## Final Accounts: A Comprehensive Guide ### Purpose of Final Accounts Final accounts provide a true and fair view of a business's financial position to all stakeholders, including employees, senior management, shareholders, and the government. Think of them as a snapshot of the company's financial health at a specific point in time. ### Types of Final Accounts * **Trading Account:** Calculates gross profit/loss (Revenue - Cost of Goods Sold). * **Profit & Loss (P&L) Account:** Calculates net profit/loss (Gross Profit - Expenses). * **P&L Appropriation Account:** Calculates retained profit (Net Profit - Dividends - Taxes). * **Balance Sheet:** Displays assets and liabilities. Remember the accounting equation: Assets = Liabilities + Owner's Equity. ### Users of Final Accounts Different stakeholders use final accounts for various purposes: * **Shareholders:** Assess investment performance and decide whether to buy, sell, or hold shares. * **Employees:** Evaluate job security and potential for pay raises. * **Managers:** Judge operational efficiency, set targets, and plan strategically. * **Competitors:** Compare financial performance. * **Government:** Ensure correct tax payments. * **Financiers:** Analyze accounts before providing financial backing. * **Potential Investors:** Assess investment viability (e.g., using ratio analysis). ### Creative Accounting (Window Dressing) While legal, creative accounting manipulates financial statements to present a more favorable picture. It's crucial to be aware of these practices to avoid misinterpretations. Examples include: * Showing short-term liabilities as long-term to improve working capital. * Overvaluing intangible assets. * Using "sale and leaseback" to boost liquidity. * Delaying payments to improve short-term figures. * Manipulating sales revenue recognition. * Choosing depreciation methods to influence asset values. Don't confuse creative accounting with fraudulent misrepresentation, which is illegal. ### Income Statement (Profit & Loss Statement) The income statement shows a firm's profit or loss over a period (usually a year). It's also known as the statement of profit or loss or income statement. **Key Components:** * **Sales Revenue:** Money earned from selling goods and services. * **Cost of Sales (COS):** Direct costs of production (Opening Stock + Purchases - Closing Stock). * **Gross Profit:** Sales Revenue - Cost of Sales. * **Expenses:** Indirect costs (rent, salaries, marketing, etc.). Interest and tax are excluded for easier comparison. * **Profit Before Interest and Tax (PBIT):** Gross Profit - Expenses. * **Profit After Interest and Tax (PAT):** PBIT - Interest - Tax. * **Dividends:** Payments to shareholders. * **Retained Profit:** Profit kept within the business. A business sells $10,000 worth of goods. Its cost of sales is $6,000. Its gross profit is $4,000. After deducting expenses of $2,000, its net profit is $2,000. **Three Main Sections:** 1. **Trading Account:** Calculates gross profit. 2. **Profit and Loss Account:** Calculates operating profit and net profit. 3. **Appropriation Account:** Shows how net profit is distributed (tax, dividends, retained profit). Bags-R-Us Ltd. sold 3000 bags at $35 each. Closing stock was $20,000, purchases were $50,000, and opening stock was $15,000. The Trading Account would show Sales Revenue of $105,000 and Cost of Goods Sold of $60,000, resulting in a Gross Profit of $45,000. ### Balance Sheet (Statement of Financial Position) The balance sheet shows a firm's assets, liabilities, and owner's equity at a specific point in time. It's a snapshot of the company's financial health. **Key Components:** * **Assets:** What the business owns (cash, inventory, equipment, buildings, etc.). * **Non-Current Assets (Fixed Assets):** Long-term assets (land, buildings, machinery). * **Current Assets:** Assets expected to be converted to cash within one year (cash, accounts receivable, inventory). * **Liabilities:** What the business owes (loans, accounts payable, etc.). * **Non-Current Liabilities (Long-Term Liabilities):** Debts due after one year (long-term loans, mortgages). * **Current Liabilities:** Debts due within one year (accounts payable, short-term loans). * **Owner's Equity:** The owner's investment in the business (share capital, retained earnings, reserves). A balance sheet might show $100,000 in assets, $60,000 in liabilities, and $40,000 in owner's equity. This satisfies the accounting equation: $100,000 = $60,000 + $40,000. ### Intangible Assets Intangible assets are non-physical assets with monetary value (goodwill, patents, copyrights, trademarks). * **Goodwill:** Reputation and established networks. * **Patents:** Exclusive rights to an invention. * **Copyrights:** Legal rights to creative works. * **Trademarks:** Exclusive rights to brands, logos, and slogans. ### Depreciation Methods (Higher Level Only) Depreciation accounts for the decrease in value of fixed assets over time due to wear and tear and obsolescence. **Methods:** * **Straight-Line Method:** Depreciation is spread evenly over the asset's useful life. * **Formula:** Annual Depreciation = (Purchase Cost - Residual Value) / Useful Lifespan * **Units of Production Method:** Depreciation is based on the asset's usage. * **Formula:** Depreciation per Unit = (Purchase Cost - Residual Value) / Total Units of Production; Depreciation Expense = Depreciation per Unit * Units Produced A machine costing $10,000 with a $1,000 residual value and a 5-year lifespan would have a straight-line depreciation of $1,800 per year. If it produced 10,000 units in year one, the units of production method would calculate depreciation based on the units produced that year. Choose the depreciation method that best reflects the asset's actual decline in value.