FINANCIAL STATEMENTS
By the end of the topic, the learner should be able to: a) identify the various financial statements b) explain the importance of each of the financial statements c) explain the concept of trading period d) prepare simple Financial Statements e) explain the various types of capital f) calculate basic ratios from financial statements g) explain the importance of each of the basic financial ratios
These are prepared at the end of a given trading period to determine the profit and losses of the business, and also to show the financial position of the business at a given time.
They includes; trading account, profit and loss account, trading profit and loss account and the balance sheet.
They are also referred to as the final statements.
The trading period is the duration through which the trading activities are carried out in the business before it decides to determines it performances in terms of profit or loss. It may be one week, month, six months or even a year depending on what the owner wants.
Most of the business use one year as their trading period. It is also referred to as the accounting period.
At the end of the accounting period, the following takes place;
Determining the profit or loss of a business
When a business sells its stock above the buying price/cost of acquiring the stock, it makes a profit, while if it sells below it makes a loss. The profit realized when the business sell it stock beyond the cost is what is referred to as the gross profit, while if it is a loss then it is referred to as a gross loss.
It is referred to as the gross profit /loss because it has not been used to cater for the expenses that may have been incurred in selling that stock, such as the salary of the salesman, rent for the premises, water bills, etc. it therefore implies that the businessman cannot take the whole gross profit for its personal use but must first deduct the total cost of all other expenses that may have been incurred.
The profit realized after the cost of all the expenses incurred has been deducted is what becomes the real profit for the owner of the business, and is referred to as Net profit. The net profit can be determined through calculation or preparation of profit and loss account.
In calculating the gross profit, the following adjustments are put in place
Therefore Net sales = Sales – Return inwards
Therefore Net Purchases = Purchases + Carriage inwards – Return Outwards - Drawings
Gross profit is therefore calculated as follows;
Gross Profit = Sales – Return inwards – (Opening stock + Purchases + carriage inwards – Return outwards – Closing stock)
Or
Gross profit = Net sales – Cost of Goods Sold (COGS)
COGS = Opening Stock + Net Purchases – Closing stock
Net Profit = Gross profit – Total expenses
Trading Account
This is prepared by the business to determine the gross profit/loss during that trading period
It takes the following format:
Name of the business
Trading Account
Dr For the period (date) Cr
|
ShsShs Opening stock xxxxxx add Purchases xxxxx add Carriage inwards xxx less Return Outwards xxx less Drawings xxxxxxx Goods available for sale xxxxxx Less Closing Stock xxx Cost Of Goods Sold (COGS) xxxxxx Gross profit c/d xxxx xxxxxx
|
ShsShs Sales xxxxxx Less Return inwards xxx Net sales xxxxxx
xxxxxx Gross profit b/d xxxx |
The trading account is completed by the time the gross profit b/d is determined
For example
The following balances were obtained from the books of Ramera Traders for the year ending may 31st 2010
Sales 670 000
Purchases 380 000
Return inwards 40 000
Carriage outwards 18 000
Return outwards 20 000
Carriage inwards 10 000
Additional information:
Required; Prepare Ramera Traders trading account for the period ending 31st May
2010
Ramera Traders
Trading Account
Dr For the period ending 31/5/2010 Cr
|
ShsShs Opening stock 60 000 add Purchases 380 000 add Carriage inwards 10 000 less Return Outwards 20 000 less Drawings 5 000 365 000 Goods available for sale 425 000 Less Closing Stock 70 000 Cost Of Goods Sold (COGS)355,000 Gross profit c/d 275,000 630,000
|
ShsShs Sales 670 000 Less Return inwards40 000 Net sales 630 000
630 000 Gross profit b/d 275 000 |
NB:Carriage outwards is not an item of Trading account, but profit and loss account as an expense.
