Accounting Principles Week 9

Question 1

Financial accounting

Answer 1

The recording, classifying and summarising, in terms of money, transaction and events, which in part are at least, of financial character, and interpreting the results thereof.

Question 2

Financial vs Managing Accounting

Answer 2

Financial:
- External users
- Past performance
- Historically orientated
- Prescribed formats
- Financial measures
- Objective
- Highly aggregate

Managing:
- Internal users
- Planning and control
- Current, future orientated
- No regulations
- Financial, operational, physical measures
- More subjective
- Disaggregate

Question 3

Financial Analysis

Answer 3

Analysis of financial measures.
Includes: balance sheet, income statement, notes of accounts or financial ratios.
It is to evaluate company’s results, performance, and trend which will be useful for taking significant decisions like investment and planning projects and financing activities.
Uses this to improve.

Question 4

Reasons for financial analysis

Answer 4

Investment and lending decisions.
Evaluation of managerial performance.
Distribution decisions.

Question 5

Assets

Answer 5

Classified between non-current and current in the Balance sheet.

Question 6

Non-current (fixed) assets

Answer 6

Intangible- patents, brand names, goodwill.
Tangible- land and buildings, plant and machinery, motor vehicles.
Investments

Question 7

Current Assets

Answer 7

Inventories (stocks)
Trade Receivables
Other Receivables
Prepayments
Cash
Assets that are held short term, for sale or consumption.

Question 8

Liabilities

Answer 8

A present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from enterprise of resources embodying economic benefits.

Question 9

Current liabilities

Answer 9

Amount falling due within one year:
Trade payables
Other payables
Accrued expenses
Bank overdraft

Question 10

Non current liabilities

Answer 10

Amounts falling due after more than a year:

Question 11

Ratio

Answer 11

The relationship between two or more items in the financial statements.
Benefits, enable comparison of:
-one company’s performance over time
-different companies in same industry sector
-different divisions within one company
-company performance within industry average

Categories:
Profitability, asset management (efficiency), short term (solvency), financial strength (long term solvency), investment potential.

Question 12

Key ratios: Profitability

Answer 12

Relevant factors:
-increases and decreases in sale prices
-increases/decreases in cost of raw materials and labour costs
-changes in the efficiency of the production process
-changes in the sales mix
-variations in the overhead costs, e.g. from changes in activity levels

Gross margin:
Gross profit/turnover (sales) X 100
Measures the profitability after charging all the costs directly associated with the goods or services sold. They can be considerably dependant upon the nature of the business.

Operating profit margin:
Operating profit/Turnover(sales) X 100
Can vary considerably between types of business, similar to gross profit margins.

Return on capital employed (ROCE)
profit before interest + tax/ capital employed X 100
Measures efficiency with which capital employed has been utilised. Means long-term funds so it includes equity and long-term loans.

Return on equity (ROE)
Profit after interest+tax-pref.dividends/ ordinary share capital + reserves + retained profit X 100
Measures the profitability of the company in relation to the capital provided by the owner of teh company.

Question 13

Key ratios: Solvency

Answer 13

Short term:
Current ratio
Liquidity (acid test or quick) ratio

Long term:
Gearing ratio
Interest cover

Question 14

Key ratio: Asset Management

Answer 14

Inventory(stock) days
Trade receivable days
Trade payable days
Asset turnover

Question 15

Limitations of ratios

Answer 15

Lack of standard definitions of ratios. Makes comparison difficult.
Balance sheet figures may not reflect normal position, e.g. seasonal business.
Different accounting policies make inter-company comparisons
difficult, e.g. uses of different measurement bases for assets.
Finding appropriate comparator companies.
Misinterpretation of ratios, if context of analysis not taken into account.
Ratios are always retrospective in that they are based on past performance.
Should not be used in isolation, but should always be used
as part of an overall assessment of the business.
Take no account of what is happening in the economy as a
whole or in the sector in which the company operates.
Ratios take no account of inflation.

Question 16

Working capital Management Ratios – Inventory
days

Answer 16

Inventory/cost of sales X 365 days.
The inventory days measures the
average number of days for which
stock was held before being sold.
The lower the number of days, the
more efficient the business is.

Cost of sales/inventory.
This measures how often inventory
“turns over” during a financial
period. i.e. how often it needs to be replaced. The more frequently, the more efficient the business is.

Question 17

Working Capital Management Ratios – Trade Receivable
Days

Answer 17

trade receivables/credit scales X 365 days
Shows how long it takes for customers to pay the amounts owing. The shorter the period, the more efficient the business is.

Question 18

discuss three types of accountancy ratios (10 marks)

Answer 18

Three key types of accountancy ratios are profitability, solvency and efficiency ratios. Profitability ratios assess a company’s ability to generate profits, after charging all the costs directly associated with the goods or services sold. Some examples for this are Gross Profit margin, which varies considerably depending on the nature of the business, or Operating Profit Margin, where the overhead expenses of businesses can vary.
Solvency ratios evaluate a company’s ability to meet its long term obligations and remain financially stable over time.
Asset Management ratios focus on how efficiently a company utilises its assets to generate revenue.

Question 19

Discuss the difference between management and financial ratios (5 marks)

Answer 19

Financial account are private limited companies and PLCs filed annual accounts with Companies House. They are publicly available and should relate to a specific financial year. They must keep accurate records of all income, expenditure, assets and liabilities.
Management accounts are instead produced to the owners or managers of a business on a monthly or quarterly basis to inform decision making and business planning. They will typically include a profit and loss statement and a balance sheet.

Question 20

explain why cash flow is important for a construction project (10 marks)

Answer 20

Cash flow is the movement of income into and out of business. It tracks the (usually) monthly incoming and outgoing for a company to show if there is a positive or negative cashflow. This information can be used to obtain loans, monitor contractor progress, manage the cash within the business and forecast business performance. Cashflow is usually on of the reasons why a company can fail, it is dynamic and unpredictable. It is needed as it gives advanced warnings of cash shortages, helps employees with financial control and provides reassurance to investors and lenders.

Question 21

discuss the term preliminaries on construction project (10 marks)

Answer 21

Preliminaries are the costs of the project which are not included on the rates. These include general plant, site staff, site set-up, facilities etc. These are essential to help the project run smoothly and are included in the bill of quantities.