Statement of changes in equity: its contents and informational aims

The statement of changes in equity shows a detail of the changes of the equity from the beginning to the end of the year.

The main reason for the equity to change is, as explained in section 4.3 above, due to the retained profit contribution to the distributable reserves. However, many other events can affect the equity. When reading an annual report you must be aware of the following most common reasons for changes of the equity:

o Issue of new shares. In this case the increases of share capital and share premium reserve are balanced by an increase in cash and debtors

o Revaluation of properties. In this case the increase of the revaluation reserve is balanced by an increase in value of the non current assets

o Changes in value of certain financial instruments. This occurs when some financial instruments, such as shares, derivatives, etc., are treated at their 'fair value through profit and loss'. The matter is regulated by IAS 39 and is, at the moment of writing this study guide, subject to a 'relaxation' of this rule

o Changes due to translation from foreign currencies. This derives from the changes in value of assets and liabilities which are denominated in different currencies in the subsidiaries that are part of the reporting entity and had to be 'translated' into the reporting currency. This translation might have created losses of gains from one year to the other.

Refer to your chosen annual report and read the statement of changes in equity. To make sense of it, you will need to read some of the relevant notes to the accounts, on the other hand you might find that some of the items are very technical, but this should not impede your effective insight in the reporting entity's movements of equity.

Analysis and interpretation of the annual report

The narrative component of the annual report

As we have seen so far, the annual report provides its readers with a large amount of information about the performance and situation of the reporting entity. You can think of all this information as different 'lenses' through which to analyze the same object, i.e. the reporting entity. As any tool, also these 'lenses' can be used effectively or misused, hence some guidance on how to use them must be sought.

This is provided by the abundant information that is normally contained in the narrative parts of the annual report. The directors' report, the operating and financial review and the other possible sections of the annual report provide different keys to interpret the figures reported in the accounts. Your interpretation of the accounts must consider these proposed views, but should also be critical of them.

On the one hand, it is widely recognized among analysts that the more information is included in the annual report, which can ease the insight in the performance and situation of the entity, the less uncertainty and risk are attached to the entity's values and prospective performance. On the other hand, the very nature of this information allows the directors to steer the attention of the readers towards certain results as opposed to others, biasing their judgment about the performance and situation of the entity. A typical example occurs when an increase in turnover is highlighted, whilst its negative effects on the profitability are not mentioned. Another example is provided by directors pointing the attention to the underling performance of the year, but neglecting that 'exceptional' events have completely undermined it during the financial year - or vice versa according to what makes the picture more convenient.

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