Unit 4 Accounting and Finance GCE A2 Business Studies

Overall Objectives You are required to; Gain an understanding of Accounting and Finance in an integrated context This builds on the what you learnt last year, in Unit 1 You should acquire the “ability to see how financial concepts such as cash flow, gearing, liquidity and profit are affected by factors outside the control of individual firms, such as the economy and the degree of competition and how firms strategies should reflect this”

Today’s objectives Capital expenditure and revenue expenditure Understanding the implication of this distinction for the profit and loss account and balance sheet (including depreciation).

Definitions and assumptions Revenue spending Expenditure on current assets and expenses Things that are used once E.g. Stock, electricity bills, rent Capital spending Expenditure on fixed assets Things that are used repeatedly Premises, machinery, vehicles

Definitions & Assumptions (2) Depreciation The accounting process concerned with the fall in the value of the fixed asset over time To maintain a true and fair view of the state of the business in the accounts, this fall should be reflected in the book value of the assets

Revenue Spending Revenue spending/expenditure is concerned with the money spent on a day to day running There are usually 3 categories: Items that will be used only once (paper, printer toner etc Items that will be used up in the very near future (stock of components for an assembly line) Items that have been used before they are paid for (rates, advertising) These items only have a short term impact on a firm, however they have a direct influence on profits The cost of stock bought for resale and the money spent on advertising is taken from the firm’s revenue to calculate the profits of the firm.

Capital spending Capital spending/expenditure is concerned with the the money spent on its long term operations One year is the difference between the long term and the short term These assets are bought by the firm with the intention of being used for several years Capital spending does not have a direct influence on a firm’s profits

Revenue & Capital spending examples Capital/Revenue Explanation Buying property Capital A long term asset for the business Extending premises For the long term use of a business Repairs to premises Revenue A one-off payment to maintain the business and its premises in a usable state Wages & salaries A one-off payment for work done in the previous week/month Buying a delivery van For repeated use by the business Petrol for the van Petrol can only be used once then more must be bought Goods bought for resale They will be sold onto customers once

The effect of capital and revenue spending on the final accounts Both capital and revenue spending will affect the financial accounts of a business Revenue spending on short-term items will only affect one accounting period Capital spending is accounted for over years of the expected lifetime of the asset The profit & loss account shows the performance of a business over a period of time I.e. one year The balance sheet shows the state of a business at a specific moment

The effect of capital and revenue spending on the final accounts (2) Items which have been paid for and used up only affect one accounting period, so they appear on the profit and loss account for the relevant trading period Therefore, revenue spending of £50,000 on staff salaries will be charged in full to the year’s profit and loss account Items which a firm intends to keep and use over a long period of time (fixed assets) will appear on the balance sheet. With the exception of depreciation, these have no direct impact on the business’ profits for a particular period This is because they affect more than one single accounting period If a firm spends £50,000 on a new shop premises, it will not show up as a cost to the year’s profit and loss account, solely on the balance sheet

The effect of capital and revenue spending on the final accounts (3) A firm buys a new factory to go alongside it’s existing plant and machinery The accounting profit for the year will no be affected The capital spending of the firm has increased The balance sheet will show an increase in the firm’s fixed assets The purchase will need to be financed, therefore there will be an equal change in the firm’s capital or long term liabilities Once the new factory is being used, expenses such as power, raw materials and wages will need to be paid. These will come off of the profit and loss account. It is expected that the extra revenue generated from the new factory will be sufficient to increase profit overall

Getting the balance right It is important for managers to achieve the right balance between revenue and capital spending. Too much capital spending could lead to a lack of funds to pay for revenue items needed to generate income Too little capital spending may cause a firm to have revenue items that cannot be processed as the plant required is not available

Depreciation Definition 4 Reasons why assets depreciate 2 methods of calculating depreciation & formulae Straight line method Declining balance method The effect of depreciation on accounts