Introduction to Financial Statements: Preparation and Presentation of Financial

Statements: Profit and Loss Statement, Balance sheet and Changes in Shareholders
Equity Statement.

Financial statements are reports that summarize the financial performance and
position of a company over a specific period. They are used by various
stakeholders, such as investors, creditors, regulators, and managers, to evaluate the
company’s profitability, liquidity, solvency, and efficiency. There are four main
types of financial statements:

 Profit and Loss Statement: This statement shows the revenues, expenses,
and net income (or loss) of a company for a given period. It measures the
company’s ability to generate profits from its operations. The basic formula
for the profit and loss statement is:

Net Income=Revenues−ExpensesNet Income=Revenues−Expenses

An example of a profit and loss statement for ABC Ltd. for the year ended
31 December 2023 is shown below:

Profit and Loss Statement for ABC Ltd.

Revenues

- Sales

- Interest income

- Other income

Total revenues

Expenses

- Cost of goods sold

- Selling and administrative expenses

- Interest expense
 Profit and Loss Statement for ABC Ltd.

- Income tax expense

Total expenses

Net income

Amount (in $)

500,000

10,000

5,000

515,000

300,000

100,000

20,000

39,000

459,000

56,000

 Balance Sheet: This statement shows the assets, liabilities, and equity of a
company as of a specific date. It reflects the company’s financial position
and the sources and uses of its funds. The basic equation for the balance
sheet is:

Assets=Liabilities+EquityAssets=Liabilities+Equity
An example of a balance sheet for ABC Ltd. as of 31 December 2023 is
shown below:

Balance Sheet for ABC Ltd.

Assets

Current assets

- Cash

- Accounts receivable

- Inventory

- Prepaid expenses

Total current assets

Non-current assets

- Property, plant and equipment

- Intangible assets

Total non-current assets

Total assets

Amount (in $)

50,000

80,000
 Amount (in $)

100,000

10,000

240,000

400,000

60,000

460,000

700,000

 Statement of Changes in Shareholders Equity: This statement shows the

changes in the equity components of a company over a period. It includes
the opening and closing balances of share capital, retained earnings, and
other reserves. It also shows the transactions that affect equity, such as
dividends paid, net income (or loss), share issuances or repurchases, and
other comprehensive income (or loss). The basic formula for the statement
of changes in shareholders equity is:

Closing Equity=Opening Equity+Net Income−Dividends+Share Issuances−Share

Repurchases+Other Comprehensive IncomeClosing Equity=Opening Equity+Net I
ncome−Dividends+Share Issuances−Share Repurchases+Other Comprehensive Inc
ome

An example of a statement of changes in shareholders equity for ABC Ltd. for the
year ended 31 December 2023 is shown below:

Statement of Changes in Shareholders Equity for ABC Ltd.

Share Capital

Opening balance
 Statement of Changes in Shareholders Equity for ABC Ltd.

Issued shares

Closing balance

Retained Earnings

Opening balance

Net income

Dividends paid

Closing balance

Other Reserves

Opening balance

Other comprehensive income

Closing balance

Total Equity

|| Amount (in $) ||
|:-------------------------------------------------------------|:------------------------------------
-------------------------| || || || 200,000 || || 50,000 || || 250,000 || || || || 100,000 || ||
56,000 || || (20,000) || || 136,000 || || || || 10,000 || || 4,000 || || 14,000 || || || || 400,000 ||

 Statement of Cash Flows: This statement shows the cash inflows and
outflows of a company from its operating, investing, and financing activities
over a period. It measures the company’s ability to generate and use cash for
its operations and growth. The basic formula for the statement of cash flows
is:
Net Cash Flow=Cash Flow from Operating Activities+Cash Flow from Inve
sting Activities+Cash Flow from Financing ActivitiesNet Cash Flow=Cash
Flow from Operating Activities+Cash Flow from Investing Activities+Cash
Flow from Financing Activities

An example of a statement of cash flows for ABC Ltd. for the year ended 31
December 2023 is shown below:

Statement of Cash Flows for ABC Ltd.

