Owner sets up a firm by putting 50,000 in

the Bank

Resources in the Firm

Funds supplied by the owner

Owners funds are called capital

Resources in the Firm are called assets

Assets = Capital

= 50,000
= 50,000

Assets
Bank

50,000
Inventory
10,000
Total
60,000

Capital +
Liabilities
Capital
50,000
Payables+10,000
Total

60,000

University College Dublin

 Assets

(A) = Capital (C) + Liabilities

(L)
Assets

are things the Firm owns

Liabilities
Capital

are owed by the Firm

is what the Firm owes the

owner

Assets
Property 30,000
Bank
50,000
30,000
Inventory10,000
Total

60,000

Capital + Liabilities
Capital 50,000
Payables 10,000

Total

60,000
University College Dublin

Assets
Property 30,000
Bank
50,000
30,000
Inventory
10,000

5,000
Receivables

5,000
Total
60,000

Capital + Liabilities
Capital
Payables

50,000
10,000

Total

60,000
University College Dublin

Assets

Capital + Liabilities

Property 30,000
Bank
50,000
30,000

Capital 50,000
Payables
10,000
5,000

5,000
Inventory

10,000

5,000
Receivables
5,000
Total
60,000

Total

60,000
5,000

Every transaction has affected two items

A Balance

Sheet is a Table showing Assets

separately from Capital and Liabilities

Assets

consist of Property, Debts owed by

customers/Receivables and the amount of
money in the bank

Liabilities

consist of money owing for

Stock/Inventory supplied to the Firm, and Bank
Loans

 We have

to record the effect of a transaction

on each of the two items

We will

record an increase or decrease in one

item and an increase/decrease in the second item

This

is called the double entry system and is

used world wide

Questions
You are required to open the asset and liability and capital accounts and record the
following transactions for June 2011
June 1 Started business with 20,000 in bank
June 5 Bought office furniture on credit from Ikea for
1,200
June 8 Bought a motor van paying by cheque 9,500
June 12 Bought machinery from HP on credit 5,600
June 26 Paid amount owing to Ikea t by cheque
June 30 Dermot Desmond lent us 5,000 - giving us the money by cheque

University College Dublin

Bank
20,000

5,000

Opening balance

Motor van
- 9,500
Ikea - 1,200
Dermot Desmond

Payables:
Ikea
+

Closing balance
14,300
Office Furniture Opening balance
0
Ikea
+ 1,200
Closing balance
1,200
Motor Van
0

Capital Opening balance

20,000

Office furniture
+1,200
Bank
- 1,200
Closing balance
0
HP
5,600

Opening balance

Machinery
+ 5,600
Closing balance

Bank

+ 9,500
Closing balance

9,500

Loan

Dermot Desmond

+5,000

+5,000
Machinery
0
HP
5,600
Total Assets

Opening balance
+5,600
Closing balance
30,600

Total Liabilities

30,600

A Firm earns a profit by selling at higher prices than

it buys
Increases in inventory are at cost price and decreases
are at selling price
Increases in inventory are debited to Purchases
Account
Decreases in inventory are credited to Sales Account
Purchases are goods bought for resale

If a firm buys a truck to deliver goods then, if it is not

purchased primarily for resale, the cost is shown in a
Truck account
The Truck is shown in the Balance Sheet as a Fixed Asset
When the Truck is sold the profit on sale is not credited to
Trading/Sales it is credited to general/non-sales revenues
Sales revenues refer to goods sold in which the firm
normally deals.

Assets

Liabilities

Factory

Payables

100,000
Inventory
70,000
Bank
30,000

20,000
Capital
180,000

Suppose the inventory is sold

for 110,000?

