Accounting Principles and Procedures L2 Flashcards
What is GAAP?
Generally Accepted Accounting Principles
What is the benefit/purpose of GAAP?
To improve the clarify of the communication of financial information
What are the 10 principles of GAAP?
Regularity
Consistency
Sincerity
Permanence
Non-compensation
Prudence
Continuity
Periodicity
Materiality
Utmost good faith
What are the International Accounting Standards?
The older accounting standards that were replaced by IFRS in 2001
What is IFRS?
International Financial Reporting Standards
Why were IFRS introduced to replace IAS?
Goal was to make it easier to compare businesses around the world
Wanted to increase transparency and trust in global reporting
What is IFRS 16?
Effective from 1 January 2019
Requires lessee to recognise assets and liabilities for all leases with a term of more than 12 months
IFRS 16 sets out principles for an IFRS reporter to recognise, measure, present and disclose leases
What is the objective of IFRS 16?
Report information that represents lease transactions
Leases need to be placed on balance sheets
What is the result of IFRS 16 accounting reporting?
Results in increase in assets, liabilities and net debt where leases are brought onto the balance sheet
Can affect key accounting and financial ratios - impacts a companies attractiveness to investors
Provides transparency on companies’ lease assets and liabilities
What governs the format of company accounts?
The Companies Act 2006
What is included in company accounts, as laid out in the Companies Act 2006?
Cover page
Information and contents
Directors report
Accountants report
Statutory profit and loss account
Balance sheet
What is a profit and loss account?
A summary of the business income and expenditure transactions on an annual basis
Gives overall profit / loss figure
What is taxation?
The amount of money or percentage that is owed to HMRC based on company profit
What is directors remuneration in a profit and loss account?
How directors are paid for their services - fees, salary, or dividends
How is gross profit calculated?
Turnover minus cost of sales
What can be determined from gross profit?
Not a lot in isolation, but when compared to previous years gross profit then can get an idea of what direction the company is heading in
What is depreciation?
A reduction in the value of an asset over time EG due to wear and tear
What is amortisation?
A reduction in the value of an intangible asset over time EG spreading out loan payments over time
What is the difference between depreciation and amortisation?
Amortisation focuses on intangible assets, whereas depreciation focuses on fixed assets
What is a balance sheet?
Outlines companies assets and liabilities
What are assets on a balance sheet?
Items the company owns which provide economic benefit
What are the two types of asset?
Fixed / Long-Term EG land, factories
Current / Short-Term EG stock, cash in bank
What are liabilities?
What a company owes to others
What are the two types of liability?
Long-Term EG not due to be repaid in next year
Current - those due within the year
What key piece of information can be concluded from a balance sheet?
Whether a company is solvent
How likely it is that the company will still be in business in a year
What is the liquidity ratio?
A financial ratio used to determine a company’s ability to pay its short term debt obligations
How is liquidity ratio calculated?
Current assets divided by current liabilities
How is liquidity ratio interpreted?
Figure of 1 means company can exactly pay off its current liabilities
Ratio of less than 1 means it is unable to pay off its current liabilities
What is Net Asset Value?
Total assets mins total liabilities
Simple way to establish how much a company is worth
Frequently shown as NAV per share
What are the three parts of a balance sheet?
Assets
Liabilities
Ownership equity
What is difference between assets and liabilities known as?
Equity / Net Asset Value / Net Worth / Capital
What is a cash flow statement?
Financial statement that summarises movement of cash in and out of a company
Why is cash flow statement believed to be the most intuitive of all financial statements?
Shows movement of money in and out of a company, and how well a company is managing it’s cash and growth
What is a credit rating?
Assessment of an organisations creditworthiness based on previous dealings
Shows ability of organisation to fulfil financial commitments EG pay rent on time
What are the main commercial credit rating agencies?
Dunn & Bradstreet
Standard and Poor (S&P)
Why do companies keep accounts?
For regulatory purposes
What are the two parts of a Dunn and Bradstreet rating?
Financial strength indicator
Risk indicator
What is covenant strength?
Tenant ability to comply with covenants laid out in their lease
What is revenue?
Income generated by the sale of products or services
What is capital expenditure?
Money spent by a business or organisation on acquiring or maintaining fixed assets like land, buildings and equipment
What is a financial audit?
An objective examination and evaluation of the financial statements to ensure they are fair and accurate
What is a ratio analysis?
Method of gaining insight into a company’s liquidity, efficiency and profitability by studying its financial statements
What are profitability ratios?
Show how well a company can generate profit from its operations
What are solvency ratios?
Compare company debt levels against its assets, equity and earnings
Suggest whether company is solvent and whether they can pay lenders debts
What are efficiency ratios?
Evaluate how efficiently a company uses assets to generate sales
What is credit control?
The practice of ensuring debtors do not take too long to pay you
What is profitability?
Used to determine company profit in relation to the size of the business
What is VAT?
Value Added Tax
Consumption tax on goods and services
Standard rate 20%, sometimes reduced rate of 5% or Zero rate of 0%
Where might you find information on a company’s assets?
On their balance sheet
Are profit and loss accounts current?
No, retrospective
What are management accounts?
Management accounts are financial reports produced for business owners/managers either quarterly or monthly
Normal includes profit and loss report and balance sheet
Less formal than year end accounts
What are company accounts?
Documents produced at year end (company financial year end differs)
Shows performance over accounting period
Legally required from all companies under Companies Act 2006
When must a company be VAT registered?
If company total VAT taxable turnover for last 12 months was over £85,000 OR if turnover is expected to go over £85,000 in next 30 days
What is EBITDA?
Earnings before interest, tax, depreciation and amortisation
It is a measure of company profitability
What does it mean for a company to go into administration?
Company becomes insolvent and is put under management of licenced Insolvency Practitioners
What is insolvency?
Individual can no longer meet financial obligations, so debts become due
Comes about due to reduction in cash inflow and increase in expenses
What is bankruptcy?
Person can no longer meet debt payments
Liquidate assets to pay debts, or create payment plan
What is receivership?
Court appointed tool that that protects a company
Receiver steps in to manage company, it’s assets and all financial decisions
What is liquidation?
Process where assets are used to pay off debts
Three types - creditors voluntary liquidation, compulsory liquidation and members’ voluntary liquidation
Why do surveyors need to be able to interpret company accounts?
To assess covenant strength of tenants
Where can you find information on company’s financial status?
Companies House
What is Limitations Act 1980?
Outlines time within which creditor can chase debtor for outstanding debt
Only applies when no contact has been made between creditor and debtor within given time limit
What is misappropriation of funds?
When someone entrusted with managing money, steals it for personal gain
What is a financial bond?
Fixed income instrument that represents a loan made by an investor, to a borrower
What are the 3 tests of insolvency?
Cash flow test - check if able to pay bills in near future
Balance sheet test - check if assets are greater than liabilities
Legal action test - check if legal action has been taken against business for debt of £750 or more
Consequences of insolvency?
Business may go into liquidation and stop trading
Business may go into administration and be sold
What is statutory profit?
A company’s earnings calculated according to UK GAAP
Principles of UK GAAP
Principles: Costs, Matching, Revenue Recognition, Full Disclosure and Going Concern
