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IB Syllabus 3.4
IB Syllabus 3.4
The learning outcomes (or assessment objectives) for this section of the IB Business Management syllabus are:
The purpose of accounts to different stakeholders (AO2)
Final accounts (AO2, AO4):
• Profit and loss account
• Balance sheet
Different types of intangible assets (AO2)
Depreciation using the following methods (HL only) (AO2, AO4):
• Straight line method
• Units of production methodAppropriateness of each depreciation method (HL only) (AO3)
In-Class Activities
In-Class Activities
Day 1-2: Introduction to Final Accounts + Income Statement Practice
Day 1-2: Introduction to Final Accounts + Income Statement Practice
How would you decide how much a company is worth?
If you were going to buy a company, what information would you want to know?
Hexagon Activity: Order Matters
Activity: Organizing the Profit and Loss Accounts: Put the pieces of the statement of profit or loss into the correct order. Fastest team of 3 wins!
Activity: Organizing the Balance Sheet: Put the pieces of the Balance Sheet into the correct order. Fastest team of 3 wins!
Statement of Financial Position Item Classification Activity
Option 1: Research a Company
Find a company that you're interested in, would like to invest in, or would like to work at.
Look up their balance sheet and income statement.
What does this tell you about the company? Are they highly profitable? How rich are they? How much debt to they have? What does this tell us about their risk level?
Do you still want to invest or work there? If so, what does the balance sheet and income statement say about the company?
Option 2: Create your own company
Make up a company
Income Statement: think about all the possible income and expenses you might have. How much would your materials cost? How many sales would you get? What other expenses would you have? What tax rate do you think you'd have? How much of your money would you pay out to yourself (the owner) in dividends?
Create an Income Statement from the information you found above.
What assets would you have an how would you pay for them? How much of your assets would be from the owner's investment or from borrowing money in the form of liabilities?
Create a Balance Sheet from the information you found above.
Review the PowerPoint https://docs.google.com/presentation/d/1uDmhokRU0EdC8J5LedE9T_t9fFIc-OdSSraFCdXec6I/edit?usp=sharing
Reflection:
1) What did you see and find interesting? What do you think about that?
2) What do you wonder about and want to know more about? What questions do you have?
3) Why do people need to learn this?
Day 3: Practice Making Income Statements and Balance Sheets
Day 3: Practice Making Income Statements and Balance Sheets
https://docs.google.com/document/d/17tv2ZUM-Y_f5M8y-V9PZ8VRrkw-4EPr5CqztNANQlFQ/edit?usp=sharing
Do Case Study: 8. The Carolina Fire Museum (CFM) Questions A-F
Day 4: Intangible Assets & Depreciation
Day 4: Intangible Assets & Depreciation
Intangible Assets (jigsaw activity)
Patents
Goodwill
Copyrights
Trademarks
Jigsaw - Step 1: Specialization (15 min.)
You must become “specialized” in your assigned Parents.
What is the intangible asset?
Provide a real life example of this intangible asset and how much its worth. How do you think they came up with this value?
No one leaves the group until everyone understands your intangible asset.
Jigsaw - Step 2: Sharing of the Wise (20 min)
Form new groups that has at least 1 “specialized person” of each intangible asset (must have at least one person from group 1, 2, 3, 4).
Please fill out the table: https://docs.google.com/document/d/1eXMR2rzH7fUMwJn9NpT327_bEooImHFzOxSkD9io2Hk/edit?usp=sharing
Depreciation
What are some examples of non-current assets where Straight Line Depreciation would be more appropriate?
What are some examples of non-current assets where Units of Production Method of Depreciation would be more appropriate?
https://docs.google.com/document/d/17tv2ZUM-Y_f5M8y-V9PZ8VRrkw-4EPr5CqztNANQlFQ/edit?usp=sharing
Do Case Study 12: Crispy Collin’s Chicken and Waffles Questions D-F
Bonus: Monopoly
Play monopoly in pairs. After each of your turns you must see how your income statement and balance sheet would change.
During the last 15 minutes make:
Income Statement
Balance Sheet
Homework
Homework
Read Textbook: pg 249 - 272
Option 1: IBDB Google Slides
Complete all practice questions in the slides as well
Option 2: 3.4 Case Study Questions
Complete all the practice exam questions except the 10 mark questions
Option 3: AI Tutor: Fint
https://app.flintk12.com/activity/financial-state-c1fd4c/session/new
Do at least 7 interactions with the AI
What you should know
By the end of this subtopic, you should be able to:
define the following terms: (AO1)
final accounts
statement of profit and loss (profit and loss account)
statement of financial position (balance sheet)
intangible asset
depreciation
explain the purpose of accounts to different stakeholders (AO2)
analyse the elements of a statement of profit or loss (profit and loss account) and a statement of financial position (balance sheet) (AO2)
construct a statement of profit or loss (profit and loss account) (AO4)
construct a statement of financial position (balance sheet) (AO4)
distinguish between different types of intangible assets (AO2)
calculate depreciation using the straight-line method (AO4)
calculate depreciation using the units of production method (AO4)
discuss the appropriateness of each depreciation method (AO3)
https://quizlet.com/_cypifs?x=1jqt&i=4jrhob
https://www.gimkit.com/view/640f287469e81f0032aafd9a
Accumulated depreciation
This refers to the accrued value of non-current assets, most of which fall in value over time due to depreciation.
