Accounting Principles and Procedures Flashcards
What is VAT?
Value added tax - consumption tax placed on product whenever value added at each stage of supply chain, from production to point of sale
What is corporation tax?
Paid by businesses in UK, calculated on annual profit in similar way to income tax for individuals
What is an audit?
Important term used in accounting, describes examination and verification of company’s financial records. Ensures financial information is represented fairly and accurately\
What is turnover?
Income / revenue a company receives from normal business activities (usually from sale of goods/services to customers)
What are management accounts?
Accounts prepared by company for internal management use / accounts prepared for a lender to evaluate how business will repay funding. Not audited externally
Management vs financial account
- Financial accounts - required by UK law for public to see - Private limited companies in UK must file annual accounts with Companies House in line with Companies Act 2006. Each set of accounts should relate to a specific financial year
- Management accounts - internal use Used by business owners and management for day-to-day and strategic decision making. Not required by law, don’t have to be filed with Companies House
Why does a business keep company accounts?
- Tax purposes- required by law
- Demonstrates company financial standing (supports loan/borrowing applications), ensure cash flow and profitability in company is being correctly managed
What is an escrow account?
- Separate account owned by third party, held on behalf of 2 other parties
- Defined contractual conditions for release of funds (mechanisms can include payment certificates)
- Can be used as a project bank account
What is a project bank account?
- Ring-fenced bank accounts allowing for payments to be made directly and simultaneously to main contractor and members of supply chain
- Cashflow disbursement model design to protect project from risk of supply chain insolvency and to speed up payment times
What are business overheads?
- Indirect costs / fixed expenses of operating a business
- Rent/leasing costs, utility bills, additional staff, insurance
Explain the principle of tax depreciation
Depreciation expense claimed by taxpayer on tax return to compensate for loss in value of tangible assets (i.e. property, plant, equipment)
3 types of accounting ratios
- Liquidity
- Profitability
- Gearing
What is liquidity ratio?
- Oranisation’s ability to turn assets into cash to pay debts
- Current assets / current liabilities
- Ratio usually 1.5, depends on sector of activity - housebuilders often operate on liquidity ration over 3 as they retain high value assets in form of unsold houses
- Liquidity ratio <0.75 can be early indicator of insolvency
What is profitability ratio?
- Assess business’ ability to generate profits
- Trading profit margin ratio = turnover - (cost of sales/turnover)
- Low margins may be due to growth strategy from company (not necessarily bad management)
What is a financial gearing ratio?
- Measures proportion of company’s borrowed funds to its equity
- Helps measure solvency
- Highly geared companies may rely mainly on borrowing
- Interest payment reduces profit
What is financial leverage?
- Investment strategy, using borrowed money
- Using financial instruments / borrowed capital to increase potential return of investment
What are capital allowances?
Practice allowing taxpayers to get tax relief on tangible capital expenditure by allowing it to be deducted against annual taxable income (tools and equipment)
Difference between gross and net in accounting terms?
- Gross = total amount of income before deductions
- Net = total amount of income after deductions/adjustments
What is equity?
- Value that an owner has in the business
- Calculated by deducting total liabilities from total assets on company balance sheet
Why is it beneficial for surveyors to understand company accounts?
- Assess financial health of competitors
- Assess financial stability of tendering contractors and subconsultants
- Aid in preparing company accounts within own surveying practice
- Review internal profitability and sustainability
Debtors vs creditors?
- Debtor = individual / business who’s borrowed funds from a business so it owes money
- Creditor = individual / business who’s lent funds to business and is owed money
What is UK GAAP?
Generally Accepted Accounting Practice in the UK - regulatory body establishing how accounts and financial reports should be prepared in the UK
When have you used company accounts in your work?
Assess financial strength of contractors at pre-qual stage and tender stages
What is expenditure?
Represents payment with either cash/credit to purchase goods / services
What is capital expenditure?
CAPEX - spent to acquire / improve assett i.e. equipment or buildings - upfront cost
What is revenue expenditure?
OPEX - day-to-day (operational) costs for running business, i.e. servicing machine, spare parts etc.
Why are CAPEX and OPEX budgets split out in business accounts?
Different tax obligations i.e. CAPEX can benefit from capital allowances
What is Companies House?
Agency incorporating and dissolving limited companies in the UK
What is HMRC?
His Majesty’s Revenue and Customs
What is a financial statement?
Forecast of income and expenditure that can be used as analytical tool to identify potential shortfalls and surpluses
What are the key financial statements/documents that companies have to produce in the UK?
- Profit and loss account
- Balance sheet
- Cashflow forecast
What’s included in an income statement?
Company revenue, costs, profits, expenses, taxes paid
What is a balance sheet?
- ‘Snapshot’ of company financial position at given point in time
- Reports on company’s assets, liabilities, ownership equity
- Used to assess financial position / health and can be compared with prev balance sheets to identify trends - provides basis for ratios
What can you tell from a balance sheet?
How much a business is worth at any given point (i.e. if business owes more than it owes, assets)
What is meant by assets and liabilities?
- Asset = materials / land / property owned, i.e. vans, cars, buildings
- Liability = loan / debt
What is a current asset?
Cash and other assets expected to be converted to cash within a year
What is a fixed asset?
