Business Accounts

Question 1

Why do solicitors need to understand business accounts?

Answer 1

• To be able to follow negotiation meetings with clients and accountants
• To understand the client’s financial position going into a transaction
• To be able to assess the financial position of a target in an acquisition
• To be proactive, for example anticipating solvency issues
• To understand and advise on financial covenants in loan agreements
• To understand a client’s duties and obligations in relation to financial records
• Important part of litigation process
• CA 2006 refers to accounts

Question 2

Why do financial statements have to be prepared?

Answer 2

• For external reporting to shareholders, creditors and the market
• For tax authorities

Question 3

What is the balance sheet?

Answer 3

A snapshot of the business at one point in time, listing everything the business owns and owes

Question 4

What are fixed and current assets?

Answer 4

Fixed: assets which are held and used in the business over the long-term

Current: assets which are expected to be used over the short-term

Question 5

What are long-term (non-current) and current liabilities?

Answer 5

Long-term: liabilities which will fall due to be repaid after one year

Current: liabilities which are payable in the short term (less than a a year)

Question 6

What is the Profit and Loss Account?

Answer 6

Shows the profit or loss made by the business over a given period.

Also known as the Income Statement.

Question 7

Why are accounts prepared for internal management?

Answer 7

• Cash: to ensure that the business has sufficient cash available to continue its day to day operations.
• Profits: to determine how much profit the business is making.
• Assets/liabilities: to determine whether it’s assets exceed its liabilities.

All three factors ensure that the business is capable of continuing to operate.

Question 8

When are accounts prepared?

Answer 8

Annual accounts are prepared at the end of each financial year, and must be audited.

Interim accounts may also be prepared to keep track of progress e.g monthly. These are not audited, and are not usually made available to shareholders.

Question 9

What are the different types of accounts?

Answer 9

• Personal accounts

- Accounts to record: assets, liabilities, capital, income, expenses

Question 10

What is the trial balance?

Answer 10

A list of all the balances on all of a business’ asset, liability, capital, income and expense accounts.

This forms the basis of information from which the financial statements are compiled.

Question 11

How is gross profit calculated?

Answer 11

For a business trading in goods:
Gross profit = income - cost of sales
Cost of sales = (opening stock + purchases) - closing stock

For a business trading in services:
Gross profit = income + (closing WIP - opening WIP)

Question 12

How is net profit calculated?

Answer 12

Net profit = gross profit - overhead costs

Question 13

What is net book value and how it is calculated?

Answer 13

Net book value is an estimation of the ‘current’ value of the asset to the business in terms of how much of the asset has been consumed.

NBV = cost - accumulated depreciation

Question 14

How is net current assets calculated?

Answer 14

Net current assets = current assets - current liabilities

Question 15

How is net assets calculated?

Answer 15

Net assets = (net current assets + net book value) - long term liabilities

Question 16

How is total capital calculated?

Answer 16

Total capital = capital at start of year + (profit - drawings)

Question 17

How is depreciation accounted for?

Answer 17

• The depreciation charge for that year is shown as an expense on the Profit and Loss Account
• The accumulated depreciation is shown as a liability (Provision for Depreciation) on the Balance Sheet

Question 18

What is an accrual?

How is it accounted for?

Answer 18

An accrual is when a business has had the benefit of something, but has not yet paid for it.

• The accrual is included in the relevant expense account on the Profit and Loss
• The accrual is included as a current liability on the Balance Sheet

Question 19

What is a prepayment?

How is it accounted for?

Answer 19

A prepayment is when a business has paid for something in advance, but has not yet received the full benefit.

• The prepayment is deducted from the relevant expense account on the Profit and Loss
• The prepayment is shown as a current asset on the Balance Sheet

Question 20

How is a bad debt accounted for?

Answer 20

• The debtors asset account is reduced by the amount of the bad debt
• The bad debt is shown as an expense under a Bad and Doubtful Debts account

Question 21

How is a doubtful debt accounted for?

Answer 21

• The Bad and Doubtful Debts expense account is adjusted to reflect the provision for doubtful debts
• The doubtful debts provision is a liability, shown under the debtors figure on the Balance Sheet

Question 22

How is profit divided between partners?

Answer 22

• Notional salaries and notional interest are distributed out of profits
• The residual profit is divided up in accordance with the profit-sharing ratio

Question 23

How is total capital calculated for a partnership?

Answer 23

The accounts for each partner are laid out individually.
The current account is adjusted in accordance with the partner’s share of profit minus their drawings for the year.
Total capital for each partner = capital account + current account (as adjusted).

Total partnership capital = each partner’s capital added together

Question 24

What is different on the P&L of a company?

Answer 24

• Income is called Turnover
• Interest receivable and interest payable are separated out and shown on their own lines
• Profit should be shown before and after taxation

Question 25

What is different about the Balance Sheet of a company?

Answer 25

• May be in a single column format
• Liabilities are called ‘creditors falling due within the year’ and ‘creditors falling due after more than one year’
• The bottom half refers to ‘reserves’ and ‘retained earnings’

Question 26

How is retained earnings calculated?

Answer 26

Retained earnings = Profit brought forward + profit for the year - dividends paid

Question 27

When will a dividend not appear on the accounts of a company?

Answer 27

When it has been proposed but not declared

Question 28

When will a dividend appear as a liability on the Balance Sheet?

Answer 28

When it has been declared but not yet paid

Question 29

When will an interim dividend appear on the company’s accounts?

Answer 29

Only when it has actually been paid