Company Accounts Flashcards
1
Q
What is a financial statement? (1)
A
- Summarises all transactions by a company during its accounting period
2
Q
What are the 3 main financial statements? (3)
A
- Balance sheet - ‘snapshot’ of a company accounts on the last day of the accounting period - year end or balance sheet date. Lists assets and liabilities of a company - illustrates financial health of a company at year end. If assets exceed liabilities, company has net assets, if liabilities exceeds assets, company has net liabilities
- Income statement - shows all income and expenditure relating to a company’s account period - usually a year. Whole 12 month periods. If income exceeds expenditure, company has profit. If expenditure exceeds income, there is a loss
- Cash flow statement - shows cash received and paid by a company during the accounting period. Similar to a bank statement and shows reasons for movements
3
Q
Who creatures financial statements? (3)
A
- Directors are responsible for producing a set of accounts
- Accounts must be audited by an independent firm (appointed by shareholders)
- Approved by shareholders at the company’s annual general meeting
4
Q
What is the Companies Act 2006? (4)
A
- Directors of a company are required to produce a balance sheet and income statement annually
- True and fair view
- Must be audited
- Large companies must also provide: comprehensive income statement with reference period (12 months), a directors report and an auditors report, cash flow statement, statement of changes in equity. These must be delivered to the Registrar of Companies
5
Q
What rules are imposed on listed companies on the LSE? (5)
A
- Directors reason for any significant departures from standard account practice
- Particulars of companies in which the group holds 20% or more of the voting shares
- A statement as to whether or not the company is a close company (under the control of its directors or 5 or fewer people)
- Particulars of any authority for the company to purchase its own shares
- Listed companies produce help yearly accounts too
6
Q
Who is exempt from producing accounts? (8)
A
- Sole trades and partnership have no legal requirement to produce accounts
- Small or medium sized companies do not need to deliver annual financial statements - must satisfy at least 2 of the below criteria
Small
- Turnover: less than £10.2m
- Total assets: less than £5.1m
- Employees: less than 50
Medium
- Turnover: less than £36m
- Total assets: less than £18m
- Employees: less than 250
7
Q
Summarise the importance of an auditors report? (5)
A
- Needed for large companies and listed companies on the LSE
- Appointed by shareholders at company meetings or trustee if it is a trust
- Must be properly prepared in accordance with Companies Act
- Give a ‘true and fair view’
- If conditions are met a ‘clean’ audit report is produced. If not, then auditor will ‘qualify’ the report
8
Q
What makes an auditors report qualified? (2)
A
- Limitation in scope: opinion cannot be formed to a lack of audit evidence
- Disagreement: the auditor disagrees with information in or view given by financial statements
9
Q
What are the two possible magnitudes for qualifications of an auditors report? (2)
A
- Material: likely to influence a user of the financial statements
- Fundamental: So important as to undermine the financial statements as a whole
10
Q
What are the 4 types of qualification of auditors reports?
