Business Accounts Flashcards
What financial statements are prepared in respect of each accounting period?
- Balance sheet
- Profit and loss account
What is a nominal ledger?
A place where transactions of a similar type are recorded e.g. sale of stock, wage payments
Several different ledgers (accounts) collective name is books
What is the principle of doube entry book-keeping?
The sum of a business’ debts should be equal to the sum of all its credits over the relevant accounting period
What is the trial balance?
A list of all balances on all of a business’ ledgers/accounts at the end of an accounting period
Debits in one column, credits in another
What is ALCIE?
Refers to the things every entry on trial balance sheet can be characterised as:
- Asset (owned by business)
- Liability (owed by business)
- Capital (injection of value from owner/investor)
- Income (earned by business)
- Expense (spent by business)
Each type of asset will be recorded in separate accounts…
* Theatre might record income from ticket sales and from venue hire in separate accounts
Difference between fixed (non-current) and current assets?
Fixed = held by company over a year providing long lasting benefit
Current = cash; can be quickly turned into cash (within one year)
Current is continually flowing through business
Difference between current liabilities and long-term (non-current) liabilities)?
Current liabilities = due to b e paid within a year
Non-current liabilities = falling due after one year
What does ‘drawings’ refer to in a sole trader’s account?
Transactions between business and owner; owner pays himself a salary by drawing profits
What is a profit and loss account?
AKA income statement
Records income of a business minus expenses incurred throughout accounting period
Are assets included in the profit and loss account?
No! Only day-to-day income and expense entires e.g. sales
What is the difference between gross profit and net profit?
Gross = all income of a business less the cost of sales
Net = gross profit less expenses of business
How is cost of sales calculated?
Opening stock + purchases - closing stock
Both asset accounts; exceptions to the rule that P+L only shows income/expense accounts
What is the balance sheet?
Snapshot of asset, liability and capital accounts from trial balance
What are the two key things a balance sheet tells the reader?
- Net asset value (NAV) - top half
- The capital invested in the business (to achieve that worth) - bottom half
Will always be the same; they balance
This is because the top half of balance sheet demonstrates how the money by the owners has been used
What is the net worth/net asset value?
The value of assets a business has less the liabilities it owes
What are year-end adjustments?
Transactions/modifications to the account entries on the trial balance
- All income matched to relevant accounting period
- Liabilities/asset values must be assessed to make sure they can be recovered through future profits in conditions of uncertainty
What are the 5 types of year-end adjustments?
- Depreciation
- Accruals
- Prepayments
- Bad debts
- Doubtful debts
What is depreciation? (YAE)
Deals with decline in value and spreads cost of asset over useful life
If not used = accounts stated at cost value well above actual value
2 methods
What are the two depreciation methods and how do you decide which is used?
- Straight-line method (e.g. shelving)
- Reducing balance method (e.g. van)
Chosen based on how asset loses value and how it produces revenue for business on ongoing basis
Amount known as the charge to depreciation/depreciation charge
What is the straight-line method?
Spreads depreciation charge evenly; same charge for depreciation each year
What is the reducing balance method?
Depreciation charged expressed as a % of the reducing balance (net book value of asset at start of relevant accounting period)
More depreciation in earlier years - less in later years
What is the net book value?
The cost - accumulated depreciation = net book value (estimate of current value of asset to the business)
When does an accrual arise?
Expense has been incurred which should be deducted from (charged against) profit in current year but has not been included in the trial balance
Acc 💅 not paying for that yet!
Business has the benefit of something in one accounting period but will not pay for it until next
How is an accrual shown on P+L and balance sheet?
Use example:
E.g. X uses legal services of B - preliminary trial balance of £27,000 in legal fees account - X has not received £5,000 bill for work done a month ago - trial balance will show £27,000 when it has actually used £32,000.
- Figure of £32,000 must be included in legal fees expense account on P+L
- £5,000 owed must be included as an accrual current liability account on balance sheet
As a result of accrual^
When does a prepayment arise?
When an expense is paid for in the current year but all/part of cost should be charged as an expense next year
Paid for something in advance during one accounting period but does not get benefit of all/some of what it has paid for until the next
How is a prepayment shown on P+L and balance sheet?
