Revision Overview (Just read over) (Just made these up from notes )

Question 1

Profit & Loss Account provides an overview of:

Answer 1

whole farm business

Question 2

Enterprise analysis provides

Answer 2

more detail of the main enterprises

Provides a statement highlighting the contribution that each main enterprise makes towards the overall farm profit/loss

Separate report produced before the P&L account

Linked to the P&L account

The structure of the P&L account is slightly different when we are using an Enterprise Analysis Account

Question 3

Preparation of the Enterprise Analysis Account

Answer 3

We consider each main enterprise separately
For each main enterprise we include:

– Income directly associated with that enterprise – All direct expenses of that enterprise

• i.e.all expenses directly traceable to that enterprise
• This is where the analysis columns in the farmer’s books and records are particularly useful

– Opening and closing stocks (inventory) related to that enterprise
So we can work out the contribution from each main enterprise to the overall farm profit/loss

Question 4

Preparation of the P&L when using an Enterprise Analysis Account

Answer 4

The trading section of the P&L account (i.e. the first part of the P&L up to Gross Profit) is structured differently when using an Enterprise Analysis Account

Omit:
* Sales minus Cost of Sales = Gross Profit

Instead include:
* Contribution from each main enterprise
Taken directly from Enterprise Analysis Account (i.e. the last figure in the report)

We then continue the P&L account as normal from “Other income” onwards

Question 5

Key Steps P and L and ENT analysis

Answer 5

Key Steps
Prepare all workings as normal

Prepare an Enterprise Analysis Account to provide us with more detail for each
main enterprise

• Income, direct expenses and stock (inventory) all specifically related to the main enterprise

*Calculate the contribution that the main enterprise makes to the overall farm profit/loss

• Prepare a P&L Account
• Slight difference to structure of P&L when we prepare an Enterprise Analysis – at
  the beginning only.
• From “Other income” onwards ,the P&L Account is the same as normal
• Prepare Balance Sheet (SOFP)
• The structure of this remains the same regardless is you prepare an Enterprise Analysis or not
  Profit and loss account
  (Statement of Profit & Loss & Comprehensive Income/ Income Statement)

Provides a statement of the operational profit (or loss) of the business for an accounting period

– Accounting period usually 12 months

– Usually select account closing date when activity and/or stock (e.g. crops in store) at minimum
General layout Account format Or Statement format

Question 6

Account preparation – accounting systems

Cash accounting system

Answer 6

– Record payments and receipts when cash paid or
received

– Simple and easy to understand

– Measures business cash flow

– But can be erratic, inconsistent measure of operational performance from year to year

Question 7

Accruals accounting system

Answer 7

– Revenue and expenses matched to period in which they are incurred regardless of when cash changes hands

– Adjustments for
Creditors and debtors (payments and receipts due but not yet made)
Prepayments & accruals

Drawings (e.g. produce consumed in home)

– Depreciation of fixed assets (buildings, machinery)

Question 8

Mixed system

Answer 8

– Commonly used on farms

– Cash method used for recording transactions with end of year adjustments to estimate “accrued” farm profit

Question 9

Preparation of the P and L

Answer 9

We look at each of the following components in turn:

Recording transactions

a) Receipts (revenue) and payments (expenditure)

b) Dealing with contra accounts

c) Debtor and creditor adjustments at end of accounting period

d) Prepayment and accrual adjustments at end of accounting period
Recording inventories (stocks)

a) Opening valuation (OV) and closing valuation (CV)

3. Treatment of expenditure on capital assets such as machinery and buildings a) Depreciation
   Other issues

a) Farm produce consumed in the home (drawings)

b) Apportionments of certain expenditures that are shared between farm and household (personal) use
Treatment of bad debts

Question 10

Recording business transactions
Accurate recording of transactions (receipts and expenditure) by category

Answer 10

– Could use manual receipts and payments books (see examples next 2 slides)
Columns for specific revenue and expense items

Date, description of transaction, cheque number

Amount (€) recorded under appropriate category column

– More common now to use computer accounts package
Commercial packages,
e.g. Kingswood, FarmPlan, Cashminder, Sage, QuickBooks, TAS books, Big Red Book etc…

Teagasc Cost Control Planner (Microsoft Excel based)

Computer systems use electronic version of receipts and payments books for data entry
– Illustrate receipts and payments analysis

Question 11

Contra accounts

Answer 11

one side can pay the other a balancing amount

Common in farm business accounting

Used where a farmer may owe money to a merchant or supplier who in turn owes money to the farm for goods supplied

Common examples:

Farmer sells milk to the Co-op but also buys feed from the co-op
Feed bill then deducted from milk cheque (one item off-set against the other)
Farmer sells grain to merchant but also buys crop inputs (seed & fertiliser) from the
merchant
Inputs bill then deducted from grain cheque (one item off-set against the other)

Must ensure both farm output (e.g. milk sales) and input purchase (e.g. feed) accurately recorded – must record both sides to the transaction!

