Annual accounts – an overview of the financial year

Is your company a success or failure? Annual accounts, also known as statutory accounts, show a company’s financial position over the span of the fiscal year. Es­tab­lish­ing your business’s finances is important for you, and to make sure you are complying with tax laws. A precise as­sess­ment of your financial situation is also important in­form­a­tion for en­tre­pren­eurs when un­der­tak­ing future planning. Here we explain exactly what the ac­count­ing term means, and what preparing annual financial state­ments should look like.

Statutory accounts are regulated by the Financial Reporting Council (FRC), Companies House and Her Majesty’s Revenue & Customs (HMRC). The aim of creating an annual is to compile and process in­form­a­tion on a company’s economic situation. There are two goals:

1. In­form­a­tion about the results of op­er­a­tions, financial position, and cash flows of an or­gan­isa­tion
2. This in­form­a­tion is used to estimate the liquidity, funding, and debt position of an entity, and is the basis for a number of liquidity ratios

Annual accounts are required by law for share­hold­ers (if you have a publicly traded company) and for HMRC, as they may use your financial state­ments in their tax as­sess­ments. Statutory accounts show how high a company’s profits or losses are and can be then used to calculate cor­por­a­tion tax.

The primary aim of preparing annual accounts for publicly traded companies, however, is to inform share­hold­ers and potential investors. Annual accounts are filed as part of your company’s annual report. Financial state­ments for a public company must be made available to all share­hold­ers and general meeting attendees, and must be filed annually with HMRC and Companies House. In­ter­ested parties, like share­hold­ers or potential investors, can use this in­form­a­tion to assess how secure their in­vest­ments are, or would be, in the company.

Deadlines are usually based around your company’s ac­count­ing reference date (ARD), this means the last day of the month of their in­cor­por­a­tion an­niversary; the filing re­quire­ment begins a year after formation and continues until the company is dissolved. Annual accounts are also important for internal com­mu­nic­a­tion. An overview of a company’s financial situation means that there is ac­count­ab­il­ity. Man­age­ment is obliged to prove how and to what extent capital has been used. The different groups involved in a company (share­hold­ers, investors, etc.) can measure the success or failure of their man­age­ment by this. That is why the detailed listing of all items in the balance sheet and income statement (the two main com­pon­ents of annual accounts) is so important. The result isn’t the only thing that counts: a bad business appraisal does not ne­ces­sar­ily mean that those re­spons­ible have done a bad job. Only an in depth look at the exact figures can reveal where the errors lie.

As pre­vi­ously mentioned, all publicly traded companies are required to prepare and publish annual reports including annual accounts. All companies are legally obliged to file their company’s accounts with Companies house, as per reg­u­la­tions stated in the Companies Act of 2006. They must also submit their annual accounts to HMRC as part of their Company Tax Return. Small and micro-entities are allowed to submit an abridged version of their accounts to Companies house (see here for more in­form­a­tion). Sole traders are not legally required to file annual accounts with Companies House, but it is re­com­men­ded that they prepare a balance sheet and profit & loss account each year for your own re­cord­keep­ing.

As well as publicly traded companies, LLCs and cor­por­a­tions are required to file annual financial reports to their Secretary of State. It is important to find out what the state reg­u­la­tions are in each state your business operates, as many of these have different rules.

Your profit and loss account reveals the economic successes or failures of your company, which is why this statement is also called an income statement. For the final amount, you offset income against expenses but list all items in detail. In this way, it is easy for third parties to trace which com­pon­ents have led to profit or loss.

The balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report. As such, this statement has both an asset and a liability element. The basis for the balance sheet is the trial balance where all ledger accounts are listed according to closing value. Finally, all quantity in­form­a­tion is omitted from the balance sheet and only monetary value plays a role. At the end, a balanced equation must be clear, both sides must have the same value i.e. total assets must equal the total li­ab­il­it­ies plus the equity. Equity is composed of capital, ad­di­tion­al paid-in capital, and retained earnings (profit from previous years).

