Accounting Principles Flashcards
GAAP
Generally Accepted Accounting Principles
Common set of accepted accounting principles, standards and procedures
Aims to improve clarity of communication of financial information
10 principles of GAAP
- Regularity
- Consistency
- Continuity
- Sincerity
- Non-compensation
- Prudence
- Permanence
- Periodicity
- Good faith (materiality)
- Utmost good faith
International Accounting Standards
- older accounting standards
- replaced by IFRS in 2001
IFRS
International Financial Reporting Standards
Why did IFRS replace IAS?
- aim to make it easier to compare businesses around the world
- aim to increase transparency and trust in global reporting
IFRS 16
- effective 1 January 2019
- lease accounting standard
- requires lessee to recognise assets and liabilities for leases with term of more than 12 months
- IFRS reporter must recognise, measure, present and disclose leases
What is the objective of IFRS 16?
- report information that represents lease transactions
- ensures leases are placed on balance sheets
What is the result of IFRS 16 financial reporting?
- increase in assets, liabilities and net debt where leases are brought into balance sheet
- can affect accounting ratios which can impact companies attractiveness to investors
- provides transparency on companies lease assets and liabilities
What governs the format of company accounts?
Companies Act 2006
What is included in company accounts as laid out in Companies Act 2006?
- cover page
- information and contents
- directors report
- accountants report
- profit and loss account
- balance sheet
Profit and Loss Account
- gives summary of business income and expenditure transactions on annual basis
- shows overall profit / loss figure at the bottom
Taxation
The amount of money owed to HMRC based on company profit
Directors Remuneration
How directors are paid for their services (salary, fees or dividends)
Gross Profit
Turnover - cost of sales
What can be determined from Gross Profit?
- not a lot in isolation
- can compare to previous year to see what direction the company is heading in
Depreciation
Reduction in value of asset over time
- EG due to wear and tear
Amortisation
Reduction in value of intangible asset over time
- EG spreading out loan payment over time
Depreciation v Amortisation
Depreciation - fixed assets
Amortisation - intangible assets
Balance Sheet
Statement of businesses financial position showing assets and liabilities at given date (usually financial YE)
Only statement that applies to single point in time in business’ calendar year
What are assets on the balance sheet?
What the company owns
EG cash, property, other investments
What are the two types of asset?
Fixed asset - land, factory
Current asset - stock, cash in bank
What are liabilities on balance sheet?
What a company owes to others
EG overdrafts, loans, borrowings
What are the two types of liability?
Long term - not due to be repaid in next year
Current - due to be repaid within the year
What can be concluded from the balance sheet?
- whether company is solvent
- how likely it is the company will still be in business in a year
Liquidity Ratio
Financial ratio used to determine company’s ability to pay its short term debt
Current Assets dived by Current Liabilities
How is the liquidity ratio interpreted?
- figure of 1 means company can exactly pay off current liabilities
- figure less than 1 means unable to pay off current liabilities
Net Asset Value
Total Assets - Total Liabilities
- simple way to establish company worth
- frequently shown as NAV per share
Three parts of balance sheet
- Assets
- Liabilities
- Ownership Equity (what remains after doing Assets - Liabilities. AKA Net Worth or Net Asset Value)
What is the difference between Assets and Liabilities known as?
- Equity
- Net Asset Value
- Net Worth
- Capital
Cash Flow Statement
Financial statement that summaries movement of cash into and out of a company
Why is cash flow statement believed to be most intuitive of all financial statements?
Shows how well company is managing cash and growth
Credit Rating
- assessment of organisations creditworthiness based on previous dealings
- shows ability of organisation to fulfil financial commitments (EG pay rent)
Main commercial credit rating agencies?
- Dun and Bradstreet
- Standard and Poor (S&P)
Why do companies keep accounts?
- regulatory purposes
- useful to see outgoings and incomings
- can compare year on year
What are the two parts of a Dun & Bradstreet rating?
