W8 Flashcards
1
Q
What are income and expense accounts in accounting?
A
Income accounts record sums received by the business, such as payments from customers for goods or services. Expense accounts record day-to-day spending, known as revenue or income expenditure. Expenses do not include spending on long-term assets, which are referred to as capital expenditure.
1
Q
What does a balance sheet record?
A
A balance sheet records the value of the total assets held by a business at a specific date. It also shows the net worth or net asset value (NAV) of the business, which is the value of its assets minus its liabilities.
2
Q
What is the purpose of making provisions for doubtful debts in accounting?
A
A business may choose to make provisions for doubtful debts to quantify its doubts about receiving payment from certain customers. This allows the business to express these doubts as an actual figure and create a cushioning effect.
3
Q
What is the principle of double-entry bookkeeping?
A
The principle of double-entry bookkeeping is that every money transaction a business undertakes will have a dual effect in its accounts. For example, if a sole trader purchases an asset for £5,000, there will be a reduction of £5,000 in the record of its cash and an increase of £5,000 in the record of the assets of the business.
4
Q
What are current liabilities and long-term liabilities?
A
Current liabilities are debts that are due to be paid within a year, such as a bank overdraft or trade creditors. Long-term liabilities, also known as non-current liabilities, are debts that are due after one year, such as a term loan.
5
Q
What is the effect of debt finance on the balance sheet?
A
Debt finance can affect the balance sheet by increasing liabilities and potentially decreasing net assets. For example, if a company takes out a loan of £750 repayable over five years, it would increase the liabilities on the balance sheet.
6
Q
What is the difference between a trade creditor and a trade debtor?
A
A trade creditor refers to a supplier of raw materials or goods that a business owes money to. On the other hand, a trade debtor refers to a customer who owes money to the business.
7
Q
How is the provision for doubtful debts account treated in the balance sheet?
A
The provision for doubtful debts account is treated as a liability on the balance sheet. It is shown in a different way from other liabilities and is matched to the receivables asset account.
8
Q
Why must the two halves of a balance sheet always balance?
A
The two halves of a balance sheet must always balance because they represent how the money invested by the owners of the business (recorded in the bottom half) has been used (recorded in the top half). If the two halves do not balance, it indicates that something has gone wrong in the financial records.
9
Q
What is the purpose of a trial balance?
A
A trial balance is a list of all the balances on all of a business’s ledgers/accounts as at the end of an accounting period. It shows debit balances in one column and credit balances in another column. The total of each of the two columns should be the same, which helps ensure the accuracy of the financial statements.
10
Q
How is the depreciation charge calculated using the reducing balance method?
A
The reducing balance method deducts the provision for depreciation from the cost figure to give the written down value. Then, the depreciation charge of 20% is applied to the written down value to calculate the charge for depreciation for the year.
11
Q
Can a sole trader’s business and personal finances be treated separately?
A
For accounting purposes, a sole trader’s business and personal finances are treated as separate entities. The business has its own capital account and the owner pays themselves through drawings out of the profits of the business.
12
Q
How are year-end adjustments used in the preparation of financial statements?
A
Year-end adjustments are transactions or modifications to the account entries on the trial balance. They are needed to apply the accruals concept to the preparation of financial statements. Year-end adjustments include items such as depreciation, accruals, prepayments, bad debts, and doubtful debts.
13
Q
How are fixed assets and current assets classified in a balance sheet?
A
Fixed assets are tangible or intangible assets owned by a business that provide long-lasting benefits. Current assets include cash and items that can quickly be turned into cash within one year, such as stock, debtors, and cash in hand. These assets are classified based on their nature and liquidity.
14
Q
How are doubtful debts accounted for in the profit and loss account?
A
Doubtful debts are accounted for in the same expense account as bad debts in the profit and loss account. However, only the increase (if any) in the provision for doubtful debts over the previous year’s provision is treated as an expense.
15
Q
What are year-end adjustments?
A
Year-end adjustments are transactions or modifications to the account entries on the trial balance. They are needed to apply the accruals/matching concept to the preparation of financial statements.
16
Q
What are year-end adjustments in accounting?
A
Year-end adjustments are made to some figures in the trial balance before preparing the financial statements. These adjustments ensure that all income and expenditure shown on the financial statements relate only to the relevant accounting period.
17
Q
What is the purpose of a profit appropriation statement in a partnership?
A
A profit appropriation statement is used to divide the profits of a partnership among the partners. It determines the allocation of profits based on factors such as interest on capital, salaries, and the agreed profit share ratio.
