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Final accounts AO2, AO4

Profit and loss account, balance sheet


Business without accounts is like playing football without counting the goals

says RCB


Firms need financial accounts, because they use money and, often, other people's money.

The tax authorities want to see Profit and loss to calculate tax payments.

Shareholders want to be sure that the directors have done a good job for them.

Investors want to see how well the firm is doing.

Company Law states Public Limited Companies MUST produce final accounts and make them public

Already you can see the two sides of accounting - expenditure and income. The order is important; usually expenditure comes before income. A firm usually has to make something and supply it before it is paid.

All payments and receipts have to be declared, what came in (income) and what went out (expenditure) by way of a profit and loss statement and what was bought and what is owed (balance sheet) to both the owners of the business and the government. This is done through a formal set of financial accounts that consist of:

  • The balance sheet
  • The profit and loss account (P&L Account)

These will be accompanied by a set of notes, which explain entries in the accounts and also give a mass of interesting information. These accounts are what are called 'historic' meaning they report what has happened in the past. They tell the reader what a firm has done, but not what it will do. Accounts are probably 3 to 6 months out of date when they are published.

First the Balance Sheet

NB: Go to page 90 of the BM Syllabus to see how to set out a BS for the IB Exams

Balance sheet -

The balance sheet is a financial statement that lists the assets, debts (Liabilites), and owners' investment (owner's equity - or what money owners have invested in the company) on a specific date - usually the last date of an accounting period (in Brazil this is 31st Dec yet in UK it is 31st March). Assets are what the company OWNS that can be used to generate income and are listed according to how long they take to be converted into cash (liquidity) least liquid assets come first. Debts or liabilities are listed according to how soon they must be paid. In effect a Balance Sheet shows how much a company is worth by subtracting liabilities away from assets to find net assets. It goes on to show how this was funded through loans and owner equity (Shareholder funds).

The balance sheet is often referred to as a 'snapshot' of the firm on a particular date. It can only be constructed to show the position on one date, and not over a period of time, as the values for assets and liabilities change constantly. The title of a Balance Sheet then includes the phrase 'as at...(particular date)'.

Balance sheets reveal the most information when they are compared with previous balance sheets, as that process shows the extent to which the business has changed; whether it has grown or contracted and how one part has grown or declined relative to another. However, there is always a story behind those changes and this is what financial analysis, such as the use of ratios, attempts to establish and explain.

The balance sheet is split into two parts:

  1. A statement of current assets (will change in less than 1 year), fixed assets (will last for more than 1 year), Current liabilities (must be payed back in less than a year) and Long term liabilites (will take more than a year to pay back)  the differnce between assets and liabilities is referred to as "Net Assets"
  2. A statement showing how the net assets have been financed (titled 'financed by'), for example through share capital and retained profits

The law requires a balance sheet to be included in the published accounts of all limited companies. In reality, all organisations that use other people's money need to prepare accounts for external users, since it is an important to provide stakeholders with feedback about the financial affairs of the organisation.

However, a balance sheet does not necessarily provide a true value of a business, because assets and liabilities are shown are historic, and some intangible but valuable assets, such as brands, quality of management and goodwill are not included.

A balance sheet has the following title which shows it is a 'snapshot' at a particular time; this is usually the last date of the firm's financial year:

Balance sheet for
XYZ Company
as at 'a date'

Now the Profit and loss account basics

NB: Go to page 91 of the BM Syllabus to see how to set out a P&L for the IB Exams

Profit and loss account

A profit and loss account is a financial statement recording all of a firm's revenues, costs (Expenses) and net income within a past trading period (the year just ended usually). The account shows gross profit and net profit or loss on its trading activities.

The Profit and Loss account (Note the difference in the title compared with BS.:

Profit and loss account
XYZ Company
for the year ended 'date'

It is conventional to give the last years accounts alongside the new ones. This enables comparisons to be made right from the start. A balance sheet will be headed like this:

Balance sheet
XYZ Company
As at 1st January 2011

2013 2014