NORMAN MANLEY LAW SCHOOL

LECTURE 3 Preparation of Financial Statements

Final Accounts and the Performance Story

The main reason for operating a business is to make a profit. If the business does not make a profit,
then it is either breaking even or making a loss.

The owners of the business and other users of the financial information need to know how well the
business has performed. Financial information helps users to better understand the company’s
performance.

Financial statements provide useful financial information on the business activities for a reporting
period.
1. Statement of profit or loss
2. Statement of financial position [Balance Sheet]
3. Statement of cash flows

The format of financial statements varies depending on the structure of the business entity and the
nature of the business. A business entity may take the form of:

Ownership structure Nature of business

• Sole proprietor Trading organization
• Partnership Legal services
• Limited liability company Banking/Trading
• Statutory Entity Provision of housing solutions

Sole Proprietor - Trading Entity

A single owner – no share of profits
The profit and loss statement will be divided in two (2) sections, the trading account and the profit or
loss account.

The Trading Account

This ascertains the gross profit or gross loss for the accounting period and is prepared for a particular
period. The gross loss or profit is then transferred to the profit and loss statement.

The profit or loss account

The profit or loss account compares the gross profit and the expenses to determine the net profit or loss
for the period.

The tax liability lies with the owner and is not reflected as a business transaction.

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Partnership providing legal services

Multiple owners of the business

There is no trading account, only a profit or loss statement with an appropriation account showing the
distribution of profits to all partners.

The income tax liability lies with each individual partner and therefore is not shown as a business
transaction.

Limited Liability Company – multiple shareholders

Multiple owners of the business

If trading, there is a trading account; if not a trading organisation say for example a bank, its financial
statement will have no trading account, just a profit or loss account.

It will also carry an appropriation account showing dividend payment to shareholders and income tax
payment to the Inland Revenue as the tax liability lies with the corporate entity and not the individual
shareholders.

Illustrative Example – Statement of Profit or Loss

John Trader
Statement of Profits or Loss
For the period ending December 31, 2020

Sales 500,000 Gross profit is sales minus cost of sales and

Less cost of sales 100,000 is the excess of sales over cost of sales
Gross Profit 400,000

Less expenses
Wages and salaries 50,000
Rent 30,000
Net profit is gross profit minus total
Insurance 20,000
Electricity 10,000
expenses
Delivery 40,000
Professional fees 60,000
Total expenses 210,000
Net profit 190,000 This is taken to the SOFP and
added to capital of the owner

The cost of sales figure will be expanded a bit later in the course and will include additional elements.

Remember the format of this statement will change depending on the form of the business structure.

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The Statement of Financial Position [ SOFP]

The SOFP is the second financial statement and it is a list of all assets, liabilities of the business and the
owners’ equity in the business in a particular format.

It reflects the financial position of the business and prepared at a point in time.

Illustrative Example - Statement of Financial Position

John Trader
Statement of Financial Position
As at December 31, 20X2

ASSETS
Non-current assets
Land and building 200,000
Fixtures and fittings 150,000 The assets are listed in order of
Machinery 100,000 permanency. The most
Motor vehicles 120,000 permanent first
Total non-current assets 570,000

Current assets
Inventory 60,000
Debtors/receivables 40,000 Current assets are short term
Short term investment 50,000 assets, expected to be used up
Cash at bank 90,000 within a 12-month period
Cash in hand 20,000
Total current assets 260,000
Total Assets 830,000

Capital and Liability

Capital 500,000
Add net profit 190,000 Owners’ equity capital + profit
Less drawings 120,000 after the deduction of drawings
Owner’s equity 570,000

Non-current liability
Long term loan 160,000
830,000 Drawings is value/amounts taken
Current Liability by owner for personal use
Creditors/payables 30,000 Drawings is generally in the form
Short term loan 40,000 of cash or goods
Bank overdraft 30,000 100,000

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Guidance Notes

The assets section of the SOFP is shown in two categories:

Non-current
Assets are of long life
Used in the business for more than 1 year
Not bought for sale
Listed in order of the most permanent

Current assets
Short term in nature and are expected to be used up in less than twelve (12) months
Listed in order of liquidity with the least liquid first and most liquid last.

[Liquid assets are those assets than may be turned into cash quickly].

Liabilities are also shown as current and non-current

Current liabilities – due for payment within 12 months of the SOFP

Non-current liabilities – not due for payment in the short term

Net Current Assets

This is the deduction of current liabilities from current assets and indicates the level of liquidity in the
business.

It is also known as working capital.

Computation of cost of sales in a trading entity

Trading Account of the Profit or Loss statement.

Sales 700,000 The cost of sales number is

Less sales returns (50,000) an aggregation of opening
Net Sales 650,000 inventory, the net purchases
Cost of Sales [purchases less returns
Opening inventory 200,000 outwards] and a deduction
Purchases 300,000 of the closing inventory
Less purchases returns (20,000) 280,000
Less closing inventory (30,000) (450,000)
Gross Profit 200,000

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The Profit or Loss Statement
The Profit or Loss statement begins with the:

Gross profit [calculated from the Trading a/c] X

plus, other non-trading income
Commission income X
Rental income X
Investment income X
Interest income X X
Total income X

• The addition of other Income and gross profit give total income.

• The subtraction of expenses from total income gives the profit or loss for the period. [for
example]

Gross Profit 20,000

Add other income
Rental income 4,000
Commission income 3,000
Interest income 5,000 12,000
32,000
Less Expenses
Salaries 7,000
Electricity 2,000
Legal fees 8,000
Stationery 1,000
Total expenses 18,000
Net Profit for the period 14,000

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Preparation of Profit & Loss Statement and Statement of Financial Position

We use information from the Trial Balance to prepare the P/L and SOFP.
All Income and expense items are transferred to the Profit & Loss and assets and liabilities and Capital
items transferred to the statement of financial position.

