Unit 3.4 : Final Accounts (INCOMPLETE - only Balance Sheets)

Question 1

Final accounts

Answer 1

1. All businesses need to keep records of their financial statements as a way to account for the money of the business, whether it belongs to the owners, investors or vendors
2. All companies must provide a set of final accounts to its various stakeholders
3. These accounts are made up of the profit and loss account and the balance sheet

Question 2

Balance sheet

Answer 2

1. shows the assets and liabilities of a business at a particular point in time
2. A balance sheet is one of the annual financial statements that all companies are legally required to produce for auditing purposes
3. It contains information on the value of an organization’s assets, liabilities, and the capital invested by the owners
4. As it shows the financial position of a business on one day only, it is often described as a snapshot of a firm’s financial situation
5. It shows a firm’s sources of finance (shown as equity) and where that money has been used and where a firm’s money has come from and what it has been spent on

Question 3

purpose of final accounts to shareholders

Answer 3

1. the owners of a company are interested to see where their money was spent and the return on their investments
2. based on its financial performance, shareholders can decide whether to hold, sell, or buy of the company’s shares

Question 4

purpose of final accounts to employees

Answer 4

1. staff are interested in their organization’s financial account to assess the likelihood of pay increments and the degree of job security

Question 5

purpose of final accounts to managers

Answer 5

1. managers use financial accounts to judge the operational efficiency of their organizations
2. financial analysis can also be useful for target setting and strategic planning

Question 6

purpose of final accounts to competitors

Answer 6

1. rivals are interested in the final accounts of a business to make comparisons of their financial performance

Question 7

purpose of final accounts to government

Answer 7

1. the tax authority examines the accounts of businesses, especially large multinationals, to ensure that they pay the correct amount of tax

Question 8

purpose of final accounts to suppliers

Answer 8

1. suppliers examine a firm’s final accounts to decide the extent to which trade credit should be given

Question 9

purpose of final accounts to potential investors

Answer 9

1. Private and institutional investors use final accounts and ratio analysis to assess whether an investments would be financially worthwhile

Question 10

Principles and ethics of accounting practice

Answer 10

1. integrity
2. objectivity
3. professional competence and due care
4. confidentiality

Question 11

Assets

Answer 11

1. Assets are items of monetary value that are owned by a business e.g. cash stocks and buildings
2. To purchase assets, firms need different sources of finance
3. Assets can be classified as fixed assets or current assets

Question 12

Fixed asset

Answer 12

1. A fixed asset is any asset used for business operations (rather than for selling) and is likely to last for more than 12 months from the balance sheet date
2. They are used to generate output and sales like physical restaurants, equipment, tables, etc

Question 13

Current asset

Answer 13

1. A current asset refers to cash or any other liquid asset that is likely to be turned into cash within twelve months of the balance sheet data
2. Three types of current assets are cash, debtors, and stocks
3. It is what it intends to change into cash within one year of the balance sheet date like stock

Question 14

Firm’s nets assets

Answer 14

1. The value of a firm’s net assets is therefore the value of all assets minus its liabilities
2. This must be equal to its equity on the balance sheet
3. Net assets = Fixed assets + Working capital - Long-term liabilities
4. Net assets = Total assets - Total liabilities

Total assets - Total liabilities = Net assets = Owner’s equity

Question 15

Equity

Answer 15

1. This section of the balance sheet shows the value of the business belonging to the owners
2. It can appear in a balance sheet as shareholder’s equity (for limited liability companies) or as owners’ equity (for business other than limited liability companies)
3. The main sections of equity are share capital and retained profit

Question 16

Share capital

Answer 16

1. Share capital refers to the amount of money raised through the sale of shares
2. It shows the value raised when the shares were first sold, rather than their current market value

Question 17

Retained profit

Answer 17

1. Retained profit is the amount of net profit after interest, tax, and dividends have been paid
2. It is then reinvested in the business for its own use
3. This money, of course, belong to its owners so appears under owners’ equity or shareholders’ equity
4. This figure for retained profits comes from the Profit & Lost account

Question 18

Current liabiltiies

Answer 18

1. Current liability are debts that the business must pay to its creditors within 12 months of the balance sheet date e.g. money owed to trade creditors or tax owed to the government or dividends owed to the company’s shareholders

Question 19

Net Current Assets

Answer 19

1. Also known as working capital (net current assets)

2. Calculated as the difference between a firm’s current assets and its current liabilities

Question 20

Long-term liabilities

Answer 20

1. Debts owed by a firm, repayable after 12 months from the balance sheet date
2. Examples include mortgages and debentures to buy the premises and the outstanding bank loans

