6 CHPT 3&amp 4

Slide 3.
Chapter 3 Measuring and reporting financial performance
LEARNING OUTCOMES
You should be able to
discuss the nature and purpose of the

income statement;
prepare an income statement from relevant

financial information;
discuss the main measurement issues that must be

considered when preparing the income statement;
explain the main accounting conventions

underpinning the income statement.
Drs. Galama, Stenden University Peter Atrill and Eddie McLaney, Accounting and Finance for Non-Specialists, 6th Edition, © Pearson Education Limited 2008
Slide 3.2
Measuring profit
Profit Total revenue for the period

(or loss)
for the
= less
Total expenses incurred in generating that revenue
period
Slide 3.3
Revenue generated by Rolls-Royce plc during the year

ended 31 December 2006
Energy
Defence aerospace
(£512m) (£1,569m)
7% 22%
18%
53% Marine
Civil aerospace (£1,300m)
(£3,775m)
Slide 3.4
Relationship between the income statement and the

balance sheet
+ Profit
Assets = Equity
(–) (Loss)
+ Liabilities
The above equation can be extended to:
Assets = Equity + Sales

revenue
– Expenses + Liabilities
Slide 3.5
Example 3.1 Better-Price Stores

Income statement for the year ended 31 October 2008
£
Sales revenue 232,000
Cost of sales (154,000)
Gross profit 78,000
Salaries and wages (24,500)
Rent and rates (14,200)
Heat and light (7,500)
Telephone and postage (1,200)
Insurance (1,000)
Motor vehicle running expenses (3,400)
Depreciation – fixtures and fittings (1,000)
Depreciation – motor van (600)
Operating profit 24,600
Interest received from investments 2,000
Loan interest 1,100
Profit for the year 25,500
Slide 3.6
Calculating gross profit for Better-Price Stores
£ £
Sales revenue 232,000
Cost of sales:
Opening inventories 40,000
Goods bought 189,000
Closing inventories (75,000) (154,000)
Gross profit 78,000
Slide 3.7
Profit measurement and the recognition of revenue
Basic criteria that must be met

before revenue is recognised
The amount of revenue can be

measured reliably
It is probable that the economic

benefits will be received
Additional criterion is to be
applied where the revenue comes
from the sale of goods
Ownership and control of the

item should pass to the buyer
Slide 3.8
Accounting for sales commission
Income statement
(profit and loss
account)
Cash flow Sales commission Balance

statement expense sheet
£6,000 at year
end
Cash £5,000
Accrual £1,000
Slide 3.9
Accounting for rent payable
Income statement
Cash flow Balance

Rent payable expense
statement sheet
£16,000
at year
end
Cash £20,000
Prepaid expense £4,000
Slide 3.10
Accounting conventions and the income statement
Materiality
Accruals
Slide 3.11
Profit measurement and the calculation of depreciation
To calculate a depreciation charge for a period, four

factors have to be considered:
The cost (or fair value) of the asset
The useful life of the asset
The residual value of the asset
The depreciation method.
Slide 3.12
Graph of written-down value against time using the

straight-line method
Written-down value (£000) 80
60
40
20
0 1 2 3 4
Asset life (years)
Slide 3.13
Graph of written-down value against time using the

reducing-balance method
Written-down value (£000) 80
60
40
20
0 1 2 3 4
Asset life (years)
Slide 3.14
Calculating an annual depreciation charge
Cost (fair value)

less
Residual value
equals
Depreciable amount
Year 1 Year 2 Year 3 Year 4

and so on
Depreciation Depreciation Depreciation Depreciation
Asset life (number of years)
Slide 3.15
Profit measurement and inventory costing methods
Common assumptions used are:
First in, first out (FIFO)
Last in, first out (LIFO)
Weighted average cost (AVCO).
Slide 3.16
Uses of the income statement
Provides information on how

effective the business has been in
generating wealth
Provides information on how the

profit was made
Slide 3.17
Chapter 4 Accounting for limited companies
LEARNING OUTCOMES
You should be able to
discuss the nature of the limited company;
describe the main features of the owner’s claim

in a limited company;
discuss the framework of rules that surround

accounting for limited companies;
explain how the income statement and balance

sheet of a limited company differ in detail from that
of a sole proprietorship or a partnership business.
Slide 3.18
Main features of a limited company
Perpetual life
Limited liability
Slide 3.19
Two main forms of limited company
Public limited company (plc)
Private limited company (Ltd)
Slide 3.20
The economic importance of public limited companies – an example
Market share of the four largest grocers: 12 weeks to 15 July 2007
Other Tesco
24.5% 31.5%
Morrison
11.1%
Sainsbury Asda
16.2% 16.7%
Slide 3.21
Corporate governance
Three guiding principles:
Disclosure
Accountability
Fairness.
Slide 3.22
The Combined Code
Every listed company should have a

board of directors
There should be a clear division of responsibilities

between the chairman and the chief executive officer
There should be a balance between

