CIMA CO2 Official Learning System - Fundamentals of Financial Accounting
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STUDY MATERIAL C2
440
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
In general, the examiner will make clear from the amount of information given and the
nature of the question the exact format required to answer the question.
●
‘other comprehensive income’, then just this section of a comprehensive income state-
ment is required.
13.2.9 Statement of changes in equity
We introduced the statement of changes in equity very briefl y in Section 13.2.1 and now
that we have discussed share capital, reserves and dividends in more detail, we can return to
the statement of changes in equity. As the name implies, the statement shows the change in
equity from the beginning of the year to the end of the year. Equity is the shareholders ’ capital
in the company and comprises shares and reserves. These may be increased by, for example:
Share issues
Total comprehensive income.
These may be decreased by, for example:
Dividends.
There may be a transfer between reserves; this will not increase or decrease the reserves in
total but will change the individual balances.
A full example of a statement of changes in equity is given below.
Statement of changes in equity of Hi Tech Ltd for the year ended 31 December 20X8
Ordinary
Shares
Share
Premium
Revaluation
Reserve
General
Reserve
Retained
Earnings Total
$’000 $’000 $’000 $’000 $’000 $’000
Balance 1.1.X8 1,000 500 300 100 400 2,300
P r o fi t for the year 600 600
Dividends (200) (200)
Shares issued 600 150 750
Transfer 75 (75)
Revaluation
property
8 0 8 0
Balance 31.12.X8 1,600 650 380 175 725 3,530
The statement of changes in equity shows the result of transactions between the owners of a
limited company and its owners. This will typically be the retention of profi t, the payment
of dividends and the issue of shares.
The equity has changed from $2,300 to $3,530 in the year.
The equity would appear in the statement of fi nancial position as follows:
Statement of fi nancial position of Hi Tech Ltd as at 31 December 20X8
Equity $’000
Ordinary shares 1,600
Share premium 650
Revaluation reserve 380
General reserve 175
Retained earnings 725
3,530
In the Learning System, where there is no change in a component of equity, the statement of
changes in equity will not be presented in full but only those columns which have changed.
441
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
These points are brought together in the following example.
Example 13.D
The trial balance of ABC Ltd at 30 September year 1 is set out below:
Debit ($’000) Credit ($’000)
Premises at cost 800
Plant and equipment at cost 460
Motor vehicles at cost 124
Accumulated depreciation at 1.10 year 0:
Premises 160
Plant and equipment 210
Motor vehicles 63
Inventories at 1.10 year 0
Raw materials 41
Work in progress 27
Finished goods 76
Sales of fi nished goods 2,702
Purchase of raw materials 837
Carriage inwards 24
Direct wages 658
Heat, light and power 379
Salaries 96
Advertising 45
Telephone, postage and stationery 23
Trade receivables and payables 256 113
Employee income tax payable 57
Balance at bank 363
Ordinary shares of $1 each 650
5% preference shares of $1 each 100
Share premium 250
Retained earnings 432
10% debentures (repayable year 20) 200
Bank deposit account 496
Bank interest received 19
Ordinary dividend paid 31
Preference dividend paid 5
Rent 215
4,956 4,956
Notes:
1.
The closing inventories at 30 September year 1 valued at cost were as follows:
$
Raw materials 37,000
Work in progress 18,000
Finished goods 39,000
2. An analysis of the raw materials consumed during the year shows that $73,000 related to the use of
indirect materials.
STUDY MATERIAL C2
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THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
3. The following amounts had been prepaid on 30 September year 1:
$
Rent 25,000
Telephone 2,000
4. The following amounts should be accrued for expenses at 30 September year 1:
$
Direct wages 57,000
Salaries 14,000
Heat, light and power 61,000
5. An analysis of the salaries cost for the year is:
$
Production 49,000
Selling and distribution 30,000
Administration 31,000
6. An allowance for receivables is to be created equal to 5 per cent of closing receivables after writing off a
bad debt of $16,000. These expenses are to be treated as selling and distribution items.
7. During the year, a motor vehicle was sold for $13,000 when it had a carrying amount of $14,000. Its
original cost was $24,000. The only entry made in respect of this transaction was to credit sales of fi nished
goods and debit bank with the proceeds.
8. Depreciation is to be calculated on all non-current assets held on 30 September year 1, at the following
rates:
Premises 5% p.a. on cost
Plant and equipment 20% p.a. reducing balance
Motor vehicles 20% p.a. on cost
It is assumed that none of the non-current assets has any expected residual value. The depreciation charge
for the year is to be apportioned as follows:
Production Selling Admin.
Premises 80% 10% 10%
Plant and equipment 70% 10% 20%
Motor vehicles 20% 60% 20%
9. Other expenses are to be apportioned as follows:
Production Selling Admin.
