Business accounts and debt finance Flashcards
Double entry bookkeeping?
- Every money transaction that a business undertakes will have a dual effect in its accounts.
- E.g., if a sole trader bought an asset for 5000, then 5000 reductions in cash and increase of 5000 in assets.
- One will be a debit entry and another a credit entry.
- As value of each debit will equal matching credit – all transactions added together – sum of business debits should be equal to sum of all its credits over accounting period
Classifications of ledgers and accounts?
Asset –
- something the business owns. Separate accounts for each type of assets
- Fixed assets – tangible – such as a building or intangible such as a trademark
o Must be held by company for over a year – and provide a long-lasting benefit
- Current assets – includes cash and items owned by business which can quickly be turned into cash (within a year)
o Continually flowing through the business
o Stock
o Debtors also known as receivables – people who owe money to business
o Cash – in bank accounts and cash in hand (petty cash)
Liability –
- something a business owes – separate account for each type of liability (loans, trade debts)
- Current liabilities - paid within a year – bank overdraft
- Long term liabilities – falling due after one year – loan from a bank
Expense
- Money spent by business – recorded on separate accounts (lighting, wages)
- Day to day spending. Not spending on a long-term asset.
- Known as income or revenue expenditure.
Year-end adjustments
- Before trial balance is used to prepare financial statements, year-end adjustments will need to be made to some figures.
Profit and loss account?
It 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 that period.
Revenue + income – corporation tax + expenses = net profit/loss
Content of it
- Therefore, a summary of fortunes of a business over a period of time.
- Only income and expense entries appear.
The format of it
- Can be referred to as an income statement
Balance sheet?
Records the position of a business in respect of its assets and liability and capital accounts at a particular date.
Date of a balance sheet
- Differs from a profit and loss account – as it’s a snapshot on a relevant given date.
Contents of a balance sheet
NAV and capital
- Net worth or net asset value (NAV) – recorded in top half
o Fixed assets: Current assets – current liabilities
o Net current assets
o Noncurrent liabilities
- Capital invested in business to achive that net worth – recorded in bottom half
- These two figures will always be the same. The two halves of a balance sheet must always balance.
Contents of it:
Asset
Liability
Capital
Entries are on it.
Year end adjustments. Depreciation?
Depreciation
- A fixed asset - may have a useful life of several years after which it’s no longer valuable.
- Depreciation is a mechanism to deal with the decline in value and to spread the cost of the asset over its useful life.
- If not used, would not give a true picture of business.
- Method: the method chosen depends on how it produces revenue for business on an ongoing basis.
- Straight-line method
o Spreads the depreciation charge evenly over the life of the asset and gives rise to the same charge for depreciation each year
o The charge each year will be included in a depreciation account as a loss – and will be shown on profit and loss account as an expense
o Accumulated depreciation – liability account thereby reducing the net book value of the asset and will be shown on the balance sheet.
- Reducing balance method
o Expressed as a percentage of reducing balance.
Year end adjustments - accruals?
Accruals
- An accrual arises when an expense has been incurred and should be charges against profit in the current year but for some reasons, the expense has not been included in trial balance.
- So, they have benefit of something in one accounting period but will not pay for it until the next accounting period.
- Will be shown as an accrual current liability and included in expense account.
Prepayments
- Arises when expense is paid in current year but all or part of the cost should be charged as an expense for the next year.
Prepayments
- Arises when expense is paid in current year but all or part of the cost should be charged as an expense for the next year.
Year end adjustments - Bad and doubtful debts?
Bad debts
- The receivables or debtors figure shows the amount of money owed to the business. Receivables entry is made up of all those who owe money to the company, each who is a debtor. This is an asset account because it represents money which the business can look forward to receiving from the people who owe It money.
A debt is a bad debt when a business knows with certainty its never going to receive it.
- Might be that debtor has gone through insolvency process – so bad debt is written off – and so removed from receivables entry in accounts as it will not be paid.
- Bad debts may be written off during the accounting year – if that’s the case there will be a bad debts expense account in trial balance.
Doubtful debts
- When a business is providing for possibility that a debt may not be paid.
- Specific doubtful debts – a business may know that a particular debtor is
Its most similar to that of a liability account and treats as such, because amount of assets available to business is reduced by amount of the provision made.
- Liability on balance sheet. It’s matched to the asset it most directly effects
Doubtful debts as expenses in the profit and loss account
- May become written off and a real cost to the business.
- So accounted for in same expense account for bad debts in profit and loss account.
Partnership accounts?
The main difference between partnerships and sole traders are the bottom half of the balance sheet (denoting capital)
For a partnership necessary to prepare a profit appropriate statement – how its divide between partners.
Separate accounts for each partner
- Drawings are withdrawals of profits by partner during the year to pay themselves. Usually based on an estimate of the partners share of the expected profits for the year.
