Accounting for Managers: Interpreting accounting information for decision-making

410 ACCOUNTING FOR MANAGERS

Table A2.4

Sales 1,100,000

Less cost of sales

Opening stock 150,000

Purchases 650,000

800,000

−Closing stock 200,000

Cost of sales 600,000

Gross profit 500,000

−Expenses 275,000

Operating profit 225,000

Profit is reduced by £2,400 (expense: 3 mths @ £800).

Asset in the Balance Sheet is increased by £7,200 (prepayment is an asset: 9 mths @ £800).

Cash flow is reduced by £9,600 (payment 31 December).

NB: The effect of the prepayment of £7,200 is to carry forward the expense to the next
financial year.

b Accrual

The simple solution is to divide £6,000 by 12 months and charge £500/mth to profit.
However, this ignores seasonal fluctuations and cash flow differences from quarter to
quarter.
The quarterly bills have been paid during the year, but the last quarterly bill was in
November. Therefore the business is missing one month’s expense (i.e. December). To
determine the amount we need to calculate the seasonal charges:

£6, 000 ×70%=£4,200 for September – February/ 6 =£700/mth.

£6, 000 ×30%=£1,800 for March – August/ 6 =£300/mth.

Accrue for one month(December)=£700.

Profit reduced by £700 (expense).

Balance Sheet reduced by £700 (accrual is a creditor).

Cash flow has no impact (no money yet paid).

NB: The effect of the accrual is to reduce by £700 the expense impact of the expected bill
for three months of £2,100, which will be received in February. This leaves £1,400 as the
expense (£700 for each of January and February).