Main difference between a Cash flow Statement and an Income statement using four example: The cash flow statement shows, what is actually flow in and out of the organisation during the relevant period, for example one year. Cash flow statement is nothing to do with profit. The income statement for Liz and Sophie show a positive figure 6,404 as a profit retained for the accounting period year end 2008. It shows that business made profit in terms of cash due to the fact that income statement is made by assumptions.
For example income statement shows that taxation is paid 2,120 paid hence the profit figure will be different where as in the cash flow statement the transaction will be recorded after this event taken place. One of the most common reason there is a difference over cash flow and profit is the difference in timing between the making of a sale and actually receiving the money. On other hand the income statements try to match the organisation's costs with the sales revenue which it generates. Therefore the cost of the sales and other expenditure should match the sales revenue for the given time.
In other words the costs only recognised when sales contact is agreed and in place and the amount of costs recognised is proportion to the amount of sales. The depreciation used for the fixed assets in Liz and Sophie is included in the income statement, because the income statement includes non cash items such as depreciation. Whereas in the cash flow statement will not show the depreciation because it is a non cash item. There are several important of fundamentals of accounting concepts and conventions. The most fundamental concepts are Prudence, Accruals, Going concern, consistency, and materiality and there are others.
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These concepts are important and must take into consideration when preparing accounts. This is because treatment of accounting is different from one another. Going Concern Concept: The going concern means that business must have intention to run at least for more than one year and there is no intention to put the company into liquidation. For example when preparing for the accounts for Liz and Sophie, accounting always assumes that business will continue to operate for longer period of time. This means you must do account preparation to continue the business as normal.
Unless if the Liz and Sophie cloths trading was going to be sold for whatever reason. Suppose for an argument say Liz and Sophie trading was treated as their business going to be closed after their financial records produced for 2008 then the value of the asset will be relevant than the going concern concept. The important factor of going concern concept is asset of Liz and Sophie business should not be valued at their breakup value which is the value it will fetch if the business gone into liquidation. In actual fact Liz and Sophie write off their fixed assets each year.
This is shown after the gross profit as a operating expenses as depreciation in the Income statement before tax paid. This expense called depreciation but it is not an actual cost although this is a provision to reduce the book value of the asset. An example of going concern concept can be used as Liz and Sophie fixed assets are depreciated over the ten years and the original cost of the asset were 23,000. The yearly deprecation is 1/10 of the original cost. Therefore deprecation cost of 2,300 will be charged.
Applying the going concern concept assumes that Liz and Sophie will continue their trading and asset will be used for the full 10 years. Therefore net book value of this asset is shown its cost less of the accumulated amount of depreciation charged up to year 2008 as shown below. The prudence concept means that if you are not realised the profit then you cannot apply this on the accounts. Basically you will state actual selling cost rather than predicted selling cost. It is important to show accounts records lower amount or actual amount rather than higher amount.
This is to record all the losses on the account rather than recoding the predictable profits on accounts. An example in Liz and Sophie accounts records indicates that it has 35k of debtors. It is possible that some of debtors may not pay all of the money and therefore Liz and Sophie may make a provision for bad debts. This can be shown on the account records as irrecoverable costs. This sort of bad debts must reflect on the income statement as matter of prudence. Example: Liz and Sophie sell cloths for 175K and outstanding debts are 35K.
Assume is doubtful if 15K will be ever paid. The Liz and Sophie make a Provision for bad debts of 15K. However, the full value of sales 175k will be shown in the income statement although the provision for bad debts will be charged at 15K. Therefore the uncertainty of the sales not being realised in the prudence concept and this suggest that 15k should not be included in the profit of the year. The consistency concept Different account procedures can affect the income statement depending on the accounting conventions/standards we use.
Therefore consistency concept suggests same treatment should be applied from period to another for same items. This would enable to make a value comparison from one period to another. Constantly changing profits will lead to an invalid account records for the business. Therefore in the consistency is important concept for the accounts for a business to flow a standard method. For example, in Liz and Sophie the method of depreciation is used as straight line method for the asset they purchased in year 2006 as shown below: Example of calculating straight line depreciation
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