Use example:
E.g. Z pays £30,000 in rent on 1 October for 12 months in advance - Z has accounting year end of 31 December - trial balance shows that Z has paid £30,000 of rent in accounting year but should only be paying rent for 3 months from October (equal to £7,500)
The figure of £22,500 is the amount that Z has prepaid in rent so…
- Correct figure of £7,500 shown in rent expense on P+L
- £22,500 (prepayment amount) will be shown in prepayment current asset account creatred on balance sheet
As a result of prepayment^
How do profits appear if an adjustment for accrual or prepayment is not made?
- Accrual not made = Profit is artifically high
- Prepayment not made = Profit artifically low
What does the ‘receivables’ (‘debtors’) figures show?
Amount of money owed to the business
Business can look forward to receiving it
What is a bad debt? What happens when there is a bad debt?
A debt that a business knows it certainly will not receive - bad debt is written off and removed from receivables entry in accounts
Also referred to as ‘impairments’
If a bad debt is not written off, what will appear to be the case?
Seems business is expecting more money to be paid in than is actually the case
E.g. X has receivables balance of £7,000 - bankrupt customer owes £360 - receivables balance must be reduced to £6,640
When does a doubtful debt occur?
When a business provides for the possibility that a debt may not be paid
Not writing off completely; just making sure accurate reflection
What are the two ways of ‘being doubtful’ about debts?
- Specific - business knows particular debtor in financial trouble
- General - market generally not doing well and provision made for a certain % of debtors not to pay
What is the provision for doubtful debts and what does it do?
Doubtful debts are quantified and expressed as a figure - ‘ring fences’ certain amount of net asset value in case a doubtful debt ends up being written off
Can be specific or general provision
Is the provision for doubtful debts treated as a liability?
Yes - the amount of assets available to a business is reduced by the amount of provision
How is the provision for doubtful debts shown in the profit and loss account?
Only the increase (if any) in provision over amount of previous year’s provision
Would be incorrect to show whole amount as expense
E.g. Y1 provision is £2500 = expense of £2500
Y2 provision is £3000 = expense of £500
How is the provision for doubtful debts shown on the balance sheet?
Shown as a liability, specifically a reduction to the Receivables account (matched to the asset it directly affects)
How is the bottom half of a partnership’s balance sheet different?
Must include a profit appropriation statement
To record how profits of business for relevant acc period are divided between partners
What are drawings?
Withdrawals of profits by the partners during the year to pay themselves
In a partnership, what is the difference between a partner’s capital account and current account?
- Current - capital can be withdrawn at partner’s discretion (drawings of partner)
- Capital - for long-term capital; original investment of partnership that cannot be withdrawn in normal circumstances
Both treated as capital accounts under ALCIE classification
How does the appropriation of profits happen in a partnership?
I.e. how are partners in a partnership paid from the profits?
2 stages
- Sums allocated to individual partner based on the a) interest on their capital or b) salaries due to each under the partnership agreement
- Remaining profit distributed to partners on agreed profit share ratio
What is the notional interest on capital?
A payment representing the interest on the capital in the partner’s (long-term) capital account
How is the notional salary treated?
I.e. recorded
As drawings
Are the notional interest and salary treated as an expense from the profit and loss account?
No! Treated as an appropriation of profit
What are residual profits?
Profits remaining after each partner has appropriated the amounts to which they are entitled under partnership agreement as notional interest and/or notional salary
Divided according to an agreed ratio
How is the notional interest and salary decided?
Through specifying in the partnership agreement
When is the company’s accounting reference date if they don’t change it?
The last day of the month in which the anniversary of incorporation falls
What are the 3 main differences for financial statements of companies cf sole traders/partnerships?
- Capital accounts - bottom half shows share capital, reserves and retained earnings
- Tax - P+L includes statement of tax company should pay (sole traders + partnerships don’t have SLP so do not pay tax)
- Dividends - as an appropriation of profits (after tax) appearining in the statement of equity
Are dividends an expense of the business?
No - they are an appropriation of profits
What is the Statement of Changes in Equity (SoCiE)?
An addition to the balance sheet showing profit brought forward and added to current year profits subject to dividend deductions
Resulting ‘retained earnings’ shown on bottom half of balance sheet
Are companies with 1 or more subsidiaries required to publish accounts for the group of companies as a whole as well as their own annual accounts?
