Business - Business Accounts (13) Flashcards
What are business accounts?
Business Accounts: Businesses create ‘final accounts’ at the end of the accounting period, comprising the ‘profit and loss’ account and ‘balance sheet’.
Terminology
Terminology: Business accounts refer to the following four terms frequently.
Income: Trade and services income, i.e. goods sales.
Expenses: Items of expenditure for short term benefit, i.e. petrol and wages.
Assets: Items owned outright, usually for long term, i.e. machinery.
Liabilities: Items the business owes to third-parties, i.e. loans.
What is the trial balance?
Trial Balance: Final accounts are prepared using the ‘trial balance’. This is the total of all debits and credits throughout the year, and if correct, should balance to ‘zero’.
What is the profit and loss account?
Profit and Loss Account: The profit and loss account demonstrates net profit for the year.
(1) Calculation: Income - Expenses = Net Profit/Loss
(2) Purpose: Businesses may identify how to increase profit and reduce loss.
(3) Layout: Set out vertically - Income -> Expenses -> Net Profit.
Left Column: Figure representing specific income/expense.
Right Column: Figure representing total income/expense. Total expense in (brackets), to demarcate a subtraction.
What is the trading account?
Trading Account: Trading businesses compile a ‘trading account’ in addition to the profit and loss to show gross profit.
(1) Calculation: Sales Income - Costs of Trading Stock = Gross Profit
(2) Purpose: Shows if profit issues exist, i.e. stock too expensive. If no issues, expenses likely to be the issue.
What is the balance sheet?
Balance Sheet: Balance sheet shows net worth of the business, as an accumulation of assets and liabilities on the final day of the accounting period (headed with date of preparation).
(1) Calculation: Assets - Liabilities = Net Worth
(2) Purpose: Provides a snapshot of the business on the day of preparation, but liable to constant flux.
Net Current Assets: Current Assets - Current Liabilities = Liquidity
Net Assets: Assets - Liabilities = ‘Debt’ Owed to Owner (If negative, business is struggling)
(3) Layout: Set out vertically - Employment of Capital (Fixed Assets -> Current Assets -> Current Liabilities -> Long-term Liabilities) -> Capital Employed.
Employment of Capital: Value of assets, minus liabilities owed to third-parties.
Fixed Assets: Plants and machinery (least to most liquid).
Current Assets: Short-term assets such as stock, book debts, cash (least to most liquid).
Current Liabilities: Liabilities repayable in 12 months from date of balance sheet.
Long-Term Liabilities: Liabilities repayable more than 12 months from DoBS.
Capital Employed: Value of capital sourced from owner + all time total profits since trading.
What adjustments are made to final accounts?
Adjustments: Final accounts are prepared on an ‘accruals basis, meaning income and expenses are recorded in the period they derive, not the period in which they are paid. As such, unpaid bills must be recorded.
(1) Outstanding Expenses: Expenses yet to be paid must be added to the final accounts.
Profit and Loss: Added as an ‘expense’.
Balance Sheet: Added as an ‘accrual’ under current liabilities.
(2) Prepayments: Payments made in advance must be added to the final accounts (such as future rent).
Profit and Loss: Reduces value of prepaid item in ‘expenses’.
Balance: Added as a ‘prepayment’ under current assets.
(3) Work in Progress: Bills yet to be issued for work completed for a client.
Profit and Loss: Added as ‘profit costs’ under income.
Balance Sheet: Added as a current asset.
(4) Closing Stock: Leftover stock unsold in the previous period.
Profit and Loss: Added as a ‘loss’ under income.
Balance Sheet: Added as a current asset as ‘stock’.
(5) Bad Debts: Debts which the business believes will not be paid.
Profit and Loss: Added as an expense.
Balance Sheet: ‘Written off’ of current assets, deducted from ‘debtors’ figure.
(6) Doubtful Debts: Debts which the business believes may not be paid.
Profit and Loss: Added as a ‘provision for doubtful debt’ under expense.
Balance Sheet: ‘Written off’ of current assets, deducted from ‘debtors’ figure.
(7) Depreciation: The loss of value of a business asset, as a percentage of its asset value.
Profit and Loss: Added as an expense.
Balance:
(8) Revaluation: The gain in value of a business asset, such as land, if revalued.
Profit and Loss:
Balance:
(9) Disposed Assets: The sale of a business asset.
Profit and Loss: Recorded in income, either as a ‘gain’ or ‘loss’ depending on value of sale.
Balance: Decrease in ‘current fixed assets’, and increase in ‘cash’.
How are business accounts analysed?
Wider Context: It is important to understand wider implications when analysing accounts.
(1) DoBS: The date of the balance sheet is a snapshot, which may be distorted by seasonal boosts.
(2) Previous Accounts: Previous accounts may demonstrate growth or reduction of business.
(3) Valuation Methods: Valuations of assets may be misleading, and closing stock may be obsolete or damaged (so will never materialise into actual profit).
(4) Debtors: Debtors may not be able to pay - are they a true asset?
(5) Overdraft: Overdrafts are liabilities, reducing current assets figure. But is this significant?
(6) Exceptional Items: Exceptional items, such as investment in plant, may distort short-term profitability.
(7) Loans: Loans tend to decrease net assets only by the interest and fees charged, as the lump value of the loan is offset by the cash injection.
What general considerations need to be kept in mind when analysing business accounts?
General Considerations: The main purpose of accounts is to ascertain profitability and means of debt repayment.
