Balance Sheets

Hi Thistleandspice,

The share premium account appears on your balance sheet. It is the difference between the par value of a company's shares and the amount that the company actually received for newly issued shares.

This is a bit of revision from CT2. Why not have a look at http://moneyterms.co.uk/share-premium-account to refresh your memory.

However, it’s not a significant issue for Subject ST7 so I’d save it until after the exam!

Be careful not to confuse the P&L and the Balance Sheet.

The Balance Sheet gives a snapshot of the company’s financial position, at the accounting date 31/12/11 say.

The P&L tells you how the company progressed over the year up until the accounting date, from 31/12/10 to 31/12/11. So it tells you how the company managed to get from the previous Balance Sheet to the current Balance Sheet.

Now to answer your question:

It doesn’t make sense to say “the Profit and Loss account makes up the shareholders’ funds”. The P&L is a list of all the things that made up the company’s profit during the previous year. The shareholders’ funds is an item in the Balance Sheet; it is the total amount of “spare” assets (in excess of the liabilities) that the company has got. So you can think of the shareholders’ funds as the sum of all the years of retained profit (not just the most recent year’s retained profit).

Similarly, it doesn’t make sense to say “the Profit and Loss account is the same as some amount”. The P&L tells you how the company managed to arrive at the RETAINED profit. In other words, the P&L is a list, and the retained profit is one item (the last item) in that list.

I’ve attached an explanation of how GEP relates to GWP. Have a look at it and then read the rest of this explanation.

Part (ii) of this question assumes that GWP=GEP because we’re given no information about previous year’s business, so we may as well assume that the business is stable, ie neither expanding or contracting.

Part (i) of this question makes no assumption about GEP because it is irrelevant. The only time when any idea of earned or unearned premium makes it into the balance sheet is to calculate the reserves, eg UPR. To calculate the UPR, you don’t need to know what was earned, only how much is still unearned.

 

Hi Thistle,

Oh I see where you’re coming from! You’re worried about all the bits that make up the Balance Sheet!

Have a look at page 14 of Chapter 24. This explains what each item means.

In the exam, you invariably only need to worry about a very simple Balance Sheet, that doesn’t give a breakdown of all the components of the shareholder’s funds. This is why I said in my previous post that you can think of the shareholders’ funds as the sum of all the years of retained profit.

To answer your question more specifically, yes, you are correct, the "profit and loss account" part would be equal to the sum of all retained profits.

Where have you seen this? Free reserves are not a liability. Can you check again?

Better go back and check. I think you’ve got your bits mixed up. Free reserves is the difference between Total assets and total liabilities. Shareholders’ net assets would be another name for free reserves.

Any reasonable layout for a balance sheet is likely to score marks. I tend to use:

Current liabilities
UPR net of DAC
AURR
Outstanding claims reserve
Total liabilities

Shareholders’ funds

Total assets

Good luck!

Katherine.

 

Hi Thistle,

The April 2011 Examiners' Report isn't very clear in my opinion, and I have to say, it is rather unusual!

It would be far clearer if they wrote:

Assets
Investments s
Current assets t
DAC u

Total assets v

Liabilities
OCR w
AURR x
UPR y
Current liabilities z
Total liabilites w+x+y+z

Free reserves v - total liabilities

I've done a quick google and you can see a few real-life balance sheets which agree with me:

http://www.admiralgroup.co.uk/pdf/annualreports/2011/sources/index.htm (page 55)

http://www.catlin.com/en/Investors/Key-financial-data/Balance-sheet

Definitely not. See below.

If acquisition costs are 20% of GWP say, then DAC will be 20% of UPR.

When you calculate expenses paid, you need to calculate ALL expenses paid. Then you can add back in the benefit for DAC later (or in your EP entry).

(If you only include non-acquisition expense in your expenses paid entry, then you won't be including any entry anywhere for your acquisition expenses.)

Thistle, it sounds to me like you have a lot of questions on this topic. The best way to get to grips with this is to practice questions. I recommend you look at the Q&A Bank, where there are plenty of questions for you to get stuck into.

You should try to work out the answers yourself, and spot the common rules / techniques that are used time and again in every question.

Good luck!

Katherine.