Professional Issues

1
Professional Issues

• Finance and Accounting in Business.

2
Learning Outcomes

• Know and differentiate between the different
  sources of capital for business ventures.
• Understand the importance of budgeting for a
  business.

3
Learning Outcomes

• Understand the process involved in calculating
  costs and setting prices.
• Been able to calculate assets depreciation.
• Know the annual statements that need to be
  submitted by a company and understand the
  characteristics of each of them.

4
Class Contents

• Need for capital and sources of funds.
• Budgeting Sales and Expenditure.
• Sales, Costing, Depreciation and Pricing

5
Class Contents

• Annual Statements
• The Balance Sheet
• The Profit and Loss Account
• Auditors Limitations and Responsibilities

6
Need for Capital

• To start a new venture, there is always a need
  for money.
• Invoices are normally issued at the end of the
  month.
• Clients usually pay their invoice from 1 to 2
  months after receiving them.

7
Need for Capital Software Companies

• There are more expenses
• Salaries, however small, for the group and for
  any other staff they may employ.
• Rent, rates, heating and lighting of the premises
  used.
• Equipment and consumables.
• Costs of advertising and marketing the products.
• Miscellaneous expenses, ranging form company
  stationery to travelling expenses for any trips
  that may be necessary.

8
Need for Capital Software Companies

• While packages are being developed, there will be
  no revenue coming into the company.
• However successful the development of the
  packages, it will take some months before sales
  reach a level sufficient to cover the companys
  on-going costs, so even after development is
  complete, more cash will be needed

9
Need for Capital Business Plan

• Raising Money Business Plan
• The purpose is to explain the plans to potential
  funders and to convince them that
• The plans are well thought out
• The venture is likely to be successful.

10
Need for Capital Business Plan

• A Business Plan Usually contains
• A description of what the company will be doing,
• information to show that the company is
  technically feasible and that founders of the
  company have the necessary expertise.
• An assessment of the size of the market and the
  competition
• A prediction of the financial performance of the
  company

11
Sources of Funds

• Government policy in the UK has, over recent
  years, strongly encouraged the growth of small
  companies and, as a result, there are many
  possible sources of funding.
• All sources of funding can be grouped in 3
  categories

12
Sources of Funds

• Grants
• Loans
• Sales of Equity

13
Sources of Funds - Grants

• A Grant is a sum of money given to a company by
  another organization.
• The company is obliged to demonstrate that it has
  been used for the purpose for which it was
  intended.
• It is not intended that the grant should ever be
  paid back to the organization which gave it .

14
Sources of Funds - Grants

• Availability of Grants
• Government (Local or National)
• European Commission Sources
• Charities
• Very often, grants are limited to a certain
  proportion of the money spent on a particular
  development and are conditional upon the
  remainder being raised from other sources

15
Sources of Funds - Grants

• Availability of grants for new companies depend
  on
• Where the company is located.
• How many people it expects to employ.
• On government policy at the time.

16
Sources of Funds - Loans

• A Loan is a sum of money lent to the company.
• Interest have to be paid at a rate that may be
  fixed or variable.
• The loan is usually for a limited period.

17
Sources of Funds - Loans

• The company is liable to pay back the loan and,
  if the company goes into liquidation, the lender
  is entitled to recover the loan from the sale of
  the assets of the company.
• In most cases, security is required for the loan
• The loan is associated with assets owned by the
  company in much the same way that a mortgage is
  associated with a house.

18
Sources of Funds - Loans

• Loans can be divide into 3 categories
• Overdraft
• Long-term loans
• Soft Loan

19
Sources of Funds - Loans

• Overdrafts They are offered by banks and allow a
  company (or an individual) to spend more money
  than is in its account, up to a specified
  maximum.
• Interest is only payable to the amount that is
  actually owed.
• Interest is usually very low.

20
Sources of Funds - Loans

• Advantages
• Most flexible and cheapest way to borrow.
• Drawback
• A bank can withdraw overdraft facilities without
  warning.

