Company financial statements
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Any candidate taking ACCA Paper 1.1, Preparing Financial Statements or CAT Paper C1, Drafting Financial Statements should be ready for a question on the preparation of company financial statements. Candidates should make themselves familiar with the use of the formats in the Companies Act 1985 (UK) or in IAS 1 ‘Presentation of Financial Statements’ (International).
The normal study route to company financial statements for publication is:
<FONT COLOR="RED" SIZE="10"><B>Stage 1</FONT></B>
Master sole traders’ accounts, including adjustments for stock / inventory, accruals, prepayments, bad debts and depreciation.
<FONT COLOR="RED" SIZE="10"><B>Stage 2 </FONT></B>
Learn the additional items required for company accounts – share capital, reserves, dividends and debentures.
<FONT COLOR="RED" SIZE="10"><B>Stage 3 </FONT></B>
Understand how the detailed accounts in Stage 2 are presented in the summarised formats required for publication.
It is clear from Paper 1.1 examination scripts that too many candidates are stuck at Stage 2, because they make no attempt to use the proper formats (see my examiner’s report on page 40 of this issue of student accountant).
The main purpose of this article is to deal with the transition from Stage 2 to Stage 3. Some points from Stage 1 and Stage 2 will be picked up in the process. In this article we deal only with the profit and loss account / income statement. We’ll look first at the formats, then move to a typical examination question and the technique for answering it.
The formats
What may put some candidates off here is that some textbooks reproduce the full horror of the UK formats straight out of the Companies Act 1985. For Papers 1.1 and C1 a lot of the detail is quite irrelevant.
Here are two simplified formats suitable for these examinations:
UK format
Profit and loss account for the year ended…
Turnover X
Cost of sales (X)
Gross profit X
Distribution costs (X)
Administrative expenses (X)
Operating profit X
Interest payable (X)
Investment income X
Profit on ordinary activities before taxation X
Taxation (X)
Profit on ordinary activities after taxation X
Extraordinary items (X)
Profit for the financial year X
Dividends paid and proposed (X)
Retained profit for the financial year X
International
Income statement for the year ended...
$m
Revenue X
Cost of sales (X)
Gross profit X
Distribution costs (X)
Administrative expenses (X)
Profit from operations X
Finance cost (X)
Investment income (see Note 2 below) X
Profit before tax X
Income tax expense (X)
Net profit from ordinary activities X
Extraordinary items X
Net profit for the year X
Notes on the formats
1. The operating expenses are classified under three headings – cost of sales, distribution costs and administrative expenses. This actually makes the use of the format easier and quicker than preparing a detailed profit and loss account / income statement, as shown in Figure 2.
2. The item ‘investment income’ does not actually appear in the IAS 1 format but the position shown for it is logical.
3. Taxation / income tax expense, if it appears at all, will always be very simple, with a given figure to be treated like any other accrual (charge in the profit and loss account / income statement and a current liability in the balance sheet).
4. Extraordinary items are rarer now than they used to be, and will feature infrequently in the examination in this type of question.
5. The UK format includes dividends paid and proposed as a deduction from profit, because the Companies Act 1985 requires them to be shown in the profit and loss account. There are two differences in the International format. First of all, proposed equity dividends will rarely arise because IAS 10 ‘Events After the Balance Sheet Date’ prohibits their inclusion unless they have been proposed or declared before the balance sheet date. Secondly, the IAS format for financial statements puts dividends paid in the statement of changes in equity.
6. Both the UK and International rules have a second format in which the expenses are analysed differently. These alternative formats are examinable but will appear less frequently in the examination than the formats used here.
An illustrative question
Figure 1 on is Question 1 from Section B of the paper examination in December 2002. (The UK version is used – the International version differs only in terminology).
Figure 1
The following items have been extracted from the trial balance of Cronos Limited as at 30 September 2002.
Reference to notes