Fixed Assets are still:

Factory
But
Bank increases by
110,000 sales proceeds
Bank

100,000

Liabilities are still:

Creditors

20,000

140,000
And
Capital has
increased by
profit of 40,000
Opening Balance
180,000
Add Profit
40,000
Closing Balance
240,000

220,000

240,000
Owner gets credit for profit

Revenues are any proceeds received from customers

for goods/services received from the firm

Expenses are any charges paid by the firm for

goods/services received

Revenues/Expenses relating to trade goods are called

Sales/ Purchases

Services paid by the firm as expenses include Wages,

Rent, Fuel, Power and Light

Questions

What 2 items are impacted

and how?

Paid insurance by cheque

Paid motor expenses by cash
Rent received in cash
Paid for stationery expenses by cash
Paid wages by cash
Received sales commission by cheque
Paid electricity by cheque

Revenue less Cost of Sales is Gross Profit

Gross Profit less Overheads is Profit before tax
Simple example:
Difference between cost of a car and sale proceeds is
Gross profit
Gross profit is reduced by Rent to arrive at profit before
tax

Show the Balances at month end classifying them into Assets,

Liabilities and Capital. Show profit add on to capital
June 1
June 2
June 5
June 12
June 26
June 30
June 30
June 30
June 30

Started business with 80,000 in the bank

Bought stationery paying by cheque 300
Bought goods on credit from Hitachi for 9,000
Bought machinery on credit from Intel 5,000
Sold goods on credit to Mercedes3,200
Paid Rent by cheque 1,000
Received cheque 2,000 from Mercedes
Paid Intel by cheque 5,000
Sold good on credit to PC World 2,300

Closing Inventory 7,000

Bank capital
Stationery
Rent
Mercedes
Intel
Closing Balance

80,000
300
- 1,000
75,700

Receivables
Mercedes
3,200
Less Bank
- 2,000
PC World
3,500
Machinery Intel
5,000
Closing Inventory
7,000

CAPITAL ACCOUNT incorporating

P/L
Capital Bank
+ 2,000
80,000
5,000
Sales
Mercedes
3,200
1,200
2,300

PC World
2,300
Total
5,500
Purchases
Hitachi
9,000
less
Closing stock (7,000)
(2,000)

Total assets
91,200

Gross Profit

Payables

Stationery expenses
Bank
300
Rent expenses1000

Hitachi
9,000
Intel Machinery
Bank
Closing Balance

5,000
- 5,000
0

Capital closing balance

82,200
Total liabilities
91,200

Total overheads
Profit(loss)
Capital closing balance
82,200

3,500

(1,300)
2,200

Trading & Profit & Loss Account/Income

Statement

Sales less Cost of Sales is Gross Profit

Gross Profit less Overheads is Net Profit before tax
Simple example:
Difference between cost of a car and sale proceeds is
Gross profit
Gross profit is reduced by Rent paid by garage to arrive
at net profit
Trading Account calculates Gross profit

Example
If you buy
100 items
and sell
80 items
and
unsold items of
20
is carried forward for sale next year

Example continued
In the next period
we begin with
20 items
from last period and
purchase another
100 items
so we have
available for sale
120 items

Example

Opening Stock/Inventory
Add Purchases
available for sale
Less Closing Stock/Inventory?
We count the stock that is not sold
Stock sold/Cost of Goods Sold

20
100
120
say 25
95

Sales 385,000
Purchases
290,000
Rent
24,000
Lighting Expenses
15,000
General Expenses
6,000
Fixtures & Fittings
150,000
Receivables
68,000
Creditors
91,000
Bank 151,000
Cash
2,000
Inventory at start of period
Long Term Loan
100,000
Capital
200,000
Totals

776,000
Closing Inventory 75,000

70,000

776000

Sales
Less: Opening Inventory
70,000
Purchases
290,000
360,000
Less: Closing Inventory
75,000
285,000
Gross Profit
Less overheads:
Rent
24,000
Lighting Expenses
15,000
General Expenses
6,000
45,000
Net Profit before taxation

385,000

100,000

55,000

Balance Sheet
Fixtures & Fittings
91,000
Receivables
Bank
Cash
100,000
Inventory
200,000
55,000
Total
446,000

