Financial statements are used to communicate accounting information to various users. Most users of accounting information are not interested (nor would they understand) in the finer details of the accounting system. Instead, they want statements that give them a summary of all the activities of the business.
Important
Each type of business entity has its own way of preparing financial statements; we will be focusing on the sole trader entity. The financial statements outlined below should include the name of the company, the name of the statement, and the day/month/year. Why? Read the Accounting Period Definition here.
The following financial statements are prepared for all businesses, for both internal and external users:
- Statement of Financial Performance (or a Profit and Loss Account, P&L)
- Statement of Movements in Equity
- Statement of Financial Position (or a Balance Sheet).
Tip
For your assessment, you will need to apply knowledge of accounting and financial statements to interpret tourism business performance and to make recommendations for business financial sustainability.
Also called an Income Statement or Profit and Loss account, this is a summary of the transactions of the business within an accounting period concerning revenue and expenses. The net result is a profit or loss which increases or decreases the owner’s equity.
Remember
Remember, revenue (or sales) – expenses = profit (or loss). Revenue can be earned from selling goods or providing a service.
Classification of Expenses
- Cost of goods sold (COGS) = opening stock (or inventory) + purchases of stock – closing inventory.
- This only applies to businesses selling physical goods, not services.
- Needs to be subtracted from the revenue.
- For instance, if you were operating a travel agency this would be the cost of the tickets being sold (or a supermarket the cost of the cans of baked beans).
NOTE: you must minus the closing inventory from the equation as you have not sold those items so they cannot contribute toward the cost of goods sold.
- Selling expenses
- Expenses incurred in actually making the sales.
- Includes: Sales staff salaries, advertising, the commission made on sales, credit card, and EFTPOS fees.
- Administration or general expenses
- All expenses other than selling and finance.
- Includes electricity, insurance, rent, telephone, and vehicle expenses.
- Finance expenses
- Expenses that relate to financing and collecting cash.
- Includes bad and doubtful debts, discount allowed, and interest.
Reflection
Each of these expense types will need to be taken away from the revenue to work out the net profit amount. How?
(The following steps correspond to the Statement of Financial of Year Ending 31 March 2008 table below).
| Step 1: | Learn the 4 expense-type headings above. |
|---|---|
| Step 2: | Identify which account headings belong to which type of expense. |
| Step 3: | Work out the cost of goods sold. |
| Step 4: | Take away the cost of goods sold from revenue. Record the answer as gross profit. |
| Step 5: | Add up the subtotals for each of the other types of expenses. |
| Step 6: | Add each subtotal and take away that total from the gross profit (from step 4). |
| Step 7: | Write down the remaining value as your net profit at the bottom. |
The definition of “Cartage” or “Cartage In” is “a charge for transporting goods for short distances, such as within a commercial area or town”. Source: Business Dictionary.
Example: As our business of supplying food to nearby cafes and restaurants grows, cartage becomes more and more of a burgeoning expense.
(Reminder: Sales Salaries sit under Selling Expenses).
The second column usually states, the sub-totals (for example, expenses). The third column contains the totals for each sub-section of the statement.
Important
Here is an example. The numbers on the right refer to the steps described above.
Check Your Knowledge
Important
How do you calculate the cost of goods sold? The cost of goods sold = opening stock (or inventory) + purchases of stock - closing inventory.
Is the calculation of costs of goods sold necessary for all businesses? Why or why not?
No, because not all businesses sell physical goods. I.e. inventory will have the costs of goods sold. A business that has service revenue would not have a cost of goods sold.
Statement of Movements in Equity
This statement summarises the changes in owner’s equity during the accounting period. For a sole trader, this statement is quite straightforward. However, for larger businesses, the statement is more complicated.
Important
- The statement of movements in equity begins with the net profit (or loss).
- The contributions from the owner (capital injections) are added and withdrawals (drawings) are subtracted.
- The opening balance of the owner’s equity from the beginning of the year is added.
| Jan Browne trading as Guides “R” Us | |
|---|---|
| Statement of Movements in Equity for the Year Ended 31 March 2009 | $ |
| Net profit | 86,172 |
| (+) Add contributions | 1,033 |
| 87,205 | |
| (-) Less withdrawals | 58,760 |
| = (Equals) Movements in equity | 28,445 |
| (+) Add equity at the start of the period | 25,292 |
| = (Equals) Equity at the end of the period | 53,737 |
Also called the balance sheet, this is a summary of the assets, liabilities and owner’s equity at the end of a period. It gives a picture of the financial position of the company on a particular date. The assets and liabilities are classified under the headings of current and non-current.
Important
The following shows how all three statements are related:
You can also download these tables as a Word document here.
Here is a recap:
Claire's Cleaning Services (CSS) had the following general ledger balances as of 31 March 2008.
| Account | $ |
|---|---|
| Accounts Receivable | 78,790 |
| Accounts Payable | 4,700 |
| Bank | 85,000 |
| Owner's Equity @ 01/04/07 | 150,000 |
| Drawings | 2,200 |
| Electricity | 5,100 |
| Equipment | 22,304 |
| Furniture | 8,000 |
| Insurance | 2,100 |
| Inventory | 87,000 |
| Loan | 31,152 |
| Prepayments | 2,000 |
| Rent | 24,960 |
| Revenue | 194,202 |
| Revenue received in advance (Unearned Revenue) | 600 |
| Telephone | 3,200 |
| Wages | 60,000 |
Explore
Access this PDF document here for further calculations on the following:
- Trial Balance
- Statement of Financial Performance
- Statement of Movements in Equity
- Statement of Financial Position
When we perform calculations the results we get are often long decimal numbers, for example, 5.6732481. To make the numbers easier to use we will shorten them, so they contain fewer figures. The process of doing so is known as rounding.
There are many different ways to round numbers, but we will all do it in one particular way so that when we do our calculations, our answers are the same.
We will ‘round’ to two decimal places, e.g. 5.6732481 is rounded to 5.67
Important
How to round numbers:
- Decide which is the last figure to keep
- In the above example, if we want to round to two decimal places, the number we want to keep is 7
- Do we need to round? Look at the figure which follows the 7; if it is less than 5, we round down
- The number after 7 is 3, which is less than 5, so we will not change 7
- If the next figure is 5 or more, we increase it by 1 (round up)
NOTE: If the number is 5, technically you could decide to round up or down. However, so that we are all doing the same thing, we will round up.
Learning Activity: Rounding Numbers
Round the following numbers to two decimal places. The first one has been done for you.
0.2658974 = 0.27
22,658.3369874 = ?
1.25698 = ?
3.69842 = ?
63.985 = ?
4.523333 = ?
Round the following numbers to one decimal place. The first one has been done for you.
0.2658974 = 0.3
22,658.3369874 = ?
1.25698 =?
3.69842 =?
63.985 =?
4.523333 =?
Round the following numbers to whole numbers (no decimal places). The first one has been done for you.
0.2658974 = 0
22,658.3369874 = ?
1.25698 =?
3.69842 =?
63.985 =?
4.523333 =?
Post your responses to the Forum, Rounding Numbers.
Complete the following multi-choice quiz to ensure you have understood this topic before moving on to the next.
