Flashcards · 4AC1 · Topic 4

The preparation of financial statements flashcards

33 cards on Topic 4, subtopics 4.1 to 4.5. Pick a subtopic or study them all.

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4.1 Financial statements of a sole trader

Cost of sales in a sole trader’s income statement: Opening inventories + purchases + carriage inwards − purchases returns − closing inventories.
Carriage inwards compared with carriage outwards: Carriage inwards: a cost of getting goods to the business, in cost of sales. Carriage outwards: a cost of delivering to customers, an expense below gross profit.
Where do discount received and discount allowed go in the income statement?: Discount received: added to gross profit as other income. Discount allowed: an expense.
Working capital and net assets: Working capital = current assets − current liabilities. Net assets = non-current assets + working capital − non-current liabilities. Net assets must equal equity.
Order of current assets in the statement of financial position: Inventories, trade receivables, other receivables, bank, cash: least liquid first, most liquid last.
Gross profit $20,400; discount received $260; expenses $15,580; opening capital $18,000; drawings $8,500. Profit and closing capital?: Profit for the year 20,400 + 260 − 15,580 = $5,080. Closing capital 18,000 + 5,080 − 8,500 = $14,580.
Is the purchase of a new delivery van an expense of the year?: No. It is capital expenditure, a non-current asset in the statement of financial position. Only its depreciation is an expense.

4.2 Financial statements of a partnership

Ordinary partnership compared with a limited liability partnership (LLP): Ordinary partners have unlimited liability: personal assets can pay the firm’s debts. An LLP is a separate legal person whose members have limited liability, so their personal assets are generally protected.
Section 24 of the Partnership Act 1890: defaults when there is no agreement: No salaries; profit and losses shared equally; 5% a year interest on a partner’s loan; no interest on capital; no interest charged on drawings.
Layout of a partnership appropriation account: Profit for the year, add interest on drawings, less interest on capital, less salaries = residual profit or deficit, shared in the profit-sharing ratio.
Drawings of $7,200 are taken evenly through the year; interest on drawings is 6% a year. Charge?: 7,200 × 6% × 6/12 = $216 (drawings taken evenly are outstanding for six months on average).
Profit for the year $48,000; interest on drawings $800; interest on capital $6,000; salary $9,000. Residual, shared 4 : 3 : 3?: Residual 48,000 + 800 − 6,000 − 9,000 = 33,800. Shares: $13,520, $10,140 and $10,140.
Current account: opening credit $900, interest on capital $1,500, share of profit $4,200, drawings $6,000. Closing balance?: 900 + 1,500 + 4,200 − 6,000 = $600 credit: the firm owes the partner $600.
How are partners’ current account balances shown in the statement of financial position?: In equity, after each partner’s capital. A credit balance is added; a debit balance is deducted.

4.3 Incomplete records

Profit for the year from opening and closing equity: Profit = closing equity − opening equity + drawings − capital introduced. Equity = assets − liabilities at each date.
Opening equity $21,400; closing equity $26,600; drawings $10,200; capital introduced $4,000. Profit?: Change in equity 5,200. Profit = 5,200 + 10,200 − 4,000 = $11,400.
How do you find credit sales from incomplete records?: Use a trade receivables control account: credit sales are the missing figure on the debit side (receipts, discount allowed, irrecoverable debts, returns and closing balance less the opening balance).
Till: opening cash $100, closing $160; banked $26,400; expenses paid from the till $3,120. Cash takings?: Takings = banked + spent from the till + closing cash − opening cash = 26,400 + 3,120 + 160 − 100 = $29,580.
Mark-up compared with margin: Mark-up = gross profit ÷ cost of sales × 100. Margin = gross profit ÷ revenue × 100. A 25% margin is a 33.3% mark-up (25 ÷ 75); a 60% mark-up is a 37.5% margin (60 ÷ 160).
Cost of sales is $32,000 and the mark-up is 25%. Revenue?: 32,000 × 1.25 = $40,000.

4.4 The calculation and interpretation of accounting ratios

Profitability compared with liquidity: Profitability: does the business earn a profit, and how much for its revenue or capital? Liquidity: can it pay its short-term debts when they fall due? Profit is not cash.
Gross profit percentage and profit for the year as a percentage of revenue: Gross profit ÷ revenue × 100. Profit for the year ÷ revenue × 100.
Return on capital employed (ROCE) as set out in the 4AC1 notes: Profit for the year ÷ capital employed × 100. Capital employed = equity + non-current liabilities (or non-current assets + working capital). State your formula.
Current (working capital) ratio and liquid (acid test) ratio: Current ratio = current assets : current liabilities. Liquid ratio = (current assets − inventory) : current liabilities. Write both as x : 1.
Current assets $54,000 (inventory $21,000); current liabilities $30,000. Current and acid test ratios?: Current ratio 54,000 ÷ 30,000 = 1.8 : 1. Acid test 33,000 ÷ 30,000 = 1.1 : 1.
Equity $95,000, non-current liabilities $25,000, profit for the year $14,400. ROCE?: Capital employed 120,000. ROCE = 14,400 ÷ 120,000 × 100 = 12%.
The gross profit percentage rises but profit for the year as a percentage of revenue falls. Why?: Expenses have grown faster than revenue (for example wages, rent or advertising), cutting profit even though the gross margin improved.

4.5 Financial statements of a manufacturer

Raw materials, work-in-progress and finished goods: Raw materials: bought, not yet used. Work-in-progress: started, not finished at the year end. Both adjusted in the manufacturing account. Finished goods: complete and ready to sell, adjusted in the income statement.
Prime cost: Raw materials consumed + direct wages + direct expenses (such as a royalty per unit).
Total cost and production cost: Total cost = prime cost + factory overheads. Production cost = total cost + opening work-in-progress − closing work-in-progress. It replaces purchases in cost of sales.
Raw materials consumed $18,350; direct wages $9,200; direct expenses $700; factory overheads $6,900; WIP $1,100 opening, $900 closing. Production cost?: Prime cost 28,250; total cost 35,150; production cost 35,150 + 1,100 − 900 = $35,350.
Is a factory supervisor’s salary a prime cost or a factory overhead?: A factory overhead (indirect wages). Only workers who make the goods are direct labour.
Rent of $15,000 is shared, 40% relating to the factory. Treatment?: $6,000 goes in the manufacturing account as a factory overhead; the other $9,000 is an expense in the income statement.