Reviewers: Valerii Plaksiienko, Doctor of Economic Science, Professor, Head of the Department of Accounting and Economic Control, Poltava State Agrarian Academy
Olena Lahovska, Doctor of Economic Sciences, Professor, Professor of Accounting and Audit Department, Zhytomyr Polytechnic State University
Viktoriia Dergachova, Doctor of Economic Sciences, Professor, Head of Management Department, Igor Sikorsky KPI
Responsible Editor: Serhii Voitko, Doctor of Economic Sciences, Professor, Igor Sikorsky KPI
Approved by the Academic Council of the National Technical University of Ukraine “Igor Sikorsky Kyiv Polytechnic Institute”
(Protocol № 5 of 30.06.2020)
Natalia Skorobogatova, Candidate of Economic Sciences, As. Prof.
ACCOUNTING IN FOREIGN COUNTRIES
Accounting in Foreign Countries [Electronic resource] : a textbook for students studying for specialty 051 “Economics”, specializations “International economics” / N. Skorobogatova ; Igor Sikorsky KPI. – Electronic text data (1 file: 1,79 МB). – Kyiv : Igor Sikorsky KPI, 2020. – 162 p.
The textbook contains the main provisions for the organization of accounting, preparation and analysis of financial statements in foreign countries. The essence of the assets, liabilities and equity of the enterprise in accordance with International Financial Reporting Standards is disclosed. The main types of accounting systems are analysed, their features are determined. The methodology of accounting for elements of assets, capital and liabilities in accordance with International Financial Reporting Standards, as well as the procedures for preparing financial statements under the terms of different accounting systems are given. The basic methodological provisions of management accounting are considered.
This textbook is designed for students specialty 051 “Economics”, will be useful for accountants, financiers who prepare and submit financial statements in accordance with international financial accounting standards.
N. Skorobogatova, 2020
Igor Sikorsky KPI, 2020
CHAPTER 1. BASIC ACCOUNTING PRINCIPLES AND
ACCOUNTING SYSTEMS 8
1.1. Conceptual basis of accounting 8
1.2. Accounting systems 11
1.3. International financial reporting standards 15 1.4. Technological process and financial accounting procedures 17
Control questions for Chapter 1 19
CHAPTER 2. FINANCIAL STATEMENTS 21
2.1. Components, purpose and general requirements
for the financial statements 21
2.2. Content and methodology of preparation of the main forms
of financial statements 23
2.3. Methods of analysis of financial condition of the enterprise
on the basis of reporting 33
Control questions for Chapter 2 38
CHAPTER 3. CASH ACCOUNTING 39
3.1. Structure of funds, characteristics of accounts
for their accounting 39
3.2. Accounting and control of monetary transactions 40
3.3. The imprest petty cash system 42
3.4. Documentation and accounting of transactions
on bank accounts 43
3.5. Accounting for current (short-term) financial investments 44
Control questions for Chapter 3 48
CHAPTER 4. ACCOUNTING FOR SETTLEMENTS
WITH DEBTORS 49
4.1. Classification and estimation of receivables 49 4.2. Accounting for sales discounts, sales returns
and value-added tax 50
4.3. Methods of estimating and accounting of doubtful accounts 54
4.4. Accounting for bills received 56
Control questions for Chapter 4 58
CHAPTER 5. ACCOUNTING FOR INVENTORIES 59
5.1. The concept and composition of inventories 59
5.2. Inventory accounting systems 59
5.3. Inventory valuation methods 63
5.4. Presentation of inventories in the financial statements 65
Control questions for Chapter 5 66
CHAPTER 6. ACCOUNTING FOR LONG-TERM ASSETS 67
6.1. Composition, classification and valuation of long-term assets 67 6.2. Accounting for the receipt and disposal of fixed assets 68 6.3. Methods of calculation and accounting for depreciation
of fixed assets 73
6.4. Accounting for natural resources and their depletion 77
6.5. Accounting for intangible assets 78
Control questions for Chapter 6 79
CHAPTER 7. ACCOUNTING FOR FINANCIAL INVESTMENTS
AND CONSOLIDATED FINANCIAL STATEMENTS 80
7.1. Types of financial investments and procedure
for their assessment 80
7.2. Accounting for long-term investments in debt (bonds) 82 7.3. Accounting for long-term financial investments in shares 84 7.4. Methodology of preparation of the consolidated financial
Control questions for Chapter 7 90
CHAPTER 8. ACCOUNTING FOR SHORT-TERM LIABILITIES 91 8.1. Types of short-term liabilities and their evaluation 91
8.2. Accounts payable 92
8.3. Accounting for debt on bills of exchange issued 94 8.4. Accounting for other short-term liabilities 95
8.5. Salary and payroll accounting 97
Control questions for Chapter 8 101
CHAPTER 9. ACCOUNTING FOR LONG-TERM LIABILITIES 102 9.1. The essence and assessment of long-term liabilities 102
9.2. Accounting for long-term bonds 102
9.3. Accounting for long-term liabilities for bills payable 111 9.4. Accounting for long-term lease obligations 112 9.5. Accounting for retirement benefit obligations 113
Control questions for Chapter 9 115
CHAPTER 10. EQUITY ACCOUNTING AND PROFIT SHARING
IN COMPANIES AND CORPORATIONS 116
10.1. Economic essence and classification of equity 116
10.2. Accounting for a sole proprietorship 117
10.3. Accounting for equity and profit-sharing in companies 118 10.4. Accounting for the formation and distribution of profits
in corporations 120
10.5. Accounting income tax and profit-sharing for corporations 133
Control questions for Chapter 10 134
CHAPTER 11. FUNDAMENTALS OF MANAGEMENT
11.1. The purpose and objectives of management accounting 136 11.2. Classification of expenses in management accounting 140
11.3. Cost accounting and costing systems 144
11.4. Costing of product at cost centre 150
11.5. Organization of accounting and control
of responsibility centres 156
Control questions for Chapter 11 157
SUBJECT INDEX 158
Historically, accounting systems were formed in countries or groups of countries under the influence of the national characteristics of their economic and political development. However, the internationalization of economic life, on the one hand, and its market unification, on the other, required the international standardization of accounting as the basis for information understanding of business and effective management. The financial accounting methodology is based on the principles of accounting generally accepted in international practice - the basic concepts that underlie the accounting and reporting of an enterprise's business, its assets, liabilities, capital, income, expenses, and financial results.
