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Revision Notes > Accounting Principles and Procedures > Flashcards

Accounting Principles and Procedures Flashcards

1
Q

Why is important that a QS understands accounting principles?

A
  • Better understand how your business works in terms of making sure your projects are profitable
  • Better understand how your client’s businesses work
  • You would need an understanding if you wanted to set up your own firm
  • Understand how to review a contractor’s credit check and why it’s important
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2
Q

What are the basic concepts of accounting?

A
  • Annual accounts
  • Profit & loss
  • Balance sheet
  • Cashflow
  • Audit set out by company law
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3
Q

What is a profit and loss statement?

A
  • What? - Shows a companies revenues and expenses over a period of time
  • Represents - profit and loss over a period of time
  • Preparation - Prepared for the financial year
  • Shows - Income and expenses
  • Sequence - prepared before balance sheet
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4
Q

What is a balance sheet?

A
  • What? - Shows a snapshot in time of a companies assets, liabilities and equity
  • Represents - financial position on a particular date
  • Preparation - On last day of financial year
  • Shows - Assets, liabilities and equity
  • Sequence - After production of P & L
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5
Q

What are annual accounts?

A
  • What? - A detailed report on a companies activities / financial performance
  • Represents - Comprehensive report on activites / financial performance
  • Preparation - End of financial year
  • Shows - Balance sheet, P&L, directors report
  • Sequence - Prepared after P&L and balance sheet
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6
Q

What would you expect to see in an account submitted to companies’ house?

A 
•	Director’s report
•	Auditors report
•	Financial Statement
      o	  Balance Sheet
      o	  Cashflow
      o	  Profit & Loss
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7
Q

What is a Financial Statement?

A

• A formal record of the financial activities of a business / or person during a period of time.

• Includes:
     o 	Balance Sheet
     o 	Profit & Loss Report
     o 	A statement of changes in equity
     o 	Cashflow statement
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8
Q

What is a Director’s Report?

A

• Statutory account that must be filed at the end of financial year by large companies
o All Private limited companies,
o Companies with turnover of more than
£10.2mil, £5.1 million on balance sheet or
more, 50 employees or more
• Includes name of each director
• Includes a summary of trading, future prospects

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9
Q

What are Retained Earnings?

A

Profit which is kept within the business to support further growth and not transferred out to owners or investors.

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10
Q

What are Dividends?

A

a portion of a company’s profit which is returned to the investors or owners

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11
Q

What are the two main types of expenditure?

A
  • CAPEX - upfront costs

- OPEX - day to day costs

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12
Q

How often are balance statement to be provided?

A

At least once a year to companies house

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13
Q

What is an asset?

A

A resource with economic value that an individual, corporation or country own or controls with the expectation that it will provide a future benefit

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14
Q

Current Asset

A
  • Short term economic resources that are expected to be turned into cash within 1 year
  • Includes cash, cash equivalents, accounts receivable, inventory and various pre-paid expenses
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15
Q

Fixed asset

A
  • Plant, equipment and buildings
  • Depreciation can be included as an adjustment for ageing a fixed asset
  • Straight line method assumes asset loses its value in proportion to its useful life
  • Accelerated method assumes the assets loses its value faster in the first few years of use
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16
Q

Financial Asset

A

Represent investment in the assets and securities of other institutions (e.g. stocks, sovereign, corporate bonds, preferred equity)

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17
Q

Intangible Asset

A

Assets that have no real physical value e.g. (patents, copy right, trademarks)

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18
Q

Liquid Asset

A

An asset that can be converted into cash in a short time with little to no loss in its value.

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19
Q

How is Liquidity assessed?

A
  • Assessed using the Quick Ratio. Aka Acid Test.
  • This measures the ability of a business to use it liquid assets to pay up its current debts immediately.
  • The ratio between the liquid assets and current liabilities (debts).
  • A normal liquid ratio is considered to be 1:1. A business with a ratio of less than 1 cannot currently pay off its current liabilities (debts).
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20
Q

What is a Liability?

A

Debts and potential debts of the company

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21
Q

What is a Statement of Changes in Equity?

A

The reconciliation of the beginning and ending balances in a business’s equity during a period of time. i.e. how much equity the business started the period with and the equity it ends with.

(Beginning Equity + Net Income) – Dividends = Ending Equity

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22
Q

What is a Cashflow Forecast?

A
  • Shows how cash has been generated and how it is spent by a business
  • Ability to pay all liabilities when required
  • Forward looking plan when costs will arise
  • Use of organised financial obligations in the next period and can see where there will be difficulties
  • Allow the client to secure funds for period
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23
Q

What is the purpose of a Cashflow?

A
  • Organisational cash flow
  • Project cash flow
  • Contractor cash flow
  • Ensures liabilities will be met, used for obtaining funding, assurance to stakeholders
24
Q

What is a Financial Account?

