-current liabilities
10% Loan 63,250
Current liabilities
Payables 29,900
Provision for income tax 5,750
Accrued charges 5,175
Bank overdraft 8,625 49,450

Total Equity & Liabilities 194,350

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© FH AACHEN UNIVERSITY OF APPLIED SCIENCES | Prof. Dr. Duc Hung Tran | 55
Other issues

Presentation of discontinued operations

 A layered treatment is required by IFRS 5, which
requires the results of continuing and discontinued
operations to be disclosed separately.
Unusual activities
 IAS 1 requires separate disclosure of nature and amount
when items of income and expense are material
 These items may include losses on termination of
operations and profits or losses on the sale of non-
current assets

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Exercise Summary

We’ve looked at how to prepare financial accounts in a

format suitable for publication:
 First we prepared an internal income statement (this
stage can usually be omitted)
 Allocation of costs and expenses – make sure you have
understood how to do this properly
 Statement of Comprehensive Income
 Statement of Changes in Equity

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Exercise Summary (cont’d)

 Information disclosed in notes, especially on non-current

assets
 Statement of Financial Position
 Presentation for discontinued operations and unusual
activities

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Required reading

• Chapter 3, E&E textbook (18th edition)

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