The use of International Financial Reporting Standards enables users of financial statements to understand the information that is specified therein.
Knowing the peculiarities of accounting in different countries, managers, economists, analysts can make more informed decisions. This will allow them, analyzing accounting data, to assess the real economic situation at the enterprise. The ability to read the information in the financial statements of the company will allow a potential investor to make the right decision to purchase the company's shares. When you are looking for a foreign partner, the analysis of its reporting will help you assess its reliability and the possibility of cooperation with it.
Thus, knowledge of International Financial Reporting Standards and the specifics of accounting in foreign countries can significantly expand the opportunities for organizing a business in international markets.
The textbook is aimed at students studying in the specialty “Economics”
specialization “International Economics”. The purpose of studying the discipline
“Accounting in foreign countries” is to master the basics and specific methods of accounting for assets, liabilities and equity of a company in accordance with international accounting standards; develop a system of knowledge about methods for assessing assets, liabilities and equity of an enterprise; methods of preparing financial statements in accordance with the requirements of international standards, as well as the peculiarities of accounting in the accounting systems of different countries.
After completing this course, students should:
− master the conceptual principles of accounting in accordance with international standards;
− know the principles of recognition of assets and liabilities of the enterprise;
− know methods of assessing inventories, accounts receivable, financial investments and other types of assets of an enterprise, its liabilities and equity;
− know and be able to use the method of reflecting the income and expenses of the enterprise, the procedure for the formation of financial results;
− know the methodology of drawing up financial statements in accordance with international accounting standards and its analysis;
− know the basics of management accounting and use accounting and analytical information to make management decisions.
The textbook consists of 11 chapters, which disclose the accounting of assets, liabilities and equity capital of enterprises in different countries, as well as the methodology for preparing financial statements, its analysis. At the end of each chapter, there is a checklist for self-assessment. The topic of the textbook is fully consistent with the work program of the discipline “Accounting in foreign countries”.
8 CHAPTER 1.
BASIC ACCOUNTING PRINCIPLES AND ACCOUNTING SYSTEMS
1.1. Conceptual basis of accounting
Accounting as a system is a set of elements of a certain content and form, interconnected by regular interaction. It is a system about the state and movement of the enterprise's resources, about the nature and results of economic activity, which reflects and summarizes business transactions in a single monetary measure [5, p. 16]. In this case, a system is understood as a set of elements that are in relationships and connections with each other and form a certain integrity, unity.
Input streams include the facts of business transactions recorded in source documents. The source documents are used to assess the economic and legal consequences of an enterprise's activities based on the results of registration of business transactions in accounting accounts. Accounting continuously provides users with information that is recorded in the accounting through a double-entry system. Therefore, in a general sense, the accounting system is understood as the accumulation and transformation of a set of data about the facts of economic life, which form comprehensive information about the financial and economic activities of an economic entity, necessary for making effective economic decisions for a certain group of users [5, p.20].
Account users are divided into two groups: external and internal. External users include investors, lenders, suppliers, customers, governments and government agencies, the public, and so on. Internal users include only a specific group of users defined by the head of the enterprise (usually, enterprise managers of different levels).
Depending on the content and purpose of the input information, financial and management are distinguished in the accounting structure. Comparison of the two types of accounting is shown in Table 1.1. The main task of accounting is the formation of information that should help managers, business owners,
investors, creditors and other users make management decisions on the activities of a particular enterprise.
Table 1.1. Comparative characteristics of financial and management accounting
No The name of
the feature Financial Accounting Management Accounting 1. Obligation Required by law It is conducted at the request of
2. Limitation Generally accepted
accounting principles and standards
3. Using meters The only monetary measure Different measuring instruments (quantitative, qualitative, monetary, natural)
4. Object of analysis Business unit as a whole Structural divisions of the enterprise (centres of responsibility - product, workshop, site, etc.)
5. Reporting frequency Regularly (annual or quarterly intervals)
Online information 6. Orientation Assessment of the past For the future (forecasting) 7. Open data Most data are accessible to
A trade secret 8. Main users
Enterprise managers and external users
Managers of different levels of enterprises
9. Responsibility for correct accounting
There is a possibility of prosecution
There is a possibility of administrative punishment 10. The degree of
accuracy and information
Some degree of accuracy according to legal and accounting requirements
There are some assumptions, estimates based on the timeliness of the information provided, the main criterion is expediency
To meet these requirements, accounting information must be:
− the most significant (weighty) for making management decisions;
− absolutely reliable;
− comparative for certain periods of time or with similar information from other enterprises;
− understandable for users, etc.
Accounting principles are the basic concepts that underlie the accounting and reporting of an enterprise's business, its assets, liabilities, capital, income, expenses, and financial results. The accounting systems of different countries or groups of countries were formed under the influence of national peculiarities of their economic and political development. Accounting principles generally accepted in all countries:
Accrual basis – the results of transactions and other events are recognized when they occur (regardless of when cash or cash equivalents are received or paid) and are recorded in the accounting records and presented in the financial statements of the periods to which they relate.
In the case of business continuity, the financial statements consist of the assumption that the entity is continuously operating and will remain in effect for the foreseeable future.