Assets purchased for long-term use, unlikely to be converted quickly into cash (i.e. land, buildings, equipment)
What is a cash flow forecast / statement?
- Document showing how much money a business / project is expected to receive and pay out over set period
- Helps plan sales / spending
- Helps understand when money will enter and leave bank account
- Measures short-term ability of firm to pay off bills
- Broken down to operating, investment and financing activities
Construction
- Usually shown as ‘S’ curve - small financial outlay at start, steep increase during midway point and tapering towards end
What is the cashflow forecast used for?
- Understand impact on future plans, possible outcomes
- Keep track of overdue payments
- Plan/manage upcoming cash gaps / surplus
- Track whether spending is on target
Why is cashflow important for a construction project?
- Allows client to gain understanding of financial commitment over duration of project and when likely to spend the money
- Can be used to determine when external funding is required
- Acts as a check against valuations, can give early indication of delays / financial difficulties
How does a cashflow forecast help a company remain solvent?
- Can predict when a business/project has money to pay out and when money is coming in
- Highlights if business/project has negative cashflow- they can do something about it in good time
What is an S-Curve?
- ‘Standard’ curve - shape of expenditure profile looks like an S
- At start of project, rate of expenditure typically lower due to site setup and lower value enabling works
- Middle of programme - higher expenditure, more expensive building components i.e. M&E, steel, materials being installed
- End - expenditure slows down (less to do) - curve flattens
How are S-Curves used by surveyors?
- Track, analyse and assess business accounts and performance
- Assess financial strength of contractors
- Compare actual progress of work against pre-contract predictions
What is a profit and loss account?
- Shows company revenue and expenses over particular period (i.e. consolidated months over a year)
- Show whether business has made a profit or loss over that period (sales vs expense)
- Can identify non-profitable work
- Indicates how revenues transformed into nett income (nett profit)
Purpose of a profit and loss account?
- Monitor and measure profit/loss
- Compare against past performance and company budgets
- Valuation purposes, compare against competitors
- Forecast future performance
- Calculate taxation
Significant problems if info inaccurate (incompetence/fraud)
Difference between a balance sheet and profit and loss account?
- Balance sheet is ‘snapshot’ at one given time, showing financial position of company (assets and liabilities)
- Profit and loss shows profit/loss over determined period
What is insolvency?
- Inability to pay off debts / creditors
- Generic term to describe bankruptcy, liquidation, administration etc.
Signs of insolvency in company accounts / credit checks?
- Low credit rating
- Liquidity ratio <0.75
- Falling working capital ratio (suggests company has taken on more contracts than it can finance)
- Low return on equity
- Highly geared company heavily reliant on loans
- Falling cashflow statement
- Can’t get bonds / being charged at high premium
Why would you not recommend the appointment of a contractor with low credit rating?
- Risk of contractor / supply chain insolvency
- Possibility the contractor might not perform satisfactorily / restricted resources on site
What would you recommend if client wanted to appoint contractor with low credit rating?
- Request performance bond for client to call on if main contractor failed to perform
- Review tender submission to ensure not excessively front loaded
- When reviewing interim valuations, careful consideration that these are accurate and not over-claimed
- Project bank account can provide additional level of assurance, should be considered
How would you determine financial standing of a company prior to doing business with them?
- Dun & Bradstreet report creates business credit report
- Score between 80-100 would have lower risk of late/default on payment
How do you carry out a credit check? Give example
- Use credit safe website to which my company subscribes to access company’s accounts
- Consider both group and company accounts
- If credit rating is low, I calculate key ratios and pass on all information to my client’s accountant for them to analyse further
How do you analyse a company’s accounts?
- Client’s accountants undertake detailed analysis
- As a QS I can look at warning signs, calculating ratios, i.e. liquidity, profitability, gearing
- Use group / consolidated accounts over company accounts (unless it’s a limited company)
What are signs of contractor insolvency on a project?
- Slowing down works
- Supply of materials drying up
- Increase in defective work
- Changes in management
- Additional / inflated payment requests
- Complaints from subcontractors
Under what circumstance might QS’ encounter insolvency?
- Project where contractor/subcontractor has serious financial difficulties and can’t pay their debts
- Client may have a project where contractor has ceased trading and needs advice
- May be appointed by external body (liquidator / administrator) to prepare report on a commercial aspect of project
What steps would you take in the event of contractor insolvency?
- Inform all parties involved (inc bondsman i.e. bank / insurance company), secure site
- Consider stopping pending payments and seek legal advice
- Take ownership of materials off-site paid for in valuation
- Schedule all plant and materials
- Value completed works and value any defects
- Monitor loss and expense incurred
- Terminate building contract, employ others to complete
What is administration?
Administrator will take over running the company to attempt to sort out financial situation - company will continue to trade
What is liquidation?
Formal process bringing about closure of limited company. All company assets sold for benefit of outstanding creditors and/or shareholders before company struck off/dissolved from Companies House register
Administration vs liquidation?
- Administration - administrator appointed to manage company’s affairs on behalf of creditors
- Liquidation - shutting down of company and selling off assets to pay creditors
What is bankruptcy?
- Way for individuals to deal with debts they can’t pay
- Doesn’t apply to companies / partnerships
- Assets shared among those you owe money to
- Allows individual to make a fresh start free from debt (with some restrictions)
RICS guidance on accounting principles?
Capital allowances
