Accounting Principles and Procedures (Level 2) - General Flashcards
What is depreciation?
The reduction in value of an asset over its useful life. Applied to fixed assets which generally experience a loss in their utility over multiple years
What are the two types of asset?
Fixed (long term) - e.g. land
Current (short term) - e.g. cash/stock
What is amortisation?
An accounting method used to spread the cost of an intangible asset over its useful life
e.g. spreading the cost of of a patent over 10 years at 10% each year
What is tenant covenant strength?
The ability of a tenant to comply with lease obligations
What are the two types of liability?
Non-cyrrent (long term) - e.g. not due soon such as long term loan, leases
Current (short term) - e.g. those due within a year
What is the efficiency ratio?
Evaluates how efficiently a company uses assets to generate sales
E.G. Cost of sales / average inventory
What is the profitability ratio?
Conveys how well a company can generate profit from its operations (profit DIVIDED by net sales)
What are financial statements?
Written records that convey the financial activities of a company
What are the key financial statements that companies provide?
Profit and loss accounts
Balance sheets
Cash flow statements
What is the difference between management and company/financial accounts?
Management accounts are for the internal use of the management team (prepared monthly/quarterly for the business owner) - more informal
Company accounts are accounts required by UK law, submitted within 9 months of YE
What governs the format of company accounts?
The Companies Act 2006
What is a balance sheet?
The balance sheet shows a company’s assets (what it owns) and it’s liabilities (so what it owes) at a given point in time.
Shows whether a company is solvent
How likely it is that the company will still be in business in a year
3 parts: Assets, Liabilities and Equity (AKA Net Worth, Net Asset Value or Capital)
What is included in company accounts, as laid out in the Companies Act 2006?
Cover page
Information/contents page
Directors report
Accountants report
Statutory Profit and loss account
Balance sheet
Notes to the accounts
Detailed Profit and loss account
What is a profit and loss account? (also known as INCOME STATEMENT, STATEMENT OF COMPREHENSIVE INCOME)
Summary of business income and expenditure prepared on annual basis
Note: best for determining covenant strength as shows thorough breakdown of turnover, expenses and gross profit
What are two types of Liability and give examples?
Liabilities: what the company owes
Fixed/Long-Term Liability: not due to be repaid within next year EG mortgage or car purchase agreement
Current: due to be repaid within next year EG salaries, rent, VAT bills
What is a cashflow statement?
Statement summarising movement of cash into and out of a company; crucial when setting up a business
It measures the short-term ability of a firm to pay off its bills
What are two types of assets and give examples?
Assets: what the company owns
- Fixed Asset: around for a long time and less liquid EG property and land
- Current Asset: around for short time and more liquid EG stock and cash in the bank
What is a ratio analysis?
Method of gaining insight into a company’s liquidity, efficiency and profitability by studying its financial statements
What is Net Asset Value?
Total Assets – Total Liabilities
What are liquidity ratios?
A financial ratio used to determine a company’s ability to pay its short term debt obligations
Liquidity ratio calculation: current assets/current liabilities (determines ability to pay short-term debt)
Anything less than 1 indicates company is facing a cash crunch
Ratio of exactly 1 means company can exactly pay off all current liabilities with all current assets
Used to determine a company’s ability to pay its short-term debt obligations
What is Acid Test Ratio?
(Current Assets – Value of Stock) / Current Liabilities (best crude test of company short-term viability)
- Note: deduct stock that is hard to shift in an emergency
What are probability ratios?
Probability ratios measure the performance of a company in generating its profits.
The trading profit margin ratio= turnover - (costs of sales/turnover)
Low margins may be due to a growth strategy from the company and not necessarily bad management
What is the difference between debtors and creditors?
Creditors: entities which are owed money by another entity
Debtors: entities that owe money to another respective company
What are financial gearing ratios?
Gearing is the amount of debt – in proportion to equity capital – that a company uses to fund its operations.
A company that possesses a high gearing ratio shows a high debt to equity ratio, which potentially increases the risk of financial failure of the business.
Where have you used company accounts in your work?
To assess tenants covenant strength; the financial strength of assignees and upon receiving tenants request for concessions/assistance
How do you analyse a companies accounts?
The clients accountants will carry out a detailed analysis but I can compare and look at warning signs by calculating ratios, such as liquidity ratios.
How would you carry out a credit check? Give an example.
My credit control team have access to Credit Safe
What is GAAP?
Generally Accepted Accounting Principles
What are the 10 principles of GAAP?
Regularity
Consistency
Sincerity
Permanence of Methods
Non-compensation
Prudence
Continuity
Periodicity
Materiality
Utmost good faith
What is the benefit/purpose of GAAP?
Common set of accepted accounting principles/standards/procedures to use when compiling financial statements
To improve the clarity of the communication of financial information; most common standard is FRS 102
What are the International Accounting Standards?
