Directors duties regarding accounts

The directors and auditors of companies are responsible by law for compiling an annual report in a form governed by law. This is for shareholders, the public and HM Inland Revenue.

The annual report must include a trading, profit and loss account and balance sheet, showing fixed and current assets, all costs of current and long-term liabilities, share capital and reserves, provision for taxation and loan repayments. The report must also include any unusual financial facts, e.g. effects of any changes in accounting procedures. It must also disclose things like values of exports, donations to political parties and directors salaries, where they exceed £60,000 per annum.

The auditors report must also state the methods of depreciation used.

The combined document must give a true and fair view of the financial affairs of the company.

Reasons companies must publish their accounts are:

• to provide information to enable shareholders to make informed decisions on whether to invest
• to help prevent fraud and corruption.

The Companies Act 1985 gives four alternative layouts for the profit and loss account (two horizontal and two vertical) and two for the balance sheet (one horizontal and one vertical). The choice is up to the directors, but must not then be changed without good and stated reasons. Vertical layouts are the most popular in the UK, so it is those we will deal with here. Remember, though, that the trading, profit and loss account is first of all a ledger account, so it inevitably starts out in horizontal format. When we are ready to distribute it, inside or outside the firm, we can rewrite it in the more popular vertical format. The two alternative vertical formats laid down by the Companies Act 1985 are shown opposite.

Turnover and cost of sales

Turnover means sales. Cost of sales is found by adding purchases and opening stock, plus carriage inwards costs, and deducting the value of closing stock.

Distribution costs

Includes costs directly incurred in delivering the goods to customers.

Administration expenses

Includes such things as wages, directors’ remuneration, motor expenses (other than those included in distribution costs), auditor’s fees, and so on.

Other operating income

This means all income other than from the firm’s trading activities, e.g. income from rents on property or interest on loans.

Directors’ report

A Directors’ report must accompany all published accounts. ‘Small’ companies, however, are exempt from filing one with the Registrar of Companies; also they only have to file a modified version of their balance sheet, and do not have to file a profit and loss account at all. Medium-sized companies also have some concessions, in that a modified form of profit and loss account and accompanying notes is allowed.

Limitations of published accounts

• Creative accounting can hide negative information.
• Not all the relevant facts have to be disclosed.

Internal accounts

Internal accounts or management accounts are those prepared only for use within the company. Unlike published accounts, they are not required by law to be set out in a certain way. However, it pays to keep them as consistent as possible with the published accounts, so that the latter can be drawn up just by adapting the internal accounts slightly.