Accounting Principles L1

Question 1

WHAT ARE THE KEY FINANCIAL STATEMENTS THAT COMPANIES PROVIDE?

Answer 1

Profit and loss accounts

Balance sheet

Cash flow statements

Question 2

WHAT IS THE DIFFERENCE BETWEEN MANAGEMENT AND FINANCIAL ACCOUNTS?

Answer 2

Management accounts are for the internal use of the management team.

Financial accounts are the company accounts required by UK law.

Question 3

WHAT IS THE DIFFERENCE BETWEEN A PROFIT AND LOSS ACCOUNT AND A BALANCE SHEET?

Answer 3

A profit and loss accounts shows the incomes and expenditures of a company and the resulting profit and loss.

A balance sheet shows what a company owns (it’s assets) and what it owes (it’s liabilities) at a given point in time.

Question 4

WHAT IS A CASHFLOW STATEMENT?

Answer 4

A summary of the actual or anticipated ingoing and outgoing of cash in a firm over the accounting period.

This shows the short-term ability to pay off its bills.

Question 5

EXPLAIN YOUR UNDERSTANDING OF THE TERMINOLOGY ‘CAPITAL ALLOWANCES’

Answer 5

Capital Allowances - Tax relief on items purchased for the business, e.g. tools.

Question 6

WHAT ARE LIQUIDITY RATIOS?

Answer 6

The ability of a company to pay off current liabilities by converting its assets into cash.

Liquidity ratio calculation = current assets / current liabilities.

The ratio is usually around 1.5 but depends on the sector of activity.

E.g., house builders often operate on over 3 as they retain high value assets in the form of unsold houses.

Less than 0.75 can be an early sign of insolvency.

Question 7

WHAT ARE PROFABILITY RATIOS?

Answer 7

Measure the performance of a company in generating its profits.

Trading profit margin ratio = turnover - (cost of sales / turnover).

Low margins may be due to a growth strategy within the business, does not always mean bad management.

Question 8

WHAT ARE FINANCIAL GEARING RATIOS?

Answer 8

Measure the financial structure of a company, crucial indicators for external suppliers of debt and internal management.

Help measure solvency.

Highly geared companies rely heavily on borrowing.

The payment of interest reduces profits.

Question 9

WHY DO CHARTERED QS NEED TO UNDERSTAND AND BE ABLE TO INTERPRET COMPANY ACCOUNTS?

Answer 9

To aid in preparing their own business accounts.

For assessing the financial strength of Contractors and those tendering for contracts.

For assessing competition.

Question 10

WHAT IS THE PURPOSE OF A P&L?

Answer 10

To monitor and measure profit (or loss).

Compare against past performance and against company budgets.

For valuation purposes and to compare against competitors.

To forecast future performance.

To calculate taxation.

Question 11

WHAT IS THE DIFFERENCE BETWEEN DEBTORS AND CREDITORS?

Answer 11

Creditors are business entities that are owed money by another entity they have extended credit to.

E.g., if you provided services to a client and they owe payment of fees, you become a creditor to the client.

Debtors are business entities that owe money to another respective company.

E.g., if you used a sub-consultant and still owe them payment of their fees then you become a debtor of the sub-consultant.

Question 12

WHAT ARE MANAGEMENT ACCOUNTS?

Answer 12

Accounts prepared by a company for internal management use.

Accounts prepared by a lender, such as a bank to evaluate how you will be able to repay the funding.

These accounts are not audited externally.

Question 13

WHAT IS A FINANCIAL STATEMENT?

Answer 13

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

Question 14

WHAT IS A PROFIT AND LOSS ACCOUNT?

Answer 14

Demonstrate a companies sales, running costs and profit or loss over a financial period, usually 1 year.

Used to show sales vs expense (invoicing vs time and disbursement).

Can also help identify non-profitable works.

Question 15

WHAT IS A BALANCE SHEET?

Answer 15

Shows the value of everything the company owns, made up of its assets and liabilities.

The balance sheet demonstrates the value of the business at any given time.

Question 16

WHAT IS A CASH FLOW FORECAST?

Answer 16

Summarises the amount of cash (or equivalents) entering and leaving a company or project entity.

On construction projects, they usually show as an ‘S’ curve.

Typically, there is a small financial outlay at the start, a steep increase during the mid-way point and a taper towards the end.

Question 17

WHAT IS AN S-CURVE?

Answer 17

S-Curve means standard and refers to the shape of the expenditure profile when shown in graphical form.

Start of project - Rate of expenditure is typically lower due to site setup and lower value enabling works.

Middle of programme - Typically increase as more expensive building components, i.e. MEP & Structural forms are installed.

Back end of programme - Rate of expenditure slows downs which is shown by the flattening of the curve.

Question 18

HOW ARE ACCOUNTING PRINCIPLES USED BY SURVEYORS?

(Cash flow, balance sheet, P&L, S-Curve)

Answer 18

To track, analyse and assess business accounts and performance.

For assessing financial strength of contractors / companies.

Compare works progress against pre-contract predictions.

