Owner sets up a firm by putting 50,000 in the BankResources in the Firm = 50,000Funds supplied by the owner = 50,000Owners funds are called capitalResources in the Firm are called assetsAssets = Capital

AssetsBank 50,000Inventory +10,000Total60,000

Capital + LiabilitiesCapital 50,000Payables+10,000Total 60,000University College Dublin

Assets (A) = Capital (C) + Liabilities (L)Assets are things the Firm ownsLiabilities are owed by the FirmCapital is what the Firm owes the owner

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AssetsProperty30,000Bank 50,000 - 30,000Inventory10,000

Total60,000

Capital + LiabilitiesCapital 50,000Payables 10,000

Total 60,000University College Dublin

AssetsProperty30,000Bank 50,000 - 30,000Inventory 10,000 - 5,000Receivables 5,000Total 60,000Capital + LiabilitiesCapital 50,000Payables 10,000

Total 60,000University College Dublin

AssetsProperty30,000Bank 50,000 - 30,000 - 5,000Inventory10,000 - 5,000Receivables 5,000Total60,000 - 5,000

Capital + LiabilitiesCapital50,000Payables 10,000 - 5,000

Total 60,000 - 5,000

A Balance Sheet is a Table showing Assets separately from Capital and LiabilitiesAssets consist of Property, Debts owed by customers/Receivables and the amount of money in the bankLiabilities consist of money owing for Stock/Inventory supplied to the Firm, and Bank LoansEvery transaction has affected two items

We have to record the effect of a transaction on each of the two itemsWe will record an increase or decrease in one item and an increase/decrease in the second itemThis 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 2011June 1 Started business with 20,000 in bankJune 5 Bought office furniture on credit from Ikea for 1,200 June 8 Bought a motor van paying by cheque 9,500June 12 Bought machinery from HP on credit 5,600June 26 Paid amount owing to Ikea t by chequeJune 30 Dermot Desmond lent us 5,000 - giving us the money by chequeUniversity College Dublin

Bank Opening balance + 20,000 Motor van- 9,500 Ikea- 1,200 Dermot Desmond+ 5,000 Closing balance 14,300

Office Furniture Opening balance 0 Ikea + 1,200 Closing balance 1,200

Motor Van Opening balance 0 Bank + 9,500 Closing balance 9,500

Machinery Opening balance 0 HP+5,600 Closing balance 5,600 Total Assets 30,600

Capital Opening balance 20,000

Payables: Ikea Office furniture +1,200 Bank - 1,200 Closing balance 0HP Machinery+ 5,600 Closing balance 5,600

Loan Dermot Desmond +5,000 +5,000

Total Liabilities 30,600

A Firm earns a profit by selling at higher prices than it buysIncreases in inventory are at cost price and decreases are at selling priceIncreases in inventory are debited to Purchases AccountDecreases in inventory are credited to Sales AccountPurchases 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 accountThe Truck is shown in the Balance Sheet as a Fixed AssetWhen the Truck is sold the profit on sale is not credited to Trading/Sales it is credited to general/non-sales revenuesSales revenues refer to goods sold in which the firm normally deals.

AssetsFactory 100,000Inventory 70,000Bank 30,000

Suppose the inventory is sold for 110,000?LiabilitiesPayables 20,000Capital 180,000

Fixed Assets are still: Liabilities are still:Factory 100,000Creditors 20,000 ButBank increases by 110,000 sales proceedsBank 140,000 AndCapital has increased by profit of 40,000Opening Balance180,000Add Profit 40,000 Closing Balance 220,000 240,000 240,000Owner gets credit for profit

Revenues are any proceeds received from customers for goods/services received from the firmExpenses are any charges paid by the firm for goods/services receivedRevenues/Expenses relating to trade goods are called Sales/ Purchases Services paid by the firm as expenses include Wages, Rent, Fuel, Power and Light

QuestionsWhat 2 items are impacted and how?

