Chapter 4 - Trial Balance and Financial Statements Flashcards
Financial Statements
They enable a business to establish if they are operating profitably.
Financial statements - sole traders
- Income statement - which shows financial performance
- Statement of Financial Position
Sole traders aren’t incorporated as larger companies are, so company law doesn’t regulate them.
They are not registered in the Companies House, so they aren’t required to file annual accounts.
But they need to produce these statements to support any personal self-assessment tax returns they make.
Financial statements - frequency
They are prepared on an annual basis, at the end of the financial year.
Larger firms will prepare interim 6 month statements, as well as monthly managed accounts (they can be financial statements that help forecast profit) for internal managerial purposes.
Financial Reporting Standards
Companies of any size are bound by the FRS (Financial Reporting Standards).
Accounting is about using that terminology that everybody understands
FRS Terminology
Balance Sheet - FRS: Statement of Financial Position
Trading Account - FRS: Gross Profit Calculation
Profit and Loss Account - FRS: Income Statement
Debtors - FRS: trade receivables
Creditors - FRS: trade payables
Final Accounts - FRS: Financial Statements
Fixed assets - FRS: Non- current assets
Long-term liabilities - FRS: Non-current liabilities
Sales or turnover or revenue - FRS: Sales Revenue
Stock - FRS: Inventory
Opening stick - FRS: opening inventory
Closing stock - FRS: Closing Inventory
Accrual (as in unpaid liabilities) - AFRS: accrual payables
Prepayments - FRS: prepaid receivables
Capital - FRS: Capital for sole trader; equity for a company
Sole Traders
Drawings
Sole traders may hire others and pay them wages.
Their own wages are called Drawings.
Drawings are deducted from Capital.
Statement of financial position will show as follows: Capital: £10,000 Net profit from Income Statement: £2,000 Drawings: (£5,000) Total: £7,000
Examples of information contained in financial statements
- if firm has made profit or loss;
- value or worth of company is established (assets and their values; amounts owed to 3rd parties);
- amount of capital tied in the business, and return made;
- HM revenue and Customs will require details of income (sole traders) and profit (companies) in order to determine tax liability;
- information will help investors decide if they want to invest in the company;
- how creditworthy the company is:
- allows comparisons with previous years’ performances and the results of similar other companies;
- assists those planning the future of the business
The Trial Balance as a financial statement platform
The Trial Balance is construed with the final balances of all accounts in the ledger.
If mathematically all entries have been done correctly, debit and credit columns will agree.
Debit balances: Assets and Expenses
Credit Balances: Liabilities, Income, Capital
Income Statement
Includes Income and Expenses.
Income - Expenses = Profit
Statement of Financial Position
Assets - Liabilities = Net Worth
Treatment of Inventory in the Financial Statements
Income Statement: deduct from ‘cost of sales’
Statement of Financial Position: Include as a ‘current asset’
Income Statement: 2 Sections
- Calculation of Gross Profit
- Calculation of Net Profit (in companies ‘operating profit/)
Gross Profit
profit earned from the firm’s trading activities during the financial year.
It is the value of what was sold to customers (net sales_ less the cost of buying those goods or manufacturing them.
The difference between these 2 figures sets out the gross profit.
Opening Inventory
Business that buy and sell goods don’t allow themselves to run out of stock, therefore at the beginning of each financial year there will be an opening inventory, which is brought forward from the previous year. It will be included in the Trial Balance.
Cost of Sales Calculation
Opening Inventory + Purchases - Closing Inventory = Cost of Sales
Gross Profit Calculation
Gross profit is the surplus made after the cost of buying (or manufacturing) from what was sold:
Sales Revenue - Cost of Sales = Gross Profit
Closing Inventory
At the end of each financial year there is a physical stock take and it’s valued at cost price.
It is important that it is accurate, as overstating it, will mean that the gross profit will be overstated too, as the cost of sales will be reduced,
The Income Statement
Shows the net profit calculation of the business.
