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3.4

Final accounts

Unit 3 · Finance and accounts · SL and HL

Final accounts are the official record of how a business performed over a year and what it owns and owes at the end of it. You must be able to construct and amend a profit and loss account and a balance sheet from data, and explain why different stakeholders read them. At HL you also calculate depreciation by two methods. One fictional business, Ombak Boards, a surfboard maker in Bali, runs through this page and the ratio pages that follow.

🎯What you need to be able to do

  • Explain the purpose of accounts to different stakeholders.
  • Construct and interpret a profit and loss account and a balance sheet.
  • Explain different types of intangible assets.
  • HL Calculate depreciation using the straight-line and units-of-production methods, and evaluate the appropriateness of each.

📚The business management

Why stakeholders use accounts

  • Shareholders and potential investors: profitability, dividends, growth; should they buy, hold or sell?
  • Managers: monitor performance, set budgets, plan decisions.
  • Employees and unions: job security, the ability to pay higher wages.
  • Lenders (banks): can the business repay loans and interest? What collateral does it have?
  • Suppliers: will they be paid if they offer trade credit?
  • Government and tax authorities: tax owed; compliance with the law.
  • Customers: will the business survive to provide warranties and supplies?
  • Competitors: benchmark their own performance.

The profit and loss account

The profit and loss account (income statement) shows the business’s revenue and costs over a period, usually a year, and therefore its profit or loss.

Profit and loss account for Ombak Boards in thousands of dollars: sales revenue 1200, minus cost of sales 720, gives gross profit 480; minus expenses 300 gives profit before interest and tax 180; minus interest 20 gives profit before tax 160; minus tax 40 gives profit after tax 120; minus dividends 50 leaves retained profit 70.
A profit and loss account in the IB format.
  • Sales revenue − cost of sales (direct costs of the goods sold: materials, direct labour) = gross profit.
  • Gross profit − expenses (overheads: salaries, rent, marketing, depreciation) = profit before interest and tax.
  • − interest = profit before tax; − tax = profit after tax.
  • − dividends = retained profit, which is added to retained earnings on the balance sheet.

Cost of sales = opening stock + purchases − closing stock.

The balance sheet

The balance sheet (statement of financial position) is a snapshot of what a business owns (assets) and owes (liabilities) at one point in time, and how it is financed (equity).

Balance sheet for Ombak Boards at 31 December 2025, in thousands of dollars. Non-current assets: property 500, machinery 260, total 760. Current assets: cash 40, debtors 120, stock 140, total 300. Total assets 1060. Current liabilities: creditors 110, overdraft 40, total 150. Non-current liabilities: bank loan 250. Total liabilities 400. Net assets 660. Equity: share capital 400, retained earnings 260, total 660.
Net assets equal equity: the balance sheet balances.
  • Non-current assets: held for more than a year: property, machinery, vehicles, and intangible assets.
  • Current assets: expected to be turned into cash within a year: cash, debtors (money owed by customers), stock.
  • Current liabilities: due within a year: creditors (money owed to suppliers), overdrafts, short-term loans.
  • Non-current liabilities: due after more than a year: long-term loans, mortgages.
  • Net assets = total assets − total liabilities.
  • Equity = share capital + retained earnings (for sole traders and partnerships, the owners’ capital). Net assets = equity.

Intangible assets

Intangible assets are non-physical assets that have value because they generate future income:

  • Patents: exclusive rights to an invention for a period.
  • Copyrights: rights over creative work (software, music, books).
  • Trademarks: protected names, logos and slogans.
  • Goodwill: the value of a business’s reputation, customer base and relationships beyond its net assets, recorded when a business is bought for more than the value of its net assets.
  • Also licences, franchises and brand names (5.8 covers intellectual property).

They are hard to value objectively, and their value can change quickly (a scandal damages a brand overnight).

Depreciation HL

Depreciation is the fall in value of a non-current asset over its useful life, through wear and tear or obsolescence. The cost of the asset is spread over its life as an expense in the profit and loss account, and the asset’s net book value (cost minus accumulated depreciation) falls on the balance sheet.

\[ \text{straight line: annual depreciation} = \frac{\text{cost} - \text{residual value}}{\text{useful life (years)}} \]
\[ \text{units of production: depreciation per unit} = \frac{\text{cost} - \text{residual value}}{\text{total expected units}} \]
Straight-line method
the same amount each year. Simple and easy to compare; suits assets that are used evenly over time (buildings, furniture). Ignores how much the asset is actually used.
Units-of-production method
depreciation depends on how much the asset is used (units produced, hours, kilometres). Matches cost to use, so suits machines and vehicles whose wear depends on usage; needs a reliable estimate of total output and records of use.

