3.

4 FINAL ACCOUNTS

AO1 AO2 AO3 AO4

Strategy Ethics
 IB
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 • These statements provide information
to the different stakeholders, such as:
• Shareholders
• Directors, managers, employees
• Customers
FINAL
ACCOUNTS • Suppliers
= FINANCIAL • Competition
STATEMENTS • Bankers
• Government/ tax authorities
• Potential investors
• Local Community
 • Thought Shower! Pg. 259
• What are the problems that would immediately arise
if accounts were not kept?
• Consider the stakeholder groups and individuals
affected
• Consider the following stakeholders and how they
PURPOSE OF would use accounting information and why it would
ACCOUNTS TO be important for them.
DIFFERENT
STAKEHOLDERS • Business Manager
• Workforce
• Banks
• Customers
• Governments and Tax Authorities
• Investors and Potential investors in a business
• Local Community
 1. One set of accounts is of limited use
• Not trend picture
2. Accounts do not measure items which
cannot be expressed in monetary form
3. The accounts of one business do not
allow for comparisons
LIMITATIONS OF
ACCOUNTING 4. Business accounts will only publish the
minimum required b y law
INFORMATION TO
STAKEHOLDERS 5. Accounts are historic
6. Window dressing
• presenting the accounts of a business in
the best possible, or most flattering, way
which could potentially mislead users of
accounts.
• Methods?
THE PRINCIPLES AND ETHICS OF
ACCOUNTING PRACTICE
 1. Integrity - This means that accountants
should act honestly in all dealings with clients,
tax authorities, stakeholders.

T H E PR I NCI PLES AND

E T H I CS OF
ACCOUNT I NG
PR ACT I CE
2. Objectivity - Accountants should not allow
bias, conflict of interest or the influence of other
people to override their professional judgement.
(ex. Consulting services,VIP client pressures).
 3. Professional competence and due care - Accountants
are required to carry out their work with a proper regard for
relevant technical and professional standards. This means that
no-one should undertake professional work which they are not
competent to perform.

T H E PR I NCI PLES AND 4. Confidentiality - Accountants should not disclose

E T H I CS OF professional information unless they have specific permission
or a legal or professional duty to do so.
ACCOUNT I NG
PR ACT I CE

5. Professional behaviour - This is the principle that, when

breached, leads to most complaints to the professional
Enron – Integrity.
accounting bodies. Clearly accountants should comply with all
Is it important to
follow best relevant legal obligations when dealing with a client’s affairs and
practices when assist clients to do the same.
dealing with
financial accounts?
 ACTIVITY 3.4.1 MALAYSIA TOURIST
FLIGHTS

PG. 262, 27 marks, 54 minutes

1. Identify three stakeholder groups that would be interested in the
accounts of Leroy’s business. [3]
2. Evaluate the usefulness of the accounts of Leroy’s business to each of
the stakeholder groups identified in question 1. [10]
3. a. Outline two ways in which accounts can be prepared ethically. [4]
b.To what extent has Flynow’s accountant acted ethically in preparing
Flynow’s accounts? [10]
FINAL
ACCOUNTS:
PROFIT AND LOSS
ACCOUNT
BALANCE SHEET
 PROFIT AND LOSS ACCOUNT

• What is the difference between profit and profitability?

• What is the purpose of profit and loss account?

• What is the purpose of a balance sheet?

 Other names for this
The account What it shows
account

The gross and net profit of the company Income statement

Profit and
Details of how the net profit is split up (or appropriated) between Statement of comprehensive
loss account
dividends to shareholders and retained profits income

The net worth of the company: this is the difference between the
Balance
value of what a company owns (assets) and what it owes Statement of financial position
sheet
(liabilities)

Cash flow
Where cash was received from and what it was spent on Statement of cash flows
statement

FINAL ACCOUNTS OF LIMITED

COMPANIES
 PROFIT AND LOSS ACCOUNT
(INCOME STATEMENT)

• Divided in two three sections:

1. Trading Account
2. Profit and loss account
3. Appropriation Account
 Sales
Trading Account Money coming into the
business from the sale of
goods or services. E.g.
Uniform

Cost of Sales
All the costs directly involved in
producing the goods or service.
E.g Stock or Raw Material

Gross Profit
Profit before expenses have been
taken out
Sales – Cost of sales = Gross Profit
TRADING ACCOUNT