Gross profit - Total Expenses of the operating business
The Income Statement
First top part: gross profit calculation
First part calculates gross profit:
Sales Revenue - Cost of Sales
Cost of sales is:
Opening Inventory + purchases - closing inventory
The Income Statement
Second bottom part: net profit (result)
The bottom part of the Income Statement is the addition of all expenses: wages, rent, electricity, phone, stationery, etc.
Deduct the expenses from the gross profit.
Gross profit - expenses = net profit
Larger businesses may have an extensive analysis of with numerous expense headings.
Statement of Financial Position
It shows assets, liabilities and capital of a business on a given date.
As opposed to the Income Statement, which shows the trading activity over a financial year.
Statement of Financial Position
Sub-sections
Non-current Assets Current Assets Current Liabilities Non-current Liabilities Capital
It must be headed with the name of the business and the date it was drawn up,
Statement of Financial Position
Top part calculations (assets and liabilities)
Add Non-Current and Current Assets
Add Liabilities
Total assets - total liabilities = Net assets
This will enable a more accurate worth of the business.
Statement of Financial Position
Capital
Capital appears in the section below, headed with the title “financed by” to show where the funds have come from.
Capital + net profit
(net profit is calculated in the capital area, because it belongs to the owner
Total net assets calculated in the top part, need to equal Capital area.
Trial Balance details in the Financial Statements
The figures in the Trial Balance only appear in the financial statements once (either the Income Statement or the Statement of Financial Position).
Any figures added in the notes of the Trial Balance, will appear twice (both in the Income Statement and the Statement of Financial Position).
Other entries
Drawings
This will cash withdrawn by the owner (usually sole trader) for personal use. This is classed as a withdrawal from the profit.
A small owner will do this, as it will be their “salary”.
Drawings will have its own account in the Nominal Ledger.
At year end the Drawings balance is deducted from the Capital in the Financed By area.
Other entries
Discounts Allowed
It’s an expense - therefore it will be included in the Income Statement
Other entries
Discounts Received
It’s treated as additional income. Because it’s not originated from the regular trading activity, it’s shown as Other Income, under gross profit.
Other Entries
Carriage Inwards
Cost the company incurs to transport goods purchased from suppliers. The costs are included in the invoice.
This will recorded as a particular expense in the nominal ledger.
It will be included in the gross profit calculation, as an addition to purchases, increase their cost.
Other Entries
Carriage Outwards
When a company charges their customers with the costs of delivery.
This will be recorded as carriage outwards, and treated as an expense in the Income Statement.
Other Entries
Sales and Purchase Returns
These are shown in the gross profit (top part of Income Statement) as deductions, so that we can get to the net figures.
Sales Returns are deducted from the Sales Revenue (right under it)
Purchase Returns are deducted from Purchases (right under it)
Other Entries
Closing Inventory
Appears in both Financial Statements, as it will be given as a note.
All figures relating to Inventory will be included in the Gross profit calculation (top part of Income Statement)
I + E = Income Statement
CAL BAL = Statement of Financial Position
Income Statement includes all accounts balances that are Income and Expenditure..
The Statement of Financial Position will include: Capital, Assets and Liabilities
income Statemen - Structure
Sales Revenue
Less Sales Returns
Cost of Sales Area (which will be deducted from above)
Opening Inventory
Purchases
Less Purchase Returns
Carriage Inwards (which the customer had to pay from selling) —-> at this point you get the Net sales
Less Closing Inventory
Adding all of these up you get the cost of sales.
Then you deduct the Sales Revenue from the Cost of Sales, and you get the gross profit.
Other Income Area Discounts Received (and add to the gross profit above)
Less Expenses Area
(any expenses, such as: electricity, motor expenses, salaries, carriage outwards (which the company had to pay from purchasing)
Statement of Financial Position Structure
Non Current Assets Computer Premises Fixtures and Fittings vehicles (add them all together)
Current Assets Inventory Receivables Bank Cash (add them all together)
Less Current Liabilities
Payables
Then you will have result for Net Current Assets: Current Assets - Current Liabilities
Then you get the Net Assets: Non Current Assets + Current Assets - Current Liabilities
This total needs to equal the Financed By area below
Financed by Opening Capital Net profit (from the Income Statement) Less Drawings (This will give the Closing Capital)
Net Assets must equal Closing Capital
