Chapter 3 • Financial statements and their interpretation
It should be said that the approach to accounting that is taken in the UK is, in prin-
ciple, very much the same as is taken throughout the world. Larger UK companies
must comply with International Financial Reporting (Accounting) Standards, set up
by the International Accounting Standards Board. This is also true of larger businesses
throughout the European Union and in an increasing number of other countries. The
objective is that all of the world’s larger businesses should adopt a common set of
accounting rules. There is a tendency for smaller businesses to follow the accounting
practices of their larger counterparts.
The intention of this chapter is not to provide a detailed course in accounting,
but to give a broad overview of the subject. This should be useful in later chapters
because reference will be made to the value of accounting information and the use of
accounting ratios. If you feel that you would like to look at the subject in greater detail
you could take up the suggestions for further reading that are given at the end of this
chapter.3.2 The financial statements
We shall now take a look at the financial statements. These will be explained in
the broadest way. Some of the points that will be made about the statements will
be qualified in the next section when we consider the rules that underpin the
statements.
Businesses that trade as companies are required to produce the financial statements
annually. Most businesses actually produce these statements much more frequently
for their own internal purposes. The statements are often used by managers as aids to
financial planning in that the data that they contain will be based on plans and fore-
casts. The published statements are, of course, based on past events.The income statement
The income statement(or profit and loss account) is a statement that sets out a sum-
mary of the trading events that will have affected the wealth of the business over a
particular period, the amount by which each type of event has affected wealth, and the
resulting net effect on wealth. The statement also goes on to show how any net
increase in the business’s wealth over the period has been deployed.
Wealth in this context is not restricted to cash. It is all the things that have
economic value to the business, net of such obligations that the business may have
to outsiders in respect of any part of its wealth. Things that have economic value to
the business (assets) include, for example, an office building owned by the business
and the money owed to it by a customer who has bought some of the business’s
output on credit. Outside obligations would include an amount owed to a loan
notes holder.
We shall now look at an example of an income statement. Jackson plc is an
imaginary manufacturing business that is listed on the London Stock Exchange.
The nature of the business’s marketing strategy is that goods are made to order
so there are never any inventories (stock) of finished goods. The form of financial
statements varies from one business to the next. The layout that is shown here is‘