Assets
The possessions owned by a business, which have a monetary value, e.g., buildings, land, machinery, equipment, inventories, and cash.
Balance sheet
Also known as the statement of financial position, this set of final accounts shows the value of a firm’s assets, liabilities, and the owners’ investment (or equity) in the business, at a particular point in time.
Cash
This refers to the money an organization has either “in hand” (at its premises) and/or “at bank” (i.e., in its bank account). It is the most liquid type of current assets.
Copyrights
These intangible assets give the registered owner the legal rights to creative pieces of work, such as the works of authors, musicians, conductors, playwrights (scriptwriters) and directors.
Costs of sales (COS)
These are the direct costs of production, such as the cost of raw materials, component parts, and direct labour.
Creditors
Also known as trade creditors, this refers to the suppliers that allow a business to purchase goods and/or services on trade credit.
Current assets
Short-term assets belonging to an organization which will last in the business for up to 12 months, e.g., cash, debtors, and stock (inventory).
Current liabilities
These are the short-term debts of a business, which need to be repaid within twelve months of the balance sheet date. Examples include bank overdrafts, trade creditors, and other short-term loans.
Debtors
A type of current asset, referring to individual or business customers that owe money to the organization as they have bought goods or services on trade credit, i.e., they need to pay within 30 and 60 days.
Depreciation
The fall in the value of a fixed asset over time, mainly due to wear and tear (usage) and obsolescence.
Dividends
These are the payments from a company’s profit (after interest and tax) paid to the shareholders (owners) of the company. The amount of dividends paid to an individual shareholder depends on the number of shares held by the individual.
Equity
Refers to the value of the owners' stake in the business, i.e., what the business is worth at the time of reporting the balance sheet.
Expenses
These are a firm’s indirect costs of production, e.g., rent, management salaries, marketing campaigns, accountancy fees, bank interest charges, travel expenses, utilities, repairs and maintenance, and general insurance.
Final accounts
These are the published accounts of an organization, made available to and used by different stakeholders, e.g., managers, employees, shareholders, sponsors, financiers, and investors.
Finished goods
These are the final products of a business, ready to be sold to customers.
Fixed assets
The long-term assets (possessions) of an organization that have a monetary value and are used repeatedly but are not intended for resale within the next twelve months, e.g. property and equipment.
Goodwill
The reputation and established networks (know-how) of an organization, which adds to a firm’s monetary value. It's the intangible value of a company derived from its ‘good nature’ in business. This could be attributed to brand loyalty, patents, talent management, good relationships with customers (and therefore wide customer base), and many other such attributes that give a business a competitive edge over its rivals. The monetary value of goodwill is derived when the selling price of a business is higher than the value of its net assets when the company is acquired or sold.
Gross profit
This refers to the profit from a firm’s everyday trading activities. It is calculated by the formula: Sales revenue – Cost of sales.
Illiquid assets
These items of value, owned by the business, cannot be sold quickly, are difficult to sell, and/or cannot be sold easily without incurring a significant loss in value.
Intangible assets
Non-physical fixed assets that are valuable to a firm’s survival and success, such as brand value, goodwill, copyrights, trademarks, and patents.
Intellectual property rights
Abbreviated as IPRs, these are a firm's fixed, intangible assets with a monetary value, comprised of goodwill, patents, copyrights and trademarks.
Liabilities
The debts of a business, i.e., the money owed to others, e.g., money owed to financiers, trade creditors, and the government (for tax).
Net assets
Refers to the overall value of an organization’s assets after all its liabilities are deducted. It is calculated by the formula: total assets minus current liabilities minus non-current liabilities.
Non-current assets
Also known as fixed assets, this refers to the long-term assets or possessions of an organization with a monetary value but are not intended for resale within the next twelve months of the balance sheet date.
Non-current liability
Also known as long-term liability, this refers to debt owed by a business which will take longer than a year (from the balance sheet date) to repay.
Overdrafts
This financial service allows customers to temporarily take out more money than is available in their bank account.
Patents
The official rights given to a business to exploit an invention or process for commercial purposes.
Profit and loss account / Statement of profit or loss
Also known as the income statement, this shows a firm’s profit (or loss) after all production costs have been subtracted from the organization’s revenues, each year. It is also known as the statement of profit or loss or income statement.
Profit after interest and tax
Also referred to as profit for period, this section of the P&L account shows the actual value of profit earned by the business after all costs have been accounted for.
Profit before interest and tax
This section of the P&L account shows the value of a firm’s profit (or loss) before deducting interest payments on loans and taxes on corporate profits.
