Business Accounts Flashcards
Why do solicitors need to understand business accounts?
- 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
Why do financial statements have to be prepared?
- For external reporting to shareholders, creditors and the market
- For tax authorities
What is the balance sheet?
A snapshot of the business at one point in time, listing everything the business owns and owes
What are fixed and current assets?
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
What are long-term (non-current) and current liabilities?
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)
What is the Profit and Loss Account?
Shows the profit or loss made by the business over a given period.
Also known as the Income Statement.
Why are accounts prepared for internal management?
- 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.
When are accounts prepared?
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.
What are the different types of accounts?
- Personal accounts
- Accounts to record: assets, liabilities, capital, income, expenses
What is the trial balance?
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.
How is gross profit calculated?
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)
How is net profit calculated?
Net profit = gross profit - overhead costs
What is net book value and how it is calculated?
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
How is net current assets calculated?
Net current assets = current assets - current liabilities
How is net assets calculated?
Net assets = (net current assets + net book value) - long term liabilities
How is total capital calculated?
Total capital = capital at start of year + (profit - drawings)
How is depreciation accounted for?
- 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
What is an accrual?
How is it accounted for?
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
What is a prepayment?
How is it accounted for?
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
How is a bad debt accounted for?
- 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
How is a doubtful debt accounted for?
- 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
How is profit divided between partners?
- Notional salaries and notional interest are distributed out of profits
- The residual profit is divided up in accordance with the profit-sharing ratio
How is total capital calculated for a partnership?
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
What is different on the P&L of a company?
- 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
What is different about the Balance Sheet of a company?
- 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’
How is retained earnings calculated?
Retained earnings = Profit brought forward + profit for the year - dividends paid
When will a dividend not appear on the accounts of a company?
When it has been proposed but not declared
When will a dividend appear as a liability on the Balance Sheet?
When it has been declared but not yet paid
When will an interim dividend appear on the company’s accounts?
Only when it has actually been paid
