Accounting principles and procedures L1

Question 1

What are financial statements?

Answer 1

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

Question 2

Why should you keep accounts?

Answer 2

To keep track of money coming in and out so they know they can pay bills and suppliers

To monitor profit and loss and company performance

To use information for future business planning

To submit annual financial statements to companies house - in accordance with company’s act 1985 limited companies must provide their year end accounts in accordance with legal format

Question 3

What is the difference between management and company accounts?

Answer 3

• management accounts are used internally by the managers
• Financial accounts are required by law and audited by a chartered surveyor

Question 4

What is a balance sheet?

Answer 4

it shows a companies assets, liabilities and equity at a specific point in time and can be used to assess its financial position.

Question 5

What is a cashflow statement?

Answer 5

This shows cash moving into and out of a company for a specific period and is generally broken down into cash relating operations, to investment and to financing. The statement will show the net cashflow position which helps to assess liquidity and shows changes in assets, liabilities and equity.

Question 6

What is a Profit and Loss Account?

Answer 6

a financial statement also known as the income statement shows the income and expenditure of the company over a specific period. allows you to identify the net profit or loss made, can be used to calculate the companies profit margin

profit margin = how efficiently the company is converting revenue into profit

Question 7

Why do chartered surveyors need to be able to understand and interpret company accounts?

Answer 7

for reviewing their own firms accounts

for assessing the financial strength of contractors and those tendering for contracts

assessing competition

Question 8

what is an asset

Answer 8

anything of value or a resource of value that can be converted into cash

Question 9

what is a liability

Answer 9

any kind of financial obligation that a business has to pay at the end of an accounting period to a person or a business.

Question 10

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

Answer 10

Profit and loss account shows the incomes and expenditures of a company and the resulting profit or loss. can identify non profitable activities the company is undertaking

Balance sheet shows what a company owns (assets) and what it owes (liabilities) at a given point in time

Question 11

what is meant by depreciation in relation to an asset?

Answer 11

Depreciation is the systematic reduction in the recorded cost of a fixed asset. examples of fixed assets that can be depreciated are furniture and IT equipment

Question 12

What are the main types of ratio analysis used to assess a companys financial strength?

Answer 12

Liquidity: ability of the company to pay its way (solvency) more companies fail due to cash flow than any other reason

current ratio: liquid assets/ liabilities

Question 13

What are generally accepted accounting principles? (GAAP)

Answer 13

a common set of accepted accounting principles, standards and procedures that a company and their accountants must follow when they compile their financial statements - it is issued by the financial reporting council with reporting standard FRS 102 covering how property included in accounts is to be values.

Question 14

What is meant by the term Gross and Net?

Answer 14

Gross = the total amount before anything is deducted ie gross earnings and gross profit

Net = the amount remaining after certain adjustments have been made for debts, deductions or expenses

Question 15

What is the difference between a sole trader, Partnership, Limited Company and LLP

Answer 15

Sole trader = a person who is the exclusive owner of the business, entitled to keep all profits after tax has been paid but liable for all losses (unlimited liability)

Partnership = a business organisation in which two or more individuals manage and operate the business. both owners are equally and personally liable for the debts of the business

Limited Company= stakeholders liability is limited to the capital they originally invested. if company becomes insolvent their personal assets remain protected. shares in a private limited are not offered to the general public (distinguishing from a public limited company)

Limited Liability Partnership= partnership in which some or all partners have limited liabilities. therefore exhibits elements of partnerships and corporations. in an LLP one partner is not responsible or liable for another partners misconduct or negligence

Question 16

How would you assess a contractors financial accounts?