LIG Enterprise
Trial Balance
As at 30 June 2021

Particulars Transfer to Debit Credit

Sales P/L 15,000

Purchases P/L 7,000
Opening inventory P/L 1,000
Purchases returns P/L 50.00
Sales returns P/L 300
Wages & Salaries P/L 2,300
Land & Building SOFP 2,000
Machinery SOFP 2,000
Rent P/L 2,200
Insurance P/L 200
Commission Income P/L 4,000
Capital SOFP 1,000
Drawings SOFP 1,000
Carriage Inwards P/L 100
Carriage outwards P/L 200
Electricity P/L 800
Creditors/Payables SOFP 1,100
Cash at Bank SOFP 550
Debtors/Receivables SOFP 1,500
21,150 21,150

Note 1: Closing Inventory was $1,200 at the end of the period.

Accountant Kindly prepare the statement of Profit

Gina or Loss and Statement of financial
position for presentation to the owners
of the business.
Ensure presentation is in keeping with
the required format.

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 LIG Enterprise
Statement of Trading and Profit or Loss
For the period ended 30 June 2021

Sales X
Less sales return X
X
Less Cost of Sales
Opening inventory X
Purchases X
Add carriage inward X
X
Less Sales returns (X)
Net purchases X
Goods available for sale X
Less Closing inventory (X)
Cost of Sales (X)
Gross Profit X
Rental Income X
Commission Income X
X

Less Expenses
Wages & Salaries X
Rent X
Insurance X
Carriage outwards X
Electricity X
Total Expenses (X)
Net Profit X

Accountant
Gina
Gina asked a couple of questions

1. Did the business make a gross profit and how

much?
2. How much did the business make from core
business?
3. How much did the business make from other
income?
4. Is the business profitable?

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 LIG Enterprise
Statement of Financial Position
As at 30 June 2021

Assets
Non Current Assets
Land & Building X
Machinery X X
____
Current Assets
Inventory [closing] X
Receivables/Debtors X
Cash at Bank X X
____ ____
Total Asset X
=====
Capital and Liabilities
Capital X
Add net profit [from overleaf] X
____
Less Drawings X
Owners Equity (X)
_____
Non Current Liabilities
Long Term Loan X

Current Liabilities
Creditors/Payables X
Short Term Loan X X
____ ____
X
====

Accountant
Gina

• Gina asked what is the extent of the

business obligations?
• Is there sufficient funds to meet the total
obligations?

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 TRADER JOE BROWN BURRELL & BUNDLE GREEN PEA LIMITED
STATEMENT OF PROFIT OR LOSS STATEMENT OF PROFIT OR LOSS TRADING AND PROFIT OR LOSS ACCOUNT
Revenue Revenue
Sales 600,000.00 Fee income 800,000.00 Revenue
Less sales returns (20,000.00) Rental Income 350,000.00 Sales 900,000.00
Net sales 580,000.00 1,150,000.00 Less sales returns (40,000.00)
Net sales 860,000.00
Less cost of sales
Opening Inventory 110,000.00 Less expenses Less cost of sales
Add purchases 120,000.00 Wages and salaries 170,000.00 Opening Inventory 120,000.00
Less purchases returns (30,000.00) 90,000.00 Delivery and postage 30,000.00 Add purchases 240,000.00
Cost of good available for sale 200,000.00 Repairs and maintenance 52,000.00 Less purchases returns (60,000.00) 180,000.00
Less closing inventory (40,000.00) Utilities 48,000.00 Cost of good available for sale 300,000.00
Cost of sales 160,000.00 Professional fees 36,000.00 Less closing inventory (7,000.00)
Gross Pofit 420,000.00 Donation 2,000.00 Cost of sales 293,000.00
Local travel 68,000.00 Gross Pofit 567,000.00
Other Income Insurance 36,000.00
Rental income 157,000.00 Rent expense 78,000.00 Other Income
Interest income 88,000.00 Commission expense 12,000.00 Rental income 160,000.00
Commission receivable 64,000.00 Total expenses 532,000.00 Interest income 90,000.00
309,000.00 Net profit 618,000.00 Commission receivable 72,000.00
729,000.00 322,000.00
Less expenses Appropriation account 889,000.00
Wages and salaries 132,000.00 Partners' salary 420,000.00 Less expenses
Delivery and postage 28,000.00 Balance of profits 198,000.00 Wages and salaries 264,000.00
Repairs and maintenance 62,000.00 Share of profits Delivery and postage 12,000.00
Utilities 36,000.00 Brown 72,000.00 Repairs and maintenance 60,000.00
Professional fees 140,000.00 Burrell 66,000.00 Utilities 54,000.00
Donation 10,000.00 Bundle 60,000.00 Professional fees 11,000.00
Local travel 82,000.00 198,000.00 Donation 20,000.00
Insurance 26,000.00 - Local travel 92,000.00
Rent expense 48,000.00 Insurance 65,000.00
Commission expense 20,000.00 Rent expense 55,000.00
Total expenses 584,000.00 Commission expense 22,000.00
Net profit 145,000.00 Total expenses 655,000.00
Net profit 234,000.00

1. No share of profits 1. Share of profits Less income tax expesnse 196,500.00

2. Tax obligation is for the owner and not the business entity 2. Tax obligation is on partners individual income Profit after tax 233,962.00
3. Unlimited liability 3. Unlimited liability attaches to each partner
Dividend payment (130,000.00)
Undistributed profits 103,962.00

1. Share of profits paid as dividend to shareholders

2. Tax expense is the obligation of the business entity.
3. Veil of incorporation protects the personal assets of the
the owners
4. Liability is limited to the business assets
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