21
Sources of Funds - Loans

• Long Term Loans Are usually made for a fixed
  period of time and have a fixed interest.
• The borrower receives the capital at the start of
  the period of the loan
• He is committed to paying interest on that amount
  through the period of the loan.

22
Sources of Funds - Loans

• Provided the borrower pays the interest on time,
  the lender cannot call in the loan.
• The borrower must repay the capital at the end of
  the period

23
Sources of Funds - Loans

• Soft Loans Are available to start up companies
  as a result of government initiatives.
• It is a loan on terms which are less demanding
  than those that prevail for commercial loans.
• The interest rates may be lower than commercial
  interest rates and security is not demanded.

24
Sources of Funds Equity Capital

• Equity capital is money paid to the company in
  exchange for a share in the ownership of the
  company.
• The relationship between loan capital and equity
  capital in a company is important and it is known
  as gearing.

25
Sources of Funds Equity Capital

• Shareholders are at a much greater risk of
  getting a poor return on their capital or even
  losing it completely than are lenders.
• In compensation for this, they stand to make
  greater profit than lenders if all goes well.

26
Gearing Example

• A company has a share capital of 100 and a loan
  capital of 10.000 at 10.
• If the company makes an operating profit of
  1.000, the interest charges will consume all the
  profits and the shareholders will receive
  nothing.

27
Gearing Example

• If the companys operating profit doubles, to
  2.000, the lender will still receive 1.000 but,
  neglecting taxation and assuming that all the
  profit is distributed to the shareholders, the
  shareholders will receive 1.000, a rate of
  return of 1000
• As the profit increase, the value of the company,
  and hence the value of the shares, increases.
• If the company is sold, the shareholders will get
  much more than their original 100 investment,
  but the lender will still only be entitled to
  their original 10.000, plus interest.

28
Gearing Example

• If the company is unsuccessful and goes into
  liquidation, the lenders will be at the front of
  the queue of people to whom money is owed,
  whereas the shareholders will get nothing until
  everyone else has bee paid in full

29
Budgeting

• A Budget is a prediction of the future financial
  position of an organization covering the current
  or the next financial year.
• A complete budget will include predictions for
  the annual financial statements.

30
Budgeting

• The Annual Financial Statements Contain
• Balance Sheet.
• Profit and Loss Account.
• Auditors Report.
• The ordinary manager in a company is much more
  concerned with budgeting for income and
  expenditure than with other aspects of budgeting.

31
Budget Example - Expenditures
32
Budgeting

• Budgeting is an iterative process.
• Adjustments to the budget need to be made
  repeatedly until budgeted sales exceed budgeted
  expenditure with a reasonable profit margin.

33
Budgeting

• The first version of the budget is likely to show
  expenditure exceeding income.
• Operating managers will want to expand their
  operations while the sales and marketing
  department will not wish to give hostages to
  fortune by being over-optimistic about the volume
  of sales it can generate.

34
Budgeting Sales and Order Intake.

• Monitoring the level of sales is an important
  managerial activity and needs to be supported by
  adequate information.
• The amount of sales in a month is the total value
  of the invoices issued during the month
• The order intake is the total value of the orders
  received.

35
Budgeting - Costing

• The price at which an organization decides to
  sell a product or a service depends on
• The cost of producing the product.
• The market conditions. (price and availability of
  competing products, elasticity of the demand)

36
Budgeting - Costing

• The cost of producing an item or providing a
  service is not a well-defined quantity.
• Different definitions of cost need to be used for
  different purposes.

37
Budgeting - Costing

• Costs can be grouped into four categories
• Raw materials and bought-in items.
• Costs of equipment.
• Direct labour costs
• Overheads.

38
Budgeting Raw Materials

• Materials which are bought by a company and
  processed as part of the companys manufacturing
  process are known as raw materials.
• Examples
• Steel bought by motor manufacturers.
• Sulphur bought by chemical companies to
  manufacture sulphuric acid.

