Introduction to Financial Accounting

Assignment Brief

Module Title: Introduction to Financial Accounting

ASSIGNMENT QUESTION

1. Prepare the accounting records and financial statements for Corr, a sole trader furniture business, as explained overleaf. (60 marks)
2. The owner of Corr does not understand the reporting of assets. Some examples of the owner’s confusion include not understanding why the buying of assets has not reduced profits for the year, not understanding what depreciation is or why there are two categories of assets. Explain what assets are and how the reporting of them provides useful information. (20 marks)
3. Explain the causes of the cash held by Corr at the 30 September 2019 being a different amount to the amount of profit made during the year.

Sample Answer

The preparation of accounting records and financial statements is a fundamental task for any business, including Corr, a sole trader operating a furniture business. Financial accounting provides a structured method for recording, summarising, and presenting business transactions so that both internal and external stakeholders can make informed decisions. In Corr’s case, the accounting cycle involves recording transactions in books of prime entry, posting these into the ledger, extracting a trial balance, and then preparing the financial statements. These statements typically include the income statement, which measures performance over a period by showing revenues, expenses, and profit, and the statement of financial position, which outlines the assets, liabilities, and capital at a specific date. By following these processes, Corr ensures that her financial reporting is accurate, consistent with accounting principles, and capable of providing useful information for decision-making.

A key area where Corr has expressed confusion is the treatment of assets within the financial statements. Assets are resources controlled by a business that are expected to bring future economic benefits. In a furniture business, these may include delivery vans, woodworking machinery, and showroom fittings, as well as intangible assets such as software licences. Assets are classified into two broad categories: non-current assets and current assets. Non-current assets, sometimes referred to as fixed assets, are those that will provide benefits to the business for more than one accounting year, for example, equipment or property. Current assets, in contrast, are short-term resources that are expected to be converted into cash or used within one operating cycle, such as inventory, trade receivables, and cash itself.

Corr’s misunderstanding arises because the purchase of an asset does not reduce the profit reported in the income statement immediately. When a van or piece of machinery is bought, the cost is capitalised, meaning it is recorded as an asset on the statement of financial position. The economic benefit of the asset is then matched against revenues over its useful life through a process known as depreciation. Depreciation is an accounting method that allocates the cost of a tangible non-current asset over the periods in which it is expected to generate income. This ensures that profits are not distorted by large one-off expenses, and instead reflect a fairer measure of ongoing business performance. Without depreciation, Corr’s financial results would fail to represent accurately how resources are being consumed to generate sales.

Another area of potential confusion relates to the difference between cash and profit. Profit is the excess of revenue over expenses for a period, based on the accrual principle of accounting. This principle requires that income and costs are recognised when they are earned or incurred, rather than when cash is actually received or paid. As a result, the profit reported in the income statement will not necessarily match the cash held at the end of the year. For example, Corr may have made significant sales during the year but if many customers bought on credit and have not yet paid, the profit will be higher than the available cash. Similarly, Corr may have paid in advance for insurance or stock, which reduces cash but is not fully treated as an expense for the year. Other differences can arise due to timing of payments for expenses such as wages, or through non-cash charges like depreciation, which reduce profit without affecting cash.

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