3.4: Final accounts

Purpose of accounts to stakeholders

Financial statements are essential for all businesses. They provide insights into a company's financial health, aid in decision-making, and often meet legal requirements.
Key components of financial statements:
Profit and loss account: Reports revenues and expenses.
Balance sheet: Shows assets and liabilities.
Legal requirements:
Audits: Independent accountants must verify the accuracy of financial statements.
Financial reporting: Companies must disclose their financial information to stakeholders.
Stakeholders and their interests:
Shareholders: Interested in investment returns and company performance.
Employees: Concerned about job security and pay.
Government: Monitors tax compliance.
Financiers and suppliers: Assess creditworthiness and risk.
Potential investors: Evaluate financial viability and profitability.

The Profit and Loss (P&L) account is a financial statement that shows a company's profitability over a specific period. It's broken down into three sections:
Trading Account:
Calculates gross profit by subtracting cost of goods sold (COGS) from sales revenue.
COGS includes the direct costs of goods sold.
Profit and Loss Account:
Calculates net profit by subtracting expenses from gross profit.
Expenses include indirect costs like administration, salaries, and utilities.
Appropriation Account:
Shows how net profit is allocated to dividends and retained profit.
Key points:
Profit: The difference between revenues and costs.
Dividends: Payments to shareholders.
Retained profit: Profit kept for reinvestment.
Limitations: Historical focus, lack of standardization, and potential for window dressing.

The balance sheet is a financial statement that shows a company's assets, liabilities, and equity on a specific date. It's like a snapshot of the company's financial health.
Key components:
Assets: Items of value owned by the company (e.g., cash, property, equipment).
Noncurrent assets: Used for operations, last more than 12 months.
Current assets: Easily converted to cash within 12 months (e.g., cash, debtors, inventory).
Liabilities: Debts owed by the company (e.g., bank overdrafts, trade creditors, loans).
Noncurrent liabilities: Due after 12 months (e.g., mortgages).
Current liabilities: Due within 12 months.
Equity: The owners' stake in the company (e.g., share capital, retained earnings).
Relationship:
Net assets = Total assets - Total liabilities.
Net assets must equal total equity.
Limitations:
Static view: Shows a snapshot of financial position on a specific date.
Estimated values: Asset values can be subjective.
Incomplete information: Intangible assets and human capital may not be included.
Lack of standardization: Different formats can make comparisons difficult.
Overall, the balance sheet provides a valuable overview of a company's financial health, but it's important to consider its limitations when interpreting the information.

Intangible assets are non-physical assets that have value and can generate revenue for a business. They are protected by intellectual property rights.
Common types of intangible assets:
Branding: Brand recognition and value.
Patents: Exclusive rights for inventions.
Copyrights: Protection for original works.
Goodwill: Reputation, customer loyalty, and employee morale.
Registered trademarks: Distinctive signs identifying a brand.
Challenges in valuation:
Subjectivity: Determining the value of intangible assets can be difficult.
Window dressing: Including intangible assets in the balance sheet might artificially inflate a company's value.
While intangible assets can be valuable, their inclusion in financial statements can be complex and subject to manipulation.

Final accounts have several limitations that can hinder their effectiveness in analyzing a business's financial performance:
Short-term focus: Analyzing a single year's accounts doesn't provide a clear picture of long-term trends.
Neglect of human resources: Employee factors like skills, loyalty, and motivation are not considered.
Overemphasis on financial factors: Non-financial factors like organizational culture and community contributions are ignored.
Lack of comparability: Access to competitor's accounts is needed for benchmarking.
Limited disclosure: Companies may intentionally withhold information to protect competitive advantage.
Historical perspective: Past performance doesn't guarantee future success.

Depreciation is the decrease in the value of noncurrent assets over time due to wear and tear or obsolescence. It's recorded as an expense to spread the cost of the asset over its useful life.
Methods of calculating depreciation:
Straight-line method: Allocates equal depreciation each year.
Units of production method: Allocates depreciation based on asset usage.
Purpose of depreciation:
Accurate valuation: Reflects the true value of assets.
Future planning: Provides funds for asset replacement.
Expense recognition: Records the cost of using assets over time.
Key considerations:
Useful life: Estimated duration of asset usage.
Residual value: Estimated value of asset at the end of its life.
Method choice: Consistency is important for comparisons.