Chapter 6 FINANCIAL STATEMENTS FOR SOLE PROPRIETORSHIPS II

Chapter 6 FINANCIAL STATEMENTS FOR SOLE PROPRIETORSHIPS (II)

Similarity and differences between the income statement and the statement of financial position Similarity A statement of financial position reports the financial position of a business as at a particular date, which is usually the end of an accounting period. Or balance sheet assets _____ liabilities and _______ capital as It shows the balances of _______, at that date. Like the income statement, the statement of financial statement and is / is not a position is a _________ ledger account.

Similarity and differences between the income statement and the statement of financial position Differences financial 1. A statement of financial position reports the _____ position of a business, while an income statement ____ financial performance reports its __________. From the perspective of individuals, the statement of financial position measures wealth of an individual, while the _______ periodic income statement measures the ____ income and expenses of that individual. __________

Similarity and differences between the income statement and the statement of financial position Differences 2. The income statement and the statement of financial position measure the financial results of a business using different concepts. The income statement reports the flows of revenues and expenses as at a particular date / over a period of time. This is flow concept. called the _____ The statement of financial position reports the balances of assets, liabilities and capital as at a particular date / stock concept. over a period of time. This is called the ______

Similarity and differences between the income statement and the statement of financial position Last month an 3 of additional 300 m Differences rainfall was collected in this reservoir. Flow / Stock concept The amount of water stored in this reservoir up to this moment is 1, 000 m 3. Flow / Stock concept

Classifications of assets and liabilities Assets Current assets Non-current assets Liabilities Current liabilities Non-current liabilities

Preparation of a statement of financial position Statement of financial position in: Horizontal style Vertical style Before updating the inventory account with the entry for the Capital balance brought closing inventory, the balance from the previous in the forward inventory account still year (i. e. , the opening capital). represents opening inventory for the year.

Closing entries 1. To transfer the balance of the profit and loss acc If the business has earned a net profit for the year: Dr Profit and loss account Cr Capital account If the business has incurred a net loss for the year: Dr Capital account Cr Profit and loss account

Closing entries 1. To transfer the balance of the profit and loss acc If the business has earned a net profit for the year: Dr Profit and loss account Cr Capital account Capital 2013 Jan 1 Dec 3 1 Balance b/f Profit and loss (net profit) $ 290, 00 0 16, 62 0

Closing entries 2. To transfer the balance of the drawings account Dr Capital account Cr Drawings account Capital 2013 Dec 3 1 “ 3 1 Drawings Balance c/f $ 2013 23, 00 Jan 1 0 Dec 3 283, 62 1 0 306, 62 0 Balance b/f Profit and loss (net profit) $ 290, 00 0 16, 62 0 306, 62 0

Classification of ledger accounts Personal accounts Accounts of individuals or entities having transactions with the firm, such as: Debtors’ accounts (accounts receivable) Creditors’ accounts (accounts payable) Impersonal accounts Accounts other than personal accounts, such as: Water charges account Cash account Office equipment account

Classification of ledger accounts Also known as temporary accounts Nominal accounts closed off Accounts that will be _____ at the end of an accounting cycle and whose balances will be shown Also known as income statement in the _________. permanent accounts Real accounts Accounts whose balances will be carried forward to the next ________ accounting cycle and will appear in statement of financial the __________ position _____. Asset accounts Liability accounts Capital accounts Expense accounts Revenue accounts

Uses of financial statements Income statement Readers of a firm’s income statement will be able to find information such as: profit during that period whether it earned a ______ how the profit was made whether the firm spent too much Profitability refers to the ability to make people whoprofits. need to know Such information is useful for profitability of a business. the operating results and ______ owner(s) _______ management and These include its _____, _________. potential investors

Uses of financial statements Statement of financial position Readers of the statement of financial position of a business will be able to find information such as: assets were held by the business on that date what _______ current whether it had sufficient _______ Solvency refers to Liquidity refers to assets the ability to meet what causedthe theability capitaltobalance to increase or decrease long-term short-term obligations. This information is useful for obligations. people who need to know solvency and long-term _______ liquidity _____ growth the ____, _____ potential of a business. owner(s) _______ management and _____. creditors These include its _____,

Uses of financial statements Therefore, financial statements are useful in providing people with different types of relevant information to decisions about a business. make informed _____ Furthermore, users of financial trends statements can project _______ with regard to the financial performance and position of a business with the use of comparative financial statements.

Users of financial statements Internal users Business owners Management Lenders External users Potential investors Suppliers and customers Government bodies

Limitations of financial statements Reporting past results past financial Financial statements report on the _____ results of a business. current or Such information may not be relevant to _______ future decision-making. ______ For example, a company that was very successful in the past may suffer substantial losses in the future. Therefore, decision-makers should not rely too heavily on past financial information when making long-term decisions.

Limitations of financial statements Assets valued at historical cost i. e. , the cost at Assets are usually valued at _____, purchased or _____. produced which the assets were _____ market value of assets is not reflected in financial The current _______ statements. For example, a machine was bought for $20, 000 two years ago. If its market value has dropped to $10, 000, the value stated in the books (ignoring depreciation) would be $10, 000 / $20, 000. Thus, the information provided by financial statements about assets is not based on current value and may not reflect their _____. true worth

Limitations of financial statements Alternative accounting policies and methods can be used When treating transactions or items of the same type, companies are allowed to choose among alternative policies and _____. methods accounting ____ For example, a number of methods can be used to value a firm’s inventory The adoption of different valuation methods would _____. lead to different financial results reported for a certain year. compare the Therefore, it could be very misleading to _____ financial results of firms without understanding the accounting policies and methods used by these firms.

Limitations of financial statements Involvement of personal judgements estimates and Financial statements involve _____ personal judgements made by accountants and __________ management. These judgements may lead to errors ______ manipulation or even _______, fraud ______.

Limitations of financial statements Lack of qualitative information quantitative Financial statements only provide ______ information which is expressed in monetary terms. qualitative ) information is not provided Non-quantitative (i. e. , _____ because it cannot be _____ objectively measured in monetary terms. morale For example, you cannot know the _______ of staff or the quality of _______ relationships with customers from the financial statements. However, these qualitative factors may be crucial to the financial success of a business and information about them may have a great impact on ________. decision-making

Limitations of financial statements Providing a summary without details summary of the Financial statements only provide a _____ financial results of a business. Details about the transactions that were responsible _______ for the results are not disclosed. Users of financial statements may not hidden issues or be aware of the _______ problems behind the reported figures.