A

The main purpose of financial accounting is to prepare financial reports that provide information about a firm’s performance to external parties such as investors, creditors and tax authorities

Examples include BS and P&L

25
Q

What are the 2 reporting standards that are used in the UK?

A

International Financial Reporting Standard (IFRS)

UK GAAP (Generally Accepted Accounting Practice)

26
Q

What is a Management Account?

A

Are prepared for internal use by a business and are not audited

27
Q

What is Equity?

A
  • Difference between the value of an asset and the value of the liabilities
  • E.g. if you have an asset (a car) worth £15k but owe £5k against a loan for the car. The car represents £10k equity
28
Q

VAT (Value added Tax)?

A
  • Contract sum is exclusive of VAT
  • VAT is paid by the employer on submission of a VAT invoice by the contractor following each interim certificate
  • Standard = 20%
  • Reduced = 5% (conversion or renovation work on some types of residential buildings)
  • Zero rated = 0% (new houses, dwellings and buildings with a charitable purpose)
  • Exempt = no VAT
  • VAT is “Recoverable” or “Irrecoverable”
29
Q

Debtor Days

A
  • Ratio measures how quickly cash is being collected from debtors. The longer it takes for a company to collect, the greater the number of days debtors.
  • Debtor days are a measure of the average time payment takes
30
Q

Lock Up Days

A
  • It is the amount of money you have tied up in work in progress and in debtors but expressed in days rather than cash
  • Suppose your turnover is £1million. That represents £2,740 per day (£1mil / 365 days). If you then had £100k in debtors and £500k in WIP, a total of £600k, you could divide this by £2,740 and show that you have 219 days of normal revenues “locked up” in your firm
31
Q

Work in Progress (WIP)?

A
  • WIP ledger represents either unchanged completed work or incomplete work. It is an asset to your firm
  • For cashflow and client service reasons the lower the WIP at the end of the month the better it is for both client and firm
32
Q

Company Accounts?

A

Is a set of documents prepared by an accountant showing incomes, expenses, assets, liabilities and profit and loss detail of a company

33
Q

Insolvency?

A
  • Is being unable to pay debts as and when they become due
  • Insolvency Act 1986 states there are 3 types:
    • Receivership - an administrative receive is appointed to realise the secure assets for the benefits of the creditors, duty to take possession of and sell the asset of the company and carry out the business of the company
    • Administration - administrator appointed by the court to make company solvent again, takes over management of the company
    • Liquidation - Legal process of selling assets and distributing funds to creditors and members
34
Q

What is Cash flow insolvency?

A

Cash flow insolvency is when an organisation has the funds but for example it is not readily available in the correct form. E.g. a person might own a house which is worth enough to pay the debt but will need to sell it first to obtain the money to pay a debt.

35
Q

What is Balance Sheet insolvency?

A

Is when a person or company does not have enough assets to pay all of their debts/liabilities. The person or company might enter bankruptcy, but not necessarily. Once a loss is accepted by all parties, negotiation is often able to resolve the situation without bankruptcy.

36
Q

What do you understand as administrative receivership?

A

Grants the ‘holders of floating charges’ power to appoint a receiver. Their duty is to fix the debt owed by disposing of assets. NOTE, much less common following Enterprise Act 2000.

An administrative receiver is authorised to take custody of the charged assets, run the company’s business and dispose of the assets, either piecemeal or as part of the sale of the business as a going concern, to satisfy the secured debt.

37
Q

What is an Administrative Order?

A

An order by a court appointing a person to manage a company that is in financial difficulty, in an attempt to ensure the survival of the company or achieve the best realization of its assets

The administrator sends formal proposals to each of the company’s secured creditors, and then a creditors’ meeting is held during which the creditors decide whether they approve of the administrator’s proposals.

38
Q

If Contractor goes Insolvent?

A
  • Contractor must notify employer in writing of the event of liquidation or insolvency
  • Client given option to terminate or to consider more constructive approach, Contractor might be able to turn it around, there may be little work left to do on site
  • Client can get contractor (under insolvency practitioners control) to finish remaining works
  • Client can novate contract to another contractor
  • Client can appoint a new contractor – this Is most likely option
39
Q

Early Warning Signs if contractor is going insolvent?

A
  • Sub contractor’s / Suppliers request payment directly from you
  • Contractor request early payment or additional funding
  • Contractor is worried about a shortage of work
  • Slow progress, decreasing activity on site, missed deadlines
  • Contractor’s employees complain about non payment of wages
  • Disappearance of equipment and materials
  • Rumours / Gossip
  • Parent Company (or other companies in the contractor’s group) show the above signs
40
Q

Steps to follow when contractor goes insolvent?