Question 12

Problem with cash accounting

Answer 12

Accounting profit provides better measure of operational performance

Cash flow and profit are not the same!

Question 13

Measuring business profit
Must allow for:

Answer 13

– Change in valuation of goods (inputs, livestock and crops) in stock (inventory)
– Payments and receipts due but not yet paid (creditors and debtors)
– Depreciation of fixed capital assets
– Produce consumed in the home (it is part of farm output)
– Apportionment of certain costs to farm business (e.g. phone, electric, water) [common in ag not so common in other businesses]
* Based on farm usage (i.e. exclude personal/household use)
* Also remember
– Private drawings (living expenses) are not a business expense
– Therefore not a farm expense in P&L

Question 14

Debtors and creditors

Answer 14

• Some revenue and expenditure items may be ‘outstanding’ at end of the account period i.e. they relate to transactions that have occurred in the accounting period but have not yet been
  settled
  – Trade Debtors (Accounts Receivable) = accounts owed to the business at end of financial year
• e.g. Payment for milk supplied in December will not be received until January
  – Trade Creditors (Accounts Payable) = accounts owed by the business at end of financial year
• e.g. Dairy feed may have been purchased/used in December but feed merchant not paid until February (merchant credit)
  – Debtor and creditor adjustments need to be made to report correct expenditure and revenue for the account period

Question 15

Adjusting for Trade Debtors i.e. to work out the actual amount of sales/revenue earned in the accounting period

Answer 15

Cash Receipts
(received during accounting period)
+
Amounts owed to the business at the end of the account year (closing debtors)
–
Amounts received during the year for items sold in the previous year (opening debtors)
=
Revenue earned in current accounting period

Question 16

Adjusting for Trade Creditors: i.e. to work out the actual amount of expenditure incurred in the accounting period :

Answer 16

Amounts paid by the business during the year for items purchased during the previous year (opening creditors)

Cash Expenditure (paid during accounting period)
+
Amounts owed by the business at the end of the account year (closing creditors)
–

Expenses incurred in current accounting period

Question 17

Prepayments and accruals
Expenses:

Answer 17

– Where an expense is prepaid at the year end, it must be adjusted for.

An amount paid in the current accounting period which relates to the following accounting period (prepayment) must not be included as part of the expenses in the current accounting period in the P&L

An adjustment is also made for prepayments in the balance sheet – recorded as a current asset

– Where an expense has been incurred in the accounting period & is due (unpaid) at the
period end, it must be taken account in the P&L account.

An amount which relates to the current accounting period but which has not been paid in the current accounting period (accrual) must be included as part of the expenses of the current accounting period

An adjustment is also made for accruals in the balance sheet – recorded as a current liability

Question 18

Payment and Accruals Revenue:

Answer 18

– Where revenue is prepaid at the year end, it must be adjusted for.

An amount received in the current accounting period which relates to the following accounting period (prepayment e.g. payment on account) must not be included as part of the income for the current accounting period in the P&L
An adjustment is also made for prepayments of income in the balance sheet – recorded as a
current liability

– Where income is due at the year end, it must be taken account in the profit and loss
account.
An amount which relates to the current accounting period but which has not been received in the current accounting period (accrual) must be included as part of the income of the current accounting period
An adjustment is also made in the balance sheet – recorded as a current asset

Prepayments and accruals at the end of an accounting period will impact not only on the current accounting period (adjustments as per previous slides), but will also have to be taken into account in the following accounting period

Question 19

Annual inventory

Answer 19

At the end of each financial year an inventory is completed for livestock, crops, materials etc (e.g. fertilisers, feed)
– Closing Valuation in P&L is simply: (quantity of each item) times (value per unit)
Ideally accounting period should end at a time of year when stocks are at a minimum
Rule = Valued at the lower of: cost or net realisable value
Livestock and crops valued at market value
– Immature stock and crops in ground may be valued at cost of production
– Revenue accept percentages of market value as approximations of the cost of home produced and immature stock & these %’s can be used in farm accounts