The older accounting standards that were replaced by IFRS in 2001
What is IFRS?
International Financial Reporting Standards
Note: set and maintained by International Accounting Standards Board
What is FRS?
Single financial reporting standard, used if not using IFRS
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?
The key objective of IFRS 16 is to ensure that lessees recognise assets and liabilities for their major leases.
What is the result of IFRS 16 accounting reporting?
Leads to increase in assets, liabilities and net debt where leases are brought onto the balance sheet
Can affect key accounting and financial ratios - impacts a company’s attractiveness to investors
What is a major way in which IFRS 16 differs from GAAP?
- GAAP UK Leases = Lessees typically account for leases as operating leases or finance leases
- IFRS Leases = Introduces a single lessee accounting model where most leases are recognized on the balance sheet.
What is a major way in which IFRS differs from GAAP?
GAAP is rules-based (on legal authority) and IFRS is principles-based.
(Can use either but IFRS is mandatory if on the London Stock Exchange)
GAAP is more detailed while IFRS is more high-level and flexible.
GAAP requires more disclosures while IFRS requires fewer disclosures.
Definitions for a profit and loss account:
Sales - invoices amounts to customers excluding VAT
Directors remuneration- How directors are paid for their services - fees, salary, or dividends
Expenses - must be business related
Corporation tax - the only tax stated in company accounts
Dividends - Tax efficient drawing for directors
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 the difference between depreciation and amortisation?
Amortisation focuses on intangible assets, whereas depreciation focuses on fixed assets
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 its cash and growth
What is a credit rating?
Assessment of an organisations creditworthiness
Shows ability of organisation to fulfil financial commitments e.g pay rent on time
What are the main commercial credit rating agencies?
Dunn & Bradstreet
Standard and Poor (S&P)
Credit Safe
What are the two parts of a Dunn and Bradstreet rating?
Financial strength indicator
Risk indicator
Rate companies 1-4 (1 being best)
5A1 reflects a financial strength of over £50M.
Why do companies keep accounts?
For regulatory purposes and so managers can monitor and measure performance over time and manage appropriately.
What is capital expenditure?
Money spent by a business or organisation on acquiring or maintaining fixed assets like land, buildings and equipment
What is revenue?
Income generated by the sale of products or services
What is a financial audit?
An objective examination and evaluation of the financial statements to ensure they are fair and accurate.
What are profitability ratios?
Show how well a company can generate profit from its operations
What are solvency ratios?
A solvency ratio measures the extent to which assets cover the liabilities.
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 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
When must a company be VAT registered?
If company total VAT taxable turnover for last 12 months was over £90,000 OR if turnover is expected to go over £90,000 in next 30 days
What is EBITDA?
Earnings before interest, tax, depreciation and amortisation
It is a measure of company profitability
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
What is misappropriation of funds?
The illegal use of another person’s money
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
What are prelists?
A documenting listing charges to be raised so checks can be carried out to verify the charges are correct prior to raising them onto the accounts system to produce tenant invoices.
What is a statement of account and what’s included?
A document that reflects transactions on a particular account, including any overall remaining or credit balances.
What is a copy invoice and what does it include?
An invoice is a request sent to the debtor for payments of goods or services. It includes the amount due and the preferred method of payment.
What are remittances?
A remittance is money that is sent from one party to another - remittance advice is a statement detailing what was paid.
What is turnover?
The amount of money taken by a business in a particular period.
What is a turnover certificate?
This certificate details the turnover for the specified turnover period.
What does turnover include and exclude?
This is stipulated in the turnover clause in the lease, would usually be Gross turnover, including monies received for goods sold, excluding VAT and employee discounts, cash refunds/credits.
What is a turnover top-up ?
The turnover element is a top-up on the base rent and is linked to the financial performance of the tenant.
Please provide an example of a standard turnover clause/ calculation?
There will be a turnover period, typically a year, which is stipulated in the lease, detailing when turnover certificates fall due and if they are to be externally audited or not.
This is along with the means calculating the turnover rent. Frequently a fixed percent (10% in this case) is adopted less the base rent, to determine if a turnover top up is due.
(The amount by which the specified percentage of the Turnover in each Turnover period exceeds the Base rent payable in respect of that turnover period)
Why request three years’ worth of P&L?
To carry out a profits test and be able to compare and review over a time period.
What is the profits test?
A typical profits test would be for the tenant to provide 3 years’ audited accounts showing a net profit of, say, 3 times the annual rent.
What is service charge reconciliation?
A comprehensive comparison of income demanded against all service charge expenditure (including accruals and prepayments) for a given service charge accounting period.
This enables the calculation of any balancing charges and credits due from tenants and/or landlords.
Why check that invoices are applied to the correct code/schedule?
Charges should be allocated to the correct code and where necessary separate schedules with the costs apportioned to those who benefit from those services, this is a transparent approach and assists in avoiding any disputes.