Qualitative characteristics of financial statements
Principle of comprehensibility - the main characteristic of information is its comprehensibility for users.
Relevance principle - information is relevant if it influences users' economic decisions by assisting them in evaluating past, present or future events, or it helps them validate or correct their past estimates.
Materiality principle – information is material if its omission or misrepresentation can affect the economic decisions of users made on the basis of the financial statements.
Principle of reliability – information is reliable when it is free of material errors and bias and users can rely on it to the extent that it shows or is expected to show the actual state of affairs.
True presentation – to be truthful, information must truthfully depict the transactions and other events that it discloses or is expected to disclose.
The prevalence of essence over form – information should be reflected in accounting in accordance with its nature and economic reality, not just based on its legal form.
Neutrality – the information in the financial statements should be neutral, free from bias.
Prudence is the exercise of some degree of caution in forming the judgment required in an estimate under conditions of uncertainty, so that assets or income are not overstated and liabilities or expenses are understated.
Completeness – the information should be complete within the materiality and cost associated with obtaining it.
Comparability – users should be able to compare late-term financial statements to determine the trend in the financial position and performance of an enterprise, so measuring and reflecting the financial impact of transactions should be performed consistently across the enterprise at different intervals, and the approach should be consistent across businesses.
Limitations on the relevance and reliability of information
Timeliness – if there is an excessive delay in the submission of information, it can become irrelevant, so a balance must be struck between the relative benefits of timely reporting and the provision of reliable information.
Ratio of benefits and costs – the benefits of information should exceed the cost of its provision.
Balance of quality characteristics – the goal is to achieve an appropriate balance of all characteristics to meet the purpose of financial reporting.
1.2. Accounting systems
Accounting for different countries is different for many reasons. However, despite the differences in accounting organization in different countries, everyone uses the method of double entry of business transactions in accounting accounts.
There are several approaches to the classification of accounting systems, but the most common is the following (Table 1.2).
Table 1.2. Classification of accounting systems The name
of the system
the system is extended Features
Australia, United Kingdom, Hong Kong, Israel, Ireland, Iceland, India, Canada, Cyprus, Mexico, Netherlands, Central America, United
States, and other countries with significant
Financial basis of accounting, that is, a strong relationship with equity and securities of different levels:
- orientation of accounting to the needs of investors and creditors;
- availability of a developed securities market;
- high level of professional accounting training;
- the presence of a large number of multinational corporations and entities Continental Austria, Belgium, Greece,
Egypt, Italy, Norway, Portugal, France, Germany, Switzerland,
Sweden, Japan, etc.
High dependence on the banking system and the state:
- close industrial relations with banks;
- detailed legal regulation of financial accounting and reporting;
- orientation of accounting and reporting on the interests of public administration of taxation;
- macroeconomic planning (significant EU influence)
Argentina, Brazil, Peru, Chile, Ecuador and other fragile economies
High inflation; stringent requirements of the state for accounting and control of income of firms and the population; unification of accounting princes (accounting policy is rigidly defined)
Recently, the following national accounting systems have also been distinguished:
− European countries – two accounting departments (general and analytical), profit base of the chart of accounts, purpose of accounting system – increase
− the United Nations – two accounting departments, the production base of the chart of accounts, the purpose of the accounting system is to increase revenue;
− Middle Eastern countries (Islamic model) – the main idea of the model is under significant religious influence.
Some scholars have identified the so-called "mixed model", which combines Anglo-American and continental models.
Accounting in most countries is within the competence of the enterprise itself. In the world practice, there are two types of regulation of accounting and reporting principles:
− professional self-government (USA, UK, etc.);
− legislation (countries with the Continental Accounting Model).
Each country regulates accounting, that is, a set of measures by which society, using its internal capabilities, affects the accounting, is divided into:
− economic – carried out with the help of methodological recommendations, explanations on the order of accounting, exchange of experience; has a non-normative character; is guided by the principle of expediency, not obligation;
legal – implemented by the state through the establishment of legal norms, outlining the limits of the possibility of behavior of subjects; the principle of obligation is based;
− moral and ethical – in some countries, ethical "standards" of auditors and accountants have been adopted, which are aimed at subconscious people's judgment about morality.
Sources of authority in regulating accounting at the national level include the following documents:
− documents of the legislative bodies (Law on Accounting, Law on Taxes, etc.);
− documents of governmental bodies (for the purpose of formation and explanation of accounting and reporting norms);
− documents of professional and private organizations (financial accounting standards or financial reporting standards developed by professional accounting organizations);
− developments made on the basis of private industry initiatives (general reporting standards, made by voluntary associations of some participants engaged in specific activities).
International accounting practice is heterogeneous, so there is a need for its standardization. Under accounting standards understand the standard requirements for accounting methods and procedures, in particular: depreciation, inventory, tax assessment, the procedure for including the results of associates and subsidiaries in the consolidated statements, accounting for exchange differences and the like. Accounting standards are divided into two types:
− International – developed by the International Accounting Standards Board (IASB) and recommended for use;
− national – accounting standards developed by each country individually for internal use.
Although the national standards of the different countries differ somewhat in name, they all have the same purpose and structure. The practice of accounting in many countries around the world uses the term "accounting policy". Accounting policies is specific principles, conditions, rules and practices adopted by the company for the preparation and presentation of the financial statements. There is no single list of generally accepted accounting policy components. However, IFRS offers a wide variety of accounting policies for entities. The specifics of accounting policies of a particular enterprise and its impact on the latter's business situation should be disclosed in the notes to the financial statements. The main requirement for accounting policy of the enterprise is its stability, adoption from year to year. Changes in accounting policies should be substantiated and set out in the notes to the financial statements. Changes can be reflected in two ways:
− retrospective – the entity has to adjust the balance of each component of equity at the beginning of the period affected by it for the very first prior period filed and other comparative amounts disclosed for each prior period filed in the same way that the new accounting policy has always been applied ;
− prospective – the application of a new accounting policy to transactions that occur after the date of the change in accounting policy, that is, a one-time recalculation is made.
