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

• Balance 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

Less accumulated depreciation

Fixed Assets
Net fixed assets
Cash
Debtors
Current assets
Stocks
Total current assets
Overdraft
Creditors
Current Liabilities
Short term loans
Total current liabilities
Net current assets
Total assets – current liabilities
Mortgage
Long term liabilities Debentures
Bank Loans
Share capital
Net assets
Accumulated retained profits
Equity

• 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
• No brief information
• Disclose wrong financial position
• 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 estimating

• Net book value = Historical cost – Cumulative depreciation