150,000

Payables

68,000
151,000
2,000 Long Term Loan
75,000

Capital

Profit
446,000

Total

 Assets

which :

are of long life

are to be used in the business; and
were not bought only for the

purposes of resale
These assets are called Non Current
Assets (fixed assets) and are listed
first on the Balance Sheet

Current Assets are cash in hand, cash at

bank, and items that will turn into cash
within 12 months such as Inventory and
Receivables
These

assets are listed starting with the

asset furthest away from being turned into
cash, finishing with cash itself

Inventory

is listed before Receivables

because the Receivables are enforceable in
law and our rights over Receivables can be
sold for cash

It

is difficult to sell Inventory profitably if

sold quickly
University College Dublin

Non Current Assets

Fixtures & Fittings

150,000

Current Assets (into cash within 12 months)

Inventory
75,000
Receivables
68,000
Bank
151,000
Cash
2,000
296,000
Total Assets

446,000

Shareholders Equity
Opening balance
Profit

200,000
55,000

Closing Balance

255,000

Non-current liabilities e.g Long Term Loans

100,000

Current Liabilities (payable <12 months)

Payables
Total

91,000
446,000

Exercise
Sales Revenue
Purchases
Rent
Motor Expenses
Salaries & wages
Motor Vans
Fixtures & Fittings
Receivables
Buildings
Payables
Bank
Inventory at start of period
Long Term Loan
Capital shareholders equity
Totals
Closing Inventory 110,000
Prepare Income Account and Balance Sheet

356,000
310,000
16,000
20,000
48,000
35,000
40,000
68,000
380,000
33,000
11,000
63,000
100,000

991,000

991,000

Sales
Less: Opening Stock
Purchases

Less: Closing Inventory

Gross Profit
Less overheads:
Rent

Motor Expenses
Salaries & Wages
Net Profit (Loss) before taxation

Sales
Less: Opening Stock
Purchases

356,000

63,000
310,000
373,000
Less: Closing Inventory
110,000
263,000
Gross Profit
93,000
Less overheads:
Rent
16,000
Motor Expenses
20,000
Salaries & Wages
48,000
84,000
Net Profit (Loss) before taxation

9,000

Non Current Assets

Buildings
Fixtures & Fittings
Motor Vans
Current Assets
Inventory
Receivables
Bank
Total Assets

University College Dublin

Non Current Assets

Buildings
Fixtures & Fittings
Motor Vans
Current Assets
Inventory
Receivables
Bank
Total Assets

380,000
35,000
455,000
110,000
68,000

40,000

11,000

189,000
644,000

University College Dublin

Equity
Opening balance
Profit
Closing Balance
Non-current liabilities
Bank Term Loans
Current Liabilities (payable <12 months)
Payables
Total Liabilities

Equity
Opening balance
Profit
Closing Balance

502,000
9,000
511,000

Non-current liabilities
Bank Term Loans
100,000
Current Liabilities (payable <12 months)
Payables
33,000
Total Liabilities

644,000

REFINING THE DATA

Figures require adjustment for a variety of reasons

Many of these adjustments are for legitimate reasons
A good understanding of these adjustments is required
as some companies use very aggressive methodologies
in applying these adjustments to suit their own ends

Depreciation of Fixed Assets

Fixed Assets such as Machinery and Motor Vans do not last for
ever

Depreciation expense is the amount of Wear and Tear of an

asset caused in an accounting period.

When an asset is used for more than one accounting period

then an attempt must be made to allocate the expense of
depreciation over the accounting periods using accounting
customs.

Straight Line method or Fixed Instalment Method

Example: Motor Lorry bought for 22,000 and
sold after 4 years for 2,000
Depreciation:
Cost (22,000) less estimated proceeds (2,000)
20,000 to be recognised over 4 years is an
expense of 5,000 each year to be charged
against profits.

