B301 Unit 9 Presentation of financial statements, cash flow and miscellaneous statements

HKSSAP 1 (2001 Dec) Presentation of financial statements / IAS1 (revised) 

Bases for preparation (items 1-43):

• Going concern
• Accrual basis of accounting
• Consistency of presentation
• Materiality and aggregation
• Offsetting:
  • Assets and liabilities should not be offset unless doing so is allowed by an accounting standard, or unless all of the following conditions are met:
    1. the reporting company and another party owe each other determinable monetary amounts;
    2. the reporting company has the ability to insist on a net settlement; and
    3. the reporting company's ability to insist on a net settlement is assured beyond doubt, and the debit balance matures no later than the credit balance
  • Items of income and expense should not be offset when the following conditions are met:
    1. an accounting standard requires or permits it; or
    2. gains, losses and related expenses arise from the same or similar transactions and are not material.
• Comparative information

The structure of financial statements

5 components:

1. Income statement (items 79-93)
   • "Nature of expenses" method: expenses are classified as raw material and consumables, staff costs, depreciation and amortization, and other operating expenses.
   • "Function of expenses" method: expenses are classified as cost of sales, distribution costs, administrative expenses, and other operating expenses. Additional disclosures on depreciation and amortization and staff costs must be made on the face of the income statement or in the notes.
2. Balance sheet (items 55-78)
   • Format 1 and 2: Hong Kong companies to classify assets and liabilities into non-current and current items. The criterion for distinguishing between a current and non-current item is whether the item is expected to be realized or settled within a year (i.e. current item) or over a year (i.e. non-current item).
   • Format 3: present assets and liabilities in order of their liquidity.
   • "Non-current assets" & "non-current liabilities" replace "fixed assets" and "long-term liabilities".
   • The sequence of assets and liabilities is arranged from less liquid items to most liquid items.
3. Statement of changes in equity (items 94-99)
   • To reflect total earnings, realized and unrealized, of the company during the period, along with the reconciliation of share capital and reserves between the beginning and end of the year.
   • Format (see table 9.10 in Unit 9 Appendix III) shows:
     • the net profit or loss for the period;
     • income and expense, gain or loss recognized directly in equity, such as revaluation and some exchange differences;
     • the cumulative effect of changes in accounting policy and the correction of fundamental errors;
     • capital transactions with, and distributions to, owners;
     • the balance of accumulated profit or loss at the beginning and end of the period; and
     • a reconciliation between the opening and closing carrying amount of each class of equity capital, share premium and each reserve,
4. Cash flow statement (detail see below)
5. Accounting policies and explanatory notes (i.e. notes to financial statements) (items 101-116):
   • provide additional information for interested users who want to assess the company's performance and financial position.
   • includes:
     • measurement bases and specific accounting policies selected;
     • changes in equity; and
     • other disclosures (e.g. nature of operations, name of ultimate holding company).

The effect of non-ordinary activities on the income statement           

Extraordinary items (HKSSAP2, revised 2001)

• Extraordinary items (IAS 8):

• income or expense that arises from events or transaction that
  • are clearly distinct from the ordinary business activities of the company
  • are not expected to recur frequently or regularly.
• both are unusual and infrequent (and material in amount) and disclosed on the face of the income statement, and separately from the profit or loss from ordinary activities.
• reported net of tax after income or loss form discontinuing operation.
• additional disclosure of the nature and amount of each individual extraordinary item is made in the notes to financial statements.

• Examples (given in HKSSAP 2):

• the expropriation of assets by a foreign government; or
• the uninsured losses from an earthquake or other natural disaster.

• Material income and expenses
  • Certain items of income and expense arising from ordinary activities to be separately disclosed because of their abnormal size, nature or incidence.
  • Previously know as "exceptional items" but is no longer used in the revised HKSSAP2.
  • E.g. disposal of fixed assets and investments, restructuring activities.

Prior year adjustments (HKSSAP2, revised 2001)                               

• PYA are required when the amounts of these adjustments are material and arise specifically from:

a) adoption of a new accounting standard and changes in accounting policies

b) correction of fundamental errors

• Examples:

• Adoption of new accounting standard: a change in the recognition criteria for 'provision' in HKSSAP28 would force companies to eliminate some provisions not meeting such criteria.
• Change in accounting policy: from LIFO to average cost
• Change in accounting estimate: the basis of amortization of an asset is changed from 30 yrs to 15 yrs.

• Accounting treatment:

• a restatement of accounts for prior year is required
• adjust the opening balance of retained profits or reserves
• Alternative treatment (IAS8): PYA through the current period income statement , i.e. not through the opening balance of retained earnings, with the disclosure of additional information in pro forma materials. (not permitted in HK because of causing confusion to users if they do not read everything in the notes.)

Events after the balance sheet date (HKSSAP 9, revised 2001)           

• in line of IAS 10.
• events and transaction occurred between balance sheet date and the approval date (by the board of directors)
• Adjusting events:
  • events provide additional evidence of conditions that existed at b/s date.
  • the related amounts to be recognized in the company financial statements.
  • e.g. the resolution of a legal claim that was pending at the balance sheet date
• Non-adjusting events:

• events that are indicative of conditions arising after the b/s date.
• the nature and financial effects of such events should be disclosed in the notes if they are material and may affect the ability of users to make decisions.
• e.g. a plan to discontinue an operation announced after the b/s date.

