Including references in the South African Companies Act
What are financial statements?
Financial statements are written records that report information about a business’s financial performance and activities during a given period of time, and its financial position at a specific point in time, providing an overall picture of the financial health of the business.
Components of a complete set of financial statements.
According to IAS (International Accounting Standards) 1, a complete set of financial statements include the following written records:
- A statement of financial position, also known as the balance sheet, at the end of a given financial period.
- A statement of profit or loss and other comprehensive income for a specific financial period, such as financial year or quarter.
The statement can be presented in one of two ways:
- as a single statement, or
- a separate statement of profit and loss, commonly called the income statement, immediately followed by a statement presenting comprehensive income beginning with profit or loss.
- A statement of changes in equity for the financial period involved.
- A statement of cash flows for the financial period.
- Notes, including noteworthy accounting policies and other explanatory notes, as well as comparative information as required by IAS 1.
The balance sheet
The balance sheet, also referred to as the statement of financial position, indicates the financial position of a business at a specific point in time, which is generally the end of a financial year.
The balance sheet comprises three segments, namely assets, liabilities, and equity, expressed as the accounting equation[1], also called the balance sheet formula: Assets = Liabilities + Equity. The equation indicates that the assets of a business are financed by liabilities (debt) and shareholders’ equity.
The equation can also be expressed as, Equity = Assets – Liabilities, meaning equity represents the difference between the assets and the liabilities.
- Assets[2]
An asset refers to something that a business owns or controls. Assets are categorised into current assets, also called short-term assets and long-term assets.
Current assets, such as cash, cash equivalents, and accounts receivable, can be liquidated fairly quickly. Long-term assets include assets such as property, plant, and equipment (PP&E), vehicles, and office equipment and furniture.
Typically, assets are listed on the balance sheet in order of liquidity.
- Liabilities
Liability refers to money a business owes to someone or some entity, such as creditors (suppliers of goods or services) and lenders, such as banks and other financial institutions.
Liabilities are classified into two types of liabilities, namely current liabilities, also known as short-term debt or non-current liabilities, and long-term liabilities, also known as long-term debt.
Liabilities are reported in the order in which they will be paid. Hence, current liabilities, that are payable within a year or less, are listed first. Examples of short-term debt are accounts payable, short-term loans, and taxes payable.
Conversely, non-current assets, such as bonds and long-term loans, are debts expected to be paid in over one year or more.
- Equity[3]
Equity also referred to as shareholders’ equity, is the amount of money a company owes to its shareholders (owners). Put in other words, equity refers to the amount of capital that is available for the owners, if all of the assets were liquidated to pay off all the outstanding debt.
Retained earnings are part of shareholders’ equity, reflecting the number of net earnings that is retained (held) by the company for future use. Put differently, it is the number of net earnings that were not distributed to shareholders as dividends.
The income statement
Contrary to the balance sheet, the income statement covers a period of time, such as a quarter or a year, indicating the financial performance of a business in terms of net profit or net loss.
The income statement, also called the statement of profit and loss, provides an overview of a business’s operations, typically, in the following sequence:
- Revenue[4] (sales) (referred to as the top line of the income statement).
- Cost of goods sold (COGS) or services rendered.
- Gross profit (= revenue less cost of goods sold).
- Other income (loss).
- Expenses[5].
- Net profit (earnings) or loss (= gross profit plus other income (loss) less expenses).
Statement of changes in equity
The statement of changes in equity, also called the statement of retained earnings, reports the movement in owners’ equity during a specific financial period.
Put another way, the statement reconciles the starting and closing balances of a company’s equity during a certain financial period, depicting the sources of the equity, as well as where the equity egresses the company.
Items contributing to changes in equity are:
- Net profit or loss as reported in the income statement.
- Dividends distributed to shareholders.
- Proceeds from shares issued.
- Share capital repaid.
- Profits and losses recognised directly in equity, such as revaluation surpluses.
- Effects of changes due to the following:
- errors in prior periods,
- adjustments in the fair value of certain assets,
- changes in accounting policy, and
- corrections of accounting errors.
Usually, this is a type of statement that is not included in the internal or management financial statements of a company. However, it is a common part of the annual financial statements.
Statement of cash flows
The statement of cash flows also referred to as the cash flow statement (CFS), reports the movement in cash of a company during a given financial period. The cash flow (movement of cash) is classified into three components, namely operating activities, investing activities, and financing activities.
