Introduction to Accounting and Finance

This report provides an introduction to accounting and finance, covering topics such as income statements, balance sheets, break-even analysis, and investment appraisal techniques. It includes case studies and calculations for Terry Joe Plc, Kokolet Limited, and Smith Howe Limited. The report offers insights into the fundamental models, concepts, and techniques used in accounting and finance.

Introduction to Accounting and
Finance

Contents
INTRODUCTION...........................................................................................................................1
Part A – Terry Joe Plc......................................................................................................................1
Statement of Income for the year ended 31st December 2018 for Terry Joe Plc........................1
Statement of Financial Position as at 31 December 2018 for Terry Joe Plc...............................3
Part B – Kokolet Limited.................................................................................................................5
a. Contribution.............................................................................................................................5
b. Break even point and margin of safety....................................................................................5
c. Calculation of profit.................................................................................................................6
d. Assessment of good strategy for Kokolet Limited..................................................................7
e. Assumptions attached to break even model.............................................................................8
Part C – Smith Howe Limited.........................................................................................................8
a. Calculating the Payback Period, the Accounting Rate of Return and the Net Present Value
of the machine, and providing recommendations........................................................................8
b. Key merits and limitations of the differing investment appraisal techniques.......................11
Key benefits and limitations of using budgets as a tool for strategic planning.........................13
CONCLUSION..............................................................................................................................13
REFERENCES..............................................................................................................................15

INTRODUCTION
Accounting and finance is a field of study which allows a learner to deeply understanding
fundamental science behind organisational accounts and other financial activities (Ahmed and
Duellman, 2013). The main aim of this report is to build an understanding about the fundamental
models, concepts and techniques used within financial accounting and management accounting.
In this report, three individual assessment parts are covered in which knowledge and skills of
accounting are applied to understand the role of finance at a local and international level. In first
part of this report, income statement and balance sheet is developed which are based on journal
and primary books of accounting. In second part of this assessment, break even and contribution
margin is determined using costing techniques. In the last part of this report, investment appraisal
techniques are used to compute Payback Period, the Accounting Rate of Return, and the Net
Present Value along with description of merits and demerits of these techniques.
Part A – Terry Joe Plc
Statement of Income for the year ended 31st December 2018 for Terry Joe Plc
Particulars Amount Total
Sales 759600
less: cost of sales 356400
gross profit 403200
less: Operating expenses:
rent 108000
wages 143010
depreciation 1100
van running expenses 40320
bad debts 1800
Electricity bill 9270 303500
Profit 99700
Working notes:
1.
Sales revenue account
1

Particular Dr. Particular Cr.
Balance 759600 Account receivables 313200
Cost of sales 291600
Cash account 90000
Cost of sales 64800
Total 759600 Total 759600
2.
Cost of sales account
Particular Dr. Particular Cr.
Credit sales 291600 Balance 356400
Cash sales 64800
Total 356400 Total 356400
3.
Rent account
Particular Dr. Particular Cr.
Bank account 135000 Prepaid rent account 27000
Balance 108000
Total 135000 Total 135000
4.
Wages account
Particular Dr. Particular Cr.
Bank account 140400 Balance 143010
Outstanding wages account 2610
Total 143010 Total 143010
5.
Depreciation
2

Cost of asset 72000
Scrap Value 6000
Estimated life 6 years
SLM Depreciation rate
(assumed)
10%
Calculation (72000-
6000/6)*10%
Depreciation for 1st year 1100
6.
Electricity expense account
Particular Dr. Particular Cr.
bank account 6840
account payables 2430 balance 9270
Total 9270 Total 9270
Statement of Financial Position as at 31 December 2018 for Terry Joe Plc
Particulars Amount Total
Liabilities
Capital 216000
Add: profits 99700
Net capital 315700
Account payable 471600
Tax payable 2880
Outstanding wages 2610
Total liabilities 792790
Assets
Fixed assets
3