18
Q
How is the cost of sales calculated on a profit and loss account?
A
The cost of sales figure on a profit and loss account is calculated using figures for opening stock and closing stock. The formula used is: Opening stock + purchases - closing stock = cost of sales.
19
Q
What is the purpose of depreciation in accounting?
A
Depreciation is a mechanism used in accounting to deal with the decline in value of a fixed asset over time. It spreads the cost of the asset over its useful life and ensures that the accounts give a true reflection of the position of the business. Depreciation can be calculated using methods such as straight-line or reducing balance.
20
Q
How are drawings by partners treated in partnership accounts?
A
Drawings by partners are withdrawals of profits made by the partners during the year. They are usually based on an estimate of the partner’s share of expected profits. If partners draw too much, they may be liable to contribute a balancing payment back to the partnership.
21
Q
What is the purpose of a profit and loss account?
A
The purpose of a profit and loss account is to record the income of a business throughout an accounting period and deduct the expenses incurred in that period. This calculation results in a profit or loss figure for the period.
22
Q
What are accruals and when do they occur?
A
Accruals occur when a business has had the benefit of something in one accounting period but will not pay for it until the next. They are made to comply with the accruals/matching concept and ensure a true reflection of the business’s financial position.
23
Q
How does the straight-line method of depreciation work?
A
The straight-line method of depreciation spreads the depreciation charge evenly over the life of the asset. It is the most common and straightforward method used when the service provided by the asset continues consistently over its useful economic life.
24
What is the difference between doubtful debts and bad debts in accounting?
Bad debts represent a cost to the business as they are debts that have been written off as uncollectible. Doubtful debts, on the other hand, represent potential costs that the business may or may not incur. They are accounted for in the same expense account as bad debts.
25
What does the balance sheet of a business show?
The balance sheet of a business shows the assets, liabilities, and capital accounts of the business. It provides a snapshot of the financial position of the business on a specific date.
26
What are prepayments and when do they occur?
Prepayments occur when a business has paid for something in advance during one accounting period but does not get the benefit of all or some of what it has paid for until the next. Prepayments are the opposite of accruals and are adjusted to match the expenditure incurred to the relevant accounting period.
27
How does the reducing balance method of depreciation work?
The reducing balance method of depreciation expresses the depreciation charge each year as a percentage of the reducing balance, which is the net book value of the asset at the start of the relevant accounting period. This method is used when an asset is likely to lose a large part of its value in the first few years of ownership.
28
How is the net asset value (NAV) calculated on a balance sheet?
The net asset value (NAV) of a business is calculated by adding the fixed assets (net book value) and net current assets, and then deducting long-term/non-current liabilities. The amount of capital invested in the business is recorded in the bottom part of the balance sheet.
29
What is the purpose of a trial balance in preparing financial statements?
A trial balance is used as a basis for preparing financial statements, primarily the profit and loss account and balance sheet. It provides a comprehensive list of all the balances on a business's ledgers/accounts, categorized by their debit and credit balances.
30
What is the impact of not making adjustments for accruals and prepayments?
If adjustments are not made for accruals and prepayments, the accounts will not give a true reflection of the business's financial position. The profit may be artificially high or low, distorting the financial position.
31
How is the provision for doubtful debts calculated?
The provision for doubtful debts can be calculated based on a specific percentage of the receivables or through a general provision. The specific or general provision is determined at each year-end and may increase, reduce, or stay the same compared to the previous year's provision.
32
What is the net asset value figure for a business after specific transactions?
After specific transactions, such as the injection of capital and obtaining a long-term loan, the net asset value figure for the business can be calculated by subtracting the long-term liability from the total assets. The net asset value represents the current value of the business after taking into account its assets and liabilities.
33
What are bad debts and when are they written off?
Bad debts are debts that a business knows with certainty it will never receive. They can be written off during the financial year or at the end of the financial year.
34
What is the difference between a profit and loss account and a balance sheet?
A profit and loss account records the income and expenses of a business throughout an accounting period to calculate the profit or loss figure. On the other hand, a balance sheet provides a snapshot of the assets, liabilities, and capital accounts of the business on a specific date.
35
What is the treatment of doubtful debts in the profit and loss account?
Doubtful debts are not shown as a whole amount in the profit and loss account. Instead, only the increase (if any) in the provision for doubtful debts over the previous year's provision is treated as an expense.