 Reducing

Balance method

A fixed % of the cost of the asset is

used to calculate Depreciation each
year
Example: machine bought for 10,000
and depreciation to be calculated at
20% per annum
10,000 X 20% is 2,000 and the
machine is reduced in value from
10,000 to 8,000 after 1 year

 Depreciation

in the second year is

20% of 8,000 which is 1,600 and
the machine value is recognised at
6,400.

In

Year 3 the Depreciation expense is

20% of 6,400 which is 1,280.

Straight Line Basis

Machine costs 10,000

5 year life with nil scrap
value

Year
Year
Year
Year
Year

Tax authorities often insist

on Reducing Balance
High upfront depreciation to
Basis using their %s
even out depreciation +
repairs over the life

1
2
3
4
5

2,000
2,000
2,000
2,000
2,000

Reducing Balance
Basis

Machine costs 10,000

5 year life with nil scrap
value
Year 1
8,800
Year 2
1,056
Year 3
127
Year 4
15
Year 5
2

Bad Debts

 With

many businesses a large proportion,

if not all, of the sales are on a credit
basis.

The

business is therefore taking the risk

that some of the customers may never
pay for the goods sold to them on credit.

This

is normal business risk and therefore

Bad Debts must be charged as a
business expense when calculating profit.

We need to make a provision against debts owing at

the end of an accounting period which may eventually
turn out to be Bad Debts. This reflects latent losses and
the charge is an amount put aside for future Bad debts.
A firm will estimate the level of Receivables/Debtors who
will never pay their accounts either
By looking carefully at each Receivable/Debtor or
by estimating a % based on experience
Some firms draw up an Ageing schedule and make
provisions based on the length of time each debt is
owing this is a judgemental adjustment to profit

Accrued Expenses

Firm paid 10,000 rent on account in the year and at the end of the year it owes
2,000 in rent
The Profits of the firm should be charged 12,000 in rent and the Liabilities listed
on the
Balance Sheet should include 2,000 for Rent owing
Thus the charge to profit is different than the cash paid

Pre-paid expenses

Insurance for the firm is 8,400 per annum payable

quarterly in advance
Firm paid 10,500 in the year
Firm will recognize 8,400 as an expense and list
2,100 as a prepayment on the assets of the Balance
Sheet again the cash paid is different than the charge
to profit

Inventory Valuation

Sales

100,000

Opening
Inventory 10,000
Add
Purchases 40,000
50,000
Less
Closing
Inventory 20,000
Cost of sales
30,000
Gross Profit
70,000

Sales
100,000
Opening
Inventory 10,000
Add
Purchases 40,000
50,000
Less
Closing
Inventory 40,000
Cost of sales
10,000
Gross Profit
90,000

Capital & Revenue Expenditure

The decision to place some

expenditure on the Balance Sheet
rather than reflect it in the Income
Statement also results in
judgemental adjustment to profit

Capital expenditure is made when a firm spends money to either buy

fixed assets or
add to the value of an existing fixed asset. Capital expenditure is
shown as an increase
to asset values on the Balance Sheet
Expenditure which is not for increasing the value of fixed assets but is for
running the business on a day to day basis is known as revenue
expenditure and charged as an
expense against profits (revenue)
Adding a room to a factory increases the value of the factory and is
capital expenditure
Painting an existing room in a factory maintains its value, does not
increase its value
and is revenue expenditure
Is fixing bugs in software capex?

