Table of Contents
Financial statements are the end results of an organization. It visualizes the whole performance of a company in a sort of a document (Akif 2008). Organizations are meant to earn economic profit and increase the shareholder’s equity. According to organizational officials, financial statements are the end products of an organization, which are of major concern for the end users like government authorities, shareholders, analysts and upper management of the company.
Before jotting down the 4 dominant components we have in a financial statement, it is better to define what actually a financial statement is. A financial report or financial statement is a document made by an organization, which usually identifies the performance of a company in terms of flow of money (Basit 2008).
The main perspective of this assignment is to identify the four components, found in a financial report of a company and how it can be used for different purposes. The four components, which can be found in a financial statement, are: Income Statement, Balance Sheet, Cash Flow Statement and Changes in Owner’s Equity. Each component has its own significance, which has been used by different users in different timeline.
Income Statement is the most important component found in a financial statement. It usually identifies the performance of an organization throughout a fiscal year. There are specific items, which can be found in an income statement like Revenue, Cost of Goods Sold, and Income before tax and income after tax (Zameer & Khalid 2009).
Each item found in this specific component is extremely important to analyze the financial performance of an organization. Revenue, which is also called as sales or turnover, represents the total sales of the company recognized in a financial year. Bottom line, which is the net income of the company, is the most important element found in an income statement to analyze how much financial benefits the company is generating from its active operations.
The users, who have interest in this component, are analysts and shareholders, who are more concerned with the net income of the company.
Balance sheet is another important component of financial report, which usually defines the actual financial position of a company. There are 3 elements that come under the umbrella of a balance sheet, which are: assets, liabilities and equity. According to the law of finance accounts, the addition of equity and liabilities should be equal to the total assets of the company (Zameer & Khalid 2009).
Bank’s credit department is of major concern with the financial position of a company to analyze how productive are the assets of the company in generating economic profit of the company. Apart from the assets, there are two other things, which are of major concern for the analysts and credit department of a bank to analyze the actual financial position of the company.
The net income earned by a company usually represented in an income statement is not the actual amount of money, which be flowing towards the organization because most of the sales of the company is on credit basis (Zameer & Khalid 2009). There are 3 elements that come under the ambit of a cash flow statement, which, particularly, are: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities.
It represents the total amount of cash, which have come in and come out from the organization. Cash flow has a strong relationship with the net income of the company because of the income statement, it is analyzed how much money has been realized from the net income of the company (Zameer & Khalid 2009).
Shareholders, external investors and corporate analysts are the concerned end users of this component and they timely analyze this component to visualize the actual financial performance of the company.
Changes in Owner’s equity
Owner’s equity is of real dominance and importance for the company because it represents the amount of equity put by the owner of the company in the stock of the company and how much external investments come into it (Zameer & Khalid 2009).
The component changes in owner’s equity represent how much change the equity section of the company has as compared to the previous financial record. This is basically a concern of corporate analysts and owners.
Balance Sheet Analysis (Kuwait Company)
In the world of book keeping, undoubtedly, balance sheet plays the most important role. In order to understand the role of Balance Sheet, first bookkeeping should be discussed. Bookkeeping can be thought of in the context of a business. It simply means the recording of financial transactions. Transactions might include purchases, sales, receipts and payments by an individual or organization. The bookkeeping process basically includes recording of only the financial effects of transactions. A financial transaction, however, can be categorized as an event or condition under the contract between a buyer and a seller to exchange an asset for payment. Thus, clearly, any event taking place, which has no economic substance, can be phased out of the context of bookkeeping. Primarily, complete details of all the transactions of the company are detailed on the financial statements of any company, which consist of five basic elements, namely:
- Statement of Financial Position(Balance Sheet)
- Statement of Comprehensive Income
- Statement of Cash Flows
- Statement of changes in Owner’s Equity
- Notes to the Financial Statements.
Amongst all these financial statements, Balance Sheet is a financial statement that summarizes the company's assets, liabilities and shareholders' equity at a specific point in time. Broadly, the importance of the balance sheet can be known from the fact that these three balance sheet segments give all the investors and other stake holders, who are concerned of the company, an idea as to what the company owns and owes, as well as the amount invested by the shareholders. Further on, it can also show the size that the company operates with and so forth every company, according to their own specific industry, earns their profits/losses on that size of the company, thus, it is evidently visible that the increase in the size of the balance sheet means the increase in size of the company and quite simply it all means the increase in size of the profits for the company. However, there are many more complex concepts, which might change the fate of the company and it is not very surprising that even with the increase in size of the balance sheet it might cause losses to occur in an already profitable company, such issues include risk management and treasury management, as well as many other factors like macroeconomic factors.
