CHAPTER 10
Financial Statements
NOTE
In practice, accruals accounts and prepayments accounts are implied rather than
drawn up. It is common for expense accounts to show simply a balance c/d and a
balance b/d. The accrual or prepayment is implied and will be shown in the
balance sheet.
Dr
Date
st
1 July
st
1 Jan
st
1 Apr
Details
Bank
Bank
Balance b/d
Insurance Account
£
Date
Details
2700.00 31st Mar Balance c/d
2700.00 31st Mar Profit & Loss a/c
5400.00
1350.00
Cr
£
1350.00
4050.00
5400.00
However, it is recommended that you follow the basic principle before attempting
to skip drawing up an accruals or a prepayments account.
Balance Sheet
The Balance Sheet (sometimes called a Statement of Financial Position) summarises the
business’s assets, liabilities and the net worth of the business. Unlike the P&L the
Balance Sheet shows the financial condition of the business at a particular point in time
(usually the last day of the business’s financial year).
The Balance Sheet is a statement of what the business owns and what the business owes.
It is called a Balance Sheet because it must balance. The business will have assets which
it pays for either by borrowing money (liabilities) or funds contributed by the owner
(equity). The value of the assets must equal the funds used to buy the assets.
As we saw at Level 1 there is the accounting equation:
ASSETS
equals
LIABILITIES
plus
CAPITAL
Depending on which format of Balance Sheet is used, this can be translated into
ASSETS
minus
LIABILITIES
equals
CAPITAL
As we have seen, the balance sheet shows the balance on the accounts which are not
revenue accounts and have not been used for the P&L. A typical Balance Sheet is shown
on the next page.
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CHAPTER 10
Financial Statements
Balance Sheet
A Buhari
As at 31st December 2013
£
£
£
Cost
Accumulated
Depreciation
NBV
80,000
50,000
40,000
170,000
0
10,000
20,000
30,000
80,000
40,000
20,000
140,000
Fixed Assets
Freehold premises
Plant and Machinery
Vehicles
Current Assets
Stock
Debtors
Less: Provision for doubtful debts
19,287
29,500
1,475
28,025
1,350
6,150
250
55,062
Prepayments
Cash at Bank
Cash in hand
Current Liabilities
Trade creditors
Accruals
22,125
500
22,625
Net Current Assets (Working Capital)
32,437
Total Assets less Current Liabilities
172,437
Long term liabilities
Bank loan
10,000
Net Assets
162,437
Capital as at 1st January 2013
Net Profit for the year
Less: Drawings
157,273
30,164
47,437
25,000
Capital at 31st December 2013
162,437
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CHAPTER 10
Financial Statements
You will notice that there are three columns. As with the P&L, there is not a lot of
significance to the columns other than it makes it easier to read. In general the right hand
column shows the totals, the middle column shows how the totals are made up, and the
left hand column shows how the subtotals are made up. The exception is the fixed asset
section, where the cost less the accumulated depreciation equals the NBV.
Let us look at the entries in detail.
Fixed Assets
Fixed assets are also known as non-current assets. A fixed asset is a property of the
business that the business uses in the production of its income. The property is not
expected to be consumed or converted to cash any sooner than one year’s time.
Examples of common types of fixed assets include buildings, land, furniture and fixtures,
machines and vehicles. Fixed assets are not items for resale but for production, supply,
rental or administrative purposes. Assets that are held for resale must be accounted for as
stock (inventory) rather than fixed asset. So, for example, if a company is in the business
of selling cars, it must not account for cars held for resale as fixed assets but instead as
stock. However, any vehicles other than those held for the purpose of resale may be
classified as fixed assets such as delivery vans and company cars.
We saw in Chapter 9 how fixed assets may be depreciated. The original cost of the asset
is reduced by the accumulated (or provision for) depreciation to arrive at the Net Book
Value (NBV). The NBV is the figure which is included in the Balance Sheet figures.
Current Assets
Current assets are assets which are reasonably expected to be converted into cash within
one year. They are usually listed in reverse order of their liquidity. Liquidity is the ease
with which you can convert into cash. Depending on the nature of the stock, this will
usually be the first item. Stock must be sold before it can become cash. If it is sold on
credit, it could be some time before its conversion to cash. Trade debtors will be the next
item since cash should be forthcoming from them within weeks. The most liquid item is
cash itself.
You may have noticed a provision for doubtful debts. Many businesses will put aside an
amount of money for credit customers who cannot or will not pay. We will look at this in
more detail at Level 3.
Current Liabilities
Current liabilities are liabilities which become due within one year. Again they will be
listed in reverse order of liquidity. Apart from trade creditors and accruals, a bank
overdraft would be shown here (rather than in the current assets) as well as any VAT due
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CHAPTER 10
Financial Statements
to be paid to HMRC. Any bank loans which are due to be paid off within the year will be
transferred here from the Long Term liabilities.
