Accounting Principles & Procedures Flashcards
What are the 3 types of financial statements you might come accross relating to a company?
Balance sheets
Income statements
Cash flow statements
What is an asset?
A resource owned or controlled by a business entity conaining economic value
What is a liability?
Something a person or company owes
Give an example of an asset
Cash
Real estate
Give an example of a liability
Payroll expenses / wages
Money owed to suppliers
Bank debt
What is the difference between financial and management accounts?
Financial accounts is the collection of accounting data to create financial statements required by law
Managerial accounting is the interal processing used to account for business transactions
What do you understand about the term Generally Accepted Accouning Principles (GAAP)
Standards that encompass the details, complexities and legalities of business accounting
→ must be followed when compiliing financial statements
What is the purpose of GAAP?
To improve the clarity of the communication of financial information
Name 3 principles of GAAP
- Regularity - rules applied as standard practice
- Consistency - use same standards throughout
- Sincerity - provide objective and accurate info
How do companies know which reporting framework to comply with?
It is set out in FRS 100 Application of Financial Reporting Requirements
Can you tell me about a common financial measure?
- Gross profit margin / net profit margin
- Working capital ( Current assets minus current liabilities)
- Debt-to-equity ratio (total debt/total equity)
What is a debt-to-equity ratio?
Solvency ratio which measures how much a company finances itself using debt as opposed to equity
What is the acid test?
Type of liquidity ratio
→ measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately
What is ROCE?
Return on capital employed
→ compares the relative profitability of a company after taking into account the amount of capital used
What is the working capital ratio?
Working capital ratio = current assets / current liabilities
→ assess companies liquidity
What is the gearing ratio?
Compares some form of owner equity (or capital) to funds borrowed by the company (debt-to-equity ratio - debt/shareholders equity)
What are net assets?
Value of a companies assets minus its liabilities
What is net assets per share?
An expression of net asset value that represents the value per share of a mutual fund or an exchange-traded fund
Can you tell me what the role of an auditor is?
Inspect organisations’ financial accounts to ensure they’re correct and comply with the law
When are audited accounts needed and why?
All UK companies require an audit, except for ‘small companies’ with turnover below £10.2m or total assets below £5.1m (or less than 50 employees)
Needed because it is require by law and provides a high level of assurance to shareholders
Do public limited companies need an audit?
Yes, PLC must get their annual financial statements audited each year by independent auditors or accountants as prescribed in section 143 of the Companies Act 2013
Tell me something you understand from the Companies Act 2006
- Replaced Companies Act 1985 and aims to improve shareholders rights, modernise and simplify corporate law
→ one of the largest acts in history with over 1300 sections
→ primary source of UK company law
What are the International Accounting Standards (IAS) ?
Previous accounting standards - replaced in 2001 by the IFRS
Why was IFRS introduced to replace IAS?
- Easier to compare businesses around the world and increase transparency and trust in financial reporting
- Foster global trade and investment
What is IFRS?
International Financial Reporting Standards
What is the difference between UK GAAP and IFRS?
FRS 102 is the most commonly used UK GAAP accounting standard and is more cost effective than IFRS
IFRS is internationally used
→ Differences in lease and investment property
What is the basis of valuation under IFRS 13?
Fair value
What is fair value?
The price that would be receieved to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
What is IFRS 16?
International accounting model that specifies how leases are recognised in financial statements
Single leaseholder accounting model - Leaseholders required to recognise leases as assets and liabilities in their financial statements
What is the objective of IFRS 16?
- Ensure that leaseholders provide relevant information that represents their lease
- Assess the effect that leases have on the financial position, financial performance and cash flows of an entity.
What is the result of IFRS 16 accounting?
- Increase in assets, liabilities and net debt where leases are brought onto the balance sheet
- Affects key accounting and financial ratios impacting a companies attractiveness and ability to raise finance
- Might result in entities taking shorter leases to reduce nebt debt on the balance sheet
WHat has changes in relation to lease accounting / IFRS 16?
CHanges the accounting substantially for lessees → eliminates a lessees classificaiton of leases as either operating leases or finance leases
When did IFRS 16 changes come into effect?
1st January 2019
What is FRS 102?
The financial reporting standard applicable in UK and Ireland
→ designed to apply to the general prupose financial statements and financial reporting of entities including those that are not constitutes as companies and those that are not-profit orientated
What changes have been made to FRS 102?
Changes in the definition of intangible assets → greater range of intangible assets recognised
Companies required to account for holiday and sick pay liabilities at each year end → for example, employees carrying over holiday recognised as a liability on the balance sheet
How have FRS 102 changes affected investment property?
Investment property is measured at fair value at each reporting date with changes in fair value recognised in profit or loss
→ will require a valuation exercise in practice → instruction of a valuation expert
What are statutory accounts?