Raw materials
These are the natural resources used in the production process to create goods and provide services to customers.
Residual value
Also known as the scrap value, this is the value of a fixed asset at the end of its useful life before it is replaced.
Retained profit
Also referred to as retained earnings, Money that a company has left at the end of the trading year after paying all costs, expenses, dividends and taxes
Sales revenue
Shown on the profit and loss account, this refers to the money an organization earns from selling goods and services.
Share capital
The value of equity in a business that is funded by its shareholders, either through an initial public offering (IPO) or via a share issue.
Short-term loans
These are advances (loans) from a financial lender, such as a commercial bank, that needs to be repaid within 12 months of the balance sheet date.
Stocks
Also known as inventories, these are the goods that a business has available for sale, per time period.
Straight line depreciation
A method of depreciation that spreads the depreciation of a fixed asset evenly over its useful life, i.e., the value of the asset falls by the same amount each year.
Tax
Refers to the compulsory deductions paid to the government as a proportion of a firm’s profits.
Total assets
The sum of a firm’s non-current assets and its current assets.
Total liabilities
These are simply the sum of current liabilities and non-current liabilities, i.e., the sum of all the monies owed by the business.
Trade creditors
Suppliers may give trade credit, which needs to be repaid at a future date (typically 30 to 60 days).
Trademarks
A form of intellectual property or intangible asset which gives the listed owner the legal and exclusive commercial use of the registered brands, logos, and/or slogans (corporate catchphrases).
Units of production method
Method of depreciation that apportions an equivalent value of depreciation to a non-current asset based on each physical unit of output. Depreciation is based on the units of usage rather than time (as used for the straight-line method).
Window dressing
Also known as creative accounting, this is the legal manipulation of financial statements based on the accounting principles and rules in the country in order to make the figures look more flattering (in the same way that people clean and tidy their homes before guest are due to arrive).
Work-in-progress
Also referred to as semi-finished goods, these are parts and components used in the production process.
Working capital
The money available for the day-to-day running of a business. It is calculated by subtracting current liabilities from current assets.
Costs of sales (COGS)
Opening stock + Purchases – Closing stock
Current assets
Cash + Debtors + Stock
Current liabilities
Bank overdraft + Trade creditors + Short-term loans
Expenses
Gross profit – Profit before interest and tax
Gross profit
Sales revenue – Cost of sales (COS)
Net assets
Total assets – Total liabilities
Net assets (alternative formula)
(Non-current assets + Current assets) – (Current liabilities + Non-current liabilities)
Profit
Gross profit – Expenses
Equity (Owners’ equity)
Share capital + Retained earnings
Retained profit
Profit after interest and tax – Dividends
Total assets
Non-current assets + Current assets
Total liabilities
Current liabilities + Non-current liabilities
Net current assets (Working capital)
Current assets – Current liabilities
3.4 Extra Notes
3.4 Extra Notes
The purpose of accounts to different stakeholders (AO2)
The purpose of accounts to different stakeholders (AO2)
Internal Stakeholders
Internal stakeholders are groups within the business that are interested in the final accounts.
They include management, owners and shareholders, and employees.
Shareholders (owners)
Shareholders/owners are interested in measuring profitability over time to assess investment returns.
They evaluate company value and growth by looking at net assets and retained profits.
Shareholders use accounts to determine dividends received from profits.
Accounts help shareholders decide whether to buy, sell, or hold shares by comparing company performance.
Key financial metrics like profitability ratios, gearing ratio, and liquidity are calculated from accounts to evaluate investment performance and risk level.
Shareholders review how effectively funds are invested and dividends received.
It's important for shareholders and owners to analyze the final accounts to make informed decisions about their investment in the company and assess its growth potential. By understanding the purpose of accounts and using them effectively, shareholders and owners can evaluate the financial performance and growth of a business.
Managers
Performance measurement: Managers use final accounts to measure the business's performance against organizational targets.
Benchmarking: They compare key indicators, such as net profit figures, with those of rival businesses to assess competitiveness.
Financial performance review: Managers review financial performance against planned or targeted performance to identify areas for improvement.
Decision-making support: Final accounts help managers assess the availability of funds for new investment projects and make informed decisions.
Budgeting and target setting: Managers set budgets and targets for the future, such as target profit, based on the information provided in final accounts.
Expenditure monitoring and control: They use final accounts to monitor and control business expenditure across different departments.
Strategic planning: Final accounts assist managers in strategic planning, considering the growth and evolution of the organization.
In summary, managers use final accounts to evaluate their performance, make financial decisions, set budgets and targets, and engage in strategic planning. By analyzing the financial data, managers can assess the company's financial health, make informed decisions, and plan for the future
Managers are interested in various aspects of the final accounts:
Expenses and costs: Managers focus on controlling expenses to ensure efficient management and performance.
Liquidity position: They assess the business's ability to cover immediate, short-term, and medium-term debts to prevent insolvency.
Profit earned: Managers analyze the profit earned during the year to evaluate the overall financial performance of the business.