Enable firms to calculate Gross Profit

• Gross profit = sales Revenue – cost of sales
(cost of goods sold, COGS)
• Sales Revenue (or sales turnover) = selling
price x quantity sold
• COGS = opening stock + purchases – closing
stock
 3.4.2 CALCULATING GROSS PROFIT

12 marks, 24 minutes
Cosy Corner Retailers Ltd has just completed its first year of trading. The managing director is keen to learn whether a
profit has been made.
Calculate gross profit for Cosy Corner Retailers Ltd for the financial year ending 31 March 2015. Show
all workings.
a. 1500 items sold for $5 each; cost of goods sold = 1500 @ $2. [3] b. Explain two reasons why you think
it is important for any business
to make a profit. [6]
Cambridge Boxes Ltd sold 3500 units in the last financial year ending
31 December 2014.The selling price was $4. All boxes cost the company
$2 each. Calculate the company’s gross profit in 2014. [3]
Profit and Loss Account

Expenses Net Profit

All other costs incurred by the business that Profit after expenses have been
are not directly involved with the taken out
production of the product (Uniform). For Gross Profit – Expenses = Net Profit
example wages, heat, electric, rent
 PROFIT AND LOSS SECTION

Limited
companies pay
corporation This section of the profit and loss account calculates both
tax on their the operating profit (net profit) (or profit before interest
profits before and tax) and the profit after tax of the business.
paying
dividends. Net profit = gross profit – overhead expenses
Overheads are costs or expenses of the business that are
not directly related to the number of items made or sold.
These can include rent and business rates, management
salaries, lighting costs and depreciation.
 ACTIVITY 3.4.3

Rodrigues buys second-hand computers, updates them and then sells them in his small shop. He has
many customers who are keen to buy computers at prices below those charged for new machines.
Rodrigues took out a bank loan to buy his shop – he has since repaid half of this loan. He employs
three electricians to help him with the computer work. He is the main shareholder in the business;
three of his friends also invested in the company when it was first set up.
Calculate the missing values V–Z for the different types of profit for Rodrigues
Traders Ltd. [5]
State three stakeholders in this business who would be interested in these
profit figures. [3]
For each stakeholder group identified in question 2, explain why the accounts
of this business are important.
 $
Revenue (4000 items @ $3 each) 12 000
Cost of goods sold (@ $1 per item) 4000
Gross profit V
Overhead expenses 3000
ACTIVITY 3.4.3 Operating profit (net profit) W
TABLE Interest 1000
Profit before tax X
Corporation tax @ 20% 800
Profit after tax Y
Dividends paid 1200
Retained profit Z
 • Measure and compare the performance of a business
over time or with other firms
• The actual profit data can be compared with the
USES OF expected profit levels of the business.

PROFIT • Bankers and creditors to help them decide whether

to lend money to the business.
AND LOSS • Potential investors may assess the value of investing
ACCOUNT in a business from the level of profits being made.
• However, when doing this it is essential to try to
differentiate between ‘low-quality’ and ‘high-
quality’ profit.

What is the difference between low quality and high quality profit?
Appropriation Account

Dividends
A sum of money paid to shareholders
decided by the company board of directors.
The amount of dividend gave depends on
the number of shares owned.
Retained Profit
The amount of earnings left after all
expenses and dividends have been paid
 APPROPRIATION ACCOUNT

This final section of the profit and

loss account (which is not always
Retained Profits: the profit left after
shown in published accounts) shows
all deductions, including dividends,
how the profits after tax of the
have been made; this is ‘ploughed
business are distributed between the
back’ into the company as a source
owners – in the form of dividends to
of finance.
company shareholders – and as
retained profits.
 Sales
Money coming into the
business from the sale of
goods or services. E.g.
Uniform

Cost of Goods Sold

All the costs directly involved in
producing the goods or service.
E.g Stock or Raw Material

Gross Profit
Profit before expenses have been
taken out
Sales – Cost of sales = Gross Profit

Expenses
All other costs incurred by the
business that are not directly involved
with the production of the product
(Uniform). For example wages, heat,
electric, rent

