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3.5 Final Accounts

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Mario Alvarado M.

on 24 August 2014

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Transcript of 3.5 Final Accounts

Final Accounts
Unit 3.5
Where their money was spent. How well investments have performed.
To assess job security and the likelihood of pay increments.
To judge operational efficiency of the organization. Target setting and strategic planning.
The Purpose and Users of Final Accounts
Incorporated businesses are legally obliged to produce final accounts, which act to ensure transparency in their use of funds.
Rival firms will be interested in the final accounts of a business in order to make comparisons of their financial performance.
Financial lenders such as banks or business angels will scrutinize the accounts of a firm before approving any financial backing.
can examine a firm's accounts to decide whether trade credit should be approved.
Potential Investors:
Private and institutional investors will use final accounts to assess whether an investment would be financially worthwhile. They will use methods such as ratio analysis in their assessment.
All companies must provide a set of final accounts consisting of three statements:
Profit and Loss Account
Balance Sheet
Cash Flow Statement

The tax authorities will want to examine the account of businesses, especially large multinationals, to ensure that businesses are paying the correct amount of tax.
Trading and Profit and Loss Accounts
Parts of the P&L Account
Trading Account
Represents the top section of the P&L account and shows the
sales revenue
and the
direct costs
of trading.
Gross Profit


Sales Revenue - Cost of Goods Sold
Cost of Sales

= Opening Stock + Purchases - Closing Stock
If a business opens trading this morning with $1,000 of stock (the cost value) and receives a delivery stock for which it pays $2,000. Assume that after the trading day it has $1,800 of the stock (at cost value) remaining. What is the COGS?
Assume that the stocks sell for three times their cost. Gross profit is then:
COGS = Opening Stock + Purchases - Closing Stock
How can a business improve its
gross profit
Profit and Loss Account
Sometimes referred to as the
profit statement
, shows the
operating profit
net profit
(or loss) of a business at the end of a trading period.
Operating Profit

= Gross Profit - Expenses
OP is the surplus (if any) from sales revenue after all
operating costs
(direct and indirect costs).
Suppose, for example, that a small florist company sold $200,000 of stock with a market value of $450,000 for the fiscal (tax) year ended on 31st December 2013. Rents payable amounted to $80,000 whilst utility bills for gas, electricity and telephone usage added up to $50,000. Other overheads added up to $30,000. The trading, profit and loss account could then be represented as:
1. What are
non-operating incomes?
2. How do you calculate
Profit Before Interest and Tax
3. Define:
interest payable
interest receivable
corporation tax
Appropriation Account
The third part of the Trading, Profit and Loss Account is called the Appropriation Account. This section of the accounts shows how the net profit is distributed. There are three parts to this account:
This represents the compulsory levy imposed by governments on company profits. This figure will be transferred to the balance sheet and shown as current liability.
This figure shows the share of net profit that is distributed to the owners of the business.
Retained profit:
This shows how much of the net profit is kept by the business for its own use, such as reinvesting in the business or to expand it.
IB Exam Format
Balance Sheet
It is a record of an organization's financial position at a specific date, usually the end of the trading year.
Since it represents the financial position of a business on one day only, it is often described as showing a "snapshot" of the financial situation of the organization.
Assets are items owned by or owed to a business, and hold a monetary value, such as cash or buildings.
Fixed Assets
Any asset that is purchased for business use, rather than for selling, and is likely to last for more than 12 months from the balance sheet date.
Tangible Fixed Assets
fixed assets such as equipment, machinery, property (land and buildings), fixtures and fittings, and motor vehicles. Apart from land and buildings, tangible fixed assets tend to depreciate over time.
Intangible Fixed Assets
These are
fixed assets such as brand names, goodwill, trademarks, copyrights and patents. These may prove to be a firm's most valuable assets although it is usually very difficult to place a value on them.
These are medium- to long-term financial investments that the business has. Businesses can hold shares and debentures in other companies, for example. Although this may generate some short-term income for the firm, investments are held for long-standing strategic reasons.
Current Assets
Refers to cash or any other liquid asset that is likely to be turned into cash within twelve months of the balance sheet date.
A liability is a legal obligation of a business to repay its lenders or suppliers at a later date. It can be interpreted as the amount of money owed by the business at the balance sheet date.
Long-term Liabilities
Are debts that are due to be repaid after twelve months, i.e. they are sources of long-term borrowing.
"Accounts payable: amounts falling due after one year"
Bank loans
Current Liabilities
Are debts that must be settled within one year of the balance sheet date.
"Creditors: amounts falling due within one year"
Interest Payable
The value of a firm's
net assets
is then the total value of all assets minus its current liabilities. This must be equal to the Capital Employed section of the balance sheet. Net assets (
assets employed
) can be calculated by using the formula:
Net Assets
Fixed Assets
Working Capital
Capital and Reserves
This section of the balance sheet appears towards the bottom. It may also appear as shareholder's funds (for limited companies) or as owners' equity (for businesses other than limited companies)
Share Capital
Refers to the amount of money raised through the sale of shares.
Retained Profit
The amount of net profit after interest, tax and dividends have been paid.
They will record any proceeds from retained profits in previous trading years. It may also include capital gains in the value of fixed assets.
The figure shows the value raised when the shares were first sold, rather than their current market value.
For businesses with preference shareholders, this section is listed as
called-up capital
(sows both ordinary and preference shares).
This money, of course, belongs to its owners so appears as Owners' Equity or Shareholders' Funds.
This will raise the value of property compared to its purchase price, so appears as
in the Reserves section of the balance sheet.
From a balance sheet, we should be able to see that:
Net assets
Long-term Liabilities
Owners' Equity
Stock Valuation
refers to the fall in the value of fixed assets over time.
Fixed assets
may depreciate for two reasons:
Wear and tear
: Assets such as computers and vehicles fall in value as they are used over and over.
Obsolete assets
: Newer and better products become available and this reduces the demand for existing fixed assets.
Methods of calculating depreciation:
Straight-line Method
To calculate the
annual rate of depreciation
, you need three variables:
the life expectancy of the asset
the scrap or residual value of the asset
the purchase cost of the asset
Reducing Balance Method
This method depreciates the value of an asset by a predetermined percentage. This percentage is used for each year.
Purchase Cost - Residual Value
residual value
is an estimate of the disposal value of the asset at the end of its useful life. Many firms use a zero residual value, however, it is unusual.
An electronic security system is bought for $25,000 and is expected to fetch a second-hand value of $5,000 in 5 years time. Calculate the annual amount of depreciation.
Net Book Value
Historical Cost
Cumulative Depreciation
Continuing the previous example, assume the business chose to use the reducing balance method to depreciate the security system at an annual rate of 25%.
Stock valuation
is the technique used to measure the value of a firm's inventories, be they
raw materials
finished stocks
Last In, First Out
This method involves using the most recent batches of stock first. Suitable for businesses that do not have sell by date on the stocks: coal, copper, aluminum, oil.
There may be some
tax benefits
Cost of Goods Sold