Value of assets: They review the value of assets owned by the company to understand the business's financial position.
Employees
Job Security
Employees can gauge how secure their jobs are by looking at profits and the balance sheet
Regular profits indicate a safe future for employees
A healthy financial position shows the business is stable
Pay Raises
Final accounts help employees determine if it's a good time to negotiate a pay rise
Profitability and a strong financial position helps employees' case for higher wages
Union Negotiations
Workers can use final accounts to discuss pay and conditions with unions
Demonstrating profits strengthens arguments for job security and pay increases
Financial Stability
Employees want to understand the overall financial health of the business
This informs how stable the company is and employees' job security
External Stakeholders
External stakeholders are groups outside the business that are interested in the final accounts of a business. They include the government, competitors, banks, the business’s suppliers and the local community.
Government
Tax Calculation and Collection
Tax authorities use profit figures to calculate taxes owed
Final accounts are scrutinized to verify the correct amount of tax is paid
Economic Contribution
Governments assess business performance to understand jobs and economic activity created
Financial health of businesses indicated in accounts helps governments provide support in difficult times
Compliance
Regulators ensure businesses follow accounting rules and tax laws through accounts inspection
Business Survival
Financial positions revealed allow assessment of liquidity and risk of closure, which can harm local economies
Fraud Detection
Accounts are audited to verify accuracy and detect any illegal practices like tax evasion
In summary, governments and their tax authorities rely on final accounts primarily to calculate tax obligations, understand economic contribution, ensure compliance with laws and spot issues affecting businesses' survival or potential fraudulent activities.
Competitors
Performance Comparison
Competitors assess own performance by comparing financial statements to rivals
Benchmarking
Accounts are analyzed to identify best practices of competitors that can be adopted
Financial Strength Assessment
Competitors evaluate overall financial health and stability of rival businesses
Profit Comparison
Profit trends are compared between competitors in the same industry
Market Standing
Financial analysis helps determine relative market position against industry peers
In summary, competitors rely on analyzing competitors' final accounts to benchmark performance, identify opportunities for improvement, assess financial strength and profitability, and understand their competitive market standing. Comparing financial statements is vital for competitors to evaluate their position and strategies.
Customers
Financial Security Assessment
Customers analyze accounts to ensure a business remains viable long-term as a supplier
Service Reliability and Security
Financial data gives insights into a firm's stability which impacts its ability to consistently deliver products/services
Future Supply Continuity
Accounts assess dependence on key suppliers and prospects of ongoing supply relationships
Profit Distribution Transparency
Customers want visibility on how earnings are used like donations, sustainability initiatives not just owner enrichment
In summary, customers rely on reviewing company accounts to evaluate financial soundness, service quality expectations, supply continuity and the ethical use of profits in order to make informed purchasing decisions. The level of transparency impacts brand perception and loyalty
Local Community
Job Preservation
Community assesses accounts to ensure business remains viable long-term employer
Economic Impact
Financial stability and continuity of offerings evaluated to protect community interests
Charitable Initiatives
Accounts reveal community support through donations and partnerships
Sustainability
Community considers ethics and if profits used for long-term operations not just owner wealth
In summary, the local community relies on analyzing a business's final accounts to guarantee financial soundness, preserve local jobs and supplier relationships, plus ensure ethical practices through charitable activities that support community well-being. This protects local economic interests and social good.
Suppliers
Debt Repayment Ability
Suppliers analyze accounts to assess if a business has sufficient liquidity to repay debts
Credit Risk Assessment
Financial statements are reviewed to evaluate creditworthiness and risk of default
Trade Credit Terms
Accounts help suppliers determine appropriate credit periods or need for immediate payment
Negotiation
Financial data assists suppliers in trade credit negotiations with customers
Trade Debtors Evaluation
Supplier's final accounts are checked by suppliers to assess debtors ability to settle dues
In summary, suppliers rely on analyzing customer accounts to evaluate debt servicing ability, credit risk exposure and determine optimal credit terms. This allows informed trade credit extension decisions.
Banks
Loan Repayment Ability
Banks analyze accounts to assess if a business can repay loans
Creditworthiness Checks
Financial statements are reviewed prior to lending to evaluate credit risk
Risk Assessment
Accounts help financers determine lending amounts based on perceived risk level
Debt Repayment Evaluation
Ability to service existing debts is judged from accounting data
Interest Payment Capacity
Financers assess if borrowing business can meet repayment obligations
In summary, banks and other financiers rely on reviewing final accounts to make informed lending decisions regarding the capacity of businesses to take on debt and honor repayment commitments, including interest payments. This allows evaluation of creditworthiness and risk exposure.
