Flashcards · 9215 · Topic 4

Preparation of financial statements flashcards

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Sole traders, partnerships and limited companies compared

Sole trader, partnership and limited company: owners and liability: Sole trader: one owner, unlimited liability. Partnership: two or more partners, usually unlimited liability. Limited company: owned by shareholders, limited liability.
Main strength and weakness of each type of business: Sole trader: keeps all profit and decides quickly; but bears the risk with limited capital. Partnership: shared skills and workload; but disputes and shared risk. Company: limited liability and continuity; but rules, cost, loss of control.
Share capital compared with loan capital: Share capital: provided by shareholders, who own the company and share its profit through dividends; part of equity. Loan capital: provided by lenders, who are owed repayment and fixed interest; a liability.
Why might a sole trader become a limited company?: Shareholders have limited liability, and the company can raise capital by selling shares and by borrowing. The cost is more rules and a shared say in running the business.

Financial statements of sole traders

Layout of a sole trader’s income statement: Revenue; less cost of sales (opening inventory + purchases less own use + carriage inwards − closing inventory) = gross profit; add other income; less adjusted expenses = net profit.
The owner takes goods costing $280 for own use. Double entry?: Debit Drawings $280; credit Purchases $280, at cost. It is not an expense.
Opening capital $15,000; net profit $9,800; drawings $7,200. Closing capital?: 15,000 + 9,800 − 7,200 = $17,600. Net assets in the statement of financial position must equal this.
Revenue $58,000; cost of sales $39,500. Gross profit and gross profit percentage?: Gross profit 18,500; 18,500 ÷ 58,000 × 100 = 31.9%.
Gross profit $15,300; wages $6,000; rent $2,400 paid with $200 owing; depreciation $800; insurance $900 paid with $150 prepaid. Net profit?: Expenses 6,000 + 2,600 + 800 + 750 = 10,150. Net profit 15,300 − 10,150 = $5,150.
How does a service business’s income statement differ?: It has no inventory and no cost of sales: it runs from revenue to expenses, with no gross profit.

Financial statements and capital and current accounts of partnerships

Order of the partnership appropriation account: Profit for the year; add interest on drawings; deduct interest on capital; deduct partnership salaries; the residual profit (or deficit) is shared in the profit sharing ratio.
Interest on a partner’s loan compared with interest on capital: Loan interest is an expense in the income statement, paid whatever the profit. Interest on capital is an appropriation of profit, credited to the partner’s current account.
A partner’s salary compared with employees’ wages: Wages paid to employees are expenses. A partner’s salary is an appropriation of profit, credited to the current account.
Profit for the year $27,640; interest on drawings $660; interest on capital $1,950; salary $8,000. Residual, shared 3 : 2?: Residual 27,640 + 660 − 1,950 − 8,000 = 18,350. Shares: $11,010 and $7,340.
Current account: opening debit $500, interest on capital $1,200, salary $6,000, share of profit $4,300, drawings $9,000, interest on drawings $270. Closing balance?: Credits 11,500 − debits 9,770 = $1,730 credit.
Where is a loan from a partner shown in the statement of financial position?: Under non-current liabilities, not in equity. Equity shows each partner’s capital account and current account (debit balances deducted).
Which partnership topics are not examined in 9215?: Admission and retirement of a partner, dissolution of partnerships and changes to the profit sharing ratio.

Internal financial statements of limited companies

The five sub-headings of a limited company’s statement of financial position: Non-current assets, current assets, equity, non-current liabilities and current liabilities.
Dividend compared with loan interest: Loan interest is an expense, deducted after operating profit to reach profit for the year. A dividend is a distribution of profit, deducted from retained earnings, never shown among expenses.
A 6% loan of $50,000 was held all year and $1,800 of interest was paid. Interest owing?: Full-year interest 3,000, so $1,200 is owing (a current liability). The income statement deducts the full $3,000.
Retained earnings at the start $12,400; profit for the year $9,100; dividends $4,000. Closing retained earnings?: 12,400 + 9,100 − 4,000 = $17,500.
A loan is repayable eight months after the year end. Where is it shown?: In current liabilities, because it falls due within one year of the statement date.
Name items the 9215 specification says are not examined for limited companies: The statement of changes in equity, preference shares, general reserves, rights issues, bonus issues and the revaluation of non-current assets.

Manufacturing accounts

Prime cost and factory overheads: Prime cost: cost of raw materials used + direct wages. Factory overheads: factory running costs that cannot be traced to one unit, such as indirect wages, factory power, insurance, rent and depreciation of machinery.
Factory cost of finished goods, and cost of sales for a manufacturer: Factory cost of finished goods = prime cost + overheads. Cost of sales = opening finished goods + factory cost of finished goods − closing finished goods.
Raw materials used $17,300; direct wages $9,700; overheads $11,000; finished goods $3,000 opening, $4,500 closing. Cost of sales?: Prime cost 27,000; factory cost 38,000; cost of sales 3,000 + 38,000 − 4,500 = $36,500.
Manufacturing account or income statement: carriage inwards, carriage outwards, depreciation of machinery, depreciation of office equipment: Carriage inwards on materials and machinery depreciation: manufacturing account. Carriage outwards and office equipment depreciation: income statement.
Rent of $12,000 is shared two-thirds factory and one-third office. Factory overhead?: Two-thirds of 12,000 = $8,000; the other $4,000 is an office expense in the income statement.
Is the provision for unrealised profit examined in 9215?: No. Finished goods move from the factory at cost.

Financial statements of clubs and non-profit making organisations

Receipts and payments account compared with income and expenditure account: Receipts and payments: cash only, including capital items, opening and closing balances. Income and expenditure: accruals basis, the year’s income and expenditure with depreciation, without capital items.
Surplus, deficit and accumulated fund: Surplus: income greater than expenditure; deficit: the reverse. Accumulated fund: the club’s capital, assets less liabilities; it rises by a surplus and falls by a deficit.
Subscriptions in arrears and in advance: In arrears: owed by members, a current asset (other receivable). In advance: received for next year, a current liability (income received in advance).
Subscriptions received $8,400; arrears $250 opening, $180 closing; advance $120 opening, $160 closing. Income?: 8,400 − 250 + 180 + 120 − 160 = $8,290.
How is a club’s bar or shop shown?: In a trading account for that activity, which finds its gross profit or loss (sales − cost of sales). The result is carried to the income and expenditure account.
Income $12,400; expenditure $10,950; opening accumulated fund $6,700. Surplus and closing fund?: Surplus 1,450; closing accumulated fund 6,700 + 1,450 = $8,150.

Incomplete records and single entry

Single entry compared with double entry: Single entry: each transaction recorded once, often only cash and bank movements. Double entry: each transaction recorded as a debit and a credit, so a trial balance can be taken out.
Statement of affairs: A list of assets and liabilities at one date, built from counted and valued items, with capital (assets − liabilities) as the balancing figure.
Opening capital $5,070; closing capital $3,830; drawings $900; nothing introduced. Profit or loss?: 3,830 − 5,070 + 900 = −340, a loss of $340.
Receivables $1,800 opening, $2,100 closing; cash received $14,200; irrecoverable debts $150. Credit sales?: 14,200 + 150 + 2,100 − 1,800 = $14,650.
Opening bank $1,200; receipts $21,500; payments to suppliers and expenses $16,250; closing bank $1,450. Unrecorded drawings?: 1,200 + 21,500 − 16,250 − 1,450 = $5,000.
Benefits and limitations of single entry: Benefits: cheap, quick and simple; little training; enough for a very small business. Limitations: no trial balance; errors and fraud harder to find; profit needs extra calculations; information is limited.