Final Accounts

Purpose of Final Accounts (FA)

• Financial reporting is a way to account for the money of
the business, whether it belongs to the owners, investors
or lenders.
• Financial accounts ensure that all payments and receipts
of a business have to be officially accounted for.
• All companies (businesses owned by shareholders) must
provide a set of final accounts
• Accounts consist of 2 statements:
• Profit and Loss Account
• Balance Sheet
Purpose of Final Accounts (FA)
• FA are legal requirements in most countries for
companies to have their final accounts audited by
independent and chartered accountants who certify the
financial statement to be accurate and truthful.
• Incorporated businesses are legally obliged to produce
FA, which act to ensure transparency in their use of
funds.
• There is no universal method to present the FA, there is
some degree of flexibility in reporting the ‘actual’
financial position of a company; much of this comes
down to the auditor’s professional judgment.
Purpose of FA for different
stakeholders:
• Shareholders

• Owners of the company are interested to see

where their money was spent and the return
on their investments.

• Owners use FA to decide whether to hold, sell

or buy more of the company’s shares.
Purpose of FA for different
stakeholders:
• Employees

• Staff are interested in their organization’s FA to

assess the likelihood of pay increments and the
degree of job security.
• Salary increments are often expressed as a
percentage of an employee's overall base pay. An
increment usually represents a portion of what
the employee earns per year. Employers use
increments to increase or decrease base salaries
or to award bonuses. (http://work.chron.com/)
Purpose of FA for different
stakeholders:
• Managers

• FA are used to judge the operational efficiency

of the organization.

• Financial analysis can also be useful for target

setting and strategic planning.
Purpose of FA for different
stakeholders:
• Competitors

• Rivals are interested in the FA of a business to

make comparisons of their financial
performance (more on Unit 3.5).
Purpose of FA for different
stakeholders:
• Government

• The tax authority examines the accounts of

business, especially large MNCs to ensure that
they pay the correct amount of tax.
Purpose of FA for different
stakeholders:
• Financiers

• Financial lenders such as banks or business

angels scrutinize the accounts of a firm before
approving any funds.
• Business angels are wealthy entrepreneurs
who risk their own money by investing in small
to medium-sized businesses that have high
growth potential.
Purpose of FA for different
stakeholders:
• Suppliers

• They examine the firm’s FA to decide the

extent to which trade credit should be given.
• Trade credit allows a business to ‘buy now and
pay later’. The credit provider does not receive
any cash from the buyer until a later date
(usually allow between 30-60 days).
Purpose of FA for different
stakeholders:
• Potential investors

• Private and institutional investors use FA and

Ratio Analysis (unit 3.5) to assess whether an
investment would be financially worthwhile.
The principles and ethics of
accounting practice
• The Association of Chartered Certified
Accountants (ACCA) is a global regulatory body
for professional accountants, assuring that its
members are appropriately regulated.

