FINANCIAL STATEMENTS ANALYSIS
Reclassified financial statements: the
Balance Sheet
TEACHING MATERIAL FOR THE
ADVANCED ACCOUNTING COURSE
PROF. G.MODUGNO
Why do Financial Statements need to be
reclassified?
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The reclassification of financial statements:
 
improves their capability to provide information to investors;
some choices taken by the Italian legislator are not consistent
with the purpose of the analysis;
 
allows to reduce the number of items in the financial
statements: this improves the understandability of the whole
picture;
 
allows to highlight some important margins in the Income
Statement, that are important to assess company’s
profitability.
RECLASSIFIED BALANCE
SHEETS
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THE FINANCIAL APPROACH AND THE
FUNCTIONAL APPROACH
Reclassified Balance Sheets
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Two alternative approaches can be used in order to reclassify the
Balance Sheet:
1. 
The “financial” approach, where assets and liabilities are classified
into two main categories, i.e. current and non current. This
approach aims at answering the question: “Is the financial position
balanced? Will the company be able to meet its obligations?”
2. 
The “functional” approach: assets are classified depending on their
destination (operating, financial) and sources of capital depending
on the subjects that provided the funds (shareowners or other
institutional investors). In this approach, trade payables and other
operating payables are subtracted from the assets, in order to
calculate the Net Invested Capital.
The Financial Approach for the
reclassification of the Balance
Sheet
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Purpose
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—  The purpose is to verify that the date of maturity of
liabilities is consistent with the duration of the assets
—  Considering that:
¡ 
Non Current Assets are expected to be transformed into cash in more
than one year (or the operating cycle of the company)
¡ 
Current Assets are expected to be transformed into cash within one
year (or the operating cycle of the company)
the reclassified Balanced Sheet emphasizes the comparison
between non current assets and long term sources of
capital, as well as between current assets and current
liabilities.
The reclassified Balance Sheet
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Non Current Assets:
Intangible
Tangible
Equity investments and l.t.
receivables
Current Assets:
Equity
Shareowners’ capital
Capital Surplus
Realized reserves
Non realized reserves
- Treasury shares
Liabilities:
1.  Non current liabilities:
Inventory (materials,
wip,f.p.)
a)  Financial liabilities
b)  Provisions for risks
c)  Employee termination
benefits
Advanced payments &
prep.expenses
2.  Current liabilities:
Acc. Receivables
Other receivables
Cash & cash equivalents
a)  Trade payables
b)  Other operating liabilities
c)  Borrowings
3.  Unearned incomes and advanced
payments from customers
Items That Need To Be Reclassified
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The distinction between “current” and “non current” assets is not
precise in the Italian structure of the Balance Sheet.
To improve the understanding of the company’s financial position, it
is necessary to reclassify some accounts:
1. 
Short term receivables corresponding to the share of long term
receivables (mainly loans to other entities) due within one year,
are included in the fixed assets;
2.  Similarly, current assets include some long term receivables, i.e.
operating receivables that are not supposed to be transformed into
cash within one year.
Both elements must be reclassified depending on their duration.
Items That Need To Be Reclassified
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3.  Treasury shares must be deducted from equity
4.  Accrued incomes can be assimilated to other operating
receivables.
5.  All trade receivables from affiliated or subsidiaries and
also from holding company should be reclassified as
trade receivables
Some guidelines to reclassification
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—  All categories of the reclassified statements (either the
Balance Sheet or the Income Statement) should be capable
of being used in the calculation of relevant ratios.
—  It makes no sense to classify into different categories
accounts having similar meanings.
—  If different choices are reasonable for the reclassification of
an item, choose the most conservative one.
—  The peculiarities of different sectors may suggest different
structures of the reclassified statements.
The Assets’ Section
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1. NON CURRENT ASSETS:
a) TANGIBLE
b) INTANGIBLE
c) EQUITY INVESTMENTS &
other financial invest.
2. CURRENT ASSETS:
a)  INVENTORY:
Materials
EQUITY
WIP
Fin. Products
b) RECEIVABLES:
Trade receivables
Other Receivables
Prepaid exp. and adv. payments
c) CASH AND CASH EQUIVAL.
LIABILITIES
Current Assets
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—  If possible, separate different elements of the inventory: by
doing this, one can separately calculate the Days of Storage
for materials and for products and assess the company’s
efficiency in the management of inventory.
—  Prepaid expenses on services and advanced payments for
materials are both non monetary assets: they can be
reclassified in the same class because of this similarity.