Also known as financial statements or year-end accounts
→ Drawn up to report various financial measures and related disclosures for filing with companies house
Why is good financial record keeping important to you?
- Makes budgetting easier
- Important for tax purposes
- Prevents fraud and theft
- Helps to efficiently manage cash flow
- Makes management easier
Tell me 3 ways you ensure that Client money is handled properly?
- Kept in a seperate account with word ‘client’ in the account name and distinct identifier of client
- Have in clear writing, confirmation from the bank that client money in the account is not to be transferred or combined
- Ensure account details are provided to clients and that money is immediatley available
What RICS guidance or schemes do you adhere to in relation to Client money?
RICS Client Money Handling, 2019 (professional statement)
RICS Client Money Protection Scheme, 2019
Explain your understanding of the VAT domestic reverse charge for building and construction services
The VAT domestic reverse charge procedure is an anti-fraud measure designed to counter criminla attacks on the UK VAT system
→ customers are able to charge themselves VAT and pay it directly to HMRC, rather than the supplier sending them an invoice at a later date
When do changes to the reverse charge apply from?
1st March 2021 - to include Building and Construction Services
What is the impact of the reverse charge on VAT accounting?
- Subcontractor impact on cashflow, losing 20% of income ahead of quarterly VAT return
- Boost to main contractors cash flow
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 page
- Directors report
- Statutory profit & loss account
- Balance sheet
- Notes to the accountant
What is a profit & loss account?
A summary of business income and expenditure transactions on an annual basis
→ gives an overall profit and loss figure
What is taxation?
Amount of money or % that is owed to HMRC based on company profit
What is directors renumeration in a profit & loss account?
Refers to how directors of a company are compensated for their services, usually fees, salary, use of company property or benefits
How is gross profit calculated?
Turnover (value of a companys sales) minus the cost of sales
What can be interpreted from gross profit?
Provides an idea of company performance year-on-year when comparing with previous gross profit
What is a better indicator of profit than gross profit?
EBITA - Earnings Before INterest, Tax, Depreciation and Amortisation
→ Calculated by subtracting administrative expenses from gross profit
→ good indicator on whether company has a future
What is depreciation?
Planned, gradual reduction in recorded value of a tangible assset over its useful life
→ applied to fixed assets, which generally experience a loss in their utility over multiple years
What is Amortisation?
The process of incrementally charging the cost of an intangible asset to expense over its expected period of use, which shifts the asset from the balance sheet, to the income statement
→ reflects the consumption of an intagible asset over its useful life
What is the difference between Amortisation and Depreciation?
Amortisation charges off the cost of an intangible asset and depreciation does so for tangible assets
What is a balance sheet?
Outlines a companys assets and liabilities
→ tells how much a company is worth
What are assets on the balance sheet?
Items that the comapny owns and can provide economic benefit
What are the two types of asset?
Fixed (around for a long time, such as land)
Current (shorter life span, such as stock)
What are liabilities ?
What a company owes to other parties
What are the two types of liability?
Long term (not due in the next year)
Current (due within the year)
What key information can be concluded from a balance sheet?
Whether a comapny is solvent
How likely it is that the company will still be in business in a year
What is the liquidity ratio?
Ability to pay short-term debt obligations
How is liquidity ratio calculated?
Current assets / current liabilities
How is the liquidity ratio figure interpreted?
Ratio of 1 = can exactly pay off all current liabilities with current assets
What is Net Asset value (NAV)?
Total assets minus total liabilities
→ if share price is higher than NAV per share, market expects company to make future profits
What are the 3 parts of a balance sheet?
Assets
Liabilities
Owners equity
What is the difference between assets and liabilities known as?
- Equity
- The net assets
- Net worth
- Capital of the company
What is the cash flow statement?
Statement providing data regarding all cash flows received from ongoing opertations and investments
→ includes cash outlflows that pay for operations and invesments
Why is the cash flow statement believed to be the most intuitive of all financial statement?
It follows the cash made by the business in 3 ways
→ operations
→ investment
→ financing
The sum of these three segments is called the net cash flow
What is a credit rating?
A numerical or quantified assessment of an organisations creditworthiness, based on previous dealings.
→ shows the ability for an organisation to fulfill their financial commitments or lieklihood of defaulting on its debt obligations
What are the main commercial credit rating agencies
- Dunn and Bradstrees (D&B)
- Moody’s
- Standard and Poor (S&P)
- Fitch Ratings
- Creditsafe
Why do companies keep accounts?
- Regulatory purposes
- Keep track of outgoing and ingoings
- Compare performance and plan future growth
What are the two parts of a Dunn and Bradsheet rating?