Whilst not a legal ob­lig­a­tion, it is common practice for companies that submit annual accounts to include ad­di­tion­al notes. These notes provide further in­form­a­tion on the contents of the balance sheet and income statement, ful­filling four functions:

• In­ter­pret­a­tion: These notes provide in­form­a­tion that explains the balance sheet and income statement in more detail. Results can be in­ter­preted better when the methods used are explained clearly.
• Clarity: To ensure that the results of the balance sheet and income statement are not mis­un­der­stood, ad­di­tion­al notes can provide cla­ri­fy­ing in­form­a­tion. A mis­un­der­stand­ing can occur if an in­ac­cur­ate financial picture is painted, and following clear guidelines can ensure that there is no confusion. This applies to both positive and negative cir­cum­stances.
• Credit: To keep the balance sheet and income statement clear, certain data is sometimes removed or omitted. In order to make sure that in­ter­ested parties can still obtain an accurate, com­pre­hens­ive picture of the current economic climate within a company, trans­fer­ring missing in­form­a­tion to the appendix notes is an option.
• Additions: Ad­di­tion­al notes can also be used if in­form­a­tion from the balance sheet and income statement is in­suf­fi­cient to present an accurate picture. Dis­clos­ures relating to items not eligible for inclusion in the balance sheet may be moved to the appendix notes.

Balance sheet policies can also be used to present the company. Le­gis­la­tion only has minimum in­form­a­tion re­quire­ments, but in no way does it prohibit ad­di­tion­al in­form­a­tion. Any statement that better explains the financial situation of a company is welcomed by the au­thor­it­ies – provided that the prin­ciples of clarity and coherence are adhered to.

Although there is no mandatory sequence of entries, certain struc­tures have become es­tab­lished in financial ac­count­ing. Your approach to the balance sheet and income statement should start with general in­form­a­tion. Which methods did you use? This is followed by ex­plan­a­tions of the annual financial statement’s two main com­pon­ents. Entries should, however, appear in the same sequence on both the balance sheet and the income statement. You can then add any other in­form­a­tion to your notes that is not included in the first two cat­egor­ies.

Of­ten­times, companies will include a man­age­ment report with their statutory accounts to help better assess a company’s future de­vel­op­ment. This man­age­ment report puts words behind the numbers provided in the income statement and balance sheet. The function of an operation review is ul­ti­mately to provide in­form­a­tion and ac­count­ab­il­ity.

In contrast to the financial state­ments, which focuses more on present­ing data and figures, man­age­ment reports are used for analysis and com­ment­ary. If your statutory account is being published and dis­trib­uted to share­hold­ers, aspects of the op­er­a­tions review will likely be touched on in the initial letter from the company director. Man­age­ment reports often include the following aspects:

• Strategic man­age­ment: This section is intended to present the course of business taken during the financial year and the company’s position. The chief executive and financial manager will often provide insight, along with a general market overview. This is an op­por­tun­ity for the company to express an opinion on the strategic future of the business.
• Risk and forecast report: This part of the report presents the expected de­vel­op­ment of the company – but not without sub­stan­ti­at­ing it first with un­der­ly­ing as­sump­tions. Planned ini­ti­at­ives will also be addressed. Third parties should be able to assess the plaus­ib­il­ity of the in­form­a­tion and comments. The forecast should cover at least one year.
• Report on financial risks: The report provides in­form­a­tion on risk man­age­ment measures. Potential financial risks for the company are also discussed here.
• Research and de­vel­op­ment plans: The in­form­a­tion in this part of the op­er­a­tions report provides an overview of the company’s research and de­vel­op­ment activ­it­ies. Although this area can be rep­res­en­ted by the expenses incurred, the expected profit can only be estimated. Planned research ini­ti­at­ives in the future are also included in this section of the report.
• Branch office report: If your company has multiple branches or offices around the country or abroad, it may be worth including their in­form­a­tion if they are organized sep­ar­ately from head office. Including this in a report can provide an insight into the geo­graph­ic­al spread of the company and might include in­form­a­tion about in­vest­ments and employee numbers in these branches.
• Re­mu­ner­a­tion report: This report is intended to provide trans­par­ency for share­hold­ers and as a result, is only relevant for publicly traded companies making this in­form­a­tion public. It provides in­form­a­tion on the re­mu­ner­a­tion of the Executive Board, the Su­per­vis­ory Board, the Advisory Board, and their former members.
• Report on a takeover situation: Publicly listed companies and part­ner­ships limited by shares must provide potential bidders with an overview of any possible takeover. Obstacles like re­stric­tions on voting rights and powers of the Board of Man­age­ment are also addressed.
• Internal control and risk man­age­ment: This section clarifies which methods are used to safeguard and mitigate the risk of fraud and in­ac­cur­ate reporting. Company auditors will test and report internal controls as part of the annual audit. 
• Directors, Executive Officers and Corporate Gov­ernance: The text is intended to provide an insight into corporate man­age­ment practices. This consists of a de­scrip­tion of and in­form­a­tion on practices that go beyond the legal re­quire­ments and – in the case of public limited companies – in­form­a­tion on diversity in bodies. In contrast to the rest of the man­age­ment report, there is no need to audit a corporate gov­ernance statement. The auditor just has a critical-reading ob­lig­a­tion to check the document for in­con­sist­en­cies.

