ACCOUNTING AND FINANCIAL STATEMENTS

In accounting, it is always assumed that a business is a 'going concern', i.e. that it will continue indefinitely into the future - which means that the current market value of its fixed assets is irrelevant, as they are not for sale. Consequently, the most common accounting system is historical cost accounting, which records assets at their original purchase price, minus accumulated depreciation charges. In times of inflation, this understates the value of appreciating assets such as land, but overstates profits as it does not record the replacement cost of plant or stock. The value of a business's assets under historical cost accounting - purchase price minus depreciation- is known as its net book value. Countries with persistently high inflation often prefer to use current cost or replacement cost accounting, which values assets (and related expenses like depreciation) at the price that would have to be paid to replace them (or to buy a more modern equivalent) today.

Company law specifies that shareholders must be given certain financial information. Companies generally include three financial statements in their annual reports.

The profit and loss account (GB) or income statement (US) shows income and expenditure. It usually gives figures for total sales or turnover and costs, expenses and overheads. The first figure should obviously be the highest, i.e. there should be a profit. Part of the profit goes to the government in taxation, part is usually distributed to shareholders (stockholders) as a dividend, and part is retained by the company.

The balance sheet shows a company's financial situation on a particular date, generally the last day of the financial year. It lists the company's assets, its long-term and short-term liabilities, and shareholders' (stockholders') funds. A business's assets include debtors as it is assumed that these will be paid. Companies also have intangible assets, whose value is difficult to quantify or turn into cash, such as goodwill, patents, copyrights and trade marks. Liabilities include creditors, as these will have to be paid. Long-term liabilities are usually loans and bonds; short-term liabilities include accrued or accumulated expenses that have not yet been paid such as taxes and interest. Negative items on financial statements, such as creditors, taxation, and dividends paid, are either enclosed in brackets or preceded by a minus sign.

In accordance with the principle of double-entry bookkeeping (that all transactions are entered as a credit in one account and as a debit in another), the basic accounting equation is Assets = Liabilities + Owners' (or Shareholders') Equity. This can be rewritten as Assets- Liabilities = Owners' Equity or Net Assets. This includes share capital (money received from the issue of shares), share premium (GB) or paid-in surplus (US) (any money realized by selling shares at above their nominal value), and the company's reserves, including retained profits from previous years. Shareholders' equity or net assets are generally less than a company's market capitalization (the total value of its shares at any given moment, i.e. the number of shares times their market price), because net assets do not record items such as goodwill.

The third financial statement has various names, including the funds flow statement, source and application of funds statement (GB), and the statement of changes in financial position (US). This shows the flow of cash in and out of the business between balance sheet dates. Companies often distinguish between operating activities, and financing and investment activities. Sources of funds include trading profits, depreciation provisions, sales of assets, borrowing, and the issuing of shares. Applications of funds include purchases of fixed or financial assets, payment of dividends, repayment of loans, and - in a bad year -trading losses.

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