Question 19

WHAT ARE ESCROW ACCOUNTS?

Answer 19

Separate bank account owned by a third party, held on behalf of two parties, i.e. project bank account.

Bank account has defined contractual conditions for the release of funds.

Mechanisms must be in place for release of funds, i.e. certificate for payments.

Question 20

WHEN HAVE YOU USED COMPANY ACCOUNTS IN YOUR WORK?

Answer 20

To assess financial strength of contractors at tender stages, i.e. Pre-Qualification stage.

Question 21

HOW DO YOU ANALYSE A COMPANY’S ACCOUNTS?

Answer 21

Client’s accountants carry out the detailed analysis, but I can access via Companies House and use calculating ratios such as liquidity ratios, profitability ratios and gearing ratios.

I should calculate the ratios myself as the company accounts may have been manipulated.

I should use the group or consolidated accounts rather than company accounts unless it is a limited company.

Question 22

NAME CALCULATING RATIOS FOR ASSESSING COMPANY ACCOUNTS?

Answer 22

Liquidity ratio - Current assets / current liabilities. Determines how quickly a company can convert the assets to cover their liabilities. A score above 1.0 indicates a company has enough assets to cover its liabilities.

Profitability ratio - Net income = Revenue minus expenses.

Gearing ratio - Divide total debt by the total shareholders equity. The ratio, expressed as a percentage, reflects the amount of existing equity that would be required to pay off outstanding debts.

Question 23

WHAT IS REVENUE?

Answer 23

The total amount of income generated by the sales / services related to primary operations of a business.

May also be referred to as turnover.

Question 24

GROSS VS NET INCOME?

Answer 24

Gross income is the total amount you earn.

Net income is actual business profit after expenses and allowable deductions are removed.

Question 25

WHAT IS EQUITY?

Answer 25

The value of an ownership interest in an asset or company.

Equity is measured by subtracting liability from the value of the assets owned.

Question 26

HOW DO YOU CARRY OUT A CREDIT CHECK? GIVE AN EXAMPLE.

Answer 26

Use the Credit Safe website via my company’s subscription to access a company’s accounts.

I consider both the group accounts and the company accounts.

If the credit rating is low, I calculate key ratios and pass on information to my client’s accountants for details analysis.

Question 27

WHAT ARE SIGNS OF INSOLVENCY IN COMPANY ACCOUNTS OR CREDIT CHECKS?

Answer 27

A low credit rating, or liquidity rating below 0.75.

Falling working capital ratio, suggests the company is taking on more work than it can finance.

Low return on equity.

Heavily reliant on loans, aka, highly geared.

A falling cash flow statement.

Question 28

WHY WOULD YOU NOT RECOMMEND THE APPOINTMENT OF A LOW CREDIT SCORE CONTRACTOR?

Answer 28

Increased risk of inadequate performance by the Contractor, i.e. cost saving on specified items / work.

Increased risk of the Contractor failing to deploy sufficient resources and materials to the project.

Increased risk of the Contractor’s insolvency during the works.

Question 29

WHAT MEASURES WOULD YOU RECOMMEND IF YOUR CLIENT WANTED TO APPOINT A CONTRACTOR WITH A LOW CREDIT RATING?

Answer 29

Advise requesting a Performance Bond for the client to call upon if the Main Contractor failed to perform.

Review the tender submission to ensure this is not excessively front-loaded.

Ensure interim valuations are accurate and not over claimed.

A project bank account to provide an additional layer of assurance.

Question 30

WHAT IS A PERFORMANCE BOND?

Answer 30

Also known as Contract Bond.

Surety bond issued by an insurance company or bank to guarantee satisfactory completion by a Contractor, fulfilling the terms of the contract.

If they fail, the surety company is responsible for completing the obligations - new Contractor / financial compensation.

Question 31

DO COMPANIES NEED TO SUBMIT ACCOUNTS?

Answer 31

Annually, consisting of:

• a profit & loss statement
• a balance sheet
• notes
• a director’s report

Auditor’s report may be necessary, but companies qualifying as small / micro-entities are exempt from audit.

Question 32

EXPLAIN YOUR UNDERSTANDING OF THE TERMINOLOGY ‘INSOLVENCY’

Answer 32

Insolvency - Inability to pay debts as liabilities exceed assets.

Question 33

EXPLAIN YOUR UNDERSTANDING OF THE TERMINOLOGY ‘SINKING FUNDS’

Answer 33

Sinking Funds - Funds set aside for future bills or long-term debt.

Question 34

EXPLAIN YOUR UNDERSTANDING OF THE TERMINOLOGY ‘COMPANIES HOUSE’

Answer 34

Companies House - An agency that incorporates and dissolves limited companies within the UK.

Companies House is the executive agency of the British Government that maintains the register of companies, employs the company registrars and is responsible for incorporating all forms of companies in the United Kingdom.

Question 35

EXPLAIN YOUR UNDERSTANDING OF THE TERMINOLOGY ‘HMRC’

Answer 35

HMRC - Her Majesties Revenue & Customs.

Department of the UK Government responsible for the collection of taxes