A
- Fundamental uncertainty
- Material uncertainty
- Fundamental disagreement
- Material disagreement
11
Q
Who is exempt from needing their accounts audited? (1)
A
- Small companies (Turnover <£10.2, total assets <£5.1m, employees <50
12
Q
Who sets the standards for financial reporting? (4)
A
- International Accounting Standards Board issues (IASB) International Financial Reporting Standards (IFRS)
- Requirement only applies to the consolidated and individual accounts of listed companies in the UK
- UK companies not using IFRS must comply with Financial Reporting Council
- Take mandatory effect for accounting periods after 1 Jan 2015 - referred to as GAAP (Generally Accepted Accounting Policies)
13
Q
What are the accounting standards of Generally Accepted Accounting Policies (GAAP)? (4)
A
- FRS 100 - Application of Financial Reporting Requirements
- FRS 101 - Reduced Disclosure Framework
- FRS 102 - Financial Reporting Standards applicable in the UK and Ireland
- FRS 105 - Amended accounting standards for micro entities - turnover not more than £632k, balance sheet not more than £316k, no of employees not more than 10
14
Q
What is the main regulation for accounting in the EU? (4)
A
- International Financials Reporting Standards by IASB
- Fourth Council Directives for entities not preparing their accounts in accordance with IFRSs
- Conflict between EU directives and IFRSs must be eliminated
- European Financial Reporting Advisory Group reviews this - technical review
15
Q
Summarise the features of a balance sheet (statement of financial positions) (6)
A
- List of asset and liability’s of a company at its year end
- Top half = total assets owned by the company
- Bottom half = equity and liabilities (paid in/still there) by shareholders and creditors
- Total assets of a company (top half) always equals equity and liabilities (bottom half) e.g. balance sheet balances
- Total assets = equity + liability. This is the accounting equation
- Net asset value = total assets - total liabilities
16
Q
What are non current assets (NCAs)? (4)
A
- Long term assets of a company - longer than 1 year
- NCAs break down into intangible, tangible and investments
- Money spent by a company on NCAs is known a CAPEX
-Any other expenditure is known as revenue expenditure and is charged against profit in the income statement
17
Q
What are intangible non current assets? (4)
A
- Generate future revenues but have no physical substance e.g. goodwill, brand names, patents and copyrights
- Most intangible NCAs have limited life and over time they wear out. Their values in subsequent balance sheets need to be reduced
- Loss of value over their useable lives is reflected in the accounts through amortisation
- Goodwill is not amortised, the value for this is tested for impairment each year
18
Q
What assets is the impairment test applied to? (3)
A
- Intangible assets with indefinite useful life
- All goodwill assets
- Whenever there is an indication of impairment
19
Q
Summarise goodwill intangible NCAs (4)
A
- Goodwill is a combination of reasons why a buyers might pay more than the sum total of the assets of the company
- Reputation, brand loyalty, quality of products and staff
- Measured as the difference between the fair value of purchase consideration paid and the fair value of the acquired business identifiable assets and liabilities
- Goodwill = difference between amount paid for a business and the assets acquired e.g. 100-80 = 20
20
Q
What are tangible non current assets? (5)
A
- Plant, property and machinery - long term assets with physical substance
- Items bought by a company to use to generate profit - provides infrastructure for the company
- Like intangible NCAs, tangible NCAs may also devalue over time - this is known as depreciation
- Freehold land doesn’t usually depreciate over time
- NCA investments are presented separately in the balanced sheet and if held for sale are not depreciated - measured at the lower of the carry amount and fair value minus costs to sell. Fair value is based on market valuation
21
Q
What are current assets? (3)
A
- Short term assets of a company
- Held for conversion into cash, usually within a year of the balance sheet date
- Three types of current assets: inventory, receivables, cash
22
Q
What is inventory in current assets? (3)
A
- Company’s inventory held at the balance sheet date e.g. number of mobile phones for a mobile phone retailer. Physical stock
- Valued prudently at the lower of cost and net realisable value
- Net realisable value is the amount the company would receive if the item of inventory was sold today minus incidental costs of sale
23
Q
What is receivables in current assets? (4)
A
- Amounts owed to a company at the year end
- Several types of receivables but the largest component of total debtors is trade receivables
- Trade receivables arise when sales are made on credit - amount owed to a company by customers at the balance sheet date
- Prepayment is recorded as an asset on the balance sheet
