Accounting Principles (Level 1) Flashcards
What is a balance sheet?
A statement / snapshot of financial position at a point in time. It shows a company’s assets (owns), liabilities (owes) and value of equity (owners investment)
What are assets?
A resource owned or controlled by a business. These can be tangible and non-tangible (physical and non-physical items).
Name a few examples of assets
Tangible - Cash, property, inventory, vehicles.
Non-Tangible - Financial investments and intellectual property
What is a Profit & Loss account/statement?
Shows a company’s revenue and expenses over a particular period of time, typically either a month or year. It will show whether the company has made a profit or loss over that time period.
It’s a retrospective statement, not current.
What is P&L used for?
Used to calculate both income and corporate tax. Failure to file either of these correctly can result in penalties and/or added interest. It also assesses a company’s financial health
What’s the difference between a balance sheet and P&L statement?
A balance sheet is a snapshot of how effectively a company uses its resources and and P&L provides info on whether a company can generate profit by increasing revenue, reducing costs or both.
What is GAAP?
Generally Accepted Accounting Principles
This is the body of accounting standards published by the UK’s Financial Reporting Standard (FRS 102)
This is a common set of accepted accounting principles, standards and procedures company’s and accountants must follow when they compile their company accounts.
What is the IFRS?
International Financial Reporting Standards
This replaced the International Accounting Standards in 2001 and it states how certain transactions or events should be reported in financial statements. Plc businesses will have more reporting requirements to IFRS.
What’s the difference between GAAP and IFRS?
GAAP are general accounting principles for location i.e. Sox Compliancy or location based. Whereas IFRS are internationally known accounting principles.
Why do firms publish their accounts?
Required by law to publish your accounts for HMRC to establish tax.
If plc, it also allows stakeholders to review
What’s the difference between an accrual and a liability?
An accrual is an expenditure you may not need to pay whereas a liability is a cost that you’re contractually obliged to pay
What’s the difference between company accounts and management accounts?
Company accounts are statutory and are required, by law, to be published to HMRC for tax purposes.
Management accounts are in-house based forms/procedures i.e. CVR’s
What is capital allowance?
A form of tax relief
An expenditure which may be used to claim against taxable profit
What is taxation?
Payments to a central or local government
Central - Income tax, National insurance, VAT, Corporation tax
Local - Grants, Business rates, Council tax
What is Corporation tax?
Tax imposed on businesses’ profits, investments or selling assets
Limited companies pay corporation tax
What taxations do construction companies incur?
Sales tax when they purchase materials, Construction Industry Scheme (CIS) tax, VAT (domestic reverse charge), stamp duty (when buying land) and business rates to local communities
What is CIS?
Construction Industry Scheme Tax
Contractors deduct money from a Subcontractors payments and pass on to HMRC for taxation purposes. This is usually imposed on self employed personnel for labour cost only
What is Domestic Reverse Charge VAT?
On March 1st 2021 the construction industry allowed customers to charge themselves VAT and pay it directly to HMRC rather than the supplier sending them an invoice at a later date, which in turns stops suppliers from avoiding paying HMRC, known as missing trader fraud.
What is cashflow?
Cashflow is the movement of income and expenditure of a business and allows a company to track if they can cover their liabilities. It allows a company to understand when there may be shortfalls in cash, which will affect paying suppliers.
How can you improve cashflow?
Shorter payment terms with clients and longer payment terms with suppliers
How do Construction cashflows work?
Cashflows are utilised to understand when costs will be incurred and the total cost of that project activity will be at the project life cycle.
It allows the Contractor to identify when funding is required and that appropriate draw down is in place
How would a Client manage cashflow?
Prior to the Contractor being appointed, they would use Consultant appointments to measure expenditure across the project lifecycle however may not be entirely accurate until a programme has been agreed
What is auditing?
It is an independent examination of accounting and financial records/statements to determine if they conform to law and appropriate accounting principles
What is the role of the auditor?
Verify the accuracy of the accounts. They are to ensure they are published within the law and within appropriate accounting principles (GAAP or IFRS)
Who requires auditing by law?
If your company has an annual turnover of over £10.2m, assets more than £5.1m or has more than 50 employees
What’s a ratio analysis?
Quantitative method of gaining insight into a company’s liquidity, operational efficiency and profitability by studying its financial statements such as the balance sheet and income statement.
Why are there issues with profitability in the construction industry?
Volatile labour, material and equipment costs
Complex projects
Bidding in advance can have an impact (inflation incorporated)
How do you maximise profit on construction projects?