1.3. International financial reporting standards
The financial statements of companies in different countries have certain differences due to social, economic and political factors. Differences in approaches to the content of financial statements have made it difficult to analyze information and make decisions in the context of international trade, transnational corporations, and the globalization of financial markets.
To ensure the harmonization of financial statements, the Committee for International Accounting Standards (IASC) was established on June 29, 1973. It was founded on the basis of an agreement between the professional accountancy organizations in Australia. UK, Ireland, Canada, Netherlands, Germany, Mexico, USA, France and Japan. The original purpose of the IASB was to formulate, publish and improve in the public interest the accounting standards to be followed in the presentation of financial statements, and to promote their adoption and compliance in all countries.
During the period of its activity, IASB issued 41 international accounting standards (IAS). Most of them have been revised to improve their quality and distribution. From 1983 to 2000, IASB members were all professional accountancy organizations that make up the International Federation of Accountants (IFAC). In May 2000, a new standard was adopted, according to which individual membership was canceled and the Committee was renamed the International Accounting Standards Board (IASB).
Most IFRSs apply to businesses of all types of business, including banks, insurance companies and other financial institutions. However, taking into account the specifics of the activities of financial institutions, additional requirements for their financial reporting are set out in IAS 30 “Disclosures in the financial statements of banks and similar financial institutions”. Restrictions on the application of individual IFRSs are given directly in the text of the standards.
Principles and terminology used in IFRS, focused primarily on commercial enterprises (private sector). Therefore, government agencies and non-profit organizations wishing to apply IFRS, if necessary, can change the titles of individual reports and the description of certain items, as well as submit additional components of financial statements.
After the reorganization in 2001, the International Accounting Standards (IAS) were renamed the International Financial Reporting Standards (IFRS).
The first International Financial Reporting Standard (IFRS 1) was approved on June 19, 2003 p. And it applies to financial statements for the period starting from 2004. At the same time, standards issued before that, retain their former name and are replaced by IFRS gradually.
For understanding and practical application of standards the Conceptual Framework (Framework) of drawing up and representation of financial reports is important. It provides an outline of the concepts underlying the general-purpose financial statements. The conceptual framework is not part of IFRSs. Therefore, in the event of a conflict between the Conceptual Framework and standard, IFRS requirements are a priority.
In order to promptly respond to the problems of practical application of standards, the IASB issues interpretations of the relevant provisions of the existing standards and the Conceptual Framework.
Structure of the standard:
− accounting object – provides a definition of accounting object and basic concepts associated with this object;
− recognition of accounting object – the criteria of attribution of accounting objects to different elements of reporting are given;
− accounting object valuation provides recommendations on the use of valuation methods and the requirements for the valuation of various elements of reporting;
− reflection in the financial statements – disclosure of information about the object of accounting in different forms of financial statements.
The approved text of any draft for discussion shall be published by the Committee in English. Committee members are responsible for preparing
translations of drafts for discussion and standards and may publish them in the language of their countries. It is mandatory to indicate the accounting authority to which the translation is made.
Practice has shown that the adoption and use of IFRSs provides:
− reduction of risk for creditors and investors;
− reducing the cost of each country to develop its own standards;
− deepening international cooperation in the field of accounting;
unambiguous understanding of financial statements and increasing confidence in its performance worldwide.
1.4. Technological process and financial accounting procedures
The accounting cycle is a certain sequence of formation of the primary, consolidated and reporting information within a single accounting system.
It consists of the following steps:
1) primary surveillance;
3) current grouping of facts of economic activity;
4) final generalization of the facts of economic activity;
5) analysis of activities.
At the end of each reporting period, a Trial Balance is compiled – a table that lists all the General Ledger accounts and the final balance for each account (Table 1.3):
Table 1.3. Structure of Trial Balance
Account name Account number Debit Credit
Fixed assets 101 Sum Sum
… … … …
Total - Sum Sum
After checking the Trial Balance, a transformational statement is prepared that reflects the closure of income accounts, expenses, and regulatory records,
most of which relate to the attribution to the entity of the income received by the enterprise and the write-off of expenses that correspond to those revenues and relate to the reporting period.
Typical regulatory accounting entries:
1) write-offs for depreciation expenses:
DR Depreciation expenses CR Accumulated depreciation
2) write-off of rent and other services previously paid and used in the reporting period for expenses of the reporting period:
CR Rent paid in advance
3) write-offs for expenses of the reporting period other direct and intermediary expenses that relate to the reporting period:
DR Expenses CR Accounts payable
4) attributing to the income of the reporting period of the prepayment received from the buyers (customers) for the goods sold (services) in the reporting period:
DR Prepayment received (or Advances Received) CR Revenues from sale (or Revenues)
5) attributing to the income of the reporting period the cost of services actually provided in the reporting period (work performed, goods sold), payment for which has not yet been received:
DR Accounts receivable (or Settlements with customers) CR Revenues from sale (or Revenues)
The features of foreign accounting methodology include the use of mixed accounting entries, that is, the simultaneous debiting or crediting of several accounts.
In the practice of foreign experience, the most common approaches to the classification of accounting accounts are the following:
1) classification of accounts in terms of the elements:
− asset accounts (fixed assets, intangible assets, finished goods, work in progress, cash, etc.);
− accounts of liabilities (different types of accounts payable and debt of the enterprise to other firms, banks, suppliers, employees, budget, etc.);
− equity accounts (reserve, additional capital, retained earnings, etc.);
− income accounts (income from each activity);
− expense accounts (expenses of the enterprise by economic elements and functional purpose);
2) classification of accounts depending on the period of use:
− real accounts – have a balance at the end of the reporting period (assets, equity and liabilities accounts);
− nominal accounts – have no balance at the end of the reporting period (income accounts, expense accounts, financial performance accounts);
3) classification of accounts based on forms of financial statements:
− accounts of Balance Sheet (assets, equity and liabilities accounts);
− accounts of Income Statement (income, expense accounts).