Question 21

Difference between balance sheets of sole traders/partnerships and limited companies

Answer 21

1. Sources of finance will differ. Limited companies can raise finance through the sale of debentures (recorded under long-term liabilities), whereas this would not appear on the balance sheet of unincorporated business
2. Shareholder’s funds is replaced with owner’s equity including the personal funds of sole traders and partners
3. Since there are no shareholders in a partnership or sole trader, dividends will not appear under their current liabilities so sole traders or partners might take out funds from the business for their personal use

Question 22

Limitations of balance sheets

Answer 22

1. As balance sheets are static documents, the financial position of a business might be very different in subsequent periods. for e.g. value of capital and reserve can change the next day due to the business using funds for expansion purposes
2. The figures are at best, only accurate estimates of the value of assets and liabilities. The market value of an asset is not necessarily the same as its book value. The true market value of a fixed asset is only known once the item has been sold. Also the values showed do not show a detailed breakdown of a firm’s assets, so the information is somewhat incomplete
3. Since there is no specific format required for producing a balance sheet, different businesses will produce accounts in varying formats and include different assets and liabilities. This can make it difficult to compare the financial position of different firms, even those that operate in the same industry
4. Not all assets are included in the balance sheet, especially intangible assets and the value of human capital (such as the market value of a player in a sports team)

Question 23

Intangible assets

Answer 23

1. Intangible assets are non-physical fixed assets that have the ability to earn revenue for a business (brand named, goodwill, trademarks, copyrights/patents)
2. They are legally protected by intellectual property rights
3. Intangible assets can account for a large proportion of a firm’s asset value, although it is usually difficult to place an objective and accurate price on such assets
4. They are not always shown in a balance sheet because their value is very difficult to measure. The subjective nature of valuing intangible assets renders it unnecessary or even impossible to include in a balance sheet
5. Could be seen as a way to artificially inflate the value of a business - no doubt that intangible assets add value to a business beyond its book value, but the uncertainty lies in how to place an accurate value of such assets

Question 24

Types of intangible fixed assets on a balance sheet

Answer 24

1. Brand recognition and value help to drive global sales for companies such as Apply or Coca-Cola. Brand cognition and loyalty is an indefinite asset for as long as the company operates
2. Patents provide legal protection for inventors. It acts as an incentive to stimulate innovation - allowing the inventor to have exclusive rights to commercial production for a specified time period. Other firms must apply and pay a fee to the patent holder if they wish to use or copy the ideas, processes, or product created by the inventor
3. Copyright provide legal protection for the original artistic work of the creator, such as an author, photographer, painter, or musician. Anyone wishing to reproduce or modify the artist’s work must first seek permission from the copyright holder, usually for a fee
4. Goodwill is the value of an organization’s image and reputation, including the value of the firm’s customer base and its business connections. (e.g. treating employees well and gaining loyalty from them)
5. Registered trademarks are distinctive signs that uniquely identify a brand, a product, or a business. Trademarks can be expressed by names, symbols, phrases, or an image (such as Nike swoosh mark)

Question 25

Depreciation

Answer 25

1. property and land tend to rise in value over time. The increase in the value of fixed assets is known as appreciation
2. However, most fixed assets tend to depreciate over time. Depreciation is the fall in the value of fixed assets over time
3. Depreciation spreads the historic cost (purchase cost) of fixed assets over their useful lifespan. The change in the value of fixed assets is shown by reassessing their value on a balance sheet

Question 26

Reasons for depreciation

Answer 26

1. Wear and tear : fixed assets such as computers are used repeatedly over time, so they tend to wear out and raise maintenance costs. Hence the value of these fixed assets declines over time
2. Obsolescence : As newer and better products become available, the demand and hence the value of existing fixed assets will fall. Obsolete assets are out-of-date assets such as old versions of vehicles, computers, or software

Question 27

Depreciation needs to be recorded into:

Answer 27

1. Calculate the value of a business more accurately. Depreciating fixed assets will reduce the value of net assets to better reflect the true value or financial position of a business. Similarly, revaluing assets that have that have appreciated will increase the net asset value
2. Realistically assess the value of fixed assets over time. The historic cost of fixed assets such as machinery and vehicles is unlikely to be equal to its current market value
3. Plan for the replacement of assets in the future. Provisions are made for purchasing new fixed assets. Depreciation is recorded on the P&L account as an expense because it reflects the fall in the value of fixed assets that will eventually need to be replaced

Question 28

Depreciation equations

Answer 28

Annual depreciation = purchase cost/lifespan

Annual depreciation = (purchase cost - residual value)/lifespan

Net book value = Historical cost - Accumulated depreciation