01 Accounting Principles

Question 1

Name some different types of business structure.

Answer 1

1. Sole-Trader
2. Partnership
3. Limited Liability Partnership (LLP)
4. Private company limited by shares (Limited or Ltd)
5. Public Limited Company (PLC)

Question 2

What’s the difference between a sole-trader and a partnership?

Answer 2

• Sole-Trader - run your own business as an individual (although do not need to work alone), meaning you are personally responsible for any losses the business makes and must pay income tax on any profits
• Partnership - business is run by more than one partner, who all share personal responsibility for the business and must pay income tax on their share of any profits

Question 3

What is an LLP and how does it differ from a partnership?

Answer 3

Limited Liability Partnership (LLP):

• Like a partnership but creates a separate legal entity so partners are not personally responsible for the business
• The LLP itself has no tax liability, so partners must still pay income tax on any profits

Question 4

What does it mean if a company has ‘Ltd.’ at the end of its name?

Answer 4

Private company limited by shares (Limited or Ltd):

• Allows for private shareholders, which it grants full limited liability to (i.e. separates the company’s liabilities from shareholders’ personal liabilities, as the company is a separate legal entity)
• Any profit it makes is owned by the company, which can be shared between shareholders but only after it pays corporation tax (see below)

Question 5

What does it mean if a company has ‘PLC’ at the end of its name?

Answer 5

Public Limited Company (PLC):

• A limited company that wants to sell shares to the public (must have an initial share capital of at least £50,000 of which at least 25% must be paid up on incorporation)

Question 6

What are the requirements for a company to produce financial statements?

Answer 6

• Companies Act 2006 - all limited companies and limited liability partnerships must produce a balance sheet and profit and loss statement at the end of each financial year (submitted to HMRC, Companies House and all shareholders)
• Self-employed sole traders and most other partnerships do not, however it is good practice to do so anyway

Question 7

Why is it beneficial to keep accurate financial statements?

Answer 7

1. Advantageous to keep adequate records to complete self-assessment tax returns accurately
2. Advantageous if a company is seeking investment, as most institutions will ask to see three years’ accounts

Question 8

What are the benefits of being able to interpret company accounts?

Answer 8

1. Assess the financial strength of your own business
2. Assess the financial strength of tendering contractors
3. Assess competition (accounts for limited companies and LLPs can be accessed via Companies House)

Question 9

What is the difference between management and financial accounts?

Answer 9

• Management accounts - for internal use by the management team
• Financial accounts - company accounts that are required by law

Question 10

What is a balance sheet?

Answer 10

• A snapshot of a company’s financial status at a particular point in time
• Details the company’s assets, liabilities and equity as of a particular date (A = L + E)
  
  • Assets - cash, buildings, equipment, prepaid insurance, prepaid rent etc.
  • Liabilities - wages, loans, interest, taxes etc.
  • Equity = assets - liabilities
• Will always balance since a company has to pay for all things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing equity)

Question 11

If you were checking the financial standing of a contractor, what would its balance sheet tell you about the company?

Answer 11

• All revenues the company generates in excess of its liabilities will go into the equity account, which represents the net worth of the company
• Helps investors get a sense of how healthy a company is by assessing what the company owns and owes, as well as the amount invested by shareholders

Question 12

What is a profit and loss statement?

Answer 12

Measures a company’s financial performance by summarising the revenues and expenses incurred over a specific period, thus showing the net profit or loss for that period

Question 13

What sections is a profit and loss statement divided into?

Answer 13

1. Operating - revenues and expenses that are a direct result of regular business operations (e.g. fees earned and salaries paid through offering the business’s service)
2. Non-operating - revenues and expenses that are not tied directly to regular business operations (e.g. selling some old equipment or a building)

Question 14

If you were checking the financial standing of a contractor, what would its profit and loss statement tell you about the company?

Answer 14

Shows investors how profitable a company is by assessing its ongoing revenues and expenses (i.e. the more money the company earns and the less it has to spend, the more profitable it is)

Question 15

What is the difference between a balance sheet and a profit and loss statement?

Answer 15

The main difference between a P&L statement and a balance sheet is time - a balance sheet summarises the financial position of the company in one specific point in time, whereas a P&L statement shows revenue and expenses over a set period of time

Question 16

What is a cash flow statement?

Answer 16

Shows the movement of cash into and out of a business - when cash inflows exceed cash outflows, it is a sign of good financial health

Question 17

What areas is a cash flow statement divided into?

