Accounting principles and procedures L1 Flashcards
What are financial statements?
Forecasts of income and expenditure which can be used as an analytical tool to identify potential shortfalls and surpluses
Why should you keep accounts?
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
What is the difference between management and company accounts?
- management accounts are used internally by the managers
- Financial accounts are required by law and audited by a chartered surveyor
What is a balance sheet?
it shows a companies assets, liabilities and equity at a specific point in time and can be used to assess its financial position.
What is a cashflow statement?
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.
What is a Profit and Loss Account?
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
Why do chartered surveyors need to be able to understand and interpret company accounts?
for reviewing their own firms accounts
for assessing the financial strength of contractors and those tendering for contracts
assessing competition
what is an asset
anything of value or a resource of value that can be converted into cash
what is a liability
any kind of financial obligation that a business has to pay at the end of an accounting period to a person or a business.
What is the difference between a profit and loss account and a balance sheet?
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
what is meant by depreciation in relation to an asset?
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
What are the main types of ratio analysis used to assess a companys financial strength?
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
What are generally accepted accounting principles? (GAAP)
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.
What is meant by the term Gross and Net?
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
What is the difference between a sole trader, Partnership, Limited Company and LLP
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
How would you assess a contractors financial accounts?
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
What are Mint and Dun &Bradstreet reports
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
What does a set of public limited company accounts include
- 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
What is auditing
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
What are the financial deadlines for accounts
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
what is equity
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
How long must a company keep financial records
3 years or 6 if PLC
What is a gearing ratio
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%
What is Hurdle rate
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
International financial reporting standards (IFRS) RICS Valuation global standards: uk national supplement 2018 sets out what two reporting frameworks
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
what is a joint venture and what is the relevant international accounting standard
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
what is a KPI used for
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
what is the aim of the IFRS 16
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
What is Net asset value (NAV)
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.
what are ordinary shares
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.
What is a quarter day
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
What is return on capital employed (ROCE)?
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
What are the four size classifications that affect the preparation of financial accounts?
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
what are the 2023 main rate corporate taxation percentages
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
what is vetting
financial reports, alongside credit reports can be used when vetting suppliers, tenants or contractors. such as D&B showing credit risk score, insolvency issues…
what is working capital
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
what is a yield
the rate of return on an investment
what is zero rated
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
Please explain your understanding of the term tax depreciation
- 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
what are overheads
- 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
What is an escrow account?
- 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.
Please name 3 different types of accounting ratios
- 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.
Why does a business keep company accounts
- 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
What is financial leverage?
- 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
What are capital allowances?
- 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
What is the difference between a current asset vs a fixed asset?
- 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
What are the key financial statements that all companies must provide/ what are the company accounts?
- Profit and loss account, balance sheet, cashflow statements
What is the difference between debtors and creditors?
- Creditors are entitys or firms who you owe money to
- Debtors are entities that owe you money
What are the signs of insolvency in company accounts/ credit checks?
- Low credit rating
- Current ratio below 0.75
- Falling working capital ratio suggesting the company has taken on more contracts than it can finance
