FINANCIAL STATEMENTS

Learning objectives

By the end of this topic, students should be able to:

i. Examine the importance of financial statements
ii. Prepare the various financial statements

Financial statements (or financial reports) are formal records of the financial activities of a business,
person, or other entity. Financial statements provide an overview of a business or person's financial
condition in both short and long term.

All the relevant financial information of a business enterprise, presented in a structured manner and
in a form easy to understand, are called the financial statements. There are four basic financial
statements:
Balance sheet: also referred to as statement of financial position or condition, reports on a
company's assets, liabilities, and Ownership equity at a given point in time.
Income statement: also referred to as Profit and Loss statement ("P&L") or Statement of
Comprehensive Income, reports on a company's income, expenses, and profits over a period of
time.
Profit & Loss account provide information on the operation of the enterprise. These include sale
and the various expenses incurred during the processing state.
Statement of retained earnings: explains the changes in a company's retained earnings over the
reporting period.
Statement of cash flows: reports on a company's cash flow activities, particularly its operating,
investing and financing activities.

For large corporations, these statements are often complex and may include an extensive set of
notes to the financial statements and management discussion and analysis
The notes typically describe each item on the balance sheet, income statement and cash flow
statement in further detail. Notes to financial statements are considered an integral part of the
financial statements.

IMPORTANCE OF FINANCIAL STATEMENTS

"The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range of users
in making economic decisions.
In order to fulfill this objective, financial statements must provide information about the following
aspects of an enterprise:
 Assets
 Liabilities
 Equity
 Income and expenses (including gains and losses)
 Cash flows

Along with other information in the notes and related documents, this information will assist users
in predicting the enterprise’s future cash flows.

Page 1 of 9
Financial statements should be understandable, relevant, reliable and comparable. Reported assets,
liabilities and equity are directly related to an organization's financial position
Reported income and expenses are directly related to an organization's financial performance.
Financial statements are intended to be understandable by readers who have "a reasonable
knowledge of business and economic activities and accounting and who are willing to study the
information diligently.

Financial statements may be used by users for different purposes:

i. Owners and managers require financial statements to make important business decisions that
affect its continued operations. Financial analysis is then performed on these statements to
provide management with a more detailed understanding of the figures. These statements
are also used as part of management's annual report to the stockholders.
ii. Employees also need these reports in making collective bargaining agreements (CBA) with
the management, in the case of labor unions or for individuals in discussing their
compensation, promotion and rankings.
iii. Prospective investors make use of financial statements to assess the viability of investing in a
business.
iv. Financial analyses are often used by investors and are prepared by professionals (financial
analysts), thus providing them with the basis for making investment decisions.
v. Financial institutions (banks and other lending companies) use them to decide whether to
grant a company with fresh working capital or extend debt securities (such as a long-term
bank loan or debentures) to finance expansion and other significant expenditures.
vi. Government entities (tax authorities) need financial statements to ascertain the propriety and
accuracy of taxes and other duties declared and paid by a company.
vii. Vendors who extend credit to a business require financial statements to assess the
creditworthiness of the business
viii. Media and the general public are also interested in financial statements for a variety of
reasons

THE ELEMENTS OF FINANCIAL STATEMENTS

These include; measurement of financial position in the balance sheet (Assets, liabilities and equity),
and measurement of performance in the income statement (Income and expenses)

The accounting equation states that:

Assets = Capital + Liabilities

Assets: Are resources owned by a business. These are resources controlled by an enterprise as a
result of past events and from which future economic benefits are expected to flow to the
enterprise.
Types of assets: These include;
Non-current assets/fixed assets: These are assets, which will be used in the business for a given
period of time for at least a year and beyond. E.g. land, buildings plant and machinery etc.

Current assets: These are the ones that can easily be turned into cash or are quickly consumed in
the day today running of the business. They are usually consumed within one year. E.g. stock,
prepayments cash at bank etc

Page 2 of 9
Liabilities: Total value of funds owed for assets supplied to a business or expenses incurred and not
yet paid or these are the present obligations of the enterprise arising from past events, the settlement
of which is expected to result in an outflow the enterprise of resources embodying economic
benefits.

Types of liabilities:
These include; current liabilities and non-current liabilities or long-term liabilities.