Answer 16

Request a copy of company accounts for 3 years which would include the profit and loss statement, balance sheet and cashflow statement. can then assess
- if contractor has been profitable in the last few years
- the liquidity ratio by looking at their assets and liabilities to see if they would be able to cover losses under a contract and stay solvent

i would always caveat any advice to a client on a contractors financial position and recommend that further advice is sought through financial reports and a qualified accountant

Question 17

What are Mint and Dun &Bradstreet reports

Answer 17

Provide scores and ratings to help identify organisations that are likely to fail or pay late

Financial strength: derived from net worth by assessing latest financial accounts

Risk indicator: likelihood of the organisation obtaining legal relief from creditors or ceasing operations within the next 12 months

Delinquency score: likelihood of the organisation to pay its obligations late

Limited as looks at past performance rather than future performance. a company may look profitable however their profit as steadily been declining over the last few years which wouldnt actually be healthy

Question 18

What does a set of public limited company accounts include

Answer 18

• Chairmans statement
• independent auditors report
• income statement (profit and loss)
• financial statement of position (balance sheet)
• corporate governance report
• remuneration report
  -other statutory information

what do you expect to see in a published set of accounts?
These should be prepared in accordance to the companies act (1985, amended 1989). these would include names of the company directors, secretary, a record of the companys assets and liabilities, entries of profit and loss as well as details of stock held at the end of the year and any dividends paid

Question 19

What is auditing

Answer 19

a report prepared by an auditor as an independent party confirms all financial accounts of a company are fair and true. Under the Companies Act 2006, reports must be prepared for all public limited companies. Small companies may be exempt from the need of audits because of the reduced size and risk of these entities

Question 20

What are the financial deadlines for accounts

Answer 20

Companies house set strict filing deadlines

9 months from the accounting reference date for private companies
6 months from the accounting reference date for public limited companies

Financial penalties if late
£150 for private company or LLP accounts up to a month in arrears
£7,500 for PLC accounts that are more than 6 months overdue

penalties are doubled if accounts are filed late in two consecutive financial years

if not filed at all: can be struck off the register or dissolved which can lead to all company assets becoming property of the crown

directors can face seperate criminal offence of not delivering company documents which could incur unlimited penalty and run the risk of a criminal record

Question 21

what is equity

Answer 21

also known as owners equity it is the value that the owner has in the business which can be calculated by deducting total liabilities from total assets on a company balance sheet

Question 22

How long must a company keep financial records

Answer 22

3 years or 6 if PLC

Question 23

What is a gearing ratio

Answer 23

financial ratio that helps when analysing acompanys capital structure and financial leverage. represents the proportion of debt finance relative to equity held in a company. Typically high gearing is above 50% and low ratio is below 25%

Question 24

What is Hurdle rate

Answer 24

minimum rate of return required on an investment. companys may have a minumum hurdle rate that it wants to achieve on projects or investments, compared to the potential or actual rate of return. this can inform investment decisions and could be established using a discounted cash flow model or even an apprisal for development or refurbishment projects

Question 25

International financial reporting standards (IFRS) RICS Valuation global standards: uk national supplement 2018 sets out what two reporting frameworks

Answer 25

IFRS and UK GAAP. PLCs must folow the IFRS when preparing their group company accounts but may adopt either these or UK GAAP for individual parent company accounts

Question 26

what is a joint venture and what is the relevant international accounting standard

Answer 26

The international accounting standard 31 interests in joint ventures defines a joint venture as a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control.
Accounting for a JV is complex and requires specialist advice from a skilled accountant

Question 27

what is a KPI used for

Answer 27

Key performance indicators are used in all areas of business to measure performance and plan for the future.
For accounting this may include budget variance, turnover by department, working capital and operating cashflow

Question 28

what is the aim of the IFRS 16

Answer 28

Leases are dealt with by IFRS 16 leases which took effect in january 2019

all leases more than 12 months must be reported on the balance sheet

aim is to ensure accurate reporting of lease transactions and allow more accurate analysis of related cash flows

Question 29

What is Net asset value (NAV)

Answer 29

Financial ratio that shows the net value of an entity’s assets minus its liabilities divided by the number of outstanding shares. typically used by mutual funds and exchange traded funds and it changes daily so it can be used to calculate the price to buy or sell shares in a particular fund or entity.

Question 30

what are ordinary shares

Answer 30

some uk limited companies are described as limited by shares so shareholders own the business and have certain rights over the company. the alternative is to be limited by guarantee which is typically used by non for profit organisations and charites.

companies that are limited by shares must have at least one share holder, usually a director. these shares are typical ordinary shares which permit one vote on each company decision and the right to recieve dividends.

Question 31

What is a quarter day

Answer 31

in england these are 25 march, 24 june, 29 september and 25 decembet - important when accounting for rent or service charge payments on a lease

Question 32

What is return on capital employed (ROCE)?