Commonly there are 2 accounts for each partner
Capital account
- For long term capital – original investment in the partnerships
Current account
- Or capital that can be withdrawn at partners discretion. Also, records partners share of ongoing business profits and show any drawings taken out this year.
Appropriation of profits
- After profit for business as a whole has been calculated – the profit needs to be divided amongst the partners.
- Sums are allocated to individual partners corresponding to any interest on their capital or salaries due to each under partnership agreement. Then remaining will be distributed to partners according to an agreed profit share ratio.
Notional interest on capital
- A payment representing interest on the capital in the partners long term capital account.
Notional salary
- Specified in partnership agreements
- Treated as appropriation of profit and not an expense in profit and loss account
- Treated as drawings
Company accounts?
Accounting reference date
- Company is free to choose its own accounting reference period.
- Under s442 – a private company must file its accounts at companies’ house within nine months after the end of the relevant accounting period.
- For public companies its 6 months
Company accounts
Capital accounts – the bottom half of the balance sheet
- Company accounts follow a format which differs from those of sole traders and partnerships.
- Tax – not in partnerships and sole traders. BUT FOR COMPANIES WHO PAY TAX ON THEIR ACCOUNT – therefore the profit and loss account include a statement of tax a company will pay on its profits.
- Dividends – are shareholders. Will usually appear on financial statement called the statement of equity - because its transactions between the company and its shareholders.
Share capital and reserves?
Top half of balance sheet is net asset value
Bottom half - is equity
Called up share capital
- The aggregate amount that has been called up – the amount of nominal value of shares that shareholders have paid on each class of issue shares. May be the same as the aggregate of the nominal value of the issued shares.
- E.g., A newly incorporated company has issued 200,000 ordinary shares of £1 and has called up 75p per share. The value of the called-up share capital in the company’s balance sheet will therefore be £150,000 (200,000 × 75p).
Reserves
- Capital of company in excess of the called-up value of the issued shares. Two categories:
- Capital reserves = e.g., a share premium account, revaluation reserve, capital redemption
o These cannot be distributed by way of dividend or other payment to shareholders. - Revenue reserves – e.g., retained earnings
o These are distributable
Capital reserves?
Share premium account
- Represents the difference between the nominal value of shares and the amount that the shareholders actually paid for the shares
- The market price of the shares once they have been issued has no bearing at all on company’s accounts, so if their market price goes up or down the share premium account will remain unaltered.
- The share premium account is a capital reserve. Assets representing it, therefore, cannot be distributed to shareholders, except in exceptional circumstances such as a bonus issue of shares (
Revaluation reserve
- Created when a company’s directors, as a matter of accounting policy wish to show more up to date values of non-current assets in the accounts.
- Like value of property portfolio may have increased.
- It represents a national profit to the company from the rise in the value. This profit is unrealised until the asset is sold.
Revenue reserves?
Dividends usually appear on a financial statement called the statement of equity
Retained earnings
- The retained earning account is the reserve account for retained profit – profits after tax earned y company.
Statement of changes in equity
- Not in the profit and loss account
Dividends
- Paid on profits generated in current or previous accounting period.
Ordinary shares
- Two types of dividends that can be paid on an ordinary share
- A final dividend is declared after the year end and paid sometime thereafter
o The size of this is recommended by the company’s directors in the directors’ report and declares by company’s shareholders by ORDINARY resolution.
- A dividend that is approved construes a debt of the company enforceable by the relevant shareholders.
- An interim dividend is paid during and in respect of the current accounting period.
Interim dividend
- The articles of a company normally give the directors the power to decide to pay interim dividends MA30. These can be paid without any ordinary resolution.
- They will be reflected in company’s accounts if they have actually been paid.
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What is debt finance?
For many private companies it may be difficult to raise money through equity finance since they can’t offer it to the public.
An alternative is debt finance – to borrow money- usually from a bank or other lenders.
Most companies have an unrestricted power to borrow.
What is debt finance?
Loan and facilities
Debt securities
A lender will wish to be protected as possible in case borrowing company cannot repay the loan. A key method of protection is to take security over the assets of the borrowing company.
Loans?
Loan facilities
An agreement between a borrower and a lender which gives the borrower the right to borrow money on the terms set out in the agreement. Include:
- Overdraft – on demand facility which means bank can call for all money owed to it at any point in time and demand that it is repaid immediately. These are unsuitable as a long-term borrowing facility. Interest is paid to bank on amount that is overdrawn.
- Term loan – loan of money for a fixed period of time, repayable on a certain date.
Resolving credit facility
- Loan of money for a specified period of time, but unlike a term loan borrower can repeatedly borrow and re-pay loans up to the agreed maximum overall amount when it chooses.
Debt securities?
Gives an investor a security acknowledging its rights.