Current liabilities:
These are obligations, which have settled within a period of one year.e.g. Accrued expenses,
creditors etc

Non-current/ long-term liabilities;

Obligations that have to be settled within a period of time of more than one year, e.g. long-term
bank loans, debentures etc.
Capital:
The total of resources invested and left in a business by the owner, plus any profits retained for use
in the business less any share of profits got out of the business by the owner (Drawings). It is
sometimes referred to as owner’s equity or net worth. It also refers to the residual interest in the
assets of the enterprise after deducting all its liabilities

3.3 STATEMENT OF COMPREHENSIVE INCOME (THE INCOME STATEMENT)

The purpose of the trading account is to determine the profit or loss incurred. This helps the
businessman to plan ahead, obtain loans from banks, other financial institutions, other businesses,
or from private individuals, informing stakeholders about the success of the business, tax calculation
due on profits.

It is necessary for comparison purposes. The part in which gross profit is calculated is referred to as
the trading account. Gross Profit is the excess of sales revenue over the cost of goods sold in the
period. Gross profit = Sales – cost of sales.
Cost of sales = (opening inventory + Purchases) – closing inventory.

Closing inventory (stock):

This is the stock, which is remaining in business at the end of the accounting period. The closing
stock of one accounting period is the opening stock of the following accounting period.
Closing inventory can be obtained through stock taking. It is valued at the cost price of the
inventories.

Net profit - Is what is left of the gross profit after all other expenses have been deducted.
This is calculated in the profit and loss account. It consists of gross profit plus any revenue other
than sales revenue less the total costs used up during the period other than those already included in
the “cost of goods sold”.
Net loss is incurred when the costs used up exceed the gross profit plus other revenues.

Typical format of financial statements for internal use

Page 3 of 9
 PC & E Ltd’s
Statement of comprehensive income for the year ended 31st December 2008

Shs Shs Shs

Sales xxx
Less returns inwards (sales returns) (xx)
Net sales xxx
Less cost of sales
Opening stock xx
Add purchases xxx
Add carriage in xx
Less purchase (returns outwards) (xx)
Net purchases xx
Cost of goods available for sale xxx
Less closing stock (xx)
Cost of sales (xxx)
Gross profit xxx
Add miscellaneous income e.g discount received xx

Less operating expenses

Salaries and wages xx
Power xx
Bad debts xx
Rent and rates xx
Depreciation xx
General expenses xx (xxx)
Profit or loss for the year before taxation xxx
Tax on profit for the year (xx)
Profit or loss for the year after tax xxx
Retained profits brought forward xxx
xxx
Less Appropriation
Transfer to reserves xxx
Interim dividends paid xxx
Proposed dividends xxx
(xxx)
Retained profits carried forward xxx

Page 4 of 9
The following trial balance was extracted from the books of Joakim Enterprises ltd for the financial
year ended 31st March 2009.

Dr. (shs) Cr. (shs)

Cash 8000,000
Bank 2,500,000
Debtors 3,000,000
Stock 1/4/2008 600,000
Vehicle, cost 7,000,000
Equipment, cost 5,000,000
Purchases. 4,000,000
Wages. 1,000,000
Electricity 200,000
Rent 700,000
Bad debts 30,000
Sales return 50,000
Sales discounts 60,000
Drawings 2,060,000
Creditors 2,000,000
Income taxes payable 3,500,000
Purchase returns
Discounts received 500,000
Sales
Provision for bad debts 80,000
1/4/2008. 12,000,000
Capital 60,000
Long term bank loan. 6,860,000

2,000,000
27,000,000 27,000,000

The following information is also available:

Closing stock at the end of the period was valued at shs 1,500,000
Additional provision of 1% of debtors has to be made against bad debts on 31st March, 2009
Of the rent paid shs 100,000 is for the financial year commencing April 1, 2009
Wages of shs 300,000 accrued
Motor vehicle is to be depreciated by 20% and equipment by 10% on costper annum.

Required:
Prepare the statement of comprehensive income and a statement of financial position for Joakim
enterprises Ltd as at the end of the period.