Van 72000
Less: depreciation 1100
70900
Current assets
Inventory 273600
Prepaid rent 27000
Cash 43200
Bank -178560
Account receivables 525600
Other receivables (suspense
account)
31050 721890
Total assets 792790
Working notes:
1.
Cash account
Particular Dr. Particular Cr.
Sales revenue 90000 Purchases account 46800
balance 43200
Total 90000 Total 90000
2.
Bank account
Particular Dr. Particular Cr.
Capital account 216000 To rent account 135000
balance 178560 Van account 112320
Wages account 140400
Electricity expense account 6840
Total 394560 Total 394560
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Financial statements are the analytical records which are developed by the end of a year
in order to ascertain how much company owes by the way of calculating liabilities and how
much company owns by computing assets (Anandarajan, Anandarajan and Srinivasan, 2012).
Terry Joe Plc is a new establishment of which income statement and statement of financial
position is developed above from which it has been interpreted that this organisation has a high
potential of attaining growth in future. After various expenses of being a new business, this
organisation has managed to earn a profit of 99700. Along with this, other there is a considerable
balance in entity’s assets and liabilities.
Part B – Kokolet Limited
a. Contribution
Particulars Formula Units
Selling price per unit 40
Total variable cost 30.15
Contribution per unit Selling price per unit –
total variable cost
9.85
Working notes:
1.
Materials 15.75
Labour 8.85
Variable overheads 5.55
Total variable cost per unit 30.15
Kokolet Limited is a wall clock manufacturer which currently sells each unit at £40. In
order to calculate contribution, selling price per unit will be deducted from total variable cost per
unit. By this, contribution per unit is calculated as 9.85
b. Break even point and margin of safety
Particulars Formula Calculation Amount
Fixed cost Production fixed +
selling fixed cost
177000+142800 319800
Contribution per unit 9.85
5

BEP (in units) Fixed cost / contribution
per unit
319800/9.85 32467.00508
BEP (in £) Fixed cost / contribution
margin
319800/24.62 1298943.948
Break even point is the situation in which a business faces no profit and no loss
conditions (Cockcroft and Russell, 2018). As per the information of Kokolet Limited, this
organisation will face a break even point when they will sell 32467 units. The break even sales
for this organisation are calculated as £1298944.
Particulars Formula Units/amount
Actual sales £2400000
BEP sales £1298944
Selling price per unit £40
MOS (in £) Actual sales - BEP
sales £1101056
MOS (in units)
(Actual sales - BEP
sales) / Selling price
per unit
27,526.4
Margin of safety is the safety level which defines the area of revenue in which earning
profit is guaranteed (Dechow and et.al., 2011). This safety margin is the difference between
actual sales and break even sales which is calculated as £1101056 for Kokolet Limited. On the
other hand, margin of safety in terms of units is calculated by dividing the MOS revenue and
selling price per unit; this is determined as 27,526 units.
c. Calculation of profit
Particulars Formula Amount
Sales 54000*40 2160000
less: Variable cost 54000*30.15 1628100
Contribution 531900
less: Fixed cost 177000+142800 319800
Profit 212100
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The situation in which kokolet Limited will produce and sell 54000 units of wall clock,
the net profit earned by this organisation will vary. This variation is the result of selling units and
also the manufactured units. The net profit in this case is calculated as £212100.
d. Assessment of good strategy for Kokolet Limited
Particulars Formula Amount
sales 62100*43.2 2682720
less: variable cost 62100*30.15 1872315
contribution Sales – variable cost 810405
less: fixed cost 454800
Profits 355605
Working notes:
1.
Particulars Increase in selling
price per unit by 8%
Old sales 40
% increase 3.2
New/revised sales 43.2
2.
Particulars Increase in sales (in
units) by 15%
Old sales 54000
% increase 8100
New/revised sales 62100
3.
Production 177000
Selling etc. 142800
Advertising expenditure 135000
Total fixed cost 454800
A good strategy is a direction which allows firm to earn reliable profit after incurring
expenses so that growth and survival can be ensured in future (Dyckman and Zeff, 2015). In this
case of Kokolet Ltd., the management of this organisation is proposing to spend £135000 against
marketing and advertisement. For this, selling price of the products i.e., wall clocks will be
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increased by 8% and sales level will be enhanced at 15%. This proposal will result into profit of
£355605 as calculated above. This profit margin is more than the profit of last proposal that is
£212100. So, it is evidently analysed that this proposal must be accepted by the company.
e. Assumptions attached to break even model
Break even model is a management accounting tool which helps a business to ascertain the units
which they must produce to reach at a situation where they have not to bear any loss. This model
is even appropriate for the new business which are in its introduction phase. There are various
assumptions which are related with break even analysis model (Foster, 2017). These assumptions
are mentioned as follows.
Break even model assumes that all the costs incurred by an organisation will be classified
into fixed and variable costs. This model does not account for semi variable costs due to which
reliability and accuracy level of this model is low. Another assumption associated with break
even model is that according to this concept, cost and revenue functions are linear. By this, it
implies that cost and revenue will increase and decrease with a uniform variation.
Price of the product manufactured by the company will remain constant in every situation is
also an assumption which is considered in this break even model. Apart from this, break even
model assumes that variable cost of the business increases or decreases with a constant rate, it
assumes that fixed costs remain constant for entire year and factor of price remains unaltered.
By considering all the above assumptions, it is analysed that the break even model cannot be
used for every differing business as this model is appropriate for organisations which work on
small scale and does not have ample cost centres. Large scale organisation has expenses which
cannot be segregated into variable and fixed costs due to which there are high chances that their
break-even point will be inaccurate (Gorshkov and et.al., 2018).
Part C – Smith Howe Limited
a. Calculating the Payback Period, the Accounting Rate of Return and the Net Present Value of
the machine, and providing recommendations
Accounting rate of return
Year EAT
1 720000
8