Cash Flow from Operating Activities

Net income

Adjustments for non-cash items

- Depreciation

- Amortization

Changes in working capital

- Increase in accounts receivable

- Increase in inventory

- Decrease in prepaid expenses

- Increase in accounts payable

Net cash provided by operating activities

Amount (in $)

56,000
 Amount (in $)

40,000

10,000

(20,000)

(30,000)

5,000

10,000

71,000

Cash Flow from Investing Activities

Purchase of property, plant and equipment

Purchase of intangible assets

Net cash used in investing activities

|| Amount (in $) ||
|:---------------------------------------|:---------------------------------------| || (100,000) || ||
(20,000) || || (120,000) ||

Preparation and presentation of financial statements are the processes of preparing

and presenting the financial information of a company in a standardized and
understandable format. The main steps involved in preparing and presenting
financial statements are:

 Identify the accounting policies and standards: The company should

follow the relevant accounting policies and standards that are applicable to
its industry and jurisdiction. These policies and standards provide the rules
and guidelines for measuring, recognizing, and disclosing the financial
 transactions and events of the company. For example, the company may
follow the International Financial Reporting Standards (IFRS) or the
Generally Accepted Accounting Principles (GAAP) depending on its
location and requirements.
 Record the financial transactions and events: The company should record
all the financial transactions and events that occur during the accounting
period in its books of accounts. These transactions and events include sales,
purchases, expenses, revenues, assets, liabilities, equity, dividends, etc. The
company should use the double-entry system of accounting, which means
that every transaction affects two accounts: one is debited and one is
credited.
 Adjust the financial records: The company should make adjustments to its
financial records at the end of the accounting period to reflect the true and
fair view of its financial performance and position. These adjustments
include accruals, deferrals, depreciation, amortization, impairment,
inventory valuation, bad debts, etc. The adjustments affect both the profit
and loss statement and the balance sheet.
 Prepare the financial statements: The company should prepare the four
main financial statements using the adjusted financial records. These
statements are: profit and loss statement, balance sheet, statement of changes
in shareholders equity, and statement of cash flows. The company should
follow a consistent format and presentation for each statement and provide
adequate notes and disclosures to explain the significant items and
assumptions.
 Audit and publish the financial statements: The company should have its
financial statements audited by an independent external auditor who verifies
the accuracy and completeness of the financial information. The auditor
issues an audit report that expresses an opinion on whether the financial
statements are prepared in accordance with the applicable accounting
policies and standards. The company should publish its audited financial
statements in its annual report or on its website for public access.

Some examples of interview questions along with solutions on preparation and

presentation of financial statements are:

 Q: What are some of the differences between IFRS and GAAP?

 A: Some of the differences between IFRS and GAAP are:
o IFRS allows more flexibility and judgment in applying accounting
policies than GAAP, which is more rule-based and prescriptive.
o IFRS uses a single-step format for the profit and loss statement, while
GAAP uses a multi-step format that separates operating income from
non-operating income.
o IFRS requires companies to present a statement of changes in equity
as a separate statement, while GAAP allows companies to include it
as part of the statement of shareholders equity or in the notes.
 o IFRS uses a single method for inventory valuation called first-in first-
out (FIFO), while GAAP allows companies to choose between FIFO
or last-in first-out (LIFO).
o IFRS does not allow companies to revalue their property, plant and
equipment to fair value, while GAAP permits it under certain
conditions.
 Q: How do you calculate depreciation expense for a fixed asset?
 A: Depreciation expense is the allocation of the cost of a fixed asset over its
useful life. There are different methods for calculating depreciation expense,
such as straight-line method, declining-balance method, units-of-production
method, etc. One of the most common methods is the straight-line method,
which assumes that the asset loses value at a constant rate over its useful
life. The formula for depreciation expense using the straight-line method is:

Depreciation Expense=Cost−Salvage ValueUseful LifeDepreciation Expens

e=Useful LifeCost−Salvage Value

For example, if a company purchases a machine for $100,000 with a salvage

value of $10,000 and a useful life of 10 years, then the depreciation expense
for each year using the straight-line method is:

Depreciation Expense=100,000−10,00010=9,000Depreciation Expense=101

00,000−10,000=9,000

 Q: How do you prepare a statement of cash flows using the indirect method?
 A: The statement of cash flows shows the cash inflows and outflows of a
company from its operating, investing, and financing activities over a
period. The indirect method starts with the net income from the profit and
loss statement and adjusts it for non-cash items and changes in working
capital to arrive at the cash flow from operating activities. Then it adds or
subtracts the cash flow from investing activities and financing activities to
get the net cash flow. The format for preparing a statement of cash flows
using the indirect method is:

Statement of Cash Flows

Cash Flow from Operating Activities

Net income

Adjustments for non-cash items

 Statement of Cash Flows

- Depreciation

- Amortization

- Gain or loss on sale of assets

- Changes in provisions

- Deferred taxes

- Etc.

Changes in working capital

- Increase or decrease in accounts receivable

- Increase or decrease in inventory

- Increase or decrease in prepaid expenses

- Increase or decrease in accounts payable

- Increase or decrease in accrued expenses

- Etc.

Net cash provided by or used in operating activities

Cash Flow from Investing Activities

Purchase or sale of property, plant and equipment

 Cash Flow from Investing Activities

Purchase or sale of intangible assets

Purchase or sale of investments

Interest received

Dividends received

Etc.