Net current assets
Net current assets are also known as Working Capital. It is calculated as the current assets
less the current liabilities. It shows the amounts of cash the business has to work with
over the next 12 months. One would hope that the current assets are more than the current
liabilities (i.e. a positive working capital). If the business has a negative working capital it
will have problems paying its debts when they become due.
Total assets less current liabilities
This shows the value of the business apart from the long term liabilities (see below). The
long term liabilities will not become due until at least 12 months so it is useful to see the
probable value of the business for (at least) the next 12 months.
Long term liabilities
These are items which are due to be repaid after more than 12 months. Items will include
bank loans and loans from other sources. Such loans will be transferred to the current
liabilities when their term becomes less than 12 months.
Capital
Capital is the amount which has been invested by the owners of the business. It shows the
net worth of the business.
Any profit is added to the capital annually and any drawings are deducted. Remember
that the owners of a company do not receive wages – they receive drawings.
Extended Trial Balance (ETB)
(This will not be assessed in the ICB exam, but it is a most useful aid in drawing up a
P&L and a Balance Sheet)
Some businesses will use an Extended Trial Balance in order to facilitate the drawing up
of the P&L and the Balance Sheet. It is basically a Trial Balance with categories
extending to the right. These categories are ‘adjustments’, ‘Profit & Loss’ and ‘Balance
Sheet’. Each category has a column for debits and credits. (See p189).
Suppose we have a Trial balance as shown on the next page:-
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CHAPTER 10
Financial Statements
Trial Balance
31 December 2013
Dr
£
Cr
£
Name of account
Sales
Sales Returns
Purchases
Purchase Returns
Sales Ledger Control
Purchases Ledger Control
Heat & Light
Rent and rates
Office Stationery
Office Wages
Office Equipment
Office equipment accumulated depreciation
Vehicle
Vehicle accumulated depreciation
Stock (at 1st Jan 2012)
Cash (till float)
Bank
VAT
Bank Loan
Capital
Drawings
162,700
1,300
80,000
1,150
10,000
1,000
900
10,000
650
40,000
12,500
2,500
16,000
4,000
7,000
200
7,500
4,750
190,800
9,600
5,000
4,850
______
190,800
We now have to transfer these balances to the Extended Trial Balance (see next page)
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CHAPTER 10
Financial Statements
Account
Balance
Dr
Cr
£
£
Sales
Adjustments
Dr
Cr
£
£
162700
Sales Returns
1300
Purchases
80000
Purchase
Returns
Sales Ledger
Control
Purchase Ledger
Control
Heat & Light
Rent and Rates
Office
Stationery
Office Wages
Office
Equipment
Acc Depn
(Office Equip)
Vehicle
1150
10000
1000
900
10000
650
40000
12500
2500
16000
n
Acc Dep
(Vehicle)
4000
Opening Stock
7000
Cash
200
Bank
7500
VAT
9600
Bank Loan
5000
Capital
4850
Drawings
4750
TOTAL
190800
190800
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Profit & Loss
Dr
Cr
£
£
Balance Sheet
Dr
Cr
£
£
CHAPTER 10
Financial Statements
Before we draw up a balance sheet and a P&L we find the following adjustments:1. A customer has gone into liquidation and the amount owing of £1000 must be
written off. (Ignore VAT).
2. Depreciation has not yet been accounted for. Equipment is depreciated at 20% per
year using the straight line method and vehicles are depreciated at 25% per year
using the reducing balance method.
3. Wages for £4500 are still owing.
4. A payment for rent of £4000 has been paid covering the period October 1st to 31st
March.
5. Stock has been counted on 31st December 2013 and it amounts to £10,000.
We now need to show these adjustments in the adjustment columns of the ETB.
Remember that each adjustment will need a double entry.
The adjustment for item 1 will be
Debit Bad Debts
Credit Sales Ledger control
£1000
£1000
We don’t have a bad debts account so we will need to create one.
The adjustment for item 2 will need to be calculated. The equipment is depreciated at
20% per year using the straight line method. 20% of £12500 is £2500.
The vehicle is depreciated at 25% per year using the reducing balance method. 25% of
the original cost less the accumulated depreciation. 25% of (£16000 - £4000) is £3000.
Therefore the adjustment will be
Debit Depreciation
Credit Accumulate depreciation Office Equipment
Credit Accumulate depreciation Vehicle
We don’t have a depreciation account so we will need to create one.
The adjustment for item 3 is an accrual.
Debit Wages
Credit Accruals
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£4500
£4500
£5500
£2500
£3000
CHAPTER 10
Financial Statements
The adjustment for item 4 is a prepayment. Only half the amount is a prepayment (3
months within the period and 3 months for the next period.
Debit Prepayments
Credit Rent and Rates
£2000
£2000
Note the treatment of the closing stock (item 5). There will be a new account for the
closing stock and we should both debit and credit this account. We will see why when we
come to extending the figures.
Debit Closing Stock
Credit Closing Stock
£10000
£10000
We need to put these adjustments into the ETB. We must total the figures to ensure the
debits match the credits.