Before specifically discussing the balance sheet items in detail, a slight introduction of the ACICO group of Kuwait is provided for better understanding of the subject items. ACICO group is a Kuwait based group with strong values and belief in what they do. Below mentioned is the Mission Statement and vision of the organization under review.
ACICO Industries aspire to become a universally recognized trademark by means of the company values through diversification of activities and self-reliance, and achieve our promises under a well-established plan and without affecting quality.
Achieving growth and integrated development take place through maintaining the quality of the products and delivering them on time, as well as building constant, confident and lifelong partnerships.
ACICO is a fast growing industrial company, who specializes in producing such products meeting all criteria of modern life necessities including building materials. The strong presence of ACICO Industries ensures success through fertile soil as the company passed through significant phases since incorporation by establishing an aerated firm plant in parallel with executing huge numbers of residential, government and commercial projects using their own unique quality products as core building materials, throughout the Middle eastern countries rather than just in Kuwait, thus, determining the future investment and management strategies of the quickly growing company. The company is currently operating through its plants located in the State of Kuwait, Kingdom of Saudi Arabia, United Arab Emirates, and the State of Qatar manufacturing the building units of reinforced and non-reinforced aerated concrete with peculiar specifications including but not just restricted to thermal insulation, light weight, high fireproofing and environmental safety.
Balance Sheet mainly contains the assets, liabilities and owner’s equity. As it is important to understand what the assets, the liabilities and the equity is, it is also important to examine the relationship that they all have as regards to the balance sheet of any organization. The relationship of these three broad categories with respect to the balance sheet is presented below as an equation:
Assets = Liability + Owner’s Equity
Assets can be regarded as any resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit or simply just a balance sheet item that represents what a firm owns. But the interesting thing according to all the accountancy guidelines is that it is necessary that future economic benefits flow to the entity, otherwise authorities disallow the categorization as an asset. Assets are of two basic natures:
Current Assets: These are assets, which are expected to yield an economic benefit to the company of less than a single reporting period. In other words, current asset is an asset, which can either be used to settle current liabilities within the next 12 months or converted into cash. Typical current assets include short-term investments, accounts receivable, cash equivalents, cash, the portion of prepaid liabilities and inventory, which will duly be paid within a year. More specifically discussing the Current assets held by the ACICO group, it categorizes:
- Cash and cash equivalents with a sum of Kuwaiti Dinars (herein used as KD) 2,337,111 in 2011 as against KD 2,437,639 in 2010. This head of balance sheet includes cash in hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less, that is readily convertible to a known amount of cash and is subject to an insignificant risk of changes in value.
- Accounts receivable and other debit balances with a sum of KD 9,462,124 in 2011 as compared to KD 8,591,743 in 2010. Likewise this head of the Balance Sheet constitutes Receivables that are recognized at inception on fair value and subsequently, measured at amortized cost with the help of the effective interest method, deducting any provision for impairment. A provision for impairment of accounts receivable is set up when there is a clear evidence of the incapability of the Group to collect all amounts due in accordance with the original terms agreed upon by the receivables. Similarly, even if there are traces that debtor is facing financial difficulties or it is probable that the he will enter financial reorganization or bankruptcy, and any defaulter’s negligence in payments are considered as indicators that accounts receivable is impaired. The amount of the provision as a result becomes the difference between the present value of the estimated future cash flows and the asset’s carrying amount, discounted at the prevailing actual effective interest rate. Interestingly, the carrying asset’s amount is reduced through the usage of an allowance account causing the amount of the loss as recognized in the consolidated statement of income. A trade receivable is written off against the allowance account for trade receivables in case it is confirmed to be a defaulter or uncollectible. Subsequent return of amounts previously written off is recognized as income in the consolidated statement of income.
- Gross amount due from customers for contract work with a sum of KD 55,127 in 2011, when compared with KD 33,978 of 2010. The asset included in this head of the balance sheet arises from dealings of the basic trade of ACICO group of construction and is exactly the amount that the customer owes to the group.
