Unit 3.5 Final Accounts

Financial Statements ▫Profit and Loss account ▫Balance sheet ▫Cash Flow statement Financial Accounting Management Accounting

Purpose and Users of Final Accounts Shareholders Employees Managers Competitors Government Financiers Potential Investors

Page 391

Trading and Profit and Loss Accounts Represents trading activity over a period of time Revenue Costs Profit

Three Parts to the P&L Trading Account Profit and Loss Appropriation Account

Trading Account (part 1) Top section of the profit and loss account Sales Revenue Cost of Goods Sold Gross Profit Revenue – COGS = Gross Profit

Cost of Goods Sold AKA Cost of Sales Includes costs directly related to production or acquisition of product to be sold (direct labor, inventory, raw materials, etc) COGS= Opening Stock + Purchases – Closing Stock

Improving Gross Profit Change suppliers ▫Find low cost supply alternatives Increase selling price ▫Risk reduction in sales volume Marketing strategies ▫To increase sales, will also increase expenses

More on Gross Profit Adjusted by customer returns Not a business’ final profit Only accounts for direct costs

Page 393

Profit and Loss Account (part 2) Operating Profit Gross Profit – Expenses = Operating Profit Net Profit Operating Profit + Non-operating income – Interest = Net Profit

Operating Costs Overheads or Expenses Indirect costs not directly related to the production or acquisition of the product sold U - utilities S - salaries A – advertising I - insurance R - rent D - depreciation

Decreasing Expenses to Increase Net Profit Reduce rent through negotiation or move Reduce resource consumption: fuel, electricity Reduce administrative costs by reassigning clerical duties to fewer individuals

Examples of Non-operating Income Renting out property Interest from bank deposits Interest/dividends from investments in other companies

Profit and Loss Account for Florists-R-Us year ended 31 st December 2008 $$ Sales Revenue450,000 Cost of Sales200,000 Gross Profit250,000 Expenses Rents80,000 Utility Bills50,000 Other Overheads30, ,000 Operating Profit90,000 Non Operating Income5,000 Profit before Interest and Tax95,000 Interest Payable8,000 Net Profit87,000

Why is interest listed separate from overheads on the income statement? Interest Payable Interest Receivable

Profit and Loss Account for Florists-R-Us year ended 31 st December 2008 $$ Sales Revenue450,000 Cost of Sales200,000 Gross Profit250,000 Expenses Rents80,000 Utility Bills50,000 Other Overheads30, ,000 Operating Profit90,000 Non Operating Income5,000 Profit before Interest and Tax95,000 Interest Payable8,000 Net Profit87,000

Why are taxes listed separate from expenses on the income statement? Corporation Tax Income Tax

Page 395

Appropriation Account (part 3) Displays how net profit is distributed: ▫Taxes ▫Dividends ▫Retained Profit

Exceptional Items One-off (one-time) transactions Affect the profit (or loss) Sale of assets, write off of bad debt, etc.

What is the correct format for the P&L when taking the IB exam? See page 397!

Page 397

Limitations to the P&L Account Historical Window Dressing No Standard Format

Balance Sheets Financial position at a given point in time Where a firm’s money comes from Where a firm’s money has been spent Assets Liabilities Capital and Reserves

Basic Accounting Equation Assets = Liabilities + Owner’s Equity

Assets Fixed Asset purchased for use rather than resale last for 12-months or longer Current Asset cash or other liquid asset last for less than one year

Fixed Assets Tangible fixed assets ▫Equipment ▫Machinery ▫Property Intangible fixed assets ▫Brand names ▫Goodwill ▫Patents Investments

Current Assets Previously mentioned in Unit 3.3 What are the three main current assets?

Liabilities The external sources of funds! Long –term liabilities longer than 12-month term mortgages, bank loans, etc. Accounts payable: amounts falling due after one year Current liabilities repaid within one year overdrafts, taxes, dividends, etc. Accounts payable: amounts falling due within one year

Net Assets Also known as: assets employed Value of all assets minus current liabilities Total Assets – Current Liabilities or Fixed Assets + Working Capital

Capital and Reserves Also known as: shareholders’ funds owners’ equity Shows the internal sources of funds

Capital and Reserves Share capital ▫money raised from the sale of shares ▫also known as called-up capital ▫based on initial public offering Retained profit ▫Net profit after interest, tax, and dividends ▫Comes from the Profit and Loss account Reserves ▫Record of retained profits from previous years ▫Revaluation (value gained from appreciated fixed assets)

Sole Traders & Partnerships vs. Limited Companies Sources of finance differ Owner’s equity is personal funds Drawings instead of dividends

Uses of Balance Sheets Net current assets / working capital Asset structure Capital structure Capital employed

Limitations of Balance Sheets Document is static, therefore information becomes outdated quickly Market value does not equal book value therefore true values are only estimates Format inconsistencies from business to business Impossible to evaluate and include all assets including intangibles and human capital

Page 403

Depreciation Defined

Intangible Assets

Stock Basics

Window Dressing

Limitations of Final Accounts

Final Accounts and Business Strategy

End Unit 3.5

3.5.1 Solution

3.5.2 Solution

3.5.3 Solution

3.5.4 Solution

3.5.5 Solution