Accounting Principles + Procedures Flashcards
What are the main 5 accounting concepts?
- Business identity – only record business transactions, not personal ones, unless they involve adding or withdrawing business resources
- Growing concern – record assets at their original cost, not at liquidation prices
- Monetary period – only record transactions that can be measured in money
- Accounting period – choose a specific time period to complete the accounting cycle
- Accrual – record income when earned + expenses when incurred, regardless of when cash is received or paid
What are assets?
What the company owns - economic resources
Current + non-current assets
What are current assets?
Cash + other assets expected to be converted to cash within a year
E.g. trading properties, prepaid expenses, accounts receivable
What are non-current assets?
Purchased for long-term use + are not likely to be converted into cash in less than 1 year
E.g. property + long-term property investment, plant, property + equipment (PPE)
What are liabilities?
What the company owes to banks/trade creditors
Current + non-current liabilities
What are current liabilities?
Amounts owed within 1 year
E.g. short-term borrowings + overdrafts
What are non-current liabilities?
Long-term financial obligations which are owed later than 1 year
E.g. debentures + loans
What is equity?
Value that would be returned to shareholders or owners if all the assets were liquidated and all the company’s debts were paid off
What is owners’ equity?
Amount of value that owner has in business
What is shareholders’ equity?
Amount of value that shareholders have in business
What is net worth?
Overall value of business
What are net assets?
Assets minus liabilities
Measure of company’s net worth
What is revenue?
Total amount of money company earns from normal business activities
‘Top line’ - appears at top of income statement
What is net income?
Amount of money left after all expenses, taxes + costs have been subtracted from revenue
‘Bottom line’ - appears at bottom of company’s income statement)
What is gain?
An increase in value of an asset or property
If sell something for more than you paid for it, the difference is your gain
What is Net Asset Value (NAV)?
Value of an entity’s assets minus liabilities, divided by number of shares
What are retained earnings?
Amount that company will keep to support future operations
Earnings that are not distributed as dividends
What are dividends?
Payment from company’s profits to investors
Only distributed if earnings are positive + there is enough cash to do so
Why should businesses keep accounts?
To keep track of money coming in + out so know they can pay bills + suppliers etc.
To monitor profit + loss + company performance
Use the information for future business planning
Use the information to highlight any problem areas so can be investigated/solved
So can submit annual financial statements to Companies House
What are the differences between financial and management accounts?
Management accounts are for internal use of management team
Financial accounts are company accounts required by law
What are the three main financial accounts?
Balance sheet
Income statement
Cash flow statement
What is a balance sheet also known as?
Statement of financial position
What is a balance sheet + what does it show?
Summarises financial position of company for one specific point in time
Shows assets, liabilities (owned v owed) + shareholder’s/owner’s equity
Does a balance sheet relate to a period in time or a specific date (snapshot in time)?
Snapshot (given date)
What is an income statement also known as?
Profit + loss account
What is an income statement?
Summary of income + expenditure to show net profit/loss during a set period of time
Can you draw comparisons between income statements for different years?
Yes – they relate to a set period of time (1 year usually)
What is the difference between a statement of comprehensive income + a statement of financial position?
Statement of comprehensive income shows income, expenditure + profit or loss of company
Statement of financial position shows what a company owns (assets) + what it owes (liabilities) at any given point in time
What is a cashflow statement?
Merges balance sheet + income statement to show actual receipts + expenditure including VAT
What is a cashflow statement split into?
Core operations
Investing activities
Financing activities
Name some assets to a business
Land
Property
Machinery
Stock
Debtor’s cash
Other investments
Name some liabilities to a business
Borrowings
Overdrafts
Loans
Creditors
Shareholder’s funds
Who are audited accounts prepared by?
Accountant
Under which Act may audited accounts be required?
Companies Act 2006
What is the role of an auditor?
Responsible for checking if financial statements comply with adopted accounting principles + examine company’s accounting control systems
Confirms reported values + identifies any material errors in the financial statements
Why are audited accounts beneficial?
Confirms no material misstatements
Identifies weaknesses
Facilitates access to finance
Better supplier terms
Required if business sold
To ensure financial statements are true + fair
Enables people to make accurate decisions based on financials
Name some typical UK company types
Sole trader
Partnership
LLP
Limited Company
Public limited company
What are some common financial measures?
Acid test
Return on capital employed
Working capital ratio
Gearing ratio
Net assets per share
What is the acid test (quick ratio)?
How well are current liabilities covered by cash/liquid assets
What is return on capital employed?