Paid insurance by chequePaid motor expenses by cashRent received in cashPaid for stationery expenses by cashPaid wages by cashReceived sales commission by chequePaid electricity by cheque

Revenue less Cost of Sales is Gross ProfitGross Profit less Overheads is Profit before taxSimple example:Difference between cost of a car and sale proceeds is Gross profitGross 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 Started business with 80,000 in the bankJune 2 Bought stationery paying by cheque 300June 5 Bought goods on credit from Hitachi for 9,000June 12 Bought machinery on credit from Intel 5,000June 26 Sold goods on credit to Mercedes3,200June 30 Paid Rent by cheque 1,000June 30 Received cheque 2,000 from MercedesJune 30 Paid Intel by cheque 5,000June 30 Sold good on credit to PC World 2,300

Closing Inventory 7,000

Bank capital 80,000Stationery - 300Rent - 1,000Mercedes + 2,000Intel - 5,000Closing Balance 75,700

Receivables Mercedes 3,200 Less Bank - 2,000 1,200PC World 2,300 3,500Machinery Intel 5,000Closing Inventory 7,000

Total assets 91,200

Payables

Hitachi 9,000Intel Machinery 5,000 Bank - 5,000Closing Balance 0

Capital closing balance 82,200

Total liabilities 91,200CAPITAL ACCOUNT incorporating P/LCapital Bank 80,000Sales Mercedes 3,200 PC World 2,300 Total 5,500Purchases Hitachi 9,000 less Closing stock (7,000) (2,000)

Gross Profit 3,500

Stationery expenses Bank 300Rent expenses1000

Total overheads (1,300)

Profit(loss) 2,200

Capital closing balance 82,200

Trading & Profit & Loss Account/Income Statement

Sales less Cost of Sales is Gross ProfitGross Profit less Overheads is Net Profit before taxSimple example:Difference between cost of a car and sale proceeds is Gross profitGross profit is reduced by Rent paid by garage to arrive at net profitTrading Account calculates Gross profit

ExampleIf you buy 100 items and sell 80 items andunsold items of 20 is carried forward for sale next year

Example continuedIn 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 20Add Purchases 100available for sale 120Less Closing Stock/Inventory?We count the stock that is not sold say 25Stock sold/Cost of Goods Sold 95

Sales385,000Purchases290,000Rent 24,000Lighting Expenses 15,000General Expenses 6,000Fixtures & Fittings 150,000Receivables 68,000Creditors 91,000Bank151,000Cash 2,000Inventory at start of period 70,000Long Term Loan 100,000Capital 200,000

Totals776,000 776000

Closing Inventory 75,000

Sales385,000Less: Opening Inventory 70,000 Purchases 290,000360,000 Less: Closing Inventory 75,000 285,000 Gross Profit100,000Less overheads:Rent24,000Lighting Expenses15,000General Expenses 6,000 45,000Net Profit before taxation 55,000

Fixtures & Fittings 150,000 Payables 91,000Receivables 68,000Bank 151,000Cash 2,000Long Term Loan 100,000Inventory 75,000Capital 200,000Profit 55,000Total 446,000 Total 446,000Balance Sheet

Assets which :are of long lifeare to be used in the business; andwere 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 ReceivablesThese assets are listed starting with the asset furthest away from being turned into cash, finishing with cash itselfInventory is listed before Receivables because the Receivables are enforceable in law and our rights over Receivables can be sold for cashIt is difficult to sell Inventory profitably if sold quicklyUniversity College Dublin

Non Current Assets Fixtures & Fittings 150,000

Current Assets (into cash within 12 months)Inventory 75,000 Receivables 68,000 Bank 151,000Cash 2,000 296,000 Total Assets 446,000

Shareholders Equity Opening balance 200,000Profit 55,000 Closing Balance 255,000Non-current liabilities e.g Long Term Loans 100,000

Current Liabilities (payable

Exercise Sales Revenue356,000Purchases310,000Rent 16,000Motor Expenses 20,000Salaries & wages 48,000Motor Vans 35,000 Fixtures & Fittings 40,000Receivables 68,000Buildings 380,000 Payables 33,000Bank 11,000Inventory at start of period 63,000Long Term Loan100,000Capital shareholders equity502,000