Heat, light and power 80% 10% 10%
Telephone, postage and stationery 10% 60% 30%
Rent 70% 10% 20%
10. Income tax of $39,000 on the profi t for the year is to be accrued.
11. It is proposed to transfer $100,000 into general reserves.
12. The premises were revalued to $850,000, and the tax on the gain is $10,000.
You are required:
(a) to prepare the statement of comprehensive income, incorporating the manufacturing and trading
accounts for the year ended 30 September year 1;
(b) to prepare the statement of changes in equity for the year ended 30 September year 1;
(c) to prepare the company’s statement of fi nancial position at 30 September year.
443
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
Solution
(a) Statement of comprehensive income of ABC Ltd for the year ended 30 September year 1
$’000 $’000
Sales (2,702–13) 2,689
Opening inventories of fi nished goods 76
Opening inventories of raw materials 41
Purchases of raw materials 837
Carriage inwards 24
902
Closing inventories of raw materials (37)
865
Indirect materials consumed (73)
Direct materials consumed 792
Direct wages (658 57) 715
Prime cost 1,507
Production overhead
Indirect materials consumed 73
Heat, light and power ((379 61) 80%) 352
Telephone, postage, stationery ((23 2) 10%) 2.1
Salaries 49
Rent ((215 25) 70%) 133
Depreciation
Premises ((5% 800) 80%) 32
Plant ((20% 250)
70%) 35
Motor vehicle ((20% 100) 20%)* 4
Loss on disposal of vehicle (1 20%) 0.2
Factory cost incurred 2,187.3
Opening work in progress 27
Closing work in progress (18)
Factory cost of goods completed 2,196.3
2,272.3
Closing inventories of fi nished goods (39)
(2,233.3)
Gross Profi t 455.7
$’000 $’000
Gross profi t 455.7
STUDY MATERIAL C2
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THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
Selling and distribution
Heat, light and power (440 10%) 44
Telephone, postage and stationery (21 60%) 12.6
Advertising 45
Salaries 30
Rent (190 10%) 19
Depreciation
Premises (40 10%) 4
Plant (50 10%) 5
Motor vehicle (20 60%) 12
Loss on disposal of vehicle (1 60%) 0.6
Bad debt written off 16
Change in allowance for receivables ((256 16) 5%)
12
(200.2)
Administration
Heat, light and power (440 10%) 44
Telephone, postage and stationery (21 30%) 6.3
Salaries 31
Rent (190 20%) 38
Depreciation
Premises (40 10%) 4
Plant (50 20%) 10
Motor vehicle (20 20%) 4
Loss on disposal of vehicle (1 20%) 0.2
(137.5)
Operating profi t 118.0
Interest received 19
Interest paid (10% $200) (20)
(1)
Profi t before taxation 117
Income tax (39)
Profi t for the period 78
Other comprehensive income
Gain on property revaluation before tax 50
Less income tax (10)
Gain on property revaluation net of tax 40
Total comprehensive income 118
(b) Statement of changes in equity of ABC Ltd for the year ended 30 September year 1
Revaluation
Reserve
General
Reserve
Retained
Earnings Total
Balance at 1 October year 0 432 432
Comprehensive income for the period 40 78 118
Dividends – ordinary (31) (31)
Dividends – preference (5) (5)
Transfer to general reserve 100 (100) 0
Balance at 30 September year 1 40 100 374 514
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FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
(c) Statement of fi nancial position of ABC Ltd as at 30 September year 1
Assets Cost ($’000)
Acc. Depn
($’000)
Carrying
Amount ($’000)
Non-current assets
Premises 850 (200) 650
Plant and equipment 460 (260) 200
Motor vehicles 100 (73) 27
1,410 (533) 877
Current assets
Inventories
Raw materials 37
Work in progress 18
Finished goods 39
94
Receivables 240
Less: allowance (12)
228
Prepayments 27
Bank deposits 496
Balance at bank 363
1,208
2,085
Equity and liabilities
Ordinary shares of $1 each 650
Preference shares of $1 each 100
Share premium 250
Revaluation reserve 40
General reserves 100
Retained earnings 374
1,514
Non-current liabilities
10% debentures 200
Income tax on gain 10 210
Current liabilities
Trade payables 113
Employee income tax payable 57
Accruals 132
Debenture interest 20
Income tax 39
361
2,085
Note :
●
On the assumption that the debentures have been in issue throughout the year, it is necessary to provide for a
full year’s interest, and to show a liability for that interest on the statement of fi nancial position.
STUDY MATERIAL C2
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THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
Exercise 13.1
Draw up an outline statement of comprehensive income, statement of changes in equity
and statement of fi nancial position to show the position of the following items:
1. gross profi t,
2 . p r o fi t before tax,
3. non-current assets,
4. current liabilities,
5. income tax,
6. interest paid transfers to reserves,
7 . p r o fi t for the year,
8. intangible assets,
9. retained earnings at the start of the year,
10. retained earnings at the end of the year,
11. current assets,
12. non-current liabilities,
13. equity,
14. other comprehensive income.