Pressure Groups
Ethical and Unethical Behavior Assessment
Accounts are analyzed to evaluate how organizations spend profits and if activities cause social or environmental harm
Beyond Legal Compliance
Unlike governments, pressure groups scrutinize impacts beyond just tax payment and rules adherence
Inform Public Opinion
Financial data exposing problematic practices may be publicized to raise awareness of issues
Influence Change
Pressure is exerted on organizations through media campaigns and lobbying to modify concerning behaviors identified through accounting review
In summary, pressure groups and NGOs rely on final accounts to determine corporate responsibility, gauge ethical standards beyond mere legalities, then publicize any issues found and advocate for reform if needed to protect social and environmental welfare.
Final accounts (AO2, AO4):
Final accounts (AO2, AO4):
• Profit and loss account (Statement of Profit or Loss)
• Balance sheet
Profit and loss account
Profit and loss account
The profit and loss account shows a firm’s profit (or loss) after all production costs and expenses have been subtracted from the organization’s revenues, each year. It shows the company's profit / surplus or loss (if profit is negative) for a certain time period (often 1 year). It also shows how well organizations sell their produces and manage their costs.
Also known as the statement of profit or loss or income statement.
It is backwards looking (based on past data), showing how well a company did in terms of revenues, costs, and profits.
Show how well an organisation is managing its expenses. So, overall, profit and loss account is a good indicator of the organisation’s trading activities.
The prescribed IB format for the profit and loss account for profit-making entities is shown below (not included on the formula sheet):
Statement of Profit or Loss: Profit-Making Entity
(Income Statement)
Statement of Profit or Loss: Non-Profit Entity
(Income Statement)
Differences between for-profit and non-profit Statements of profit or loss
Non-profits have no owners and therefore all "surplus" stays within the business for its operations (no dividends)
For-profit entities that get "profit" which they can pay out to owners in the form of dividends
Profit and Loss Account - Key Terms
Sales revenue is the money an organization earns from selling goods and services. It can also include other revenue streams.
Costs of sales (COS) are the direct costs of production, such as the cost of raw materials, component parts, and direct labour. COS are sometimes referred to as cost of goods sold, i.e., the cost of production paid by the business for the goods and services that it sells. The formula for calculating COS is: Opening stock + Purchases – Closing stock.
Gross profit refers to the profit from a firm’s everyday trading activities. It is calculated by the formula: Sales revenue – Cost of sales.
Expenses are a firm’s indirect costs of production, e.g. rent, management salaries, marketing campaigns, accountancy fees, bank interest charges, travel expenses, utilities, repairs and maintenance, and general insurance. Note that both interest and tax are not included in this section of the P&L account, despite being expenses. This is because both interest and tax costs that the firm has no control over as interest rates and tax rates are determined by the government. By excluding these expenses in this part of the P&L, it is easier to make historical, inter-firm and international comparisons.
The profit before interest and tax section of the P&L shows the value of a firm’s profit (or loss) before deducting interest payments on loans and taxes on corporate profits.
The profit for period section of the P&L account shows the actual value of profit earned by the business after all costs have been accounted for, i.e., profit after interest and tax. The profit (after interest and tax) belongs to the owners of the business, so can then be distributed between the shareholders/owners and/or bee kept in the business as a source of internal finance.
Tax refers to the compulsory deductions paid to the government as a proportion of a firm’s profits. In the above example, corporation tax is 10% of a company’s profits.
Dividends are the payments from a company’s profit (after interest and tax) paid to the shareholders (owners) of the company. The amount of dividends paid to shareholders as a whole is determined by the company’s board of directors. The amount of dividends paid to an individual shareholder depends on the number of shares held by the individual.
Any funds left over from profits (after interest and tax) that is not paid to shareholders is kept within the business for its own use. This is called retained profit. It is a vital internal source of finance for most businesses. Retained profit is is important for assessing the profitability of a business over a specific period of time, usually one year. It is calculated as by using the formula: Retained Profit = Profit after interest and tax – Dividends.
3.4-profit-and-loss-account-posters-(maria-pardo).pdfBalance sheet
Balance sheet
The statement of financial position (also known as the balance sheet) is a ‘snapshot’ of a company’s financial position at a specific point in time, such as the end of the financial year. It states the company’s assets and liabilities and shareholders’ investment or equity in the business.
The Balance Sheet Must Balance
Assets = Liabilities + Equity
Or
Assets - Liabilities = Equity
OR
Net assets = Total assets – Total liabilities
Net assets = Equity
For the statement of financial position to be valid, both sides of the equation must ‘balance’.
Net assets are everything that an organisation owns minus all the debts it has. At the same time, net assets (what company owns after all debts) are the same as equity (how much an organisation is worth).
Part 1: Assets
Assets are items of property owned by the organisation. They can be current and non-current (or fixed).
Current assets are short-term liquid assets that last for up to one year (cash, debtors, stock (inventory), etc).
Non-current (fixed) assets are long-term assets that last for more than one year (machinery, buildings, cars, land, equipment, intangible assets, etc).
So the main point here is that whatever an organisation owns for more than a year is recorded as a non-current assets, and whatever an organisation owns for less than a year is a current asset.
