Preparing Financial Statements - Introduction Chapter 6 © Luby & O’Donoghue (2005)
Revision • Key terms: • Revenue • Expenses • Assets • Liabilities • Capital
Reporting profit • The Profit & Loss Statement tells whether the business has made a profit or loss for the period under review. Profit is calculated by deducting expenses from revenue. • In order to ascertain profit two accounts are usually prepared: • 1.The Trading Account and • 2.The Profit & Loss Account
Trading, Profit & Loss Accounts • The Trading Account shows the gross profit i.e. the difference between sales revenue and the cost of sales. • The Profit & Loss Account discloses the net profit after charging all appropriate expenses.
Example • C. Maguire operates a small retail business in a Dublin suburb. Draw up a trading account from the following extracts in the books of C. Maguire for the year ended 31 December. Note: C. Maguire's closing stock amounted to €12,000 at the year end.
The Balance Sheet • The Balance Sheet is a statement of the assets and liabilities of a business at a particular date.
The Profit and Loss Account is normally prepared for a period of time showing the summary revenues and expenses over a period of time. • Trading, Profit & Loss Account for period ending dd/mm/yy • This is unlike the Balance Sheet which, shows what the business owns (assets), and owes (liabilities and capital) at one point in time, usually the end of the year. • Balance Sheet as at dd/m/yy
Key terms • Returns • Stock • Cost of sales • Carriage • Fixed assets • Current assets • Current liabilities • Long term liabilities
Example • The following trial balance has been extracted from the accounts of T Raftery, who operates a retail business, focused on the tourist market selling souvenir china and glass crafted items for the year ended 31/12/04. You are required to prepare a trading, profit and loss account for the period. • At the 31/12/04 the business had stock of unsold goods worth €5,000.
The accruals concept • The calculation of profit is based on the accruals concept and knowledge of this concept is essential in understanding the net profit figure and the differences between cash and profit.
Accruals concept - key issues • When calculating net profit expenses should be matched against related revenues. In the trading account of a product based company expenses are matched to sales on a unit basis, and in the profit and loss account expenses are matched on a time basis. For a service company all expenses are matched on a time basis. • Net profit is the difference between revenues earned (not necessarily received) and expenses charged (not necessarily paid). Thus net profit is worked on a transactions basis. Transactions are matched, checking that all costs incurred in earning the periods revenue have been included whether paid or not. • This is also consistent with the realisation concept which states that transactions are accounted for when they have issued or have been issued an invoice not necessarily when cash is received. Many business that buy and sell on credit, sales and purchases in the trading, profit and loss account will be a mixture of cash and credit transactions. Also, some expenses will not have been paid by the year-end however they are still included as expenses in the profit and loss account irrespective of whether they are paid or not. Any unpaid expenses will also be shown in the balance sheet under liabilities.
Accruals concept - summary • Sales in the trading account is made up of cash sales and credit sales. • Debtors in the balance sheet will be made up of credit sales for which monies have not been received by the end of the period. • Purchases in the trading account is made up of cash and credit purchases. • Trade creditors in the balance sheet will be made up of credit purchases for which no payment has been made by the period end. • Expenses in the profit and loss account are made up of expenses paid and expenses owed • Expenses owed at the year-end will be shown in the balance sheet under current liabilities