7-Finance and Accounting

📖 DISCLOSURE REQUIREMENTS

Annual Report

An annual report is a formal document that big companies (especially public corporations) must prepare every year.

• Public corporation = a company whose shares can be bought by anyone on the stock exchange.
• Shareholders = people who own shares (small ownership pieces) in the company.

👉 The annual report shows:

• what the company did during the year,
• how much money it made or lost,
• and its financial health.

Why? Because shareholders want to know:

• Is the company making profit?
• Is it safe to keep my money invested here?
• Should I buy, sell, or hold my shares?

If a company is listed on a stock exchange (like Karachi Stock Exchange, New York Stock Exchange, etc.), there are extra disclosure rules. These exchanges want to protect investors by forcing companies to be transparent (open about their operations and finances).

📑 What’s Inside an Annual Report?

Here’s what it normally contains:

1. General corporate information – name, address, history, and background of the company.

2. Operating and financial highlights – main achievements and important numbers from the year.

3. Narrative text, graphics, and photos – explanations, charts, and visuals to make it easier to understand.

4. Management’s discussion and analysis (MD&A) – where the managers explain the company’s performance, challenges, and future outlook.

   • This is like the CEO’s commentary on how the business is going.

5. Financial statements – the main money reports:

   • Balance Sheet (snapshot of what company owns and owes at one moment),
   • Income Statement / Profit & Loss Account (shows profit or loss over a period),
   • Cash Flow Statement (tracks cash coming in and going out).

6. Auditor’s Report – an external accountant (auditor) reviews the numbers and confirms they are reliable.

7. Summary of financial data – key numbers, usually compared across several years.

8. Accounting policies – the rules and methods the company uses for preparing its accounts (for example, how it calculates depreciation).

👉 In short, the annual report is like a report card of the company.

📊 Balance Sheet

A balance sheet is one of the financial statements in the annual report.

👉 It shows:

• Assets = what the company owns.
• Liabilities = what the company owes.
• Net worth / Equity = assets minus liabilities (what would be left for owners if everything was sold and debts paid).

It’s called a snapshot because it shows the financial position at one point in time (usually the last day of the company’s financial year).

Net Worth

This is the value of the company if:

• it sold everything it owns (assets),
• paid off everything it owes (liabilities),
• and kept the leftover.

👉 Example: If Jemima owns assets worth Rs.500,000 and owes Rs.300,000, her net worth = Rs.200,000.

Depreciation

Depreciation = the gradual reduction in the value of fixed assets over time because they wear out, get used, or become outdated.

Standard accounting practice is:

• Each year, reduce the value of fixed assets in the balance sheet to show they’re losing value.

🏢 Assets

Assets = things the company owns that have value. They are divided into two big categories:

1. Fixed Assets

• Long-term things the company keeps and uses to run its business.
• Examples: land, buildings, machinery, vehicles, computers, office furniture.
• They are not bought to be sold in everyday business.
• Value shown = purchase price – depreciation.

👉 Example: A delivery van used by a shop = fixed asset.

2. Current Assets

• Short-term items that can be turned into cash quickly (within a year).
• Examples: cash, accounts receivable (money customers owe the company), inventory (stock of goods to sell).
• Value shown = cost price or market price, whichever is lower (conservative approach in accounting).

👉 Example:

• A bookstore has 1,000 books.
• Each book costs Rs.2 to produce, sells for Rs.10.
• In the balance sheet, the stock is shown as Rs.2,000 (cost), not Rs.10,000 (selling price).
• Why? Because until they are sold, you cannot count the profit.

📌 Important Distinction Example

• If a company buys a car for its sales staff → it’s a fixed asset (used in business operations).
• If a car dealer buys a car to resell → it’s a current asset (part of inventory for sale).

✅ So to recap in simple terms:

• Annual report = company’s yearly progress card.

• Balance sheet = picture of what company owns and owes at one moment.

• Assets = valuable things company owns.

  • Fixed assets = long-term use (machines, land).
  • Current assets = short-term, easily turned into cash (inventory, cash itself).

• Depreciation = fixed assets lose value over time.

• Net worth = how much owners would have if everything was sold and debts paid.

📝 Questions to Check Your Understanding

1. Why do companies prepare annual reports?
2. What’s the main difference between a balance sheet and an income statement?
3. Explain in your own words what depreciation means.
4. Why are inventory items shown in the balance sheet at “cost price or market value, whichever is lower”?
5. If a company buys a computer for Rs.100,000 and it will last 5 years, how will its value appear in the balance sheet after year 2 (straight-line depreciation)?

