Preparation of financial statements

Accounting A2 · Financial accounting. The idea in plain words, the rules to remember, the mistake to avoid and a worked example, written and checked by Mega Lecture.

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The idea

Each type of business needs statements that suit its owners. A partnership adds an appropriation account to share the profit. When a partner joins or leaves, or the ratio changes, goodwill and any revaluation gain are credited to the old partners in the old ratio. If goodwill is not kept in the books, it is then debited to the partners of the new firm in the new ratio.

A club is not run for profit. Its receipts and payments account is a cash summary. Its income and expenditure account uses accruals and shows a surplus or deficit, which changes the accumulated fund.

A manufacturer first finds its cost of production. A limited company follows IAS 1 and also prepares a statement of changes in equity and a statement of cash flows.

Rules to remember

Goodwill created: credit the old partners in the old profit-sharing ratio. Goodwill written off: debit the partners in the new ratio.
A revaluation profit or loss is shared by the old partners in the old profit-sharing ratio.
Dissolution: the realisation account is debited with the carrying amounts of the assets and the costs of dissolution, and credited with the sale proceeds; the balance is shared in the profit-sharing ratio.
Accumulated fund = assets − liabilities of the club. Closing fund = opening fund + surplus (or − deficit).
Subscriptions income for the year = cash received − opening arrears + opening in advance + closing arrears − closing in advance.
Prime cost = direct materials + direct labour + direct expenses. Cost of production = prime cost + factory overheads + opening work in progress − closing work in progress.
Provision for unrealised profit = closing inventory of finished goods at transfer price × mark-up % ÷ (100 + mark-up %).

Common mistake

Students take the factory profit percentage straight off the transfer price. A 25% mark-up on cost is 25/125 of the transfer price, not 25% of it.

Worked example

A club received $18 400 in subscriptions during the year. At the start of the year subscriptions in arrears were $600 and subscriptions in advance were $900. At the end of the year arrears were $750 and advance payments were $400. What is the subscriptions income for the year?

Take out cash that belongs to last year: $18 400 − $600 opening arrears = $17 800.
Add the opening advance, which was paid last year for this year: $17 800 + $900 = $18 700.
Add closing arrears and take off the closing advance: $18 700 + $750 − $400 = $19 050.

Answer: Subscriptions income for the year is $19 050.

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