The Concept of Consistency - Speech or Presentation Example

Q1a) Olympic Trading and Profit and loss account For the year ended 30th June 20X1 $ $ $ Sales 554,800 Less:return inwards 9,880 544,920 Less Cost of goods sold: Opening stock 28,690 Purchases 257,640 less: return outwards 26,220 231,420 260,110 less: closing stock 30,780 229,330 Gross profit 315,590 Less:expenses Increase in provision for bad debts 798.0 Bad debt expense 4,180 Advertising 11,400 Electricity and Gas (21090+1710+760) 23,560 Insurance (10830-3040) 7,790 Motor Expenses 31,540 Postage and stationery 4,560 Rent and rates (39710-2470) 37,240 Salaries and wages 70,680 Carriage outwards 28,500 Depreciation expense for motor vehicles (79800-7220)×20% 14,516 Depreciation expense for fixtures and fittings (228570×10%) 22,857 257,621 Net profit 57,969 Olympic Balance sheet As at 30th June 20X1 Fixed Assets: $ $ $ Motor vehicles at cost 79,800 Less: Provision for depreciation 21,736 58,064 Fixtures and Fittings at cost 228,570 Less: Provision for depreciation 142,557 86,013 144,077 Current assets: stock 30,780 debtors 45,600 less Provision for bad debts (45600×3%) 1,368 44,232 Prepaid rates 2,470 Prepid insurance 3,040 cash 1,140 81,662 Current Liabilities: creditors 38,950 Accrued electricity 760 Accrued Gas 1,710 Bank Overdraft 10,640 52,060 29,602 173,679 Financed By: Capital 159220 Add:Net profit 57,969 217,189 less:drawings 43510 173,679 Q1B) Accruals: According to the accruals concept, expenses and revenues should be shown in the profit and loss account as they have been incurred rather than as they have been paid. Trading and profit and loss accounts should always be prepared on accrual basis so that the expenses of the company are matched by its revenue earned over a specified period of time (Wood and Sangster 98). The expenses in the profit and loss account should adequately reflect the expenses incurred in earning that revenue, since some expenses are always incurred to generate revenue. In the above financial statements, prepaid rates were deducted from the rate expense in the profit and loss account since the rates paid in advanced does not adhere to the year 20X1 and the expense is of the next year rather than of the current year. Hence it is not included in calculating the net profit. Going Concern: A business is considered to be going concern if there is no intention to terminate the business in the near future. However, if the business is short of working capital and the owner is unable to pay of its creditors, the business may be forced to close. According to the going concern concept, it is assumed that the business will run forever. Hence the financial statements are prepared keeping in mind the going concern concept. Prudence: The prudence concept is intended to prevent profit from being overstated. Overstating the profit can have serious drawbacks for a business. If the profit is overstated, the owner may believe that his income is higher than it really is, and may withdraw too much money from the business. This may lead to shortage of cash and eventually to the failure of the business (Randall 48). Hence it is extremely important for a business to show a realistic a profit figure on its financial statements and it is better for profit to be understated rather overstated. This principle of preventing the profit to overstate is also known as principle of conservatism. So the prudence concept is aimed at ensuring that the profits are realistic and not overstated. In the above financial statements, provision for bad debts was made so that the profits are not overstated in case there are any bad debts. Consistency: The business should record its transactions in the same way in the same accounting period and in all the future periods. The accounting methods used by the business should remain consistent. The concept of consistency is important to ensure that the profits or losses of different periods, and the balance sheets can be compared to achieve better results. In the above financial statements, business uses a straight line depreciation method for fixtures and fittings. According to the consistency concept, the business should consistently use this method for fixtures and fittings in the future as well and should not switch to other depreciation methods. Q2a) John Higgens can raise short term and long term finance in following ways: 1) Preference shares: John Higgins may issue preference shares to raise up capital for the limited company. These shares are called preference shares since they enjoy certain rights that ordinary shareholders do not enjoy (Brigham and Ehrhardt 48). Preferred share holders receive fixed dividends from the company’s profit before the ordinary shareholders become entitled to dividends. 2) Ordinary shares: The ordinary shareholders are the actual owners of the company. The profit that remains after paying dividends to the preferred shareholders belongs to the ordinary shareholders and they get dividends out of that remaining profit. Ordinary share holders have the voting rights and have the power of decision making which preferred shareholders do not possess. Moreover, all the reserves also belong to the ordinary shareholders. When the limited company discontinue its operations, the assets that remain after paying all the creditors and preferred shareholders, belong to the ordinary shareholders. 3) Debentures: A document given by a limited company to someone who has lent it money is called a debenture. A debenture states the amount of the loan, the interest rate to be paid on the loan and the dates on which interest has to be repaid each year. It also includes the date on which the company has to repay the loan. Debenture holders have to be repaid even if the company is not making profits. The company has to sell its assets in order to pay the debenture holders and they are preferred over the preferred and ordinary shareholders. Q2b) The advantages of trading as a sole trader over a limited liability company are as follows: 1) The formation of the business is easy and inexpensive whereas setting up a limited liability company involves a lot of complications and is time consuming. 2) There are few government regulations on a sole trader business whereas in a limited liability company, lots of government regulations get involved. 3) The taxes imposed on a sole trader are far less than those imposed on a limited liability company. The earnings of the limited liability company are double taxed; the earnings of the limited liability company are taxed and then the earnings paid out as dividends are also taxed (Weygandt, Kieso, and Kimmel 198). Disadvantages of a sole trader business when compared to a limited liability company include: 1) A sole trader has an unlimited liability for business debts. This means that the sole trader can lose more money than he initially invested. On the other hand, a limited liability company offers its owners limited liability which means that the investor will not lose money more than the amount he have invested in the company. 2) A sole trader cannot generate a large amount of capital whereas a limited liability company can generate a very high amount of capital through its shareholders and hence a limited company can have more capital to invest in the growth of the business. 3) The life of a business is dependent on the life of the sole trader. Hence the life of the sole trader company is limited to the life of the person who created it. On the other hand, a limited company has an unlimited life since it can continue even after the death of the original owners. Works cited: Sangster and Frank Wood. Business Accounting. Boston: Pearson Education, 1999. Print. Randall, Harold. Accounting. Cambridge: University of Cambridge, 2005. Print. Ehrhardt and Eugene Brigham. Financial Management. Florida: South-Western College, 2003. Print. Kimmel, Kieso, and Jerry Weygandt. Accounting principles. Illnois: Donald Fowley, 2008. Print. Read More