Business Accounts Flashcards
What are the financial statements prepared in respect of each accounting period?
- profit and loss account
- balance sheet
What is ‘book-keeping’?
The process by which businesses record money transactions
What is a ‘nominal ledger’?
Where transactions of a similar type are grouped together and recorded (e.g. nominal ledger)
What are ‘books?’
The collective name for all of the different ledgers/accounts used by the business.
What is double entry book-keeping?
Every money transaction that a business undertakes will have a dual effect in its accounts.
One aspect will be recorded as a ‘debit entry’ and the other as a ‘credit entry’.
Sum of debits should be equal to the sum of the business’s credits over the period.
What does ‘ruled off’ mean?
Used to compare the financial performance year-on year.
Ledger/accounts are ruled off at the end of each accounting period/financial year.
What is a trial balance
A trial balance is a list of all the balances on all of a businesses ledgers/accounts as at the end of an accounting period.
The trial balance shows debit balances in one column and credit balances in another column. The total of each of the two columns should be the same (and thus balance).
Usually put together by a business or its accountants and forms the basis of information from which the financial statements are then compiled.
How are ledgers/accounts classified?
ALCIE
Asset: something a business owns. A business will have a separate account for each category of asset (e.g. motor vehicles, cash at bank)
Liability: something a business owes. A business will have an account for each type of liability (e.g. loans, trade debts)
Capital: usually identifiable as an injection of value from an owner or investor rather than money generated by the business.
Income: money earned by the business, usually from a regular source. Each main income source of the business will have a separate account.
Expense: money spent by the business. Each different type of expense is recorded in a separate account (e.g. heating and lighting).
What is a fixed asset?
Also called ‘non-current assets’. Any asset, tangible (such as a building) or intangible (such as a trade mark), owned by a business that will enable it to make a profit.
What are the requirements for an asset to be defined as a fixed asset?
To be defined as a fixed asset, it must be held by the company for over a year and provide some long-lasting benefit to the company.
What are current assets?
Current assets continually flow through the business, and therefore have a shorter term nature.
Include cash and items owned by the business (or owed to the business) which can be turned into cash (as a rule of thumb, within one year).
E.g. stock/inventory, debtors, cash
What are liabilities?
An amount owed by the business to somebody else. There are two types:
- Current liabilities: include bank overdraft, trade creditors (such as suppliers)
- Long-term liabilities: fall due after more than one year
Capital - sole trader
For accounting purposes, business and sole trader are two separate entities.
Sole trader invests a lump sum of own money into business when setting it up.
A sole trader’s capital account will include the profits the business has retained over the years.
Owner pays itself by means of drawings out of the profits of the business.
What are expense accounts
Record day-to-day spending.
Do not include spending on long-term assets which are sometimes confusingly referred to as ‘capital expenditure’.
What are Income accounts?
Record sums received by the business such as payments from customers in relation to sales of goods or services made by the business.
What are Year-end adjustments?
Adjustments made to some of the figures to ensure all income and expenditure shown on the final financial statements relate only to the relevant accounting period.
What is the status of a bank overdraft in the books of a sole trader business?
A liability
What is a profit and loss account?
Sometimes referred to as ‘income statement’ - international standards.
Prepared using the trial balance.
Essentially records the income of a business throughout an accounting period minus expenses incurred in that period, to arrive at a profit (or loss) figure for the period.
Accounting period to which it relates will be recorded in the heading for the account: ‘for the period ending on [last day of the period]’ or ‘for the year ended [last day of the period].
Which entries from the trial balance are transferred into the profit and loss account?
As a general rule, only the income and expense entries.
Note: The ‘cost of sales’ figure in the profit and loss account is calculated using the figures for ‘opening stock’ and ‘closing stock’. These are both asset accounts, so these two accounts are exceptions to the general rule that a profit and loss account shows only income and expense accounts.
What is the label for the final figure (at the end) of a profit and loss account?
Net profit
What is the formula to calculate gross profit?
Gross profit = Sales - Cost of Sales
What is the formula to calculate the ‘cost of sales’?
Opening stock + purchases - closing stock = cost of sales.
Where are the income entries put on the profit and loss account?
At the top of the profit and loss account.
What is a balance sheet?
Records the position of a business in respect of its asset, liability and capital accounts from the trial balance.
What is the date of a balance sheet?
It is a snapshot relevant on a given date (whereas a profit and loss account relates to a specific period)>
Date at the top of the balance sheet is the last day of the period to which it relates. Heading will always contain ‘as at’.
