Text 3 Financial Statements

The complex organisation of a modern firm makes it important to keep systematic records of the claims of different classes of people against it. The accounting instrument employed for this purpose is called a balance sheet, or a statement of financial position. On the left side of the sheet are listed all the wealth and all the claims to wealth owned by the firm, together with the value of each. These are the firm's assets. Assets are usually classified and listed in order of their liquidity, that is, by the ease with which they can be converted into money. Cash and bank accounts, the most liquid assets, are listed at the top, with accounts receivable (bills due from customers and others), which are somewhat less liquid next, and land and buildings that take time and trouble to sell listed last.

On the right side of the balance sheet are listed all the claims against the firm's assets, 1iabi1ities and debts owed to people outside the firm. They are listed first and usually listed according to their permanence. Current liabilities, which are least permanent, include bills and accounts payable to individuals and to other firms, amounts owed to banks on short-term notes, payroll due to workers, and other debts due to coming in the immediate future. Outstanding bonds are a longer-term liability. The residual, or balance, left over after subtracting all liabilities from the total value of assets, is the ownership equity.

The statement is called a “balance sheet” because the total of the claims must exactly equal, or balance, the total of, the assets. There is, of course, nothing mysterious about this. It simply means that whatever part of the value of the assets is not owed to somebody else is automatically part of the owners’ equity. The balance sheet summarises the firm's financial position at a given moment of time and it necessarily changes from moment to moment to reflect the changes in that position as the firm does business.

As the balance sheet summarizes the financial position of the firm on a given date, the income statement summarizes the firm's productive operations during a given period of time, usually a fiscal year. The income statement is a systematic summary of revenues and costs, organized to enable owners to see how the firm has operated. It gives figures for total sales or turnover (the amount of business done by the company during the year) and for costs and overheads. The first figure should be greater than the second: there should generally be a profit – an excess of income over expenditure. Part of the profit is paid to the government in taxation, part is usually distributed to shareholders as a dividend, and part is retained by the company to finance further growth, or repay debts, to allow for future losses, and so on. Although accountants differ in the exact arrangement of items and in the amount of detail given, the essence of the income statement is to show the year’s total receipts, total costs and profit. The statement also shows the allocation of profit between dividends and retained earnings, and the distribution of the dividends among the different classes of shareholders. In fact, the income statement can be reorganised to show the value added by the firm’s operations and the distribution of this value among the different participants in production.

A third financial statement has several names: the statement of changes in the USA, the source and application of funds statement, the source and uses of funds statement, the funds flow statement, the cash flow statement, the movement of funds statements. As all these alternative names suggest, this statement shows the flow of cash in and out of the business between balance sheet dates. Sources of funds include trading profits, depreciation provisions, borrowing, the sale of assets, and the issuing of shares. Applications of funds include the purchase of fixed financial assets, the payment of dividends and the repayment of loans, and, in a bad year, trading losses.

If a company has a majority interest in other companies, the balance sheets and profit and loss accounts of the parent company and the subsidiaries are normally combined in consolidated accounts.

Assignment to text 4:

1. Look through the text concentrating on the word “audit” and its derivatives.

2. Write down the main issues of the text

3. Read the text once more, check and correct your list of issues if necessary.

4. Divide the text into paragraphs to make it easier for comprehension. Try to restructure the text accordingly.

5. Read and translate the following words and word combinations:

accuracy, annual general meeting, board of directors, checking, deficiencies, determine, deviations, directives, external, implemented, ratified, shareholders (GB) or stockholders (US), standard operating procedures, subsidiaries, a synonym, transnational corporations (TNC)

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