36
What is a provision for doubtful debts and when is it made?
A provision for doubtful debts occurs when a business provides for the possibility that a debt or debts may not be paid. It can be specific or general and is made to accurately reflect the fact that the business may not receive all of the money owed to it.
37
What is the significance of a trial balance in accounting?
A trial balance is a crucial tool in accounting as it ensures that the sum of all debits equals the sum of all credits. It helps identify any errors or imbalances in the accounts before preparing financial statements, ensuring the accuracy and reliability of the financial information.
38
How is the provision for doubtful debts shown on the balance sheet?
The provision for doubtful debts is shown as a liability on the balance sheet. It is matched to the receivables asset account to accurately represent the business's affairs and demonstrate prudent provision for potential unpaid debts.
39
How are assets and liabilities classified in a balance sheet?
In a balance sheet, assets and liabilities are separated to provide a clear view of a business's financial position. Assets are things owned by the business, such as fixed assets and current assets. Liabilities are amounts owed by the business to others.
40
How are income and expense entries transferred into a profit and loss account?
Income and expense entries from the trial balance are transferred into a profit and loss account. For example, sales (income account) is recorded at the top of the profit and loss account, while expenses such as telephone and postage (expense accounts) are recorded in the expenses section.
41
What is the purpose of year-end adjustments for bad and doubtful debts?
Year-end adjustments for bad and doubtful debts ensure that the accounts accurately reflect the possibility of not receiving all or part of the money owed to the business. Bad debts are written off, reducing the receivables account, while a provision for doubtful debts is made as a liability.
42
What is the net current assets figure on a balance sheet?
The net current assets figure on a balance sheet indicates how much cash the business could make available at short notice. It is calculated by subtracting current liabilities from current assets.
43
What are the five year-end adjustments?
The five year-end adjustments are depreciation, accruals, prepayments, bad debts, and doubtful debts.
44
What are the specific adjustments for accruals and prepayments?
Accruals occur when an expense has been incurred but not yet paid for, while prepayments occur when an expense is paid for in advance but not fully utilized. These adjustments ensure that the expenses are matched to the relevant accounting period.
45
How are asset, liability, and capital entries transferred into a balance sheet?
Asset, liability, and capital entries from the trial balance are transferred into a balance sheet. Fixed assets and net current assets are categorized as assets, while current liabilities and long-term/non-current liabilities are categorized as liabilities. The amount of capital invested in the business is recorded in the capital section of the balance sheet.
46
What is the impairment of receivables on a company balance sheet?
The impairment of receivables on a company balance sheet refers to the adjustment made to reflect the decrease in value of the company's assets.
47
What causes the figure for Net Assets to rise in the Balance Sheet?
The increase in the value of the asset in the Balance Sheet causes the figure for Net Assets to rise correspondingly. This is achieved by creating or increasing an existing revaluation reserve by the same value.
48
What is the purpose of debt finance?
Debt finance is a method for companies to borrow money, usually from a bank or other lenders, as an alternative option to raising funds through equity finance. It allows companies to raise capital and meet their financial needs.
49
What is a revaluation reserve and what does it represent?
A revaluation reserve represents a notional profit to the company from the rise in value of the asset. However, this profit is unrealized until the asset is sold, and as such, it is a capital reserve and is not distributable as a dividend until the company sells the asset and realizes the profit.
50
What is the difference between a fixed charge and a floating charge?
The key element of a fixed charge is that the creditor can control what the security provider can do with the fixed charge assets.
A floating charge ‘floats’ over the whole of a class of circulating assets. Whatever assets in that class happen to be owned by the security provider at any given time are subject to the floating charge, and the security provider is free to dispose of the assets as it wishes until ‘crystallisation’.
51
How can a reduction in a re-valued asset's value be set off?
Any subsequent reduction in a re-valued asset's value can be set off against the revaluation reserve.
52
What are debt securities?
Debt securities are a means by which a company receives money from external sources. In return for finance provided by an investor, the company issues a security acknowledging the investor's rights. The security is a piece of paper acknowledging the debt, which can be kept or sold to another investor.
53
Why is a fixed charge considered a stronger form of security?
A fixed charge is considered a stronger form of security because the holders of fixed charges are paid first in the order of priority in the event of a company's liquidation. It provides more control over the charged assets and restricts the borrower from disposing of or creating further charges without the creditor's consent.
54
What are dividends and how are they paid?