39
Budgeting Bought in items

• Companies also buy items that are incorporated,
  unchanged, into their products. Such items are
  known as bought-in items
• Examples
• Computer manufacturers buy ICs from specialist
  suppliers.
• Motor manufacturers buy door locks to incorporate
  in the cars.

40
Budgeting Costs of Raw Materials and Bought in
Items

• There is no difficulty in determining how many of
  which bough-in item, or how much of each type of
  raw material, goes into the final product.
• A company which uses chips or sulphur will
  usually carry a stock

41
Budgeting Costs of Raw Materials and Bought in
Items

• it is quite likely that not all the stock was
  purchased at the same time or at the same price.
• It may not be known from which batch the chips or
  the sulphur used in producing a give unit of
  output came,
• how do we decide which price to use in assessing
  its costs?

42
Budgeting Costs of Raw Materials and Bought in
Items

• The usual practice is to adopt a FIFO policy for
  costing regardless of the order in which the
  items or materials are used.
• The cost of the oldest batch is used until a
  quantity equal to the size of that batch had been
  used, and then the cost of next batch is used in
  the calculations

43
Budgeting Costs of Raw Materials and Bought in
Items

• In the case of raw materials or bought-in
  components whose price may fall dramatically as a
  result of over-supply, a FIFO policy for costing
  may render a companys prices uncompetitive and
  the current cost then has to be used instead.

44
Budgeting Cost of Equipment

• The cost of a unit of output from an asset
  depends critically on its utilization.
• Example What is the cost of owing a car?

45
Budgeting Cost of Equipment

• A car is bought for 10,000.
• It was kept for 3 years and then sold for cash.
• Each year the car was used for 10,000 miles.

46
Budgeting Cost of Equipment

• The effects of inflation is going to be neglected
  (The price of a new equal car remains the same
  all the time).
• The selling price of the car is expected to be
  4,200
• (the exact figure will depend on the make and
  model of the car, the physical shape of the car
  and the geographical location).

47
Budgeting Cost of Equipment

• Different Costs Involved
• Depreciation Is the difference between what was
  paid for the car and the price it was sold for
• Interest that needs to be paid on borrowed money
• Opportunity costs Are cost generated as a result
  of being unable to take up another opportunity of
  using the capital
• Example putting the money in the bank to
  generate interest at a fixed rate. Instead of
  buying the car. (at 3 generate 927)

48
Budgeting Cost of Equipment

• These costs are called fixed costs that is, they
  do not vary with the amount that we use the
  equipment.
• Other examples of fixed costs include road tax
  (140/year) and insurance (700/year).

49
Budgeting Cost of Equipment

• variable costs are costs which vary in
  proportion to the amount that the equipment is
  used.
• The most obvious of these cost in the car example
  would be fuel.

50
Budgeting Cost of Equipment

• Example Assuming price of fuel 0.7/lt and
  average consumption is 10 miles/lt
• The cost per mile will be

51
Budgeting Cost of Equipment

• Other variable costs vary in a less smooth
  manner
• Example A set of tyres will last for some
  40,000 miles if they are properly looked after a
  replacement set might cost 200.
• This gives a cost of 0.5p per mile for wear and
  tear of the tyres.
• Since only 30,000 miles have been covered at the
  moment of sale, nothing should have been spent in
  the replacement tyres.

52
Budgeting Cost of Equipment

• Servicing costs are similar in nature assuming
  that servicing is needed every 10,000 miles (at
  150/service) and the service is not done just
  before selling the car, two services will need to
  be added to the cost of the car.

53
Budgeting Cost of EquipmentCost of Owing a Car
for 3 years
54
Budgeting Cost of Equipment

• If the costs are distributed over the 30,000
  miles that have been driven in the car, the cost
  per mile will be 38.82p.
• This cost per mile is very dependant on how many
  miles we drive in the three year period, that is,
  on the utilization of the car.
• If the mileage is doubled (60,000), allowing for
  additional fuel and servicing plus 200 for a new
  set of tyres and 500 for repairs, the total cost
  will rise to 14,897 and the cost per mile will
  fall to 24.82p

55
Budgeting Cost of Equipment

• This car example is what economists would call an
  ex post calculation.
• It is based on a knowledge of what actually
  happened to the asset (car)
• It can only be carried out after the asset has
  been sold (or disposed at scrap value).

