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Principles of financial statements

Learning Outcomes - Principles and Preparation of Financial Statements

At the end of this unit students will be to

Income statements (trading and profit and loss accounts

  • calculate the gross and net profits or losses based on accounting principles, for a specified period
  • recognise that net profit (or loss) is the increase (or decrease) in the net assets during that period.

Balance sheets

  • recognise that they are statements of balances of assets and liabilities on a specified date
  • recognise and define non-current assets (fixed assets), intangible assets, current assets, current liabilities (creditors: amounts due within 12 months), long-term liabilities (creditors: amounts due after more than one year), working capital, capital employed and capital owned
  • comment on the inter-relationship of balance sheet items.

Preparation of financial statements (final accounts)

Sole traders

  • explain the difference between a trading business and a service business
  • prepare income statements (trading and profit and loss accounts) and balance sheets for trading
    businesses in either horizontal or vertical form
  • prepare income statements (profit and loss accounts) and balance sheets for service businesses in
    either horizontal or vertical form
  • make adjustments for provision for depreciation using the straight line (equal instalment), diminishing (reducing) balance and revaluation methods
  • make adjustments for accrued and prepaid expenses and accrued and prepaid income
  • make adjustments for bad debts and provisions for doubtful debts
  • make adjustments for goods taken by the owner for own use.


  • explain the advantages and disadvantages of forming a partnership
  • outline the importance and contents of a partnership agreement
  • explain the purpose of an appropriation account
  • prepare income statements (trading and profit and loss accounts), appropriation accounts and balance sheets in either horizontal or vertical form
  • show the treatment of interest on partners’ loans, interest on capital, interest on drawings, partners’ salaries and the division of the balance of profit or loss
  • make adjustments to financial statements (final accounts)
  • explain the uses of, and differences between, capital and current accounts
  • draw up partners’ capital and current accounts in ledger account form and as part of a balance sheet presentation.

Limited liability companies

  • understand the meaning of the term limited liability
  • prepare simple appropriation accounts in either horizontal or vertical form
  • understand and distinguish between authorised, called-up, paid-up share capital
  • understand and distinguish between share capital (preference shares and ordinary shares) and loan capital (debentures)
  • understand the capital structure of a limited company comprising preference share capital, ordinary share capital, general reserve and retained profits (profit and loss account)
  • prepare appropriation accounts in either horizontal or vertical format
  • prepare balance sheets in either horizontal or vertical form.

Clubs and societies

  • distinguish between receipts and payments accounts and income and expenditure accounts
  • prepare receipts and payments accounts
  • prepare accounts for revenue-generating activities, e.g. refreshments, subscriptions
  • prepare income and expenditure accounts and balance sheets
  • make adjustments
  • calculate the accumulated fund.

Manufacturing accounts

  • distinguish between direct and indirect costs
  • distinguish between direct material, direct labour, prime cost and factory overheads
  • understand and make adjustments for work in progress
  • calculate factory cost of production
  • prepare manufacturing financial statements: income statements (trading and profit and loss accounts) and balance sheets
  • make adjustments to financial statements (final accounts)

Incomplete records

  • prepare opening and closing statements of affairs
  • calculate net profit or loss from changes in capital over time
  • calculate sales, purchases, gross profit, trade receivables (debtors) and trade payables (creditors) and other figures from incomplete information
  • prepare income statements (trading and profit and loss accounts) and balance sheets
  • make adjustments to financial statements (final accounts)
  • apply the techniques of mark-up, margin and inventory (stock) turnover to arrive at missing figures.

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