📉 Depreciation

Straight Line Method

• Depreciation = the way companies spread out the cost of an asset (like machines, computers, cars) over the years it will be useful.
• Instead of recording the full cost immediately, you divide it evenly across its life.

👉 How it works:

1. Decide how many years the asset will be useful.
2. Divide its cost by that number of years.
3. Subtract that amount each year from the asset’s value.

This is called the straight-line method because the value decreases by the same amount each year.

Example:

• Database server cost = Rs.100,000.
• Useful life = 5 years.
• Annual depreciation = 100,000 ÷ 5 = Rs.20,000.

Balance sheet values each year:

• End of Year 1 → Rs.80,000.
• End of Year 2 → Rs.60,000.
• End of Year 3 → Rs.40,000.
• End of Year 4 → Rs.20,000.
• End of Year 5 → Rs.0.

So, by year 5, the asset has “used up” its value.

Historic Cost

• Historic cost = the original purchase price of an asset, not its current market price.
• Assets are usually recorded in the balance sheet at this cost (minus depreciation).

Selling above depreciated value

If the company later sells the server for more than its depreciated value:

• The difference is considered income (profit).

Example: Server after 3 years = book value Rs.40,000. If sold for Rs.50,000 → Rs.10,000 profit is shown in income.

Intangible vs Tangible Assets

• Tangible assets = physical things (computers, buildings, cars).
• Intangible assets = non-physical but useful things (software, patents, brand reputation).

Example in your notes:

• A payroll software package (intangible).
• Even though it’s not physical, it helps in daily operations for many years.
• Logically, it should also be depreciated.
• BUT many companies treat software as a current expense (spend it all in the year they buy it), even though rules allow depreciation.

💰 Working Capital

• Working capital = current assets – current liabilities.
• It measures how much money a company has for running day-to-day operations.

👉 If it’s positive, the company can pay its short-term bills easily. 👉 If it’s negative, the company may struggle to cover daily expenses.

Example:

• Current assets = Rs.500,000 (cash, stock, receivables).
• Current liabilities = Rs.300,000 (short-term debts, payables).
• Working capital = Rs.200,000. This Rs.200,000 is the “buffer” the company has to keep things running smoothly.

🧾 Creditors

• Creditors = people or institutions the company owes money to.
• If repayment is due in more than 1 year → long-term creditors (like bank loans).
• If repayment is due within 1 year → short-term creditors (like unpaid supplier bills).

So “creditors: amounts falling due after one year” = debts the company must pay back in the long term.

📌 Called-up Share Capital & Share Premium

Share Capital

• When a company issues (sells) shares, investors pay money in exchange for ownership.
• The par value (or face value) = the nominal, basic value printed on the share (e.g., Rs.10 per share).

Called-up share capital = the actual money raised from issuing these shares.

Share Premium

• Often, shares are sold at a price higher than the par value.
• The extra money paid by investors (over par value) = share premium.

Example:

• Par value of a share = Rs.10.
• Company sells it for Rs.15.
• Rs.10 goes into called-up share capital.
• Rs.5 goes into share premium account.

📊 Profit and Loss Account (a.k.a. Income Statement)

• Shows income and expenses over a given period (usually a year).
• Tells if the company made a profit or loss.

⚠️ Important:

• It does not include money raised from loans or selling shares.
• It also does not include buying big fixed assets (like buildings or machinery) → those go into the balance sheet and get depreciated.

So, it only focuses on operational income and expenses.

💵 Cash Flow Statement

This is the bridge between:

• the balance sheet (what you own and owe), and
• the profit and loss account (how much you earned and spent).

It shows:

• Cash that actually came in (from sales, loans, share issues).
• Cash that actually went out (to pay suppliers, salaries, loan interest, new assets).

👉 Cash = not just physical notes. It includes:

• money in the bank,
• short-term highly liquid investments,
• minus overdrafts (when you take more out of your bank than you have).

✅ So in easy terms:

• Depreciation = spreading cost of assets over years.
• Historic cost = original purchase price.
• Working capital = money left for daily use (current assets – current liabilities).
• Creditors = people/businesses you owe money to.
• Called-up share capital = money raised by selling shares at par value.
• Share premium = the extra money above par value.
• Profit and Loss Account = summary of income and expenses → profit or loss.
• Cash Flow Statement = real cash movements in and out.

📝 Questions to Test Yourself

1. What is the difference between depreciation and working capital?
2. Why do companies record assets at historic cost rather than current market value?
3. A machine costs Rs.50,000 and lasts 10 years. Using straight-line depreciation, what is its value in the balance sheet after 3 years?
4. If a company issues shares of par value Rs.10 but sells them at Rs.18, how much goes into called-up share capital and how much into share premium?
5. Why is the profit and loss account not the same as the cash flow statement?