Solution
Statement of comprehensive
income
Gross profi t X
Less : expenses (X)
Operating profi t X
Interest paid (X)
P r o fi t before tax X
Income tax (X)
P r o fi t for the period X
Other comprehensive income X
Total comprehensive income X
Statement of changes in equity
Reserve Retained earnings Total
Balance at the start of the period
Retained earnings for the year
Dividends
Transfer to reserves
Balance at the end of the period
447
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
Statement of fi nancial position
Non-current assets X
Intangible assets X
Current assets X
X
Equity X
Non-current liabilities X
Current liabilities X
X
13.3 Statement of cash flows
In this section we shall illustrate the preparation of a statement of cash fl ows, which is
often prepared for limited companies but may also be prepared for other types of organisa-
tion. It should be noted that a ‘cash fl ow statement’ has been renamed ‘statement of cash
fl ows’ in accordance with IAS 1 (Revised) Presentation of Financial Statements.
13.3.1 What is a statement of cash flows?
A statement of cash fl ows recognises the importance of liquidity to a business by report-
ing the effect of the transactions of the business during the period on the bank, cash and
similar liquid assets. At its simplest, it is a summary of receipts and payments during the
period, but this method of presentation does not answer a common question asked by the
readers of fi nancial statements: ‘ Why does the profi t made during the period not equate
to an increase in cash and bank balances? ’ What is needed, therefore, is a statement that
commences with the profi t made during the period, and shows how that profi t, and other
transactions during the same period, have affected the fl ow of cash into and out of the
company.
The syllabus states that the presentation for a statement of cash fl ows should be based
on IAS 7 Statement of Cash Flows and that requirement is followed in this Learning System.
13.3.2 Why does the profit earned not equal
the change in bank and cash balances?
There are three main reasons why this does not occur:
1 . P r o fi t is calculated on an accruals basis, which means that revenue is taken when it is
earned, not when it is received, and expenses are deducted on the same basis to match
with that revenue. Bank and cash balances change when monies are received and paid
out. Thus the bank balance will be different from profi t due to items such as the inven-
tories balance, unpaid receivables and payables, accruals and prepayments, both at the
start and at the end of the period. For example, an increase in inventories means more
cash has fl owed out; an increase in receivables means less cash has fl owed in; an increase
in payables means less cash has fl owed out.
2. The calculation of profi t includes some items that do not affect cash at all or affect it
differently. For example, profi t is after deducting depreciation, which involves no move-
ment in cash. The profi t or loss on disposal of a non-current asset will be taken into the
profi t calculation, but it is the proceeds of sale that affect cash. In addition, there may
STUDY MATERIAL C2
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THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
be other accrued items in the statement of comprehensive income, for example taxa-
tion. Similarly, the change in allowance for receivables is a non-cash item. These do not
affect cash at the same time as the accrual is made, for example, taxation may be paid
after the year end, thus the amount of tax paid out during a period will be the bill for
the previous year, not that for the current year.
3. Bank and cash balances are affected by some items that do not affect profi t, such as
the purchase of non-current assets (only depreciation affects profi t), the raising of addi-
tional capital or the repayment of loans.
The statement of cash fl ows has three sections:
1. Cash fl ows from operating activities
As the name implies, this is the cash fl ow from operating the business and mainly
relates to the income statement. This is called ‘ cash generated from operations ’ . Cash
from operating activities is then calculated after deducting:
Interest paid
Income tax paid
2. Cash fl ows from investing activities
This has four main sections:
Purchase of non-fi xed assets
Proceeds on sale of non-fi xed assets
Interest received
Dividend received
3. Cash fl ows from fi nancing activities
This has four main sections:
Proceeds from issuing shares
Proceeds from loans
Repayment of loans
Payment of dividends
13.3.3 Cash flows from operating activities – cash
generated from operations
The starting point for a statement of cash fl ows is the cash fl ow from operations. ‘ Operations ’
are the normal, everyday activity of the company that earn it profi t, and that result in cash
fl ow. For the purposes of a statement of cash fl ows, we begin with the operating profi t in the
statement of comprehensive income, and then proceed to convert this into cash fl ow.
449
FUNDAMENTALS OF FINANCIAL ACCOUNTING
THE FINANCIAL STATEMENTS OF LIMITED COMPANIES AND THE STATEMENT OF CASH FLOWS
The result will be as follows:
$ $
Operating profi t X
Add :
Depreciation charge for the period X
Loss on disposal of non-current assets X
Decreases in inventories levels X
Decreases in receivables X
Increases in payables X
X
O r
Less :
P r o fi t on disposal of non-current assets X
Increases in inventories levels X
Increases in receivables X
Decreases in payables X
(X)
Cash generated from operations X
Example 13.E
A company had the following items on its statements of fi nancial position at the end of year 1 and year 2:
Year 1 ($) Year 2 ($)
Inventories 35,000 25,000
Receivables 24,000 28,000
Payables 31,000 33,000
In addition, the statement of comprehensive income for year 2 included the following items:
$$
Gross profi t 90,000
Less :
General expenses 17,000
Depreciation on plant 10,000
Loss on disposal of plant 4,000
(31,000)
Operating profi t 59,000
Add : interest receivable (13,000)
Less: interest payable (3,000)
Profi t before tax 69,000