Accounting Principles and Procedures

Question 1

What are the key financial statements that all companies must provide?

Answer 1

The key financial statements to be provided by companies are profit and loss account, balance sheet and cash flow statement

Question 2

What is the difference between management and financial accounts?

Answer 2

Management accounts are for the internal use of the management team. Financial accounts are the company accounts required by law.

Question 3

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

Answer 3

A profit and loss account shows the incomes and expenditures of a company and the resulting profit and loss. The balance sheet shows what a company owns (assets) and what it owes (liabilities) at a given point in time.

Question 4

What is a cashflow statement?

Answer 4

It is the summary of the actual or anticipated ingoing and outgoing of cash in a firm over the accounting period. It is broken down into operating, investigating and financing activities. It measures the short term ability of a firm to pay off its bills.

Question 5

Key terminology (extra learning)

Answer 5

Capital Allowances – Tax relief on certain items brought for business (tools,etc)
Sinking funds – Set aside revenue for future expense or long term debt (service charge works)
Insolvency – Inability to pay debts. Liabilities exceed assts.
Companies House – Agency that incorporates and dissolves limited companies
Dun & Bradstreet Financial Rating / Check – Credit checks (there are other firms)
HMRC – Her Majesties Revenue and Customs.

Question 6

What are the main types of ratio analysis used to assess a company’s financial strength?

Answer 6

Management Operating Ratios – these cover the liquidity and profitability aspects of the company and, to many builders, liquidity ratios are prime ratios.

Question 7

Liquidity ratios?

Answer 7

Measure the ability of the company to pay off his current liabilities by converting its current assets into cash.
Current (current assets / Current liabilities) –
Usually around 1.5 but it depends on the sector of activity (house builders over 3 because they have high assets in unsold houses). Less than 0.75 suggest insolvency.
Acid Test ( 30 day cash and near cash / current liabilities ) –
How much of the assets can be converted into cash within 30 days. It depends on the sector of activity. Once again low ratio for house builders because cant sell all their land and houses in short term.
Debtor ratio & creditor ratio ( Number of days to receive payments / pay off debts ) -
The creditor ratio is usually 30 days and the debtor ratio is often higher which is why good cashflow management is essential.
Work in progress ( number of days to complete a piece of work ready for sale ) -
Contractors receive interim payments (there is a retention applied) but developers and house builders don’t. It can take a year before the work is complete which can cause liquidity issues.

Question 8

Working Capital

Answer 8

Measures how much more capital may be needed to finance the operations. A falling ratio may mean that the company has taken on more work than it can finance and may be heading for cashflow difficulties.

Question 9

Profitability ratios

Answer 9

Measures the performance of the company to generate profits.
Return on equity (profit after tax / equity (capital in shares)) – best ratio
Return on capital employed (operating (overheads deducted) profit / capital employed) – best ratio
A low return can be wiped out in recession, or loan interest may be higher than profit, useful to decide to invest or not, or take over a company.
Trading profit margin (turnover – cost of sale / turnover)
Low margins may be due to a growth strategy from the company, not always bad management.
Operating profit margin (operating profit / turnover)
Capital employed = shared capital + reserves + long term and short term loans + overdrafts + creditors etc.

Question 10

Financial Gearing Ratios

Answer 10

These measure the financial structure of the company which are crucial indicators for the external supplies of debt and equity, as well as for internal management. They help to measure solvency. Highly geared companies rely mainly on borrowing. The payment of interest reduces the profit.
Debt / equity (capital in shares) – best ratio
Debt / capital employed
Interest cover (profit/loan interest)

Question 11

Investment Ratios

Answer 11

These relate to the financial returns that a company is achieving and the resultant ratios will determine the demand for shares and the availability of new equity finance for the builder. (it is about investment by the shareholders not by the company’s management team)

Question 12

Why do chartered surveyors need to understand company accounts?

Answer 12

For own business accounts
For assessing competition

Question 13

What is the purpose of a profit and loss?

Answer 13

Monitor and measure profit (or loss). Significant problems can arise if the information is inaccurate, either through incompetence or deliberate fraud.
Compared to its past performance, compared to the budget and compared to other businesses.
Assist in forecasting future performance (next periods Budget)
Calculate tax

Question 14

What is the difference between debtors and creditors?

