Accounting Test 3

Question 1

What are the 5 features of a sole trader?

Answer 1

• Person who owns and runs their own business
• Keeps all their profit (after taxes are paid)
• Have unlimited liability
• Are personally liable for the business debts
• Personal assets may be at risk if they can’t pay their creditors

Question 2

What are the 2 sources of sole trade financing?

Answer 2

1. Owners capital
2. Borrowings

Question 3

What can borrowings be broken down into?

Answer 3

Overdraft
Loan

Question 4

Explain what is meant by an overdraft and list the 6 features

Answer 4

→ Occurs when the bank balance goes below 0 and beyond
→ Shown as a current liability
→ Flexible
→ Short-term
→ Working capital
→ However, bank can recall at any time

Question 5

Explain what is meant by a loan and list the 7 features

Answer 5

→ Longer term
→ Shown as a non-current liability
→ Not flexible
→ Differing terms
→ Allows budgeting for payments
→ May need security
→ Allows you to buy assets

Question 6

What are the two types of Limited Companies?

Answer 6

1. Private Limited Company (Ltd)
2. Public Limited Company (Plc)

Question 7

List the 5 features of a Private Limited Company

Answer 7

• At least one member
• Cannot sell shares to public
• Must have limited or Ltd in name
• At least one director
• Money invested by owners is called EQUITY

Question 8

List the 7 features of a Plc

Answer 8

• At least £50,000 issued share capital
• Name must include Plc
• At least 2 members
• At least 2 directors
• Can sell shares to public
• Dividend payments expected
• Vulnerable to take-over bids

Question 9

What are the 2 legal statuses of limited companies?

Answer 9

• Separate legal personality:
• Limited liability

Question 10

What are 3 methods of financing limited companies?

Answer 10

• Debt (loans)
• Equity (shares)
• Usually a mixture of the two

Question 11

Explain what is meant by Equity

Answer 11

• Equity is provided by shareholders
• Company owned and run for benefit of shareholders
• Shares must include ordinary and occasionally, preference
• Capital section biggest change
• Drawings do not appear in limited company accounts, only applicable to sole traders
• Capital is now referred to as equity

Question 12

Explain what is meant by Reserves

Answer 12

• All reserves belong to shareholders
• Revenue reserves CAN BE distributed as dividends
  i.e. retained earnings from I.S – undistributed profits.
• General Reserves to guard against events i.e. inflation

Question 13

Explain what is meant by Capital Reserves

Answer 13

• Cannot be distributed as dividends
  i.e. share capital, share premium, revaluation reserve (adjustment for Increase in value of buildings etc)

Question 14

Explain the 5 features of Ordinary Shares (equity)

Answer 14

• Voting rights
• No automatic entitlements to dividends
• Higher risk
• Market value usually much higher than nominal value
• Attend AGM

Question 15

Explain what is meant by Ordinary Shares

Answer 15

• All shares have a nominal or par value, usually £1.00, but may be 25p, 50p
• This is the share capital in the SOFP
• If the shares are sold for more, any difference goes into Share Premium
  NOTE** NOMINAL VALUE IS NOT THE SAME AS THE MARKET VALUE***

Question 16

Explain what is meant by Authorised and Issued shares

Answer 16

• Companies have an authorised amount of shares that they can issue
• The amount of shares actually issued is shown in the SOFP
  NOTE** THESE MAY NOT BE THE SAME AMOUNTS***

Question 17

Explain what is meant by Dividends

Answer 17

• In large companies, directors propose dividend for approval by shareholders at AGM.
• Interim Dividend (Paid)
• Final Dividend (Proposed)
• Dividend Declared as PENCE per share (Based on the quantity of ISSUED SHARES)

Question 18

Explain what is meant by Preference Shares

Answer 18

• No voting rights
• Fixed rate dividend
• Cumulative
• Paid from after Tax Profits
• Paid out before Ordinary Dividends
• Less risky than ordinary shares

Question 19

Explain what is meant by Borrowing (Debt)

Answer 19

• Loan stock or debentures
• Specified rate of interest
• Specified period of time
• No voting rights
• Safer investment
• Different types: Convertible, Redeemable, Mortgage debenture

Question 20

List the 5 benefits of Borrowing

Answer 20

→ Maintain control
→ If profits increase = more for shareholders
→ Enables expansion
→ Plan cash flow
→ Interest allowable against tax

Question 21

List the 5 dangers of borrowing

Answer 21

 Interest and loan must be repaid
 Failure to pay can destroy company
 Consider risk of increased interest rates
 Companies with high borrowing are high risk
 Increased risk to shareholders

Question 22

Explain Retained Profits

Answer 22

• Profit made can be paid as dividends or ploughed back into business
• Depends on company’s success and dividend policy
• Usually a mixture of the two

Question 23

What are the 6 other sources of finance?

Answer 23

• Lease rather than buy assets
• Outsourcing activities
• Careful working capital management – Debtors-Stock-Creditors
• Factoring
• Cost savings
• Obsolete assets