24
Q
What are provisions on the balance sheet? (5)
A
- Uncertain fall in the amount of an asset
- Changes in provisions are charged as an expense on the income statement
- Provisions for doubtful debt - made to highlight potential default on an amount of receivables
- Provisions for depreciation - shows the accumulated depreciation on an NCA
- Provisions for unrealised profit on stock - recognises unrealised manufacturing profit - where a company makes finished goods rather than buying them from an external provider. If good is not sold, profit is not realised
25
What is bad debt? (3)
- Certainty that customer is not going to pay
- Written off to the income statement as an expense to the business
- Removed from receivables in the balance sheet - no longer an amount owed
26
What is cash on the current assets section of the balance sheet? (1)
- Physical cash and coins and any credit balances in company bank accounts
27
What is share capital and share premium? (3)
- Share capital and share premium = total of amount paid into company by shareholders
- Issued share capital - total amount of issued capital where shareholders are required to pay - company may ask shareholders to pay in instalments
- Paid up share capital - share capital paid by the shareholders - may be less than the issued capital as payments may be in instalments - ‘calls in arrears’
28
How is share capital recorded? (3)
- Nominal values of shares issued is recorded in the share capital line
- MINIMUM amount a company is legally permitted to accept for the shares it issues e.g. if 1m £1 shares were issued for £1.5 each, share capital will be £1m
- Share capital = nominal value x no of share issued
29
How is a share premium recorded on the balance sheet? (3)
- Any excess over nominal value a company receives when issuing shares is recorded in the share premium account
- If company issues 1m £1 shared at £1.50, share premium would be £0.5m over nominal value
- Uses of share capital and share premium are restricted by the Companies Act 2006
30
How does the Companies Act 2006 limit share capital and share premiums? (4)
- Capitalised as part of a scrip issue (transfers from share capital to share premiums)
- To write off preliminary expenses on formation of the company
- To write off costs associated with the issue of new shares
- To write off the premium or discount on the issue or redemption of debentures
31
What are reserves on financial statements? (2)
- Amount that belongs to shareholders that have been retained by a company
- Two types of reserves - revaluation reserve and profit/loss reserve
32
What is a revaluation reserve? (7)
- Companies have choice over how they value tangible NCAs in the top half of the balance sheet
- Can be stated at cost (amount originally paid for the assets) or at market value
- Process of restating cost to market value is known as revaluation
- If market value is greater than the cost, the asset values in the top half of the balance sheet will increase
- As top and bottom half of balance sheet always equal - the increase in asset values in top half will have to be matched by associated increase in the bottom half
- Line that increases in bottom half is revaluation reserve - cumulative amount at which asset values have increased as result of revaluations
- Profit is not realised until the asset is sold. Non distributable and cannot be used to pay dividends
33
What is retained earnings? (6)
- Known as profit and loss reserve
- Profit left in the company to fund growth
- Retained profit from income statement is added to the profit and loss reserve in the balance sheet
- Retained profit can be used to fund the payment of dividends - profit and loss reserve is distributable
- Scrip issues can also be made from P/L reserve
- Negative balance on P/L reserve is possible and indicates poor trading history
34
What are current liabilities? (4)
- Amount owed by a company within one year of balance sheet date
- Biggest component is trade payables - amount owed to suppliers for purchases made on credit
- Liabilities also include dividends, tax and overdraft payable
- Includes accruals ‘accrued expenses’ that have been incurred by year end but not invoiced by the supplier e.g. gas, electricity, phone bills
35
What are non current liabilities? (2)
- Amounts owed and due for payment more than one year from the balance sheet date
- Reflects the outstanding elements of any debt finance raised by a company e.g. long term bank loan, loan stock, debentures
36
What are provisions for liabilities and charges? (3)
- Liabilities due to past everts e.g losing a court case that requires compensation to be paid out creates a provision on the balance sheet to take into account the future liability
- Recorded as an outflow of resources to settle a liability
- Needs to be reliably estimated
37
What are contingent liabilities? (3)
- Uncertain liabilities e.g. guarantees and warrantees on goods - could give rise to contingent liabilities
