2.7 It is important to recognise that the profit and loss account is not prepared on the basis of the cash effects of the various transactions: in January there are purchases of £7,000, and in March further purchases of £3,500. However the charge in the profit and loss account reflects the costs of the sales in that month, rather than the purchases. The purchases are paid for on delivery in January, but in March the supplier allows Jane 30 days credit. However the purchases in March are entered into the accounts when the delivery is made to Jane, not when the invoice from the supplier is settled. 2.8 Along similar lines, two windsurfers are sold in February and three are sold in March. However Jane does not receive the cash for these sales until the following month, as she has decided to give credit to her customers. However the sales are not recognised at the time that the cash is received, but at the point that the customer takes the goods from the premises and the sales invoice is created. 2.9 There are two payments made on the first day that Jane opens for business: she pays the landlord £1,500 as a rental deposit and she spends £1,200 for a van which has seen decidedly better days. Neither of these payments are reflected as an immediate cost to the business: the deposit to the landlord will be refundable at the end of December and is therefore shown as such; the value in the van will be gradually used up during the year. This consumption of the value is called “depreciation”; as previously noted this reflects the gradual usage of fixed assets by virtue of the passage of time and their use in the business. 2.10 This approach of moving away from the cash effects of transactions to look at the underlying commercial transactions is referred to as “matching” or the “accruals basis”. The concept of matching is addressed in the “statement of principles for financial reporting” which provides the conceptual framework that underpins United Kingdom Generally Accepted Accounting Principles and Practice (otherwise known as “UK GAAP”). In addition to this, paragraph 26 of Financial Reporting Standard 18 (“FRS 18”) states: “An entity should prepare its financial statements, except for cash flow information, on the accruals basis of accounting.”
2.11 The next point to make is that accounting deals with uncertainties: the following assumptions are implicitly included in the profit and loss account of Jane’s Windsurfing:
the stocks will be sold for at least the cost price;
the customers will pay the amounts owing;
there will be no damage to the shop and therefore no claim by the landlord;
the landlord will not become insolvent, and the rent deposit will therefore be returned;
there will be no warranty claims in respect of defective goods sold, or such claims will be met by the supplier, with no cost to Jane;
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