Dividends are payments made to shareholders out of profits generated in the current or previous accounting periods. They can only come out of retained earnings and are not shown in the Profit and Loss account. Dividends can be interim or final, and some shares may pay a preference dividend.
55
What is the purpose of taking security over assets in a loan agreement?
Taking security over assets in a loan agreement provides the lender with protection in case the borrower defaults on the loan. It allows the lender to have a claim on specific assets to recover their money.
56
What is the importance of registering charges within a specific timeframe?
Charges must be registered within 21 days beginning with the day after creation under s 859A CA 2006. Failure to register charges within this timeframe will render them void and the loan will become immediately repayable.
57
What are the main types of loan facilities?
Loan facilities include overdrafts, term loans, and revolving credit facilities. Overdrafts are on-demand facilities where the bank can call for immediate repayment. Term loans are loans for a fixed period of time, repayable on a certain date. Revolving credit facilities allow borrowers to repeatedly borrow and repay loans up to an agreed maximum overall amount.
58
How are dividends recorded in the financial statements?
Dividends are recorded in a financial statement called the 'statement of equity' or 'statement of changes in equity' because they are transactions between the company and its shareholders. They are included in an addition to the Balance Sheet called the Statement of Changes in Equity (SoCiE), which shows profits brought forward and added to current year profits subject to any deductions for dividends. The resulting 'Retained Earnings' will appear on the bottom half of the Balance Sheet, showing the total profits carried forward to the next accounting period.
59
What are some options for the bank to secure a loan?
The bank can take security over valuable assets owned by the company, such as machinery or future assets. They can also request a personal guarantee from the entrepreneur if they have valuable assets. Additionally, the bank may require the company to give security for the loan, such as granting a mortgage over their home.
60
When must companies file their accounts at Companies House?
A private company must file its accounts at Companies House within nine months after the end of the relevant accounting reference period. A public company must file its accounts within six months after the end of the relevant accounting reference period.
61
What is the difference between debt securities and equity securities?
Debt securities are a means for a company to receive money from external sources by issuing a security acknowledging the debt. Equity securities, on the other hand, represent ownership in a company. Debt securities have a maturity date when the company pays back the value of the security, while equity securities do not have a fixed repayment date.
62
What are the different forms of security?
The different forms of security include pledge, lien, mortgage, and charge. A pledge involves giving possession of the asset to the creditor until the debt is paid back. A lien allows the creditor to retain possession of the asset until the debt is paid back. A mortgage involves transferring ownership of the asset to the creditor, subject to the right of the security provider to require the creditor to transfer the asset back when the debt is repaid. A charge creates an equitable proprietary interest in the asset in favor of the creditor, without transferring ownership.
63
What is the purpose of the retained earnings account?
The retained earnings account is the reserve account for retained profits. It represents profits after tax earned by the company over its history and not distributed by way of dividend or appropriated to another reserve. Retained earnings generally increase from year to year as most companies do not distribute all of their profits.
64
What are the formalities involved in creating security for a loan?
To create security for a loan, certain formalities need to be followed. The security created by the borrower needs to be registered with Companies House within 21 days of its creation. This involves delivering a statement of particulars, a certified copy of the charge, and the relevant fee to Companies House.
65
What are the main differences in the content of financial statements for companies compared to sole traders and partnerships?
The main differences in the content of financial statements for companies compared to sole traders and partnerships relate to the bottom half of the Balance Sheet. This is because the capital of a company consists of share capital, reserves, and retained earnings.
66
What is the main benefit of taking security?
The main benefit of taking security is to protect the creditor in the event that the borrower enters into a formal insolvency procedure. It ensures that the creditor has a claim on the assets to recover the debt owed.
67
What are convertible bonds and preference shares?
Convertible bonds are bonds that can be converted into shares in the issuer. On conversion, the issuer issues shares to the bondholder in return for giving up the right to receive interest and repayment of the principal amount invested. Preference shares are equity securities that give the holder a definite amount of dividend ahead of other shareholders and may have a fixed maturity date for redemption or purchase by the company.
68
What role does tax play in company accounts?
Unlike sole traders and partnerships, companies have separate legal personality and must pay tax on their own account. The Profit and Loss Account of a company includes a statement of the tax the company should pay on its profits, known as corporation tax.
69
What is the Statement of Changes in Equity and how does it relate to dividends?
The Statement of Changes in Equity (SoCiE) is a separate calculation that shows how profits for the year are carried over into the bottom half of the Balance Sheet. Dividends are included in the SoCiE as deductions in calculating the Retained Earnings, which appear in the bottom half of the Balance Sheet. The SoCiE is appended to the bottom of a company's Balance Sheet.