This statement, also known in­ter­na­tion­ally as the statement of retained earnings in the US, is an integral part of annual accounts for capital market-oriented companies. The aim of the statement of changes in equity is to reflect changes in equity – and in all its com­pon­ents – between two balance sheet dates. All changes (i.e., not just successes) in the company should be listed. State­ments of changes in equity use the contents of the income statement to provide context for the balance sheet. State­ments of changes in equity are required by the In­ter­na­tion­al Financial Reporting Standards (IFRS) in cases when com­par­at­ive balance sheets and income state­ments are provided together. Whilst there is no reg­u­la­tion under com­mer­cial law for how this document should be struc­tured, they generally include the following items:

• Issued capital
• Capital reserve
• Retained earnings
• Re­valu­ation reserves
• Retained earnings
• Annual profit

This in­form­a­tion is ac­cu­mu­lated on the basis of values from the previous years’ key date and shows all events from there that have led to changes. At the end, the figures of the last key date should be displayed. This results in a clear table that includes all changes in equity.

A complete statutory account also includes a cash flow statement. Even if you, as an en­tre­pren­eur, are not required to prepare a cash flow statement, it is still re­com­men­ded that you do so: the aim of the cal­cu­la­tion is to show the cash flows between two reporting dates. For example, a cash flow statement provides in­form­a­tion on the movements of all accounts that affect liquidity and provides more in­form­a­tion on the flow of money within a company than the statutory accounts with the balance sheet, income statement and notes can.

The cash flow statement is divided into three totals:

• Cash flow from operating activ­it­ies
• Cash flow from investing activ­it­ies
• Cash flow from financing activ­it­ies

The cash flow can be cal­cu­lated using two different methods, the direct method and the indirect method.

The original or direct method of cash inflows and outflows is based on the cash flows directly in the re­spect­ive business trans­ac­tions. This means that you can calculate the cash flow statement directly from all incoming and outgoing payments – the balance results in the cash flow statement. In this case, the items are marked according to their purpose:

Using this method, the in­form­a­tion for the cash flow statement is de­term­ined from the annual accounts. To do this, you first adjust the income statement for all non-cash business trans­ac­tions (like de­pre­ci­ation). Only the first part of the cash flow statement (cash flow from operating activ­it­ies) changes as a result: cash flows from investing and financing activ­it­ies are generally de­term­ined directly.

The aim of segment reporting is to provide in­form­a­tion on the in­di­vidu­al business segments of a company. This enables third parties to gain a better insight into the areas and therefore better assess the op­por­tun­it­ies and risks of in­vest­ment than is possible with the data from the income statement and balance sheet alone. Complete segment reporting is only mandatory for publicly traded companies that are required to prepare financial state­ments.

