PICCOLO 's

INCOME STATEMENT
FOR THE YEAR ENDED 31st MAY 2011
PARTICULARS AMOUNT(UGX) AMOUNT(UGX)
Revenue/Sales $300,000
LESS COST OF SALES
Opening Inventory $30,000
Purchases $190,000
Closing Inventory $42,000 $42,000 $178,000
GROSS PROFIT $122,000
LESS EXPENSES
wages $56,000
Heating and Lighting $17,600
Add Accrued Expenses H &l $1,800 $19,400
Repairs to Plant & machinery $5,100
Advertising $7,000
Prepaid Advertising -$6,000 $1,000
Depreciation 3,200+ 11,000 $14,200 $95,700
Deficit $26,300

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 PICCOLO'S
STATEMENT OF FINANCIAL POSITION
AS AT 31 STMAY 2011
ITEMS
ACCUMULATED-
ASSETS COST DEPRECIATION NET BOOK VAVLUE
NON CURRENT ASSET
Land $20,000 $0 $20,000
Free hold buildings $80,000 $43,200 $36,800
Plant & machinery $76,000 $43,000 $33,000
CURRENT ASSETS
Inventory (42000-40000) $2,000
Trade Variables $14,000
Bank $5,500
Prepaid Advertising $6,000 $27,500
TOTAL ASSETS $117,300
EQUITY & LIABILITIES
Capital $150,000
Net profit $26,300
Drawings 40,000+27,100 -$67,100 $109,200
CURRENT LIABILITIES
Trade Payables $6,300
Accrued Heating & Lighting $1,800 $8,100
TOTAL EQUITY & LIABILITIES $117,300

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Adjustments
Workings
Inventory 42000-40000
Free holdings at cost on straight line method
Depreciation 4% X 80,000 =3200

Planting & machinery at cost Reducing balance Method

Depreciation (76,000-32,000) =44,000
25% X44, 000 =11000
Total Depreciation =14, 200

Prepaid Expenses (advertising) 6,000

Outstanding Heating & Lighting 1,800

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c)

(i) Prepayments

In the above text they were seen as prepaid expenses (Prepaid Advertising expenses).

In other words it is an expense paid in advance.

A prepaid expense is an expense which has already been paid out but relates to the subsequent accounting period.

In the income statement the prepaid expenses were reduced on the general advertising expenses in order to remain with only that
period that is accounted for .( for the year ended 31st may 2011)

In the statement of financial position prepaid expenses were recorded as current Assets.

ii) Accruals

An accrued expense is an expense which has been incurred but not yet paid.

We had accrued heating & lighting Expense.

In the income statement the accrued expense was added on the general heating & lighting expense in the trial balance to increase the
expense

In the statement of financial position the accrued expenses were recorded as current liabilities.

iii) Depreciation

All fixed Assets except land depreciate.

Depreciation is the reduction in value of an Asset due to wear and tear.

In the income statement depreciation charge is recorded as an expense among others.

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In the statement of financial position it was recorded as Accumulated Depreciation to reduce the cost of the asset and get the Net
Book Value

(d) Importances of the prepared reports to any Business Entity

1. To Evaluate Risk and Return

A balance sheet lists all of your business assets and liabilities in one place. Current and long-term assets reflect your ability to
generate cash and sustain operations. Short- and long-term debts prioritize your financial obligations.
Ideally, you would have more assets than liabilities, indicating a positive net worth. If you’re current liabilities exceed your cash
balance, your business will likely require additional working capital from lenders or investors. A balance sheet can also reveal
when debt levels are unsustainable.
2. To Secure Loans and Investors
Your balance sheet allows people to quickly understand the financial condition of your business. Most lenders require a balance
sheet to determine a business’s financial position and creditworthiness.
If you apply for a loan, your prepared reports can help demonstrate to lenders that you are likely to repay your debts in a
timely manner. Potential investors use balance sheets to understand where their funding will go and when they can expect to
see a return on their investment.
3. To Make Long-Term Business Decisions
Tracking your business finances can help you identify potential issues before they become major problems. Most small
businesses fail because of cash flow problems that can be identified early and corrected if balance sheets are accurate and up-
to-date.