• Accountants and Financial Professionals must

abide by the principles and ethics of accounting
practice to maintain a positive reputation for the
businesses and to prevent fraudulent practices.
ACCA’s Code of Ethics & Conduct:
5 guiding principles for accounting practice
• Integrity - practice must be straightforward and honest; fair
and truthful behavior
• Objectivity - practice should be free from bias and any conflict
of interest
• Professional competence and due care - Accountants to
maintain professional knowledge and skills and must act
diligently when providing professional accounting services
• Confidentiality - Accountants must respect the confidentiality
of information they acquire in their professional duties
• Professional behavior – Accounting practices must comply
with relevant laws and regulations. Accountants to behave
with courtesy and consideration toward others.
Profit and Loss Account (P&L)
• Also known as Income Statement
• P&L is a financial statement of a firm’s trading
activities over a period of time, usually one year.
• Main purpose is to show the profit or loss of a
business during a particular trading period.
• There are 3 sections of an income statement:
• The trading account
• The profit and loss account
• The appropriation account
TRADING ACCOUNT
Ways to improve gross profit
• Using cheaper suppliers
• This reduces the COGS although finding
cheaper suppliers without hindering quality
can be problematic
• Increase selling price
• This raises the value of each item sold, but is
likely to cause a fall in the volume of sales
• Enhanced marketing strategies
• Promotion, packaging to make the product
appealing but will raise the firm’s expenses
 Exercise
Question 3.4.2
Trading account for
Clockworks Ltd.
 The information below represents
data for Clockworks Ltd.
• 3,000 clocks sold at $35 each
• Closing stock valued at $20,000
• Purchases totaled $50,000
• Stock at April 1, 2013 was valued at
$15,000
(a) Define the term closing stock
(b) Construct a trading account for Clockworks
Ltd. for the year ended March 31, 2014.
Profit and Loss (P&L) Account
Profit and Loss (P&L) Account
• Also known as ‘Profit Statement’ shows the net
profit (or loss) of a business at the end of the
trading period.
• Net profit = Gross profit – Expenses
• Expenses are the indirect or fixed costs of
production
Ways to increase net profit
• Rent charges could be negotiated
• Fuel consumption such as heating and lighting
could be targeted
• Administration costs could be examined by
reviewing the work of clerical staff to reduce
costs
• Combine jobs or employ fewer people to carry out
certain tasks
EXAM TIP!

 Corporate tax is the compulsory levy

imposed by governments on
company profits. This figure is
transferred to the balance sheet and
shown as a current liability.
Appropriation Account
• Final section of the P&L account
• 2 parts:
• Dividends
• Retained profit
Appropriation Account:
DIVIDENDS
• This shows the amount of net profit after interest and tax
that is distributed to the owners (shareholders) of the
company.
• The share of net profit (after interest and tax) allocated
to shareholders is based on the decision of the BoD and
is approved at the company’s Annual General Meeting.
• Usually paid biannually. An interim dividend is paid
approximately half way through the year and then the
final dividend is declared and paid at the end of the
firm’s fiscal year.
• The figures are transferred to the Balance Sheet and
shown under CURRENT LIABILITIES.
Appropriation Account:
RETAINED PROFIT
• This shows how much of the net profit after
interest and tax is kept by the business for its
own use, such as investing it in the company or
to expand the business.
• This figure is transferred to the “Financed by”
section of the firm’s balance sheet.
Limitations to the P&L account
• P&L shows historical performance of a business.
There is no guarantee that future performance is
linked to past performance or success.
• Window dressing can occur (the legal
manipulation of FA to make them look financially
more attractive. This disguises the underlying
financial position of the company.
• As there is no internationally standardized
format for producing a P&L account
The Balance Sheet
• Companies are required to produce for auditing
purposes
• Contains information on the value of an
organization’s assets, liabilities and the capital
invested by the owners
• As it shows the financial position of a business
on one day only (usually the last day of the
accounting year), it is often described as a
‘snapshot’ of a firm’s financial situation.
• Helps ensure that all monies within the
organization are properly accounted for
3 Parts of the Balance Sheet:
• Assets
• Items of monetary value that are owned by a business
• Liabilities
• Legal obligation of a business to repay its lenders or
suppliers at a later date (amount of money owed by
the business)
• Equity (capital and reserves)
• Shows the value of the business belonging to the
owners
Formula:
Total Assets – Total Liabilities = Owner’s Equity
ASSETS
• Fixed Asset
• Any asset used for business operations (rather
than for selling) and is likely to last for more
than 12 months from the B/S date

• Current Asset
• Refers to cash or any other liquid asset that is
likely to be turned into cash within 12 months
of the B/S date
• Types: Cash, Debtors, Stocks
LIABILITIES

• Current Liabilities
• Debts that must be settled within one year of
the balance sheet date
• Ex. Taxes owed to the government, dividends
to shareholders and bank overdrafts
• Long-term liabilities
• Debts that are due to be repaid after 12
months
• Ex. They are sources of LT borrowing
• Debentures, mortgages and bank loans
EQUITY (Capital and Reserves)
This section shows the value of the business
belonging to the owners. It can appear in 2 ways:

• Shareholder’s Equity
• For limited liability companies
• Owner’s Equity
• Businesses other than limited companies
EQUITY (Capital and Reserves)
Two main sections:
• Share Capital
• Refers to the amount of money raised through the sale of
shares
• It shows the value when the shares were first sold, rather
than the market value

• Retained Profit
• Amount of net profit after interest, tax and dividends
have been paid
• Reinvested in the business for its own use
• Money belongs to the owners
• The figure comes from the firm’s P&L account
Balance Sheet
Formula:

• Total assets – Total Liabilities = Equity

• Review Page 261

EXAM TIP!

 The main difference between the

balance sheet of incorporated and
unincorporated businesses is that
share capital does not appear as
part of their equity because the latter
do not have shareholders.
 The vast majority of examination
questions will ask you to interpret the
balance sheet of a limited liability
company.
Limitations of Balance Sheet
• Static documents – financial position of a
business may be different in subsequent periods
• Figures are only estimates of the values of assets
and liabilities
• Different businesses will produce accounts in
varying formats and include different assets and
liabilities which makes difficult to compare
financial positions of different firms
• Not all assets are included esp. intangible assets
and the value of human capital
Intangible Assets
• These are non-physical fixed assets that have the
ability to earn revenue for a business
• Examples: brand names, goodwill, trademarks,
copyrights and patents
• Protected by intellectual property rights
• Intangible assets can account for a large
proportion of a firm’s asset value, although it is
usually difficult to place an objective and
accurate price on such assets.
Intangible Asset: BRAND
• Brand recognition and brand value help to drive
global sales for companies (ie. Apple, Coca-cola)
• According to Forbes, the Apple brand is worth
$104 billion. The Microsoft, Coca-Cola and IBM
brands are worth more than $50 billion
• Branding is an indefinite asset as brand
recognition and brand loyalty stay with the
company for as long as it operates.
Intangible Asset: PATENTS
• Provide legal protection for inventors, preventing
others from copying their creation for a fixed
number of years
• Act as an incentive to stimulate innovation
• Allow the inventor to have exclusive rights to
commercial production for a specified time
period
• Other firms must apply and pay a fee to the
patent holder if they wish to use or copy the
ideas, processes or products created by the
inventor
Intangible Asset: COPYRIGHT
• Provides legal protection for the original artistic
work of the creator (author, photographer,
painter or musician)
• Ex: newspaper, sound recordings, computer
software and movies
• Anyone wishing to reproduce or modify the
artist’s work must first seek permission from the
copyright holder, usually for a fee.
Intangible Asset: GOODWILL
• Value of an organization’s image and reputation.
• Value of the firm’s customer base and its
business connections.
• Goodwill is the sum of customer and staff loyalty
and can provide a major competitive edge for
any business.
• “Goodwill is the one and only asset that
competition cannot undersell or destroy” –
Marshal Field, US entrepreneur.
Intangible Asset: REGISTERED
TRADEMARK
• Distinctive signs that uniquely identify a brand, a
product or a business.
• Can be expressed by names, symbols, phrases or
an image
• It can be sold so ownership can be transferred
for appropriate fees and is reflected in the firm’s
balance sheet
• Example: In 1993 Volkswagen bought the
Bentley brand for 430 million pounds ($860
million)
DEPRECIATION (HL)
Depreciation
• Depreciation is the fall in the value of fixed
assets over time due to:

Wear and tear – cause to raise

maintenance cost

Obsolescences – out of date assets (old

versions)
Depreciation
• Depreciation spreads the historic cost (purchase
cost) of fixed assets over their useful lifespan.
• The change in the value of fixed assets is shown
by reassessing their value on the balance sheet.
• It needs to be recorded in order to:
• Calculate the value of a business more
accurately.
• Realistically assess the value of fixed asset over
time.
• Plan for the replacement of assets in the
future.
Methods of calculating depreciation