- Inventories with a sum of KD 4,611,238 in 2011 as against KD 5,993,340. Inventories, as the name suggests, are the assets that are held by the company as stock piles, which is probably necessary for an organization like ACICO group due to huge and ongoing nature of work being carried out. Inventories are valued at the net realizable value or the lower cost after rendering allowances for any slow-moving or obsolete items. Costs comprise direct materials and direct labor costs and those overheads that have been incurred in bringing the inventories to their present location and condition. Cost is determined on a weighted average basis in ACICO group.
Non-Current/Long term/Fixed Assets: These are assets, which are expected in the eyes of the management to yield benefit for more than a single reporting period. In simple words, these are assets, which cannot easily be converted into cash or, more specifically, comparing that to the Current Assets that it cannot be converted into cash for a further 12 months at the balance sheet date.
- Investments available for sale with a sum of KD 2,007,996 in 2011, as compared with KD 2,551,862 in 2010. Investments available for sale are non-derivative financial assets that are either designated in this category as a result of the management’s intention of selling it and that of trading purposes or not classified in any of the other categories. They are included in non-current or long term or Fixed assets unless management intends to dispose of the investment within 12 months from the end of the reporting period.
- Investment in associates with a sum of KD 12,172,768 in 2011 against KD 13,039,429 in that of 2010. This head of the long term assets sheds light on the investment that the group has made in the companies, in which their holding accumulates from 20% to 50%. This means the group does not consolidate the results of the organization as in the case of subsidiaries, which hold more than 50% share and thus, the controlling power of the organization.
- Investment properties with a sum of KD 172,523,309 in 2011 and in comparison with KD 169,914,248, which existed in 2010. This account head Investment properties comprise completed property, property under construction or re-development held of the same to earn rentals or for capital appreciation or for that matter of fact. Investment properties are measured at cost at inception including purchase price and transaction costs. Subsequent to initial recognition, investment properties are stated at their fair value at the end of the reporting period. Gains or losses arising from changes in the fair value of investment properties are included into the consolidated statement of income for the period, in which they arise.
- Similarly, the Right of utilization of leasehold with a sum of KD 531,363 in 2011 against KD 588,819 in the year 2010. Leasehold right represents a long term lease agreement. The Group amortizes the lease value over the lease period and thus, appears in the non-current assets.
- Fixed assets with a sum of KD 31,887,875 in 2011 as opposed to 31,781,630 in 2010. By the term Fixed Assets, management denotes the non-current assets f property, plant and equipment. The initial cost of these fixed assets comprises its purchase price and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Expenditures incurred after the fixed assets have been put into operation, such as repairs and maintenance and overhaul costs, are normally charged to income in the period, in which the costs are incurred. In situations, where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of fixed assets beyond its originally assessed standard of performance, the expenditures are capitalized as an additional cost of fixed assets.
Intangible Assets: These are assets, which do not have a physical presence and they are non-monetary that cannot be seen, touched or physically measured and as a result of time and effort making them separately identifiable and thus, meeting all the criteria of an intangible asset.
- Goodwill is as the only intangible asset that ACICO group has summed up at KD 1,000,000 in 2011 and KD 1,500,000 in 2010. Goodwill simply is the difference between the fair value of contingent liabilities, liabilities, and identifiable assets and the cost of the acquisition, as at the date of the acquisition, all arising over an acquisition of a subsidiary.
Liability: Any liability in the balance sheet can be regarded as the obligation of an entity, which arises as a result of past transactions and events, the settlement of which might result in the transfer or use of assets, provision of services or other causing an economic outflow from the organization. More simply, liabilities are the debts, which will cause future economic outflow from the organization.
a) Due to banks’ liability held by ACICO group of KD 7,494,726 in 2011, when compared with KD 7,803,624 in 2010. The amount in this Balance Sheet head portrays the borrowing that ACICO group has made as at the reporting date. Borrowings are recognized at inception on the fair value, after netting off transaction costs incurred. Borrowings are subsequently established at amortized value; any difference between the redemption value and net of transaction costs (the proceeds) is recognized in the consolidated statement of income over the period of the borrowings using the effective interest method. Fees paid on the establishment of loan facilities are recognized as transaction costs of the loan to the extent that it is probable that some or all of the facility will be drawn down. In this case, the fee is deferred until the draw-down occurs. To the extent there is no evidence that it is probable that some or all of the facility will be drawn down, the fee is capitalized as a pre-payment for liquidity services and amortized over the period of the facility, to which it relates. Annual interest rate on bank overdrafts varies from 1% to 2.5% over the Kuwait Central Bank’s discount rate.