Answer 14

Creditors – your firm owes another firm money e.g. if you owe a sub consultant fees then they are a creditor.
Debtors – A firm who owes your firm money e.g. a client who owes you fees is a debtor.

Question 15

What are Management Accounts?

Answer 15

The accounts prepared by a company for internal management use, or accounts prepared for a lender, such as a blank to evaluate how you will be able to repay the funding. They will not be audited externally.

Question 16

What is the Late Payment of Commercial Debts act 1998 and Late Payments of Commercial Debts Regulations 2002?

Answer 16

Statute that allows the recovery of interest at the bank of England base rate plus 8% on debts which are not paid by agreed payment date.
Standard forms of contract will usually include express provisions for dealing with this issue. These will supersede the above-
NEC3 ECC :
Clause 51.1 – interest is paid on late payment at a rate stated in the contract data. Part 1 – should not be less than 2% plus the rate of a stated bank.
ICE (6th edition) :
Clause 60 (7) – interest paid at 2% above base lending rate of bank stated in appendix to form of tender.
JCT SBC/Q :
Clause 4.13.6 Interim certificates and 4.15.6 Final Certificates, 5% above the bank of England dealing rate.

Question 17

Financial Statements

Answer 17

Forecasts of income and expenditure can be used as an analytical tool to identify potential shortfalls and surpluses.

Question 18

Profit and loss

Answer 18

Shows company sales, running costs and profit/ loss over financial year. Used to show sales vs expense (invoicing vs time and disbursements). Can be used to identify non-profitable work.

Question 19

Balance sheet

Answer 19

Shows the value of everything the company owns, owes and is owed.
Shows the value of the business at any given point.
Useful for investors.

Question 20

Cash flow

Answer 20

Summarises amount of cash or cash equivalents entering and leaving a company. Used in CA projects and is shown as a ‘S’ curve. Small financial outlay at the start, steep increase during and tapers off at the end.

Question 21

Usefulness to Surveyors

Answer 21

Track, analyse and assess business accounts and performance.
Assessing financial strength of contractors.
Assessing market competitors.

Question 22

Escrow Accounts

Answer 22

A separate account owned by a third party, held on behalf of two other parties.
A bank account with defined contractual conditions for the release of funds.
Can be used as a project account.
Mechanisms must be in place fo the release of funds such as, payment certificates.
Ratio analysis
Assesses financial strength.
Evaluates operating and financial performance over time or compared against competitors.

Question 23

Liquidity Ratios

Answer 23

Measures current assets against current liabilities (availability of cash/ cash equivalents).

Question 24

Solvency Ratios

Answer 24

Measures firms ability to meet long term obligations e.g. debt to assets, debt to capital, debt to equity.

Question 25

Profitability Ratios

Answer 25

Measures firms ability to earn profit.
Establishes margins.

Question 26

Return to assets Ratios

Answer 26

Net income (divide) total assets.
Measures efficiency of assets.

Question 27

Return on Equity Ratios

Answer 27

Net income against dividends and equity.

Question 28

What is an LLP?

Answer 28

Limited Liability Partnership
In a traditional partnership – joint liability – all partners accountable for another’s mistake.
LLP – technically they are ‘members’ of the LLP and not ‘partners’
Provides additional protection through limited liability. Only liable for your own negligence/default etc.
Governed by the limited liability partnership regulations 2001.

Question 29

How do you analyse company’s accounts?

Answer 29

The clients accountants will carry out the detailed analysis but I can look at the warning signs by calculating ratios such as liquidity ratios, profitability ratios and gearing ratios.
I should always calculate the ratios myself as those included in the company accounts may be manipulated.
I should always use the group or consolidated accounts rather than the company accounts unless it is a limited company.

Question 30

Why do you analyse companies accounts?

Answer 30

To assess a company’s financial performance over a period of time and against similar companies.

Question 31

How do you carry out a credit check?

Answer 31

I use the credit safe website to which my company subscribes to access company’s accounts.
I consider both the group accounts and the company accounts. If the credit rating is a bit low, I calculate some key ratios and pass on all the information to my clinets accountants for them to analyse further.

Question 32

What are signs of insolvency in company accounts/ credit checks?

Answer 32

Low credit rating.
A current ratio below 0.75
A falling working capital ratio suggesting that the company has taken on more contracts than it can finance.
A low return on equity.
Highly geared company (rely on loans)
A falling cashflow statement.