• The in­di­vidu­al segments result from the internal or­gan­isa­tion­al structure of the company. If there are different internal segments, the company has to choose the one that best rep­res­ents the op­por­tun­it­ies and risks. IFRS 8 requires an entity whose debt or equity se­cur­it­ies are publicly traded to disclose in­form­a­tion to enable users of its financial state­ments to evaluate the nature and financial effects of the different business activ­it­ies in which it engages and the different economic en­vir­on­ments in which it operates. IFRS 8 requires judgement in its ap­plic­a­tion. Man­age­ment should consider the key principle as it de­term­ines its segment dis­clos­ures rather than relying on a set of rules. The key concept is that the entity should provide in­form­a­tion used by man­age­ment that will allow users to un­der­stand the entity’s main activ­it­ies, where those activ­it­ies are located and how well those activ­it­ies are per­form­ing.

Segments whose op­por­tun­it­ies and risks are the same can be combined. The reason for this is that it is re­com­men­ded to only list 10 segments in total in the report. The aim is to keep segment reporting as clear as possible and still provide a com­pre­hens­ive picture of the company. It is easy to dif­fer­en­ti­ate between a primary and secondary reporting format, since segments are created once by a business sector and once re­gion­ally. The accrual/deferral type, which better rep­res­ents the op­por­tun­it­ies and risks, is auto­mat­ic­ally assigned to the primary reporting format. If this cannot be clearly de­term­ined, business segments are generally primary and regions are generally secondary segments.

• General in­form­a­tion
• In­form­a­tion about the re­port­able segment; profit or loss, revenue, expenses, assets, li­ab­il­it­ies, and the basis of meas­ure­ment
• Re­con­cili­ations
• Entity-wide dis­clos­ures

Whilst there is no set way to present your segment report, one of the most popular ways is in tabular form. You don’t just enter the current values, but also the previous year’s values, so that third parties can get the most com­pre­hens­ive im­pres­sion possible. Following the principle of con­sist­ency, you should choose the same display format in each period. Since you have to ac­com­mod­ate for both report formats, choose either the single-level or com­bin­at­or­i­al type.

In single level seg­ment­a­tion, the primary and secondary report formats are listed one below the other:

The com­bin­at­or­i­al display form, on the other hand, links the two seg­ment­a­tions and displays them in a matrix:

Statutory accounts always consists of at least a balance sheet and a profit and loss statement. In addition, the Generally Accepted Ac­count­ing Prin­ciples (GAAP) should be followed. These are generally accepted rules that apply not only when you are preparing statutory accounts, but also in general ac­count­ing. It must be possible for an in­de­pend­ent third party to un­der­stand the in­form­a­tion provided.

Pay attention to these rules when preparing your Statutory accounts:

• Reliable, veri­fi­able, and objective: For example, showing land at its original cost of £10,000 (when it was purchased 50 years ago) is con­sidered to be more reliable, veri­fi­able, and objective than showing it at its current market value of £250,000. Eight different ac­count­ants will wholly agree that the original cost of the land was £10,000 – they can read the offer and ac­cept­ance for £10,000, see a transfer tax based on £10,000, and review documents that confirm the cost was £10,000. If you ask the same eight ac­count­ants to give you the land's current value, you will likely receive eight different estimates. Because the current value amount is less reliable, less veri­fi­able, and less objective than the original cost, the original cost is used.
• Con­sist­ent: You use con­sist­ency to make it easier to compare the financial state­ments of different periods. To do this, you use the same terms and schemas each year when creating financial state­ments. The type, value and quantity de­term­in­a­tion for in­di­vidu­al items should also remain the same year after year.
• Com­par­able: Investors, lenders, and other users of financial state­ments expect that financial state­ments of one company can be compared to the financial state­ments of another company in the same industry.

Miller Cor­por­a­tion

Miller City

Annual account for the financial year from 01.01.2018 to 31.12.2018

Balance

Assets

Li­ab­il­it­ies and owner’s equity

Profit and loss account

Please note the legal dis­claim­er relating to this article.