56
Budgeting Cost of Equipment

• For costing a piece of machinery in industry, an
  ex ante estimate of what will happen is needed.
• This is an estimate that can be made at the start
  of the life of the machine.

57
Budgeting Cost of Equipment

• This also means making assumptions about what
  happens to the average machine of that type in
  the same environment.
• The same type of calculation will be carried out
  (excluding the lost of capital) but depreciation
  needs to be looked at more carefully.

58
Budgeting Cost of Equipment

• Depreciation can be looked at in two ways
• As the reflection of the diminishing value of the
  item both its market value and its value to the
  company as its life passes.
• As a way of distributing the cost of owning the
  item over the work which it produces.

59
Budgeting Cost of Equipment

• There are several ways of calculating
  depreciation.
• The two most commonly used are
• Straight Line Depreciation
• Reducing Balance Depreciation

60
Budgeting Depreciation

• Calculation Parameters
• Initial cost of a unit of the produced item C
• Life of the item (likely) in years n
• Resale or scrap value of the item (reached at the
  end of the item life) S

61
Depreciation Straight Line

• Then the annual depreciation is calculated as

62
Depreciation Straight Line

• The VALUE of the item at the end of year m is
• Straight line depreciation is simple and adequate
  for many purposes. In particular it is a
  reasonable way of distributing the cost of owning
  the item over its useful lifetime.

63
Depreciation Reducing Balance

• If we want the depreciated value of the asset to
  reflect its diminished market value, straight
  line depreciation is unrealistic.
• The resale value of an asset normally falls much
  more in absolute terms during the earlier years
  of its life than during the later years.

64
Depreciation Reducing Balance

• The reducing balance method of calculating
  depreciation reflects this.
• A factor r (0ltrlt1) is chosen as the fraction by
  which the value falls in each year

65
Depreciation Reducing Balance

• Using Reducing Balance, the annual depreciation
  will be
• An the price of the asset at the end of year m
  will be

66
Depreciation Reducing Balance

• The value of the factor r should allow for the
  scrap price to be reached at the end of the life
  of the asset
• With the reducing balance method, the value of
  the asset can never fall to zero. The effect of
  no resale value can be obtained assigning S1

67
Budgeting Depreciation
68
Budgeting Depreciation
69
Budgeting - Depreciation

• For the purpose of internal costing, a company is
  free to use whatever methods it wishes for
  calculating depreciation.
• In its published accounts the same method must be
  used for all assets of the same type
• It is common to use the same methods for internal
  costing as are used in published accounts.

70
Budgeting Cost of Labour

• The costs of labour are basically all the costs
  associated with an employee of the company.
• If an employee works for one hour in order to
  produce an item, what cost should we attribute to
  the employees time?

71
Budgeting Cost of Labour

• First, the total cost of the employee needs to be
  calculated
• Example Suppose the annual salary of the
  employee is 15,000.
• In addition to the salary, the company is obliged
  to pay what is known as the Employers National
  Insurance Contribution.
• This depends on the salary in a rather
  complicated way for a salary of 15,000, it
  comes to about 1,500.

72
Budgeting Cost of Labour

• If the company runs a pension scheme, then it is
  normal for the employer as well as the employee
  to make a contribution to this
• We will assume that the employer contribution is
  6 (900).
• In some cases, there may be other allowances
  payable, such as car allowances or clothing
  allowances (which we will ignore for this
  example).