Question 33

What is company act 2006?

Answer 33

It is a comprehensive piece of legislation that regulates all aspects of private and public companies. This includes general guidance on accountancy obligations and details of accounts that companies must return annually.

Question 34

Explain your understanding of the term tax depreciation?

Answer 34

Tax depreciation is where the declining value of an asset is offset against a companies taxable profit.
The depreciation in value can be recorded as an expense in oreder to reduce the amount of taxable income.
This can be applied on things such as plant, tools, vehicles, computers, furniture and buildings.

Question 35

What are overheads?

Answer 35

The term overheads means the operating costs of the business that are incurred on an ongoing basis.
Overheads can be both fixed or variable.
Example of fixed overheads could take the form of rent on office buildings or building insurance costs that do not change each month.
Whereas as variable overheads tend to fluctuate depending on the activity of the business for example delivery or utility charges,

Question 36

Name the three different types of accounting Ratios?

Answer 36

Liquidity ratio
Profitability ratio
Gearing Ratio

Question 37

Why does a business keep company accounts?

Answer 37

Record and measure a companies profitability
Tax calculation including tax calculating taxable deductions
Legislation requires companies to keep accurate records
Business growth is encouraged by identifying profitable operations whilst also allowing management to minimise any loss making activities.

Question 38

What is financial leverage?

Answer 38

Financial leverage is the concept of using borrowed funds in the form of debt to enhance business operations and increase the companies profitability and rates of return.
In the event that the rate of return invested via borrowed funds is higher than the interest on those funds then more profit can be generated.

Question 39

What are capital allowances?

Answer 39

Capital allowances allow tax payers to gain tax relief by using their expenditure to be deducted from their taxable income.
The expenditure used to lower taxable income is only allowed within certain categories for example-
Plant and Machinery
Integral parts of structures and buildings
Research and development costs
Patents

Question 40

What is the difference between a current asset vs a fixed asset?

Answer 40

Current assets can normally be converted into cash within one financial year and are regarded as assets that allow day to day operation of the business. Examples may include money owed to the company following sales of its products or services, inventory and prepaid expenses.
Fixed assets typically cannot be converted into cash within one year. These kind of assets are recorded on a companies balance sheet as fixed assets the company owns on a long term basis. Examples include vehicles, office furniture, machinery, buildings and land.

Question 41

What is current rate of VAT and Corporation Tax?

Answer 41

VAT is 20%, Corporation Tax is 19%

Question 42

How often are accounts expected to be lodged and where?

Answer 42

Annually and lodged with Her Majesties Revenues and Customs (HMRC).

Question 43

What is a balance sheet?

Answer 43

A statement of assets, liabilities and capital within a business.

Question 44

What is the difference between operational expenditure and capital expenditure?

Answer 44

Capital expenditure is the amount used to purchase physical goods that will be used for more than one year and recorded as an asset on Balance Sheet.
Operating expenditure makes up the bulk of the company’s regular costs and are tax deductible in the year they are made. A capital expense item can be an operating expense if leased.

Question 45

What is the purpose of keeping company accounts?

Answer 45

Identifying, measuring and recording economic data/performance

Question 46

What headings would you expect to see in a set of accounts?

Answer 46

• Chairman’s Statement
• Independent Auditors report
• Profit and Loss Account
• Balance Sheet
• Corporate Governance Report
• Remuneration Report

Question 47

Give some examples of accounting ratios and what they show?

Answer 47

Liquidity ratio –
* Current Ratio = Current Assets/Current Liabilities
Financial Leverage Ratio –
* Debt Ratio = Total Debt/Total Assets
Profitability Ratio –
* Return on Assets = Net Income/Total Assets

Question 48

How can accounts show covenant strength?

Answer 48

Using 3 years’ worth of audited accounts you can assess their ability to pay rents on time. The higher the covenant the lower the risk.

Question 49

What are IFRS?

Answer 49

The international Financial Reporting Standards are a set of accounting principles developed by International Accounting Standards Board (IASB).

Question 50

What is GAAP UK?

Answer 50

The Generally Accepted Accounting Procedures UK is the body of accounting standards and other guidance published by UK Financial Reporting Council. Came in to effect on 1st January 2015.