Level 1 Flashcards
What is the purpose of business accounts?
- Tax / regulatory purposes
- Managers to monitor business performance & operational decisions
- External analysts to give investment recommendations on certain companies
Accounts are prepared to provide a uniform accounting framework which enables easy comparison of performance, and fair tax and regulatory systems.
Should personal transactions be recorded in business accounts?
Not unless it involves:
- cash injection (equity/personal loan)
- withdrawal (dividends/loan)
What is a ‘going concern’?
A business assumed to have the resources to continue operating indefinitely, and making a profit, until it provides evidence to the contrary
–> Assets recorded based on their original cost/fair value
What is an accounting period?
Each business chooses an accounting period in which to complete a cycle of the accounting process (monthly/quarterly/annually - following a calendar or fiscal year i.e. 25th March)
What is Accrual Accounting?
It is an accounting method where revenue and expenses are recorded when they are earned/incurred, rather than when payment is received or made
What are the different types of business activities that should be recorded?
- Operational (day-to-day expenses including selling a service/leasing an office premises)
- Investment (acquisition/disposal of long-term assets e.g purchase of equipment/real estate asset)
- Financial (obtaining/repaying capital - shareholders/creditors, e.g. issuing shares, paying dividends, taking out loans)
What are the various elements of financial statements?
- Assets
- Liabilities
- Equity/Capital
- Income/Revenue
- Expenses/Losses
What are Current Assets?
Cash/other assets expected to be converted to cash within a year
e.g. cash and cash equivalents, accounts receivables, trade receivables, prepaid expenses, inventory, financial assets, trading securities/properties
**cash and cash equivalent: currency, cheques not yet deposited, petty cash, savings, UK gilts/bonds etc.
What are Non-Current Assets?
Assets purchased for long-term use and not likely to be converted to cash within one year
e.g. intangible assets (patents, trademarks, licenses, copyright, goodwill), property, plant & equipment (PPE), long-term investment property
Difference between Property as PPE and Investment Property?
Property can be held for operational purposes (“PPE”) e.g. a company’s HQ, or as investment properties held to receive income/capital appreciation etc.
N.B. US GAAP does not differentiate between the two.
What are liabilities?
Monies owed to banks/bondholders/trade creditors
What are the difference types of liabilities?
CURRENT LIABILITIES
Amounts owed within one year (e.g. short-term loans, overdrafts, creditors & taxes, advance payments)
NON-CURRENT LIABILITIES
Long-term financial obligations which are owed in more than 1 year’s time (e.g. debentures/loans, derivatives liabilities, deferred revenues)
What is Owner’s Equity?
The firm’s NET WORTH and the difference between assets and liabilities, including accounts such as capital/additional paid-in capital/retained earnings
–> Can be positive or negative. Where negative, this is a signal for impending bankruptcy (or a new business)
What is the difference between revenue and gains?
Both are forms of income.
Revenue - income arising from operational activities, including sales, fees, interest, dividends, royalties, rent
Gains - do not form part of the normal business operations and are non-monetary (e.g. capital gains discovered from upward property revaluations - income not immediately realised)
What is the difference between expenditure and expenses?
Expenditure is a cash outflow that will increase the asset account (it affects the cash account, but not the profitability margin as it is considered an investment in the business)
(Operating) Expenses affect profitability directly. These include refurb works etc.
What is a contra-account?
An account used to offset some part of the value of another account. Common accounts include:
- Allowance for bad debts - estimate of how much of the accounts receivables will not be paid by customers
- Sales returns & allowances
- Accumulated depreciation - offsets property, plant & equipment
What is the ‘bottom line’?
Net income - Money gained/lost after all costs and expenses have been deducted from total sales
What are retained earnings?
Earning the company will keep in the company to support future operations (i.e. not distributed as dividends)
What is the equation for retained earnings?
Ending Retained Earnings = Beginning Retained Earnings + Net Income - Dividends
What are dividends?
Amount distributed to owners of a business if retained earnings are positive and there is enough cash to do so.