Express differently, the CFS enables the stakeholders of a company to recognise how effectively a company generates money to fund its operating activities, pay-off its debt obligations, and fund investments.
- Operating activities reflect the cash flow (in and out) from the primary operations of a business. Cash from operations comprise, inter alia, any changes made in cash, accounts receivable and payable, decreases or increases in inventory, expenses (such as rent, interest, wages) income tax payments, and money received from sales of goods and services.
- Investing activities indicate the cash flow from, among others, the following transactions:
- the purchase and sale of assets, such as fixed assets like vehicles, and property, plant, and equipment (PP&E),
- payments involved in mergers or acquisitions, and
- loans to or from individuals and entities.
- Financing activities show the cash flow generated from investors (shareholders) and lenders (banks and other financial institutions). In addition, financing activities comprise the following:
- repurchases of shares,
- dividends paid,
- interest on debt, and
- repayments of debt.
The cash flow statement complements the balance sheet and the income statement. However, the CFS can be difficult to compile, hence, it is more frequently issued to outside parties.
Notes to the financial statements
According to the first standard of the International Accounting Standards (IAS 1), the notes to the financial statements must meet the following requirements:
- ‘present information about the basis of preparation of the financial statements[6] and the specific accounting policies used,
- disclose any information required by IFRSs [International Financial Reporting Standards] that is not presented elsewhere in the financial statements, and
- provide additional information that is not presented elsewhere in the financial statements but is relevant to an understanding of any of them.’
The importance and purpose of financial statements
Generally, the purpose of financial statements is to provide information about the financial position, financial performance, and cash flows of a business or an entity, enabling a wide range of users and stakeholders to make informed economic decisions.
Furthermore, financial statements allow stakeholders and other users to:
- utilise accounting ratios[7] (financial ratios), determining whether a business:
- is profitable (profitability ratios[8]), and
- is able to pay back its short-term and long-term debts (liquidity ratios[9] and coverage ratios[10]),
- identify opportunities for growth,
- investigate specific business transactions as described in the notes to the financial statements, and
- discover any warning signs of possible future financial problems.
References in the South African Companies Act concerning financial statements
The Companies Act (Act 71 of 2008) of South Africa (hereafter referred to as the Act), states that financial statements include, inter alia, the following types of statements:
- annual financial statements,
- provisional financial statements,
- interim (preliminary) reports, and
- group and consolidated financial statements (when a group of companies is involved).
Furthermore, the Act comprises various sections with regard to financial statements. (This article will focus on some of the content of a number of the related sections.)
Section 4
Regarding the solvency and liquidity test that is required from companies, any financial information to be considered must be based on financial statements that satisfy the requirements of section 29 of the Act.
Section 24
Section 24 (3) requires that every company must keep the annual financial statements, required by the Act, ‘for seven years after the date on which each such particular statement were issued.’
Section 28
According to section 28 (1), a company is obliged to ‘keep accurate and complete accounting records in one of the official languages of the Republic [of South Africa] in order to satisfy its obligations ‘with respect to the preparation of financial statements.’
Section 29
In section 29, the Act covers financial statements in particular, regulating in section 29 (1) that any financial statements provided by a company must:
- satisfy the prescribed financial reporting standards as to form and content,
- ‘present fairly the state of affairs and business’ of the company, explaining ‘the transactions and financial position of the business of the company,
- indicate the assets, liabilities, and equity of the company and, additionally, its income and expenses, ‘and any other prescribed information,’
- display the date on which the statements were created, as well as ‘the accounting period to which the statements apply,’
- carry, on the first page of the statements, a clearly visible notice that indicates:
- whether the statements:
- ‘have been audited in compliance with any applicable requirements’ of the Act,
- If not audited, ‘have been independently reviewed in compliance with any applicable requirements’ of the Act,
- ‘have not been audited or independently reviewed,’ and
- ‘the name, and professional designation, if any, of the individual who prepared, or supervised, the preparation’ of the statements.
Section 29 (2) requires that financial statements, including annual financial statements, not be:
- ‘false or misleading in any material respect, or
- incomplete in any material particular.’
