3.4.

Final Accounts

 Final accounts
 Financial statements that inform stakeholders about the financial profile and
performance of a business
 Businesses need to keep detailed records of purchases, sales, inventory, and other
financial transactions
 Important terminology
 Current assets
 Liquid assets are assets that are easily turned into cash
 Aside from cash
 Debtors – money owed to the company
 Stocks – unsold inventory
 Current assets = Cash + Debtors + Stocks
 Current liabilities
 Money owed by the business, must be paid by 12 months
 Overdrafts – short term loan to cover cash problems
 Creditors – money owed to suppliers for goods bought on credit
 Tax
 Current liabilities = Overdrafts + Creditors + Tax
 Working capital
 Money needed by the business for its daily operations (running costs)
 Also known as net current assets
 WC = Current assets – Current liabilities
 Working capital is needed as buffer for expected shutdown in cash flow

 Principles and ethics of accounting practices

 These are general rules and concepts that govern the field of accounting
 Failure to uphold accounting ethics in businesses can result in legal challenges
 Window dressing
 Also called creative accounting; legal way of manipulating financial
statements.
 Manipulations include:
 Different stock valuation (FIFO/LIFO Pricing)
 Unrealistic valuation of intangible assets
 Classifying current liabilities as long-term liabilities
 Sale of fixed assets to improve working capital
 Debtors may be included to boost profit

 Profit and loss account/income statement

 Shows the trading position of the business over a period of time, determining the
income, profit or loss
 Parts of an income statement
 Heading: Profit and loss for (company name) for year ended (date)
 Trading account – shows the difference between sales and direct costs
 Profit and loss account
  Shows operating or net profit after deducting operating expenses
and interests
 Depreciation is included as expense
 Appropriation account – shows how net profit is distributed to tax,
dividends and retained earnings
 Trading account
 Shows Gross Profit = Sales revenue – Cost of sales
 Revenue = amount earned from sales
 Cost of Sales/Goods Sold = Value of inventory + Purchases –
Closing Stock OR Variable cost x Quantity sold
 Remember: not all sales are from cash; sales revenue is not the
same as cash received by the business.
 Profit & loss account
 Deduct overheads from gross profit to get operating profit (or net
profit before tax and interest)
 Appropriation account
 Interest subtracted
 Net profit before tax
 Taxes – Compulsory income tax (levy on profits)
 Net profit after tax
 Subtract Dividends – share of profits distributed to shareholders
 Retained Profit – how much of the profit is left in the business for
future development
 B
alance sheet
 Shows the overall value, thus financial position of a company at a specific date
 Includes value of assets, liabilities, and capital employed
 Shows where a firm’s money came from and how it was spent
 Balance sheets are useful if there’s a prior balance sheet to compare with
 Net assets = Liabilities + Owner/Shareholder’s equity
 Balance sheets comprises
 Title on top: Balance sheet for (Company) as at (Date)
 Assets
 Fixed
 Items purchased for business use (not for sale in the near
future)
 Tangible – physical
 Intangible – non-physical assets (e.g. brand name,
goodwill, patents, etc.)
 Investments – medium to long term investments or
government bonds
 Current assets
 Current liabilities
 Net assets = Working capital + Fixed assets
 Capital and reserves (shareholder’s equity)
  Share capital – money raised through the sale of shares
 Retained profits – money left for business use (usually based on
the current income statement)
 Reserves – proceeds from the retained earnings from previous
years; may also include capital gains on fixed assets
 Loan capital
 Net assets = long-term liabilities + owner’s equity
 Therefore, the source of funds matches the use of funds

 Types of intangible assets:

 Trademarks
 Intangible asset legally preventing others from using a business’ logo,
name, or other branding
 Copyrights
 Protects the author’s ownership of his work
 Legal right to publish one’s own work
 Patents
 Grants a company the sole right to manufacture and sell an invention for a
period of time, usually 20 years
 Only inventions that are new, not obvious, and not a combination of
previous inventions, can be patented
 Utility model
  Grants a company the sole right to manufacture and sell a new item, but
for a shorter period of time, usually 7 years
 Different from a patent – a utility model can simply be a new way of using
an existing item
 e.g. using a bucket as Chickenjoy container
 Branding
 Set of intangible assets, impressions, and reputations associated with a
name, brand, or logo, that differentiates it from competitors
 Goodwill
 The established reputation of a business regarded as a quantifiable asset
 Represented by the excess of the price paid at a takeover for a company
over its fair market value
 Limitations of income statement and balance sheet
 Takes time to prepare (could have lost on the way)
 Needs comparison with historical records
 The data is purely quantitative
 Auditing – process of examining and validating financial accounts by an external
entity to protect all stakeholders
 Depreciation (HL only)
 Fall in the value of fixed assets over time
 Spreads the historic cost of an item over its useful lifetime
 Opposite of depreciation is appreciation
 Depreciation helps reflect the value of the business more accurately
 Helps the business plan for asset replacement in the future
 Depreciation is recorded as an expense, yet no money is actually spent (should
show up in expenses in the income statement, but will not appear in cash flow forecast)
 Calculating depreciation
 Straight-line method
 Constant amount of depreciation is subtracted from the value of the
asset each year
 Simple but unrealistic since assets usually depreciate faster at the
start of the lifespan
 Requires estimates on both life expectancy and residual value
 Does not consider effect of obsolescence
 Repairs and maintenance cost of assets usually increases with age,
thus reducing the profitability of the asset
 Annual depreciation = (Purchase cost – Residual value) / Lifespan
 Reducing balance method
 Calculates depreciation by subtracting a fixed percentage from the
previous year’s net book value
 More accurate than the straight-line method but more complex
 By calculating a precise rate of depreciation, it suggests a level of
accuracy for the process of depreciation, which is unjustified
 Residual value and life expectancy are always estimates
 Net book value = Historical cost – Cumulative depreciation