Importance of Trading account
Profit and Loss account
In preparation of this account, the gross profit is brought down on the credit sides, with all other revenues/income of the business being credited and the expenses together with the net profit being debited. Net profit = Total Revenues (including Gross Profit) – Total expenses
Name of the business
Profit and Loss Account
Dr For the period (date) Cr
|
Shs Expenses Insurance xxx Electricity xxx Water bills xxx Carriage Outwards xxx General expenses xxx Provision for Depreciation xxxx Discount allowed xxx Commission allowed xxxx Rent paidxxxx Any other expense xxxx Net profit c/d xxxx xxxxxx
|
Shs Gross profit b/d xxxxxx Discount received xxx Rent income xxx Commission received xxx Any other income received xxx
xxxxxx Net profit b/d xxxx |
The Profit and Loss Account is complete when net profit b/d is obtained. In the trial balance, the revenues/incomes are always credited, while the expenses are debited, and the same treatment is found in the Profit and Loss Account. (Any item that is taken to the Profit and Loss Account with a balance appearing in the Debit (Dr) side of a trial balance is treated as an expense, while those appearing in the Credit (Cr) side are revenue e.g. discount balance appearing in the Dr Side is Discount Allowed, while the one on Cr side is Discount Received)
For example
The following information relates to Akinyi’s Traders for the period ending March 28th 2010. Use it to prepare profit and loss account.
Gross profit 100 000 Discount received12 000
Salaries and wages 20 000 Power and lighting 10 000
Opening stock 150 000 Rent income 10 000
Commission allowed 15 000 Commission received 16 000
Repairs 10 000 Discount allowed 8 000
Provision for depreciation 6 000 Carriage outwards 4 000
Akinyi Traders
Profit and Loss Account
Dr For the period ending 28th March 2010 Cr
|
Shs Expenses Power and lighting 10 000 Carriage Outwards 4 000 Salaries and wages 20 000 Provision for Depreciation 6 000 Discount allowed 8 000 Commission allowed 15 000 Repairs 10 000 Net profit c/d 65 000 138 000
|
Shs Gross profit b/d 100 000 Discount received 12 000 Rent income10 000 Commission received 16 000
138 000 Net profit b/d 65 000 |
In case the expenses are more than the income, then the business shall have made a net loss, and the loss will be credited.
Net profit/loss can also be found through calculation as follows;
Net profit/loss = Gross profit + Total other revenues – Total expenses
For the above example;
Total other revenues = 12 000 + 10 000 + 16 000= 38 000
Total expenses = 10 000 + 4 000 + 20 000 + 6 000 + 8 000 + 15 000 + 10 000
= 73 000
Therefore; Net profit = Gross profit + Total other revenues – Total expenses
= 100 000 + 38 000 – 73 000= 65 000
Importance of Profit and Loss account
Trading, Profit and Loss Account
This is the combination of trading account and trading profit and loss account to form a single document. It ends when the net profit/loss brought down has been determined. That is;
Name of the business
Trading, Profit and Loss Account
Dr For the period (date) Cr
|
ShsShs Opening stock xxxxxx add Purchases xxxxx add Carriage inwards xxx less Return Outwards xxx less Drawings xx xxxxx Goods available for sale xxxxxx Less Closing Stock xxx Cost Of Goods Sold (COGS) xxxxxx Gross profit c/d xxxx Xxxxxx
Expenses Insurance xxx Electricity xxx Water bills xxx Carriage Outwards xxx General expenses xxx Provision for Depreciation xxxx Discount allowed xxx Commission allowed xxxx Rent paid xxxx Any other expense xxxx Net profit c/d xxxx xxxxxx
|
ShsShs Sales xxxxxx Less Return inwards xxx Net sales xxxxxx
xxxxxx Gross profit b/d xxxx
Discount received xxx Rent income xxx Commission received xxx Any other income received xxx
xxxxxx Net profit b/d xxxx |
End Year Adjustments
The following items may require to be adjusted at the end of the trading period
Adjustment on revenues
The revenue may have been paid in advance in part or whole (prepaid revenue) or may be paid later after the trading period (accrued revenue).
