Statement of Profit or Loss and Financial Position Review

Statement of Profit or Loss

• Part of the double-entry system, often shown as a T-account.

• Figures can go straight to the statement of profit or loss, but technically go via a profit or loss ledger account.

• Often, the ledger account step is skipped, and accounts are prepared directly from the trial balance to the statement of profit or loss.

• Net profit goes to the capital account on the statement of financial position.

Statement of Financial Position

• Includes assets, liabilities, and capital accounts.

• Not part of the double-entry system; balances are not transferred out but kept in their ledger accounts and carried down to the next period.

• Balances from the statement of profit or loss and drawings ledger accounts are cleared out to the capital account at the end of the period.

• Net profit increases capital; drawings reduce capital.

Statement of Financial Position Errors

• Statement of financial position is a key statement for stakeholders to use to assess the position of our business.

• It's important to prepare a statement of financial position accurately because that could affect the understanding of users of financial statements, particularly in relation to our financial position at the end of the period.

Asset Categorization

• Assets must be categorized correctly (non-current vs. current).

• Current assets compared to current liabilities indicate liquidity.

• Example: 5,000,000 current assets vs. 50,000,000 current liabilities may indicate financial difficulty.

Debits and Credits

• Ensure debits and credits are correctly recorded.

• Assets should not be recorded as expenses and vice versa.

• Avoid capitalizing expenses to overstate profit.

• Implication: Accurately representing a business's financial state is vital.

Expenses vs. Assets

• Incorrectly recording repairs as a non-current asset will overstate assets and profits, and will understate expenses.

Accounting Ratios

• Incorrectly categorizing liabilities (current vs. non-current) will skew accounting ratios, like Return on Capital Employed:

  • ROCE = \frac{Profit}{Capital + Long Term Debt}

  • If Long term debt is categorized wrong, the key ratio of return on capital employed will be distorted.

Capital Account

• The drawings T account, alongside the statement of profit or loss T account, both need balances clearing into the Capital account.

Process

1. Clear balances in drawings and profit or loss accounts to the capital account.

2. Debit side of the capital account on the drawings account.

3. Balance off Capital ledger account.

Example:

• Drawings (1,500)

• Profit from the period 2,000 that increase capital

• Balance : 9,000

• Less 1,500 : 7,500 balance

Which agrees to the statement of financial position balance for the capital carried down

Drawings

• Money taken out of the business by its owner.

• Usually cash, but can be stock or inventory.

  • If stock is taken, record at cost, not sales price.

Opening Trial Balance

• Question: What is the total assets figure?

• Fixtures: 5,000 (Asset)

• Receivables: 2,000 (Asset)

• Bank Account: 1,000 (Asset, assuming not an overdraft)

• Loan: (Liability)

  • Total Assets: 5,000 + 2,000 + 1,000 = 8,000