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3.4 Final accounts 2014
Transcript of 3.4 Final accounts 2014
Accounts are financial records of business transactions which provide information to groups within and outside an organization. They help keep track of assets, liabilities, revenue, and expenses
Accounts can help up answer business questions:
How much did we buy from a supplier?
Have they been paid yet?
How much profit did we make last year?
Can the business repay a loan?
How much did we pay in wages last week?
What is the value of our fixed assets?
All businesses keep detailed records of purchases, sales and other financial transactions.
3.4 Final Accounts
KEY LEARNING OUTCOMES:
Explain the purpose of accounts
Evaluate the importance of final accounts to different stakeholders
Understand the principals and ethics of accounting practice
Identify and understand the main components of a profit and loss account
Identify and understand the main components of a balance sheet
Construct and amend accounts from information given
Understand what intangible assets are
HL ONLY - Calculate depreciation using the straight line and reducing/declining balance methods.
HL ONLY - Identify the strengths and weaknesses of each depreciation method
Stakeholders and accounting information
Investors and potential investors
Assess the value of their business and their investment in it.
Establish whether the business becoming more or less profitable.
Determine what share of the profits are the investors receiving.
Decide whether the business has the potential for growth.
As potential investors compare the details to other businesses before making an investment decision.
As actual investors, decide whether to consider selling all or parts of their holding.
Who Uses Financial Accounts?
There are internal and external stakeholder users of accounts. Below is a list of the main stakeholders.
Creditors such as suppliers
Governments and tax authorities
Investors and potential investors
Assess whether the business is secure enough to pay wages and salaries.
Determine whether the business is likely to expand or be reduced in size?
Determine whether jobs are secure?
Find out whether, if profits are rising, a wage increase can be afforded.
Find out how the average wage compares with the salaries paid to company executives?
See if the business in profitable and likely to expand, which could be good for local economy.
Determine whether the business is making losses and whether this could lead to closure.
At the end of each accounting period, usually one year, accountants will draw up the financial statements of the business. For companies these will be included in the annual report, which are not only sent to every shareholder but also available in the public domain and can be accessed by any external stakeholder.
Types of Accounts:
The profit and loss account
(aka Income Statement) - this records the revenue, costs and profit (or loss) of a business over a given period of time.
- an accounting statement that records the values of a business's assets, liabilities and shareholder's equity at a one point in time. This shows the net worth of a company: the difference between the value of what a company owns (assets) and what it owes (liablities).
Profit and Loss Account
Measure the performance of the business to compare against targets, previous time periods and competitors.
Providing information for making decisions such as new investments, closing branches and launching new products.
Control and monitor the operation of each department and division of a business.
Set targets or budgets for the future and review these against actual performance.
Decide whether to lend money to the business.
Assess whether to allow an increase in a line of credit (overdraft).
Decide whether to continue a loan or line of credit.
Creditors such as suppliers
Assess whether the business is secure and liquid enough to pay its debts?
Assess whether the company a good credit risk.
Decide whether it should collect its outstanding debt early?
Government and tax authorities
Calculate how much tax is due from a business.
Determine whether the business is likely to expand and create more jobs.
Assess whether the business in danger of closing down?
Confirm that thebusiness adhering to laws and accounting regulations?
Shows how profits after tax are distributed (appropriated) to the owners or shareholders.
Profit and Loss Accounts
Calculates the Net Profit/Net Loss and calculates the Profit/Loss after taxes are paid.
Shows gross profit/loss from trading activities of the business. **Sales is the not the same as CASH RECEIVED.
Sales revenue 3060
Cost of goods sold 1840
Gross Profit 1220
Net Profit before
interest and tax 640
Net profit before tax 560
Net profit after
interest and tax 448
Retained Profit 248
The Profit and Loss Account
For appropriate format see handout
Revenues generated by the business (also known as sales turnover)
Cost of Sales (or cost of goods sold:
Direct costs required to produce the product to sell (also known as cost of goods sold).
Cost of sales = opening stock + purchases - closing stock.
Gross Profit =
Sales revenue less the cost of sales.
Overheads or expenses:
penses not directly related to producing the item sold.
= gross profit - expenses.
Sometimes you will be asked to
existing profit and loss accounts. For example if sales increase by 30% and the cost of sales and cost of goods sold per unit decreases by $1.
Cost of sales (1840) Gross Profit 1220
Net Profit before taxes and interest 640
is an accounting statement that records the values of a business's assets, liabilities and shareholders' equity at one point in time - a snapshot - a moment in time. In a company this wealth belongs to the shareholders. Companies aim to increase shareholders' equity.
Shareholder's equity comes from two main sources:
1. Share capital - capital invested in the company through the purchase of shares.
2. Retained Profit - profits of the company that have accumulated over time. These are also known as reserves.
A Balance Sheet contains the following categories:
- Things the company owns.