Totals991,000991,000

Closing Inventory 110,000 Prepare Income Account and Balance Sheet

SalesLess: Opening Stock Purchases Less: Closing Inventory Gross Profit Less overheads:RentMotor Expenses Salaries & Wages Net Profit (Loss) before taxation

Sales356,000Less: Opening Stock 63,000 Purchases 310,000373,000 Less: Closing Inventory110,000 263,000 Gross Profit 93,000Less overheads:Rent 16,000Motor Expenses 20,000Salaries & 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 380,000Fixtures & Fittings 40,000Motor Vans 35,000 455,000Current Assets Inventory 110,000Receivables 68,000 Bank 11,000 189,000 Total Assets 644,000University College Dublin

Equity Opening balanceProfit Closing BalanceNon-current liabilitiesBank Term LoansCurrent Liabilities (payable

Equity Opening balance502,000Profit 9,000 Closing Balance511,000Non-current liabilitiesBank Term Loans100,000Current Liabilities (payable

REFINING THE DATA

Figures require adjustment for a variety of reasons Many of these adjustments are for legitimate reasonsA 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 everDepreciation 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 MethodExample: Motor Lorry bought for 22,000 and sold after 4 years for 2,000Depreciation: 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 methodA fixed % of the cost of the asset is used to calculate Depreciation each yearExample: machine bought for 10,000 and depreciation to be calculated at 20% per annum10,000 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 10,0005 year life with nil scrap value

Year 12,000Year 22,000Year 32,000Year 42,000Year 52,000

Tax authorities often insist on Reducing Balance Basis using their %s

Reducing Balance Basis

Machine costs 10,0005 year life with nil scrap valueYear 18,800Year 21,056Year 3 127Year 4 15Year 5 2

High upfront depreciation to even out depreciation + repairs over the life

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 eitherBy looking carefully at each Receivable/Debtor or by estimating a % based on experienceSome 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 owingThus 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 advanceFirm paid 10,500 in the yearFirm 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 100,000OpeningInventory 10,000AddPurchases 40,000 50,000

LessClosing Inventory 20,000Cost of sales30,000Gross Profit 70,000Sales 100,000OpeningInventory 10,000AddPurchases 40,000 50,000LessClosing Inventory 40,000Cost of sales 10,000Gross 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 SheetExpenditure 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 expenditurePainting 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 activitiesThese large sums of money need large numbers of investors willing to support large scale risksLimited 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 firmInvestors 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 lossesUniversity College Dublin

A Public Limited Company (PLC) is quoted on the Stock Exchange and can offer its shares to the public generallyA Private Limited Company (Ltd) offers its shares privately to people and cannot offer its shares publiclyUniversity 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)PreferredCreditors(2)Secured Bank Loans(3)Unsecured Bank Loans(4)Payables &Other shortTerm liabilities(5)SubordinatedDebt(6)Preference Shareholders(7)Ordinary shareholder equity

Preference Shareholders get a pre-arranged % rate of dividend each year before the ordinary shareholders get anythingOrdinary 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 shareholdersIssued Share Capital is the total of the share capital issued to shareholdersDividends can only be paid out of profits - no profits no dividendsSubordinated debt is monies received by way of long term loans and interest is paid not dividendsInterest 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 unsecuredSubordinated 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 163,000Motor Vehicles at cost 280,000Depreciation Provisions at 31.12.2010Motor vehicles 120,000Purchases & Sales 525,000 986,000Dividend paid 15,000Motor Expenses 81,000Sundry Expenses 11,000Wages & Salaries 99,000Directors remuneration 62,000Profit & Loss Account 146,000Bank Loans 100,000Receivables & Payables 586,000 135,000 2,237,000 2,237,000Authorised share capital: 1,000,000 in ordinary shares of 1Inventory at 31 December 2011 543,000Motor expenses owing 4,000Provide for depreciation of all fixed assets at 20% reducing balance method

Income statement for the year ended 31 December 2011 Sales986,000Less:Opening Inventory415,000Add Purchases525,000940,000Less Closing Inventory543,000397,000Gross Profit 589,000Less:Motor Expenses 85,000Sundry Expenses 11,000Wages & Salaries 99,000Directors Remuneration 62,000Depreciation 32,000289,000Profit before tax 300,000