Answer 17

1. Operating activities - cash received or spent as a result of a company’s business activities (e.g. sales, wages etc.)
2. Investment activities - payments made to acquire long-term assets and cash received from their sale
3. Financing activities - cash received through debt or paid out through debt repayments (e.g. issuing stock, paying off loans, repurchasing shares etc.)

Question 18

What is the purpose of a cash flow statement?

Answer 18

Helps investors see if a company is having trouble with cash, which may not be readily identifiable in the balance sheet and profit and loss statement

Question 19

What procedures will a business implement to help maintain a positive cash flow?

Answer 19

1. Ensure income is well managed and regularly collected
2. Consider obtaining credit from a bank or other investors
3. Set aside emergency reserves to cushion any unexpected events

Question 20

How does revenue expenditure differ from capital expenditure in business accounts?

Answer 20

• Capital Expenditure - a one-off amount spent to acquire or improve a fixed asset, e.g. equipment, buildings etc.
• Revenue Expenditure - a recurring expense that helps to maintain (rather than improve) the business, e.g. repair costs
• Revenue expenditure is fully tax-deductible when calculating taxable profits, whereas capital expenditure is not

Question 21

Do all business accounts have to be audited?

Answer 21

• Companies Act 2006 - business accounts require auditing except when the company is classed as ‘small’ (i.e. where 2 of the following criteria are met for 2 years running, or 1 year if it’s within the company’s first accounting period):
  
  • Turnover < £6.5m
  • Total assets < £3.26m
  • Employees < 50
• However, bank/investors may require audits regardless

Question 22

What is VAT?

Answer 22

Value Added Tax (VAT) is a tax on consumption paid by registered companies to HMRC and is levied on most goods and services

Question 23

Outline the different VAT rates applicable to building work.

Answer 23

1. Standard rate - 20%
2. Reduced rate - 5%
3. Zero rate - 0%
4. Exempt
5. Outside - goods and services supplied by unregistered suppliers

Question 24

Outline a typical scenario where the VAT on construction work is zero rated.

Answer 24

Includes building services for disabled people, construction and sale of new domestic buildings

Question 25

Outline a typical scenario where the VAT on construction work is reduced rated.

Answer 25

Includes energy saving materials installed permanently in residential/charity premises, renovating a dwelling that has been empty for at least 2 years

Question 26

Outline a typical scenario where the VAT on construction work is exempt.

Answer 26

Includes commercial land and buildings (selling/leasing/letting)

Question 27

When must a company be VAT registered?

Answer 27

A company must be VAT registered if its annual taxable turnover exceeds £82,000 (2015 figure)

• NB: ‘taxable turnover’ includes zero-rated goods/services, but not those that are exempt or outside the scope of VAT

Question 28

How is VAT collected by HMRC?

Answer 28

Each quarter, all VAT registered businesses must submit their VAT returns online to the HMRC and settle any outstanding tax liabilities:

• Output tax - the amount of tax a company has charged customers/clients
• Input tax - the amount of tax a company as paid for purchases made
• The difference between the two is either paid to HMRC or reimbursed by HMRC

Question 29

Explain the principles behind capital allowances?

Answer 29

Allow a business to claim tax relief on capital purchases that form part of the service it offers, e.g. equipment, machinery, business cars etc.

Question 30

What is corporation tax and what are the current rates?

Answer 30

• Tax paid on company profits
• Current rate is 20%, however previously the rate depended on the size of the profit

Question 31

What is landfill tax and how is it calculated?

Answer 31

• Tax on top of normal landfill fees if a business gets rid of waste using landfill
• Charged by weight and the amount depends on the rate:
  
  • Lower rate - £2.60 per tonne (for ‘inactive waste’ such as rocks and soil)
  • Standard rate - £82.60 per tonne (all other waste)
• Aims to deter businesses using landfill and encourage recycling where possible

Question 32

What is aggregates levy and what is its current rate?

Answer 32

• Tax on sand gravel and rock that has been either:
  
  • Dug from the ground
  • Dredged from the sea in UK waters
  • Imported
• Currently £2 per tonne
• Aims to promote the use of recycled aggregates

Question 33

What is stamp duty and when does it apply?

Answer 33

• Tax payable when buying property or land over a certain price in England, Wales or N. Ireland
• Amount depends on the value (different thresholds at different rates) and whether the land/property is residential or non-residential/mixed-use
  
  • NB: current rates on gov.uk