73
Budgeting Cost of Labour

• The total cost of employing the employee for the
  year is

74
Budgeting Cost of Labour

• Second, the number of hours worked in a year
  needs to be calculated
• Assuming a five day week, there are 260 possible
  working days in a year. I
• If there are 20 working days of holiday plus 8
  days of public holidays, the number of possible
  working days is reduced to 232.
• We must make some allowance for days off for
  sickness. The best that can be done is to take
  the average of the company as a whole, since we
  cannot predict what will happen to an individual
  employee this might be 8 days.
• This brings the total of days worked down to 224

75
Budgeting Cost of Labour

• If we assume a seven hour day, the number of
  hours worked is 1568. The cost per hour is
  therefore

76
Budgeting - Overheads

• Some costs like raw materials, use of specific
  machinery and some labour costs, can be directly
  associated with specific products or services.
• Therefore they are taken into account directly in
  determining prices.

77
Budgeting - Overheads

• Other costs cannot be directly associated with
  specific products or services
• sales and marketing costs
• managers costs.
• costs related to the preparation of bids.
• They must still be covered by the total revenue.
  These are called Overheads.

78
Budgeting - Overheads

• Some of the overheads can be associated with
  specific parts of the organization and should be
  covered by the revenue earned by those parts
  these are called departmental overhead.
• Other overheads can only be associated with the
  whole organization these are known as corporate
  overheads.

79
Budgeting - Overheads

• The concept of an overhead may vary from one
  organization to another
• A software house based at a single site may find
  it impracticable or not worthwhile to associate
  the cost of rent, rates, heating and lighting
  with individual projects or departments it will
  therefore treat those as corporate overheads.
• A computer manufacturer producing peripherals on
  one site, processors on another, and system
  software on a third, will treat the cost of these
  premises as departmental overheads.
• A company that runs a number of aluminium
  smelters at different sites will associate costs
  of each site with the aluminium produced there.

80
Budgeting - Overheads

• There is no right way of allocating overheads
  to individual parts of the organization or to
  individual products.
• How it is done depends partly on the policy of
  the organization and partly on the nature of the
  overhead.

81
Budgeting - Overheads

• There are two basic approaches to handle
  overheads as costs
• overheads can be added to costs of the inputs
  (labour, machine time, etc.)
• or they can be added to the costs of the outputs
  (products and services).
• In a software house, overheads are usually
  recovered by adding them to the direct labour
  costs.

82
Budgeting - Overheads

• A manufacturing company is more likely to recover
  overheads by adding a mark-up to the direct cost
  of each product.
• It is usual to make the amount added for
  overheads a fixed percentage of the costs to
  which it is being added, whether this is an input
  or an output.

83
Budgeting - Overheads

• With the overall constraint that all overheads
  must ultimately be recovered from revenue, the
  following principles should apply to the way that
  overheads are distributed
• Consistency similar costs should be treated in
  similar ways.
• The treatment of overheads should encourage
  managers to behave in ways which optimize the
  performance of the company as a whole rather than
  just the performance of their own department.
• The treatment of overheads should not distort the
  price structure of the companys products so as
  to make them uncompetitive.

84
Budgeting - Overheads

• It should be remarked that it is easier to
• enunciate these principles in general than
• it is to implement them in practice.

85
Budgeting - Pricing

• The prices that a company charges for its
  products and services are ultimately constrained
  by the long-term requirement that the revenue
  from its trading operations must exceed the costs
  of those operations.
• For a company which provides a range of products
  and services, the unit price of each item can be
  adjusted to maximize the companys profit and
  need not necessarily be related to the cost of
  providing the item

86
Budgeting - Pricing

• Using Math
• A company produces n products.
• The cost of producing a unit quantity of product
  i is ci.
• The quantity of product i which can be sold at a
  unit price of pi is

87
Budgeting - Pricing

• The trading profit can be expressed as

88
Budgeting - Pricing

• It is desirable that the choice of pi is done in
  a way that it maximizes this equation.
• This choice of the pi will be constrained by
  limitations on the qi resulting from the fact
  that the company only has limited resources and
  cannot produce indefinitely large quantities of
  any of the products

89
Budgeting - Pricing

• For most companies, the way in which qi depends
  on pi is much too uncertain for this approach to
  be useful.
• Pricing in such circumstances is usually based on
  the cost of producing the product or providing
  the service, plus a percentage for profit

90
Budgeting - Pricing

• In some industries, it is normal to discount
  prices for quantity or for favoured customers so
  that published prices must be sufficiently high
  to allow a sale to be profitable even after
  discounting.