Yes - shareholders of parent company should have access to info re subsidiary
Does every subsidiary in the group have a duty to prepare its own individual accounts?
Yes - but so many exemptions that rare in practice to do so
The bottom half of a company’s balance sheet shows equity - what does this balance with?
The net asset value
What is called up share capital?
The aggregate amount that has been ‘called up’ on each class of issued shares
- Called up = the amount (not necessarily all!) of the nominal value of shares that company has required its shareholders to pay
Does not include any premium
Will the called up share capital equal aggregate of the nominal value of issued shares?
Not if they are not fully paid
Rare
What are the reserves?
The capital of the company in excess of the called up value of the issued share capital
What are the two categories of reserves and are they distributable?
- Capital reserves (share premium account, revaluation reserve) cannot be distributed by way of dividend/payment to shareholders
- Revenue reserves (retained earnings) can be distributed to shareholders by dividends
Think: what is invested in the business cannot be distributed, what is made can be
What is the share premium account?
Represents the difference between the nominal value of the shares and the amount that shareholders actually paid (the subscription price if greater)
As in card above - cannot be distributed to shareholders
Does the market price of shares once issued have a bearing on company’s accounts?
No - share premium account remains unaltered
What is the revaluation reserve?
Created when directors want to show more up to date values of non-current assets in the accounts
E.g. the value of real property portfolio has increased - company re-values these assets to their current value
How does the revaluation reserve affect the balance sheet?
Top half = figure for net assets (e.g. through property) rises
Bottom half = create/increase existing revaluation reserve by the same value
What is meant by the revaluation reserve being a ‘notional profit’ to the company?
The profit is unrealised until the asset is sold - the revaluation reserve is therefore a capital reserve and not distributable as a dividend until the company sells the asset and realises the profit
Must dividends be paid out of profits generated in the current period?
No - can be paid from profits generated from current or previous period
Do dividends belong in the profit and loss account?
No! They are transactions between the business and its owners so will show up in the SoCiE
What are the two types of dividend that can be paid on ordinary shares?
- Final - declared after the year end and paid thereafter
- Interim - paid during re current accounting period
How is a final dividend recommended and declared (approved)?
- Directors recommend in Director’s Report
- Shareholders declare (approve) by ordinary resolution
But declaration not complete until OR
What is the difference between a proposed dividend and a declared divident? Which is a debt enforceable by shareholders and what does it mean to be enforceable?
- Proposed = A recommended final dividend that has not been approved by shareholders yet (is not an enforceable debt)
- Declared = A final dividend approved by shareholders (is an enforceable debt)
Enforceable debt = can sue upon
Do both the proposed and declared dividends appear on the balance sheet? If so where?
Only a final dividend as a deduction in calculating the Retained Earnings (in SoCiE)
What if a declared dividend has not been paid by the time the accounts for the year have been prepared? What if it has been paid?
- Not paid = will appear as part of current liabilities (and taken into accountin SoCiE at year-end)
- Paid = only taken into account in SoCiE
Do interim dividends need an ordinary resolution?
No - Articles normally give directors power to pay interim dividends
Is an interim dividend a debt enforceable by the shareholders?
No! Any board resolution to pay interim dividend may be rescinded
Will interim dividends appear in a company’s accounts if they have not been paid?
No - will only appear if they have actually been paid
Taken into account in SoCiE when paid (same as declared and paid)
Will dividends be included in the P+L?
No!!! They are an allocation of profit and not an expense of the company
Dividends example
How are preference share dividends paid and how is their amount calculated?
Two instalments each year - amount of dividend already known due to their nature
What is a bonus issue of shares?
AKA capitalisation issue or scrip issue
Company converts some of its reserves into share capital by issuning fully paid shares to existing shareholders on a pro rata basis for no consideration
I.e. shareholders do not pay for the bonus shares
What does pro rata mean re bonus issue of shares?
The proportion of shares held by each shareholder pre and post bonus issue will not change
So proportions of voting rights stay the same!
What can a company use for a bonus issue of shares?
Retained earnings or share premium account
So does not make the company any money
Are assets and liabilities changed after a bonus issue?
No!
