1. BUSINESS & MANAGEMENT Unit 3.5 Final Accounts 1/39
Huijia Private School - Bernard Seah

2. KEY TOPICS Standard Level Higher Level 2/39
Business & Management
Unit Final Accounts
Standard Level
Introduction to Final Accounts
Profit & Loss Accounts
Balance Sheet
Window Dressing
Higher Level
Depreciation – Straight Line & Reducing Balance
Intangible Assets – Patents, Copyrights & etc.
Stock Valuation – LIFO & FIFO
NB: - Students will not be tested on Manufacturing Accounts or Double Entry
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Huijia Private School - Bernard Seah

3. Introduction
Businesses to have some way of knowing where there money is going. Small businesses keep these so they can keep track of profit and spending.
Corporations (Private limited liability companies and Public limited liability companies) need to legally keep these for a number of years. In some countries, the period is as long as 7 years so as to facilitate corporate governance.
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4. Things that need to be kept by a corporation
Profit & Loss Account
Balance Sheet
Cash Flow Statement
Explains the “trading” that took place during a period of time.
Assets and Liabilities of a business.
Shows money coming in and money going out.
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5. Businesses need to be audited from an outside source so that everyone knows that the accounts are correct.
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6. Stakeholders who look at the final accounts
Shareholders
Employees
Managers
Competitors
The owners of the company like to see where their money is being spent.
They would like to see how secure their job is and to see if they might receive a pay raise.
Use the accounts to see how well they are performing and to plan for the future.
Other firms will look to see how businesses are performing compared to themselves.
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7. Stakeholders who look at the final accounts
Government
Financiers
Tax collectors will make sure that businesses are paying their fair share.
Banks, business angels and suppliers will make sure a business is running sound before giving finance or credit.
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8. Terminology
Revenue
Cost
Profit
Profit Quality
Revenue is money that comes into a business from trading accounts.
Cost is the money that flows out of a business for revenue expenditures like rent/mortgage payments, wages (payment to staff), costs of material.
Profit is the difference between revenue and costs.
Profit quality of a business refers to the long-term prospects of making money for a firm. Businesses with low quality products and high prices will have low profit quality.
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9. Profit & Loss Accounts/ Income Statements
P&L Account or Income Statement?
What information does a P&L Account give?
P&L Account is used by profit-motivated organizations whereas Income Statements is used by non-profit organizations as there not profit-motivated.
Usually works for one year and explains how much profit is being made (or not made).
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10. P&L Account comprises of three parts
Trading Account
Profit & Loss Account
Appropriation Account
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11. = + - = - Trading Account Cost of Goods Sold Opening Stock Purchases
Closing Stock = -
Gross Profit
Sales Revenue
Cost of Goods Sold
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12. Trading Account for HIO
$ $
5,000
3,000
200
500
________
Sales
Cost of goods sold
Opening stock
Add: Purchases
Less: Closing stock
Total Cost of Goods Sold
Gross Profit
2,700
2,300
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13. Trading account for CBO
$ $
2200
1500
400
300
________
_____
Sales
Cost of goods sold
Opening stock
Purchases
Closing stock
Gross profit
1,600
600
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14. Ways to improve Gross Profit
Use cheaper suppliers but try not to reduce quality
Increase selling price but try to not lose customers
Use marketing strategies – promotions and repackaging. This might increase sales but will definitely increase expenses.
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15. Gross Profit does not take into account the fixed costs of a business such as production costs, rent and advertising costs.
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16. P&L Account:
Shows the operating profit and net profit of a business.
Operating Profit =Gross Profit - Expenses
Expenses are listed on Pg. 393 box 3.5 (1st Edition) or Pg. 346 box 3.5a (2nd Edition).
The operating profit is the actual profit made by a business
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17. List of Expenses 17/39 Director Fees Salaries Secretary Fees
Income received by directors for directorship.
Director Fees
Monthly salaries, commission, incentives & bonuses.