In world practice, there are three approaches to building a chart of accounts:
matrix; linear; hierarchical. In many countries of the Anglo-American accounting system, there is no single account plan. The company administrations themselves form the most appropriate chart of accounts – a set of all accounts of the enterprise with the corresponding codes. As a rule, the accounts are arranged in the following order: assets, liabilities, equity, income, expenses. In some countries, there are national charts of accounts that are used by all businesses (Germany, France, Russia, Ukraine, etc.). In particular, the 4th EU Directive obliges EU members to apply a standard chart of accounts.
Control questions for Chapter 1
1. What are generally accepted accounting principles?
2. When is revenue recognized?
3. What are the qualities that accounting information is expected to have?
4. What are accounting systems?
5. What accounting principles do you know?
6. Why do you need International Financial Reporting Standards?
7. What is the difference between active and passive accounts?
8. What company information is available to external users?
9. Give examples of regulatory accounting entries.
10. What are the types of accounting?
21 CHAPTER 2.
2.1. Components, purpose and general requirements for the financial statements
Financial statements are written reports that quantify the financial strength, performance and liquidity of a company. The purpose of the financial statements is providing information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions. To achieve this, the financial statements provide information about the assets; liquidities; equity; revenue and expenses, including profit and loss; contributions and payments to owners; cash flows.
A complete set of financial statements includes:
− a statement of financial position (balance sheet) at the end of the period;
− a statement of profit or loss and other comprehensive income for the period (presented as a single statement, or by presenting the profit or loss section in a separate statement of profit or loss, immediately followed by a statement presenting comprehensive income beginning with profit or loss)
− a statement of changes in equity for the period
− a statement of cash flows for the period
− notes, comprising a summary of significant accounting policies and other explanatory notes [IAS 1].
The financial statements are prepared on the basis of financial accounting data. Users of financial statements include existing and potential investors,
employees, creditors, customers, government agencies and the public (table 2.1). No single financial report can provide all the information users need,
therefore all components of financial statements must be considered and interpreted as a whole.
Table 2.1. Information needs of users of financial statements
№ User group Information needs Decision-making based on analysis of report information 1 Investors The ability of an enterprise
to pay dividends
Decisions regarding the acquisition, holding or sale of investments
2 Employee Stability and profitability of the enterprise, wages (level and debt), pension provision
3 Banks Timeliness and completeness of loan repayment and interest
Opportunity and conditions for granting new loans
4 Suppliers and other lenders
completeness of payment of bills
Opportunity and terms of entering into new agreements 5 Customers Ability to get the necessary
goods and services
Opportunity and terms of entering into new agreements 6 Government Timeliness and
completeness of payment of taxes
Determination of national income and allocation of resources
7 Society Impact of enterprise activity on the well-being of society (employment, ecology, etc.)
Opportunity and conditions of cooperation
An item is recognized as an element of the financial report if it meets the requirements:
− it is probable that the future economic benefits associated with it will increase or decrease;
− the estimate (value or cost) of an item can be reliably determined.
Financial statements must faithfully reflect the financial position, financial results of operations and cash flows of the enterprise.
Most countries in the world use standard financial reporting forms, are developed and approved on a national scale. So, for the countries of the European Union, the forms and content of the annual financial statements of companies are regulated by 4 EU Directive. Each EU member state can specify the forms and content of reporting, depending on its national characteristics, adhering to the principles of their preparation.
However, in some countries model financial reporting forms are not developed or approved on a national scale (USA, UK, Canada, etc.). Companies in these countries independently choose the form of reporting (more or less detailed) in accordance with national requirements regarding their content and principles of formation.
In most countries, financial statements are prepared and presented to external users at annual intervals (after the end of the calendar year). However, for internal needs, it consists mainly of short intervals (monthly or quarterly). Ukrainian enterprises prepare and submit quarterly and annual financial statements.
Enterprises, in addition to financial statements, submit a financial review, which contains the main factors that determine the results of the enterprise; sources of financing of the enterprise and its policy on managing borrowed capital and related risks, etc. Also, in many countries, the enterprise includes environmental and other types of reports in the annual report. However, IFRS only relate to financial statements and do not apply to other information included in annual statements.
2.2. Content and methodology of preparation of the main forms of financial statements
The main forms of financial statements are a statement of financial position (balance sheet), a statement of profit or loss, a statement of changes in equity, a statement of cash flows, notes to the financial statements. Consider the features of compiling these forms of financial statements.
The balance sheet is a statement of financial position of an enterprise that reflects its assets, liabilities and equity in monetary terms at a particular date. In
general, the balance of the enterprise is represented by the following formula (equation):
Assets = Liabilities + Equity
According to IFRS, an asset is a resource that is controlled by company as result of past events and is expected to provide economic benefits in the future.
Terms of recognition of the object of accounting as an asset:
− enterprise received it as a result of past transactions or events (purchase, construction, etc.), since only the intention to purchase the object does not yet mean its actual acquisition;
− the resources received represent the future economic benefits – the potential ability of the asset to contribute (directly or indirectly) to the receipt of cash or cash equivalents to the enterprise;
− resources are controlled by the enterprise (ownership or other legal rights to the assets);
− the possibility of a reliable assessment of the asset.