Net Profit
Profit after expenses have
been taken out
Gross Profit – Expenses = Net
Profit
Strengths
Gives an indication of the profitability of the business – the quantitative
profit or loss figure gives an objective indication of how well the business is
doing in terms of its core business operations. This is valuable information
for shareholders and other stakeholders. It can be also used to see how well
managers can control overheads.
Can be used to make profitability, efficiency and liquidity comparisons with
competitors in the same industry.
Can be used to evaluate the effectiveness of the firm's business strategies
as a good profit figure indicates good design and implementation of
production, financial, human resources and marketing strategies.
Can be used to forecast future profit/loss (bearing in mind that forecasts
are not always accurate) –profit/loss statistics over time can present a trend
which in turn can be used for forecasting.
LIMITATIONS APPROPRIATION
ACCOUNT
Limitations
Used on its own, the profit and loss account only gives a limited indication
of the financial health of the business. Another final account, the balance
sheet, provides additional information on the financial well-being of the
business. Including the cash flow statement (which will be covered in
subtopic 3.7) to ascertain any cash flow problems can provide an even
more comprehensive view.
Is based on historical data and cannot therefore be automatically used to
predict the future profitability of the company.
Some assumptions for a firm selling goods on credit, such as that all credit
sales will be fully paid up, may result in an inaccurate profit figure if there
are defaults.
'Window dressing': the manipulation of the final accounts to present a
favourable position when in actual fact it is not as profitable. For example,
increasing credit sales at the time of preparing the profit and loss account
will overstate the actual profit earned.
ACTIVITY: HUMAN PROFIT
AND LOSS ACCOUNT OR
MYSTERY SEABURN
 They can be used to measure and compare
the performance of a business over time or
with other firms – and ratios can be used to
help with this form of analysis.

The actual profit data can be compared

with the expected profit levels of the
business.
THE USE OF
PROFIT AND
LOSS ACCOUNTS Bankers and creditors of the business will
need the information to help them decide
whether to lend money to the business.

Potential investors may assess the value of

investing in a business from the level of
profits being made.

What is the difference between low quality and high-

quality profit?
 THE BALANCE
SHEET

This final section of the profit

and loss account (which is not
always shown in published
accounts) shows how the
profits after tax of the business
are distributed between the
owners – in the form of
dividends to company
shareholders – and as retained
profits.
Balance Sheet: an accounting
statement that records the
Please look at table 3.4.4 in the textbook for key terms and explanatory
values of a business’s assets,
liabilities and shareholders’ notes in a balance sheet
equity at one point in time
 THE BALANCE SHEET

The balance sheet records the net wealth or shareholders’ equity of a business at one
moment in time. In a company this net wealth ‘belongs’ to the shareholders.
The aim of most businesses is to increase the shareholders’ equity by raising the value of
the business’s assets more than any increase in the value of liabilities.
Shareholders’ equity comes from two main sources:
The first and original source was the capital originally invested in the company through the
purchase of shares. This is called ‘share capital’.
The second source is the retained earnings of the company accumulated over time through
its operations. These are sometimes referred to as reserves – which is rather misleading as
they are not reserves of cash.
 Companies have to publish the income
statement and the balance sheet for the
previous financial year as well in order to
allow easy comparison.

The titles of both accounts are very important

as they identify both the account and the
FYI company.

Whereas the income statement covers the

whole financial year, the balance sheet is a
statement of the estimated value of the
company at one moment in time – the end of
the financial year.
Balance sheets should always
balance.

Think of it as two separate

documents.

The top part (above line)

shows the company’s assets
and liabilities

The bottom half (below line)

shows where the money has
come from to purchase the
assets.

Net assets and Equity should

always match!
 Fixed Assets Depreciation
Items that are The value a good loses
bought to be used over time. Eg a car is not
by a business over worth the same in 1 year
a long period of after it was purchased
time
E.G Till, Vehicle Current Liabilities
Short term debts that
Current Assets
usually owed for less
Items that are
than a year
defined as short
E.G – Wages, Bills
term possessions.
E.G Stock, Cash Working Capital
This shows how much
Long-Term Liabilities money the business is likely
Long Term debts payable to have within the next 12
over a long period of time. months because it shows
E.G Bank loan or Mortgage what will be left when they
sell all of their current
Net Assets assets
(total assets – and then pay their current
Current Liabilities) – liabilities
long term liabilities Current assets – Current
Liabilities
 Financed By
This section highlights
how you have financed
your business for the year

Share Capital
Capital which a business
raises from the sale of
shares

Retained Profits
Profit ploughed back into
the business from previous
year. Can be seen on P&L
Account

Equity
Share Capital + Retained
Profits
 Fixed tangible Fixed intangible Non- current Shareholders’
Current assets Current liabilities
assets assets liabilities equity