executive and non-executive directors
The board should receive timely information
Appointments to the board should be subject to

rigorous, formal and transparent procedures
Slide 3.23
The Combined Code (Continued)
All directors should submit themselves

for re-election at regular intervals
There should be formal and transparent procedures

for developing policy on directors’ remuneration
The board has a responsibility for ensuring that a

satisfactory dialogue with shareholders occurs
Boards should use the annual general meeting to

communicate with private investors
Slide 3.24
The Combined Code (Continued)
Institutional shareholders have a responsibility to

use their votes
The board should publish a balanced and

understandable assessment of the company’s
position and performance
Internal controls should be in place to protect

the shareholders’ wealth
Formal and transparent arrangements should be

in place for internal controls and financial
reporting and for maintaining a relationship with
auditors
Slide 3.25
Sources of long-term finance for a typical limited company
Long-term finance
Share Retained Long-term

issues profits loans
Slide 3.26
Further issues of new shares
Rights issues
Public issues
Private placings
Slide 3.27
Availability for dividends of various parts of the shareholders’ claim
Share capital Not

(at nominal available
for
or par value)
dividend
Capital
reserves
Available
for
dividend
Revenue
reserves
Slide 3.28
Example 4.5 Da Silva plc
Income statement for the year ended 31 December 2008
£m
Revenue 840
Cost of sales (520)
Gross profit 320
Wages and salaries (98)
Heat and light (18)
Rent and rates (24)
Motor vehicle expenses (20)
Insurance (4)
Printing and stationery (12)
Slide 3.29
Example 4.5 Da Silva plc (Continued)
Income statement for the year ended 31 December 2008
£m
Depreciation (45)
Audit fee (4)
Operating profit 95
Interest payable (10)
Profit before tax 85
Taxation (24)
Profit for the year 61
Slide 3.30
Example 4.5 Da Silva plc
Balance sheet as at 31 December 2008
£m
Non-current assets
Property, plant and equipment 203
Intangible assets 100
303
Current assets
Inventories 65
Trade receivables 112
Cash 36
213
Total assets 516
Equity
Ordinary shares of £0.50 each 200
Share premium account 30
Other reserves 50
Retained earnings 25
305
Slide 3.31
Example 4.5 Da Silva plc (Continued)
Balance sheet as at 31 December 2008
£m
Non-current liabilities
Borrowings 100
Current liabilities
Trade payables 99
Taxation 12
111
Total equity and liabilities 516
Slide 3.32
Accounting standards
Deal with issues such as:
what information should be

disclosed;
how information should be

presented;
how assets should be valued;
how profit should be measured.
Slide 3.33
Sources of external accounting regulations for a UK public limited company listed on the
London Stock Exchange
External International
Company
accounting financial
law
rules reporting
standards
Stock Exchange rules

imposed by FSA
Slide 3.34
The relationship between the shareholders, the directors and the auditors
Directors
Account
Review
Elect
Report
Shareholders Elect Auditors

6 CHPT 3&amp 4

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Slide 3.

Chapter 3 Measuring and reporting financial performance

discuss the nature and purpose of the

prepare an income statement from relevant

discuss the main measurement issues that must be

explain the main accounting conventions

Profit Total revenue for the period

Revenue generated by Rolls-Royce plc during the year

Relationship between the income statement and the

The above equation can be extended to:

Assets = Equity + Sales

Example 3.1 Better-Price Stores

Calculating gross profit for Better-Price Stores

Sales revenue 232,000

Opening inventories 40,000

Goods bought 189,000

Closing inventories (75,000) (154,000)

Gross profit 78,000

Profit measurement and the recognition of revenue

Basic criteria that must be met

The amount of revenue can be

It is probable that the economic

Ownership and control of the

Accounting for sales commission

Cash flow Sales commission Balance

Accounting for rent payable

Cash flow Balance

Prepaid expense £4,000

Accounting conventions and the income statement

Profit measurement and the calculation of depreciation

To calculate a depreciation charge for a period, four

The cost (or fair value) of the asset

The useful life of the asset

The residual value of the asset

The depreciation method.

Graph of written-down value against time using the

Written-down value (£000) 80

Graph of written-down value against time using the

Written-down value (£000) 80

Calculating an annual depreciation charge

Cost (fair value)

Year 1 Year 2 Year 3 Year 4

Asset life (number of years)

Profit measurement and inventory costing methods

Common assumptions used are:

First in, first out (FIFO)

Last in, first out (LIFO)

Weighted average cost (AVCO).

Uses of the income statement

Provides information on how

Provides information on how the

Chapter 4 Accounting for limited companies

discuss the nature of the limited company;

describe the main features of the owner’s claim

discuss the framework of rules that surround

explain how the income statement and balance

Main features of a limited company

Two main forms of limited company

Public limited company (plc)

Private limited company (Ltd)

The economic importance of public limited companies – an example

Market share of the four largest grocers: 12 weeks to 15 July 2007

Three guiding principles: