Financial Analysis and Valuation

Lecture 2
Ignacio García de Olalla

(Pettersen, Plenborg & Kinserdal Ch.2)

Introduction to financial statements and bookkeeping
Introduction to Financial Statements and
Bookkeeping

• The key elements of financial statements:

1. Income statement
2. Statement of financial position (Balance)
3. Cash flow statement
4. Statement of changes in owners’ equity (Endringer i konsernets
egenkapital)
5. Notes, comprising a summary of significant accoutning policies and
other explanatory information
The Income Statement
(Resultatregnskap)
• It discloses a firm’s earnings for a predefined period (in general 12
months).

• In general:
Revenues (inntekter)
- Expenses (kostnader)
= Earnings (fortjeneste)

• Definitions:
• Income: increases in economic benefits during the accounting period in the form of
inflows or enhancements of assets or decreases of liabilities that result in increases in
equity, other than those relating to contributions from equity participants.

• Expenses: decreases in economic benefits during the accounting period in the form of
outflows or depletions of assets or incurrences of liabilities that result in decreases in
equity, other than those relating to distributions to equity participants.
 The Income Statement
(Resultatregnskap)
• As a minimum, the income statement must include the following items:
• Revenues
• Finance costs
• Share of the profits or loss of associates and joint ventures accounted for using the equity
method
• Post tax profit or loss of discontinued operations
• Tax expenses

• Certain items must be disclosed either in the income statement or in its notes if
they occur:
• Write-downs of inventories to net realisable value (or reversals) (nedskrivninger).
• Write-downs of property, plant and equipment to recoverable amounts (or reversals)
• Provisions for restructurings of the activities of an entity or reversals (avsetninger).
• Disposals of PPE
• Disposals of investments
• Discontinuing of operations
• Litigation settlements (rettssaker)
• Other reversals of provisions
 The Income Statement
(Resultatregnskap)
• In addition, firms must present an analysis of expenses either by nature or by
function (see Table 2.1 in textbook)

Nature of expense method Function of expense method

Revenue Revenue
Other income Cost of sales
Gross profit
Changes in inventories of finished
goods and work in progress
Employee benefits expenses Selling and distribution costs
Depreciation and amortisation Administrative expenses
Other expenses Other income
Total expenses Other expenses
Profit Profit

• If a firm uses the function of expense method, it must report in the notes additional
information about the nature of expenses (depreciation, amortisation, employee
benefits).
The Income Statement (Resultatregnskap)
The Statement of Comprehensive Income
(utvidet resultat)

• It presents all income and expenses items, whether or not these are
recognised in the income statement.
o Changes in revaluation surplus.

o Actuarial gains and losses on defined benefit plans.

o Exchange differences on translating the financial statements of foreign

operations.

o Gains and losses on re-measuring available-for-sale financial assets.

o The effective portion of gains and losses on hedging instruments in a cash

flow hedge.

o Income tax relating to other comprehensive income.

 The Balance Sheet (Balansen)
• A summary of a firm’s financial position at a specific point in time showing a firm’s total
investments (assets) and how these have been financed (liabilities and equity).

• Total Assets (eiendeler)= Total Liabilities (Gjeld) + Total Equity (egenkapital)

• Assets and liabilities are divided into current and non-current.

• Current assets (omløpsmidler): those that satisfy one or more of the following:
• Expected to be realised in, or intended for sale or consumption within an operating cycle
• Held primarly for trading purposes
• Expected to be realised within 12 months after the reporting date
• Cash or cash equivalent

• Current liabilities (kortsiktig gjeld): those that satisfy any of the following:
• Expected to be settled within an operating cycle
• Held primarly for trading purposes
• Expected to be realised within 12 months after the reporting date
• The firm does not have an unconditional right to defer settlement of the liability for at least 12 months
after the reporting date.
The Balance Sheet (Balansen)
• Basic classification:
Assets
Property, plant and equipment
Investment property
Intangible assets
Financial assets
Investments accounted for using the equity method
Biologial assets
Inventories
Trade and other receivables
Cash and cash equivalents
Liabilities and Equity
Trade and other payables
Provisions
Current interest-bearing liabilities
Tax liabilities and tax assets
Deferred tax liabilities
Non-current interest-bearing liabilities
Minority interests
Issued capital and reserves
 The Balance Sheet

• Different industries might need to present information in a different manner.

• An accountant must choose whether to present additional items based on:

• The nature and liquidity of assets
• The function of the assets within the entity
• The amounts, nature and timing of liabilities.
 The Cash Flow Statement
(Kontantstrømoppstillingen)

• It reports a company’s sources and uses of cash, and the net change in the company’s cash
resulting from the firm’s operating, investing and financing activities, for the period the
statement was prepared for.

• It provides help to assess a company’s ability to generate cash and to see how this cash is
being employed.

• Help discover earnings quality. Correlation with earnings?

• Important for our course.

• Check Table 2.6.

 Statement of Changes in Owners’ Equity
(Endringer i konsernets egenkapital)
• It reconciles equity at the beginning of the period with equity at the end.
• Retained earnings

• Revaluation of reserves

• Certain items that bypass the income statement (for example some currency translations, or some fair
value adjustments)

• Increases in share capital and share repurchases.

• Why for us?

• Some items may bypass the income statement and be recognised directly as equity. These items might
have to be reclassified as part of operating income.

• In addition, are the changes in equity due to the operations of the firm or to transactions with the
owners?
 Recording Transactions and Preparing
Financial Statements
• Every transaction that is recorded consists of at least one debit and one credit
record.

• The total amount of debits must equal the total amount of credits per transaction.

• T-accounts: Title of Account

Debit side Credit side
Dr. Cr.

• IMPORTANT:
• Balance sheet accounts: left side represents resources owned by the firm. Right side
represents claims for owners or third parties.

• Income statement accounts: left side represents expenses. Right side represents
revenues.
 Recording Transactions and Preparing
Financial Statements

• Let’s do some examples:

1. A firm rents an office for 100 and pays either in cash a) or on account b).

2. A firm purchases inventory for 700 and pays either in cash a) or on account b).
 Recording Transactions and Preparing
Financial Statements

3. A firm sells a product for 200 to a client, who either pays cash a) or on account b).

4. A firm borrows 100.

 Recording Transactions and Preparing
Financial Statements

5. Investors pay-in additional share capital 0f 1 000 000.

6. Now, let’s go together through Example 2.1 in the textbook.