Acca f3 Financial Accounting (int) Study Text

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21: Preparation of financial statements for companies   Part F  Preparing basic financial statements 

2.3.1 Managers' salaries 

The salary of a sole trader or a partner in a partnership is not a charge to the income statement but is an 

appropriation of profit. The 

salary of a manager or member of management board of a limited liability 

company, however, is an expense in the income statement, even when the manager is a shareholder in 

the company. Management salaries are included in 

administrative expenses. 

2.4 Finance cost 

This is interest 

payable during the period. Remember (from the previous chapter) that this may include 

accruals for interest payable on loan stock. 

2.5 Income tax expense 

This represents taxation as detailed in 2.6 below. Once again this will include accruals for the tax due on 

the current year's profits. However, it may also include adjustments for any over or under provision for 

prior periods (see example 2.6.1 below). 

2.6 Taxation 

Taxation affects both the statement of financial position and the income statement. 

All companies pay some kind of corporate taxation on the profits they earn, which we will call 

income tax 

(for the sake of simplicity), but which you may find called 'corporation tax'. The rate of income tax will 

vary from country to country and there may be variations in rate within individual countries for different 

types or size of company. 

Note that because a company has a 

separate legal personality, its tax is included in its accounts. An 

unincorporated business would not show personal income tax in its accounts, as it would not be a 

business expense but the personal affair of the proprietors. 

(a) The 

charge for income tax on profits for the year is shown as a deduction from net profit.

(b) 

In the statements of financial position, 

tax payable to the government is generally shown as a 

current liability as it is usually due within 12 months of the year end. 

(c) 

For various reasons, the tax on profits in the income statement and the tax payable in the statement 

of financial position are not normally the same amount. 

2.6.1 Example: taxation 

A company has a tax liability brought forward of $15,000. The liability is finally agreed at $17,500 and this 

is paid during the year. The company estimates that the tax liability based on the current year's profits will 

be $20,000. Prepare the tax liability account for the year. 

Solution

TAX LIABILITY ACCOUNT 

$

$

Cash paid

17,500

Balance b/f

15,000

Balance c/f

20,000

Income statement

22,500

37,500

37,500

Notice that the income statement charge consists of the following: 

$

Under provision for prior year (17,500 – 15,000)

2,500

Provision for current year

20,000

22,500

Notice also that the balance carried forward consists solely of the provision for the current year. 

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Part F  Preparing basic financial statements

  21:  Preparation of basic financial statements for companies

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2.7 Accounting concepts 

You will notice from the above that the accounting concepts apply to revenue and expenses. In particular, 

the matching concept applies and so expect to have to adjust for accruals and prepayments. 

2.8 Interrelationship of income statement and statement of financial

       position 

When we were dealing with the financial statements of sole traders, we transferred the net profit to the 

capital account. In the case of limited liability companies, the net profit is transferred to retained earnings 

in the statement of changes in equity (SOCIE). The closing balance of the accounts in the SOCIE are then 

transferred to the statement of financial position. 

2.9 Gains on property revaluation 

These arise when a property is revalued. The revaluation is recognised in the other comprehensive income 

part of the statement of comprehensive income. 

For example an asset originally cost $5,000 and was revalued to $15,000. The $10,000 goes to revaluation 

reserve. However, rather than the SOCIE (see 

Section 5

 for a practical example), the $10,000 transfer to 

the revaluation reserve is recognised in the statement of other comprehensive income. 

3 Items in the statement of financial position

3.1 Assets 

The assets are exactly the same as those we would expect to find in the accounts of a sole trader. The only 

difference is that the detail is given in notes and only the totals are shown on the face of the statement of 

financial position. 

3.2 Equity 

We looked at share capital and reserves in detail in the previous chapter. Remember that movements must 

be reported in the SOCIE. 

Capital reserves usually have to be set up by law, whereas revenue reserves are appropriations of profit. 

With a sole trader, profit was added to capital. However, in a limited company, share capital and profit 

have to be disclosed separately, because profit is distributable as a dividend but share capital cannot be 

distributed. Therefore any retained profits are kept in the retained earnings reserve. 

3.3 Liabilities 

Liabilities are split between current and non-current and this is dealt with in detail in the next section. 

3.4 Concepts 

The statement of financial position makes use of the accounting equation concept that: 

Assets = Capital + Liabilities 

The statement of financial position is also prepared according to the 

business entity convention (that a 

business is separate from its owners). 

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