91
Budgeting Pricing in Software Companies

• Software companies are faced with pricing in
  three contexts
• Pricing a bid to provide services, such as
  consultancy, design or programming, with payment
  based on the effort supplied (time and
  materials).
• Pricing a bid for a contract to supply software
  at a fixed price.
• Pricing a software product which they have
  developed or for which they are agents.

92
Budgeting Pricing in Software Companies

• Biding for Time and Materials
• The price will depend on the cost of labour plus
  overheads.
• The price may need to be modified to take into
  account a number of factors

93
Budgeting Pricing in Software Companies

• Factors
• How badly the company needs the business
• The Desirability of the client
• The general level of the market
• All the factors will affect the pricing offered
  to gain the bid for the contract.

94
Budgeting Pricing in Software Companies

• Fixed Price Contract
• All the costs need to be calculated beforehand
• Estimation of resources needed
• Cost of Labour Travel and Subsistence Expenses
• Costs for Bought in products (maintenance,
  operating costs, floor space, insurance, etc.)

95
Budgeting Pricing in Software Companies

• Costs of financing the work (due to usual delay
  in payments)
• Costs of servicing the final product (to cover
  guarantee period)
• Increase in price according to level of risk
  perceived in the contract (can be up to 50
  additional.

96
Budgeting Pricing in Software Companies

• Pricing Software Products
• The resource used in developing the products
  should be known and from these the costs of the
  development calculated .
• The costs of maintaining and supporting the
  product must also be estimated
• They usually consists on a fairly substantial
  fixed cost plus a small variable element
  depending on the number of copies sold.

97
Budgeting Pricing in Software Companies

• The cost of selling the product must also be
  taken into account (Strategies for level of sales
  are different)
• PRICING IS CRITICALLY DEPENDANT ON THE STIMATE OF
  LIKELY SALES

98
The Annual Statement

• There are three important annual statements that
  a company must supply according to the Companies
  Act 1985
• Balance Sheet
• Profit and Loss Account
• Auditors Report

99
Balance Sheet

• A Balance sheet is a snapshot of the financial
  state or an organization at a single instant
  (normally the end of the organizations financial
  year).
• It shows the value of what the organization owns
  (assets) and what it owes (liabilities).

100
Balance Sheet

• A Balance sheet must balance
• the total assets and the total liabilities should
  be equal.
• To achieve this, a balancing item needs to be
  included on one side of or the other
• This item is usually labelled excess of asset
  over liability

101
Balance Sheet

• In commercial balance sheets, the assts and
  liabilities are grouped into various categories
  and a single figure is given for each category.
• There will be several notes to the balance
  sheet describing the basis of the account and
  giving more detail about certain items such
  items will cross reference the notes

102
Balance SheetExample
103
Balance Sheet

• Assets are divided into
• Fixed Assets
• Current Assets
• Liabilities are also divided into
• Current Liabilities (due in less than 1 year)
• Long Term Liabilities

104
Balance Sheet - Fixed Assets

• They contribute towards the company productive
  capacity
• They depreciate according to the company
  depreciation policy
• They can also be subdivided into
• Investments
• Tangible Assets
• Intangible Assets

105
Balance Sheet - Current Assets

• They are items which are bought and sold in the
  course of the companys day to day trading
  activities.
• They must be valued at the lower of cost and net
  realizable value (the money that would be
  obtained by selling them, less any expense of the
  sale)

106
Balance Sheet - Current Assets

• Manufacturing companies will usually have items
  in their list of current assets covering stock of
  finished products or raw materials.
• Contracting companies will usually have an item
  for amounts recoverable on contracts or work
  in progress, that is work being carried out
  under contract to clients that has not yet been
  billed.