Depreciation non-current assets may lose value over time as they're used (example: cars lose value the more you drive them. Same with machinery). Depreciation must be subtracted from non-current assets to provide a more realistic value.
Total assets = Current assets + Non-current assets
Assets should be written in order of liquidity:
Cash is the most liquid asset of the business. It is like water of the business because it is essential and because it flows.
Part 2: Liabilities
Liabilities are money owed by the organisation to its suppliers and lenders. The situation with liabilities is similar to that of the assets: they can also be current and non-current (long-term).
Current liabilities are short-term debts that are paid for within one year (overdrafts, creditors, short term loans, etc).
Non-current (long-term) liabilities are long-term debts that payable after one year (mortgages, long-term loans, etc).
Total liabilities = Current liabilities + Non-current liabilities
Part 3: Equity
Equity is the value of all assets if they were liquidated.
Liquidation is the process of converting all assets into cash.
The most liquid asset is cash, which is like water in the business world. The easier it is to convert an asset into cash (i.e to sell it for cash), the more liquid an asset is. The harder it is, the less liquid an asset is.
For profit-making entities equity is comprised of share capital and retained earnings.
For non-profit entities, equity consists of retained earnings only, because there are no shareholders in non-profit entities.
Statement of Financial Position: Profit-Making Entity
(Balance Sheet)
Statement of Financial Position: Non-profit Entity
(Balance Sheet)
Statement of Financial Position - Key Terms
Non-current assets (also known as fixed assets) are the long-term assets or possessions of an organization with a monetary value but are not intended for resale within the next twelve months of the balance sheet date. Instead, the non-current assets are used over and over again as part of the organization’s operations. Typical non-current assets include buildings, plant (production facilities), equipment, machinery, and vehicles.
The value of most non-current assets falls in value over time due to depreciation. Hence, the balance sheet includes “accumulated depreciation” (of non-current assets) to calculate the net value of the organization’s non-current assets at the point of constructing the balance sheet. Non-current assets are generally highly illiquid assets. These items of value, owned by the business, cannot be sold quickly, are difficult to sell, and/or cannot be sold easily without incurring a significant loss in value.
Buildings and machinery are examples of non-current assets
Current assets are possessions of an organization with a monetary value, but intended to be liquidated (turned into cash) within twelve months of the balance sheet date. These include cash (in hand and at the bank), debtors, and stocks (inventory):
Cash refers to the money an organization has either “in hand” (at its premises) and/or “at bank” (i.e. in its bank account). Cash is the most liquid of current assets and is easily accessible to the business.
Debtors are a type of current assets, referring to individual or business customers that owe money to the organization because they have bought goods or services on trade credit. The usual trade credit period is between 30 and 60 days.
Stocks (also known as inventories) are the goods that a business has available for sale, per time period. Stocks are intended to be sold as quickly as possible, thereby generating cash for the business.
In turn, stocks (inventories) can be categorized in three ways:
Raw materials are the natural resources used in the production process to create goods and provide services to customers.
Work-in-progress (also referred to as semi-finished goods) are parts and components of a final product in the production process. They are the items that are in the process of being produced in order to sell to customers.
Finished goods are the final products, ready for sale to customers. These products are of most value to customers.
Total assets are simply the sum of non-current assets and current assets.
Current liabilities are the short-term debts of a business, which need to be repaid within twelve months. Typical examples include bank overdrafts, trade creditors, and other short-term loans.
Bank overdrafts allow customers to temporarily take out more money than is available in their bank account. This banking service enables pre-approved customers are used for very short term purposes and typically repaid within a few months in order to avoid high interest charges.
Trade creditors - Suppliers may give trade credit (typically for 30 to 60 days), which needs to be repaid at a future date.
Short-term loans - These are advances (loans) from a financial lender, such as a commercial bank, that needs to be repaid within 12 months of the balance sheet date.
Non-current liabilities are the long-term debts of a business, falling due after 12 months of the balance sheet date. In other words, this refers to the long-term borrowings of the business, such as long-term loans and mortgages.
Total liabilities are simply the sum of current liabilities and non-current liabilities, i.e. the sum of all the monies owed by the business.
Net assets refers to the overall value of an organization’s assets after all its liabilities are deducted. Hence, net assets is calculated by using the formula:
Net assets = Total assets – Total liabilities
or
Net assets = (Non-current assets + Current assets) – (Current liabilities + Non-current liabilities)
Equity refers to the value of the owners' stake in the business, i.e. what the business is worth at the time of reporting the balance sheet. Equity is comprised of both share capital and retained earnings.
Share capital refers to the value of equity in a business that is funded by shareholders, either through an initial public offering or via a share issue.
Retained earnings is value of equity in a business that is funded by the accumulated profit after tax that has not been distributed as dividends to shareholders. Instead, it is kept as an internal source of finance for the business to use.
Extra Tips
Top tip 1!
Retained profit appears in both the balance sheet and profit and loss accounts:
Balance sheet: retained earnings is recorded as a source of equity. This is the cumulative amount of profit (after deductions for interest, tax, and dividend payments) that has been retained and accumulated by the business.
