Service Firms

Cash Records and the Analysed Receipts and Payments Account

A service firm's primary cash record is the Receipts and Payments Account, which is simply a summarised cash book. It begins with the bank balance at the start of the year, lists all money in on the receipts (debit) side and all money out on the payments (credit) side, and ends with the bank balance at the close of the year.

An Analysed Receipts and Payments Account sets out separate receipts (debit) and payments (credit) sides with analysis columns so that every cash inflow and outflow is categorised as it is entered. This structure helps the firm monitor specific fee streams, keep overhead spending under control, and reconcile the closing bank balance.

Receipts (Debit Side)

Payments (Credit Side)

The cash book records cash as it moves, without distinguishing between revenue transactions, capital additions, personal withdrawals, or debt repayments. You can never treat the closing bank balance or net cash flow as profit. Under the accruals concept, cash receipts and payments must be converted into the actual revenues earned and running costs incurred for the twelve-month period of account.

Stage 1: Opening Statement of Capital and Finding Missing Figures

Before starting the final accounts, calculate the owner's opening net worth (Capital) on day one of the financial year:

If you leave this step to the end, you will have no opening capital figure to start the Financed By section, and the Balance Sheet cannot be completed. Work it out first.

Opening Valuation Rules

• Fixed assets at Net Book Value: Deduct accumulated depreciation whenever the question provides both a depreciation policy and enough information (such as purchase dates and rates) to calculate it. If no policy is given for a specific asset — land, for instance, is not depreciated — enter it at cost.
• Opening bank position: An opening balance on the debit (receipts) side is a current asset. An overdrawn opening balance appearing on the payments side is entered as a current liability.
• Debtors and Prepayments: Fees due from private clients or state health boards, stocks of consumables, and prepaid expenses (insurance, commercial rates) are opening assets.
• Creditors and Fees Received in Advance: Amounts owed for practice supplies, accrued expenses (wages due, light and heat due), commercial loans, and advance fee deposits paid by patients for upcoming procedures are opening liabilities.
• Corporate structure: If the service firm is a company, the balancing figure is labelled Capital and Reserves (issued share capital plus profit and loss reserves) instead of the owner's Capital, and dividends replace drawings.

When Opening Capital is Given

Exam questions frequently supply the opening Capital figure. When this occurs, Total Assets minus Total Liabilities will not balance with the stated figure because an item has been deliberately omitted. The difference between your net assets and the stated capital is the missing figure — almost always the accumulated depreciation on fixed assets up to day one.

For example, if assets as listed total €622,000, creditors are €4,500, and Capital is stated as €508,000:

Deduct this €109,500 from the fixed assets and carry it directly into the accumulated depreciation column of the closing Balance Sheet.

Stage 2: Accrual Adjustments, Incomes, and Expenses

To prepare the Income and Expenditure Account, convert each cash receipt and disbursement into its true earned or incurred amount for the trading year.

Professional Fees Earned

• Fees Due: Opening fees due relate to work carried out last year (deduct); closing fees due represent uncollected work completed this year (add as an earned gain and report under Current Assets).
• Fees Received in Advance: Opening prepayments cover treatments provided during this year (add); closing advances represent unearned deposits collected for next year (deduct from revenue and enter under Current Liabilities).
• Bad debts: If an unpaid fee is deemed irrecoverable, deduct the amount from closing fees due and charge it under Expenditure as bad debts (applying the prudence concept).

Investment Income

Investments are classified under Financial Assets at cost. Never simply lift the investment income figure from the cash book. Calculate the full annual entitlement from the nominal value:

If a 5% investment of €40,000 was held all year, the Income and Expenditure Account must show €2,000 (€40,000 × 5%) under Income. If the Receipts and Payments Account shows €1,800 lodged, enter the remaining €200 as investment income due under Current Assets.

Supplies Consumed

Operational materials (such as dental fillings, cleaning fluids, and heating oil) are consumed while delivering services rather than resold. Determine the true consumption charge:

Hidden Cash Adjustments and Loan Repayments

• Loan repayments: Cash books often show a combined line such as 'loan repayments'. Split this between interest (an expense) and principal (a reduction of liability). If a firm holds an opening 6% loan of €40,000 and pays €9,000, interest is €2,400 (€40,000 × 6%) charged to Expenditure, while €6,600 (€9,000 − €2,400) reduces the loan liability in the Balance Sheet to €33,400.
• Drawings funding practice costs: If the owner paid a surgery expense out of personal cash withdrawals, deduct that amount from drawings and add it to the relevant expense line.
• Private use of practice funds: If a portion of practice rent, rates, or telephone covers the owner's private residence, deduct that share from the business expense and add it to drawings.
• Capital introduced: If the owner lodges private funds (such as private savings or sale of a personal vehicle), this is a capital receipt. Do not credit Income; add it to Capital in the Financed By section.
• Unrecorded bank entries: Deduct unrecorded bank charges from the closing bank balance and charge them to Expenditure. For a dishonoured cheque, deduct the amount from the bank balance and reinstate the debtor under fees due.