✏️Worked example

(a) Using Ombak Boards’ data, verify gross profit, profit before interest and tax and retained profit. (b) Show that the balance sheet balances. (c) HL Ombak buys a shaping machine for $300 000 with a residual value of $60 000 after 5 years, and expects it to make 40 000 boards (10 000, 12 000, 8000, 6000 and 4000 in years 1 to 5). Calculate depreciation by both methods.

(a) ($000) Gross profit = 1200 − 720 = 480. PBIT = 480 − 300 = 180. Profit before tax = 180 − 20 = 160; profit after tax = 160 − 40 = 120; retained profit = 120 − 50 = 70.

(b) Total assets = 760 + 300 = 1060. Total liabilities = 150 + 250 = 400. Net assets = 1060 − 400 = 660. Equity = 400 + 260 = 660. They are equal.

(c) Straight line: (300 000 − 60 000) ÷ 5 = $48 000 a year. Units of production: 240 000 ÷ 40 000 = $6 per board, so $60 000, $72 000, $48 000, $36 000 and $24 000. Both leave a net book value of $60 000 after 5 years.

Net book value of the machine over five years. The straight-line method falls by 48 thousand each year from 300 to 60. The units-of-production method falls faster early on (to 240, 168, 120, 84) because usage is higher in the first years, and also reaches 60 in year 5.
Both methods end at the residual value; the path depends on usage.
Check it. Total depreciation must equal cost minus residual value: 5 × 48 = 240, and 60 + 72 + 48 + 36 + 24 = 240 ($000).
Deducting dividends before tax, or putting the overdraft under non-current liabilities. Overdrafts are repayable on demand: always current liabilities.

📝Practise

Work through these on paper, then reveal the answer.

1. [2 marks] Define the term current assets.
Assets that the business expects to convert into cash within one year, such as cash, debtors and stock.
2. [2 marks] A firm has sales of $850 000, opening stock $60 000, purchases $400 000 and closing stock $70 000. Calculate gross profit.
Cost of sales = 60 000 + 400 000 − 70 000 = $390 000. Gross profit = 850 000 − 390 000 = $460 000.
3. [4 marks] A company has non-current assets $500 000, current assets $180 000, current liabilities $90 000, a long-term loan $150 000 and share capital $300 000. Calculate net assets and retained earnings.
Net assets = (500 000 + 180 000) − (90 000 + 150 000) = $440 000. Equity = net assets, so retained earnings = 440 000 − 300 000 = $140 000.
4. [4 marks] Explain why a bank and a shareholder might look at different parts of a company’s final accounts.
A bank considering a loan focuses on the balance sheet (liquidity, existing debt, assets available as collateral) and whether profit covers interest. A shareholder focuses on profit after tax, dividends and retained profit (return on their investment and growth prospects).
5. HL [4 marks] A delivery van costs $45 000 and will be sold for $5000 after 4 years. Calculate straight-line depreciation and the net book value after 2 years.
Annual depreciation = (45 000 − 5000) ÷ 4 = $10 000. NBV after 2 years = 45 000 − 20 000 = $25 000.
6. HL [4 marks] Explain why the units-of-production method may be more appropriate than straight line for a delivery van.
A van’s wear depends on kilometres driven, which may vary a lot from year to year. Units of production charges more depreciation in heavy-use years and less in light ones, so the expense matches the actual use of the asset and the revenue it helped generate, giving a more accurate profit figure. It requires reliable mileage records and an estimate of total lifetime kilometres.

🔗Go deeper — other people’s work

These are external resources, not mine. If one stops working, tell me and everything above it on this page still stands.

  • Indonesia Stock Exchange — listed companies’ annual reports with real income statements and balance sheets.
  • AccountingCoach — tutorials on the balance sheet, income statement and depreciation.
  • IFRS Foundation — the international standards that most published accounts follow.