b) Accounts payable and other credit balances held by the ACICO group in 2011 KD 13,483,521, as against KD 11,720,482 in 2010. This Balance sheet head includes the short term debts that will, during the current financial period, cause an economic outflow from the entity. Accounts payable are recognized initially at moderate price and subsequently measured at amortized cost using the effective interest method.
c) Gross amount due to customers for contract work held by the ACICO group KD 709,652 in 2011, as against KD 1,625,447 in 2010. It represents the net amount of costs incurred plus recognized profits, less progress billings for all contracts in progress and the sum of recognized losses. Cost comprises direct materials, direct labor and an appropriate allocation of overheads. For contracts, where progress billings recognized profit (less recognized losses) plus exceed the costs incurred, the excess is included under liabilities.
d) Due to related parties held at the balance sheet date by the ACICO group KD 3,161,166 in 2011, while KD 5,822,112 in 2010. The Group can enter into various transactions with related parties, which might include the shareholders, key management personnel, associates and other related parties in the normal course of its business concerning financing and other related services. Since the obvious control that the related party exercises over the organization thus the prices and terms of payment are approved by the Group’s management.
e) Loans, held at the balance sheet date by the ACICO group, summed up to KD 128,522,930in 2011, whereas there were KD 127,186,886 in 2010. The term loans approximately carries interest ranging from 2.5% to 3.5% per annum over the Kuwait Central Bank’s discount rate, DIBOR and EIBOR as of December 31, 2011. Since loans need to be guaranteed for the safety of the lending institution thus, the following methods of securitizing are used:
- Promise to complete a first degree pledge for investments available for sale
- Promise to complete a first degree pledge for investment in associates
- Investment properties
- Promise to complete a first degree pledge for investment property
- Promise to complete a first degree pledge for Fixed assets
f) Provision for end of service indemnity held at the balance sheet date by ACICO group was KD 1,097,331 in 2011 and KD 990,276 in 2010. Provisions are the amounts of doubtful debts, which the management assumes the business will not probably be able to recover and thus, the balance sheet item gets doubtful and for that very purpose a liability is booked in the shape of provision.
Apart from the assets and liabilities of a balance sheet, Equity is also present in it. This represents the share of the Owner or, in other words, the stake that the owner retains in its own business. Keeping in mind that each individual shareholder owns the business thus, all of the stakes of the shareholders appear on the balance sheet as equity including the Reserves kept in the books of the organization, for example, the revaluation reserve, which accumulates in the balance sheet as a result of subsequent upwards movement in the value of the Fixed Assets or other specific Non-Current assets held at the balance sheet date by the company. These all accumulate to build a complete balance sheet, which in turn constitutes a major part of the financial statements of the organization reviewed rigorously by all the stakeholders trying to get their own specific related information to fulfill their needs and requirements.
Difference of Balance Sheet IFRS or U.S. GAAP
The world’s accounting system is either based on International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). GAAP is used generally in the United States, where IFRS is mainly used in European Union and other countries. Many countries have their own accounting systems, where many companies do not follow either system. The two primary systems have some differences in them, which affect the preparation of financial statements. These differences are mainly in accounting treatment or assumptions. The main philosophy behind each system is similar except of few differences, from which key differences are discussed below.
Regarding cosmetic differences, International Accounting Standard 1 (IAS 1) does not prescribe a particular format for presentation of financial statements. As a result, multiple formats have evolved in practice. The presentation of the balance sheet in many countries that are, or were, members of the British Commonwealth use the format: Assets – Liabilities = Stockholders’ Equity, rather than the U.S. format of Assets = Liabilities + Stockholders’ equity. In addition, balance sheet items are shown from the least liquid to the most liquid, the reverse of the U.S. format. The example of a cosmetic difference is usage of different words to refer to identical financial statement item. A few examples with the international term followed by the U.S. counterpart are: Stocks Inventory, Turnover Sales, Share Issue Premium Additional Paid-in Capital, Share Capital – Common Stock or Paid-in Capital, Creditors Accounts Payable, Debtors Accounts Receivable, Revenue Reserves Retained Earnings.
