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Summary Chapter 2: Financial Statements
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A complete summary of Chapter 2: Financial Statements from the Corporate Finance textbook assigned to the module. This includes outlines from the slides as well.
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Financial Management 244Chapter 2: Financial Statements
When attempting to analyze the financial position of a company, external capital
providers often struggle to find the relevant financial information about the company.
Companies are required to publish annual financial reports, which include the
following financial statements:
Statement of financial position
Statement of comprehensive income
Statement of cash flows
Objective of Financial Reporting
Listed firms have to prepare their financial reports according to International
Financial Reporting Standards (IFRS). This framework defines the type and nature of
the information that should be provided.
The objective of financial reporting is to provide financial information about the
reporting entity that is useful to existing and potential investors, lenders and creditors
in making decisions about providing resources to the entity.
Bearing the objective of financial reporting in mind, there are three aspects that are
important:
Financial reporting is specifically directed towards potential external-capital
providers.
Financial reporting provides financial information about the company’s
economic resources, claims on these resources, and changes in resources
and claims.
Financial reporting attempts to provide other useful information to external-
capital providers to inform their decision making.
Users of Financial Reporting
External-capital providers are the most important users of financial reporting. The
primary users of financial reporting include existing and potential equity investors,
lenders and other creditors.
Financial reporting is also useful to all of the company’s stakeholders, which include:
shareholders, management, customers, employees, competitors and government.
Information Provided by Financial Reporting
Financial reporting provides information about a company’s economic resources
(assets) and the claims on these resources (equity and liabilities). The three main
aspects of information provided by financial reporting are:
Summary of the firm’s financial position
Financial performance
Changes in financial position
Qualitative Characteristics of Useful Financial Reporting
, Financial Management 244
To ensure the financial information provided by financial reporting is useful, the IFRS
framework identifies six fundamental qualitative characteristics:
Relevant and faithfully presented
Verifiable
Comparable
Understandable
Timely
Accurate and objective
Standardization of Financial Statements
Financial statements of different companies do not always contain comparable
financial information, as a result of different accounting standards or reporting dates.
This is usually solved by analysts by standardizing financial statements in order to
facilitate comparison between different companies and across time. Most companies
in South Africa have switched to the IFRS framework to help facilitate this solution.
Statement of Financial Position
The statement of financial position (SFP) provides a summary of a company’s
financial position at a specific date, usually the end of its financial year. The SFP is
organized into two sections, distinguishing between its assets and its equity and
liabilities.
Assets
Assets represent a capital investment, usually with the idea of economically applying
the assets in order to generate revenue. Assets can be distinguished between non-
current and current assets.
The difference between current and non-current assets is usually based on:
Turnover rate of capital
Ease of conversion
Physical characteristics
Non-Current Assets
Non-current assets are assets that are applied for a relatively long period of time,
normally more than one year. There are three types of non-current assets: tangible,
intangible and financial assets. Under these different types of assets are the
following:
Tangible assets
Property, plant and equipment (PPE) @ Cost price
Accumulated depreciation
PPE @ Carrying value
Assets under construction
Intangible assets
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