Question

(INTRODUCTION TO FINANCIAL MANAGEMENT)

Question 2

a) Distinguish between any TWO (2) types of financial information contained in the various financial statements in Malaysian corporation.

b) Explain any FIVE (5) type of valuable information that may be found in the notes to financial statements.

c) Describe a situation in which the information in the notes would be essential to making an informed decision about the value of a company.

Answer 1

Answer a)

The financial information of a corporation is generally contained within a set of financial statements. The main/primary statements include standard reports like the Balance Sheet, the Income Statement (also known as the Statement of Profit or Loss), the Cash flow Statement and the Statement of Shareholders’ Equity. In addition to these, the financial statements also include the Notes to the Financial Statements, the Financial Statement Ratio computations, the Auditors' Report and the Report by the Board of Directors/Management.

We differentiate below between the information contained in the two major financial statements, i.e. the Balance Sheet and the Income Statement.

• On the basis of Timing:
  • The Balance sheet shows what a company owns (Assets) and owes (Liabilities) at a specific moment in time and is hence issued "as at the date".
  • The Income statement shows total revenues and expenses for a period of time and is hence issued "for the period/year".
• On the basis accounts transferred:
  • Accounts that are transferred to the balance sheet are not closed as on the reporting date.
  • Accounts that are transferred to the income statement are closed as on the reporting date.
• On the basis of Items reported
  • The Balance sheet is a statement that shows a detailed listing of assets, liabilities, and equity showing the financial condition of a company on a given date.
  • The Income statement shows the summarized view of revenues and expenses of a particular accounting period.
• On the basis of Use:
  • The Balance sheet is analysed/used to determine if the company has enough assets to meet financial obligations.
  • The Income statement is analysed/used to evaluate performance.
• On the basis of Creditworthiness:
  • Lenders will use the Balance sheet to see if they should extend any more credit
  • They use the income statement to decide on whether or not the business is making enough profit to pay its liabilities.

Answer b)

The Notes to the Financial statements are supplemental notes that are added to the reported financial statements of the corporation. They make important discloures that explain the numbers included in the financial statements and the accounting policies adopted by the company. They help different types of users, such as financial analysts and investors, to interpret the financial statements. The notes may also provide information on issues relating to the overall financial health of the company. Common notes to the financial statements include accounting policies, depreciation of assets, inventory valuation, subsequent events, etc.

The following information contained in the notes may prove to be of value to the users of the financial statements -

1. Accounting policies - This section provides information on the accounting policies adopted by the management of the Corporation in preparing the financial statements. Some of the disclosures made here are the depreciation method used, how the company values inventory, accounting for intangibles, etc. All the accounting policies adopted in the financial statements must be disclosed in the section
2. Depreciation of assets - This section provides information on the method adopted by the company when depreciating the assets, which may cause significant fluctuations between the net income in the income statement and the asset values reported in the balance sheet. Information on the depreciation method in the notes informs the users of such differences in net incomes reported in the financial statements.
3. Valuation of inventory - The valuation of inventory note informs users how the company valued its inventory, making it easy for them to compare inventory figures from one period to another or comapre to other competing entities. The section provides information on two main inventory issues, i.e., how inventory amount is stated and the method used to determine inventory cost.
4. Subsequent events - The notes also provide information on any subsequent events. Subsequent events refer to events that occur after the balance sheet date but before the release of the financial statements. How the company handles the events depends on whether they are recognized or unrecognized, and accordingly, whether they affect the financial statements or not.
5. Contingent liability - A contingent liability refers to liability that has not occurred, but the conditions are favorable for the liability to occur in the future. An example of a contingent liability is a lawsuit against the company or an income tax dispute. Disclosing the contingent liabilities informs users that the company will incur a loss in the future if the impending event ends up against the company’s favor.

Answer c)

As seen in the above section , the information contained in the Notes to the financial statements is essential for the users of the financial statements. Analysis of the notes would be essential to making an informed decision about the value of a company, while evaluating future investments in the company.

Any investor contemplating making an investment in the Company would need to analyse the Notes to the Financial Statements to ensure compliances to the GAAP, as disclosed by the Accounting Policies, since non-compliance could lead to various legal/regulatory problems, which could prove detrimental to the appreciation of the investment value.

The investor must also carefully consider the information provided regarding the depreciation of assets and the valuation of inventories as these form the bulk of the assets of the Company and are thus the actual underlying value of the Company. The information regarding the intangible assets provided must also be analysed to ensure that there is sufficient technological capacity within the company to ensure growth.

Similarly, information regarding the subsequent events, and the contigent liabilities of the company must also be carefully analysed to provide a view of the immediate expected projections and their possible losses to the company, that may prove to detrimental to the appreciation of the investment value.

Thus, the future investor may use the information in the notes to make an informed decision about the value of a company.