The following types of valuation are used to determine the carrying amount of an asset:
− historical (actual) cost – the amount of cash, cash equivalents or other forms of compensation provided at the time the asset is received; it contains the purchase price (net of discounts) and all costs required to bring them to condition of use as intended. For self-produced assets, historical cost is the cost of producing them;
− current (recoverable) cost – the amount of cash, equivalents or other forms of compensation that would be required to purchase the same or a similar asset at the current time (balance sheet date);
− net realizable value – the cost of selling an asset in the ordinary course of business, minus the cost to complete its production and sale;
− market value of the asset – the net value of its acquisition or sale in an active market (used to value securities);
− amount of expected recovery – the amount that the company expects to receive as a result of the future use of the asset, including its residual value
(used to determine the carrying amount of property, plant and equipment and intangible assets, IAS 36 “Impairment of Assets”);
− present value of the asset is the present (discounted) value of the future net cash flows expected to be used in the ordinary course of business;
− fair value of the asset – the amount by which an asset can be exchanged in transactions between knowledgeable, interested and independent parties (for example, when one company is acquired by another).
A liability is the present debt of the enterprise to other legal entities and individuals, that arose as a result of past economic transactions or other events, the repayment of which in the future is expected to reduce the resources of the enterprise embodying economic benefits.
Terms of recognition of a liability as an element of the balance sheet:
− asset is received or the company has concluded a non-cancellable agreement to purchase it;
− ability to estimate it reliably, however, for provisions it is difficult to determine the amount of liabilities at the time of their occurrence (provisions is a liability for which the amount or timing of future payments is not determined:
warranty repair or replacement of products at the time of initial sale, IAS 37
“Provisions, Contingent Liabilities and Contingent Assets”) – the amount is reserved based on previous experience and predictive estimates of specialists.
The following types of valuation are used to determine the carrying amount of the liability:
− historical cost of the liability – the amount of proceeds received in exchange for it or the amount of cash or cash equivalents payable to settle the liability in the ordinary course of business;
− current cost of the liability – the amount of undiscounted cash or cash equivalents that would be required to repay the liability at the current moment (balance sheet date);
− settlement (payment) cost – the amount of undiscounted cash or cash equivalents that is expected to be paid to pay off the liability in the ordinary course of business;
− present value of the liability – the present (discounted) value of future net cash payments that is expected to be required to settle the liability in the ordinary course of business;
− fair value of the liability – the amount by which the liability could be settled in transactions between knowledgeable, interested and independent parties.
Equity – the part of assets of an enterprise that remain after deducting its liabilities. The valuation of equity is determined by the valuation of relevant assets and liabilities.
International standards do not determine the form of the balance sheet, but only contain requirements for the disclosure of certain items of assets, liabilities and equity.
IFRS 1 contains a minimum list of items that should be listed directly in the balance sheet. However, the list is not exhaustive, so additional items (or lines), headings and interim summaries should be included in the balance sheet, if required by other standards or if required to accurately reflect the financial position of the entity.
International standards do not specify the format of the balance sheet, so an entity may choose the form of presentation of financial position information, unless otherwise provided by law.
The following balance models have become widespread in international practice:
1. Assets = Liabilities + Equity 2. Assets - Liabilities = Equity
The first model can be implemented in vertical or horizontal form, and the second only in vertical form. Regarding the balance sheet form, it should be said that there are two most commonly used forms in international practice, namely:
− a bilateral form in which the assets of the enterprise are placed on the left (balance sheet asset) and liabilities and equity – on the right (balance sheet liability and equity);
− a one-sided or sequential form, in which the asset, liability and equity balance are sequentially top-down.
In addition, within these balance models, its items can be classified as current and non-current and are presented in a sequence of increasing or decreasing their liquidity (maturity) (Fig. 2.1). The liquidity of funds should be understood as their ability to be transformed into cash for a certain period of time.
Figure 2.1. Grouping of assets on the basis of increasing liquidity of funds The liabilities of the balance sheet are grouped and placed from top to bottom on the basis of a reduction in the maturity of the debt. In the United States, England, Canada and some other countries, the balance sheet items are grouped in the opposite direction.
To disclose the real financial position of the enterprise, the assessment of balance sheet items is of great importance. According to the generally accepted principle of cost, the valuation of assets supplied to the enterprise is carried out at the actual costs of their acquisition or their own production. However, in the course of economic activity, assets are used and their value changes. Fluctuations in prices on commodity and stock markets also have a certain impact. Therefore, in accordance with international accounting standards, the assets of an enterprise must be assessed and presented in the balance sheet on the basis of the principle of net prices.
Intangible assets Fixed assets Long-term financial
investments Warehouse stocks
Receivables Short-term financial
assets Increase in liquidity of objects
A statement of profit or loss (Income Statement) is a statement of income, expenses and financial results of the enterprise. In different countries, it may have a different name: a profit and loss statement (P&L), statement of profit or loss, revenue statement, statement of financial performance. The financial result of an entity is determined by comparing the income and expenses of the reporting period.
Income is an increase in economic benefits in the form of an increase in assets or a decrease in liabilities, which results in an increase in an entity's own capital (excluding capital growth through contributions from participants). It may be in the form of proceeds from the sale of products, goods or services, fees, interest, rent, dividends, etc.
Income is recognized in the Income Statement at the time when the economic benefits associated with an increase in an asset or a decrease in an obligation occur and can be measured reliably.
Expenses are a decrease in economic benefits in the form of a disposal of assets or an increase in liabilities, which results in a decrease in the equity of the enterprise (except for a decrease in capital due to its withdrawal or distribution between owners). Costs mean the consumption of resources (money, inventories, fixed assets, etc.) in the course of the enterprise's activities and include: the cost of sales, salaries, utilities, depreciation, etc.
