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Reading

FINANCIAL STATEMENTS

Which eight of the following sixteen words would you expect to find in a short text defining the different financial statements?

Now read the text, and underline the eight words you chose above:

Companies are required by law to give their shareholders certain financial information. Most companies include three financial statements in their annual reports.

The profit and loss account shows revenue and expenditure. It gives figures for total sales or turnover (the amount of business done by the company during the year), and for costs and overheads. The first figure should be greater than the second: there should generally be a profit - an excess of income over expenditure. Part of the profit is paid to the government in taxation, part is usually distributed to shareholders as a dividend, and part is retained by the company to finance further growth, to repay debts, to allow for future losses, and so on.

The balance sheet shows the financial situation of the company on a particular date, generally the last day of its financial year. It lists the company's assets, its liabilities, and shareholders' funds. A business's assets consist of its cash investments and property (buildings, machines, and so on), and debtors - amounts of money owed by customers for goods or services purchased on credit. Liabilities consist of all the money that a company will have to pay to someone else, such as taxes, debts, interest and mortgage payments, as well as money

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owed to suppliers for purchases made on credit, which are grouped together on the balance sheet as creditors. Negative items on financial statements such as creditors, taxation, and dividends paid are usually printed in brackets thus: (5200).

The basic accounting equation, in accordance with the principle of doubleentry bookkeeping, is that Assets = Liabilities + Owners’ (or Shareholders’) Equity. This can, of course, also be written as Assets – Liabilities = Equity. An alternative term for Shareholders' Equity is Net Assets. This includes share capital (money received from the issue of shares), sometimes share premium (money realized by selling shares at above their nominal value), and the company's reserves, including the year's retained profits. A company's market capitalization – the total value of its shares at any given moment, equal to the number of shares times their market price – is generally higher than shareholders’ equity or net assets, because items such as goodwill are not recorded under net assets.

A third financial statement has several names: the source and application of funds statement, the sources and uses of funds statement, the funds flow statement, the cash flow statement, the movements of funds statement, or in the USA the statement of changes in financial position. As all these alternative names suggest, this statement shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, borrowing, the sale of assets, and the issuing of shares. Applications of funds include the purchase of fixed or financial assets, the payment of dividends and the repayment of loans, and, in a bad year, trading losses.

If a company has a majority interest in other companies, the balance sheets and profit and loss accounts of the parent company and the subsidiaries are normally combined in consolidated accounts.

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Vocabulary Practice

Word Partnerships - Account

EXERCISE 1

All the words below can be combined with account, accounts or accounting, in a two-word partnership: e.g. bank account, accounts payable or tax accounting. Add the word account, accounts or accounting to each of the

EXERCISE 2

Complete the following sentences:

1.Auditors are supposed to make sure that companies follow their stated

_____________.

2.Companies can choose from a variety of _____________, but they are not allowed to change them too often.

3.Lots of money obtained in dubious or illegal ways is deposited in

_____________ in Swiss banks.

4.The basic _____________ is Assets = Liabilities + Owners’ Equity.

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5.The _____________ at the London Stock Exchange usually lasts two weeks. It is followed by an ___________ on which all bills must be settled.

6.The _____________ is one of the three basic financial statements.

7._____________ consist of money that is expected to be received. The contrary, _____________ consist of money that is owed to other people.

8.The role of _____________ is to provide figures and statements that will aid decision-making.

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B

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ACCOUNTING PRINCIPLES

There are various possible ways of recording debits and credits, valuing assets and liabilities, calculating profits and losses, etc. But there are about a dozen generally accepted “accounting principles” that accountants must follow in order to present “a true and fair view” of a company's finances.

EXERCISE 4

Match up these six accounting principles with the definitions below:

1.The separate-entity or accounting entity assumption

2.The continuity or going-concern assumption

3.The unit-of-measure assumption

4.The time-period or accounting period assumption

5.The historical cost principle

6.The revenue or realization principle

a.All transactions and other items to be accounted for must be' in a single, supposedly stable monetary unit.

b.An enterprise is an accounting unit separate from its owners, creditors, etc.

c.Financial data must be reported for particular (short) periods, which makes accrual and deferral necessary.

d.Revenue is realized at the moment when goods are sold (or change hands) or when services are rendered.

e.The business will continue indefinitely into the future.

f.The initial price paid for the acquisition of assets is the one that is recorded in accounts.

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EXERCISE 5

Which principles do these sentences refer to?

1.This accords with a company’s legal status as an artificial person.

2.This implies that the current market value of fixed assets is irrelevant, as they are not for sale.

3.This makes it unnecessary to estimate current market values every year.

4.This means that each company has its own financial year (US: fiscal year).

5.This requires multinational companies to convert their consolidated statements into a single currency.

6.This is why balance sheets often contain an entry for debtors: goods that have been sold, but are not yet paid for.

EXERCISE 6

Match up these five accounting principles with the definitions below:

1.The matching principle

2.The objectivity principle

3.The consistency principle

4.4 The full-disclosure principle

5.The principle of conservatism (or prudence)

a.All data recorded should be verifiable and free from bias.

b.Financial reporting must include all significant information.

c.The revenues generated in an accounting period are identified with related costs whenever they were incurred.

d.The same methods (of inventory valuation, depreciation, etc.) must be used from one period to the next.

e.Where alternative accounting methods are possible, one understates rather than overstates profits.

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EXERCISE 7

Which principles do these sentences refer to?

1.This is the contrary of recording “below-the-line” items.

2.This is one of the justifications for historical cost accounting, which requires no subjective assessments of replacement values.

3.This leads to the accrual (accumulation) and deferral (postponement) of costs.

4.This means that insignificant trivial expenses, like each pencil or typewriter ribbon, need not be accounted for separately, but are exempted by the principle of materiality.

5.This prevents companies selecting methods according to the inflation rate, etc.

Comprehension Check

TASK 1

Read the following extract from an article about accounting ratios. Choose the best word to fill each gap from A, B, C or D below. For each question 1 - 6, mark one letter (A, B, C or D). There is an example at the beginning (0).

FINANCIAL STATEMENTS AND PROFITABILITY RATIOS

The financial statements of a business provide important information for people outside the business who do not (0) __________ access to the internal accounts. For example, existing and (1) __________ shareholders can see how much profit a business made, the value of its assets and the level of cash (2) __________. Although these figures are useful, they do not mean a great deal by themselves. In order to (3) __________ any real sense of the figures in the final accounts, they need to be properly analysed using accounting ratios and then (4)

__________ with either the previous year's ratios or against averages for the industry. The profitability of a company is important and a key (5) __________

of its success. In the profit and loss account the figures shown for gross profit and

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net profit mean very little by themselves. However, (6) __________ them as a percentage of sales they become much more useful. The figures can then be evaluated against those of previous years, or with those of similar companies.

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