Session 3 Flashcards
What are the components of the business accounts?
1) double entry book keeping,
ledgers and the trial balance
with this, each transaction will be recorded in two places in the books of the business. One will be as a debit and one as a credit. The total of both of these must be the same.
2) the profit and loss account- this is the income of a business throughout an accounting period minus expenses incurred in that period
3) the balance sheet- this represents the net worth or net asset value of the business.
The capital invested in the business to achieve that net worth is recorded in the bottom half.
These two must balance
A year end adjustment are transactions or modifications to the account entries on the trial balance.
All income and expenditure must be ‘matched’ to the relevant accounting period; and
all current obligations must be anticipated as liabilities and all asset values must be assessed to make sure they can be recovered through future profits in conditions of uncertainty.
4) year end adjustments- depreciation- two methods of depreciation-
1) straight line method
2) the reducing balance method.
the method that is chosen will depend on not only how the asset loses value but how it produces revenue for business on an ongoing basis.
5) Year end adjustments-accruals and prepayments
A prepayment arises when an expense is paid for in the current year but all or part of the cost should be charged as an expense next year. For example if the business has paid for something but not yet received the benefit, then the profit of the business will be artificially low
An accrual arises when an expense has been incurred and should be charged against profit in the current year but by the time the accounts are drawn up, that expense has not been included in the trial balance. For example, the profit of the business will be shown as artificially high unless the adjustment is made.
6) year end adjustments- bad and doubtful debts- A debt is a ‘bad debt’ when a business knows with certainty that it is never going to receive. The debt is therefore removed from the ‘receivables’ entry in the accounts
Doubtful debts when a business is providing the possibility that a debt or debts may not be paid.
2 types:
1) specific doubtful debts
2) general doubtful debts
7) partnership accounts
each partner in a partnership will have a capital account and a current account. Partners in a partnership will take ‘drawings’ i.e a share of the profits.
Surplus profits are distributed to the partners in the following way:
1) interest on their capital
2) salaries
3) remaining profit will be distributed according to an agreed profit share ratio
The profit appropriation statement must be completed before the balance sheet can be drawn up
8) intro to company accounts
Companies have to file accounts and made up to their accounting reference date.
3 main differences:
1) format
2) tax
3) dividends
alongside that, there is equity and reserves included on the balance sheet
9) share capital and reserves
The called-up share capital is the amount of the nominal value of its shares that the company has required its shareholders to pay.
different types of reserves:
1) capital
2) revenue
The share premium account represents the difference between the nominal value of the shares and the amount that the shareholders actually paid for the shares
A revaluation reserve is 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
10) dividends
Dividends will usually appear in the financial statement called the ‘statement of equity’.
dividends are included in an addition to the balance sheet called the statement of changes of equity.
The resulting ‘retained earnings’ will appear in the bottom half of the balance sheet, showing the total profits carried forward to the next accounting period
2 types of dividends:
1) interim
2) final.
Dividends are paid or payable out of profits generated in the current or previous accounting periods.
What is debt finance?
Debt finance:
1) loan facilities or
2) debt securities.
A key method of protection is for the lender to take security over the assets of the borrowing company.
What forms of security are there?
1) pledge- lender takes physical possession and they give you money in return. If you pay back the money, you get the asset back.
2) lien- asset will be kept until you pay
3) mortgage- charge by way of legal mortgage.
4) fixed charge- a lender takes a charge over an asset (still letting them use it) but the borrower cannot sell them without consent. If they fail in repaying the loan, the bank has rights in the machinery and can possess them/appoint a receiver to take in and sell the machinery.
5) floating charge- this is a floating charge over a whole of a class of circulating assets. The borrower is allowed to freely dispose of the assets as it wishes until ‘crysallisation’. This is when the charge stops floating and fixes to the asset in the relevant class. The creditor thus acquires control of those assets.
6) guarantee
What is the effect of equity and debt finance on the balance sheet?
Equity:
Both the net asset value of the company will change and the total equity
Debt:
The net asset value of the company will not change as a result of the loan and the equity will not change
What is gearing?
This is the ratio of debt to equity and is an important indicator of the financial health of a company.
This ratio is known as a company’s gearing (or leverage). The higher the ratio of debt to equity, the more highly a company is geared.
Gearing is calculated by the formula:
Long term debt (non-current liabilities) divided by Equity (total equity) x 100
What is the insolvency procedure in a corporate sense>
Firstly, what is the meaning of insolvency?
1) cash flow test- an inability to pay debts as they fall due
2) the balance sheet test- the company’s liabilities are greater than its assets
3) failure to comply with a statutory demand of over £750
4) Failure to satisfy enforcement of a judgement debt
What options are there for a company facing financial difficulties?
1) do nothing- directors risk personal liability here
2) do a deal- reach either an informal or formal arrangement with the company’s creditors with a view to rescheduling debts
3) appoint an administrator- this is a collective formal insolvency procedure (which considers the interests of all the creditors)
4) request the appointment of a receiver- this is an enforcement procedure (by a creditor)
5) put the company into liquidation- this is a collective insolvency procedure
Informal and formal arrangements
Informal agreements with creditors- standstill agreements with a view to not enforcing rights for a period of time to rescue the company
Formal:
Pre-insolvency moratorium- gives the company some breathing space to rescue the company
Company voluntary arrangement- this is an arrangement agreed by the company’s creditors and members to achieve an agreement in respect of its debts. These do not bind secured creditors
Restructuring plan- court sanctioned compromise between a company and its creditors and shareholders to restructure the company’s debts
What are the statutory objectives of administration?
the goal is to:
1) rescuing the company as a going concern
2) achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up
3) realising the property in order to make a distribution to one or more secure or preferential creditors
What is receivership?
this is an individual enforcement procedure which benefits only the appointing creditor:
1) administrative receivers
2) fixed charge receivers
3) court-appointed receivers
What are the type of liquidation?
1) compulsory liquidation- this is court appointed
2) voluntary liquidation:
a) members voluntary liquidation- company is still solvent but shareholders decide to liquidate the company.
b) creditors voluntary liquidation- company is insolvent.
What is the statutory order of priority?
- liquidators fees and expenses of preserving and realising assets subject to fixed charges
- amount due to fixed charge creditor out of the proceeds of selling assets subject to the fixed charge
- other costs and expenses of the liquidation
- preferential creditors (the first tier and then the secondary tier)
- creation of the prescribed part fund (if available) for unsecured creditors
- amount due to creditors with floating chages
- unsecured/trade creditors (including payment of the prescribed part)
- interest owed to unsecured creditors
- shareholders
What about personal insolvency?
2 procedures:
1) bankruptcy
2) individual voluntary arrangements- an alternative to bankruptcy and is also a collective procedure.