Net cash provided by or used in investing activities

Cash Flow from Financing Activities

Issuance or repayment of debt

Issuance or repurchase of shares

Dividends paid

Interest paid

Etc.

Net cash provided by or used in financing activities

| Net increase or decrease in cash || | Cash at the beginning of the period || | Cash at
the end of the period ||

Some more examples of interview questions along with solutions on preparation

and presentation of financial statements are:

 Q: What are the main components of the profit and loss statement and what
do they represent?
 A: The main components of the profit and loss statement are:
o Revenues: These are the inflows of economic benefits from the
company’s main activities, such as sales of goods or services, interest
income, dividend income, etc. They represent the amount of money
that the company earns from its customers or other sources.
o Expenses: These are the outflows of economic resources from the
company’s main or supporting activities, such as cost of goods sold,
selling and administrative expenses, interest expense, income tax
expense, etc. They represent the amount of money that the company
spends to generate revenues or to maintain its operations.
o Net income: This is the difference between revenues and expenses. It
represents the amount of money that the company retains as profit or
incurs as loss for the period.
 Q: What are the main components of the balance sheet and what do they
represent?
 A: The main components of the balance sheet are:
o Assets: These are the resources that the company owns or controls
that have future economic benefits, such as cash, accounts receivable,
inventory, property, plant and equipment, intangible assets, etc. They
represent the amount of money that the company expects to receive or
use in the future.
o Liabilities: These are the obligations that the company owes to others
that result from past transactions or events, such as accounts payable,
accrued expenses, loans, bonds, deferred taxes, etc. They represent
the amount of money that the company expects to pay or settle in the
future.
o Equity: This is the residual interest that the shareholders have in the
assets of the company after deducting all liabilities, such as share
capital, retained earnings, other reserves, etc. It represents the amount
of money that the shareholders have invested in or earned from the
company.
 Q: What are some of the common ratios that can be calculated from
financial statements and what do they measure?
 A: Some of the common ratios that can be calculated from financial
statements and what they measure are:
o Liquidity ratios: These measure the ability of a company to meet its
short-term obligations with its current assets. Examples are current
ratio and quick ratio.
 Current ratio = Current assets / Current liabilities
 Quick ratio = (Current assets - Inventory) / Current liabilities
o Solvency ratios: These measure the ability of a company to meet its
long-term obligations with its total assets. Examples are debt-to-
equity ratio and interest coverage ratio.
 Debt-to-equity ratio = Total liabilities / Total equity
  Interest coverage ratio = Earnings before interest and taxes /
Interest expense
o Profitability ratios: These measure the efficiency and performance
of a company in generating profits from its revenues and assets.
Examples are gross profit margin, net profit margin, return on assets,
and return on equity.
 Gross profit margin = (Revenues - Cost of goods sold) /
Revenues
 Net profit margin = Net income / Revenues
 Return on assets = Net income / Average total assets
 Return on equity = Net income / Average total equity
o Activity ratios: These measure how effectively a company manages
its assets and liabilities. Examples are inventory turnover, receivables
turnover, payables turnover, and asset turnover.
 Inventory turnover = Cost of goods sold / Average inventory
 Receivables turnover = Revenues / Average accounts
receivable
 Payables turnover = Cost of goods sold / Average accounts
payable
 Asset turnover = Revenues / Average total assets

I have searched the web for some websites that provide interview questions and
solutions on preparation and presentation of financial statements. Here are some of
the links that I found:

 45 Important Financial Statement Questions and Answers [With PDF]: This

website provides 45 questions and answers on various aspects of financial
statements, such as objectives, components, users, limitations, etc. It also
provides a PDF file for download.
 23 Financial Statements Interview Questions and Answers - Global
Guideline: This website provides 23 questions and answers on topics such as
current assets, loans, advances, fixed assets, investments, current liabilities,
provisions, miscellaneous expenditures, etc.
 MCQS on Financial Statements - Unacademy: This website provides
multiple choice questions on financial statements with four options each.
The answers are also given at the end of the page.
 Analysis of Financial Statements - Corporate Finance Institute: This website
provides a comprehensive guide on how to analyze financial statements,
covering the income statement, the balance sheet, the cash flow statement,
and rates of return. It also provides examples and templates for each
statement.