70
What are the main documents required for a term loan?
The main documents required for a term loan are a term sheet, a loan agreement, and a security document (if the loan is to be secured), commonly known as a debenture.
71
What are the consequences of failure to comply with the requirements for keeping records of charges?
Failure to comply with the requirements for keeping records of charges is an offense. The company and every officer of the company who is in default may be liable to a fine.
72
What is a bonus issue of shares and how is it funded?
A bonus issue of shares, also known as a capitalization issue or scrip issue, is when a company converts some of its reserves into share capital by issuing fully paid shares to existing shareholders on a pro rata basis for no consideration. The company will use its retained earnings or its share premium account to fund the issue.
73
What is the order of priority among creditors in the event of liquidation?
In the event of liquidation, creditors are paid in the following order: 1) Creditors with fixed charges, 2) Preferential creditors, 3) Creditors with floating charges, 4) Unsecured creditors, and 5) Shareholders
74
How are preference dividends calculated and when are they paid?
Preference dividends are usually paid in two installments each year. The amount of the dividend is already known each year, and it will appear as a deduction in the Statement of Changes in Equity (SoCiE) to calculate the Retained Earnings in the bottom half of the Balance Sheet.
75
What is the difference between a debt security and security for a debt?
A debt security is a type of debt, such as a bond, issued by a company. Security for a debt refers to something that the lender takes over the assets of the borrower to protect their interests. It is important not to confuse the two terms.
76
What is the difference between capital reserves and revenue reserves?
Capital reserves, such as the share premium account and revaluation reserve, represent the capital of the company in excess of the called-up value of the issued share capital. Revenue reserves, such as retained earnings, are distributable reserves that can be distributed to shareholders in the form of dividends.
77
What happens when a floating charge crystallizes?
When a floating charge crystallizes, it ceases to float over all of the assets in a class and instead fixes onto the assets in the class charged at the time of the crystallization. This prevents the borrower from dealing with those assets, similar to a fixed charge.
78
What is a proposed dividend and how does it differ from a declared dividend?
A proposed dividend is a dividend that has been recommended by the directors but has not yet been approved by the shareholders. It does not constitute a debt enforceable by the shareholders until it is approved. A declared dividend, on the other hand, has been approved by the shareholders and constitutes a debt of the company enforceable by the relevant shareholders.
79
What are the different forms of security that may be granted for loans?
The most common forms of security for loans are fixed or floating charges.
80
What is the share premium account?
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. It is a capital reserve and cannot be distributed to shareholders, except in exceptional circumstances.
81
What is the effect of equity financing on the balance sheet of a company?
Equity financing affects both halves of the balance sheet. The net asset value of the company changes, and the total equity increases due to the issuance of shares.
82
What is the statutory order of priority of payment of creditors in a company's winding up
In a company's winding up, there is a statutory order of priority of payment of creditors. Generally, a floating charge ranks below a fixed charge and preferential creditors when the company's assets are realized. However, if a floating charge document contains a term prohibiting the creation of a later fixed charge and the later fixed charge holder had notice of this restriction, the floating charge will have priority.
83
What are representations and undertakings in loan agreements?
Representations are statements of fact as to legal and commercial matters made on signing the loan agreement and repeated periodically during the life of the loan. Undertakings are promises to do or not do something, or to procure that something is done or not done.
84
What is the effect of debt financing on the balance sheet of a company?
Debt financing has no overall effect on the net asset position or equity of the company. It only affects the top half of the balance sheet, specifically the current liabilities.
85
What is an interim dividend and how is it treated in the accounts?
Interim dividends can be paid without the need for an ordinary resolution of the shareholders. They will only be reflected in a company's accounts if they have actually been paid. When an interim dividend has been paid, the amount of the dividend will have been deducted from the assets and will be shown as an item on the trial balance. Interim dividends are treated the same as declared (and paid) dividends in the Statement of Changes in Equity (SoCiE).
86
What is a revaluation reserve?
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. It reflects the increase in value of the company's assets.
87
What is the prescribed part fund for unsecured creditors?
Floating charges created on or after 15 September 2003 are subject to a part of the proceeds of the assets being set aside. This is known as the prescribed part fund for unsecured creditors.
88
What happens to profits after tax that are not paid out as dividends?
Profits after tax not paid to shareholders as dividends are retained in the company. They contribute to the retained earnings account, which represents the reserve account for retained profits.
