IB DP Business Management: Final accounts

This guide covers section 3.4 (Final accounts) of Unit 3 in the IB Business management guide, first assessment 2024. Most of the section applies at both SL and HL. The two depreciation methods and the choice between them are marked “HL only” in the guide, and this page labels them the same way. Use it with the course hub, the printable checklist, the revision notes and the practice questions. For the wider unit, see the Unit 3 overview. To test yourself on Unit 3 as a whole, try the diagnostics.

What 3.4 asks you to do

Content point in the guide	What you must be able to do	Level
The purpose of accounts to different stakeholders	Explain why each stakeholder group reads the accounts	SL and HL
Final accounts: profit and loss account, balance sheet	Describe both, and prepare or complete them from given data	SL and HL
Different types of intangible assets	Identify and explain intangible assets	SL and HL
Depreciation: straight line method, units of production method	Calculate depreciation by each method	HL only
Appropriateness of each depreciation method	Judge which method suits a given asset	HL only

The guide gives these points a mix of AO2 and AO4 demands, and the appropriateness of depreciation methods an AO3 demand. The guide describes Paper 2 as based on unseen stimulus material with a quantitative focus, so expect to calculate as well as describe. The guide does not name the intangible assets you need, so the examples below are standard ones.

The purpose of accounts to different stakeholders

A business records its transactions and summarizes them into final accounts at the end of a trading period. The guide names two: the profit and loss account and the balance sheet. Different stakeholders read the same figures for different reasons. Link this to the stakeholders guide.

Stakeholder	What they look for	Why
Owners and shareholders	Profit, retained profit, dividends, value of equity	Judge the return on their investment and whether to invest more or sell
Managers	Costs, profit, asset levels	Judge performance against targets and plan the next period
Employees and trade unions	Profit and the ability to pay	Judge job security and the scope for pay rises
Lenders such as banks	Existing loans, assets, profit	Judge whether the business can repay and what it could offer as security
Suppliers	Amounts owed, cash and short-term assets	Decide whether to offer credit
Government and tax authorities	Profit before tax	Work out the tax due
Potential investors and competitors	Profit and asset strength	Compare the business with alternatives
Local community	Profit, size, signs of growth or decline	Judge the business’s future as an employer

Accounts show the past. A shareholder who wants to know whether next year looks good has to combine them with other information. Say this when you evaluate how useful accounts are.

The profit and loss account

The profit and loss account shows the profit or loss a business made over a period. It runs from sales revenue down to the profit left for the owners. The guide does not set out a layout, so the form below is the standard one.

Sales revenue
- Cost of sales   (opening inventory + purchases - closing inventory)
= Gross profit
- Expenses        (wages, rent, marketing, other overheads)
= Operating profit
- Interest paid
= Profit before tax
- Tax
= Profit after tax (net profit)
- Dividends
= Retained profit for the year

Inventory is also called stock. Retained profit is the part of profit kept in the business. It is also one of the internal sources of finance in 3.2.

Worked example: Fenrow Ceramics

Fenrow Ceramics makes dinner sets. For its latest year, all figures are in thousands of dollars. Sales revenue was 840. Opening inventory was 60, purchases were 372 and closing inventory was 72. Wages were 190, rent and utilities 84, marketing 46 and other overheads 40. Interest paid was 12. Tax is charged at 25% of profit before tax. Dividends were 30.

Line	Working	Amount
Cost of sales	60 + 372 - 72	360
Gross profit	840 - 360	480
Total expenses	190 + 84 + 46 + 40	360
Operating profit	480 - 360	120
Profit before tax	120 - 12	108
Tax	25% of 108	27
Profit after tax	108 - 27	81
Retained profit	81 - 30	51

Unit check: all lines share the same unit. Write “thousand dollars” or state it in the heading. Dropping the unit costs the clarity that the command term calculate asks for (“obtain a numerical answer showing the relevant stages in the working”).

The balance sheet

The balance sheet shows what a business owns, owes and is worth at a single point in time. It rests on the accounting equation:

assets = liabilities + equity

Section	What it contains
Non-current assets	Items kept for more than a year: premises, equipment, vehicles, and intangible assets
Current assets	Items likely to become cash within a year: inventory, trade receivables (debtors), cash
Current liabilities	Debts due within a year: trade payables (creditors), overdraft, tax owed
Non-current liabilities	Debts due after more than a year: long-term bank loans
Equity	Share capital and retained profit built up over the years

Two figures follow from the layout. Working capital is current assets minus current liabilities. Net assets are total assets minus total liabilities, and they equal equity.

Worked example: Fenrow Ceramics continued

At the year end the balance sheet showed, in thousands of dollars: equipment and premises 420; a registered trademark 60; inventory 72; trade receivables 58; cash 40; trade payables 64; tax owed 27; a bank loan repayable in six years 150; share capital 250. Opening retained profit was 108.