Page 5 of 9
Solution
Joakim Enterprises
Statement of Comprehensive Income for the Year Ended31st March 2009

Shs. Shs shs

Sales 12,000,000
Less: sales returns 50,000
Net sales ----------------
11,950,000

Less: c of goods sold

Opening stock ¼ 600.000
Add: purchase 40,000.000
Less: purchase returns 500,000
Net purchase 3,500,000
Cost of goods available for sale 4,100.000
Less: closing stock 3 1/3 1,500,000
Cost of goods sold 2,600,000
Cross profit 9,350,000
Add; other incomes
Discount received 80,000
Net gross profit 9,430,000
Less operating expenses
Wages: 1,000,000
Add: account 300,000 1,300,000

Electricity 200,000
Rent 700,000
Less: prepaid 100,000 600,000

Bad debts 30,000

Add: addnal provision
(1/0 x 3,000,000) 30,000 60,000

Sales discounts 60,000

Definition; motor vehicle
(20% x 7,000,000) 1,400,000
Equipment
(10% x 5,000,000) 500,000 4,120,000

Net profit 5,310,000

Page 6 of 9
 Joakim Enterprises

Statement of financial position as at 31st march 2009

Noncurrent assets SHS SHS SHS.

Cost Ac depr. NBV.

M/Vehicle 7,000,000 1,400,000 5,600,000

Eqpt 5,000,000 5,000,000 4,500,000
12,000,000 1,900,000 10,100,000

Current Assets
Stock 31/3 1,500,000
Debtors 3,000,000
Less: prov. For b/d 60,000
Add: increase
In prov. (1% )
30,000 90,000 2,910,000
Prepaid net 100,000
Bank 2, 000,000
Cash 800,000

Total current assets 7,810,000

Less: current Liabilities

Creditors 2,000.000
Income taxes payable 3.500.000
Accmed wages 300,000 5,800.000
NCA(working capital) 2,010,000
TNA (capital employed) 12,110,000

Financed by:
Capital 6,860.000
Add: net profit 5,310.000
12,170,000
Less: drawings 2,060,000
Owner’s equity 10,110,000
Add: long term liabilities:
Bank loan 2,000,000
Capital employed 12,110,000

Page 7 of 9
Exercise
The following trial balance relates to the books of Kaddu Enterprises for the period ended 30th June,
2009
Debit Credit
Rent 1,560,000
Insurance 305,000
Lighting expenses 516,000
Motor expenses 1,960,000
Salaries and wages 4,850,000
Sales 35,600,000
Purchases 30,970,000
Sundry expenses 806,000
Vans 3,500,000
Creditors 3,250,000
Debtors 6,810,000
Fixtures 3,960,000
Buildings 28,000,000
Cash at bank 1,134,000
Drawings 6,278,000
Capital 51,799,000

90,649,000 90,649,000

Additional information 30.06.2009:

Stock at 30 June 2009 was 9,960,000

Motor van is to be charged at 10% using the reducing balance method.
No record had been made for the fact that Kaddu used goods worth Ushs. 1,750,000 for personal
use.

Required:
Extract a statement of comprehensive income for the year ended 30 June 2009.

3.4 STATEMENT OF FINANCIAL POSITION (THE BALANCE SHEET)

Is a statement showing the financial position of a business as at a given date. It shows the assets,
liabilities and capital of a business.

The accounting equation:

Any business requires resources in order to be set up and start trading. Assuming the owner of the
business has supplied all the resources, then resources supplied by owner = resources in the
business. Resources supplied by the owner are referred to as capital, whereas the actual resources in
the business are called assets. Other than the owner of the business, other people may supply
resources to the business. The amount owing to these people is what is referred to as liabilities.

Page 8 of 9
Format of a Statement of Financial Position (balance sheet)

ABC Statement of Financial Position as at 31 DEC 2002

ASSETS:
Non-current assets
Property, plant & equipment xxx
Good will xxx
Manufacturing licenses xxx
Investments in associate’s xxx
Other financial assets xxx
Xxxxx
Current assets:
Inventories xxx
Trade & other receivables xxx
Prepayments xxx
Cash and cash equivalents xxx xxxxx
Total assets xxxxx

EQUITY & LIABILITIES:

Capital & reserves
Issued capital xxx
Reserves xxx
Accumulated profits (losses) xxx
Xxxx
Minority interests’ xxxx

Non- current liabilities;

Interest bearing borrowings xxxx
Deferred tax xxxx
Retirement benefit obligation xxxx xxxxx

Current liabilities
Trade & other payables xxxx
Short-term borrowings xxxx
Current portion of interest bearing borrowings xxxx
Warranty provision xxxx xxxxx
Total equity & liabilities xxxxx

From Kaddu’s records in illustration 1 above, prepare the statement of financial position as at the
end of the period.

Page 9 of 9