Statement of changes in equity For the year ended 31 December 2011Share Retained Totalcapitalearnings equity Balances at 31 December 2010 750,000146,000 896,000

Profit for the year 300,000 300,000

Less Ordinary Dividend (15,000) (15,000)Balance at 31 December 2011750,000 431,000 1,181,000

Non Current Assets CostAggregate Net DepreciationMotor Vehicles 280,000 152,000 128,000

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

Shareholders Equity Authorised Share capital 1 shares1,000,000Issued Share capital 750,000Retained earnings 431,000 Closing Balance1,181,000Non-current liabilitiesBank Loans 100,000Current Liabilities (payable

Cash Flow statements

Sales turnover is vanitySelling Prices must be sufficient to support the needs of the businessProfit is sanityProfit must be achieved and provide sufficient funds for the businessBut Cash is KING

Financing

Operations

Investment

Dividend

Payments

Interest

Payments

Purchases

of goods

Expenses

Taxes

Purchase

of Fixed

Assets

Sales

Sale of Fixed Assets

Raising

Finance

Trading/Operations

Investing/

divesting

Receivables and Inventory are uses of funds - high levels reduce cashHigh 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

ExamplesDepreciation which is a charge to the business relating to spending carried out in previous yearsAmortization 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 Accounte.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 2010 2011Equipment at cost 28,000 37,000 less Depreciation to date 11,000 14,00017,000 23,000Current Assets Inventory 9,000 10,000Receivables 11,000 13,000Bank balances 14,000 4,000? 34,000 27,000Less Current LiabilitiesPayables 4,000 3,000 Current Tax 2,000 4,000 6,000 28,000 7,000 20,000 45,000 43,000

Balance Sheet example2010 2011

Financed by:Capital 28,000 25,000 Add Net profit after tax 9,000 13,000 37,000 38,000Less Dividends 12,000 9,000 25,000 29,000Loan from Citibank 20,000 14,000 45,000 43,000

Tax paid was 2,000 and accrued 4,000Interest paid to Citibank amounted to 2,000Depreciation expense was 3,000

Cash Flow Statement for the year ended 31 December 2011

Cash flows from operating activitiesProfit before tax(13,000+4000)17,000Depreciation 3,000Interest expense 2,000Operating profit before working capital changes 22,000 Increase in inventories (1,000)Increase in receivables (2,000)Decrease in payables (1,000)Cash generated from operations 18,000Interest paid (2,000) Income taxes paid (2,000)Net cash from operating activities 14,000

Key Drivers of cash generated from operations are : Volumes of sales and sales margins (difference between selling prices and purchase prices)Control of overheads Management of working capital

*Profit before tax(13,000+4000)17,000Depreciation 3,000Interest expense 2,000Operating profit before working capital changes22,000

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

Cash Flow Statement for the year ended 31 December 2011Net cash from operating activities 14,000

Cash flows from investing activitiesPurchase of property, plant Equipment (9,000)Interest receivedDividends receivedNet cash used in investing activities (9,000)

Cash flows from financing activities

Decrease in Long Term Debt (6,000)Dividends paid(9,000)

Net cash used in financing activities (15,000)

Net reduction in cash and cash equivalents (10,000)

Cash & cash equivalents at beginning of period 14,000Cash & cash equivalents at end of period 4,000

Key message is that capital expenditure, repayment of long term debt and dividend payments have caused an outflow of funds

Financial HighlightsReview of the yearChairmans ReviewChief Executives reviewOperations ReviewFinancial ReviewOther reviewsDirectors InformationCorporate Governance Information*

Directors ReportStatement of Directors ResponsibilitiesAuditors ReportFinancial Statements Accounting PoliciesInformation re subsidiary companies (where relevant)Investors InformationNotice of AGM

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Sets of rules and guidelines established by the accounting professionUse require by the lawAlso, some companies legislation requirements in FSRole of StandardsWhen to recognise and de-recognise items in Financial Statements How to present a particular transactionHow to value and measure items What to disclose about the issue/ item

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