Profit and loss account: retained profit (after taxes have been deducted and dividends have been distributed).
Top tip 2!
Students often get confused between the components of the profit and loss account and the balance sheet. Be aware of a couple of important and clear differences between these two sets of final accounts:
Whereas the P&L account records a firm's income and expenses, the balance sheet show the firm's assets and liabilities.
The P&L account covers a specific period of time (such as the period up to the end of the firm's financial year). By contrast, the balance sheet provides a snapshot (at one point in time) of what the firm owns and what it owes.
Top tip 3!
As stated in the guide, the balance sheet needs to be taught to AO2 and AO4 (page 29). Hence, this term must be referred to when teaching and learning this component of Unit 3.4.
However, when constructing or presenting the balance sheet in the external assessments, the term "statement of financial position" should be used as the heading (page 59).
So, this means that students can refer to the "balance sheet" in their written responses to a question in the final exams, but not for the title or heading when constructing or presenting this as a set of final accounts.
Balance sheet and P&L formulas (not in formula booklet)
The following formulae are not provided in the formula sheet in the final exams, but are useful to know in order to construct the final accounts:
Costs of sales (COS) = Opening stock + Purchases – Closing stock
Current assets = Cash + Debtors + Stock
Current liabilities = Bank overdraft + Trade creditors + Short-term loans
Expenses = Gross profit – Profit before interest and tax
Gross profit = Sales revenue – Cost of sales (COS)
Net assets = Total assets – Total liabilities
Net assets (alternative formula) = (Non-current assets + Current assets) – (Current liabilities + Non-current liabilities)
Profit = Gross profit – Expenses
Equity (Owners’ equity) = Share capital + Retained earnings
Retained profit = Profit after interest and tax – Dividends
Total assets = Non-current assets + Current assets
Total liabilities = Current liabilities + Non-current liabilities
Net current assets (Working capital) = Current assets – Current liabilities
Different types of intangible assets (AO2)
Different types of intangible assets (AO2)
Intangible Assets: Non-physical items of value owned by a company that have a lifespan of more than a year. They are considered non-current assets
Copyrights ©
Goodwill
Patents
Trademarks ™
Copyrights ©
Copyrights give the registered owner the legal rights to creative works of authors, musicians, conductors, playwrights (scriptwriters), directors, art, photographs, computer software.
Copyright protects authors’ and artists’ exclusive right to publish, reproduce, perform, distribute and sell the artistic works.
Legal Protection
Copyright protects creative works such as books, music, movies, photos, software from unauthorized use
Exclusive Rights
It gives authors/artists exclusive rights over publishing, reproduction, performance, distribution and sale of works
Long Duration
Typically lasts 50 years after creator's death under Berne Convention, or up to 70 years in some countries
Public Domain
Works enter public domain when term expires and are no longer copyright protected
Registered Owner Rights
Copyright gives legal control over creative works to registered owners such as authors, musicians, directors
Commercial Use
Owners have exclusive rights to commercial exploitation and distribution of intellectual property
Protection from Competition
Prevents unauthorized copying or use of works by other parties
In summary, copyright is a form of legal protection for creative works that provides exclusive usage and commercialization rights to registered owners and creators.
Harry Potter books and films
The Lion King musical and animated movies
Trademarks ™
Trademarks ™ are a form of intellectual property that give the owner exclusive commercial use of the registered brands, logos, and/or slogans (catchphrases).
A trademark is a distinctive mark, sign or symbol that a company or individual uses to identify or brand itself to distinguish itself from competitors, after registration with the relevant government entity.
Examples include the Coca-Cola logo, the McDonald’s golden arches, Microsoft Windows, Dangote and Alibaba.com.
Any individual or organisation that uses a registered trademark that they do not own can be legally prosecuted.
Patents
Patents are the official rights given to a business to exploit an invention or process for commercial purposes.
Example: Covid vaccines have been the focus of a number of patent disputes
Exclusive Rights
Patents legally protect an inventor's product or process from being copied for a set period, usually around 20 years
Temporary Monopoly
This allows patent holders to earn large revenues without competition for the duration of the patent
Incentive for Innovation
The patent system encourages R&D investment by businesses even for costly innovations
Profit Opportunity
Patents can be sold profitably to other companies or used commercially by the original inventor
Intangible Asset Value
Patents add worth as they provide a unique selling point for a limited time
Valuation Methods
The value of a patent can be derived from potential net cash flows or other financial projections
In summary, patents legally protect new inventions or processes, incentivize innovation through temporary market exclusivity, and increase business value by providing commercialization opportunities and competitive advantages.
Goodwill
Goodwill is the reputation and established networks (know-how) of an organization, which adds significance above the market value of the firm’s physical assets.
When a company is bought from another company, Goodwill is calculated by subtracting the fair market value of a company's assets and liabilities from the purchase price of the company.