• Revised standard specifically deals with dividends proposed or declared after the b/s date.  Enterprise is required not to recognize those proposed dividends as liabilities at the b/s date but as a separate component of equity in the balance sheet.
• Disclosure of proposed dividend:

The proposed final dividend is shown as part of the shareholders' fund rather than as liabilities.

HKSSAP 15 Cash Flow Statements (Revised 2001, IAS7)                      

• Objective: 
  • to supplement the traditional financial reporting statements for providing additional information on the cash inflows and outflows of the enterprises.
  • to help users of financial statements review the past year's cash flow situations and assess the ability of the enterprise to generate future cash flows.
• Mandatory for all companies in Hong Kong and present it as an intergral part of its financial statement for each period for which financial statement are presented.
• Exemption:
  • A entity with revenue of less than HK$20 million p.a. unless it:
    • is listed on a recognised stock exchange, or
    • is a dealer registered under the Securities Ordinance; or

• A charity or non-profit entity whose financial statements are prepared on a cash basis.

Structure of the cash flow statement:

• cash flows from operating activities;
• cash flows from investing activities; and
• cash flows from financing activities.

Operating activities (items 12-14, 17-19, 30-35)

• net cash resulting from operations included in the income statement in arriving at profit after tax.
• direct method (more useful in estimating future cash flows):
  • cash receipts from customers
  • cash payments to suppliers and employees
  • interest paid
  • income tax paid
• Indirect method (more cost effective):
  • start from the operating profit before tax in the profit and loss account adjusted for:
    • accruals and deferrals of income and charges;
    • cash items of income and expense associated with investing or financing cash flows and non-cash items, to arrive at the net cash from operating activities.
  • Adjustments should separately disclose movements in inventories, trade receivable, trade payables, non-cash items, interest paid and income tax paid.

Investing activities (item 15)

• Include those relating to the acquisition and disposal of any asset held as a long-term asset or as a current asset investment, but excluding "cash equivalents".
• Cash inflows:
  • receipts from sales of fixed assets
  • receipts from sales of subsidiaries
  • receipts from sales of other investments
  • receipts from repayments of loans granted to other entities that are held as investments
• Cash outflows:
  • payments to acquire fixed assets
  • payments to acquire subsidiaries
  • payments to acquire other investments
  • payments for acquiring debts, or for granting loans to other entities.

Financing (items 16-20)

• Include receipts from or repayments to external providers of finance.
• Cash inflows:
  • receipts from issuing shares
  • receipts from issuing debentures and loans
  • receipts from long- and short-term borrowings
• Cash outflows:
  • payments to purchase or redeem the company's own shares
  • payments to purchase or redeem the company's own debentures
  • repayments of short-term borrowings
  • payments of capital elements of finance lease rental payments
  • payments of expenses and commission on issues of shares and debentures.
• Dividends paid may be included here because they are involved in obtaining financing resources, e.g. shares issued.

Miscellaneous items

• Extraordinary items: shown under the standard heading according to the nature of each item.
• Exchange differences: 
  • Settled transactions -- no further adjustments
  • Unsettled momentary items -- adjustments required because no cash flows are involved in them.
• Finance leases:
  • Interest element -- cash outflow under "Returns on investments and serving of finance"
  • Capital element -- cash outflow in "Financing"
• Cash: Cash in hand and deposits repayable on demand, and includes cash in hand and deposits denominated in foreign currencies.
• Cash equivalents: short-term investments that are within 3 months of maturity when acquired (less advances from banks repayable within 3 months from date of the advance, if any).  However, an investment which, when bought, was more than 3 months away from maturity is not cash equivalent even if the period remaining to maturity is less than 3 months.
• Format of reconciliation in the cash flow statement:

            (At the end of cash flow statement)

            Net increase / (decrease) in cash and cash equivalents            X

            Cash and cash equivalents at the beginning of period              X

                 Cash and cash equivalents at the end of period                      X

Format of cash flow statement (indirect method, unit 9, pg.53)

Miscellaneous statements                                                                   

• Social and environmental reporting
  • "Social responsibility": a business should report its contributions, not just relating to financial and economic issues, but also relating to the community and environment.
  • Report includes: employment policy, staff benefits and development, community relations, donations, products and services, environmental issue and others.
  • International Survey of Environmental Reporting 1996 conducted by KPMG, around 75% of corporations in Europe and North America disclosed environmental information in their annual reports. However, only 11% of Hong Kong public companies did the same.
  • No accounting standard for the content and format of environmental reporting.
  • e.g. http://www.clpgroup.com
• Statements of value added
  • Corporate Report (1975): additional statement
  • "Value added" is divided among employees, government, and providers of capital (suppliers of long-term credit and shareholders).
• Employment reports
  • Additional information disclosure concening employees is helpful for certain user groups in assessing working conditions as well as the industrial relations maintained by a particular business.
  • Areas covers:
    • the number of employees, reasons for changes in the size of the workforce, the age and sex distribution of the workforce;
    • the hours of work, scheduled and actual, and reasons for the difference; and
    • training of employees, safety and health factors, pension schemes, etc.
    • e.g. http://www.mtr.com.hk