Chapter 3

Understanding
financial
statements

Slides by Prof J Krüger &

Prof C Rootman
Learning outcomes: Chapter 3
 identify the users of financial statements
 briefly describe the International Financial Reporting
Standards
 explain how the types of accounts may be classified
 record changes in the financial position
 summarise financial information in the financial statements
 interpret the auditors’ report and the directors’ report.

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Introduction
• Fair representation of firm’s financial performance and
position
• Public companies – annual shareholders’ report
 Letter to shareholders (chairperson of BoD)
 Summary of values of firm
 Mission statement
 Overview of performance – economic, environmental and
social conditions
 Financial statements
 Statement of financial performance
 Statement of financial position
 Statement of retained earnings
 Cash flow statement

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Introduction (cont.)
• Revenue vs Earnings after tax (EAT)
• Comparative statement
 Financial performance – 3 years
 Financial position – previous year
 Notes to statements

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Users of financial statements
• Shareholders – worth of interest in company as
shareholders provide equity financing
• Management – plan and control activities to achieve
objectives
• Lenders – assess likelihood of repaying funds
• Labour unions – wage negotiations
• Investment analysts – share valuation (over-, under- or
fairly priced)
• Government – tax payment
• Rating agencies (Moody’s, Fitch, S&P) – assess investment
grade and to issue credit ratings

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IFRS and GAAP
• IFRS – set of international accounting standards by
International Accounting Standards Board (IASB)
 Standardisation, uniformity and quality
• GAAP
 Accounting entity – transactions
for entity only to be recorded
 Money measurement – money as a
universal accounting denominator
 Conservatism – most conservative approach
 Consistency – changes need to be reported
 Materiality – not material in relation to nature and scope
of entity’s activities
 Historic cost – original cost of assets

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IFRS and GAAP (cont.)
 Double entry – assets vs how financed
 Going concern – continuity
 Accounting period – record income and expenses as
earned or incurred
 Realisation period – income earned should be
measurable
 Accrual principle – income earned (received or not)
recorded, expenses incurred (paid or not) recorded

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Classification of financial information
Types of accounts
based on purpose of
account

er
d g Financial position Financial performance
Le

Revenue (income)
Asset accounts
accounts

Liability accounts Expense accounts

Owners’ equity
accounts

Assets = Owners’ equity + Liabilities 8

Recording changes
• Transactions recorded on daily basis in ledgers

Figure 3.2:
The flow of information
Through the accounting
system

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Recording changes (cont.)
Table 3.1: The debit and credit rule
Type of account Rule
Assets
Liabilities
Owners’ equity
Revenue (income)
Expenses (cost)

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Summarising
Figure 3.1:
An example
of a statement of
financial
performances

Transactions
affecting more
than accounting
period – 2 types

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Summarising (cont.)
Example 3.1
• Cost R1 400 000
• Installation cost R 100 000
• Useable years 5
• Straight-line vs accelerated depreciation
• (R1 400 000 + R100 000) / 5 = R300 000 per annum

Year Percentage Amount

1 40%
2 30%
3 15%
4 10%
5 5% 12
Summarising (cont.)
Table 3.3: Example of a condensed statement of financial
performance

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Summarising (cont.)
Table 3.4: Example of an old-fashioned statement of financial
position

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Summarising (cont.)
Table 3.5: Example of the modern format of a statement of
financial position

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Cash flow statement
Table 3.6: An example of a cash flow statement

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Cash flow statement (cont.)
Table 3.7: An example of a statement of retained earnings

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Auditors’ report
• Annual financial statements were audited and fair
representation
• Dissatisfaction?
• Report qualified

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Directors’ report
• Overview of firm and state of affairs
 Nature of activities
 Profit or loss
 State of affairs
 Additional financing raised
 Major changes in nature of firm’s non-current assets
 Dividends paid and/or declared

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Financial management and accounting
• Handling of funds
 Financial accountant – use principles for recording
transactions (accrual principle – when transaction
occurs)
 CFO – firm’s liquidity and solvency, assessing need for
current and non-current assets (and how to finance
these assets)
• Decision making
 CFO analyses financial statements as provided by
financial account for decision making purposes
• Historical versus future orientation
 Statements provide information pertaining to past year
 Currently information used for future planning and
strategising
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Example – SG pg. 14
Referring to PEPKOR Holdings Limited (see Examples of open
questions for Chapter One). View the Annual Financial
Statements and answer the following questions:
(a) Identify the applicable accounting period of the latest
Annual Financial Statements.
(b) Consider the Directors’ report and identify whether there
was any movement in ordinary shares.
(c) What debt did PEPKOR obtain during the financial year?

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Example – SG pg. 14 (cont.)

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Example – SG pg. 14 (cont.)

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Example (cont.) – SG pg. 13
(a) 1 October 2023 to 30 September 2023
(b) Issued 17.1 million ordinary shares, repurchased and
cancelled 27.8 mission ordinary shares and sold 523 619
ordinary shares to a company within the group.
(c) PEP05 (three-year floating rate notes of R348 million at
three-month Jibar plus 123 bps) and PEP06 (five-year
floating rate notes of R850 million at three-month Jibar
plus 138 bps) were obtained.

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Preparation for next session
• Work through Chapter 3
• Questions in study guide
• Problems at the end of the chapter

• Read through Chapter 4 and download/print the

slides

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