Salaries
Fees paid to the secretarial firm.
Secretary Fees
Fees paid to the audit firm.
Audit Charges
Administration fees charged (e.g. by statutory boards.).
Administration Charges
Market Research, Market & Sales Promotions, Door Gifts & etc.
Marketing Costs
Personal Insurance (Life & Term), Fire Insurance for Property & etc.
Insurance Premiums
Interests incurred from bank loans, hire purchase, overdrafts, & etc.
Interest Charges
Rental charges (including management fee) of land and property.
Rental
Pen, paper, ink cartridges, boxes, stapler and etc.
Stationery Costs
Air & Sea freight, warehousing charges, land delivery charges & etc.
Transportation and Distribution Costs
Gas, heat, electricity, telephone and water charges.
Utility
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18. Profit and loss account for PML $ $
Sales ,000
Cost of goods sold
Opening stock ,000
Purchases ,000
Closing stock ,000
Cost of stock _______
Gross profit _________
Expenses
Salaries ,000
Utilities ,000
Transportation ,000
Others ,000
Total Expenses _________
Operating Profit _________
14,000
26,000
12,000
14,000
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19. Some basic things businesses do to try and reduce expenses and increase profit
Try to negotiate for lower rent or move. (this can be dangerous to some businesses.)
Reduce using air conditioning and heating.
Cutting down on administrative personnel.
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20. Non Operating Income
Examples include interest earned at a bank, rent charged on property owned by business and dividends earned from shares in other companies. These are counted as non-operating income. It is counted after operating profit.
Interest payments and taxes are counted after operating profit as well.
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21. Profit and loss account for Larry’s $ Chinese school
Sales Revenue
Cost of sales (30000)
Gross Profit ________
Expenses (7000)
Operating Profit ________
Non-operating income
Net Profit before interest and tax ________
Interest payments (5000)
Net Profit ________
20,000
13,000
16,000
11,000
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22. Appropriation Account
This shows how profits are distributed between taxes, dividends(money paid to shareholders (shown as a current liability)) and Retained profit (money used by the business to grow(shown as a capital reserve)).
Businesses have no choice when it comes to taxation but they make decisions on how much money should be paid in dividends and how much should be kept as retained profits during shareholders meetings. (Most businesses pay out dividends twice a year).
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23. While there is no set rule on how these accounts should be run in the end the trading; profit and loss account and appropriation account are all under the title PROFIT AND LOSS ACCOUNT
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24. Profit and loss account for __________ $ ________________________________
Sales Revenue ________
Less: Cost of sales __________
Gross Profit ___________
Less: Expenses _________
Profit before interest and tax (Operating Profit) ___________
Add: Non-Operating Income
Less: Interest payments
Net Profit Before Taxes and Dividends ___________
Less: Tax ___________
Net Profit after interest and tax ________
Less: Dividends _________
Retained Profit _________
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25. Businesses have to be careful not to get excited about a big number in the Gross Profit column because these numbers are derived before taxes and expenses.
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26. Limitations to Profit & Loss Accounts (P&L)
Only can show past performance and can be difficult to say what will happen in the future.
Window dressing – Some businesses will “play with their numbers” so that they can make it look more attractive to shareholders.
Because of a lack of standards it is hard to compare the profit and loss accounts of different firms.
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27. Balance Sheets
Legally required record of a businesses financial position at the end of the trading year. It shows a businesses assets, liabilities and the capital invested.
Basic function of a balance sheet is to show where money comes from and where it goes.
Must contain three sections: Assets, Liabilities and Capital & Reserves.
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28. Money owned by a business or owed to a business.
Assets
Money owned by a business or owed to a business.
Fixed assets will last for more than a year and will most likely not be sold.
Current assets – will be turned into working capital within a year. Cash and liquid assets.
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29. Different types of Fixed Assets
Tangible Fixed Assets
Intangible Fixed Assets
Long-term Investments
Non physical things but they have a value that is hard to determine; e.g. patents, copyrights, trademarks, brand names, etc.
