What The Annual Accounts Show

One purpose of keeping records is to prepare the accounts at the end of the financial year, so that you can see how the business is doing. An example of the year end accounts is shown in Figures 35 and 36.

As you can see, these accounts consist of two main pages (plus a further page of notes which give more details; Figure 37). There are many different ways of setting out year end accounts but the example shows one of the commonest layouts.

Balance Sheet

The first page, the balance sheet, is a ‘snapshot’ of the assets and liabilities of the business at a certain point in time. At the year end, in this example, the business owned the assets and owed the liabilities as shown on the balance sheet. You can tell a lot from the balance sheet. In this one, what has happened to the £6,622 on deposit from last year? Has the business spent it on bigger stocks?

Profit And Loss Account

The second page, the profit and loss account, is a summary of trading income and expenditure for the period. Is the gross profit margin bigger, or smaller, as a percentage of its sales? Why is the net profit less when sales seem to be up? Are the overheads under control?

Two Types Of Expenditure

There is an important distinction to be made at this stage:

Capital Expenditure

Capital expenditure relates to the purchase of fixed assets used by the business and having a lasting effect over several years.

Revenue Expenditure

Revenue expenditure on the other hand only contributes once to the







earning of profits; except for what may remain as stock, it is wholly used up in the period the expenditure is incurred. For example, expenditure on a new piece of equipment or a new building would be capital: it should benefit the business for many years. Expenditure on raw materials or motor expenses will have no long-term benefit so it is regarded as revenue expenditure.

In the same way income can be classified as revenue or capital. If a factory, or piece of equipment, is sold at a profit – that is a capital profit. On the other hand, if stocks are sold, that is revenue income.

Example

Figure 38 shows the trial balance used on page 84, this time showing which of the nominal ledger accounts are profit and loss account items and which are balance sheet items. This broadly follows the distinction between revenue and capital. There may be some confusion with regard to revenue items such as stock and debtors: although these items are not of a capital nature, the values are included on the balance sheet as they represent assets held at the end of the accounting period. (Stock also appears on the profit and loss account but in this case it is to reflect the change in the level of stock during the year – opening stock less closing stock.)

If you look at the totals on each side of the trial balance you will see that they are equal: the trial balance does in fact balance. But, if you just take the profit and loss items (Accounts 1 to 100) then the totals of these codes on their own do not balance. The debits total £121,961.02 and the credits total £140,253.56.

The difference by which the credits exceed the debits is £18,292.54, which is in fact the amount of the profit for the year. Conversely if you look at the balance sheet items the debits exceed the credits by the same amount. This excess of debits reflects the increase in assets resulting from the year’s trading profit.