GCE Business

Contents of published accounts

Objectives
 Make simple amendments to balance sheets and
income statements (profit and loss accounts) from
given data
 Explain the importance of accounting for the
depreciation of fixed assets and apply the straight-
line depreciation method to simple problems
 Draw up balance sheets and income statements
(profit and loss accounts) from given data
 Explain the significance of goodwill, net realisable
value of stocks and depreciation to the final accounts
of a business
 Amending income statements
$
Sales revenue (5000 units @ $3.00) 15,000
Cost of goods sold (@ $1.00 per unit) 5,000
Gross profit 10,000
Overhead expenses 4,000
Net profit (profit before tax and interest) 6,000
Interest 2,000
Profit before tax 4,000
Corporation tax @ 20% 800
Profit after tax 3,200
Dividends paid 1,200
Retained profit 2,000
 Activity 31.1 page 564 question 1
$
Sales revenue (5000 units @ ...............)
Cost of goods sold (@ ............... per unit)
Gross profit
Overhead expenses
Net profit (profit before tax and interest)
Interest
Profit before tax
Corporation tax @ ............... %
Profit after tax
Dividends paid
Retained profit
 Activity 31.1 page 564 question 2
$
Sales revenue (................. units @ ...............)
Cost of goods sold (@ ............... per unit)
Gross profit
Overhead expenses
Net profit (profit before tax and interest)
Interest
Profit before tax
Corporation tax @ ............... %
Profit after tax
Dividends paid
Retained profit
 Amending balance sheets
ASSETS
Non current assets:
Property 2000
Equipment 500
2500
Current assets:
Inventories 120
Accounts receivable 650
Cash 20
790
TOTAL ASSETS 3290
EQUITY and LIABILITIES
Current liabilities:
Accounts payable 450
Overdraft 30
480
Non-current liabilities:
Long-term loans 250
250
TOTAL LIABILITIES 730
Shareholders’ equity:
Share capital 2000
Retained earnings 560
2560
TOTAL EQUITY and LIABILITIES 3290
 Activity 31.2 page 566 Question 1a – 1f
ASSETS
Non current assets:
Property
Equipment

Current assets:
Inventories
Accounts receivable
Cash

TOTAL ASSETS
EQUITY and LIABILITIES
Current liabilities:
Accounts payable
Overdraft

Non-current liabilities:
Long-term loans

TOTAL LIABILITIES
Shareholders’ equity:
Share capital
Retained earnings

TOTAL EQUITY and LIABILITIES

Further amendments to the published accounts
 Goodwill
Goodwill arises when a business is valued at or sold for more than the
balance sheet value of its assets.

Example of Goodwill
If business A buys out business B for $2m, yet the net asset value of B is
only $1.5m, then A has paid $0.5m for the ‘goodwill’ of business B.

There are two accounting conventions regarding goodwill,

 It should not appear as an asset of an existing business because it is so
difficult to value and can disappear rapidly
 It will appear on the balance sheet that has brought another firm and has
paid for goodwill. It will appear as a non-current intangible asset.
However, this should be taken off the balance sheet as soon as possible
for the same reason as above.
Further amendments to the published accounts
Valuing intangible assets

Goodwill is an example of an intangible asset, but it is not the only one.

Patents, copyrights, well-established brand names and capital spent on
research and development into new products – these all assets that do
not exist in a physical sense, yet they add value to a company.

A-Level Business Studies students need to recognise that,

 Intangible assets are difficult to put a value on
 The market value of companies with considerable intangible assets
will be much greater than the balance-sheet or book value

 Intellectual property
Intellectual property is an intangible asset that has been developed from
human ideas and knowledge.
Further amendments to the published accounts
Capital expenditure and revenue expenditure

 Capital expenditure
Capital expenditure is any item brought by a business and retained for
more than one year, that is the purchase of fixed or non-current assets.

 Revenue expenditure
Revenue expenditure is any expenditure on costs other than non-current
asset expenditure.

All revenue expenditure is on assets and expenses that give short-term

benefits to the business – within one year. They will all be recorded in full
on each year’s profit and loss account.
Capital expenditure is more complicated. Capital expenditure is recorded
on the accounts by a process called depreciation.
 Further amendments to the published accounts
Capital expenditure and revenue expenditure?

Expenditure Capital or revenue Reason

expenditure

Purchase of computers
for administration
department
Salaries of the
administration staff

Supplies added to
inventories for resale

Maintenance costs of
the building

Extension to the existing

building
Depreciation of assets
 Depreciation
Depreciation means the decline in the estimated value of a
non-current asset over time.

Nearly all fixed/non-current assets will depreciate or decline

in value over time.

Assets decline in value for two main reasons:

 Normal wear and tear through time
 Technological change, making either the asset, or the
product it is used to make, obsolete.
How depreciation is calculated
 The straight-line method of depreciation
Straight-line depreciation is a constant amount of
depreciation is subtracted from the value of the assets each
year.

= original cost of asset – expected residual value

expected useful life of asset (years)

 Net book value

Net book value means the current balance-sheet value of a
non-current asset = original cost – accumulated depreciation.
How depreciation is calculated
 The straight-line method of depreciation
A firm of lawyers purchases three new computers costing
$3000 each. The expected useful life of the computers is 4
years. At the end of this period the second-hand value of each
computer is estimated to be $200.

Straight-line depreciation = $9000 - $600 = $8400 = $2100

4
The depreciation charge of $2100 will be shown on the firm’s
overhead expenses on the income statement, and will be
shown on the firm’s value of computers (reduced by $2100
each year until year 4, then $200 at end of year 4) on the
balance sheet.
Calculating depreciation: straight-line method
example
Year Annual depreciation Net book value of the three
charge computers

Present 0 $9000

1 $2100 $6900

2 $2100 $4800

3 $2100 $2700

4 $2100 $600
Further amendments to the published accounts
 Net realisable value (NRV)
Net realisable value (NRV) the amount for which an asset (usually an
inventory) can be sold minus the cost of selling it.

Example of NRV
A shoe shop buys in ten pairs from a supplier for $10 a pair. At the end of
the financial year, it has three pairs remaining unsold. They have now
gone out of fashion. The shopkeeper believes that they could only be sold
at a reduced price, below the price he paid for them - $8 a pair. Therefore,
the realisable value of the three pairs of shoes is only $24. It is this value –
not $30 – that should appear on the balance sheet as the conservative
principle states that losses should be recorded as soon as they are
believed to occur.