Long-term money that is usually put into other businesses (e.g. stocks, debentures and bonds).
Buildings, equipment, vehicles, etc. Tend to depreciate in value over time.
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30. Legal obligations of Liabilities
Long-term liabilities – paid under accounts payable money that will not be paid back till after a year.
Current liabilities – Money that needs to be paid within a year. Shown in the balance sheet under creditors
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31. Capital and Reserves (shareholders funds (limited companies)) Owners’ Equity for other types of businesses
Share capital – (called up capital) Money raised from the initial sale of shares of a business. (NOT THE CURRENT SHARE PRICE)
Retained profit – The net profit that a business has after paying expenses, taxes and dividends. Will match figures from profit loss account.
Reserves - proceeds from retained profits in previous trading years. Includes capital gains in the value of fixed assets. (This happens when property goes up in value (revaluation)). Depreciation is not calculated here.
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32. Owners’ equity = Net Assets – Long term liabilities
Capital and Reserves
Capital and Reserves are money owed to the owners so it is considered a liability. It is not considered long term or short term liability because there is no set time that it needs to be repaid. It is also considered permanent capital (internal source of finance).
Owners of a business own the value of the assets after deducting debt.
Many countries require that businesses report their balance sheet for two years.
Owners’ equity = Net Assets – Long term liabilities
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33. Differences in Balance Sheet
Balance sheets of unincorporated businesses (Sole traders, partnerships) will be different from incorporated business (Public and Private) in the following ways:
Sources of funds are different (limited business have more options)
No shareholders funds for unincorporated businesses
Unincorporated businesses pay no shareholders so they may have drawing accounts to use the funds for personal use.
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34. Uses of Balance Sheets 34/39
From the Working Capital figure, businesses can see how much money they have to “play with”.
Asset Structure lets a business see if they have an increase in stocks which can mean “overtrading”.
Capital Structure helps to see where capital is coming from.
Capital Employed helps a business know how much money they are using.
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35. Limitations of Balance Sheets
Balance sheets do not change if they are not updated; the information or data could be well off.
When evaluating stock or other assets it can be hard to predict what the actual value is. Because the real price of something is not known until it is sold.
Because businesses run a balance sheet in different ways it can be difficult to compare them.
Intangible Assets are very hard to determine the value of. So many things like trained workers are left off a balance sheet.
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36. Creative Accounting or Window Dressing is a legal way to make accounts look better
Show an overdraft that is repayable after 12 months as long-term liability.
Giving higher value to intangible assets.
Using lease back and straight selling of assets to show a profit.
Moving around paying back loans so that the business can show lower profits before reporting income for tax reasons.
Declare sales revenue that is sold on credit as if it was paid in cash.
Delay declaring depreciation of fixed assets.
Using these methods can hide the real value of a firm.
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37. Other limitations of Final Accounts
Sets of final accounts are necessary for good analyzing (either intra firm or historical).
The skills of the workers are ignored .
Qualitative factors are ignored as well as ethical objectives.
Need to see the accounts of different businesses to make judgments about performance of the business.
Because they are public record many businesses will try to hide as much information as possible in their reports.
It can be dangerous to use past information to predict the future. Some managers have trouble keeping this in mind.
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38. Keep in mind that Profit and Loss Accounts cover a period of time while Balance Sheets are focused on a frozen moment in a business.
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39. Final Accounts and Business Strategy
Auditing is the process of having outside people go over your “books”(final accounts). Many countries require this for two reasons: disclosure and accountability of financial matters of a business.
Today intellectual property rights (patents and copyrights and trade marks) are extremely important and for some businesses the most important thing they have.
Some countries do not recognize the intellectual property rights and this can cause major political problems.
Balance sheets are used to help businesses understand their needs day to day. Also these figures will help a business to know when they can expand.
Also the final accounts can let shareholders know where their money is being spent.
When looking for a balance sheet or other final accounts for a business a good place to start is the annual report.
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