Expenses are recognized in the Income Statement when there is a decrease in future economic benefits associated with a decrease in assets or an increase in liabilities that can be reliably determined. They are recognized in the Income Statement based on the principle of compliance, that is, they are included in the statement of income in the period in which the income for which these expenses were recognized. If the anticipation of economic benefits is expected over several accounting periods and it is difficult to establish their relationship with the income of a particular period, expenses are recognized in the form of depreciation.
In practice, different formats of the Income Statement are used, but all the varieties of these formats can be classified as follows (Fig. 2.2). The horizontal format, which has a two-sided format (left shows revenue and right, costs), is infrequent in practice.
Figure 2.2. Income Statement Formats
Functional income statement provides for the grouping of expenses by business functions (production, sales, research, management) and can be multi-stage or one- stage. Production costs are included in the cost of sales of a product, which is presented in a separate article, and the remaining costs are attributed to sales, administrative and other expenses (Fig. 2.3).
Sales revenue X
Cost of sale (X)
Gross profit X
Other income X
Sales costs (X)
Administrative expenses (X)
Other expenses (X)
Figure 2.3. An example of a functional income statement form
The multi-stage report provides for a step-by-step calculation of profit (loss) for the period. In a one-step report, ordinary activities initially list all items of income and then all items of expense. The difference between the revenue and expense totals shows the
profit of the company. Such a report is widespread in US companies but is not widely available in other countries. IFRS provide that entities that apply cost classification by function should additionally disclose cost elements.
For some Western European countries (France, Belgium, Spain, Finland, etc.), it is typical to produce a Profit and Loss Statement based on cost elements (Fig. 2.4).
Income from operating activities X
Other income X
Changes in inventories of finished goods and work in progress
Used raw materials (X)
Expenses for payments to employees (X)
Depreciation expense (X)
Other expenses (X)
Total costs (X)
Figure 2.4. Example of Income Statement based on cost items
The positive value of changes in work-in-progress balances and finished goods means that the production volume in the reporting period exceeds the sales volume, and the negative, on the contrary, indicates that the sales volume exceeds the production volume.
Functional income statements are the most common. Therefore, even European companies interested in expanding their international relations are printing their reports in English in a functional way.
In EU countries, the income statement form is nationally approved and uniform for all businesses. In countries such as the US, England, Canada, and some others, the form of report is arbitrary in terms of income, cost, detail and grouping.
The content and methodology of preparing the Statement of Cash Flow are governed by IAS 7 Statement of Cash Flow. The main purpose of the cash flow statement is to provide users with information about which sources of money the enterprise received, in what directions and for what purposes the money was spent, as the balance of cash changed during the reporting period. In this case, cash flow is reflected in the report from three types of activities: operating, investment, financial (Fig. 2.5).
The receipt of money Activity Payment for money
Figure 2.5. Scheme of cash flow of the enterprise from three activities Cash flow information from operating activities may be provided using direct or indirect methods. When using the direct method to determine the net change in cash arising from operating activities, the cash flow statement consistently lists all major income (or income) classes (items) whose difference indicates an increase or decrease in cash. Indirect method provides the statement of cash flows net income (loss), which later consistently adjusted to the value of the net change in cash excluding the impact of non-cash transactions and transactions related to investment and financial activities.
IAS 7 encourages entities to use the direct method, which provides useful information for estimating future cash flows. However, as practice shows, if there
From sale of goods and services, interest on loans
and securities purchased From the sale of property,
securities and repayment of loans From issuing shares, bonds, obtaining loans
Financial activity Investment
Employee pay, billing to suppliers (including prepayment), taxes
Purchase of property, securities and loans
Repayment of bonds and other debts, payment of dividends,
redemption of own shares
is a choice, enterprises give preference to the indirect method. So, in the USA it is used by 97.5% of companies, and in Spain this method is mandatory.
Meanwhile, in some countries, for example in Australia, the direct method is mandatory.
Information on cash flows as a result of investment and financial activities must be submitted in the Cash Flow Statement only by the direct method - the main classes (items) of cash income and expenses for each type of activity should be given separately.
The statement of changes in equity is intended to provide users with information on changes that have occurred in the composition and structure of equity capital for the reporting period (year). In this case, the changes are disclosed by the components of equity capital: authorized capital, additional capital, reserve capital, retained earnings, etc. The source for compiling this form of financial reporting is the information of the accounting accounts, which reflect the components of equity capital.
This report is in the form of a table that reconciles the balance of each item of equity at the beginning and end of the period. In this case, each change (increase or decrease) in equity is submitted in the Statement of changes in equity in a separate line.
Each item of the balance sheet, profit and loss statement, statement of cash flow should be cross-referenced with any related information in the notes. By nature, notes can be divided into:
− relate to the financial statements as a whole (disclosure of accounting policies and key estimates, disclosure of unforeseen events, liabilities, other financial and non-financial information);
− disclose separate items in the financial statements.
The format and scope of annotations are usually not regulated, but in some countries, they may be tightly regulated by national law (Italy, Portugal, etc.). Most countries have minimum requirements for the amount of information that should be disclosed.
2.3. Methods of analysis of financial condition of the enterprise on the basis of reporting
Horizontal (trend), vertical (structural) and ratio analysis are widely used in the analysis of financial statements.
Horizontal analysis consists in comparing individual indicators (articles) of the enterprise balance sheet, profit and loss statement and other reports for two adjacent reporting periods, or in dynamics over several years. It allows you to determine the development trends of the enterprise and individual performance indicators.
Vertical analysis is a structural analysis of the balance sheet, income statement or other forms of financial reporting. It allows you to study and evaluate the structure of the assets of the enterprise, i.e. the share of current and non-current assets, cash, financial investments, fixed assets, stocks, etc. in total assets.