How profitable is capital invested in a business
What is working capital ratio (liquidity)?
Ability of a company so pay (solvency) / how quickly can assets be turned into cash to pay short-term obligations
What is gearing ratio?
Exposure of business to loans as opposed to share capital
What is net assets per share?
Price which shares can be bought + sold at
What is the most common reason for business failure?
Cash flow issues
Which are the two financial reporting frameworks recognised by UK company law?
IFRS
UK GAAP
What is the difference between UK GAAP + IFRS?
UK GAAP – for UK companies
IFRS – for international companies
What does UK GAAP stand for?
UK General Accepted Accounting Principles
What is UK GAAP?
Financial reporting framework for how company accounts are prepared
Adopted by some companies in UK
Issued by Financial Reporting Council + has 6 FRS – 100, 101, 102, 103, 104, 105
FRS provide guidance on the way financial reports are set out, with FRS 102 covering how property included in accounts is to be valued
What is FRS 102?
Main financial reporting standard for most entities
Used by small + medium sized businesses as part of UK GAAP
What does FRS 102 say about investment property?
Investment properties must be measured at fair value, with any changes in fair value recognised in profit or loss
Why might the fair value measurement for investment property accounting in FRS 102 problematic?
Can affect key profitability ratios (with the potential to breach loan covenants)
When was FRS 102 last updated and when will changes come into effect?
Last updated in March 2024
Changes will come into effect on 1 January 2026
What are some of the key changes to FRS 102?
A new model for companies to report sales, helping show exactly when + how they earn money
Companies must show leases on their balance sheets, making it clear what they owe + what they are renting (this makes financial statements more transparent)
Enhanced guidelines to ensure consistency + comparability in how companies measure the fair value of their assets
Clearer instructions on how to handle situations where unsure about how much tax companies owe
What is FRS 105?
Financial reporting standard
Provides simplified accounting requirements for very small businesses (micro-entities)
What is IFRS + what does it stand for?
International Financial Reporting Standards
Internationally adopted + the required standard by EU companies
Tell me what it means to prepare accounts in accordance with IFRS
Following a set of global accounting rules to ensure financial statements are transparent, comparable + consistent across different countries
Which type of entity must use IFRS?
Listed companies
Can companies choose between IFRS and UK GAAP?
Publicly listed companies must use IFRS for financial statements
Other companies can choose + should seek advice from accountant
Why is an annual report important for a public limited company?
Explains performance to shareholders + investors
Helps potential investors in decision making
What is the benefit of being a Public Limited Company (PLC)?
Audited accounts are publicly available – public + suppliers can check financial performance
What is the valuation basis for financial reporting under IFRS?
Fair value
What is the Red Book definition of fair value?
The price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date
What does IFRS 16 relate to?
Lease accounting
What is IFRS 16?
International accounting standard for leases
Effective from 1 January 2019
Aim of IFRS 16 – to ensure accurate reporting of lease transactions + to allow more accurate analysis of related cash flows
When did IFRS 16 come into force?
1 January 2019
What are the impacts of changes to IFRS 16?
Eliminated off balance sheet lease accounting
Affected financial metrics, e.g. gearing ratio, EBITDA
Encouraged short-term arrangements as leases under 12 months are exempt
When would you want to assess financial strength of an entity as a surveyor?
Prospective tenants
Contractors/tenders
Profits valuation
Name some typical credit check reports
D&B
Experian
Creditsafe
What would you look for in a credit check report?
Risk assessment rating (e.g. D&B risk assessment)
Failure risk score
Delinquency score
Financial ratios
For a typical credit check report, what would be the best financial rating?
A/1
What else would you ask to assess financial strength of an entity, e.g. prospective tenant?
References – bank, trade, landlord and accountant, Accounts (3 years’ audited), Profits Test and business plan (if a new business)
What is the profits test?
Net profit for proposed business must be 3x rent for 3 consecutive years or NAV of business must be 5x rent
Why is it important to check financial strength of entities you deal with?
Assess risk of default and impact on investment security
What is Corporation Tax?
Tax company pays when they make a profit
Do LLPs pay Corporation Tax?
No
What is insolvency?
When company can’t pay debts
Potential consequences are liquidation
What are some causes of insolvency?
Reduced cashflow
Increased expenses
Unexpected costs
What are the IAS?
International Accounting Standards
Set of guidelines for preparing financial statements
What is the difference between IAS and IFRS?
Both accounting standards adopted by different boards
Different adoption timelines + requirements throughout different countries