Limited Companies

 Large

businesses need large sums

of money to finance their activities

These

large sums of money need

large numbers of investors willing
to support large scale risks

Limited

Companies are necessary

to attract large numbers of
investors

Investors in businesses which are unlimited can be

made bankrupt if the firm gets into financial
difficulties - private monies, not invested in the firm,
can be taken to pay for the debts of the firm

Investors in businesses which are limited can lose

only the amount of money they have invested in the
business

To become a member of a limited company a (shareholder) person must buy one

or more of the companys shares
If a company loses all its assets, all the shareholder can lose is his shares.
Apart from that he cannot be forced to pay out of his private money for Limited
Company losses

University College Dublin

Public Limited Company (PLC) is

quoted on the Stock Exchange and
can offer its shares to the public
generally

Private Limited Company (Ltd)

offers its shares privately to people
and cannot offer its shares publicly
University College Dublin

Private Limited Companies are usually smaller but most very

large
limited companies are Public Companies as their capital needs
can
only be funded through public subscription

A Shareholder of a limited company obtains his reward

in the form
of a share of the profits, known as a dividend.

(1)Preferred
Creditors
(2)Secured
Bank
Loans
(3)Unsecured
Bank
Loans
(4)Payables &
Other short
Term liabilities
(5)Subordinated
Debt
(6)Preference
Shareholders
(7)Ordinary
shareholder
equity

 Preference

Shareholders get a prearranged % rate of dividend each year

before the ordinary shareholders get
anything
Ordinary Shareholders receive a %
decided each year which represents a
share of the profits remaining after
Preference Dividends

Authorised Share Capital is the total amount of capital which the

company is allowed to issue to its shareholders
Issued Share Capital is the total of the share capital issued to
shareholders
Dividends can only be paid out of profits - no profits no dividends
Subordinated debt is monies received by way of long term loans
and interest is paid not dividends
Interest is payable whether the company makes a profit or not

Secured Debt Instruments (Bonds)/

(Debentures)

Unsecured debt instruments (Bonds)/

(Debentures)

Bank debt can be secured or unsecured

Subordinated debt these peoples rights to be

repaid are subordinate to the other lenders
above

Given the following information, you are required to draw up an income

statement for the year ended 31 December 2011, and a balance sheet at that
date:

Share capital issued; ordinary shares 1

750,000
Inventory 31 December 2010
415,000
Bank
163,000
Motor Vehicles at cost
280,000
Depreciation Provisions at 31.12.2010
Motor vehicles
120,000
Purchases & Sales
525,000
986,000
Dividend paid
15,000
Motor Expenses
81,000
Sundry Expenses
11,000
Wages & Salaries
99,000
Directors remuneration
62,000
Profit & Loss Account
146,000
Bank Loans
100,000
Receivables & Payables
586,000
135,000
2,237,000
2,237,000

Authorised share capital: 1,000,000 in ordinary shares of 1

Inventory at 31 December 2011 543,000
Motor expenses owing 4,000
Provide for depreciation of all fixed assets at 20% reducing balance method

Income statement for the year ended 31 December 2011

Sales
Less:

Opening Inventory
Add Purchases
Less Closing Inventory

Gross Profit
Less:

Motor Expenses
Sundry Expenses
Wages & Salaries
Directors Remuneration
Depreciation
Profit before tax

986,000

415,000
525,000
940,000
543,000
397,000
589,000
85,000
11,000
99,000
62,000
32,000
289,000
300,000

Statement of changes in equity

For the year ended 31 December 2011
Share
capital

Balances at 31 December 2010

896,000
Profit for the year

Less Ordinary Dividend

Balance at 31 December 2011
1,181,000

Retained
earnings

Total
equity

146,000

300,000

300,000

(15,000)
750,000

(15,000)
431,000

750,000

Non Current Assets

Cost
Motor Vehicles

280,000

Aggregate
Depreciation
152,000

Net
128,000

Current Assets
Inventory
543,000
Receivables
586,000
Bank
163,000
1,292,000
Total Assets
1,420,000

University College Dublin

Shareholders Equity
Authorised Share capital 1 shares
Issued Share capital
Retained earnings
Closing Balance

1,000,000
750,000
431,000
1,181,000

Non-current liabilities
Bank Loans
Current Liabilities (payable <12 months)
Payables