Early involvement at tender stage, having a thorough understanding of the risk/ER’s
Improving productivity
Reducing waste
Use of MMC’s
What is insolvency?
A company becomes insolvent if they are unable to pay their debts (more liabilities than assets on their balance sheet)
Name types of insolvencies
Administration - Administrator deals with your assets/accounts to create a plan to pay creditors
Liquidation - Attempt to offset your assets against your liabilities
What happens if the Contractor goes into insolvency?
Under the JCT Form of Contract, the employer is to ensure all unfixed materials/goods are protected and retained onsite. They should then look at terminating the contract or novating another Contractor. From a payment perspective, the employer should asses the ‘actual’ value of works, any cost for materials and plant onsite but then deduct the approximate cost of the novation and completion of the works. If no performance bond in place, any loss will be non-recoverable
What should a PQS do if a Main Contractor goes insolvent?
- Inform the client
- Cancel any payments to the insolvent party
- Secure the site
- Insure the site
- Call in the bond
- Value the remaining works (and onsite goods/materials/plant)
- Re-tender the works/approach 2nd place tenderer/take on Subcontractors direct
What is a performance bond?
Issued to one party of a contract as a guarantee against the failure of the other party to meet obligations specified in the contract.
Usually provided by a bank or insurance company to make sure contractors complete designated projects.
How is VAT applicable to Construction projects?
Value Added Tax (VAT) is applied to the cost of certain goods/services however only accountable to companies who are VAT registered. Suppliers can be exempt of zero-rated in varying instances
What is a sole trader?
A person who is an exclusive owner of a business and keeps all profits after tax but has unlimited liability (all losses)
What is a partnership?
Two or more individuals manage and operate the business. Equal owners and share liability for debts/profit.
What is a Ltd company?
A business that has a separate legal identity from its owners and managers.
Shareholders liability is limited to the capital invested
If the company becomes insolvent, the shareholders assets remain protected
What is an LLP?
Limited Liability Partnership which some or all partners have limited liabilities. In an LLP, one partner is not responsible or liable for another partners misconduct or negligence
What is a liquidity ratio?
Liquid assets / Liabilities
Liquidity ratio is used to determine a debtor’s ability to pay off current debt obligations without raising external capital (ability to cover short term obligations)
What is profitability ratio?
Refers to a financial ratio that measures the profitability of an investment by comparing the net profit generated from an investment to its initial cost, it tells you how much profit you gained relative to the amount you invested
Used to show a company’s ability to make a profit over a certain period.
(Net Profit / Investment) x 100%
What’s a Net Gearing Ratio?
Net Gearing Ratio = Debts / Equity (expressed as a %)
It measures how much a company is funded by debt vs how much it’s financed by equity.
High Gearing Ratio’s indicate that a company is at greater financial risk, because during times of lower profits and higher interest rates, the company would be more susceptible to loan default and bankruptcy.
Why do Chartered Surveyors need to understand and interpret company accounts?
Companies business accounts
For assessing the financial strength of contractors and those tendering for contracts
For assessing competition
Tax reasons
What’s the difference between gross & net?
Gross refers to the total amount before anything is deducted and net is the amount after all adjustments/deductions.
What is depreciation?
The systematic reduction of a recorded cost of a fixed asset. Examples of this is furniture and IT equipment.
Why should a company have accounts?
Cash flow - Understands in and outgoings to assist in management of bills and payments of subcontractors and suppliers
Monitor profit and loss (company performance)
Business planning for the future
Highlight problem areas
To submit annual financial statements to Companies House & tax reasons
How would you assess a contractors financial accounts?
Request a copy of the company’s accounts from the past 3 years (Balance sheet, P&L, etc.)
Then assess: profitability, liquidity ratio and overall financial health to calculate the risk of doing business with them
What legislation is there in accounting?
The FRS - Financial Reporting Standards
The Companies Act 2006
What is revenue and capital expenditure?
Revenue expenditure is a short-term expense, while capital expenditure is a long-term investment. Revenue expenses are used to run a business’s day-to-day operations, while capital expenditures are used to improve a business’s efficiency and capacity
Types of credit control in Construction/generally?
Business process that promotes the selling of goods or services by:
Extending credit to customers
Cash discounts
Payment terms
Vesting for cashflow
How would you review a companies financial health that you may look to work with?
Vetting the Subcontractors accounts
Using expertise of int/ext accounts to review liquidity, profitability and gearing ratios
Analyse their cashflow
What’re the taxations on Partnerships and LLP’s?
Both treated the same, where members are treated as self-employed and require to do their own tax returns. Each individual is assessed on their share of the profits and is solely responsible for their own assessment to HMRC.