Prepaid revenue is subtracted from the revenue/income to be received and the difference is what is treated in the profit and loss account or trading profit and loss account as an income, while the accrued revenue is added to the revenue/income to be received and the sum is what is treated in the above accounts as the actual revenue.
Only the prepaid amount and the accrued amounts are what are then taken to the balance sheet.
Adjustment on the expenses
The expenses may have been paid for in advance in part or whole (prepaid expenses) or may be paid for later after the trading period (accrued expenses).
Prepaid expenses is subtracted from the expenses to be paid for and the difference is what is treated in the profit and loss account or trading profit and loss account as an expense, while the accrued expenses is added to the expenses to be paid for and the sum is what is treated in the above accounts as the actual expenses.
NB: Only the prepaid amount and the accrued amounts are what are then taken to the balance sheet.
Adjustment on fixed assets
The fixed assets may decrease in value, due to tear and wear. This makes the value to go down over time, what is referred to as depreciation. The amount of depreciation is always estimated as a percentage of cost.
The amount that shall have depreciated is treated in the profit and loss account or T,P&L as an expense, while the value of the asset is recorded in the balance sheet, less depreciation.
For example;
Dr. (shs) Cr. (shs)
Sales 980,000
Purchases 600,000
Returns 80,000 20 000
Carriage in 40,000
Carriage out 3,000
Stock (Jan 1st 1999) 120,000
Rent 60,000 45 000
Discount 15,000 25 000
Motor vehicle 150 000
Machinery 250 000
Debtors 120,000
Salaries 18,000
Commission 7,000 12 000
Capital 178,000
Insurance 15 000
Creditors 240,000
Cash 122 000
1 540 000 1 540 000
Additional information
Required: Prepare trading profit and loss account for the period ending 31st December 1999
Adjustments: Provision for depreciation;
Machinery = 5100 ×250 000 = 7 500
(New balance of machinery = 250 000 – 7 500 = 242 500. The 242 500 is taken to the balance as Machinery (fixed asset), while 7 500 is taken to the trading profit and loss account as expenses)
Motor vehicle = 10100 ×150 000 = 15 000
(New balance of Motor Vehicle = 150 000 – 15 000 = 135 000. The 135 000 is taken to the balance as Motor Vehicle (fixed asset), while 15 000 is taken to the trading profit and loss account as expenses)
Paka Traders
Trading, Profit and Loss Account
Dr For the period 31/12/1995 Cr
|
ShsShs Opening stock 120 000 add Purchases 600 000 add Carriage inwards40 000 less Return Outwards20 000 620 000 Goods available for sale 740 00 Less Closing Stock 100 000 Cost Of Goods Sold (COGS)640 000 Gross profit c/d 260 000 900 000 Expenses Insurance 15000 Carriage Outwards 30000 Salaries 18 000 Provision for Depreciation Motor vehicle 15 000 Machinery 7 500 22500 Discount allowed 15 000 Commission allowed 7 000 Rent paid 60 000 Net profit c/d 174 500 342 000
|
ShsShs Sales 980 000 Less Return inwards 80 000 Net sales 900 000
900 000 Gross profit b/d 260 000 Discount received 25 000 Rent income 45 000 Commission received 12 000
342 000 Net profit b/d 174 500 |
The net profit/loss may be taken to the balance sheet.
The items that have been adjusted will be recorded in the balance sheet less the adjustment.
The Balance Sheet
The balance sheet will show the business financial position in relation to assets, capital and liabilities. The adjustment that can be made will be on Fixed assets and capital only. That is;
Fixed assets are recorded less their depreciation value (should there be provision for depreciation) as the actual value.
Actual value of assets = Old value – depreciation.
Capital is adjusted with the following; Net capital, Drawings and additional investment. i.e.