89
What is an Event of Default in a loan agreement?
An Event of Default is a clause in a loan agreement that gives the bank contractual remedies if the borrower breaches representations, undertakings, or other terms of the agreement. It allows the bank to call in its money early if the borrower shows signs of becoming an enhanced credit risk.
90
What are the general rules regarding equity and debt finance in relation to the balance sheet?
Equity finance affects both halves of the balance sheet, while debt finance only affects the top half of the balance sheet. Equity finance leads to an increase in share capital and cash, while debt finance does not change the net asset value or equity.
91
What is the called-up share capital?
The called-up share capital is the amount of the nominal value of its shares that the company has required its shareholders to pay. It represents the aggregate amount of the nominal value of the issued shares, excluding any premium.
92
What are the requirements for keeping records of charges?
A company must keep available for inspection a copy of every charge and a copy of every instrument that amends or varies any charge. These documents must be kept at the company's registered office or another permitted location. The company must inform Companies House of the place where the documents are available for inspection.
93
What are the main documents involved in debt finance transactions?
The main documents involved in debt finance transactions are the term sheet, loan agreement, and security document. The term sheet outlines the key terms of the transaction, the loan agreement sets out the main commercial terms of the loan, and the security document details the security granted for the loan.
94
How are bonus issues of shares funded and what impact do they have on the Balance Sheet?
Bonus issues of shares are funded by converting reserves into share capital. The assets and liabilities of the company are unchanged after the bonus issue. The bonus issue will appear in the top half of the company's Balance Sheet as a current liability and will be deducted in the Statement of Changes in Equity (SoCiE) to calculate the Retained Earnings in the bottom half of the Balance Sheet.
95
Why might private companies choose debt finance over equity finance?
For many private companies, it may be difficult to raise money through equity finance since they are unable to offer shares to the public. Debt finance provides an alternative option to raise funds by borrowing money from banks or other lenders.
96
What is the equity of redemption in relation to a mortgage?
In a mortgage, the security provider retains possession of the asset but transfers ownership to the creditor. The transfer is subject to the security provider's right to require the creditor to transfer the asset back when the debt is repaid. This right is known as the equity of redemption.
97
What is the power of a company to borrow and are there any restrictions?
Most companies have unrestricted power to borrow, but it is necessary to consider when the company was incorporated and check the company's Articles to ensure there are no restrictions on borrowing.
98
What is the purpose of retained earnings and how does it change over time?
Retained earnings represent profits after tax earned by the company over its history and not distributed by way of dividend or appropriated to another reserve. It generally increases from year to year as most companies do not distribute all of their profits.
99
What are the different ways in which a company can be valued?
A company can be valued using methods such as the balance sheet valuation, which looks at the value of the company's assets minus its liabilities, or the multiplier valuation, which looks at the average profit of a company and multiplies it by a factor relevant to the particular industry.
100
What are the advantages and disadvantages of a floating charge from a creditor's perspective?
The advantages of a floating charge include flexibility for the security provider to dispose of assets in the ordinary course of business until crystallization occurs. However, the disadvantages include uncertainty about the value of the secured assets and a lower priority in the order of payment of creditors in the event of insolvency or liquidation.
101
What are the powers of the bank in case of an Event of Default?
In case of an Event of Default, the bank may exercise its powers based on the security provided. For fixed charges, the bank can appoint a receiver or exercise a power of sale. For floating charges, the charge crystallizes and the bank acquires control of the assets.
102
What is the purpose of a guarantee in relation to a loan?
A guarantee for a loan means an agreement that the guarantor will pay the borrower's debt if the borrower fails to do so. Guarantees can come from companies or individuals and provide additional security for the lender.
103
What changes occur on the balance sheet when a company issues shares at a premium?
When a company issues shares at a premium, several changes need to be recorded on the balance sheet. The cash received is shown as an increase in the assets on the top half of the balance sheet. The nominal amount of the new shares is shown as an increase in the share capital on the bottom half of the balance sheet. The premium per share is shown in the newly-created share premium account.
104
What is the purpose of a debenture in a loan agreement?
A debenture is a type of security document commonly used in secured loan transactions. It sets out the details of the security granted by the borrower to the lender. The debenture is sent to Companies House for registration purposes.
105
What is the difference between a downstream guarantee and an upstream guarantee?