= Opening stock + Purchases - Closing Stock
Gross Profit

Sales revenue
Suppose that Gadgets-R-Us makes gadgets for teenage children for which they charge an average price of $50. The cost of stock varies from week to week. Its transactions and production schedules for March are as follows:
1st March
: 30 units bought at $25 per unit
5th March
: 20 units issued for production, $25 per unit
8th March
: 20 units bought at $30 per unit
10th March
: 15 units issued for production
First In, First Out
Stock is valued based on the order in which it was purchased by the business. Stock is valued at the
most recent
purchase cost. It is suitable for businesses that
regularly rotate their stock
It is
more realistic
and representative of the current market value of stocks. However, it will
boost the value of gross profit
, hence,
higher taxes
Suppose that Gadgets-R-Us makes gadgets for teenage children for which they charge an average price of $50. The cost of stock varies from week to week. Its transactions and production schedules for March are as follows:
1st March
30 units bought at $25 per unit
5th March
20 units issued for production
8th March
20 units bought at $30 per unit
10th March
15 units issued for production
Activity 2:
Satine Enterprise Limited recently bought a new company car for $25,000. The firm expects to replace it in five years time. The current resale value of the car in five years time is $2,900. The company uses an annual depreciation rate of 35%.
a. Using the reduce balance method, calculate the book value of the asset after the first two years.
(4 marks)
b. Calculate how much the car would have depreciated in the same period if the straight-line method had been used.
(4 marks)
c. Explain which method would reduce the net book value by the end of the third year.
2 marks
Activity 1:
Zawada Electronics is a Canadian importer and exporter of consumer electronics, specializing in the trade of computer accessories. Selected financial data from the company on 31st December are shown below.
a. Construct a balance sheet for Zawada Electronics for both years.
(5 marks)
b. State the values of the firm's working capital for both years.
(5 marks)
Activity 3
Crystal Arts is a producer of expensive crystal chandeliers. Each chandelier sells for $1,000. During this month, the firm has taken orders for 15 chandeliers. It has 10 units as opening stock, purchased at a cost of $500 each. Crystal Arts replenishes its stock by ordering another 10 units, but inflation has raised costs to $600 per unit. Operating expenses are $1,000 per month and the rate of corporation tax is 30%.
a. Using both LIFO and FIFO methods of stock valuation, construct a simplified Profit and Loss account for Crystal Arts to show the effects on gross and net profit.
(10 marks)
Effects of FIFO and LIFO on the trading account
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