Company’s car

Work in progress

Four-year bank
loan

Money owed to
suppliers

Issued share
capital

Dividends owed to
shareholders

Value of patents

Payments due
from customers

Retained earnings

Cash in bank
 Marketing-related intangible assets

Customer-related intangible assets

Artistic-related intangible assets

DIFFERENT TYPES
OF INTANGIBLE
ASSETS Contract-related intangible assets

Technology-related intangible assets

Goodwill
Intangible assets are assets that have no physical
substance and are not financial instruments
(i.e. bank accounts and accounts receivables).
 Study the simplified version of the 2013
balance sheet for Mauritius Telecom as at 31
December 2013 (millions Mauritian rupees).
• Define the following terms in the balance sheet:
• trade receivables
• inventories
ACTIVITY 3.4.6 • current assets
MAURITIUS • shareholders’ equity. [8]
TELECOM • Using the financial data in the Mauritius Telecom
balance sheet, analyse how the company’s financial
position has changed from 2012 to 2013. [8]
• Discuss the usefulness of this accounting information
for:
• a potential investor in Mauritius Telecom
• creditors of Mauritius Telecom. [10]
 2013 2012

Non-current assets 8868 8649

Current assets:

Inventories 372 321

ACTIVITY 3.4.6 Trade receivables and other receivables 1779 1795

MAURITIUS Cash and cash equivalents 4786 5263

TELECOM Total current assets 6937 7379

TOTAL ASSETS 15 805 16 028

Total non-current liabilities 1020 2083

Total current liabilities 5974 4678

Shareholders’ capital and reserves (shareholders’
8811 9267
equity)
TOTAL EQUITY AND LIABILITIES 15 805 16 028
 IB
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DEPRECIATION – HL
 IB
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 • What is depreciation?
Discussion • Can you think of items and assets
that depreciate?
 Straight Line Method

This is a method of
depreciation that
The amount deducted
spread out the cost of
is constant.
the equipment equally
over its lifetime.
 • The following information is required in
Calculating order to calculate the straight line method:
the straight • The useful life of the asset
• The original cost of the asset
line method • The residual or scrap value of the asset
 • Research online an asset of your choice. Investigate
how much it costs (brand new), then try and find the
second hand selling price (on ebay, amazon, etc.)
Activity
• Try to read information on how long this asset lasts
• E.g. Iphone 7, longboards, samsung s7, ps4, ferrari,
bmw 5 series, van
 Equation

Annual Depreciation;

Original cost (price) – residual value (scrap value)

Expected useful life of asset

Using the information you found previously, calculate the

depreciation rate in the following format..
 FOR EXAMPLE

Chinon Africa Investments Ltd buys a delivery truck for

transporting fresh fruit and vegetables to all its
supermarket franchise outlets at a cost of $100,000. It has
an estimated residual or scrap resale value (at the end of its
life) of $25,000 and an estimated useful life of 5 years.
Calculate the annual provision for depreciation.

e.g. Go on ebay, find a PlayStation 3.

What is the average Price it is selling
for now? What is the Price it initially
sold for? How many years ago was it
initially released.
 FOR EXAMPLE
Table 1. Straight line depreciation for the delivery truck
example.

This depreciation figure is charged to Year end Depreciation ($) *Book value ($)
the profit and loss account as an 0 100,000
expense, i.e. it is deducted as an
expense and theoretically reduces the 1 15,000 85,000
net profit. This same figure is also 2 15,000 70,000
used to depreciate or reduce the value
of fixed assets in the balance sheet. 3 15,000 55,000
The fall in value of the truck over the 4 15,000 40,000
years can be illustrated by a straight
line on the graph when the 5 15,000 25,000
depreciation figure is graphed against
the number of years, hence the
name straight line depreciation. *Book value is the cost of an asset minus accumulated depreciation.
Year Annual Net Book Value on
depreciation vehicle ($)
expense ($)
0 0 30,000
1 6000 24000
2 6000 16000
3 6000 12000
4 6000 6000

STRAIGHT LINE EXAMPLE

 Depreciation Expense

Sometimes you will E.g. calculating the

be asked to calculate expense if it was
the depreciation purchased on 1st July
expense for an asset 2012 with the year
for a partial year. ending 31 Dec 2012.
 • This method adopts an accelerated
Reducing/ depreciation technique whereby the
Declining depreciation amount to an asset
Balance declines over time.(i.e. more at the
start, less at the end)
Method
 • NBV (net book value) in Year 1:

Equation • Cost of asset – (Cost of asset x

depreciation rate %)
 How to answer YEAR DEPRECIATION ($) NET BOOK VALUE
($)

0 0 30,000

• Answer in a table format:

1 9900 (30,000 x 0.33) 20100

2 6633 (20,100 x 0.33) 13467

3 4444.11 (13,467 x 0.33) 9022.89

4 2977.55 (9022.89 x 0.33) 6045.34

 • Explain the consequences of selecting too high of a
Discussion: depreciation rate.