A downstream guarantee is given by a parent company of a subsidiary to guarantee a loan made to the subsidiary. An upstream guarantee is given by a subsidiary to guarantee a loan made to the parent company. A cross-stream guarantee is given by one subsidiary to guarantee a loan made to another subsidiary within the same group of companies.
106
What is the effect of equity and debt finance on the balance sheet?
Equity finance affects both the net asset value and total equity of the company. Debt finance has no overall effect on the net asset value or equity of the company.
107
How does issuing shares at a premium affect the balance sheet?
When a company issues shares at a premium, the top half of the balance sheet shows an increase in assets due to the cash received. The bottom half of the balance sheet shows an increase in share capital due to the nominal amount of the new shares. Additionally, the newly-created share premium account reflects the premium per share.
108
What are the financial ratios commonly used to measure the financial performance of a company?
There are various financial ratios that can be used to measure the financial performance of a company. Some commonly used ratios include the current ratio, debt-to-equity ratio, return on equity, and gross profit margin.
109
What is the significance of earnings per share?
Earnings per share is a commonly used ratio that measures the financial performance of a company. It shows the return due to ordinary shareholders and is calculated by dividing profit after tax by the average number of ordinary shares in issue during the period when the profit was generated. An increase in the number of shares in issue will result in a dilution of the earnings per share figure.
110
How does debt finance affect the balance sheet?
When a company takes out a loan, two changes are recorded on the balance sheet. The company's liabilities are increased by the amount of the loan, and the company's assets (cash) are also increased by the loan funds. As a result, the net assets remain unchanged, and total equity is also unchanged.
111
What is gearing and how is it calculated?
Gearing, also known as leverage, is the ratio of liabilities to shareholder funds (total equity) in a company. It indicates the financial health of a company. Gearing is calculated by dividing long-term debt (non-current liabilities) by equity (total equity). The higher the ratio of debt to equity, the more highly geared a company is.
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What are the risks and advantages of high gearing?
Highly geared companies are seen as more of a credit risk by banks and other lenders, making it more difficult for them to raise further loans in the future. Highly geared companies also have less equity to absorb any losses, which can be especially dangerous in bad economic conditions or high-interest rate environments. However, increasing gearing may be advantageous to shareholders as it does not require share dilution through the issue of new shares.
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What is the gearing ratio and how does it indicate the financial health of a company?
The gearing ratio, also known as leverage, is the ratio of liabilities to shareholder funds (total equity) in a company. It indicates the financial health of a company by showing the proportion of debt to equity. A higher gearing ratio means a company is more highly geared, indicating a higher level of debt compared to equity.
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What are the risks associated with highly geared companies?
Highly geared companies are seen as more of a credit risk by banks and other lenders, making it more difficult for them to raise further loans in the future. They also have less equity to absorb any losses the company might make. Highly geared companies may struggle to meet interest payments, especially when economic conditions are bad or interest rates are high.
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Why would a company choose to be highly geared?
A company may choose to be highly geared if it has a highly profitable investment opportunity available. By borrowing money, the company can make a larger investment than it could have made using only its own resources. If the investment performs well, all the profit (after interest) belongs to the company. However, if the investment performs poorly, the company will have lost more money and still have to pay the interest on the debt.
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How does debt finance affect the gearing ratio of a company?
Debt finance increases the liabilities of a company without affecting the net assets figure. As a result, the gearing ratio, which is the ratio of liabilities to shareholder funds (total equity), increases. Taking out a loan increases the amount of long-term debt, while total equity remains unchanged.
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A company takes advice on an employment dispute and incurs legal fees of £5,000 but has not yet been invoiced for that work by the end of its financial year. The company’s business accounts for the said financial year are being drawn up.
Which of the following statements is correct?
The legal fees are an accrual and if not reflected in the business accounts then the company’s assets will be overstated by £5,000 in the balance sheet.
The legal fees are an accrual and if not reflected in the business accounts then the company’s assets will be understated by £5,000 in the balance sheet.
The balance sheet will not balance owing to the sum of £5,000 having not been paid yet.
The legal fees are a prepayment and if not reflected in the business accounts then the company’s profits will by understated by £5,000.
The legal fees are a prepayment and if not reflected in the business accounts then the company’s assets will be overstated by £5,000 in the balance sheet.
The legal fees are an accrual and if not reflected in the business accounts then the company’s assets will be overstated by £5,000 in the balance sheet
Correct. The company has received the value of the legal advice already but has not yet paid for it. It will therefore be an accrual (as opposed to a prepayment). As the value has been received already and the company has committed to paying this sum then £5,000 has already been incurred. This needs to be reflected as a liability in the balance sheet, otherwise it would be misleading.