What is net asset value?
Net asset value (NAV) or net worth of the business represents the value of the assets it has, less the liabilities it owes.
NAV and Capital
NAV: This is recorded in the top half of the balance sheet
Capital: recorded in the bottom half of the balance sheet.
These two figures should always be the same unless something has gone wrong. The two halves of the balance sheet must always balance.
Because: Top half demonstrates how the money invested in the business by the owners of the business has been used and bottom half shows the money invested by the owners of the business.
Where do asset, liability and capital entries transfer from the trial balance?
They are recorded on the balance sheet.
Order on balance sheet:
Assets
Liabilities
Capital
How is net current assets calculated?
Current assets - current liabilities = net current assets
This gives an indication of how much cash the business could make available at short notice.
What is depreciation?
A mechanism used in the accounts to deal with this decline in value to spread the cost of the asset over its useful life.
What is the additional step partnerships must make to correctly prepare a balance sheet?
They must prepare a profit appropriation statement.
This records how the profits of the business for the relevant accounting period are divided between the partners.
Is a way to work out the distribution of profits in a partnership.
How are drawings recorded for accounting purposes for partnerships?
Each partner will have their own account, commonly there are two accounts for each partner (both classified as capital accounts):
- Capital account: for long-term capital. This represents the partner’s original contribution (and any subsequent investments). Cannot be withdrawn in normal circumstances.
- Current account: for capital that can be withdrawn at the partner’s discretion. This account records partner’s share of the ongoing business profits. It will also show any drawings that the partner has taken out over the year.
How are profits divided among partners?
- Sums are allocated to individual partners corresponding to any interest on their capital or salaries due to each of them under the partnership agreement
- Remaining profit will be distributed to the partners according to an agreed profit sharing ratio.
Partnership: Notional ‘interest’ on capital
A payment representing interest on the capital in the partner’s long-term capital account.
Rate of interest would be specified in the partnership agreement.
It is notional interest, so it is really an appropriation of profit under a different name.
Although labelled as interest, it should not be treated as an expense item in the Profit and Loss Account.
Partnership: Notional ‘salary’
One or more partners might receive a notional salary. Amount will be specified in the PA and is really an appropriation of profits.
Generally for partners, any salary paid to them:
a) must be treated as an appropriation of profit, not an expense in the Profit and Loss Account (which is how the salaries of employees are represented), and
b) will be treated as drawings.
How are share of profits/share of ‘residual profits’ treated?
Residual profits are profits remaining after each partner has appropriated the amount(s), if any, to which they are entitled under the partnership agreement as notional interest and/or as a notional salary.
The residual profits are divided amongst the partners according to an agreed ratio.
What are drawings: partnership
Withdrawals of profit by the partners of a partnership
How does a partnership balance sheet differ to that of a sole trader?
The top half is similar to that of a sole trader; the bottom half is different.
Why do companies prepare accounts?
They are obliged to do so by statute.
Must also take on a particular format and appearance.
Must also present a true and fair view of the profits, assets and liabilities of the company.
Accounting reference date (companies)
A company’s accounting reference date (ARD) is the last day of the month in which the anniversary of its incorporation falls.
A company is able to change its ARD to a date of its choice.
A company is free to choose its own accounting reference period.
When is the deadline for a private company filing its accounts at Companies House?
Must file its accounts within nine months after the end of the relevant accounting period.
When is the deadline for a public company filing its accounts at Companies House?
Must file its accounts within six months after the end of the relevant accounting period.
What are the three main differences in the content of financial statements for companies?
- Capital accounts: the bottom half of the balance sheet
- b/c capital consists of share capital, reserves and retained earnings - Tax: profit and loss account of a company will include a statement of the tax the company should pay on its profits (corporation tax)
- Dividends: will usually appear in a financial statement called the ‘statement of equity’ (or included in addition to the Balance Sheet)
- will show profits brought forward and added to current year profits subject to deductions for dividends - resulting ‘retained earnings’ will appear on the bottom of the balance sheet.
Consolidated accounts
Where a company has a subsidiary, consolidated accounts will show the accounts for the group of companies as a whole.
What is the Statement of Changes in Equity?
An addition to the balance sheet which shows profits brought forward plus current year profit (less dividends paid).
How do companies’ financial statements deal with tax?
The profit and loss account of a company includes a statement of the tax the company should pay on its profits.