2 720000
3 720000
4 720000
5 1720000
Average annual profit 920000
Cost 8000000
Scrap value 1000000
Average investment 8500000
ARR 10.82%
Working notes:
1.
Year Cash inflow Cash
outflow Depreciation
EBIT
(Inflow -
(outflow -
depreciation)
Add:
depreciation
Net cash
flow
1 3400000 1280000 1400000 720000 1,400,000 2,120,000
2 3400000 1280000 1400000 720000 1,400,000 2,120,000
3 3400000 1280000 1400000 720000 1,400,000 2,120,000
4 3400000 1280000 1400000 720000 1,400,000 2,120,000
5 3400000 1280000 1400000 720000 1,400,000 2,120,000
5
Inflow from
the sale of
machine
1000000
2.
Calculating Depreciation
Particulars Amount (in £)
Cost 8000000
Scrap Value 1000000
Expected useful life 5
Depreciation 1,400,000
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Accounting rate of return or ARR is the percentage which expected to be gained against
the investment. This rate is calculated by comparing the average investment which is been done
and the average profit which is predicted to be gained by that investment (Hillier and et.al.,
2013). In this case, ARR is calculated as 10.82% which means every year, Smith Howe Limited
will gain 10.82% as a return on their invested amount against the machinery amounting 8000000.
Net present value
Year Net cash
flow
PV factor
@ 9%
Discounted
cash flow
1 2120000 0.917431193 1944954.128
2 2120000 0.841679993 1784361.586
3 2120000 0.77218348 1637028.978
4 2120000 0.708425211 1501861.447
5 3120000 0.649931386 2027785.925
Total discounted
cash flow 8895992.065
Less: initial
investment 8000000
Net Present value 895992.0646
Net present value is the amount differing from net cash inflows and outflows over a
specific period of time (Loughran and McDonald, 2016). NPV enables to ascertain present value
of their machinery every year. NPV calculated in this case is £895992.
Payback period
Year Net cash flow Cash Flow
1 2120000 2120000
2 2120000 4240000
3 2120000 6360000
4 2120000 8480000
5 3120000 11600000
3
0.773584906
10