Here are some possible interview questions and answers for the financial
statements:
 What are the main components of the income statement?
o The income statement shows the revenues, expenses, and net income
of a company over a period of time. The main components are:
 Revenue: The amount of money earned from selling goods or
services to customers.
 Expenses: The costs incurred to generate revenue, such as cost
of goods sold, operating expenses, interest, taxes, etc.
 Net Income: The difference between revenue and expenses,
representing the profit or loss of the company.
 How does the balance sheet relate to the income statement?
o The balance sheet shows the assets, liabilities, and equity of a
company at a specific point in time. The balance sheet is linked to the
income statement through the following items:
 Retained Earnings: The cumulative net income of the company
that has not been distributed to shareholders as dividends.
Retained earnings increase or decrease by the amount of net
income or loss in each period.
 Depreciation and Amortization: The allocation of the cost of
fixed assets and intangible assets over their useful lives.
Depreciation and amortization reduce the value of assets on the
balance sheet and are also recorded as expenses on the income
statement.
 Working Capital: The difference between current assets and
current liabilities, representing the liquidity of the company.
Changes in working capital affect both the balance sheet and
the cash flow statement, which is derived from the income
statement.
 What are the three sections of the cash flow statement and what do they
measure?
o The cash flow statement shows how cash flows in and out of a
company from operating, investing, and financing activities. The
three sections are:
 Operating Activities: The cash flows related to the core
business operations of the company, such as revenue
collection, expense payment, inventory purchase, etc.
Operating activities reflect how well the company generates
cash from its products or services.
 Investing Activities: The cash flows related to the acquisition
or disposal of long-term assets, such as property, plant,
equipment, intangible assets, investments, etc. Investing
activities reflect how the company allocates its capital for
growth or maintenance purposes.
 Financing Activities: The cash flows related to the issuance or
repayment of debt, equity, or dividends. Financing activities
 reflect how the company raises or returns funds to its
shareholders or creditors.
 What is the statement of changes in equity and why is it important?
o The statement of changes in equity shows how the equity of a
company changes over a period of time due to various transactions.
The main components are:
 Share Capital: The amount of money raised from issuing
shares to shareholders.
 Share Premium: The amount of money received from
shareholders above the par value of shares.
 Reserves: The accumulated profits or losses from previous
periods that have not been distributed as dividends or
transferred to retained earnings.
 Retained Earnings: See above.
o The statement of changes in equity is important because it provides
information about how the company manages its capital structure and
dividend policy. It also shows how much value is created or Here are
some possible interview questions and answers for the financial
statements:
o What are the main components of the income statement?
o The income statement shows the revenues, expenses, and net income
of a company over a period of time. The main components are:
o Revenue: The amount of money earned from selling goods or
services to customers.
o Expenses: The costs incurred to generate revenue, such as cost of
goods sold, operating expenses, interest, taxes, etc.
o Net Income: The difference between revenue and expenses,
representing the profit or loss of the company.
o How does the balance sheet relate to the income statement?
o The balance sheet shows the assets, liabilities, and equity of a
company at a specific point in time. The balance sheet is linked to the
income statement through the following items:
o Retained Earnings: The cumulative net income of the company that
has not been distributed to shareholders as dividends. Retained
earnings increase or decrease by the amount of net income or loss in
each period.
o Depreciation and Amortization: The allocation of the cost of fixed
assets and intangible assets over their useful lives. Depreciation and
amortization reduce the value of assets on the balance sheet and are
also recorded as expenses on the income statement.
o Working Capital: The difference between current assets and current
liabilities, representing the liquidity of the company. Changes in
working capital affect both the balance sheet and the cash flow
statement, which is derived from the income statement.
 o What are the three sections of the cash flow statement and what do
they measure?
o The cash flow statement shows how cash flows in and out of a
company from operating, investing, and financing activities. The
three sections are:
o Operating Activities: The cash flows related to the core business
operations of the company, such as revenue collection, expense
payment, inventory purchase, etc. Operating activities reflect how
well the company generates cash from its products or services.
o Investing Activities: The cash flows related to the acquisition or
disposal of long-term assets, such as property, plant, equipment,
intangible assets, investments, etc. Investing activities reflect how the
company allocates its capital for growth or maintenance purposes.
o Financing Activities: The cash flows related to the issuance or
repayment of debt, equity, or dividends. Financing activities reflect
how the company raises or returns funds to its shareholders or
creditors.
o What is the statement of changes in equity and why is it important?
o The statement of changes in equity shows how the equity of a
company changes over a period of time due to various transactions.
The main components are:
o Share Capital: The amount of money raised from issuing shares to
shareholders.
o Share Premium: The amount of money received from shareholders
above the par value of shares.
o Reserves: The accumulated profits or losses from previous periods
that have not been distributed as dividends or transferred to retained
earnings.
o Retained Earnings: See above.
o The statement of changes in equity is important because it provides
information about how the company manages its capital structure and
dividend policy. It also shows how much value is created or
destroyed for shareholders over time.
o destroyed for shareholders over time.
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