Question 20

Depreciation

Answer 20

Useful life of fixed assets extends well beyond typical 12 month accounting period

– Not sensible to include full cost as expense in P&L for single year
– We apportion the costs over several years => depreciation

Depreciation is the calculated annual charge for the usage of fixed assets in the business

– “The portion of a fixed asset’s cost consumed during the current accounting period”

Assets values in balance sheet =
(original (historic) purchase cost - accumulated depreciation)

Two key methods employed:

– Straight Line Method
– Declining Balance Method/Reducing Balance Method

Question 21

Straight Line Method

Answer 21

Charges an equal amount of depreciation to each period (i.e. linear write-down of asset)

In farm accounts SL depreciation is typically used for buildings and land improvements
– In such cases, estimated residual value is normally zero
– Estimated life of asset varies (10 to 20 years typical)

Question 22

Reducing balance

Answer 22

Also known as Reducing Balance Method
Depreciation rate is expressed as a percentage, and the % rate is applied to the reducing balance of the asset
– Reducing balance is the Written Down Value (WDV) after deduction of cumulative depreciation in previous years

Question 23

Home consumption + private expenditure

Answer 23

• Farm produce consumed in the home – e.g. Milk used in house
• The value of this produce must be entered on the receipts side of P&L if we are to accurately measure output from the business
• Private use of phone, electric, car
  – Apportion costs according to farm use
• e.g. if 50% of electricity bill due to farm then record 50% of annual ESB outlay as expense in farm P&L
• Private drawings (living expenses)
  – NB: NOT entered as expense in P&L account. Business receipts and expenses only in P&L. – Drawings impact on the capital section of the balance sheet

Question 24

Bad debts – irrecoverable debts

Answer 24

– Related to Debtors (Accounts Receivables)
– Where a debtor is not recoverable -> Bad Debt
– Reason why a bad debt (irrecoverable debt) may arise:
The receivable may be refusing to pay one of a number of invoices.
The receivable may be refusing to pay part of an invoice.
Only a proportion from a number of invoices may be paid due to business failure.
The receivables’ business has failed and nothing will be received.
Must be recorded in accounts
When initial sale was made => Recorded Sales and Debtors
Now must remove it as the money is no longer recoverable
How?
Include the amount as an Expense (this in effect cancels out the previous sale) and reduce the remaining Debtors balance in the accounts by the amount of the bad debt
– Can include a “provision for bad debts” in our accounts – provisions are not examinable in this course

Question 25

Net Worth =

Answer 25

the difference between assets and liabilities

Question 26

Capital =

Answer 26

is the owner’s investment in the business (so capital = net worth)

Question 27

Assets
All resources owned and controlled by the farm business which are of value – Assets are divided into:

Answer 27

• Fixed Assets (Non-Current Assets) = Assets that generate return over a number of years and are not traded on an annual basis as part of business activity
  – E.g. Land, buildings, machinery, equipment, breeding livestock
• Current Assets: More liquid assets that change on day-to-day basis, trading assets
  – E.g. Stock (e.g. traded livestock, crops), materials, cash, bank balance, trade debtors

Question 28

Liabilities

Answer 28

Liabilities - Money that is owed by the business – Liabilities divided into:
* Long Term Liabilities (Non-Current Liabilities) = monies which are repayable over longer term (>1 year)
– E.g. Bank loans (term loans), mortgages, family loans
* Current Liabilities: monies that have to be paid in short-term (<1 year) – E.g. Trade creditors, bank overdraft, lease payments

Question 29

Balance Sheet equation:

Answer 29

Net Worth = Assets minus Liabilities
Net Worth also known as (Net) Capital and Owner’s equity

– The amount of money invested by the owner in the business

– Or equivalently: the amount of money owed by the business to the owner (reason why it appears on liabilities side of Balance Sheet)

Change in Net Worth from one accounting period to another is a key measure of financial stability and progress
– Falling Net Worth often symptom of underlying financial problem
– Increasing Net Worth indicates growth of the farm business (progress)

Question 30

Functions of SOFP

Answer 30

Provides a snapshot of the financial position of the business at the balance sheet date

Question 31

Key measurements provided:
Solvency :Liabilities > Assets ⇒ Insolvent
Liquidity
Composition of business assets
Working capital (Current Assets – Current Liabilities)
How quickly can assets be converted to cash to pay debts as they fall due?
Gearing (leverage): Extent to which business capital is financed by borrowing
Net Worth (aka. Equity or Capital): The owner’s stake (share) in the business