Once the adjustments have been completed we must put the new totals into the P&L
columns and the Balance Sheet columns. We must look at each account and ‘extend’ it by
the adjustment. We must add debits to debits and credits to credits. We must subtract
credits from debits and debits from credits.
This is where care must be taken to ‘extend’ the figures to the right columns (P&L or
Balance Sheet). Note the treatment of both the opening and closing stock. The opening
stock is debited to the P&L and the closing stock is credited to the P&L. This is the
adjustment required in the calculation of the Cost of Sales. The closing stock is also
debited in the Balance Sheet.
Once the figures have been ‘extended’ we will find that the debits and credits do not
balance on the P&L or the Balance Sheet. However, the amount it doesn’t balance by will
be the same for the P&L as for the Balance Sheet. This missing figure will be the profit
figure. Looking at the Balance Sheet, if the ‘missing’ figure is a credit a profit will have
been made; if the ‘missing figure is a debit a loss will have been made.
The completed ETB is shown on the next page. Look at each entry and ensure you would
be able to do this for yourself. Particularly make sure you know which accounts are P&L
accounts and which are Balance Sheet accounts.
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CHAPTER 10
Financial Statements
Account
Balance
Dr
Cr
£
£
Sales
Adjustments
Dr
Cr
£
£
Profit & Loss
Dr
Cr
£
£
162700
Balance Sheet
Dr
Cr
£
£
162700
Sales Returns
1300
1300
Purchases
Purchase
Returns
Sales Ledger
Control
Purchase Ledger
Control
Heat & Light
80000
80000
Rent and Rates
Office
Stationery
Office Wages
Office
Equipment
Acc Depn
(Office Equip)
Vehicle
Acc Depn
(Vehicle)
Opening Stock
10000
1150
1150
10000
1000
9000
1000
1000
900
900
2000
650
8000
650
40000
4500
44500
12500
12500
2500
2500
5000
16000
16000
4000
3000
7000
7000
7000
Cash
200
200
Bank
7500
7500
VAT
9600
9600
Bank Loan
5000
5000
Capital
4850
4850
Drawings
4750
4750
Bad Debts
1000
1000
Depreciation
5500
5500
Accruals
4500
Prepayment
2000
Closing Stock
10000
2000
10000
Profit
TOTAL
4500
10000
10000
25000
190800
190800
23000
23000
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173850
25000
173850
61950
61950
CHAPTER 10
Financial Statements
Once we have completed the ETB we can draw up the P&L and Balance Sheet
Trading and Profit and Loss Account
For the Year Ended 31st December 2013
£
Sales
£
162,700
Less Sales Returns
1,300
Net Sales
161,400
Cost of Sales
Opening stock
7,000
Purchases
80,000
Less Purchase Returns
1,150
Less Closing Stock
10,000
75,850
Gross Profit
85,550
Expenses:
Heat & Light
900
Rent & Rates
8,000
Office Stationery
650
Office Wages
44,500
Bad Debts
1,000
Depreciation
5,500
60,550
Net Profit
25,000
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CHAPTER 10
Financial Statements
Balance Sheet
As at 31st December 2013
£
£
£
Cost
Accumulated
Depreciation
NBV
12,500
16,000
28,500
5,000
7,000
12,000
7,500
9,000
16,500
Fixed Assets
Office Equipment
Vehicles
Current Assets
Stock (as at 31st December 2013)
Debtors (Sales Ledger Control)
Prepayments
Cash at Bank
Cash in hand
10,000
9,000
2,000
7,500
200
28,700
Current Liabilities
VAT
Trade creditors (Purchase Ledger Control)
Accruals
9,600
1,000
4,500
15,100
Net Current Assets (Working Capital)
13,600
Total Assets less current liabilities
30,100
Long term liabilities
Bank loan
5,000
Net Assets
25,100
Capital as at 1st January 2013
Net Profit for the year
Less: Drawings
4,850
25,000
29,850
4,750
Capital at 31st December 2013
25,100
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CHAPTER 10
Financial Statements
EXAM TIP
You must use all the accounts in the TB in either the P&L or the Balance Sheet. If
possible it is a good idea to mark off each account from the TB as it is used in the
Financial Statements.
Chapter Summary
•
All the accounts from a Trial Balance are brought together into two
financial statements; the Profit & Loss account and the Balance Sheet.
•
The Profit & Loss account shows all the revenue accounts. It takes the net
sales and deducts production costs to show a Gross Profit. Expenses are
then deducted from the Gross Profit to show a Net Profit (or loss).
•
The Balance Sheet shows what a business owns and what it owes. As the
name suggests, the Balance Sheet must balance.
•
Adjustments are made to accounts so that what is recorded is the amount
due in the period rather than what is actually paid. These adjustments are
called accruals and prepayments
•
An Extended Trial Balance may be used as a tool to help prepare the P&L
and the Balance Sheet.
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