1. The Profit and Loss Account (2)

2. Aims & Objectives Aims:
To look further at the construction of the profit and loss account. To introduce partnership accounts, and manufacturing and service sector accounts.
Learning Outcomes:
On completion of this section you should be able to:
1. Understand the need for provisions against certain current assets.
2. Understand the effect of the following on financial statements: carriage in and out, sales and purchases returns, discounts received and given.
3. Construct more complex financial statements including the effects of the above items
4. Describe and explain the differences between the profit and loss account layouts for manufacturing, trading and service businesses.
5. Understand the differences between sole trader and partnership accounts

3. Further adjustments to transactions to construct and profit and loss account
The recognition of bad and doubtful debts
The application of the prudence principle requires us to account for possible bad and doubtful debts.
Bad debts are expensed to the income statement/profit and loss account in the period they become known and the balance sheet debtor figure is reduced by same amount
Doubtful debts are accounted for by establishing a ‘provision for doubtful debts’ (a provision is an amount written off/retained to provide for a known liability of which the amount and or timing cannot be determined with substantial accuracy)
An estimate is made of the % of debtors (after taking account of bad debts) who will not pay. The period change in this amount is expensed to the income statement/profit and loss account. The balance sheet debtors figure is reduced by the total of the provision.

4. Example 1
As at 31 July 20X1 Ash’s debtors total £397,700. Included in this is a debt of £17,000 owed by King. King has recently ceased trading and the debt will not now be paid. As a response to this situation Ash has also decided to make a general provision for doubtful debts of 3% of debtors. He has never previously made a provision against debtors.
What will be the effect of the above on Ash’s income statement/profit and loss account for the year ended 31July 20X1 and balance sheet as at that date?
Debtors £397,700
minus bad debts £ 17,000 - expense p&l
= £380,700
minus closing
provision
required (x .03) £ 11,421 - expense p&l
= £369,279 - final debtors balance
sheet figure

5. Example 2
As at 31 July 20X2 Ash’s debtors total £436,000. He wishes to maintain the provision for doubtful debts at 3% of debtors.
What will be the effect of the above on Ash’s income statement/profit and loss account for the year ended 31July 20X2 and balance sheet as at that date?
Debtors £436,000
minus closing
provision
required (x .03) £ 13,080 = £422,920 final debtors
balance sheet figure
closing provision £ 13,080
minus opening
provision ,421
= increase in
provision £ 1,659 = expense p&l

6. Further items in final accounts
Carriage in
Where the business pays for the carriage in (transport costs) of purchases made
Recorded as an increase in the cost of purchases
Carriage out
Where the business pays for the carriage out (delivery costs) of sales made
Recorded as an expense

7. Further items in final accounts
Sales returns (returns in)
Where goods sold by the business are returned
Recorded as a reduction in the sales figure
Purchases returns (returns out)
Where goods purchased by the business are returned
Recorded as a reduction in the purchases figure
Discounts received
Where the business is offered a discount on purchases made
Recorded as other income received
Discounts allowed
Where the business offers a discount on sales made
Recorded as an expense

8. How does all this fit together, then?
Note: this information is set out as a ‘trial balance’. The trial balance ‘balances’ in the following manner:
Left column = where the money has gone to e.g. assets,
expenses/losses, distributions
Right column = where the money has come from e.g. capital,
liabilities, revenue/gains, introductions
Further information as at 30 June 20X5 not yet taken into account in the above:
Stock was valued at £11,517
Motor vehicle expenses owing £55
Rent prepaid £275
A bad debt of £85 is to be provided for.
The provision for doubtful debts is to be equal to 2.5 per cent of debtors

9. Changing a Provision - Example
Provision
Effect in P&L Account
Expenses
Decrease in Provision (40)
Provision
Increase in Provision 60

10. Partnership Accounting
What differences are there between sole traders and partnerships?
A sole trader business is a owned by a single person, whereas a partnership involves more than one person -(generally) between 2-20 partners
How do these differences affect accounting for partnerships?
Partnership accounting requires a recording of each partners’ share of the profit and capital of the business:
The profit and loss account has an additional account – the appropriation account – which ‘shares out’ the year’s profits between the partners
The balance sheet capital section includes
A capital account which represents the long-term capital invested into the partnership by the individual partners, and
a current account which represents the partners’ share of the profits of the business, minus their drawings.

11. Example
King & Cooper have both invested £25,000 into their partnership. Their salaries for the year are £15,000 and £7,500 respectively and their current accounts stand at £20,000 and £10,000 respectively. They share residual profits in King’s favour 2:1. Their accounts for the year are as follows

12. Manufacturing and Service business accounts
What differences are there between trading, manufacturing and service business?
Trading businesses buy-in and re-sell various goods
Manufacturing businesses make and re-sell various goods
Service businesses do not make or buy-in goods for re-sale

13. How do these differences affect accounting for manufacturing business?
Manufacturing businesses will have specific costs relating to the manufacture of the product. These are summarised in a separate ‘Manufacturing Account’ before being transferred to the trading account
There are likely to be three different types of stock recorded on the balance sheet: raw materials, work-in-progress and finished goods
The accounts record certain expenses (those of production/manufacture) as part of the cost of goods, rather than recording all expenses in the profit and loss account

14. For cost of manufacture – Think Purchases
Cost of Goods Sold =
Opening Stock
+ Purchases
- Closing Stock
In a manufacturing company’s accounts
Purchases is replaced with Cost of Goods Produced