107
Balance Sheet - Current Assets

• The valuation of any of these items is subject to
  a degree of uncertainty.
• The finished goods have not yet been sold it
  might prove impossible to sell them.
• The work in progress value on a software contract
  may be based on the assumption that the software
  is 90 complete, but software projects have been
  know to remain 90 complete for a very long time

108
Balance Sheet - Liabilities

• The liabilities section of a commercial balance
  sheet effectively distinguishes between current
  liabilities, and long term liabilities.
• It is usual practice to arrange current
  liabilities next to current assets in the balance
  sheet so that they can be deducted to give a
  figure for net current assets

109
Balance Sheet - Liabilities

• The phrase provisions for liabilities and
  charges refers to items which the company knows
  it will have to pay but whose precise amount may
  be uncertain
• Example tax on previous years earnings which
  has still to be assessed.
• work which may have to be carried out by the
  company under warranty.

110
Balance Sheet Net Assets

• It is customary to show how the net assets have
  come about
• Using the Example
• Called-up share capital is the face value of the
  shares that have been issued.
• The figure from the profit and loss account is
  the total value of the profits and losses made by
  the company since it was established
• The share premium reserve is the extra money
  raised when shares have been sold at above their
  face value

111
The Profit and Loss Account

• A profit and loss account shows what has happened
  to an organizations financial position over a
  period of time (usually 1 year).
• It records the money received and the money spent
  during the period.
• It is also known as income and expenditure
  account in the case of non-profit making
  organizations.

112
The Profit and Loss Account
113
The Profit and Loss Account

• There is a distinction between cost of sales
  and other operating expenses.
• This distinction is an uncertain one and some
  companies do not show the items separately.
• Example For a package software company, there is
  a real difference between the expenditure on
• Selling, printing documentation, installing
  software, etc. all of which are the costs of
  sale
• The development of new versions of existing
  packages or on new products, which would come
  under the heading of other operating expenses.

114
The Profit and Loss Account

• The bottom line of the profit and loss account
  shows the retained profit for the year, that is
  the profit not paid out in tax or dividends to
  shareholders.
• This profit is added to the cumulative retained
  profit in the previous years balance sheet to
  give the value of the retained profit shown in
  the new balance sheet.

115
Auditors Report

• The Companies Act 1989 requires that company
  accounts should be accompanied by an auditors
  report.
• The purpose of the report is to provide members
  of the company and the public at large with an
  assurance that, in the opinion of the auditors,
  the accounts give a true and fair view of the
  state of the affairs of the company

116
Auditors Report

• It is important to understand the limits of
  auditors responsibilities.
• Accounting standards permit the figures in the
  annual statements to be presented in a variety of
  different ways.
• The auditors responsibility is limited to
  certifying that the accounts have been prepared
  in accordance with these standards
• Auditors have no authority to question whether
  the particular choices are the most appropriate
  for the company, provided that they are used
  consistently

117
Auditors Report

• there is the issue of whether the company is a
  going concern.
• is the company is likely to survive its next
  financial year?
• Example
• The balance sheet and the profit and loss account
  present a picture of a healthy company.
• The auditors can certify is true and fair,
• and yet the company has little chance of
  surviving the next twelve months (depending on
  the type of trade).

118
Auditors Report

• If auditors have reason to suspect that the
  company is a going concern, they are expected to
  carry out procedures to test the position.
• Typically they examine cash flow predictions and
  seek assurances that suitable credit facilities
  will be available over the next 12 months.
• If they have no such suspicion, they are not
  required to take such action

119
Auditors Report

• The primary responsibility for preventing and
  detecting fraud lies with the directors of the
  company, not with the auditors.
• Auditors, however, do have a responsibility to do
  their work in such a way as to have a reasonable
  expectation of finding anything seriously
  misleading in the financial statements.
• If they find evidence of fraud, they have the
  duty to report it to the directors.