N.B. REITs must pay out at least 90% of their rental income to shareholders to retain their tax-exempt status
What are the main types of financial statements?
- Balance Sheets
- P&L (Income Statement)
- Cash flow statement
What is a balance sheet?
It shows a company’s financial position at a particular POINT IN TIME. This includes assets & liabilities.
What is the basic accounting equation for a balance sheet?
Assets = Liabilities - Owner’s Equity
What is a profit and loss account?
It shows a company’s performance for a specific period of time
What is the equation for a P & L?
Net Income = Revenue - Expenses
What is the other term for a P and L?
Income statement
What is a cashflow statement?
It shows how changes in the balance sheet accounts and income affect cash/cash equivalents. Broken down into three components: 1. Cashflow from Operations 2. Cashflow from Investing 3. Cashflow from Financing
What does a cash flow statement show?
It shows how well a business manages its cash position i.e. how well it generates cash to pay its debts and fund its operating expenses
What are the two common accounting frameworks used?
- UK Generally Accepted Accounting Principles (GAAP)
2. International Financial Reporting Standards (IFRS)
What are the differences between UK GAAP and IFRS?
IFRS is principles-based (not as prescriptive therefore more room for interpretation), GAAP is rules-based.
Where a company distributes its financial statements outside of the company, GAAP must be followed.
What does IFRS show?
PPE (property, plant, equipment)
- properties recognised at costs & depreciated over time
- revaluation is optional
- if revalued, gains/losses are recognised in income statement (P&L)
- operating leases must be recognised as a right-to-use asset, and as a lease liability in the balance sheet, and depreciated over time
Investment Properties
- can be carried at cost (and depreciated) or revalued at fair value
- preference given to fair value model
- revaluation gains/losses recognised in income statement
- If property is carried at cost & depreciated, fair value disclosure is required.
What does double-entry accounting refer to?
Where each transactions is reflected in at least two accounts in order to keep the balance sheet equation balanced.
e.g. A bank loan for £10k is reflected as a cash increase (asset) of £10k, AND an increase in payable debt (liability) of £10k
Why is financial statement analysis important?
It allows investors, regulators and managers to identify strengths/weaknesses of a business’ overall financial health, and its ability to remain solvent and pay creditors/shareholders accordingly
What are the common adjustments needed to analysis financial statements of real estate companies?
- Net Asset Value
- Net Operating Income
- Funds from Operations
- Earnings
What is the Net Asset Value?
Owners’ Equity
What is the Net Operating Income?
Recurring rental income & other income from property - non-recoverable operating expenses
–> this does not include corporate overheads, interest, depreciation, capital expenditures or income taxes.
LTV Ratio?
Long-term solvency measure that gages the ability of the property portfolio to pay for its loan secured against the underlying property assets:
LTV = Outstanding Mortgages/Properties at Fair Value
Debt to Equity Ratio?
Gages the extent to which a business is using third-party finance to its growth:
Debt to Equity = Total Debt / Net Asset Value
Interest Coverage Ratio?
Interest Cover Radio = Net Operating Income/Interest Payments
Debt Service Coverage Ratio?
Debt Service Coverage Ratio = Net Operating Income/Interest Payments + Principle Repayments
What does a set of public limited company (plc) accounts contain?
- Chairman’s statement
- Independent Auditor’s report
- P&L account
- Balance Sheet
- Corporate Governance report
- Remuneration report
- other statutory information
What are management accounts?
Accounts prepared for internal use by a business and are no audited
What are audited accounts?
Accounts prepared by a chartered/certified accountant
What is a consolidated set of accounts?
Comprises a number of individual subsidiary accounts for a company within a single set of accounts
Is a cash flow statement included in annual accounts?
No but it is prepared for management purposes
What are the recent changes under IFRS 16?
The new standard requires lessees to recognise nearly all leases on the balance sheet, to reflect their right to use an asset for a period of time, and the associated liability of payments.
N.B. service charge payments are accounted for separately
Do the new IFRS 16 lease accounting standards apply to all leases?
Only applicable to those over £5,000 in value, and over 12m in length