Answer 32

a financial ratio that measures profitability and efficiency with which a company uses its capital. calculated by taking earnings before interest and tax and dividing it by capital employed being total assets minus current liabilities.

can be used to assess companys financial health and performance

Question 33

What are the four size classifications that affect the preparation of financial accounts?

Answer 33

micro, small, medium and large

defined according to thresholds for turnover, balance sheet totals and average employee numbers

smaller the company the smaller the requirements for preparing and filing accounts ie micro entities can file balance sheets with less detail and are exempt from auditing

Question 34

what are the 2023 main rate corporate taxation percentages

Answer 34

main rate 19% and special rate for unit trusts and open ended investment companies of 20%

companies also pay corporation tax on chargable gains, ie profits from disposal of business assets such as land and property which capital allowances can be claimed against but this requires specialist advice

Question 35

what is vetting

Answer 35

financial reports, alongside credit reports can be used when vetting suppliers, tenants or contractors. such as D&B showing credit risk score, insolvency issues…

Question 36

what is working capital

Answer 36

The amount available to a company for day-to-day use and describes the ability of a company to meet its current liabilities.

current assets/current liabilities - does not include long term or less liquid assets such as property

Question 37

what is a yield

Answer 37

the rate of return on an investment

Question 38

what is zero rated

Answer 38

This is a rate of value added tax (VAT).

vat is a consumption based tax that must be charged on top of the price of goods and services if a supplier is registered

the supplier can recover vat on purchases made.

some goods and services are exempt from or outside the scope of VAT ie royal mail postage costs

standard VAT rate is 20% - however their are reduced rates of 0-5% ie installation of air conditioning units has been zero rated since april 2022

Question 39

Please explain your understanding of the term tax depreciation

Answer 39

• 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 order to reduce the amount of taxable income
• This can be applied to things such as plant, tools, vehicles, computers, furniture and buildings

Question 40

what are overheads

Answer 40

• The terms overheads means the operating cost of the business that are incurred on an ongoing basis
• Can be fixed or variable.
• Fixed could be the rent of the office buildings or building insurance costs that do not change each month
• Variable tends to fluctuate depending on the activity of the business for example delivery or utility charges

Question 41

What is an escrow account?

Answer 41

• Escrow accounts are contractual agreements that are used as financial instruments within a transaction
• The asset or currency being transferred between two primary parties is held by an intermediary third party
• The currency is held securely by the third party until each of the 2 parties have met their contractual obligations allowing the money to then be transferred
• Often used by mortgage lenders when compleing on the buying or selling of the real estate being exchanged.

Question 42

Please name 3 different types of accounting ratios

Answer 42

• Liquidity ratios- organisations ability to pay their debt obligations and assess its margins of safety by looking at a number of metrics including their operating cash against short term debt
• Profitability ratios: assess an organisations ability to generate profits from its sales operations and shareholding equity. The ratio indicates how efficiently a company is in generating its profit
• Gearing ratios – compare capital within the company against its debts. Gearing is a measure of companies financial leverage and sets out what proportion of the firms activities are funded by shareholders vs its creditor funds.

Question 43

Why does a business keep company accounts

Answer 43

• Record and measure companies profitability
• Tax calculation including 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 44

What is financial leverage?

Answer 44

• 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 finds is higher than the interest on those funds then more profit can be generated

Question 45

What are capital allowances?

Answer 45

• Capital allowances Allow tax payers to gain tax relief by using their expenditiure to be decucted from their taxable income
• The expenditure used to lower taxable income is only allowed within certain categories for example
  o Plant and machinery
  o Integral parts of structures and buildings ie lifts
  o Research and development costs
  o Patents

Question 46

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

Answer 46

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

Question 47

What are the key financial statements that all companies must provide/ what are the company accounts?

Answer 47

• Profit and loss account, balance sheet, cashflow statements

Question 48

What is the difference between debtors and creditors?

Answer 48

• Creditors are entitys or firms who you owe money to
• Debtors are entities that owe you money

Question 49

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

Answer 49

• Low credit rating
• Current ratio below 0.75
• Falling working capital ratio suggesting the company has taken on more contracts than it can finance