Trade Receivables and DSO
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—  The calculation of DSO (Days of Sales Outstanding, i.e a ratio that aims
at estimating the average time needed by the company to collect cash
from clients) considers at numerator all trade receivables.
—  In the Balance Sheet, trade receivables are classified in two different
classes:
¡ 
Account receivables
¡ 
Receivables from Subsidiaries and Affiliated companies: this item
contains trade as well as financial receivables.
In the reclassified balance Sheet, all account receivables should
considered in the same category
Trade Receivables and DSO
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BALANCE SHEET
according to civil law
RECLASSIFIED
BALANCE SHEET
ACCOUNTS
RECEIVABLE CII 1
ACCOUNTS
RECEIVABLE
TRADE RECEIVABLE
CII 2,3,4
RECEIVABLES FROM
SUBSIDIARIES ,
AFFILIATED & PARENT
CO. C II 2,3,4
FINANCIAL
RECEIVABLE CII 2,3,4
OTHER RECEIVABLES
Transactions with related parties: an example
(Graniti Fiandre: Trade Payables)
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As well as for Trade Receivables, also Trade Payables are divided in different classes:
•  Accounts Payables
•  Liabilities with Related Parties: include financial an trade payables
In the reclassified Balance Sheet, trade payables should be grouped in the same class.
Hereinafter there is an example of this:
Reclassifying Equity: Contributed Capital vs.
Retained Earnings
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Items of the Equity can be:
¢ 
Contributions from shareowners: i.e. shareowners’ capital and capital surplus
¢ 
Retained earnings: i.e. legal reserve, revaluation reserve, statutory reserve…
¢ 
Income of the period
For the addressees of the Financial Statements, it might be relevant to
quantify and separate the contributed capital and the retained incomes.
Nevertheless, it is not uncommon that shareholders’ capital include also
earnings: this happens, for instance, when bonus shares were issued by
the company. Therefore, it is often difficult to separate contributions
and earnings.
Reclassifying Equity: an alternative
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—  Accumulated earnings can be classified as
—  “realized”: earnings produced in market transactions
—  “not realized”: earnings arising from the change in the fair value of
an asset or liability
this distinction can be used in order to understand the quality of earnings
and assess the financial health of the company.
In Italy, non realized earnings are usually excluded from the Income
Statement: with the only exception of revaluations of financial assets
that are shown in the class D of the Income Statement, all other non
realized incomes are recorded as increases of the Equity.
EQUITY RECLASSIFICATION
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ASSETS
EQUITY:
Capital
Capital surplus
Realized Incomes
Non Realized Incomes
Income of the period
- Treasury Shares
LIABILITIES
Reclassifying the Equity
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RECLASSIFIED SHAREH.’S EQUITY
Share capital
Share premium reserve
Non realized earnings
Realized retained earnings
Net profit (loss)
- Treasury Shares
Non Realized Incomes: the Italian case
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According to the Italian civil law, non realized incomes should not be
recorded because of conservatism. Nevertheless, there are some
exceptions:
a) 
Write-up of equity investments and other fin. investments (account
D18, Income St.)
b) 
Foreign exchange gains (account C17 bis, Income St.)
c) 
Revaluation reserves (Equity)
Only the first two elements influence the Net Income, while the third one is
a direct movement of the Equity.
If any write up or foreign exchange gain occurred, they have to be allocated
to a non distributable reserve.
Non Realized Incomes in the IFRS: main concepts
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—  IFRS 1 has introduced the concept of Comprehensive
Income:
“Comprehensive income is the change in equity of a
business enterprise during a period from
transactions and other events from non-owner
sources.”
—  It includes all non-owner changes in equity, in
contrast to net income, which doesn’t include many
non realized incomes.
The Statement of Comprehensive Income
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—  According to IFRS, all non realized gains and losses are
therefore recorded as components of the comprehensive
income.
—  The traditional structure of the Income Statement has been
integrated, in order to complete the Statement also with
non realized components.
—  Two approaches can be adopted by companies, according to
IFRS:
One statement approach: realized and non realized
components are confused in the same statement
¡  Two statements approach: most of the non realized
components are shown in a separate section called Statement
of Comprehensive Income
¡ 
An example: Heineken Comprehensive
Income Statement, 2010
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Reclassifying equity: some conclusions
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—  In the Italian context, it is difficult to separate
realized and non realized reserves in the equity: the
nature of the reserve is often undetermined.