- These are tangible items that will be retained and used by a business for at least 1 year. Examples are land, buildings and vehicles.
- Items that are seen as liquid (easily converted to cash) such as inventory, accounts receivable and cash.
- Money the company owes.
- Debts of the business that will usually have to be paid within one year. Examples are short term debts such as accounts payable, loans and unpaid taxes.
- Items that will take longer than one year to pay such as long-term loans, mortgages and debentures (bonds).
Working Capital = Current Assets - Current Liabilities
- Money paid into company by shareholders and Retained Profits
Share Capital 110
Retained Profit 85
Fixed Assets 500
Accumulated depreciation 20
Net Fixed Assets 480
Debtors (Accts Rcvbl) 12
Total current assets 57
Creditors (Accts Pyble) 15
Short-Term Loans 22
Total current liabilities 42
Net Current Assets (Working capital) 15
Total assets less current liabilities 495
Long term liabilities (debt) 300
NET ASSETS 195
Past Paper Questions
Limitations of accounting information:
It is common for stakeholders to believe that, because accounts are based on "numbers" and not descriptive words, they must be "accurate and fair". Unfortunately this is not always the case.
The following factors need to be remembered by stakeholders when they use the accounts provided by a business to make judgements and assessments.
One set of accounts is of limited use.
A series of accounts is needed to be able to compare the performance of business over time.
Accounts do not measure items which cannot be expressed in monetary terms
Accounts do not measure the state of technology within a business or the ability and skills of the management team. The reputation of the business cannot be valued.
The accounts of one business do not allow for comaprisons.
Effective assessment of a business performance can only be made in comparison with other firms engaged in similar activities.
Business accounts will only publish the minimum information required by law.
Published accounts are a summary and they do not "tell the whole truth" about a business. If the data was very detailed and specific, beyond legal requirements, as this could be of real assistance to competitors.
Accounts are historic.
Accounts can be up to six months out of date at the time of publication and they never contain the future financial plans or budgets of a business. Accoutns report what has happened, not what is going to happen.
In public companies, this type of "creative accounting" can account to fraud - which is - illegal. There are several ways in which companies try to make their business look more successful than they are.
Key Concept- Ethics.
just before the end of the year to make it appear that the business is more liquid than it appears.
Encouraging early debt payments by offering discounts before the end of the financial year, while delaying payments to creditors, to improve liquidity.
Loans may be taken out just before the date of the accounts to improve the liquidity position, but may be repaid a few days later.
Inflating the value of intangible assets such as brand names and patents owned by the business.
Window dressing methods:
Recording revenue expenditure as capital expenditure. Revenue expenditure, like rent, is payable in the present year. Capital expenditure can be spread over several years through the process of
. Spreading the payment over a number of years will increase profit in the current year.
What do these terms mean?
What determines how trustworthy the accounting information you receive is?
Enron Movie -
The Smartest Guys in the Room
The principles and ethics of accounting practice
The importance of reliable accounting information to individual groups of stakeholders requires that accountants should act ethically when recording financial transactions and when drawing up final accounts. Most professional groups of accountants have five key fundamental principles as part of their ethical code of conduct for members:
This means that accountants should act honestly in all dealings with clients. Accountants are also required to act honestly with tax authorities and all other stakeholder groups. Integrity means being straightforward, honest and truthful in all professional and business relationships. Accountants should not be associated with any information that is believed to contain a false or misleading statement or which is misleading by omission.
Accountants should not allow bias, conflict of interest or the influence of other people to override their professional judgement. Examples would include:
recommending services, such as business consultancy simply because the accounting fees for the service.
giving in to pressure exerted by an important business client who wants the accountant to window-dress accounts, so as to avoid losing a large fee.
Professional competence and due care.
Accountants are required to caryy out their work with a proper regar for relevant technical and professional standards. This means not one should undertake professional work which they are not competent to perform. This principle also puts responsibility on accountants to continually update their level of professional knowledge - such as on government tax changes - and skill based on current developments in practice, legislation and techniques.
Accountants should not disclose professional information unless they have specific permission or a legal or professional duty to do so.
This is the principle that, when breached, leads to most complaints to the professional accounting bodies. Accountants should comply with with all the relevant legal obligations when dealing with a client's affairs and assist clients to do the same.
Please refer to page 90 and 91 in the Business Management Guide for proper format. Please note changes were made to the 2014 syllabus Financial Statement formatting requirements - if you are looking at past questions do remember this.
The Profit and Loss Account
There are three sections of a profit and loss account:
The trading account.
This shows how gross profit (or loss) has been made from the trading activities of the business.