Depreciation
Rate • Explain the consequences of selecting too low of a
depreciation rate.
 ACTIVITY 3.4.7

Hardy Engineering depreciates equipment using the straight- line method. The business has just bought a new lathe
costing $3m. The makers claim it should have a useful life of ten years. Hardy’s accountant estimates that, based on
past experience, the machine could be resold for only $200000 in ten years’ time. He believes that this figure could
be too optimistic if technological change accelerates over this period. The chief executive wants the accountant to
calculate the impact on the company’s accounts if the declining balance method is used. He asked the accountant to
‘calculate the impact on annual depreciation if we used a declining balance figure of 12%’.
Define the term ‘depreciation’. [2]
Calculate the annual depreciation for the new lathe using the straight-line
method. [3]
Calculate the annual depreciation in the second year if the declining balance method is used. [3]
Evaluate Hardy Engineering’s decision to use the declining balance method
of depreciation. [10]
Straight Line Method: Adv/Dis
Easy to calculate and apply.
The same depreciation amount
is deducted in the profit and
loss account, thus making profit
comparisons over time easy.
Because the asset can be
depreciated to its scrap value
or totally, the full cost of the
asset to the firm can be
accounted for.
Assumes that the asset will be used
equally over the years of its useful
life, especially because maintenance
and repair costs will be higher in
the later years of the asset. The
equal amounts of depreciation over
the years is therefore inaccurate
for very long-term assets like plant
and equipment.
Because the useful life of some
assets cannot be easily predicted,
the straight-line method cannot be
used.
The useful life and residual value of
the asset are estimates so the
figure is not completely accurate.
Reducing Balance: Adv & Dis
It is easy to understand and apply.
It is more realistic for assets which have a higher utility in the
earlier years of their life, such as computers, which are more
efficient in the first few years compared with several years later
when they could in fact become obsolete due to the rapid
advances in technology.

Deciding the percentage to use for

depreciation is subjective.
The percentage of depreciation to be
applied would have to be very high if the
company wants to reduce the book value
to zero.
 • The formula used to obtain the rate of depreciation
may be subjective because without the residual
value it cannot be used.
Additional • It lowers profits (stakeholders might object to this)
disadvantages
• It defers tax payments for later years (good if
business is successful, but can make things more
difficult if business is facing cash flow pressures)
 What is meant by depreciation of a fixed
asset?

Name two disadvantages of straight-line

method

REVIEW
Name to advantages of reducing balance
method.

Create a Quizlet Game OR compete

against my own!
 Scoot Fun (SF)
Scoot Fun (SF) is a family-owned private limited company
specializing in scooter rentals to a student market
segment. Most of the scooters will need replacement in
January 2014. SF will purchase 20 new scooters at a total
cost of $80 000. They are expected to have a useful life
of four years and the total residual value (scrap value) of
the 20 scooters is estimated at $4000.
Past Paper Questions SF’s Finance Manager currently uses a straight line
method of depreciation, but she has now decided to
adopt a reducing balance method of depreciation.
However, she is still considering the percentage rate at
which the assets (scooters) should be depreciated. The
Finance Manager is also looking for various sources of
finance for the purchase of the new scooters.
SF’s shareholders would like to receive higher dividends
in the coming year. One way to do this is to find a legal
way to reduce SF’s tax expense in the coming year.
Describe one advantage and one disadvantage of a private limited company. (4)

Explain two appropriate sources of finance that SF could use to purchase the 20 new scooters. (4)

Using the straight line method of depreciation, calculate the depreciation for each year and the book value
(value of scooters less depreciation) of the 20 new scooters at the end of each year of their expected useful life
(four years) (show all your working). (4)

Using the reducing balance method of depreciation, calculate the depreciation for each year and the book value
(value of scooters less depreciation) of the 20 new scooters at the end of each year of their expected useful life
(four years). Use a 40 % depreciation rate (show all your working). (4)

Explain one consequence of the Finance Manager’s decision regarding the percentage rate at which the assets
should be depreciated. (3)

Examine the decision of SF’s Finance Manager to change the depreciation method from straight line to reducing
balance. (6)
 KEY CONCEPT QUESTION

With reference to one organisation that you

have studied, discuss the importance of ethics
in producing a set of final accounts. [20]
 IB
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