ACCOUNTING FUNDAMENTALS UNIT :5

CHAPTER 29

PAGE 528

Why businesses have to keep accounting records

• To know its financial position as at the end of the year. E.g.: How much does the business owe?

• To know the result of its business operation. E.g.: It has made profit or loss.

• To help it make business decision.• To compare the results of the business operation.

Internal & External Users Of Accounting Information

Business Managers• To measure the performance of the business.• To help them take decisions such as new investments.•  To control the operation of each department & division

of the business.• To set targets or budgets for the future & compare these

with actual performance.

Banks• a) To decide whether to lend money.• b) Decide whether to allow an increase in overdraft facilities.• c) To decide whether to continue an overdraft facility or a loan.

Creditors such as suppliers• To see if the business is secure & liquid enough to pay off its debts.• To decide whether the business is a good credit risk.• To decide whether to press for payment.

Customers• To decide whether the business is secure.• To determine whether they will be assured of future

supplies of the goods they are purchasing.• To decide whether there will be security of spare parts or

service facilities.

Government & tax authorities• To calculate how mush tax is due from the business.• To determine whether the business is likely to expand or

create more jobs.• To decide whether the business is in danger of closing

down.• To confirm that the business is staying within the law in

terms of accounting regulations

Investors such as shareholders in the company• To assess the value of the business & their investment in it.• To decide whether the business is becoming more or less

profitable.• To determine what share of the profits investors are receiving.• To decide whether the business has potential for growth.• Compare these details with those from other businesses before

making a decision to buy shares.• If they are actual investors to decide whether to consider selling

all or part of their holding.

Work force • To decide whether the business is secure enough to pay

wages.•  To determine whether the business is likely to expand.• To determine whether jobs are secure.• To find out whether, if profits are rising, a wage increase

can be afforded.• To find out how the average wage in the business

compares with the salaries of directors.

Local community• To see if the business is profitable & likely to expand.• To determine whether the business is making losses &

whether this could lead to closure.• To decide whether there is need to get involved.

Limitation Of Published Accounts

• All stakeholders have a use for the published accounts of the business.

• The companies will only release the absolute minimum of accounting information as laid down by company law.

• Company directors obviously wish to avoid sensitive information falling into the hands of competitors or pressure groups.

Are Published Accounts Really Accurate?

• Stakeholders are often concerned about the accuracy of the published accounts.

• No company can publish accounts that it knows to be illegally misleading.’

• There are many instances when in compiling accounts it is necessary to use judgments & estimations.

• These judgments can often lead to a difference of opinion between accountants. E.g: Over the precise value of goods (stocks) or the value of other assets.

Window Dressing

Presenting the company account in a favourable light –to flatter the business performance.

Common forms of ‘window dressing’ accounts include:

a)Selling assets such as building.

b) Reducing the amount of depreciation of fixed assets.

c) Ignoring the fact that some customers (debtors) who have not paid for goods delivered.

d) Giving stock levels a higher value then they are worth.

e) Delaying paying bills or incurring expenses until after the accounts have been published.

• For these reason, published accounts of companies need to viewed with caution by stakeholders.

• They are useful starting point for investigating the performance of a business.

Financial & Management Accounting

Financial Accounting

a) Collection of data on daily transactions.

b) Preparation of the published report & accounts of a business.

c) Information is used by external groups.

d) Accountants are bound by the rules & concepts of the accounting profession.

e) Accounts prepared once or twice a year.

f) Covers past periods of time.

Management Accounting

a) Preparation of information for managers on any financial aspect of a business, its departments & products.

b) Information is only made available to managers.

c) Accounting reports prepared as & when required by managers.

d) No set rules.

e) Cover past time periods, but can also can be concerned with the present or future.

Main business accounts

• Income statement • Balance sheet • Cash flow statement

TABLE 29.3 page 534

Accounting concepts and conventions

• Double entry principle• Accruals• The money measurement principle.• Conservation • The realisation concept

Income Statement

• This document is prepared once a year

• Usually it compares the current years figures with last years results

3 parts of Income statement

• The Trading Account – This calculates the Gross Profit

• The Profit and Loss account – This Calculates the amount of Net Profit

• The Appropriation account :Profit after tax is distributed as dividends and kept as retained profit.

Mr Reading's Burger Bar – Trading Account       2007      

       

       

             

Sales (Turnover)   300     

             

             

Cost of Sales            

  Opening Stock 40       

  Purchases 120       

    160       

             

  Less Closing Stock 30       

      130     

Gross Profit     ???    

               

How much stock was left over from last year

How much stock was left over from this year (unsold stock)

Mr Reading's Burger Bar profit and loss account                

      2007   2008

    £OOO £OOO   £OOO £OOO  

               

Sales (Turnover)   300    350 

               

Cost of Sales              

  Opening Stock 40    30   

  Purchases 120    145   

    160    175   

               

  Less Closing Stock 30    35   

      130    140 

Gross Profit     170    210 

          mbnj  

Less expenses          

Wages   50    55 55 

Insurance   2    3   

Rates   11    12   

Rent   30    35   

Telephone   11    11   

Advertising   4    5   

Depreciation   5    2   

IT   3    4   

Light and heat 2    8   

      118    135 

Net Profit     52    75 

Last years closing stock becomes the new year’s opening stock

Gross Profit this is the direct cost of purchasing the goods that were sold during the financial year.

Sales turnover It is operating profit minus interest costs and corporation tax.

Cost of goods sold Profit left after all deductions including dividends have been made. This is ploughed back into company as a source of finance.

Net Profit This records the revenue costs and profit(or loss) of a business over a given period of time.

Profit after tax The total value of sales made during the trading period. It is calculated by selling price * quantity sold.

Retained profit The share of profit paid to shareholders as return for investing in the company.

Dividends It is the sales revenue less cost of sales.

Income statement It is gross profit minus overhead expenses.

Gross Profit     170            Less expenses      Wages   50     Insurance   2     Rates   11     Rent   30     Telephone   11     Advertising   4     Depreciation   5     IT   3     Light and heat 2           118   Net Profit     ???  

On some profit and loss accounts this is not listed

Mr Reading's Burger Bar plc – profit and loss account

Net Profit before tax     52    75 

               

 Tax   12    17 

Profit After Tax   40    58 

Dividends paid     15    20 

Retained profit carried forward   25    38 

               

The Appropriation Account – shows what happens to the net profit. Sole Traders and Partnerships do not have to do an appropriation account..

Tax paid on profits

Total value of dividends paid to share holders

Money kept by the business for its own uses

Income statement                    2007    2008    £OOO £OOO   £OOO £OOO             Sales (Turnover)   300    350                          Cost of Sales              Opening Stock 40    30   Purchases 120    145     160    175                Less Closing Stock 30    35       130    140Gross Profit     170    210          mbnjLess expenses        Wages   50    55 55Insurance   2    3 Rates   11    12 Rent   30    35 Telephone   11    11 Advertising   4    5 Depreciation   5    2 IT   3    4 Light and heat 75 2    8       118    135Net Profit     52    75             Corporation Tax   12    17Profit After Tax   40    58Divends paid     15    20Retained profit carried forward   25    38

Trading Account

Profit and Loss Account

Appropriation account

Low quality profit

• They cannot be easily repeated or sustained

High quality profit

• Profit that can be repeated and sustained.

Balance sheet

• Fixed assets • Current assets • Current liabilities • Long term liabilities • Working capital• Share holders funds