Profit n Loss Account + Balance Sheet

Research and development expenditure

- Many companies such as pharmaceutical companies, spend huge amounts on research and development every year in order to maintain or enhance their competitive position. - Companies need to account for these costs - An intangible non-current assets should only be recorded when the entity is confident that the expenditure will generate future profit - Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding - Development is the application of research findings or other knowledge to a plan or design for production or new or substantially improved materials, devices, products, processes, systems or services before the start of commercial production or use

Why assets depreciate in value?

- Technology moves on - Time - Wear and tear

Why is depreciation important for financial accounts?

- The balance sheet has to show an accurate value of the assets on the day it is prepared - Depreciation is a business expense (i.e. they are losing money) which must be deducted in order to show accurate levels of profit - depreciating fixed assets

Asset structure

- can be analyzed - increase in the value of fixed assets - suggest the firm is undergoing expansion - significant increase in value of stocks - suggest over trading

Capital Employed

- gives indication of size - higher the capital employed, the greater its market value

Limitations of Balance Sheet

- no specific format - different businesses/accountants produce different formats -> difficult to compare - not accurate -> figures are only estimates of value of assets and liabilities - not all assets are including especially intangible assets and the value of human capital

Balance Sheet

- one of the 3 annual financial statements that all companies are legally required to produce for auditing purposes. - states the sources of finance + where money has been spent -> ensure that all monies within the firm are properly accounted for - shows the financial position of a business on one day only -> a snapshot Contains info on: - the value of an organization's assets - liabilities - capital invested by the owners 1. assets - fixed assets, current assets 2. liabilities - current liabilities -> current assets - current liabilities = net current assets (working capital) -> fixed assets + net current assets = net asset 3. capital and reserves - long term liabilities + capital and reserves = capital employed

Liability

a legal obligation of a business to repay its lenders or suppliers at a later date -> amount of money owed by the business 2 classifications: - long term - debts that are due to repaid after 12 months - current - debts that must be settled within 1 year of the balance sheet date

Profit and Loss Account

shows the net profit (or loss) of a business at the end of a trading period also called, INCOME STATEMENT 1. trading account - sales - cost of sales = gross profit (show the different between sales turnover and the cost) 2. profit and loss account - gross profit - expenses = net profit 3. appropriation account - net profit - taxes= dividends -> retained profit (show where net profit is distributed)

Share capital

the amount of money raised through the shares - shows the value raised when the shares were first sold rather than their current market value

Retained Profit

the amount of net profit after interest, tax and dividends have been paid -> then reinvested back into the business come from PnL

Expenses

the indirect or fixed costs of production expenses are regular or ongoing indirect costs for a business. they will vary from business to business but will invariably include: - administration charges - management salaries - marketing costs, such as advertising - insurance premiums, e.g. for buildings, vehicles and stock - interest on bank loans - rent of land and property - stationery costs - transportation and distribution costs - utility bill, e.g. gas, electricity, telephone and water charges

Reserves

the proceeds from retained profits in previous years

Depreciation

the reduction in value of a tangible fixed asset over its useful life span - Machinery - Fixture and fittings - Premises - Vehicles LAND and BUILDINGS don't tend to depreciate

Capital structure

to see sources of finance

Gross Profit

Gross Profit = sales revenue - cost of good sold

Reducing Balance Method

Net Book Value = Historical Cost - Cumulative Depreciation - reducing balance method depreciates the value of an asset by a predetermined percentage for the duration of its useful life. - more realistic in representing the diminishing market value of fixed assets over time. - unnecessary if the purpose is to spread the cost of an asset over its useful lifespan - deciding on the rate of annual depreciation is rather subjective

Working Capital

Net Current Asset/Working Capital = Current Assets - Current Liabilities - indication of the short-term liquidity position of the business - shows the money available for the daily running

Net Profit

Net Profit = Gross Profit - Expenses this gross profit, calculated from the trading account, is used to deduct all expenses (indirect costs) to calculate net profit also called OPERATING PROFIT

Net assets

Net assets = Fixed Assets + Working Capital - must equal with capital employed

Whereabouts on the balance sheet and profit & loss account is depreciation recorded?

BS: fixed assets PnL: expenses

Cost of good sold

Cost of good sold = opening stock + purchases - closing stock

The Straight Line Method

Cost of the Asset - Residual Value of the Asset _______________________________________ Useful Life (years) Cost of the Asset: what you paid for Residual Value of the Asset: (end value) what's it going to be worth when you're finished with it - inaccurate to be 0 -> unusual for fixed asset to lose all of its value Useful Life: how long you intend to keep it for straight forward and easy to understand - depreciating an equal amount each year is not realistic

Fixed asset

any asset purchased for business use, rather than for selling, and is likely to last for more than 12 months from the balance sheet date. - tangible - physical -> vehicles, property, equipment, fixtures and fittings (furniture), motor vehicles - intangible - non-physical - investments -> held for long-term strategic reasons medium - long term financial investments that the business has - ex. shares and debentures - can generate some short-term income such as dividend or interest payments

Intangible Fixed Assets

are non physical assets - have the ability to earn Accounting rule: only include intangible assets when you buy a new business then get take off right away - Development expenditure - Goodwill - value of an organization's image and reputation + can also include its customer base and connections - Patents (legal protection for investors), licenses (copyrights), trade marks

Capital and Reserves

may appear as SHAREHOLDERS' FUNDS (Limited companies) or OWNERS' EQUITY (for businesses other than limited companies) - no definite date for repayment -> view as sources of permanent capital

Current Asset

refers to cash or any other liquid asset that is likely to be turned into cash within 12 months of the balance sheet date. 3 main kinds: - cash - debtors - stocks