Stage 3: Depreciation Policies and Asset Disposals

Always examine the question notes carefully for specific instructions on depreciation. Some papers specify that a full year's depreciation is charged in the year of acquisition and none in the year of disposal. If no special condition is stated, calculate charges pro rata based on the exact months of ownership.

Straight-Line vs Reducing-Balance Policies

• Straight line (% per annum on cost): The charge remains constant each year ($Cost \times Rate$).
• Reducing balance (% per annum on net book value): Each year's charge equals $NBV \text{ at start of year} \times Rate$. Under reducing balance, you cannot multiply a single year's charge by the years held. You must build up opening accumulated depreciation one year at a time.

For example, if equipment costing €50,000 on 01/01/2023 is depreciated at 20% on book value, calculate the 01/01/2025 opening position as:

• Year 2023: 20% × €50,000 = €10,000 (NBV = €40,000)
• Year 2024: 20% × €40,000 = €8,000 (NBV = €32,000)
• Opening Accumulated Depreciation = €18,000; asset enters the Statement of Capital at €32,000.

Mid-Year Disposals and Additions

For straight-line assets where an addition or disposal takes place mid-year, separate the calculation into three elements:

1. Retained assets: Charge 12 months on original assets retained all year: $(\text{Opening Cost} - \text{Cost of Sold Asset}) \times \text{Rate}$.
2. Disposed asset: Charge depreciation from the start of the year up to the disposal date.
3. Acquired asset: Charge depreciation from the acquisition date to the end of the year.

(Note: If the reducing-balance method applies, substitute the opening Net Book Value in place of cost for these calculations.)

Accounting for the Disposal

Do not enter the gross cash proceeds into the Income and Expenditure Account; they represent a capital cash inflow. Calculate the net gain or loss:

Enter a profit on disposal under Income; enter a loss on disposal under Expenditure. In the closing Balance Sheet, eliminate both the original cost and the total accumulated depreciation of the sold asset from the fixed asset schedule.

Stage 4: Sideline Retail Activities

Many service firms operate a commercial retail sideline alongside professional consultations — such as a vet selling specialised pet foods or an optician retailing designer frames. Because retail involves buying and selling tangible stock, prepare a separate Trading Account working:

Direct shop expenses include dedicated sales staff wages or an agreed proportion of surgery overheads (e.g. 25% of reception wages).

Presenting the Sideline in Final Accounts

• If the question asks for a separate sideline account, transfer only the net figure to the Income and Expenditure Account: enter a net profit under Income or a net loss under Expenditure.
• If the question requests a single combined statement, enter the shop's Gross Profit under Income, and include the shop's direct running expenses under Expenditure.
• In either approach, ensure apportioned costs are never double-counted. If €6,000 of receptionist wages is charged against the shop, the wages charged to main clinic expenditure must be reduced by €6,000.
• Always include the shop's closing stock under Current Assets and any unpaid shop suppliers under Current Liabilities in the year-end Balance Sheet.

Stage 5: Standard SEC Presentation Formats

Layout and clear signposting earn significant presentation marks. Keep to the vertical format approved by the State Examinations Commission.

Income and Expenditure Account Skeleton

Income and Expenditure Account for the year ended ...
Income:                                                €          €
  Professional fees earned                                      xxx
  Investment income earned                                      xxx
  Profit on disposal / Sideline profit                          xxx
Total Income                                                    XXX
Less Expenditure:
  Supplies consumed                                   xxx
  Staff salaries and wages                            xxx
  General overheads (light, heat, insurance)          xxx
  Loan interest                                       xxx
  Depreciation charges                                xxx
  Loss on disposal / Sideline loss                    xxx      (XXX)
Excess of Income over Expenditure (Net Profit)                  XXX

Balance Sheet Skeleton

Balance Sheet as at ...
Tangible Fixed Assets:                      Cost    Acc. Dep.   NBV
  Premises                                   xxx       xxx      xxx
  Equipment                                  xxx       xxx      xxx
Financial Assets: 5% Investments                                xxx
                                                                XXX
Current Assets: Stocks, Debtors, Prepayments, Bank     xxx
Less Creditors: amounts falling due within 1 year:     (xxx)
Working Capital (Net Current Assets)                            XXX
Total Net Assets                                                XXX

Financed By:
Long-Term Liabilities (Commercial Loans)                        xxx
Capital at 01/01                                       xxx
Add: Capital Introduced                                xxx
Add: Net Profit                                        xxx
Less: Drawings                                        (xxx)     xxx
Capital Employed                                                XXX

Stage 6: Higher Level Management Advice and Financial Ratios

Part (b) or (c) of a Higher Level service firm question typically asks you to evaluate a proposed borrowing facility, fee revision, or capital expansion. You must never write unsupported general commentary. Always state a clear recommendation in your opening sentence, followed by at least four reasons backed by figures and ratios derived from your completed accounts.