Payback period 3.773584906
Payback period is the recovery period in which amount which is invested against an asset
can be recovered. Payback period for this case of Smith Howe Limited is 3.7 years which means
amount invested by this company of £8000000 will be recovered by them in 3 years and 8
months.
Recommendations
By analysing measures of NPV, ARR and IRR, it has been seen that if Smith Howe
Limited invests in this machinery of £8000000 then they can earn return of 10.82% every year
and also in just 3 years and 8 months they will be able to recover their entire invested amount. It
is highly recommended for Smith Howe Limited to buy this machinery so that they can enhance
their operations.
b. Key merits and limitations of the differing investment appraisal techniques
Investment appraisal is the procedure of determining the attractiveness of an investment by
ascertaining the net return which can be gained against that invested amount and the period in
which whole invested amount can be recovered. There are various investment appraisal
techniques which helps a business to predict attractiveness of the investment which they are
considering to purchase. These techniques are Net present value, Accounting rate of return and
payback period. Merits and limitations of all these techniques are assessed as follows.
Net present value
It is the worth of current sum of money in comparison to the future value the same amount will
have when this is financed at a certain compound interest rate. This method of investment
appraisal is used when company wish to do the financial planning for the capital with some
projected savings or project (Schlegel, Frank and Britzelmaier, 2016).
On the most effective merit of NPV is that it accepts non conventional cash flows. This
type of cash flow does not have a pattern in them, they vary according to the situation of the
business. NPV is appropriate technique for such cash flows as well. Another benefit of NPV
which makes it appropriate for companies of any scale is that it factors risks. This technique assit
by factoring the risks involves in the investment. This risk can be seen in abive practical to be
used as discounting factor of 9%. This risk factor is a combination of financial, operating and
other business risks.
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Despite of its various benefits, there are few limitations of NPV as well which makes it
inappropriate for few organizations. One of the most influential demerit of NPV is that it ignores
sunk cost. Sunk cost is the cost which is incurred at the time of installation of the machinery.
This cost is not considered in the process of NPV due to which present value ascertainment is not
accurate. Other limitations of NPV includes that it might not boost the earning per share and
return on earnings.
Accounting rate of return
As already discussed, ARR is the percentage rate which is predicted to be gained against the
invested amount. Benefits of this investment appraisal technique includes the simplicity and
understandability of this technique. ARR is easy to calculate and does not require skilled
accountant which makes it appropriate for small scale firms. This technique also assists by
recognising the elements such as tax and depreciation due to which results can be said to be
accurate. Due to its simplicity, ARR is often used to compare between the two investment which
helps in better decision making (Westerweel, Basten and van Houtum, 2018).
ARR has various limitations as well which makes it non suitable in some cases. This
investment technique ignores time factor due to which average return calculation gets impacted.
This time factor is the estimated value of the life of the asset which is not considered in the case
of ARR. No external affairs or factors are considered in the calculation by ARR due to which
risk of inaccuracy increases.
Payback period
Payback period is the time duration in which a business can recover its invested amount.
Payback period is simplest to be computed and interpreted. A business can easily identify
payback period of two investments and whichever investment has less payback period is
selected. Considering this, benefits of PBP investment appraisal technique is quick decision
making and simplicity (Anandarajan, Anandarajan and Srinivasan, 2012).
On the contrary, there are various limitations of payback period which includes neglecting
of time value, cash flows, return on investment and profitability. All these demerits states that
this investment technique can be used as a supporting evidence but cannot be used as a basis of
decision making.
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Key benefits and limitations of using budgets as a tool for strategic planning