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 Small business owners often underestimate the importance of budgeting, overspend on startup costs and wait too long to seek
credit. These common financial problems can be avoided by creating a sound business plan and using prepared reports to
guide business decisions.
4. To Prevent Potential Problems
The primary reason for a business is to make a profit. A well-run business should show increasing equity. If your business isn’t
doing that, looking at specific assets and liabilities on your balance sheet can help you figure out why.
For example, if most of your assets are inventory that could be creating unnecessary risk. Inventory that doesn’t sell can quickly
become a serious liability.

5. Helps you understand revenue. Income statements include revenue as well as expenses. These include costs of goods sold,
operating expenses, and other business expenses. The income statement provides a company’s net income or net loss by
subtracting total expenses from total revenue. Business decisions, such as expanding or shrinking operations, can be influenced
by this figure, which is a critical indicator of financial health.
6. Makes company analysis simple. A company’s income statement also provides valuable information to investors, lenders, and
other stakeholders. It can increase investor confidence and the likelihood of securing financing or other investments by
providing detailed information on revenues and expenses.
7. Allows for frequent reporting. Business owners monitor progress, identify trends, and find potential problems or opportunities
on an income statement regularly. By adjusting operations, a business owner can keep profitability in check if expenses are
continuously rising.

Basically, an income statement is a great tool for businesses of all sizes because it shows a company’s financial performance and
can help them improve profitability.

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(e) Limitations of the prepared reports

The following are all limitations of prepared reports:

1. Dependence on historical costs

Transactions are initially recorded at their cost. This is a concern when reviewing the balance sheet, where the values of
assets and liabilities may change over time. Some items, such as marketable securities, are altered to match changes in their
market values, but other items, such as fixed assets, don’t change. Thus, the balance sheet could be misleading if a large
part of the amount presented is based on historical costs.

2. Inflationary effects
If the inflation rate is relatively high, the amounts associated with assets and liabilities in the balance sheet will appear
inordinately low, since they are not being adjusted for inflation. This mostly applies to long-term assets.

3. Intangible assets not recorded

"Any intangible assets are not recorded as assets. Instead, any expenditures made to create an intangible asset are
immediately charged to expense. This policy can drastically underestimate the value of a business, especially one that
has spent a large amount to build up a brand image or to develop new products. It is a particular problem for startup
companies that have created intellectual property, but which have so far generated minimal sales.

4. Based on specific time period

User of prepared reports can gain an incorrect view of the financial results or cash flows of a business by only looking at one
reporting period. Any one period may vary from the normal operating results of a business, perhaps due to a sudden spike in
sales or seasonality effects. It is better to view large number of consecutive prepared reports to gain a better view of ongoing
results.

5. Not always comparable across companies

If a user wants to compare the results of different companies, their prepared reports are not always comparable, because
the entities use different accounting practices. These issues can be located by examining the disclosures that accompany the
prepared reports.

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 6. Subject to fraud
The management team of a company may deliberately skew the results presented. This situation can arise when there
is undue pressure to report excellent results, such as when a bonus plan calls for payouts only if the reported sales level
increases exceeding the industry norm.

7. No discussion of non-financial issues

The prepared reports do not address nonfinancial issues, such as the environmental attentiveness of a company’s operations,
or how well it works with the local community. Business reporting excellent financial results might be a failure in these other
areas.

8. Not verified
If the prepared reports have not been audited, this means that no one has examined the accounting policies, practices, and
controls of the issuer to ensure that it has created accurate prepared reports. An audit opinion that accompanies the
prepared reports is evidence of such a review.

9. No predictive value
The information in a set of prepared reports provides information about either historical results or the financial status of a
business as of a specific date. The statements do not necessarily provide any value in predicting what will happen in the
future. &or example, a business could report excellent results in one month, and no sales at all in the next month, because a
contract on which it was relying has ended.& Financial statements are normally 'quite useful documents, but it can pay to be
aware of the preceding issues before relying on them too much.

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