ACCOUNTING AND FINANCE
ESSENTIAL STUDY GUIDE
CONTAINING
UNIT 4 REVISION NOTES
1
ACCOUNTING AND FINANCE
Partnership
UNIT
4A
REVISION
NOTES
RATIO ANALYSIS - THE USE OF RATIOS TO ANALYSE PERFORMANCE
We can assess how well a business or club is doing by calculating 5 ratios, using
information from the final accounts. This process lets us compare:
 one year with another
 one business with another
 the performance of the business with the industry average
Comparisons can be made on the basis of profitability, activity and liquidity (the ability
of the business to pay its creditors on time).
The Profitability ratios are:
Formula
What the result means
Gross Profit Percentage =
Gross Profit X 100
Net Sales
What percentage of each pound
of net sales is gross profit
Net Profit Percentage
Net Profit X 100
Net Sales
What percentage of each pound
of net sales is net profit
Net Profit X 100
Capital at start
What percentage investors get
back on each pound invested
Cost of Goods Sold
Average Stock
How many times average
stock is replaced
Current Assets
Current Liabilities
How many times current liabilities
can be paid by with current assets
=
Return on Capital Invested =
An Activity ratio is:
Rate of Stock Turnover =
A Liquidity ratio is:
The Current Ratio/
Working Capital Ratio
=
As a generalisation, the higher the results of these ratios the better the organisation is
doing, except for the Current Ratio which should be as close to 2:1 as possible. Lower
indicates possible liquidity problems ie inability to pay creditors when due, higher,
indicates that funds could be better used by purchasing/renewing equipment.
The results of these ratios allow conclusions to be drawn about the strengths and
weaknesses in the performance of the organisation and suggestions can be made as to
how and where improvements can be achieved. This is usually done in a report.
2
ACCOUNTING AND FINANCE
Partnership
UNIT
4B
REVISION
NOTES
Sole Trader businesses often struggle to compete with larger firms. The limited amount
of capital they are able to raise prevents them growing big enough to compete with
much larger firms. One solution to this problem is for the sole trader to form a
Partnership with others who are willing to invest (contribute) capital in return for a
share of profits.
Advantages and Disadvantages to the Sole Trader of forming a Partnership
Advantages:
Disadvantages:
More capital becomes available
More expertise to run the business
Can share the workload
Need to share profits with other partners
Need to consult other partners
Need to have common goals
PARTNERSHIP
PARTNERSHIP AGREEMENT
CAPITAL ACCOUNT
APPROPRIATION ACCOUNT
CURRENT ACCOUNT
RESIDUAL PROFIT
A business partnership is usually between 2 and 20 people, bound by a legal
agreement, all working with the common aim of making profit. This legal agreement
should cover any areas which could cause disagreements.
The Partnership Agreement (Deed) is the legal document setting out:
 the name the partnership will trade under
 how much capital each partner is contributing
 what role each partner will play (what expertise they will specialise in eg
accountant, legal matters, sales)
 the ratio in which profits and losses will be shared
 if any interest will be paid on Capital contributed
 if any interest will be charged on Drawings
 any salaries paid to partners – to whom and how much
3
ACCOUNTING AND FINANCE
Partnership
UNIT
4B
REVISION
NOTES
HOW PARTNERSHIP STATUS AFFECTS THE ACCOUNTS
1 The Trading and Profit and Loss Account is followed by an Appropriation
Account which shows how net profit is shared out between the partners. Here is an
example of an Appropriation Account:
PETERS AND CONNORS – LEGAL PARTNERS
Appropriation Account for year ended 30 June
£
£
Net Profit
98,000
Less Partnership Salary – Connors
5,000
Residual Profit
93,000
Share of Profit:
Peters (3/5 x 93,000)
55,800
Connors (2/5 x 93,000)
37,200
93,000
Partnership salaries (as
stated in the Partnership
Agreement) are paid out of
Net Profit first. This leaves
Residual Profit which is
divided according to the
Partnership Agreement and
is often in the same
proportion as the Capital
put in by the partners.
2 The Ledger contains a Capital Account and a Current Account for each partner.
Each partner’s Capital Account is credited with the amount invested and debited with
any capital the partner takes out eg on retirement. Here is a partner's capital account:
CAPITAL ACCOUNT – CONNORS
Date
Details
2005
1 July
Debit
Credit
Balance
£
£
£
Balance
60,000 Cr
Each partner’s Current Account is credited with anything the business is giving to the
partner eg salary, share of profit, interest on capital and debited with drawings the
partner takes during for year, interest paid on those drawings and share of any losses.