It is important to note that, as not all sales are for cash in most businesses, the sales turnover figure is not the same as cash received by the business. The formula for calculating sales revenue is
sales revenue = selling price X quantity sold.
Therefore, if 120 items are sold at $2 each, the sales revenue is $240.
Costs of goods sold (or cost of sales) this is the direct costs of purchasing the goods that were sold during the financial year.
Profit and loss section.
This section of the profit and loss account calculates both the
(profit before interest and tax) and the
profit after tax
of the business.
Overheads are costs or expenses of the business that are not directly related to the number of items made or sold. These can include rent, management salaries, lighting costs and depreciation.
The final section of the profit and loss account (which is not always shown in published accounts) shows how the profits after tax of the business are distributed between the owners - in for form of dividends to
retained profits (
retained profits are put back into the company and are a source of finance)
Title: Profit and loss account for ABC Co.
for the year ended
31 May 20xx
If you are only given limited information, construct the Profit and Loss account up until New Profit only.
The use of profit and loss accounts:
They can be used to measure and compare the performance of a business over time or with other firms - and ratios can be sued to help with this form of analysis.
The actual profit data can be compared with the expected profit level of the business.
Bankers and creditors of the business will need the information to help them decide whether to lend the money to the business.
Protential investors may assess the value of investing in a business from the level of profits being made. However, when doing this it is essential to try and differentiate between "
" and "
: a one-off profit that cannot be repeated - the same of an asset for example for higher than its balance sheet value.
profit that can be repeated and sustained.
Do: profit and loss account practice sheet - page 1.
Theory of Knowledge
This company catches your eye. It's financial stats are excellent. Just read its annual report: rising gross and net profits, a very strong balance sheet and an excellent financial position. It's a leader in the industry and its in a market that is growing very rapidly. As a potential share buyer why wouldn't you go for this well-run company with its excellent product and huge potential earnings?
But you have emotional misgivings about buying this business.
In your class brainstorm what your emotional misgivings might be.
Discuss the single emotional reason that would stop you from buying a share in a business.
Cost of Goods Sold (Expanded)
Gross Profit = sales revenue - cost of goods sold
Cost of goods sold is the direct cost of producing or purchasing the goods sold during the period.
Cost of Goods Sold (COGS) = Opening Stock + Purchases
A firm at the beginning of a trading period had $1000 worth of stock. It then bought more stock valued at $2000. It then closed the period with stock valued at $1800. What is the COGS?
COGS = 1000 + 2000 - 1800
The expanded Cost of goods sold can be included in the trading account section on the profit and loss account.
Trading account for Company X for the year ended 1 April 20xx
Cost of Goods Sold:
Opening Stock 1000
Closing Stock 1800 1200
Gross Profit 2400
Do: profit and loss account practice sheet - page 2 - expanded COGS and amending P&L Accounts
and TeddyBears Picnic - P&L only.
Shareholder's equity = total value of assets less total value of liabilities.
Balance Sheet for ABC Ltd as at 31 May 20xx
What do you notice
In what category would the following items appear on a company's balance sheet.
Fixed assets, Intangible asset, Current asset, Current Liability, Long-term Liability or Shareholder's Equity
Work in progress
Four-year bank loan
Money owed to suppliers
Issued share capital
Dividends owed to shareholders
Value of patents
Payment due from customer
Cash in bank
Different types of intangible assets
are assets thathave no physical substance and are not financial instruments (such as bank accounts and accounts receivable). They include assets types such as goodwill, copyright, patents and trademarks.
- arises when a business is valued at or sold for more than the balance sheet values of its assets. It is the value of the organizations image and reputation. Goodwill is the value paid for the company in excess of fair market value of the net assets aquired. Goodwill can only be recorded as part of an aquisition of another company. Accountants do not recognize internally generated goodwill.
COPYRIGHT - Artistic- related intangible assets
- gives ownership rights to plays, literary works. musical works, pictures, photographs, and video and audiovisual material. A copyright protecting these ownership rights can be granted for the life of the creator + 50 - 100 years.
- These provide inventors with the exclusive rights to manufacture, use, sell or control their invention of a product. The owners are provided with legal protection that prevents others from copying thier ideas. Inventors apply for an pay a fee to be granted permission to use it for usually ~20 years.
- These are a recognizable symbol, word, phrase or design that is officially registered and that identifies a product or business. Trademarks also help to distinguish one firm's products from another's.
Examples of trademarks include:
Intangible assets are difficult to value, due to their subjective nature and in many cases they will not show on the balance sheet. Their value can fluctuate over time and simple changes in the reputations of an organization can either inflate or deflate a firm's value. As a result, intangible assets can be used to "window dress" or artificially increase a firms value just befor a purchase.
The Enron Story - Accounting Fraud