Intangible Asset Value
Goodwill represents the additional worth of a business beyond the value of tangible assets such as equipment and property
Attributes that Add Value
Features like brand loyalty, patents, talent retention, strong customer relationships give competitive advantages
Reputation and Networks
Goodwill incorporates an organization's reputation and established know-how/connections
Employee Loyalty and Commitment
Willingness of staff to go above normal duties indicates high morale and devotion to the business
Attracting Workers and Investors
A positive goodwill value can help attract quality employees and equity investment
Materializes on Sale
The monetary worth of goodwill is realized particularly when a business is acquired or sold at a premium above net assets
Subjective Nature
As an intangible asset, goodwill value involves some degree of judgement
In summary, goodwill represents an organization's additional value from strengths like brands, talent and relationships that drive customer loyalty and attract investment. Its monetary worth crystallizes particularly on sale.
TOK Connection:
Does ownership of knowledge help or hinder innovation?
Does the ownership of medical patents help or hurt people?
Provides an incentive for scientists, engineers, artists and others to develop new ideas. If these innovators know that they can get exclusive rights to produce and profit from their ideas for a period of time, they may be more willing to spend time and money to innovate.
However, a compelling argument against ownership of intellectual property is that it slows innovation by preventing innovators from building on the work of others. Many new ideas are not completely original but develop ideas that already exist. Intellectual property protections often block those kinds of innovations.
Depreciation using the following methods (HL only) (AO2, AO4):
Depreciation using the following methods (HL only) (AO2, AO4):
• Straight line method
• Units of production method
Depreciation
Depreciation refers to the fall in the value of a non-current asset.
As a non-current asset is used over and over, its value drops due to wear and tear (usage and natural ageing). In addition, newer and better models and/or improved technologies become available, further depreciating the value of older assets such as computer equipment (obsolescence).
Net book value (NBV) = Original cost of asset – Accumulated depreciation
Note: Book value is the value of the asset that is recorded in the balance sheet.
Residual Value
Many used assets can be sold for a second hand value, known as a residual value (or scrap value or salvage value).
This is the value of the non-current asset at the end of its useful life, before it is replaced. In some cases, the degree of wear and tear or the availability of newer technologies mean the residual value of the asset is zero.
Fastest Depreciating cars in the UK (2023) after 3 years
The slowest depreciating cars after 5 years
The fastest depreciating cars after 5 years
Straight line method
Straight line method
The straight-line method of depreciation is used to calculate the fall in value of an asset evenly over its useful life. This method uses the formula:
Straight-line Method of Depreciation
Example:
For example, Chinon Africa Investments Ltd buys a delivery truck for transporting fresh fruit and vegetables to all its supermarket franchise outlets at a cost of $100 000. The truck has an estimated residual or scrap resale value (at the end of its life) of $25 000 and an estimated useful life of five years.
Calculate the annual provision for depreciation.
Answer:
Units of production method
Units of production method
Units of production method of Depreciation
Example:
For example, Company A acquires machinery on 1 January 2022 for $20 000. Company A creates a production plan for four years that shows total lifetime production of 8000 units, and at that point the residual value will be $0. Company A’s production plan is shown in Table 3 and the annual depreciation of the value of the asset is shown in Table 4.
Answer:
Appropriateness of each depreciation method (HL only) (AO3)
Appropriateness of each depreciation method (HL only) (AO3)
The straight-line depreciation method is best used for assets that
operate in a consistent way throughout the life of the asset
have a predictable life span
suitable for less expensive items, such as furniture
small businesses that value accounting simplicity
can be used for assets that may not become obsolete over their lifespan
The units of production method is best used for assets that may see
varied levels of use over time
more appropriate for more expensive assets, where having an accurate value for depreciation is very important for accounting purposes and product pricing decisions
Advantages and disadvantages of each depreciation method
More Straight Line method advantages and disadvantages
Advantages of the straight line method
Advantages of the straight line method of calculating depreciation include:
The ease of calculating depreciation, as the same amount is deducted each year. This means depreciation is treated as a fixed cost and does not change with the level of output or production.
It is suitable for depreciating assets that have a known useful shelf-life and can be estimated accurately.
It is also suitable for assets that have a consistent usage rate over the lifetime of the asset, e.g., furniture or automated machinery.
It is also easier to depreciate the value of assets until their scrap value is zero.
As the same amount is charged to the profit and loss account each year, it is easier to make historical comparisons of the data.
Disadvantages of the straight line method
Disadvantages of the straight line method of calculating depreciation include:
Many non-current assets, such as motor vehicles and computers, depreciate in value the most during the initial stages of their useful shelf life. Hence, using a uniform depreciation value can be misleading and inaccurate.
In addition, many assets do not depreciate consistently as they become less efficient over time. For example, machinery, computers and vehicles tend to have higher repair costs over time. The depreciation expense does account for (higher) maintenance costs over time.
It is not suitable or useful if the functional life span of the asset cannot be estimated accurately.
Scrap values are only estimates of the future value of an asset. This makes the provisions for depreciation less accurate.
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