Basis of property, plant, and equipment
IFRS: May use either revalued amount or historical cost. Revalued amount is fair price at a date of revaluation less impairment losses and subsequent accumulated depreciation.
US GAAP: Usually demanded to use historical cost.
Recognition of deferred tax assets
IFRS recognizes only if realization of tax benefit is ‘probable’. US GAAP always recognizes, but a valuation allowance is provided unless realization is ‘more likely than not’. Further, applying the ‘more likely than not’ criterion through the use of a valuation allowance results in disclosure differences between IAS 12 and SFAS 109.
Measurement of impairment loss
IFRS based on the recoverable amount (the higher of the asset’s value-in-use and fair value less costs to sell). US GAAP is based on fair value.
IFRS capitalizes, if certain criteria are met. US GAAP expense (except for certain costs associated with developing internal use software and certain website development costs).
Subsequent expense on purchased in-process R&D
If IFRS meets the definition of development, it capitalizes. US GAAP expenses out.
Revaluation of intangible assets
If the intangible asset trades in an active market, IFRS permits. US GAAP generally prohibits.
Measuring minority interest
IFRS ascertains Minority’s percent of fair values. US GAAP ascertains Minority’s percent of carrying amount (book values) on acquired company’s books.
IFRS recognizes immediately as a gain. US GAAP initially allocate on a pro rata basis against the carrying amounts of certain acquired non-financial assets, with any excess recognized as an extraordinary gain.
Loans and receivables
Classification is not driven by a legal form under IFRS, whereas legal form drives the classification of “debt securities” under the US GAAP. The potential classification differences drive subsequent measurement differences under IFRS and US GAAP aims for the same debt instrument. Loans and receivables may be carried at different amounts under the two frameworks.
US GAAP IFRS
A worldwide effective tax rate is used to record interim tax provisions under the US GAAP. Under IFRS, a separate effective tax rate is used for each Tax basis.
Under IFRS, a single asset or liability may have more than one tax basis, whereas there would generally be only one tax basis per asset or liability under the US GAAP.
Differences in consolidation can arise as a result of:
• Differences in how economic benefits are evaluated when the consolidation assessment considers more than just voting rights (i.e., differences in methodology)
• Specific differences or exceptions, such as:
-- The consideration of variable interests
-- De facto control
-- How potential voting rights are evaluated
-- Guidance related to de facto agents and related parties
-- Reconsideration events
The differences are too much in revenue recognition. The US GAAP highlights the main concepts of Revenue recognition and provides extensive set of rules to be followed, where IFRS majorly explained the Revenue recognition in a generalized manner and do not provides comprehensive rules. The US GAAP does not allow accounting of revenue until the price of revenue is set and no contingency left in a transaction. As opposed, IFRS allows recognizing revenue when it is probable that the economic benefit will flow to the entity and that the amount of revenue can be reliably measured. IFRS does not set details of industry specific revenue recognition, were the US GAAP provides significant treatments on industry specific recognition. This can lead to a discussion, where IFRS allows recognizing revenue earlier as compared to the US GAAP, which prohibits such a treatment.
The main difference arises in construction contract, which applies in ACICO Industries Co. The IFRS allows percentage completion method for recognizing revenue for constructing contract, and thus, ACICO Industries Co. recognizes the revenue in accordance with the percentage of completion method of accounting. Thus, if the price can reliably be measured by the ACICO Industries Co., it may recognize the revenue as per IFRS. As opposed, if the US GAAP would have been followed, the price of the transaction must be set and known to the parties, where significant reliance on probabilities are not allowed. US GAAP do not allow the percentage completion method.
IFRS (IAS 2) does not allow LIFO (last-in-first-out) measurement of inventories, while the US GAAP does. This is a huge difference as the operating results and cash flows might be significantly different according to IFRS than the US GAAP. Cost is determined on a weighted average basis in ACICO Industries Co. If the accounting be followed under the US GAAP, ACICO may determine the cost on LIFO basis, which currently is not affecting accounts of ACICO Industries Co. as the US GAAP allows determining the cost on the weighted average basis.
The measurement of inventory might vary, when cost is greater than market (US GAAP) or net realizable value (IFRS).
P.S. The PNL change impact does also affect the Balance sheet, as the PNL is closed in Balance sheet and eventually the Balance sheet footings are changed significantly.