The structure of short-term and long-term debt and equity is similarly analysed. In the structural analysis of the statement of profit and loss, all the items of the report relate to the volume of net sales (sales revenue). The advantage of this type of analysis is the logical possibility of comparing the percentages of the structure of indicators of the firm with the structure of indicators of other firms, regardless of their size. This makes it possible to find the optimal structure of assets and liabilities of the enterprise for successful implementation of economic and financial activities.
Ratio analysis is a quantitative method of gaining insight into a company's liquidity, operational efficiency, and profitability by studying its financial statements. The system of relative indicators includes indicators of solvency (liquidity), turnover (business activity), debt (capital structure), profitability (profitability), etc. It should be noted that in different countries the number of such indicators may vary. In addition to the main ones, other indicators are calculated. The assignment of a certain indicator to a particular group may have an element of conventionality.
1. Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety through the calculation of metrics including the current ratio, quick ratio, and operating cash flow ratio.
The current ratio measures an enterprise's ability to pay off its current liabilities (payable within one year) with its current assets (cash, accounts receivable, inventories). The higher the ratio, the better the enterprise's liquidity position:
𝑆1 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠≥ 1 (2.1)
The source of information for determining this ratio is the balance of the enterprise.
The quick ratio:
𝑆2 =𝐻𝑖𝑔ℎ𝑙𝑦 𝑟𝑒𝑎𝑙𝑖𝑧𝑎𝑏𝑙𝑒 𝑎𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 𝑎 𝑙𝑖𝑡𝑡𝑙𝑒 𝑏𝑖𝑡 > 1 (2.2) Highly realizable assets are highly liquid assets that include cash, short-term financial investments, accounts receivable and others. In practice, such assets are determined by the difference between the amount of current assets and inventories.
Absolute liquid ratio:
𝑆3 = 𝐶𝑎𝑠ℎ+𝐶𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (2.3) Cash equivalents include securities that can be converted into cash within a period of no more than three months.
Net working capital is determined by the difference between current assets and current liabilities:
𝑆4 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 (2.4)
It is a measure of an enterprise’s liquidity and its ability to meet short-term obligations, fund operations of the business.
2. Capital structure The debt ratio:
𝐷1 = 𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 (2.5) This ratio indicates the proportion of sources involved in the formation of the assets of the enterprise. A constant excess of 50% and a tendency to its growth may indicate signs of bankruptcy of the enterprise. The most optimal and least risky this ratio is at the level of 25-30%.
Financial independence ratio:
𝐷2 = 𝐸𝑞𝑢𝑖𝑡𝑦
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠× 100 (2.6)
Long-term debt to equity ratio:
𝐷3 = 𝐿𝑜𝑛𝑔−𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡
𝐸𝑞𝑢𝑖𝑡𝑦 × 100 ≤ 50% (2.7)
3. Profitability ratios
Gross profit margin is a measure of profitability that shows the percentage of revenue that exceeds the cost of goods sold:
𝑃1 = 𝐺𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 × 100 (2.8)
Operating profit margin:
𝑃2 = 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 × 100 (2.9)
36Net profit margin:
𝑃3 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠× 100 (2.10)
Return on investment (ROI):
𝑅𝑂𝐼 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠× 100 (2.11) When calculating this indicator, investment should be understood as the entire amount of funds invested in the assets of the enterprise (the total amount of assets on the balance sheet of the enterprise).
Return on equity (ROE):
𝑅𝑂𝐸 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
𝐸𝑞𝑢𝑖𝑡𝑦 × 100 (2.12)
Payback period of equity capital:
𝑃𝑃 = 100%
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 (𝑖𝑛 %) (2.13)
Earnings per share:
𝐸𝑆 = 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡−𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝐸𝑛𝑑−𝑜𝑓−𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑚𝑚𝑜𝑛 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 (2.14) 4. Activity Ratios – the ratios, that indicates how efficiently an enterprise is leveraging the assets on its balance sheet, to generate revenues and cash.
Inventory turnover is the ratio that shows how many times an enterprise has sold and replaced inventory during a reporting period.
𝑂1 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑔𝑜𝑜𝑑𝑠 𝑠𝑜𝑙𝑑
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 (2.15)
Days sales of inventory or Days inventory:
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑡𝑢𝑟𝑛𝑠365 𝑑𝑎𝑦𝑠 = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟 𝑡𝑢𝑟𝑛 (2.16) If the analysis is based on quarterly reports, 90 days are taken to calculate inventory turnover.
Receivables turnover ratio:
𝑂2 = 𝑁𝑒𝑡 𝑐𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 (2.17)
Receivable turnover in days:
𝑂3 = 365 𝑑𝑎𝑦𝑠
𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑟𝑎𝑡𝑖𝑜 (2.18) In the analysis of the quarterly financial statements, 90 days are taken to calculate the receivable turnover in days.
𝑂4 = 𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 (2.19) This efficiency ratio compares net sales (income statement) to fixed assets and measures an enterprise's ability to generate net sales from its fixed-asset investments.
𝑂5 = 𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑙𝑒𝑠 (𝑟𝑒𝑣𝑒𝑛𝑢𝑒)
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑎𝑠𝑠𝑒𝑡𝑠 (2.20) This metric indicates the return on assets.
Indicators of the financial condition of the enterprise are compared by reporting periods (in dynamics) to identify trends in development. It is important to compare them with the performance of other companies, as well as with the industry performance.
Control questions for Chapter 2
1. What are assets? What are liabilities?
2. What are the terms liabilities and capital?
3. What is the general purpose of financial statements?
4. What is the purpose of an income statement? a balance sheet? How do they interrelate?
5. Define the terms revenue and expense.
6. What is net income? What information does it convey?
7. What is the purpose of the statement of changes in equity? The statement of cash flows?
8. What does horizontal reporting analysis show?
9. What is the difference between current assets and non-current?
10. What is the equity of the enterprise? How to calculate it, if you know the assets and liabilities of the enterprise?