100,000

Total Liabilities

1,420,000

139,000

Cash Flow statements

Sales turnover is vanity

Selling Prices must be
sufficient to support the
needs of the business
Profit is sanity
Profit must be achieved and
provide sufficient funds for
the business
But Cash is KING

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Receivables and Inventory are uses of funds - high levels

reduce cash

High levels of Payables enable cash levels to remain high

A Financial Statement which shows the sources and how

much cash comes into the company during the period and
what applications of cash were chosen by the company
during the period

Some items included in a companys profit statement are

not cash items

Examples
Depreciation which is a charge to the business relating to
spending carried out in previous years
Amortization of Goodwill is also a charge to profits but
relates to cash outflows carried out in previous years

Cash receipts & payments are not the same as

revenues & expenses in the Profit & Loss Account
e.g. the issue of new shares results in a cash inflow
which will not be shown in the Profit & Loss account

Cash from the sale proceeds of fixed assets will increase the
bank balance of the company but only the surplus over the
carrying value of the asset is profit
Purchase of a fixed asset is shown on the balance sheet and
not shown as expenses charged to profit

Non Current Assets

Equipment at cost
less Depreciation to date

2010

2011

28,000

37,000

11,000

14,000

17,000

23,000

Current Assets
Inventory

9,000

10,000

Receivables

11,000

13,000

Bank balances

14,000

4,000

34,000

27,000

Payables

4,000

3,000

Current Tax

2,000

4,000

Less Current Liabilities

6,000

28,000
45,000

7,000

20,000
43,000

Balance Sheet example

2010
Financed by:
Capital
Add Net profit after tax
13,000
Less Dividends
9,000
Loan from Citibank

2011

28,000

25,000
9,000

37,000
12,000

38,000

25,000
20,000
45,000

29,000
14,000
43,000

Cash Flow Statement

for the year ended 31 December 2011
Cash flows from operating activities
Profit before tax
(13,000+4000)
17,000
Depreciation
3,000
Interest expense
2,000
Operating profit before working capital changes
Increase in inventories
(1,000)
Increase in receivables
(2,000)
Decrease in payables
(1,000)
Cash generated from operations
18,000
Interest paid
(2,000)
Income taxes paid
(2,000)
Net cash from operating activities
14,000

22,000

Key Drivers of cash generated from operations are :

Volumes of sales and sales margins (difference between selling
prices and purchase prices)
Control of overheads

Profit before tax (13,000+4000)

Depreciation
Interest expense
Operating profit before working capital changes

17,000
3,000
2,000
22,000

This is also known as EBITDA

Companies must keep their Debt/Borrowings below a multiple of 3 3.5
times
In the same way as individuals looking for a mortgage keep their
mortgage loan below 3.5 times their salary
Important to remember when doing the CA

92

Cash Flow Statement

for the year ended 31 December 2011
Net cash from operating activities
Cash flows from investing activities
Purchase of property, plant Equipment
Interest received
Dividends received
Net cash used in investing activities
(9,000)

14,000

(9,000)

Cash flows from financing activities

Decrease in Long Term Debt
Dividends paid
Net cash used in financing activities

(9,000)

(6,000)
(15,000)

Net reduction in cash and cash equivalents

(10,000)
Cash & cash equivalents at beginning of period
14,000
Cash & cash equivalents at end of period
4,000
Key message is that capital expenditure, repayment of long term debt and

 Financial Highlights
Review of the year

Chairmans Review
Chief Executives review
Operations Review
Financial Review
Other reviews

Directors Information
Corporate Governance

Information
95

 Directors Report
Statement of Directors

Responsibilities
Auditors Report
Financial Statements
Accounting Policies
Information re subsidiary companies
(where relevant)
Investors Information
Notice of AGM
96

Sets of rules and guidelines established by

the accounting profession
Use require by the law

Also, some companies legislation requirements

in FS

Role of Standards
When to recognise and de-recognise items in

Financial Statements
How to present a particular transaction
How to value and measure items
What to disclose about the issue/ item

97
97