Closing Capital/Net capital (C.C) = Opening/initial capital (O.C) + Additional Investment (I) + Net profit (N.P) or (less Net Loss) – Drawings
CC = OC + I + NP – D
Where:
Opening Capital: - the capital at the beginning of the trading period
Closing capital: - the capital as at the end of the trading period
Additional Investment: - any amount or asset that the owner adds to the business during the trading period
Net profit: - the profit obtained from the trading activities during the period. In case of a loss, it is subtracted.
Types of Capital
The capital in the business can be classified as follows:
Working Capital = Total Current Assets – Total Current Liabilities
Capital Employed = Total Fixed assets + Working Capital
Or
Capital employed = Capital Invested + Long term liabilities
Name of the business
Balance Sheet
As at (date)
|
Shsshs Fixed Assets Land xxxxx Buildings xxxxx Motor Vehicle xxxxx Any other fixed assets xxxxxxxxxxx Current Assets Stock xxxx Debtors xxxx Bank xxxx Cash xxxx Prepaid Expenses xxxx Accrued revenues xxxx Any other current assets xxxxxxxxxx
Xxxxxx |
Shs shs
Capital xxxxx Add Net profit xxxx Add additional investt xxx Less drawings xxx Net Capital xxxxx Long term liabilities Long term loan xxxx Any other xxxxxxxx Current liabilities Creditors xxxx Short term loan xxxx Accrued expenses xxxx Prepaid revenues xxxx Any other xxxxxxxxx xxxxxx |
Example 00A: The following information were extracted from the trial balance of Mwema traders on 31st December 2010
Sales 750 000 Furniture 288 000
Purchases 540 000 Electricity expenses 16 000
Sales return 24 000 Motor vehicle 720 000
Return outwards 30 000 Rent expenses 2 500
General expenses72 000 Capital 842 500
Commission received 24 000 Bank Loan 250 000
Cash 156 000 Creditors 216 000
Debtors 244 000
Additional Information
-Motor Vehicle 15% p.a. on cost -Furniture 6% p.a. on cost
Required
-Owner’s equity -Borrowed capital -Working capital -Capital employed
Adjustments:
Motor Vehicle = 15100 ×720 000 = 108 000
Therefore Motor vehicle = 612 000
Furniture = 6100 ×288 000 = 17 280
Therefore furniture = 270 720
Mwema Traders
Trading, Profit and Loss Account
Dr For the period 31/12/2010 Cr
|
ShsShs Purchases 540 000 less Return Outwards30 000 510 000 Goods available for sale 510 000 Less Closing Stock 72 000 Cost Of Goods Sold (COGS)438 000 Gross profit c/d 288 000 726 000 Expenses General expenses 72 000 Electricity expenses 16 000 Less Electricity prepaid 4 000 12 000
Rent expenses 2 500 Accrued rent exp3 500 6 000
Provision for Depreciation Motor vehicle 108 000 Furniture 17 280 125 280 Net profit c/d 96 720 312 000
|
ShsShs Sales 750 000 Less Return inwards 24 000 Net sales 726 000
726 000 Gross profit b/d 288 000 Commission received 24 000
312 000 Net profit b/d 96 720 |
Mwema Traders
Balance Sheet
As at 31/12/2010
|
Shsshs Fixed Assets Motor Vehicle 612 000 Furniture 270 720 882 720
Current Assets Stock 72 000 Debtors 244 000 Electricity prepaid 4 000 Bank 50 000 Cash 156 000 526 000
1 408 720 |
Shsshs Capital 842 500 Add Net profit 96 720 Net Capital 939 220
Long term liabilities Bank Loan 250 000
Current liabilities Creditors 216 000 Accrued rent 3 500 219 500
1 408 720 |
Importance of Financial Ratios
Rate of stock turnover also help in determining how fast or slow the stock is moving. It also helps in computing the gross profit or loss.