Accounting - Financial reporting for limited companies

Accounting - Financial reporting for limited companies

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  • Created by: Joanna
  • Created on: 10-04-12 15:07

Main features of a limited company

  • Artificial person created by law
  • Has a separate life to its owners and is granted a perpetual existence
  • Must take responsiblity for its own debts and losses, but its owners are granted limited liability
  • A public company can offer its shares for sale to the public, a private company cannot
  • It is governed by a board of directors, which is elected by the shareholders
  • Corporate governance is a major issue
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Financing the limited company

  • The share capital of a company can be of two main types: ordinary shares & preference shares
  • Holders of ordinary shares (equities) are the main risk takers and are given voting rights; they form the backbone of the company
  • Holders of pereference shares are given the right to a fixed dividend before ordinary shareholders receive a dividend
  • Reserves are profits and gains made by the company and form part of the ordinary shareholders' equity
  • Borrowings provide another major source of finance
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Share issues

  • Bonus shares are issued to existing shareholders when part of the reserves of the company is converted into share capital. No funds are raised.
  • Rights issues give existing shareholders the right to buy new shares in proportion to their existing holding
  • Public issues are made direct to the general investing public
  • Private placings are the share issues to particular investors
  • The shares of public companies may be bought and sold on a recognised Stock Exchange
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Reserves

  • Two types: Revenue reserves and Capital reserves
  • Revenue reserves arise from trading profits and realised profits on the sale of non-current assets
  • Capital reserves arise from the issue of shares above their nominal value or from the upward revalutation of non-current assets
  • Revenue reserves can be withdrawn as dividends by the shareholders whereas capital reserves normally cannot
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Financial statements of limited companies

  • Based on the same principles of those of the sole proprietorship and partnership businesses. There are some differences in the detail
  • The income statement has three measures of profit displayed after the gross profit: operating profit, profit before taxation and profit for the year
  • The income statement shows audit fees and tax on profits for the year
  • Any uinpaid tax and unpaid, but authorised, dividends will appear in the statement of financial position as current liabilities
  • The statement of comprehensive income extends the income statement to include all gains and losses, both realised and unrealised
  • The statement of changes in equity reconciles the equity figure at the beginning of a reporting period with that at the end
  • The share capital plus the reserves make up 'equity'
  • Limited companies subject to Internation Financial Reporting Standards must produce a statement of comprehensive income and statement of changes in equity
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Directors' duty

The directors have a duty to

  • Maintain appropriate accounting records
  • Prepare and publish financial statements and a directors' report
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The need for accounting rules

Accounting rules are necessary to

  • acoid unacceptable accounting practices
  • improve the comparability of financial statements
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Accounting rules

  • The International Accounting Standards Board (IASB) has become an important source of rules
  • Company law and the London Stock Exchange are also sources of rules for UK companies
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Other statutory reports

  • The auditors' report provides an opinion by independent auditors concerning whether the financial statements provide a true and fair view of the financial health of a business
  • The directors' report contains information of a financial and a non-financial nature, which goes beyond that contained in the financial statement
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Creative accounting

  • Despite the accounting rules in place there have been examples of creative accounting by directors
  • This involves using accounting practices to show what the directors would like users to see rather than what is a fair representation of reality
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The need for a statement of cash flows

  • Cash is important because no business can operate without it
  • The statement of cash flows is specifically designed to reveal movements in cash over a period
  • Cash movements cannot be really detected from the income statement, which focuses on revenue and expenses rather than on cash receipts and cash payments
  • Profit (or loss) and cash generated for the period are rarely equal
  • The statement of cash flows is primary financial statement, along with the income statement and the statement of financial position
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Preparing the statement of cash flows

The layout of the statement contains three categories of cash movement:

  • Cash flows from operating activities
  • Cash flows from investing activities
  • Cash flows from financing activities

The total of the cash movements under these three categories will provide the net increase or decrease in cash and cash equivalents for the period

A reconciliation can be undertaken to check that the opening balance of cash and cash equivalents plus the net increase (or decrease) for the period equals the closing balance

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Calculating the cash generated from operations

The net cash flows from operating activities can be derived by either the direct method of the indirect method

The direct method is based on the analysis of the cash records for the period, whereas the indirect method used information contained within the income statement and statements of financial position of the business

The indirect method takes the net operating profit for the period, adds back any depreciation charge and the adjusts for changes in inventories, receivables and payables during the period

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Interpreting the statement of cash flows

The statement of cash flows shows the main sources and uses of cash 

Tracking the cash movements over several periods may reveal financing and investing patterns and may help predict future management action

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