A
  • Secure the site
  • Accurate assessment of works completed
  • Interim valuation / notional final account / financial positions
  • List all unfixed materials on and off site and paid by the employer
  • Stop all payments to the contractor
  • Client is under no obligation to pay the contractor if liquidated
  • Check the works are still insured
  • If performance bond in contract, underwriters should be informed
41
Q

What Is Credit Control?

A

A system businesses or banks use to make sure they only give credit to customers who are able to pay, and pay on time.

42
Q

What is turnover and profit?

A

What is turnover and profit?

Turn Over
• Net sales generated by a business

Profit
• Residual earnings of a business

43
Q

What types of businesses / traders are there?

A
  • Self employed (Sole trader)
    • Must keep records of income and expenses for tax return
    • Must keep records of personal income
    • Traditional accounting or cash based accounting
  • Limited company
    • A company limited by shares or limited by guarantees
  • Business Partnership
44
Q

How often does a firm submit their tax returns?

A

Once a year to HMRC (April to April)

45
Q

Name some taxes that a business may pay?

A
  • Corporation Tax – Must be paid if you’re a limited company, foreign company with a UK branch or unincorporated. Tax on profits, usually 19%-17%
  • National Insurance Contribution (12 and 2%)
  • VAT (tax on goods and services)
46
Q

Revenue and capital expenditure

A

Capital Expenditure
• Major investment of capital that a company makes to maintain or expand its business to generate additional profit
• Includes (acquiring sites, equipment, manufacturing plant etc.)
• Companies are not allowed to recover the cost of the asset in the year the expense was made, they must recover this through year by year depreciation over the useful life of the asset.

Revenue Expenditure
• A cost that is charged to expense as soon as the cost Is incurred e.g. maintaining an asset, repairs
• Costs incurred to support current operations, they do not extend the life of the asset or improve it generating revenue

47
Q

What is Auditing?

A
  • The examination of the financial report of an organisation (presented in the annual report), by someone independent of that organisation.
  • The financial report includes a balance sheet, an income statement, a statement of changes in equity, a cashflow statement and notes comprising a summary of significant accounting policies and other explanatory notes.
48
Q

What is Ratio Analysis?

A
  • The comparison of line items in the financial statement of a business
  • Used to evaluate a number of issues with an entity such as liquidity, efficiency of operations & profitability
  • Useful for analysis outside of a business

Trend Line
• Calculate each ratio over a large number of reporting periods to see if there is a trend

Industry Comparison
• Calculate the ratios for competitors and compare the results

49
Q

What is Profitability?

A

Profit
• An absolute number determined by the amount of income or revenue above and beyond the costs or expenses a company incurs
• Appears on a company’s income statement

Profit = Total Revenue – Total Expenses

Profitability
• While profit is an absolute amount, profitability Is relative
• It Is the metric used to determine the scope of a company’s profit in relation to the size of the business
• Measurement of efficiency, if a business will be successful or fail

50
Q

What must you do when you charge VAT?

A
  • Charge the right rate of VAT
  • Work out the VAT if a single price is shown that includes or excludes VAT
  • Show the VAT information on your invoice
  • Show the transaction in your VAT account
  • Show the amount on your VAT return
51
Q

What does HMRC stand for?

A

Her Majesty’s Revenue & Customs

52
Q

What is the Corporation Tax rate?

A

Profit under £300k - 19%

Profit over £300k - 30%

53
Q

Difference between Profit & Profitability?

A
  • The profit is an absolute number which is equal to revenue minus expenses. If a company has £200 in revenue and £180 expenses, its profit is £20.
  • Profitability is a relative number (a percentage) and expresses the ratio between profit and revenue. Profitability = profit divided by revenue multiplied with 100.
  • In the above case, Profitability = £20 / £200 * 100 = 10%
  • So, you have £20 profit and a 10% profitability.
54
Q

What does Current Ratio mean?

A

The current ratio is the same as the quick ratio / acid ratio but includes for items which are not as quick to convert to cash. Using a current ratio can be the difference between determining whether a business could pay of its debts. As a quick ratio could be 0.8 (bad) but a current ratio could be 1.1 (able to pay debts).

55
Q

What are the key differences between Quick Ratio and Current Ratio?

A
  • Both ratios assess a company’s abilities to pay its debts by using cash and assets it can convert into.
  • Quick ratio uses cash and liquid assets which are items that can very quickly be converted into cash
  • Current ratio is the above but includes assets not so quick to convert to cash.
  • Another thing is that they both indicatively highlight how quick a company can pay its debts. If the quick ratio is over one then the company can pay its debts quickly. If it is below one it might not be able to pay its debts super quick at all.
  • If a current ratio is then over one, then the company can pay its debts but not as quickly as it will need to convert other assets into cash. This might be the only way to pay debts.
56
Q

Key financial legislation?

A
  • The Companies Act 2006
  • The Small Companies and Groups Regulations 2008
  • The Partnerships Regulations 2008

Revision Notes (10 decks)

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