8 Debt finance and business accounts Flashcards
1
Q
how long is an accounting period?
A
a full year
2
Q
what are the financial statements prepared in respect of each accounting period?
A
- profit and loss account
- balance sheet
3
Q
What are book-keeping ledgers?
A
The process by which businesses record money transactions
4
Q
What is double entry book-keeping?
A
Every money transaction that a business undertakes will have a dual effect in its accounts.
For example, if a sole trader purchases an asset for £5,000, there will be a reduction of £5,000 in the record of its cash and an increase of £5,000 in the record of the assets of the business.
5
Q
What is a trial balance? and what does it show?
A
A trial balance is a list of all the balances on all of a business’s ledgers/accounts as at the end of an accounting period.
The trial balance shows debit balances in one column and credit balances in another column. The total of each of the two columns should be the same.
6
Q
ALCIE ledger on the trial balance
A
Assets
Liabilities
Capital
Income
Expenses
7
Q
Another term for fixed assets
A
non-current assets
8
Q
What do current assets include?
A
cash and items owned by the business (or owed to the business) which can quickly be turned into cash
9
Q
Examples of current liability
A
Bank overdraft (repayable on demand)
Trade creditors (such as suppliers of raw materials).
10
Q
Example of non-current liability
A
Term loan
11
Q
What do expense accounts record?
A
day-to-day spending
12
Q
Purpose of Year-end adjustments
A
to ensure that all income and expenditure shown on the final financial statements relate only to the relevant accounting period.
13
Q
What does the profit and loss account record?
A
The income of a business throughout an accounting period minus expenses incurred in that period, to arrive at a profit (or a loss) figure for the period.
14
Q
What does the balance sheet record?
A
The position of a business in respect of its asset, liability and capital accounts from the trial balance.
15
Q
Why does a balance sheet differ from a profit and loss account?
A
The balance sheet of a business differs from a profit and loss account as it is a snapshot relevant on a given date (unlike the profit and loss account which relates to a period, which in most cases is a year).
The date at the top of a balance sheet is the last day of the accounting period to which it relates. The heading of a balance sheet always contains the words ‘as at’ a specified date.
The balance could be different the very next day, for example, if an asset were sold and the proceeds used to pay bills.
16
Q
Contents of a balance sheet
A
The net worth or net asset value (NAV) of the particular business (ie the value of the assets it has, less the liabilities it owes). This is recorded in the top half of the balance sheet.
AND
The capital invested in the business to achieve that net worth. This is recorded in the bottom half of the balance sheet.
these two figures will always be the same
17
Q
What are year-end adjustments?
A
transactions or modifications to the account entries on the trial balance.
18
Q
what are the five year-end adjustments?
A
- Depreciation
- Accruals
- Prepayments
- Bad debts
- Doubtful debts
19
Q
What is depreciation?
A
A mechanism used in the accounts to deal with a decline in value and to spread the cost of the asset over its useful life.
20
Q
What are the 2 methods of depreciation
A
- the straight line method
- the reducing balance method
21
Q
How is the straight-line method used?
A
- spreads the depreciation charge evenly over the life of the asset
- gives rise to the same charge for depreciation each year.
- the straight-line method is used where the service provided by the asset continues throughout its useful economic life on a consistent basis
22
Q
How is the reducing balance method used?
A
- The depreciation charge each year is expressed as a percentage (x %) of the reducing balance (ie the net book value of the asset at the start of the relevant accounting period).
- More depreciation is thus charged in earlier years than in later years since the net book value of the asset reduces year on year.
23
Q
When would the reducing balance method be used?
A
where an asset is likely to lose a large part of its value in the first few years of ownership eg motor vehicles.
24
Q
What is the net book value and how is it calculated?
A
It is an estimate of the current value of the asset to the business
calculation:
NET BOOK VALUE =
COST – ACCUMULATED DEPRECIATION
25
What is an accrual?
Occurs when a business has had the benefit of something in one accounting period but will not pay for it until the next.
لم يكن موجود بالحساب وبعدين ينحط ورة سنة
26
What is a prepayment?
A prepayment arises when an expense is paid for in the current year but all or part of the cost should be charged as an expense next year.
It occurs when a business has paid for something in advance during one accounting period but does not get the benefit of all or some of what it has paid for until the next.
27
What is a bad debt?
A debt is a 'bad debt' when a business knows with certainty that it is never going to receive it.
The debt is therefore removed from the 'Receivables' entry in the accounts as it will not be paid.
28
What is a doubtful debt? How does it differ from a bad debt?
A doubtful debt occurs when a business is providing for the possibility that a debt or debts may not be paid.
A doubtful debt differs from a bad debt in that the business is not writing off the debt completely. It is just making sure that the accounts accurately reflect the fact that the business may not receive all of the money owed to it.