Financial Strength indicator (5A - HH)
→ indicator of size of tangibles and net worth based on recent balance sheet
Composite credit appraisal/risk indicator (1,minimum → 4, high risk)
→ overall evaluation of creditworthiness and takes several factors into account: financial condition, payment history, length of operation, employee numbers etc
What is covenant strength?
Tenant ability to comply with lease obligations
What is revenue ?
Income generated by the sale of products or services
What is capital expenditure?
Money spent by a business on acquiring or maintaining fixed assets (land, real estate, equipment)
What is a financial audit?
Objective examination/evaluation of financial statement to ensure they are fair and accurate
What is ratio analysis?
Method of gaining insight into a companys liquidity efficiency and profitability by studying its financial statements
What are profitability ratios ?
Convey how well a company can generate profit from its operations
→ Gross profit ratio (gross profit/net sales)
→ Net profit ratio (Net profit/net sales)
→ operating profit ratio (EBITA/net sales)
What are solvency ratios?
Compare a companys debt levels with its assets, equity and earnings
→ suggest whether a company is solvent and can pay debt
- Debt equity ratio
- Interest coverage ratio
- Equity ratio
What are efficiency ratio?
Evaluate how effective a company uses its assets to generate sales and maximise profits
→ also called activity ratios
What is credit control?
Strategies employes by businesses to accelerate sales of products or services through the extension of credit to potential customers and Clients
→ Process of checking their creditworthiness to ensure that credit is only given to parties able to pay it
What is profitability?
Determines the scope of a companys profit in relation to the size of the business
→ measure of efficiency
What is insolvency?
When an individual or company can no longer meet their financial obligations to lenders as debts become due
→ can arise from poor cash management, reduction in cash inflow, and increases in expenses
What is VAT?
Consumption tax on goods and services, levided at each supply chain stage where value is added
- 20%
- 5% (reduced rate for some goods and services)
- 0% (zero rate)
Where might you find information on comapnys assets?
On the balance sheet
What is a cash flow statement?
A statement that summarises the movements of cash and cash equivalents that come in and go out of a company
→ measures how well a company manages its cash posittion
Whats the difference between a profit and loss statement and a balance sheet?
Balance sheet reports the assets, liabilities and shareholder equity at a specific point in time
A profit & loss statement summarises a companys revenues, costs and expenses during a specific period
Are profit & loss accounts current?
No - retrospective
What are management accounts?
Reports produced for the business owners and managers
They are for internal use and personalised to the users requirements → usually balance sheets or profit & loss statements
What are company accounts?
Documents prepared at the end of the financial year showing a companys performanec over the accounting period
→ legally required from all companies under the Companies Act 2006 → must be preared in accordance with the Act
What is capital expenditure?
Money spent by a business to acquire, upgrade and maintain physical assets
When must a company be registered for VAT?
Total VAt taxable turnover for the last 12 months was over £85,000
or
The turnover is expected to go over £85,000 in the next 30 days
What is the VAT threshhold?
Amount of money a company can earn before registering for VAT → £85,000
What is EBITA?
Earnings Before Interest, Taxes and Amortisation
→ measure of a companys profitability
What is Goodwill?
An intangible asset that is associated with the purchase of one company by another
→ Portion of the purchase price that is higher than the sum of the net fair value of all assets purchasd in the acquisition and the liabilities assumed in the process
→ the value of a companys name, brand reputation, loyal customer base represents aspects of goodwill → this is why one company may pay a premium for another
What does it mean for a company to go into administration?
A company becomes insolvent and it is put under the management of licenced insolvency practicioners
What is insolvency?
The state that a company or individual enters when they are not able to pay their debts
What is bankruptcy?
A legal proceeding initiated when a person or business is unable to repay its outstanding debts and liabilities
→ makes sure any assets are shared amongst creditors and allows the party to make a fresh start from debt, with restrictions
What is receivership?
A court appointed tool that can assist creditors to recover funds in default and can help companies avoid bankruptcy
→ aims to return companies to profitability
→ court appoints an independent receiver who manages the comapnys business
Why do chartered surveyors in your pathway need to understand and be able to interpret company accounts?
TO assess the covenant strength of tenants
To assist with building operations
Where can you find information on a companys financial status?
Companies House
Credit check from credit agencies
What is liquidation?
A process where assets are used to pay off its debts
Leftover money goes to shareholders and the company is then clsoed / de-registered
What is the differennce between management and financial accounts?
Management accounts are internal
Financial accounts are required by law and must follow a pre-determined format
What is the Limitations Act 1980?
Outlines the time limit which a creditor can chase a debtor for outstanding debts
→ Only applies where no contact between creditor and debtor has been made in a specific period
What is the meaning of misappropriation of funds?
Occurs when a person entrusted to manage someone elses money or property, steals all or part of that for their own gain
→ can be internal, such as a employee or external, such as targeted infiltration
