Types of Business

They tend to be small as they are constrained by the limited financial resources of their owner. Preparing final accounts for sole traders is assessed in the Advanced Diploma level’s Final Accounts Preparation unit.

The greater number of owners compared with a sole trader increases the availability of finance and this is often the reason for forming this structure. Producing accounts for partnerships is assessed in the Advanced Diploma level’s Final Accounts Preparation unit.

Definitions

Sole-trader
Organisations that are owned and operated by one person.

Limited Companies
These are organisations recognised in law as ‘persons’ in their own right.  A company may own assets and incur liabilities in its own name.  The accounting of these organisations must meet certain minimum obligations imposed by legislation, for example, via company law and other regulations.

Drafting financial statements for a limited company is assessed in the Professional Diploma level’s Financial Statements of Limited Companies

Partnership
These are organisations owned by two or more persons working in common with a view to making a profit.

Types of Accounting

2.1 – Management accounting and financial accounting

Depending on what purposes the statements are being produced for, the accounts can be referred to as being either management accounts or financial accounts.

2.2 – The two main financial statements

The objective of financial accounting is to provide financial information about a business. This information is given in a set of financial statements (or accounts), which consists of two principal statements:

  • The statement of profit or loss. This is a summary of the business’s transactions (income and expense) for a given period.
  • The statement of financial position. This is a statement of the assets and liabilities of the business at a given date. This date is the end of the period covered by the statement of profit or loss.

These financial statements are the final product of the accounting system of a business and it is useful to be aware of where all of the double entry bookkeeping that you will study in this chapter is leading. However, you do not need to know anything about the format or rules governing the preparation of the financial statements for this unit.

Definitions

Sole-trader:
Organisations that are owned and operated by one person.

Limited Companies:
These are organisations recognised in law as ‘persons’ in their own right.  A company may own assets and incur liabilities in its own name.  The accounting of these organisations must meet certain minimum obligations imposed by legislation, for example, via company law and other regulations.

Drafting financial statements for a limited company is assessed in the Professional Diploma level’s Financial Statements of Limited Companies

Partnership:
These are organisations owned by two or more persons working in common with a view to making a profit.

Management Accounts:
These are usually prepared on a monthly basis to present timely financial and statistical information to business managers. This aids managers to run the business more effectively by making day-to-day and short-term decisions.

Financial Accounts:
These are prepared annually, mainly for the benefit of people outside the management of the business, such as the owners of the business (for example, shareholders who have appointed directors to run the business on their behalf), HM Revenue and Customs, banks, customers, suppliers and the government.

Definitions

  • Sales revenue is income generated from the trading activities of the business.
  • Cost of sales is the cost of buying or producing the goods for resale.
  • Gross profit is the profit remaining, after the cost of sales have been deducted from sales revenue.
  • Sundry income– other types of income that aren’t generated by the primary trading activities of the business.
  • Expenses – are the day to day running costs of the business.
  • Net Profit or loss – the profit or loss remaining after expenses have been deducted.
£ £
Sales revenue X
Less: Cost of sales
Inventory on 1 January (opening inventory) X
Add: Purchases of goods X
–––
X
Less: Inventory on 31 December (closing inventory) (X)
––– (X)
–––
Gross profit X
Sundry income:
            Discounts received X
            Commission received X
            Rent received X
––– X
–––
X
Less: Expenses:
            Rent X
            Rates X
            Lighting and heating X
            Telephone X
            Postage X
            Insurance X
            Stationery X
            Payroll expenses X
            Accountancy fees X
            Bank charges and interest X
            Irrecoverable debts X
            Delivery costs X
            Van running expenses X
            Selling expenses X
            Discounts allowed X
––– (X)
–––
Profit/(loss) for the year X/(X)
–––

Definitions

  • An asset is something owned or controlled by a business, available for use in the business.
  • Non-current assetan asset which is to be used for the long term in the business and not resold as part of the trading activities, for example the purchase of a delivery van.
  • Current asseta short-term asset of the business which is to be used in the business in the near future i.e. cash or something that will soon be converted into cash.
  • A receivable – is an example of a current asset. A receivable is someone who owes the business money i.e. a credit customer.
  • A liabilityis an amount owed by the business, i.e. an obligation to pay money at some future date.
  • A payable – is an example of a liability. A payable is someone the business owes money to i.e. a credit supplier.
  • Capital – is the amount which the owner has invested in the business; this is owed back to the owner and is therefore a special liability of the business.
  • Drawingsare amounts withdrawn by the owner for their own personal use: drawings may be of cash or items of inventory.
  Cost Depreciation CA
£ £ £
Non-current assets
   Freehold factory X X X
   Machinery X X X
   Motor vehicles X X X
––– ––– –––
X X X
––– –––
Current assets
   Inventories X
   Trade receivables X
   Cash at bank X
   Cash in hand X
–––
X
Current liabilities
   Trade payables (X)
–––
Net current assets X
–––
Total assets less current liabilities X
Non-current liabilities
   Loan (X)
–––
Net assets X
–––
Capital at 1 January X
Net profit for the year X
–––
X
Less: Drawings (X)
–––
Proprietor’s funds X
–––

2.5 – The difference between ‘cash’ and ‘bank’

A possible confusion in terminology is caused by the apparent interchangeable use of the words ‘cash’ and ‘bank’.

The normal use of the words suggests that a bank account operates by paying money out of the account with a cheque and paying either cash or cheques into the account. In practice you cannot pay ‘cash’ out of a bank account.

However, accounting terminology does not stick to this distinction, and the terms cash and bank are for the most part, interchangeable. Thus the bank account is often referred to as the ‘cash book’. Similarly we will often refer to someone ‘taking cash out of the bank’ or we will say things like ‘John bought a car for £5,000 cash’, whereas in reality John would have paid for the car using a cheque.

For the early part of your studies all movements of cash/cheques shall be made through the bank account and references to ‘cash’ or ‘cheques’ effectively mean the same thing.

2.6 – Capital and revenue

You must also be able to define capital expenditure, revenue expenditure, capital income and revenue income.

Definitions

  • Capital expenditureis the purchase of, or improvement of, non-current assets.
  • Revenue expenditure – is the day to day running costs of the business.
  • Capital income – is income from the sale of capital assets of the business.
  • Revenue income is income generated from the sale of goods or services.

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