(1) Profitability: A business may be profitable, but have no cash or means to repay debts. For example, it’s profit is all ‘owed’ as book debts.
(2) Debt Repayment: The company may be worth a lot, but if this is all tied up in fixed assets, its liquidity may mean it cannot pay debts.
(3) Liquidity: It is important to therefore determine the liquidity of a business’s assets. Cash is most liquid, debts are reasonably liquid, stock is not as liquid and prone to damage.
Debt Factors: Debt may be sold to a ‘debt factor’, purchasing the debt from the company at an undervalue, but providing instant liquidity.
What are partnership accounts?
Partnership Accounts: Partnerships must reflect additional information, due to its multiple ownership.
(1) Partner Records: Each partner will have a record, showing their capital contributions, profit owed to them, and sums withdrawn for the year.
(2) Partner Capital Accounts: Each partner will have a ‘capital account’ showing the capital they have contributed.
Profit Share
Profit Share: Partners (incl. LLPs) share profits and losses equally by default, or in accordance with the bespoke partnership agreement. They may also receive a salary, and interest on their capital contributions.
(1) Salary: Salary simply means first-rights to a certain amount of profit prior to the remaining profits being distributed.
(2) Interest: Interest is a means of awarding greater profits to those who have contributed more capital.
(3) Taxation: Partners submit personal tax returns, and claim personal allowances.
Profit and Loss Account
Profit and Loss Account: The profit and loss account is the same as above, but includes an ‘appropriation account’ to show how net profits have been divided amongst partners under the net profit section.
(1) Appropriation Account: Net profit, as divided between partners.
(2) Current Accounts: The appropriations are divided into ‘current accounts’, representative of the net profit of each partner, including salary and interest.
(3) Changing Partners: If a partner joins or leaves during the accounting period, the partnership net profit must be apportioned between the period before and after change. This is reflected in two appropriation accounts.
First Account: The allocation of profits earned before the change.
Second Account: The allocation of profits after change, in accordance with the new profit-share structure.
Balance Sheet
Balance Sheet: The balance sheet is similar to above, but includes the capital and current accounts of each partner under the ‘capital employed’ section, subject to drawings.
How are shares reflected in company accounts?
Shares: Shares are reflected in company accounts, recorded in a ‘share capital’ and ‘share premium’ account.
(1) Share Capital Account: Records total of shareholder capital paid for shares, i.e. the total par value.
(2) Share Premium Account: Recorded total of premium paid by shareholders on top of nominal value.
(3) Balance Sheet: These are recorded on the balance sheet, and may be differentiated by type of share.
Name: Referred to as ‘capital and reserves’, or ‘financed by’, or ‘equity’.
Maintenance of Capital
Maintenance of Capital: Companies must maintain their share capital, unless authorised to buyback shares.
(1) Buyback: Shares are bought back and cancelled, and share capital is reduced by the par value of them.
(2) Transfer: Transfers have no effect on the accounts.
What is the profit and loss account?
Profit and Loss: Company profit and loss is largely the same as a sole trader, with certain additions.
Corporation Tax
Corporation Tax: As companies themselves pay tax, this is reflected on the accounts. This is generally not paid prior to the preparation of final accounts.
(1) Profit and Loss: Records profit ‘before tax’ and ‘after tax’.
(2) Balance Sheet: Records tax as a ‘current liability’ until paid.
Payment: Once paid, liability decreases, and so does cash from the current assets section.
Dividends
Dividends: Companies may pay dividends from its distributable profits, including prior years if permitted.
(1) Profit and Loss: Not included as an expense, but cash figure will be reduced once paid.
Retained Profit
Retained Profit: The balance of net profit reserved after tax and dividends is shown on the ‘profit and loss reserve’.
(1) Effect: This is profit made in trade, not capital.
What is a company balance sheet?
Balance Sheet: Other than share capital and premium accounts, the main differentiation is ‘reserves’.
Reserves
Reserves: Company balance sheets tend to maintain ‘revenue’ and ‘capital’ reserves.
(1) Revenue Reserves: Effectively retained profit and loss which can be distributed to shareholders.
Labels: These may be labelled, such as ‘debenture payments’, to indicate intended use. This does not restrict the use, and still constitutes revenue reserves, but is a helpful tool for management.
(2) Capital Reserves: Capital that cannot be distributed to shareholders, constituting the long-term capital of the company. This is the surplus paid for shares above par value, i.e. the premium.
What further administration is required for parent companies in terms of accounts?
Parent Companies: Parent companies must produce consolidated final accounts for the entire group.
(1) Purpose: Reflects the group as a single unit, enabling shareholders to assess holistic performance.
(2) Members: Individual companies within the group must still prepare their own final accounts.
What are the statutory accounting regulations?
Statutory Regulation: Companies are subject to statutory accounting regulations (Part 15 CA 2006).
(1) General Rule: Companies must maintain ‘adequate accounting records’ and yearly accounts.
Director Approval: Directors must approve these accounts, provided they are satisfied they give a true and fair reflection of the assets, liabilities and finances of the company.
Breach of Duty: Directors can incur civil and criminal liability for untrue or misleading statements.
(2) Administration: Companies must file annual accounts to the Registrar of Companies, and a copy to shareholders, debenture holders, and those entitled to notice of a general meeting.
(3) Auditing: Companies must have their accounts audited annually.
Exception: Small and dormant companies are typically exempt, though shareholders with more than 10% of nominal share capital can request audit.