—  In the international context, more and more
emphasis was given to this distinction; non realized
components are now allocated to a non distributable
reserve
Liabilities
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The aim of the reclassification is to summarize liabilities into
two groups:
a)  Current liabilities
b)  Non current liabilities
When non monetary liabilities (current and non current) are
relevant, they might be grouped in an adjunctive class.
While the Italian Balance Sheet has 4 categories:
a.  Contingent liabilities
b.  Employee benefits
c.  Liabilities
d.  Accrued expenses and unearned revenues
Contingent Liabilities
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—  Contingent liabilities are often long term liabilities,
but their expiring dates are not specified, neither in
the statement nor in the notes. The company itself
often doesn’t know when the liability have to be paid
—  A conservative approach would suggest to classify
them as current liabilities
Pension benefits & Employee Severance Indemnity
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ITALIAN LAW B) CONTINGENT LIABILITIES RECLASSIFIED BALANCE SHEET LONG TERM LIABILITIES 1 for pension benefits & similar Financial liabili)es (non curr. debts) 2 taxes Employee severance indemnity & similar provisions 3 other Other long term liabili)es SHORT TERM LIABILITIES C) EMPLOYEE SEVERANCE INDEMNITY If it is not specified which part of provisions for pension benefits and Employee Severance Indemnity are current liabili)es, one can consider the whole amount as a long term liability. Current Liabilities
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—  It is necessary, first, to separate interest bearing liabilities
(i.e. financial) and operating liabilities, that do not produce
explicit interests
—  In the operating liabilities, the class of trade payables is the
most relevant for the analysis: it allows the calculation of
Days of Payables, a ratio that gives the average time needed
to pay suppliers.
—  All other operating liabilities, including accrued expenses,
can be grouped in another class
Liabilities: the classes
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Assets
Equity
LIABILITIES:
1.  Non current liabilities:
a)  Financial liabilities
b)  Provisions for risks
c)  Employee termination
benefits
2.  Current liabilities:
a)  Trade payables
b)  Other operating liabilities
c)  Borrowings
3.  Accrued expenses and advanced
payments from customers
Working Capital And Operating
Working Capital
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NON CURRENT
ASSETS
EQUITY
NON CURRENT
LIABILITIES
WC (working capital)
CURRENT ASSETS
CURRENT
LIABILITIES
In finance, the WC often is mentioned with reference only to the sum of the
operating items of current assets and liabilities (inventory, operating receivables
and payables). This measure is used to calculate the operating cash flow.
The Functional Approach to the
reclassification of the Balance
Sheet
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Functional Balance Sheet (1)
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TANGIBLE AND INTANGIBLE FIXED ASSETS
+ WORKING CAPITAL
- CONTINGENT LIABILITIES
- EMPLOYEE SEVERANCE INDEMNITY & SIMILAR LIABILITIES
a) NET OPERATING INVESTED CAPITAL (NOIC)
+ EQUITY INVESTMENTS & LONG TERM FIN. INVESTMENTS
+ MARKETABLE SECURITIES, CASH & CASH EQUIVALENTS
b) CAPITAL INVESTED IN FINANCIAL ASSETS
NET INVESTED CAPITAL: a) + b)
EQUITY
LONG TERM FINANCIAL LIABILITIES
SHORT TERM FINANCIAL LIABILITIES
TOTAL COLLECTED CAPITAL
Functional Balance Sheet (2)
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TANGIBLE AND INTANGIBLE FIXED ASSETS
+ EQUITY INVESTMENTS
+ WORKING CAPITAL (OPERATING)
- CONTINGENT LIABILITIES
- EMPLOYEE SEVERANCE INDEMNITY & SIMILAR LIABILITIES
NET INVESTED CAPITAL: a) + b)
EQUITY
LONG TERM FINANCIAL LIABILITIES
SHORT TERM FINANCIAL LIABILITIES
- MARKETABLE SECURITIES, CASH & CASH EQUIVALENTS
TOTAL COLLECTED CAPITAL
Functional Balance Sheet (3)
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TANGIBLE AND INTANGIBLE FIXED ASSETS
+ EQUITY INVESTMENTS
+ WORKING CAPITAL (OPERATING)
- CONTINGENT LIABILITIES
- EMPLOYEE SEVERANCE INDEMNITY & SIMILAR LIABILITIES
NET INVESTED CAPITAL: a) + b)
EQUITY
NET FINANCIAL POSITION
TOTAL COLLECTED CAPITAL
Reclassified Balance Sheet: Mediaset Group
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Net Financial Position: Mediaset Group
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E
N
I
2
0
0
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