- Risk indicator (1 - 5 where lower is better)
- Financial strength indicator (A - E where A is better)
Overall, helps identify organisations likely to fail or pay late
Tenant Covenant Strength
Tenant ability to comply with covenants laid out in lease
Revenue
Income generated by the sale of products or services
Capital Expenditure (CAPEX)
Money spent by a business or organisation on acquiring / maintaining fixed assets (EG buildings, land, equipment)
Financial Audit
An objective examination and evaluation of financial statements to ensure they are fair and accurate
Ratio Analysis
Method of gaining insight into company’s liquidity, efficiency and profitability by studying financial statements
Profitability Ratio
Shows how well company can generate profit from its operations
Solvency Ratio
Compares company debt against assets, equity and earnings to conclude whether company is solvent and whether they can pay their debts
Efficiency Ratio
Evaluates how efficiently a company uses its assets to generate sales
Credit Control
Process of ensuring debtors do not take too long to pay you
Profitability
Determines company profit in relation to the size of the business
VAT
Value Added Tax
- consumption tax on goods and services
- standard rate is 20% but can be reduced rate of 5% or zero rate
Where do you find information on company’s assets?
On the balance sheet
Are profit and loss accounts current?
No, they are retrospective
Management Accounts
- financial reports produced for owners/managers either monthly or quarterly
- includes profit and loss statement and balance sheet
- less formal than year end accounts
Company Accounts
- documents produced at year end for each company (YE differs)
- shows performance over account period
- legally required from all companies under Companies Act 2006
When must company be VAT registered?
- if company total VAT taxable turnover for last 12 months was £85k
Or
- if turnover expected to go over £85k in next 30 days
EBITDA
Earnings Before Interest Tax Depreciation and Amortisation
Note: it is a measure of company profitability
What does it mean if company goes into administration?
company becomes insolvent and is out under management of insolvency practitioners
Insolvency
Individual can no longer meet financial obligations so debts become due
- occurs due to reduced cash flow / increased expenses
Bankruptcy
- person can no longer meet debt payments
- liquidate assets to pay debts or make payment plan
Receivership
- court appointed tool to protect a company
- receiver steps in to manage company, assets and all financial decisions
Liquidation
- assets used to pay off debts
- three types:
1. creditors voluntary liquidation
2. compulsory liquidation
3. members’ voluntary liquidation
Why do surveyors need to be able to interpret company accounts?
To assess covenant strength of tenants
Where do you find information on a companies financial status?
Companies House
Limitations Act 1980
- outlines time within which creditor can chase debtor for outstanding debt
- only applies when no contact made between creditor and debtor within given time limit
Misappropriation of funds
Someone entrusted with managing money steals it for personal gain
Financial Bond
Fixed income instrument that represents loan made by investor to a borrower
3 tests of insolvency
- Cash Flow Test - check if able to pay bills in near future
- Balance Sheet Test - check if assets are greater than liabilities
- Legal Action Test - check if legal action has been taken against business for debt of £750 or more
What are consequences of insolvency?
- business may go into liquidation and stop trading
- business may go into administration and be sold
Statutory Profit
Company’s earnings calculated according to U.K. GAAP
Invoice v Application for Payment
Invoice - VAT payable once invoice generated
Application for Payment - VAT payable once gross payment received, and then VAT receipt generated
Why do clients prefer Application for Payment over an Invoice?
Means they only have VAT liability for rents paid, rather than all rents charged
Note: if you raise invoices, you have VAT liability in rent even if not been paid (if never paid, can claim back VAT retrospectively but not ideal)
How do you determine covenant strength?
- profit and loss account
- cash tenant is holding in bank
- look at management accounts (more up to date than company accounts)
- independent financial reports EG Dun and Bradstreet
Creditors
People the company owes money to
Acid Test Ratio
Take current assets, remove value of stock (hard to shift in emergency) and divide by current liabilities
Considered to be best test of company short term viability
Intangible Assets
Things you cannot sell EG copyright or patents
Balance Sheet Example
ASSETS:
- Current: cash, supplies, prepaid expenses
- Fixed: property, equipment, land
- Intangible: goodwill
LIABILITIES:
- Current: rent, salaries, tax
- Long term: mortgage, purchase agreements (EG car due over 10 years)
STOCKHOLDERS EQUITY:
- Common Stock
- Retained Equity
Profit & Loss Example
INCOME:
- sales, services, other
EXPENSES
- advertising, electricity, insurance, rent, salaries, vehicles
OVERALL PROFIT/LOSS
How is VAT dealt with in respect of rent demands?
use application for payment rather than an invoice
RPI v CPI
former tends to be higher as it is a broader measure and considers housing costs too