29
What are the two ways of 'being doubtful' about debts?
Specific and general doubtful debts
SPECIFIC - A business may know that a particular debtor is in trouble financially or is disputing its liability to pay the debt.
GENERAL - A business may not have any information on a specific debtor but knows that the market generally is not doing well and wants to make a general provision for a certain percentage of its debtors not to pay
30
How can a business quantify its doubts and express them as an actual figure?
Show the figure as the 'Provision for Doubtful Debts'
The amount allocated to the provision for doubtful debts account is set afresh at each year-end. It might increase, reduce or stay the same compared with the previous year’s provision.
31
How is the provision for Doubtful Debts treated on the Balance sheet?
as a liability, and is matched to the asset is most directly affects, the receivables asset account
32
How do partnerships correctly show their capital on the Balance Sheet?
Prepare a profit appropriation statement.
This records how the profits of the business for the relevant accounting period are divided between the partners.
33
In partnerships accounts, what are 'Drawings'?
withdrawals of profit by the partners during the year, to pay themselves - based on the estimate of the partner's share of expected profits for the year.
if they draw too much, they could be liable to contribute a balancing payment back to the partnership.
34
What are the 2 accounts for partners within a partnership?
CAPITAL account - for long-term capital.
Represents the partner's original investment in the partnership. This cannot be withdrawn in normal circumstances.
CURRENT account - for capital that can be withdrawn at the partner's discretion.
Records the partner's share of the ongoing business profits.
35
What is a company's accounting reference date (ARD)?
the last day of the month in which the anniversary of its incorporation falls
36
What is different about company accounts?
1. Capital accounts: the bottom half of the balance sheet
- the capital consists of share capital, reserves and retained earning
2. Tax
- partnerships and sole traders do not have to pay tax because they do not have a operate legal personality
- tax in the statement of tax os corporation tax
3. Dividends
- Shareholders' return on their investment is the dividend that they may receive
- like drawings that a sole trader takes from their business, a dividend is an appropriation of profits (after tax)
37
How will dividends appear in a financial statement?
Statement of equity
- they are transactions between the company and its shareholders
38
What does the bottom half of a company's balance sheet show?
EQUITY - will balance with the top half of the balance sheet (the Net Asset Value)
39
What is the Called up share capital
the amount of the nominal value of its shares that the company has required its shareholders to pay
40
A newly-incorporated company has issued 200,000 ordinary shares of £1 and has called up 75p per share. The value of the called-up share capital in the company’s Balance Sheet will therefore be....
£150,000 (200,000 shares x 75p)
41
What are Reserves and what categories can they be split into?
Capital of the com many in excess of the called up value of the issued share capital.
categories:
- CAPITAL reserves (eg share premium account, revaluation reserve, capital redemption reserve)
- REVENUE reserves (eg retained earnings)
42
What does the share premium account represent?
the difference between the nominal value of the shares and the amount that the shareholders actually paid for the shares ie the subscription price
43
What is a Revaluation reserve?
created when a company's directors wish to show more up to date values on non-current assets in the accounts
44
What are Retained Earnings?
the reserve account for retained profits
- they represent profits after tax earned by the company over its history and not distributed by way of dividend or appropriated to another reserve
45
Where is the profit/retained earnings of the year carried out on the Balance Sheet
Statement of Changes in Equity (the SoCiE) - Bottom half/
NOT the profit and loss account
46
Two types of dividend that can be paid on ordinary shares (ordinary dividends)
- the FINAL dividend - declared after the year end and paid some time thereafter
- the INTERIM dividend - paid during the current accounting period
47
What is a final dividend that has been approved by the shareholders called?
A declared dividend
- constitutes a debt of the company enforceable by the relevant shareholders
48
Is an unpaid interim dividend a debt?
no
- interim dividends will only be reflected in a company's accounts if they have actually been paid.
49
Meaning of debt finance
alternative option to raise finance - borrowing money from a bank or other lenders
50
Difference between 'debt security' and 'security for a debt'
debt security is a type of debt
security for debt - something that the lender will take over the assets of the borrower in order to protect their interests.
51
Two classifications of the types of debt finance
Loan facilities and debt securities
52
What is a loan facility?
an agreement between a borrower and a lender which gives the borrower the right to borrow money on the terms set out in the agreement.
53
What is an overdraft and under which classification of debt finance does it fall under?
- when the bank can call for all of the money owed to it at any point in time and demand that it is repaid immediately
- LOAN FACILITY
54
What is a term loan and under which classification of debt finance does it fall under?
a loan of money for a fixed period of time , repayable on a certain date. the lender cannot demand early repayment unless borrower has breached terms of agreement
- LOAN FACILITY
55
What is a Revolving credit facility and under which classification of debt finance does it fall under?
