1.6 The Main Financial Statements

Companies prepare their financial statements complying with the presentation requirements of applicable accounting standards.

The IFRS/IAS are the International Financial Reporting/Accounting Standards issued by International Accounting Standards Board (IASB), or its predecessor International Accounting Standards Committee (IASC). IAS 1,Presentation of Financial Statementswas the first international accounting standard issued by IASC, which sets out the form and content of the financial statements.

IAS 1 identifies a complete set of financial statements for a reporting period (typically a year) as comprising:

●a statement of financial position(SOFP) as at the end of the reporting period;

●a statement of profit or loss (SOPL) and other comprehensive income(SOCI) for the reporting period, which can be in a two-part format including a separate statement of profit or loss;

●a statement of changes in equity (SOCIE) for the reporting period;

●a statement of cash flows(SOCF) for the reporting period;

●notes comprising a summary of significant accounting policies and other explanatory information.

In our textbook, we are only concerned with the simple formats of SOFP and SOPL part of the statement of profit or loss and other comprehensive income.

1.6.1 Statement of Financial Position

A statement of financial position is a list of all the assets controlled and all the liabilities owed by a business as at a particular date: it is a snapshot of the financial position of the business at a particular moment. Monetary amounts are attributed to assets and liabilities. It also quantifies the amount of the owners’ interest in the business by capital/equity, which is the amount invested in a business by the owners.

Assets and liabilities are explained in detail in Chapter 3. However, the sum of the assets will always be equal to the sum of the liabilities plus capital/equity due to the principle of the accounting equation, which will be illustrated in Chapter 5.

A sample SOFP of a sole trader is shown in Exhibit 1.4 as follows.

In the above SOFP, the total assets are equal to total capital and liabilities, which is always the case in every SOFP. If we produce an SOFP that is “unbalance”, that means we do something wrong and should locate and correct the error to make it “balance”. This is the reason why in practice, people are used to calling SOFP a “Balance Sheet” more often.

There are a number of factors affecting a company's financial position at any one time which include:

●the economic resources it controls (cash, labour, materials, machinery, skills);

●its financial structure (whether it is funded by owners, lenders, suppliers, or by all three and to what extent respectively);

●its liquidity (short-term availability of cash) and solvency (long-term access to funds);

●its adaptabilityto changes in its operating environment.

Users can find out information concerning all the above factors by interpreting the SOFP. Through the interpreting, they can assess the entity's liquidity and solvency position, evaluate its requirements for further financing, and predict whether it is likely to obtain the financing successfully.

1.6.2 Statement of Profit or Loss

A statement of profit or loss shows income generated and expenses incurred during a certain period in a way of comparison, that is to say, it shows whether the entity has had more income than expense (a profit for the period has been made), or vice versa (a loss for the period has been suffered).

A sample statement of profit or loss is shown in Exhibit 1.5 below.

Users can evaluate the business's financial performance by studying the SOPL. They are going to understand the returns the entity has made, and assess managerial performance in discharging the responsibilities to make good use of shareholders’ funds, and predict the future returns going to be obtained.

Now let's look at Exhibit 1.4 and 1.5 together, we can see that they are connected. The profit for the year of $10,400 in SOPL is added to the capital of SOFP to get the capital carried down. The relationship between SOPL and SOFP can be shown more clearly in the following chart by Exhibit 1.6.

The two SOFPs are static snapshots of the business's financial positions for the start and the end of the year. They show what the business owns and owes at the two points of time. Between the two points, SOPL is a dynamic statement, explaining what has happened to change the year start financial position into the year end. These two statements form the basis of financial statements. For limited liability companies, the other two statements (statement of cash flows and statement of changes in equity) and notes are required by statute or by accounting standards. Statement of cash flows is also a dynamic statement, showing the cash changes for the year, and statement of changes in equity is a reconciliation telling the story of how the equity has been changed for the year.

These four financial statements complement each other, and together they show the whole picture to users. The five terms in bold are the elements of financial statements, which will be illustrated in detail in Chapter 3.