Here is a partner's current account:
CURRENT ACCOUNT - CONNORS
Date
Details
Debit
2005
1 July
£
Credit
£
Balance b/f
Balance
£
6,000 Cr
2006
30 June
Salary
30 June
Share of Profit
30 June
Drawings
5,000
4
5,000
11,000 Cr
37,200
48,200 Cr
43,200 Cr
ACCOUNTING AND FINANCE
Partnership
UNIT
4B
REVISION
NOTES
A final credit balance on the Current Account represents value the partner is able to
take out of the business at the end of the year. Partners sometimes leave all or part of
the credit balance as additional finance for the business and this is carried forward to
the following year. When a Current Account has a debit balance it is because the
partner has taken out more than entitled to and represents what the partner owes the
business. The credit balances on all the partners' capital and current accounts
represent investment in the business and are therefore transferred to the 'Financed by'
section of the Balance Sheet at the end of the accounting year.
3 The Balance Sheet for a Partnership
PETERS AND CONNORS - LEGAL PARTNERS
BALANCE SHEET AS AT 30 JUNE
Fixed Assets:
£000s
£000s
Premises
Machinery
Current Assets:
Stock
Debtors less Provision (15,000-1,000)
Cash
Less Current Liabilities:
Bank Overdraft
Accruals
Creditors
3
1
7
20
14
4
38
11
Financed By:
Capital Account Balances:
Peters
Connors
Current Account Balances:
Peters
Connors
90
60
5
43
5
£000s
120
50
170
28
198
150
48
198
Money
columns
are often
headed up
'thousands
of pounds'
to save
entering
all the
zeroes in
large
amounts
These are
the
closing
balances
on the
individual
Capital
and
Current
Accounts
from the
ledger
ACCOUNTING AND FINANCE
Partnership
UNIT
4B
REVISION
NOTES
CORRECTION OF ERRORS
Errors can be grouped into 2 main categories – those not revealed by the Trial
Balance and those revealed by the Trial Balance.
ERRORS NOT REVEALED BY THE TRIAL BALANCE
These are mistakes made in the ledger accounts that affect both a debit and a credit
balance, so the columns in the Trial Balance agree but each mistake discovered
should be corrected by means of a double entry in the appropriate ledger accounts.
These types of errors can be errors of:
Omission – where a document/transaction has been missed out completely
Commission – where the debit and credit is correct but in the wrong person's account
Principle - where the wrong class of account has been used eg an asset account
instead of an expense account
Original Entry – where an error has been made reading the amount from the source
document
A Compensating Error – when 2 separate errors for the same amount cancel each
other out
A Complete Reversal of Entry – where the correct amounts have been entered in
the correct accounts but round the wrong way. You need to 'double up' the amount to
correct this kind of error.
Here is an example of an error of commission and how to correct it. Remember this
error would not have shown up when doing the Trial Balance.
£300 paid to us by J Smith (a debtor), has been credited to T Smith account. (We
must assume the bank account part of the double entry is correct but the wrong
debtor’s account has been credited).
To correct this error, in the ledger:
Debit T Smith - to take out the £300 wrongly credited and
Credit J Smith - to correctly record the payment made as it should have been done in
the first place
6
ACCOUNTING AND FINANCE
Partnership
UNIT
4C
REVISION
NOTES
ERRORS REVEALED BY THE TRIAL BALANCE
Errors in the ledger which cause the Trial Balance columns not to agree, are errors
which affect only one account involved in the double entry. Here is an extract from a
Trial Balance which fails to balance and the process to correct it.
Trial Balance of E Bunyan as at 31 December
Debit
£
(Totals after all accounts have been listed)
189,000
Suspense Account
3,000
192,000
Credit
£
192,000
______
192,000
E Bunyan’s Ledger
Date
Details
Suspense Account
31 Dec
Balance
Debit
Credit
Balance
£
3,000
£
£
3,000 Dr
The Trial
Balance is made
to agree by
making an entry
called 'Suspense
Account' with a
value sufficient
to balance the 2
columns
a Suspense A/c
is opened in the
ledger with a
balance to that
value
The following errors are then discovered:




The Sales Account has been underadded by £1,000
A cheque paid to a creditor, Adams, was entered correctly in the Bank A/c for £2,000 but
in Adams' account as £200
Purchase of a second hand van on credit for £3,500 was entered in the creditor's account
but not entry was made in the Motor Vehicle account
A payment for £1,300 Rent was entered in the Rent account but no entry had been made
in the Bank account
E Bunyan’s Ledger
To correct these
'single account errors',
use the Suspense A/c
to complete the double
entry as follows:
Credit Sales A/c
Debit Adams A/c
Debit M.Veh A/c
Credit Bank A/c
Date
Details
Suspense Account
31 Dec
Balance
31 Dec
Sales
31 Dec
Adams
31 Dec
Motor Vehicle
31 Dec
Bank
7
Debit
Credit
Balance
£
3,000
1,000
£
£
3,000 Dr
4,000 Dr
2,200 Dr
1,300 Cr
-----
1,800
3,500
1,300
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