- Regarded as unpredictable to warrant any specific provision being set aside for them in the accounts
- Company should disclose a note to the account the nature of the liability committed to covering this
38
Summarise accounting for defined benefit schemes (4)
- Creates a liability on the sponsoring company to meet liabilities set out in the scheme
- Direct impact on sponsoring company’s balance sheet
- Could leave volatility - to reduce this, the company has to set a threshold of increase/decrease in NAV of the fund that needs to be recognised on the balance sheet (10%)
- Anything beyond 10% is charged to the income statement
39
What changes in equity impacts the balance sheet? (4)
- Scrip issue - impacts share capital and premium reserves
- Stock split/consolidation - does not impact balance sheet if stock splits/consolidation - nominal only changes
- Share buyback - cancels equity and reduces cash - reflected in cash
- Rights issue - impacts share premium reserve
40
What is a financial instrument? (3)
- Any contract that gives rise to a financial asset of one entity and financial liability / equity instrument of another entity
- Different to a financial asset e.g. cash, derivatives, owned assets
- Financial liabilities - owed assets - debt, loans, obligations
41
What is recognition in financial statements? (4)
- Financial instruments should be recognised on financial statements
- Instrument can be reconsidered on payment of receipt of money due
- For derivatives, where there is no initial outflow of cash, obligation will not be visible until maturity - recognition should occur when contract is agreed rather than when asset is paid for
- Hedged instruments and hedged asset should also be recognised - value of asset being hedged (fair value hedge) or income on the asset (income hedge)
42
What is derecognition? (2)
- Occurs when contractual rights to cash flows of financial assets have expired
- Financial asset has been transferred (sold)
43
What are repurchased shares? (2)
- If a company buys back its own shares, this is deducted from the equity on the balance sheet
- Any gain or loss on the shares will not be recognised in profit or loss
44
How should financial instruments be classified and measured? (5)
- Financial assets should be recorded at fair value
- Any changes in fair value should be recognised as they arise
1. Fair value through profit and loss (FVPL)
2. Fair value through other comprehensive income (FVOCI)
3. Amortised cost
45
Summarise the depreciation of tangible NCA (7)
- Depreciation is deducted from the value of tangible NCAs in the balance sheet annually and charged to the income statement as a cost
- Net book value = cost of asset - accumulated depreciation
- Straight line and reducing balance are methods used to calculate depreciation
- Annual depreciation = original cost - expected residual value/expected useful life
- Expected useful life is an estimate of how long a company will use the asset
- Expected residual value is an estimate of the future resale or scrap value of the asset
- Annual depreciation as a constant percentage of previous period’s net book value - Annual depreciation = 1-n sq root expected residual value/original cost
46
What are the ‘cost flow assumptions’ when valuing inventory? (3)
- First in first out (FIFO) - old inventory purchases are sold first, leaving new items in year end inventory
- Last in first out (LIFO) - new investory purchases are sold first, leaving old items in year end inventory
- Weighted average - inventory is drawn proportionally from units held
47
What are post balance sheet events? (3)
- Time difference between the balance sheet date and date on which directors approve the accounts
- Adjusting events - relates to events that arise from conditions existing at the balance sheet date e.g. insolvency of a debtor or obsolescence of inventory - in this case, accounts should be adjusted
- Non adjusting events - new conditions that do not exist on the balance sheet such as M&A - not included in balance sheet but will need to be recognised
48
What is an income statement? (3)
- Records income and expenditure relating to a company’s accounting period
- Shows profit from trading (operating profit) and how it is spent e.g. tax, dividends and payment of interest
- If there is profit left after all expenditure, this is called retained profit and this is added to the profit/loss reserve in the balance sheet
49
W
50
What is revenue expenditure and capital expenditure? (2)
- CAPEX - money spent of creating future benefits e.g. machinery
- Revenue expenditure - spent to cover costs e.g. office supplies, phone services - not related to the direct production of the goods/services. Value of life must not increase and useful life must not extend
51
What is turnover/revenue? (3)
- Turnover - sales a company makes. Income that is generated - can be cash and credit. Recognised when the product process is complete and associated revenue is recognised.