Tangible Assets:
• Straight line method
• Reducing balance method

Intangible Assets:
• Amortization
 Straight line method of Depn.
• Simplest and most commonly used, however depreciating
fixed assets by an equal amount each year is not realistic
• Variables:
Life expectancy of the asset (how long it is intended to be
used before it needs to be replaced)
Residual value of the asset (how much it is worth at the
end of its useful life)
Purchase cost of the asset
• Annual depreciation = Purchase Cost
Lifespan
• Annual depreciation = Purchase Cost less Residual Value
Lifespan
Reducing Balance Method
• Depreciates the value of an asset by a predetermined
percentage for the duration of its useful life.
• This reduces the value of an asset by a larger amount in
the earlier years of its useful life.
• This method is more realistic in representing the falling
market value of fixed assets over time. However, it is not
as straightforward to calculate and deciding on the
annual rate of depreciation is somewhat subjective.
• Net book value = Historical cost less Accumulated
Depreciation
• Annual depreciation = Ending Net Book Value x annual
rate of depreciation (%)
Lifespan of capital equipment
 EXAM TIP!
• As always with quantitative techniques, it is
vital to look beyond the financial data. You
should consider qualitative issues such as
organizational objectives, the state of the
economy and corporate culture. Final accounts
are just one part of the quantitative analysis
required to give an accurate appraisal of the
firm’s financial position. Budgeting is an
important consideration for the daily operation
of a business, while investment appraisal
assesses the financial gains on growth and
expansion plans. So, the importance of any
single financial statement in strategic planning
and analysis should be handled with prudence.
 Appropriation Account

• Refers to the final section of a P&L

account and shows how the net profit
after interest and tax is distributed,
ie. dividends to shareholders and/or
retained profit kept by the business.
 Balance Sheet

• Contains financial information on an

organization’s assets, liabilities and
the capital invested by the owners on
one specific day, thus showing a
‘snapshot’ the firm’s financial
situation.
 Book Value

• Is the value of an asset as shown on

the balance sheet.
• The market value of assets can be
higher than its book value because of
intangible assets such as the brand
value or the goodwill of the business.
 Cost of goods sold (COGS)
or Cost of Sales (COS)

• Shown in the trading account and

represents the direct costs of
producing or purchasing stock that
has been sold.
 Depreciation (HL)

• Is the fall in the value of fixed

assets over time, from wear and tear
(due to the asset being used) or
obsolescence (outdated or out of
fashion).
 Final Accounts

• Are the published annual financial

statements that all limited liability
companies are legally obliged to
report, i.e. the balance sheet and the
P&L accounts.
 Fixed Assets

• Are items owned by a business, not

intended for sale within the next 12
months, but used repeatedly to
generate revenue for the
organization, e.g. land, premises and
machinery.
 Goodwill

• Is an intangible asset which exists

when the value of a firm exceeds its
book value (the value of the firm’s
net assets).
 Gross Profit

• Is the difference between the sales

revenue of a business and its direct
costs incurred in making or
purchasing the products that have
been sold to its customers.
 Historical Cost

• Refers to the purchase cost of a

particular fixed asset.
 Intangible Assets

• Are fixed assets that do not exist in

a physical form, e.g. goodwill,
copyrights, brand names and
registered trademarks.
 Net Assets

• Show the value of a business by

calculating the value of its assets
minus its liabilities. This figure must
match the equity of the business in
its balance sheet.
 Net Profit

• Is the surplus (if any) that a business

makes after all expenses have been
paid for out of gross profit.
 P&L Account or Income
Statement

• Is a financial record of a firm’s

trading activity over the past 12
months, consisting of 3 parts: the
trading account, the P&L account and
the appropriation account.
 Retained Profit

• Is the amount of net profit after

interest, tax and dividends have been
paid. It is then reinvested in the
business for its own use.
 Share Capital

• Refers to the amount of money

raised through the sale of shares. It
shows the value raised when the
shares were first sold, rather than
their current market value.