In section 29 (3), a company is authorised to provide ‘any person with a summary of any particular statements’, on condition that:
- any summary is in accordance with any prescribed requirements, and
- the first page of the summary must indicate prominently:
- that it is a summary of specific financial statements prepared by the company with the date of the statements,
- whether the summarised financial statements have been audited, unaudited, or independently reviewed,
- ‘the name, and professional designation, if any, of the individual who prepared, or supervised the preparation of the financial statements that are summarised, and
- the procedure required to obtain a copy of the summarised financial statements.
Section 30
Section 30 deals with annual financial statements, stating in section 30 (1) that a company is required to prepare annual financial statements within six months after the end of its financial year, ‘or such shorter period as may be appropriate to provide the required notice of an annual general meeting.’
Section 30 (2) requires that annual financial statements:
- of a public company be audited, or
- regarding any other company:
- be audited, if so, required by certain regulations and under certain circumstances, such as the annual turnover and nature and extent of the business’s activities,
- be audited voluntarily, if so, decided by the company, or
- be independently reviewed in a manner that satisfies the regulations made by the Minister of Finance regarding the different categories of companies, ‘unless exempted if it is a private company.’
Section 30 (3) states that the annual financial statements of a company must include the following reports:
- an auditor’s report (if the statements are audited),
- a director’s report concerning the ‘state of affairs, the business, and profit or loss of the company,’ including:
- any important information, enabling the shareholders to value the company’s state of affairs, and
- ‘any prescribed information.’
In addition, section 30 (3) sets the following requirements:
The annual financial statements:
- must be approved by the board of directors and signed by an authorised director, and
- ‘be presented to the first shareholders meeting after the statements have been approved by the board.’
Section 30 (3) deals further with the disclosure of the remuneration of the directors in the financial statements.
Section 31
Section 31 regulates the access to financial statements or related information, stating in section 31 (1) that any person ‘who holds or has a beneficial interest in any securities issued by a company,’ is granted the right to:
- without demand, ‘receive a notice of the publication of any annual financial statements of the company required by this Act,’ in which the steps required to acquire a copy of the statements are described,
- on-demand, ‘receive without charge one copy of any annual financial statements of the company required by this Act.’
Section 61
Section 61 deals with shareholder’s meetings, specifying in section 61 (8) that a public company must present on an annual general meeting of its shareholders, its ‘audited financial statements for the immediately preceding financial year.’
Section 62
Section 62 (3) regulates that a notice of an annual general meeting (AGM) of a company must include:
- ‘a summarised form of the financial statements to be presented,’ and
- directions on how the complete annual financial statements for the preceding financial year can be obtained.
Section 77
Section 77, the liability of directors and prescribed officers, warns in section 77 (3) that a director of a company ‘is liable for any loss, damages, or costs sustained by the company as a direct or indirect consequence of the director having signed, consented to, or authorised the publication of any financial statements that were false or misleading in a material respect.’
Section 88
According to section 88 (2) the duties of a company secretary include, among other duties:
- ‘certifying in the company’s annual financial statements whether the company has filed required returns and notices in terms of the Act’ and
- ‘ensuring that a copy of the company’s financial statements is sent … to every person who is entitled to it.’
Section 89
Section 89 (2) allows a company secretary who is removed from office by the board of directors, to require the company to include a statement in its financial statements, ‘setting out the company’s secretary’s contention as to the circumstances that resulted in the removal.’
[1] See the article, ‘The Accounting Equation Explained for Dummies,’ for more information about the equation.
[2] See the article, ‘Assets Explained for Dummies,’ for additional information.
[3] The article, ‘Equity Explained for Dummies,’ provides more information about shareholders’ equity.
[4] See the article, ‘The Difference Between Earnings and Revenue Explained for Dummies,’ for more detail.
[5] More information about and examples of expenses can be found in the article, ‘Expenses Explained for Dummies.’
[6] Accentuations in citations from the International Accounting Standards (IASs) and the Companies Act are by the article writer.
[7] See the article, ‘Accounting Ratios Explained for Dummies,’ for more information.
[8] The article, ‘Profitability Ratios in Accounting Explained for Dummies,’ explains profitability ratios in detail.
[9] See the article, ‘Liquidity Ratios in Accounting Explained for Dummies,’ for a detailed explanation of liquidity ratios.
[10] The article, ‘Coverage Ratios in Accounting Explained for Dummies,’ provides more information about coverage ratios.