- If accounting period is over a year, revenue, costs and profit are apportioned over time e.g. construction of road and bridges
- TR = P * Q
52
What is the cost of sales and operating costs? (4)
- Cost of sales - all costs directly associated with producing or providing a service e.g. raw material, labour, land etc
- Selling and distribution covers delivery of the goods to the customer such as advertising and transportation
- Direct costs - directly associated with production - raw materials, labour/wages
- Indirect costs - overheads - heating, lighting, power
53
What is operating/trading profit? (2)
- TR - TC
- Trading profit, profit before interest and tax (PBIT) or EBIT (earnings before interest and tax)
54
What is interest and tax? (2)
- If a company has debt finance, it will pay interest - this comes from operating profit
- Corporation tax is paid out of operating profit minus interest
55
What are dividends? (2)
- If a company has profit after payments of interest and tax, it can reward shareholders by paid dividends (profit on shares)
- Dividends paid and proposed come out of the retained profit
56
What is retained profit? (2)
- Profit remaining after all payments have been made
- Retained profit is added to the P/L reserve in the balance sheet
57
What are alternative performance measures? (2)
- Some companies use non IFRS and non GAAP measures when communicating performance
E.g EBITDA, adjusted earnings, free cash flow
- These measures have come under scrutiny due to unclear standards, definition and inconsistent application
58
What are the features of a statement of comprehensive income? (4)
- Only required if a company has one of more items that would be considered other comprehensive income
- Separate financial statement that is presented immediately following income statement - the both can be combined
- Statement of comprehensive income covers the same period of time as the income statement and covers net income/earnings from the company’s income statement and other comprehensive income/change to net income
- Other comprehensive income includes: unrealised holding gains/losses, fx gains and losses, pension plan gains/losses and pension prior service costs or credits
59
What is the statement of changes in equity? (8)
- Balance sheet is a static image of capital and reserves
- Company’s must present a statement of changes inequity as a separate component on financial statements - composition of equity and how its changed
- Statement must show:
1. Amount of new share capital issues
2. Amount of dividend paid during the year to shareholders
3. Amount of property, plant and equipment is valued up and down
4. Amount of net income retained during the year
5. Movements in unrealised gains/loss reserve and reserve for changes in fx gains/losses
60
What is a cash flow statement? (5)
- Balance sheet and income statement are prepared on an accruals basis
- Profit is a key measure but is not supported by cash generation - not all income items have immediate cash effect e.g. depreciation with no associated outflow, sales and purchases made on credit
- Cash flow statement shows cash generated, what sources of cash have been used
- Cash flow statements under the International Accounting Standard 7 (IAS 7)
- 3 types of cash flow - operating, investing, financing
61
Explain the 3 types of cash flows? (3)
- Operating - cash flows resulting from business activities of a company
- Investing - cash flows relating to acquisition and disposal of non current assets
- Financing - cash flows resulting from the issue or redemption/repayment of equity and debt
62
What is free cash flow? (3)
- Surplus cash that a company has available
- Cash remaining one all compulsory (non-discretionary) payments have been made
- Enterprise cash flow and equity cash flow - 2 types
63
What is enterprise cash flow? (3)
- Total cash flow generated by company that is available to providers of capital - lenders and holders
- Measure comparable across companies irrespective of capital structure
- No payments to providers of capital have been dedicated
64
How is FCFF calculated? (1)
- Net income + non cash charges (depreciation) - investment in fixed capital - investment in working capital -+ net interest payment = FCFF
65
What is free cash flow to equity (FCFE) and how is it calculated? (4)
- Cash flow generated by a company that is available to equity shareholders only
- Excludes cash owed to lenders
- Simply looks at FCF before shareholders receive dividends
- FCFE = FCFF net interest + net borrowing
66
What are the main adjustments to cash flow statements during reconciliations of net cash for low from operative activities and op profit? (5)
- Depreciation charges - add to trading profit
- Increase in provisions - add to trading profit
- Increase/decrease in inventory ‘stock’ - deduct from/add to trading profit
- Increase/decrease in debtors ‘receivables’ - deduct from/add to trading profit
- Increase/decrease in creditors ‘payables’ - deduct from/add to trading profit
67
What are group accounts? (4)
- A group consists of subsidiaries e.g. Cazenove and the parent company e.g. Schroders
- Group account have to be prepared in addition to parent company individual accounts
- A company is a parent if it holds the majority of voting rights in that company (more than subsidiary)
- An associate company in accounting is a company in high another company owns significant portion of voting shares - usually 20-50%. In this case, owner does not consolidate company accounts
68
How is control evidenced by the provider in group accounting? (4)
- Over 50% of voting rights by virtue of agreement with other investors
- To govern the financial and operating policies of the other enterprise under a statute or an agreement
- To appoint or remove the majority of the members of the board of directors
- To case the majority of votes at a meeting of the board of directors
69
What is a minority interest? (5)
- A holding of more than 50% represents legal control
- Anything less than this is a minority interest
- Minority interest is legally entitled to X% of the profits and assets
- The results and assets of both minority and majority entities are added together. Majority company controls them all
- The minority interests share of profit in the income statement and assets in the balance sheet is taken out of the groups results via a minority interest line