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A company raises £200,000 through an issue of 100,000 £1 ordinary shares at a price of £2 per share fully paid in cash.
Which of the following statements best describes the effect of the share issue on the company’s balance sheet?
Cash increases by £200,000; share capital increases by £100,000 and the share premium account increases by £100,000
Cash increases by £200,000 and share capital increases by £100,000
Net assets and total equity increase by £200,000
Current assets increase by £200,000; share capital increases by £100,000 and the share premium account increases by £100,000
Current assets and total equity increase by £450,000
Cash increases by £200,000; share capital increases by £100,000 and the share premium account increases by £100,000
119
A company raises £800,000 by way of a 3-year term loan and uses these funds to purchase some new machinery at a cost of £800,000.
Which of the following statements describes the net impact of these transactions on the company’s Balance Sheet?
Increase in non-current liabilities by £800,000; no change on cash/cash equivalents; increase in non-current assets by £800,000; no change in Net Asset Value.
Increase in current liabilities by £800,000; no change on cash/cash equivalents; increase in non-current assets by £800,000; no change in Net Asset Value.
Increase in non-current liabilities by £800,000; increase in cash/cash equivalents by £800,000; increase in non-current assets by £800,000; increase in Net Asset Value by £800,000.
Increase in current liabilities by £800,000; no change on cash/cash equivalents; increase in current assets by £800,000; no change in Net Asset Value.
Increase in non-current liabilities by £800,000; decrease in cash/cash equivalents by £800,000; increase in non-current assets by £800,000; decrease in Net Asset Value by £800,000.
Increase in non-current liabilities by £800,000; no change on cash/cash equivalents; increase in non-current assets by £800,000; no change in Net Asset Value.
Correct. The first transaction – taking out the loan increases the non-current liabilities by £800,000 and increases the cash and cash equivalents by £800,000. The second transaction – purchase of machinery increases the non-current assets by £800,000 and reduces the cash and cash equivalents by £800,000. The net effect of both transactions is no change to the cash and cash equivalents or to the Net Asset Value.
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A private limited company runs a car dealership and is seeking to borrow £1,000,000 by way of a loan from a bank. The bank is considering the security that it should consider taking from the company to secure the loan. The most valuable category of assets owned by the company is the vehicles which it has for sale on its forecourt.
What would be the most appropriate form of security interest for the bank to take over the vehicles?
A floating charge because the vehicles are a type of fluctuating asset.
A debenture because this is the most comprehensive form of security the bank can take.
A fixed charge because the vehicles are a type of permanent asset.
A pledge, because this is the most secure form of security the bank can take.
A charge by way of legal mortgage because the vehicles are a type of property.
A floating charge because the vehicles are a type of fluctuating asset.
Correct. This answer reflects the most appropriate answer. Whilst the other answer options might sound plausible, they are each incorrect. The vehicles represent fluctuating assets in this scenario (as they are the stock of the company) in relation to which a floating charge is the most appropriate security that the bank could take. A pledge, whilst possible as a form of security, is not appropriate as it would involve the as sets being physically transferred to the bank which due to their size and number and the fact that the company would then not be able to sell them would be inappropriate. Whilst vehicles can sometimes be considered a permanent asset, in this case they represent the stock of the company. As the vehicles are therefore a fluctuating assets the company needs to be able to freely dispose of them and so are not appropriate for a fixed charge. Whilst a debenture does contain comprehensive security interests, a debenture in itself is not a form of security interest. A charge by way of legal mortgage is only appropriate as a form of security over land.
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A private company incorporated in 2016 with unamended Model Articles wishes to raise money for working capital purposes by borrowing from a bank. The bank will take security for the loan over the company’s assets. No changes have been made to the company’s articles since incorporation.
Which of the following best describes the procedure to be followed to ensure the bank has effective security?
The loan agreement will need to be registered at Companies House within 21 days beginning with the day after the date of signing of the loan agreement.
The security document will need to be registered at Companies House within 21 days beginning with the day after the date of creation of the security.
The company is unable to grant security for this loan as it would breach the financial assistance rules.
The company will need to approve the granting of security in respect of the loan to the bank by shareholder resolution.
The security document will need to be registered at Companies House within 21 days from the date of creation of the security.
The security document will need to be registered at Companies House within 21 days beginning with the day after the date of creation of the security.