Budgets are the records which has future predicted transactions based on the present records.
Budgets are used as strategic planning tool by which future expenses and revenues are planned
so that effective organisational operations can be assured. There are various advantages and
limitations of budgetary tools when used for strategic planning. These merits and limitations are
analysed as follows.
Budgets motivates the management of the organisation to predict future problems and
identify possible preventions and cures for that problem so that any contingent situation in future
can be sensed. Budgets also allows to control incomes and expenses by which an effective
strategic planning can be done as it facilitate in planning for future spending levels. Budget is an
effective tool for strategic planning as it helps in directing the capital and resources of the
organisation towards the profitable channels (Zore and et.al., 2018).
Budgetary tool acts as a yardstick or a benchmark to which future cost flows are compared
so that efficiency in every year can be ascertained. This element of budgets makes it appropriate
for strategic planning. The process of future planning is based on few aims which are correlated
to both individual and organisational gaols. These aims can be first measured by budgets and risk
factor in these can be predicted and then finally milestones can be set.
Apart from these benefits, there are few limitations as well of using budgets as a tool of
strategic planning. The most influential limitation is that budgets are developed on the basis of
forecasting which involves high factor of uncertainty (Ahmed and Duellman, 2013). If budgets
are used as a tool for strategic planning, then there is a high chance of inaccuracy. The success of
budgets as a strategic tool depends upon cooperation of all the members of management. Due to
any mismanagement among staff can impact upon operations of the organisation which is
planned in strategic planning.
CONCLUSION
From the above report, it has been concluded that the study of accounting and finance is the
core of handling and controlling funds of an organisation. In this report, various financial
statements and management books are developed from it has been found that every transaction is
recorded with a logic which impacts another transaction. It has been also concluded that finance
plays an important role when it comes to analysing the books of organisations either on local or
international level. Various fundamental models, concepts and techniques are analysed against
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financial and management accounting from which it has been concluded that both the concepts
of accounting are used to record, summarise and then interpret the financial transactions of a
business so that it can assist in decision making process.
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REFERENCES
Books and Journals
Ahmed, A. S. and Duellman, S., 2013. Managerial overconfidence and accounting conservatism.
Journal of Accounting Research. 51(1). pp.1-30.
Anandarajan, M., Anandarajan, A. and Srinivasan, C. A. eds., 2012. Business intelligence
techniques: a perspective from accounting and finance. Springer Science & Business Media.
Cockcroft, S. and Russell, M., 2018. Big data opportunities for accounting and finance practice
and research. Australian Accounting Review. 28(3). pp.323-333.
Dechow, P. M. and et.al., 2011. Predicting material accounting misstatements. Contemporary
accounting research. 28(1). pp.17-82.
Dyckman, T. R. and Zeff, S. A., 2015. Accounting research: past, present, and future. Abacus,
51(4). pp.511-524.
Foster, T. A., 2017. Budget planning, budget control, business age, and financial performance in
small businesses.
Gorshkov, A. S. and et.al., 2018. Payback period of investments in energy saving. Magazine of
Civil Engineering. 78(2).
Hillier, D. and et.al., 2013. Corporate finance (No. 2nd Eu). McGraw Hill.
Loughran, T. and McDonald, B., 2016. Textual analysis in accounting and finance: A survey.
Journal of Accounting Research. 54(4). pp.1187-1230.
Schlegel, D., Frank, F. and Britzelmaier, B., 2016. Investment decisions and capital budgeting
practices in German manufacturing companies. International Journal of Business and
Globalisation.16(1). pp.66-78.
Westerweel, B., Basten, R. J. and van Houtum, G. J., 2018. Traditional or Additive
Manufacturing? Assessing component design options through lifecycle cost
analysis. European Journal of Operational Research. 270(2). pp.570-585.
Zore, Ž. and et.al., 2018. Maximizing the sustainability net present value of renewable energy
supply networks. Chemical Engineering Research and Design. 131. pp.245-265.
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