The Four Core Formulas

The Four Evaluation Pillars

1. Profitability and borrowing return: Compare the practice's ROCE with the interest rate charged on the proposed loan. If the firm generates an ROCE of 25% and the borrowing costs 7%, the practice earns far more using the borrowed capital than the money costs to service, making borrowing profitable. If ROCE is lower than the loan rate, advise against the loan.
2. Repayment capacity and solvency: Calculate interest cover. A cover between 3 and 5 times is considered adequate, and higher figures indicate a substantial margin of safety. Below 3 times, a small dip in patient revenue could cause default. Check closing liquidity: strong cash balances and a healthy quick ratio support debt repayment.
3. Security and capital structure: Check the practice gearing. If gearing is well below 50%, the business is low-geared and carries low borrowing risk. Note whether fixed assets (such as freehold surgery premises) are free of prior mortgages and can provide suitable collateral security for the bank.
4. Non-financial and commercial factors: Check the scale of personal drawings. If the owner withdraws most of the annual profit for private living expenses, cash needed to meet loan principal repayments could dry up. Highlight market risks: arbitrary increases in private fees risk losing patients to local competing practices. Note the money measurement concept as a limitation: the reputation, skill, and goodwill of the practitioner do not appear anywhere on the Balance Sheet, despite being the business's most valuable asset.

Stage 7: Sources of Finance and the Matching Rule

The syllabus requires Higher Level candidates to advise on short-term and long-term sources of finance. You must be able to recommend appropriate sources for a specific business proposal and explain your choices.

Short-Term Sources (Repaid within one year — day-to-day working capital)

• Bank overdraft: Highly flexible for smoothing seasonal dips; interest is paid only on the overdrawn amount, but it is repayable on demand and carries higher interest rates.
• Trade credit: Typically 30 days interest-free credit from dental, medical, or office suppliers; delays payment but risks losing cash settlement discounts.
• Accrued expenses: Short postponement of overhead payments (such as light and heat or wages); strictly short-term breathing space.
• Tighter credit control: Chasing overdue fees from health insurers or private patients; releases tied-up cash immediately at zero cost.

Long-Term Sources (More than one year — fixed asset purchases and structural expansion)

• Term loan or mortgage: Repayments are spread over several years to match the useful life of the asset; interest is tax-deductible, but fixed legal security (collateral) is required.
• Leasing or hire purchase: Avoids a large initial cash drain when buying specialised clinical equipment; total payments over time exceed cash price, and leasing does not transfer ownership.
• Retained profits: Financing development internally avoids interest charges and preserves independence, provided the owner exercises drawings discipline.
• Sale of investments: Liquidating existing financial assets (such as 5% government bonds) avoids taking on new debt at higher market rates (e.g. 7%).
• Capital introduced: The owner introduces private funds into the practice; incurs no debt obligations, but ties up personal family wealth.

The Matching Rule

Always match the duration of the finance to the life of the asset. Funding a long-term capital investment (like building a new surgery wing) with a bank overdraft breaches the matching rule: the bank can demand repayment long before the treatment room has generated sufficient fees to repay the borrowing.

Key terms

Service Firm

A commercial business that generates profit by providing professional, personal, or technical expertise to clients rather than manufacturing or retailing physical merchandise.

Receipts and Payments Account

A summarised cash book recording all cash inflows and outflows during the accounting period, without distinguishing between capital and revenue items or adjusting for accruals.

Analysed Receipts and Payments Account

A cash book layout incorporating dedicated analysis columns to categorise transactions (fees, supplies, wages, drawings) as they are entered.

Statement of Capital

A balance sheet schedule prepared on the first day of the financial year to calculate the proprietor's opening net worth (Total Assets minus Total Liabilities).

Income and Expenditure Account

The revenue account of a service business that matches earned income against incurred running costs to establish net profit or loss for the trading year.

Accruals Concept

The fundamental accounting rule requiring revenues and expenses to be matched to the financial period in which they are earned or incurred, regardless of cash movement timing.

Fees Due

Professional income earned for services completed during the year but not yet collected from patients or insurers at the balance sheet date; classified as a current asset.

Fees Received in Advance

Cash received from patients for treatments scheduled in the following year; treated as a current liability because the service obligation remains unfulfilled.

Supplies Consumed

The cost of operational consumables used up in delivering services during the year: Opening Stock plus Credit Purchases minus Closing Stock.

Drawings

Cash or practice resources withdrawn by the owner for private personal use; deducted from owner's capital in the Balance Sheet and never treated as an expense.

Capital Employed

The total long-term funding invested in the business: Closing Capital plus Long-Term Liabilities (Commercial Loans and Mortgages).

ROCE

Return on Capital Employed: operating profitability expressed as a percentage: (Net Profit + Loan Interest) / Capital Employed × 100.

Interest Cover

A solvency ratio measuring how comfortably operating profit covers annual loan interest: Net Profit before Interest divided by Annual Loan Interest.

Gearing

The proportion of long-term business funding made up of fixed-interest debt: (Long-Term Debt / Capital Employed) × 100.