Accounting and Innovation
Innovation is the life-blood of any business. New products, services and ways of doing business all lead to sustainable longer-term profits. Sometimes innovation comes at a substantial cost, for example in research and development costs. In these recessionary times, budgets for things like product research and development are often slashed. Of course accountants are blamed for this. But can accountants play a role in injecting innovation into businesses in these tough times. According to Richard Young, writing in Financial Management (September, 2009), accountants can inject a dose of realism in to innovative ideas and projects. They can be a ‘wet blanket’, which although has a negative tone, may actually be exactly what is needed in lean times. With a smaller pot of money to be spent on product innovation, accountants can help determine the longer-term profitability of new products or services, preventing great ideas becoming poor sellers. Accountants also bring structure, based on their expertise of the many business processes involved in getting innovative ideas afloat. For example, accountants can ensure that the costs of any new product are minimised – production costs, marketing and distribution costs etc. They can thus help take the innovation to something which is based on costs and profits, something which investors and managers readily understand. Innovative and creative people are often uncomfortable with such language.
Accounting rules in smaller companies
Limited companies must prepare financial statement in accordance with accounting standards and Company Law. As you can imagine, complicated rules and laws are often way too much for a small company to deal with. Most to the time, directors of small companies leave the work of preparing financial statement up to practicing accountants. In fact, in the UK and Ireland, small companies are also exempt from the requirement to have their financial statements audited provided they meet certain conditions.
In June 2008, the UK’s Accounting Standards Board (ASB) issue an accounting standard specifically designed to cater for and simplify the accounting rule for small companies. What constitutes a small company is specified by Company Law. In the UK, any company with turnover of not more than £5.6m, a balance sheet total of not more than £2.8m and has less than 50 employees is a small company. If a business meets these criteria, it can then adopt the ASB’s Financial Reporting Standard for Small Entities (FRRSE). This standard is very useful in that it incorporates all requirements relating to financial statements as set out in Company Law. Thus, by following this standard in the preparation of its accounts, a company is also fully compliant with the law. The FRRSE covers many areas of financial statements- for example: the profit and loss account, fixed assets, current assets, the Directors Report and much more. It also exempts smaller companies from some more complex requirements of other accounting standards. If your business is a small company, it might be worth while asking your accountant if the FRRSE is suitable for you. It might simplify their work, and as a result save you some fees.
Here is a link to the ASB’s website, where you can download the FRRSE for free;
http://www.frc.org.uk/documents/pagemanager/asb/FRSSE/FRSSE%20Web%20optimized%20FINAL.pdf
The profit and loss account (income statement)
This brief post covers the basics of the profit and loss account. The profit and loss accounts lists all income and expenditure, with the difference being they profit or loss made by the business. The profit and loss account has two parts, albeit in the same statement. The first part account calculates the profit earned from buying and selling goods. This is called the Trading account.
Here’s an example of the layout.
Trading account for Red Books for year ended 31/12/2009
|
€/£ |
€/£ |
|
| Sales |
|
250,000 |
| LESS COST OF SALES |
|
|
| Opening stock |
20,000 |
|
| Purchases |
150,000 |
|
|
170,000 |
|
|
| Less closing stock |
30,000 |
|
| Cost of sales |
|
140,000 |
| Gross profit |
|
110,000 |
Here’s a brief explanation of each of the some of the items and terms above. First, there is the title of the account. It informs the user of the name of the statement (what), the name of the business (who) and the time period involved (when).
Sales: The amount of money earned by the business selling books in the past year i.e. Income. Sales returns/returns in may have to be subtracted to get this figure.
LESS COST OF SALES: this is a heading, which indicates that this calculation is going to be completed. This calculation will work out the cost of all the books that were sold in the year. It is calculated as follows
Cost of sales = opening stock + purchases – closing stock.
Opening stock: This is the value of stock left over from the previous year. This stock will be the first to be sold in the this year, thus it is a cost for this year (c.f. the accruals concept)
Purchases: This is the cost of all the new books bought during the year. (Additional costs like carriage in and import duty might be added to the purchase cost). Purchase returns/returns out may have to be subtracted.
Closing stock: This is the value of all the books left at the end of the year. It is subtracted from opening stock and purchases, as it does not form part of the goods sold during this year (c.f. accruals concept).
Cost of sales: This is the answer to the calculation of the cost of sales.
Gross profit: This measures the profit the business makes by buying and selling books. It is calculated as follows:
Gross profit = Sales – Cost of Sales
The second part, the profit and loss account calculates the profit the business has earned after allowing for all the expenses incurred in running the business. Here’s an example following on from the trading account above
Profit and loss account for Red Books for year ended 31/12/2009
| €/£ | €/£ | |
| Gross Profit | 110,000 | |
| LESS EXPENSES | ||
| Wages and salaries | 40,000 | |
| Depreciation | 20,000 | |
| Light, heat and telephone | 10,000 | 70,000 |
| Net Profit | 40,000 |
As you can see, the profit and loss account starts with the Gross Profit and deducts expenses to arrive at Net Profit. Net profit is the profit that is owed to the owner(s) of the business. In the case of a sole trader, this forms part of the capital of the business, whereas with a company the shareholders may be paid a dividend from available profits.
All other elements from the Trial Balance i.e. assets, liabilities and capital do not appear on the Profit and Loss account, but the balance sheet.
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