- a loan of money for a specified period of time, but unlike a term loan, the borrower can repeatedly borrow and re-pay loans up to the agreed maximum amount
- LOAN FACILITY
56
What are debt securities?
a means by which the company receives money from external sources.
57
What are convertible bonds?
bonds which can be converted into shares in the issuer.
- the issuer issues shares to the bondholder in return for its agreement to give up its rights to receive interest and repayment of the principal amount invested
58
What are preference shares?
shares of a company's stock with dividends that are paid out to shareholders before common stock dividends are issued.
Often called an equity hybrid
59
The main debt finance documents
1. Term sheet
- statement of the key terms of the transaction agreed by the lender and borrower (eg loan amount, interest rate etc)
2. Loan agreement
- sets out the main commercial terms of the loan such as amount of interests, dates on which interest will be paid etc.
3. Security document
- if a loan is secured, a separate security document will be negotiated.
4. Debenture
- name of particular doc which creates a security
- covers any form of debt security issued by a company, including debenture stock, bonds and any other securities of a company
60
important terms in loan agreements
- Representations - statements of fact as to legal and commercial matters made on signing of the loan agreement
- Undertakings - promised to do or not to do somethings
- Event of default - breach of representations and undertakings gives bank contractual remedies where the breach constitutes an event of default
61
What is Security?
temporary ownership, possession or other proprietary interest in an asset to ensure that debt owed is repaid
62
Pledge
form of security
- the security provider (usually borrower) gives possession of the asset to the creditor until the debt is paid back.
63
Lien
form of security
- the creditor retains possession of the asset until the debt is paid back
64
mortgage
form of security
the security provider retains possession of the asset but transfers ownership to the creditor
65
Charge
form of security
- the security provider retains possession of the asset. However, rather than transferring ownership, a charge simply involves the creation of an equitable proprietary interest in the asset in favour of the creditor.
66
Fixed charges
type of charge
- the creditor can control what the security provider can do with the fixed charge assets - normally taken over assets such as machinery and vehicles
67
Floating charges and meaning on crystallisation
type of charge
- a security over a group of non-constant assets that change in quantity and value.
- crystallisation - the floating charge stops floating and fixes to the assets in the relevant class which are owned by the security provider at the time of crystallisation.
68
Disadvantage of floating charges
- might be sold by security provider before crystallisation occurs
69
Guarantee for a loan
not a security
- an agreement that the guarantor will pay the borrower’s debt if the borrower fails to do so.
70
Who are the charges registered with?
Companies House
71
Time limit for registering charges
within 21 days beginning with the day after the day on which the charge is created
72
Which form details the particulars (of registering charges)?
Form MR01
73
Effect of failure to register
- charge is void against a liquidator and any creditor of the company
- debt becomes immediately payable
74
Difference between equity and debt finance on the Balance Sheet
EQUITY
- both the net asset value of the company will change AND the total equity
DEBT
- the net asset value of the company will not change as a result of the loan and the equity will not change
75
Equity finance: effect on the Balance sheet
1. increase share capital (bottom half of the balance sheet) - to show the nominal value of the shares issued to the shareholders
2. Increase the cash (current assets: top half) - to show the cash received for the shares issued to the shareholder
76
How is the price of a share calculated?
by working out the value of the company as a whole and diving it between the number of shares in issue
- this will give the value per share, which can be used to help determine the price
77
price of a share will comprise of
nominal value plus a premium
78
Earnings per share meaning and how is it calculated
shows the return due to the ordinary shareholders
and is calculated by dividing profit after tax by the average number of ordinary shares in issue whilst the profit was generated
79
Gearing ratio
ratio of debt to equity, indicator of a company's financial health
- the higher the ratio of debt to equity the more highly the company is geared
80
Formula for gearing ratio
Long-term debt (Non-current liabilities) x 100%
_____________________________
Equity (Total Equity)
81
TRUE OR FALSE
When lending, a bank’s primary concern will be to obtain for itself the most favourable interest rate possible.
FALSE, the main concern is that it is paid interest in amount it has lent in full and on time.
82
TRUE OR FALSE
There is little a bank can do to protect itself against the risk of the borrower not being able to meet loan repayments, apart from suing the borrower for any unpaid debt.
FALSE, could enforce security + loan agreement for any unpaid debt.
83
TRUE OR FALSE
The fact that the bank can seek recovery of its loan out of the sale proceeds of the secured assets is a central feature of what is known as ‘security’ in a debt finance context.
TRUE, if u take security over assets u take priority over all assets.
84
What type of security is a property?
Charge by way of legal mortgage
85
What type of security is a vehicle?
Fixed charge
86
What type of security is stock?
Floating charge
87
What type of security is cash in the bank?
Floating charge
88
What type of security is plant and machinery?
Fixed charge
