Financial Statements – Professional Diploma study tips

Financial Statements is a unit which AAT students traditionally find difficult so First Intuition tutor Nick Craggs is going to give you some useful tips.

If asked to complete a Statement of Financial Position (SFP) and Statement of Profit and Loss (SPL) students may be presented with a trial balance and from this a series of adjustments will need to be made in order to prepare the financial statements.  You will be using your learning from the Advanced Diploma and applying them within the context of a Limited company.

Adjustments required are likely to include accruals and prepayments, and these adjustments do not get any more complicated than that expected in the Advanced Diploma.  Accruals and prepayments simply move the expense into the accounting period in which it was incurred, from the period in which it was paid. However, it will be based on new concepts introduced at this level, such as accruing for interest on debentures.

Accruals and Prepayments impact upon both the statement of financial position (there will be an additional current asset or liability), and the statement of profit and loss (there will be an increase or decrease to the expense).

If you want to have a recap of prepayments, please click here.

If you want a recap of accruals, please click here.

Another common adjustment is depreciation.  This adjustment is very similar to previous studies, but there is often an added complication at the Professional level.  Sometimes land and property is included in the Non-Current Asset cost figure.  Land and property are not normally depreciated as they do not have a tendency to fall in value, therefore the value of the land and property should be removed before the depreciation charge is calculated.

For example, if the value of land and machinery in the trial balance is £2,500,000 and there is accumulated depreciation of £600,000; there is a net book value of £1,900,000.  Additional information may show that the cost of land, which is not depreciated is £400,000 and the depreciation policy of the machinery is 20% reducing balance basis.

The cost of the land should be removed from the net book value figure of £1,900,000, so only the net book value of the machinery remains of £1,500,000 (£1,900,000 – £400,000).  This figure will then be depreciated at 20%, which will be £300,000 (£1,500,000 x 20%).

There may also be need to account for a revaluation, in which case a student will increase the asset to the revalued amount before calculating the depreciation charge.  The revaluation will then be recognised in other comprehensive income.

The depreciation charge will reduce the net book value of the non-current assets in the statement of financial position, and there will be an increase to overheads in the statement of profit or loss, usually entered into administration costs. A little more complicated than the previous level, but nothing a well prepared student shouldn’t be able to do.

You can see some worked examples of depreciation calculations here.

One important adjustment which is new at this level, and in all sets of financial statements for Limited Companies, is the tax charge.  This is an important topic to master.  Often is it not as simple as putting the tax charge in the statement of profit and loss, and the liability in the statement of financial position.  It is common that in the previous year, the tax charge in the accounts did not match exactly the amount which was subsequently paid.  So any difference between the tax paid and the charge which was in last year’s accounts, will need to be corrected in this year, which will affect the tax charge, but not the tax liability.  To calculate the tax charge, it is advisable to use a control account.

For example, the opening balance in the tax liability account is a credit balance of £110,000 for the previous year’s tax liability.  The tax liability was then calculated by HMRC as only being £100,000.  This leaves a liability of £10,000 in the tax liability account.

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The amount of £10,000 is not owing to HMRC so this amount needs to written off.

So the double entry for this is to debit the tax liability, as we are not going to pay the over provision, and credit the tax charge, as the tax charge was too great last year.

We then introduce this year’s tax charge, which we are told is £88,000.

Therefore, we should;

Debit tax charge account SPL £88,000

Credit tax liability account SFP £88,000

Then the balancing figure is the tax charge in the SPL for the year, which was can find using a T account:

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So you can see here the tax charge shown in the statement of profit and loss is less than the actual liability due to the over provision from the previous year.

You can have a recap of control accounts here.

There are few more complications with the preparation of accounts of limited companies, but the under riding principles should be very familiar from your previous studies.

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Nick Craggs worked in practice for a number of years gaining a wide breadth of experience, from preparing accounts of small sole traders to auditing multimillion pound businesses. He specialises in teaching AAT at First Intuition.

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