2Aims & 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 items4. 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
3Further adjustments to transactions to construct and profit and loss account The recognition of bad and doubtful debtsThe 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 amountDoubtful 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.
4Example 1As 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 £397,700minus bad debts £ 17,000 - expense p&l= £380,700minus closingprovisionrequired (x .03) £ 11,421 - expense p&l= £369,279 - final debtors balancesheet figure
5Example 2As 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 £436,000minus closingprovisionrequired (x .03) £ 13,080 = £422,920 final debtorsbalance sheet figureclosing provision £ 13,080minus openingprovision ,421= increase inprovision £ 1,659 = expense p&l
6Further items in final accounts Carriage inWhere the business pays for the carriage in (transport costs) of purchases madeRecorded as an increase in the cost of purchasesCarriage outWhere the business pays for the carriage out (delivery costs) of sales madeRecorded as an expense
7Further items in final accounts Sales returns (returns in)Where goods sold by the business are returnedRecorded as a reduction in the sales figurePurchases returns (returns out)Where goods purchased by the business are returnedRecorded as a reduction in the purchases figureDiscounts receivedWhere the business is offered a discount on purchases madeRecorded as other income receivedDiscounts allowedWhere the business offers a discount on sales madeRecorded as an expense
8How 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, distributionsRight column = where the money has come from e.g. capital,liabilities, revenue/gains, introductionsFurther information as at 30 June 20X5 not yet taken into account in the above:Stock was valued at £11,517Motor vehicle expenses owing £55Rent prepaid £275A 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
9Changing a Provision - Example ProvisionEffect in P&L AccountExpensesDecrease in Provision (40)ProvisionIncrease in Provision 60
10Partnership 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 partnersHow 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 partnersThe balance sheet capital section includesA capital account which represents the long-term capital invested into the partnership by the individual partners, anda current account which represents the partners’ share of the profits of the business, minus their drawings.
11ExampleKing & 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
12Manufacturing and Service business accounts What differences are there between trading, manufacturing and service business?Trading businesses buy-in and re-sell various goodsManufacturing businesses make and re-sell various goodsService businesses do not make or buy-in goods for re-sale
13How 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 accountThere are likely to be three different types of stock recorded on the balance sheet: raw materials, work-in-progress and finished goodsThe 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
14For cost of manufacture – Think Purchases Cost of Goods Sold =Opening Stock+ Purchases- Closing StockIn a manufacturing company’s accountsPurchases is replaced with Cost of Goods Produced