Purpose of Final Accounts
Proper accounting lets managers have better financial control and planning, and is also a legal requirement for incorporated businesses. Producing final accounts ensures that all payments and receipts of the business have been officially accounted for.
Purpose of Final Accounts for the Different Stakeholders
Shareholders - The owners of a company will be interested to see where their money was spent and the return on their investments.
Potential Investors - Similar to shareholders, potential investor will assess whether investing in the business will be financially worthwhile
Employees - Staff will be interested in the likelihood of a pay increase or performance-related bonus.
Managers - Managers use finance accounts to judge the operational efficiency of the organisation, and to map out their targets and strategic planning for the next fiscal year.
Competitors - Rivals are interested in benchmarking their own performance against others in the industry.
Government - Authorities will examine accounts to ensure they are not committing fraud.
Financiers - Financial lenders will scrutinise financial accounts to assess the risk of a loan, this will decide the amount of capital they will be willing to loan, and the interest they will charge.
Suppliers - Suppliers will examine financial accounts to determine whether trade credit should be given to the business.
Profit & Loss Account
Profit & loss account - The financial statement of a firm’s trading activities over a period of time, usually over the fiscal year. The main purpose is to show whether the business has made a profit or a loss over the trading period.
There are three sections: the trading account, the profit and loss account, and the appropriation account.
Trading Account - Shows the difference between sales revenue and direct costs of the goods sold, otherwise known as the gross profit.
Gross Profit = sales revenue - cost of goods sold
Profit & Loss Account - Shows the net profit or loss at the end of a trading period, by reducing all indirect costs and other expenses from the gross profit earned.
Net Profit = gross profit - expenses
Appropriation Account - Shows how the net profits after interest and tax are distributed between dividends and retained profits.
- Dividends - Amount of net profit after interest and tax that is distributed to the owners of the company, equivalent to the number of shares they hold.
- Retained Profit - Amount of net profit after interest and tax that is reinvested into the business to improve or grow operations.
Limitations of P&L Account
Done in Hindsight - Shows historical performance of the business, and makes no forecast of its future performance.
Window Dressing - Legal manipulation of financial accounts, is a common practice to deceive potential investors and other stakeholders that the business is more financially successful than reality.
Balance Sheet
Balance Sheet - Financial statement containing information on the value of an organisation's assets, liabilities and the capital invested by the owners.
A balance sheet contains three essential parts: assets, liabilities and equity.
Assets - Items of monetary value that are owned by the business.
- Fixed Assets - An asset used for business operations that is likely to last for more than 12 months from the balance sheet date, such as premises, machinery and equipment. Accumulated depreciation of fixed assets is included to retrieve the current value of net fixed assets.
- Current Asset - The working capital of the business, such as cash and any other liquid asset that can be quickly converted into cash (debtors, stocks, etc.).
Liabilities - Legal obligation of a business to repay its debt at a later date.
- Long-Term Liabilities - Debts to be repaid after twelve months, such as a mortgage, debentures and bank loans.
- Current Liabilities - Debts that must be settled within one year of the balance sheet date. Examples include short-term loans, overdrafts, trade creditors, taxation and dividends.
Equity - Shows the value of the business belonging to the owners.
- Share Capital - the amount of money raised through the sale of shares.
- Retained Profit - Amount of net profit after tax and interest that has been reinvested into the business.
Net Assets = total assets - total liabilities
Owners' Equity = Net Assets
Limitations of Balance Sheets
Accuracy - The figures are only estimations of the value of assets and liabilities. The market value of an asset is not necessarily the same as its book value, meaning the business will likely not be able to sell any fixed assets for as much as they are valued in the balance sheet.
Incomprehensive - Intangible assets and the value of human capital are not included in the balance sheet.
Intangible Assets
Intangible Assets - Non-physical fixed assets that have the ability to earn revenue for a business. They are legally protected by intellectual property rights, and can be used solely by the business.
- Brand - Recognition and loyalty help to drive global sales
- Patents - Innovations cannot be replicated by competitors, giving the business a competitive edge
- Copyright - Provides legal protection for original artistic work. Anyone who seeks to use such works must pay a licensing fee to the business.
- Goodwill - The value of an organisation’s image and reputation.
- Trademarks - Like copyrights and patents, trademarks provide legal protection against replications, and a licensing fee must be paid for use.
Depreciation
Appreciation - Rise in value of fixed assets over time.
Depreciation - Fall in value of fixed assets over time, usually due to wear and tear of assets, and obsolescence due to changing market trends and innovations.
Straight Line Method - Depreciation of fixed assets by a constant rate annually. The residual value, which is an estimate of the scrap or disposal value of the asset at the end of its useful life, is considered by deducting it from the purchase cost before calculation.
Book value = purchase cost - residual value
Annual depreciation = book value / expected lifespan
Reducing Balance Method - Depreciation by a predetermined percentage for the duration of its useful life.
Depreciation = depreciation percentage x prior net book value
Final book value = initial book value - accumulated depreciation