Line	Working	Amount
Non-current assets	420 + 60	480
Current assets	72 + 58 + 40	170
Total assets	480 + 170	650
Current liabilities	64 + 27	91
Working capital	170 - 91	79
Non-current liabilities	bank loan	150
Net assets	650 - 91 - 150	409
Retained profit at year end	108 + 51	159
Equity	250 + 159	409

Net assets equal equity, so the balance sheet balances. The link between the two accounts is the 51: the retained profit from the profit and loss account is added to the retained profit in equity. If your balance sheet does not balance, an error exists, and the missing figure is often a retained profit you forgot to carry across.

How to read it: working capital of 79 is positive, so the current assets exceed the debts due soon. The loan sits in non-current liabilities, so repayment pressure is spread over years. A bank would compare these with the profit figures before lending more. The guide deals with ratios in 3.5, so only the plain figures are needed here.

Intangible assets

An intangible asset is an asset with no physical form that is expected to bring benefit over more than one year. The guide lists “different types of intangible assets” without naming them, so learn these standard ones:

• Patents: legal protection for an invention, giving the owner sole rights to use or license it.
• Trademarks and brand names: signs, names or logos that identify the business’s products.
• Copyrights: protection for written, musical, artistic or software creations.
• Licences and franchise rights: permission to produce or trade under another party’s name or rules.
• Goodwill: the extra amount a buyer pays for a business above the value of its identifiable net assets, reflecting its reputation and customer base. For example, if a buyer pays 540 for a business whose identifiable net assets are worth 360, goodwill is 180.

Intangible assets appear in non-current assets. They are harder to value than physical items because there is nothing to inspect, and their worth can fall suddenly if a brand is damaged or a patent expires. A business may also hold valuable assets that never reach its balance sheet, so the balance sheet can understate its real worth.

Depreciation (HL only)

Depreciation spreads the cost of a non-current asset over its useful life. Each year’s charge is an expense in the profit and loss account. It also lowers the asset’s value on the balance sheet, which is called its net book value:

net book value = cost - accumulated depreciation

Depreciation is a book entry. It lowers profit without any cash leaving the business that year. The cash left when the asset was bought. Note the reasoning, because it links to the profit-versus-cash distinction in 3.7.

Straight line method

Straight line writes off an equal amount each year. This is the standard form:

annual depreciation = (cost - residual value) / useful life

The residual value is the estimated worth of the asset at the end of its life.

Units of production method

This method ties the charge to how much the asset is used. This is the standard form:

depreciation per unit = (cost - residual value) / total expected units

annual depreciation = depreciation per unit x units produced that year

Worked example: a kiln

Fenrow buys a kiln for 96,000 dollars with a residual value of 12,000 dollars, a useful life of 7 years and an expected total output of 420,000 pieces.

Straight line: (96,000 - 12,000) / 7 = 12,000 dollars a year. After one year the net book value is 84,000 dollars.

Units of production: (96,000 - 12,000) / 420,000 = 0.20 dollars per piece. In year 1 the kiln fires 90,000 pieces, so depreciation is 18,000 dollars and the net book value is 78,000 dollars. In year 2 it fires 55,000 pieces, so depreciation is 11,000 dollars and the net book value is 67,000 dollars.

Choosing a method

This is an AO3 point, so give a reason tied to the asset.

• Straight line suits assets that lose value mainly with time, such as a building, office furniture or a software licence. It is simple and predictable, but it ignores how hard the asset works.
• Units of production suits assets worn out by use, such as a machine whose output varies or a vehicle measured by distance. It matches the charge to the wear, but you must be able to estimate lifetime output, and charges swing between years.

A strong answer uses the case: if output is stable, the two methods give similar charges and simplicity favours straight line. If output swings with demand, units of production matches cost to benefit better.

Common errors

• Writing expenses into cost of sales, or leaving out opening inventory when building cost of sales.
• Treating dividends as an expense. They come after tax, from profit after tax.
• Putting a long-term loan in current liabilities, or the overdraft in non-current liabilities.
• Forgetting that net assets must equal equity, and not checking.
• Calling depreciation a cash payment. It is not.
• Ignoring the residual value when calculating depreciation.
• Giving a generic list when asked why accounts matter to a stakeholder. Name the group and the figure that group uses.

Frequently asked questions

What is the difference between the profit and loss account and the balance sheet? The profit and loss account shows the profit or loss a business made over a period. The balance sheet shows what the business owns, owes and is worth at a single point in time, based on the accounting equation assets = liabilities + equity.

What is goodwill? Goodwill is the extra amount a buyer pays for a business above the value of its identifiable net assets, reflecting things such as its reputation and customer base. It is an intangible asset.

Does depreciation reduce cash? No. Depreciation is a book entry that spreads the cost of a non-current asset over its useful life, so it lowers profit without any cash leaving the business that year; the cash left when the asset was bought.

When should a business use the units of production method instead of straight line? Units of production suits assets worn out by use, such as a machine whose output varies or a vehicle measured by distance. Straight line suits assets that lose value mainly with time, such as a building or office furniture, and is simpler and more predictable.

How are the profit and loss account and the balance sheet linked? The retained profit for the year from the profit and loss account is added to retained profit in equity on the balance sheet.

Official syllabus

International Baccalaureate Organization, Business management guide, first assessment 2024: section 3.4 Final accounts and the Glossary of command terms.