8 Debt finance and business accounts Flashcards
how long is an accounting period?
a full year
what are the financial statements prepared in respect of each accounting period?
- profit and loss account
- balance sheet
What are book-keeping ledgers?
The process by which businesses record money transactions
What is double entry book-keeping?
Every money transaction that 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.
What is a trial balance? and what does it show?
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.
The trial balance shows debit balances in one column and credit balances in another column. The total of each of the two columns should be the same.
ALCIE ledger on the trial balance
Assets
Liabilities
Capital
Income
Expenses
Another term for fixed assets
non-current assets
What do current assets include?
cash and items owned by the business (or owed to the business) which can quickly be turned into cash
Examples of current liability
Bank overdraft (repayable on demand)
Trade creditors (such as suppliers of raw materials).
Example of non-current liability
Term loan
What do expense accounts record?
day-to-day spending
Purpose of Year-end adjustments
to ensure that all income and expenditure shown on the final financial statements relate only to the relevant accounting period.
What does the profit and loss account record?
The income of a business throughout an accounting period minus expenses incurred in that period, to arrive at a profit (or a loss) figure for the period.
What does the balance sheet record?
The position of a business in respect of its asset, liability and capital accounts from the trial balance.
Why does a balance sheet differ from a profit and loss account?
The balance sheet of a business differs from a profit and loss account as it is a snapshot relevant on a given date (unlike the profit and loss account which relates to a period, which in most cases is a year).
The date at the top of a balance sheet is the last day of the accounting period to which it relates. The heading of a balance sheet always contains the words ‘as at’ a specified date.
The balance could be different the very next day, for example, if an asset were sold and the proceeds used to pay bills.
Contents of a balance sheet
The net worth or net asset value (NAV) of the particular business (ie the value of the assets it has, less the liabilities it owes). This is recorded in the top half of the balance sheet.
AND
The capital invested in the business to achieve that net worth. This is recorded in the bottom half of the balance sheet.
these two figures will always be the same
What are year-end adjustments?
transactions or modifications to the account entries on the trial balance.
what are the five year-end adjustments?
- Depreciation
- Accruals
- Prepayments
- Bad debts
- Doubtful debts
What is depreciation?
A mechanism used in the accounts to deal with a decline in value and to spread the cost of the asset over its useful life.
What are the 2 methods of depreciation
- the straight line method
- the reducing balance method
How is the straight-line method used?
- spreads the depreciation charge evenly over the life of the asset
- gives rise to the same charge for depreciation each year.
- the straight-line method is used where the service provided by the asset continues throughout its useful economic life on a consistent basis
How is the reducing balance method used?
- The depreciation charge each year is expressed as a percentage (x %) of the reducing balance (ie the net book value of the asset at the start of the relevant accounting period).
- More depreciation is thus charged in earlier years than in later years since the net book value of the asset reduces year on year.
When would the reducing balance method be used?
where an asset is likely to lose a large part of its value in the first few years of ownership eg motor vehicles.
What is the net book value and how is it calculated?
It is an estimate of the current value of the asset to the business
calculation:
NET BOOK VALUE =
COST – ACCUMULATED DEPRECIATION
What is an accrual?
Occurs when a business has had the benefit of something in one accounting period but will not pay for it until the next.
لم يكن موجود بالحساب وبعدين ينحط ورة سنة
What is a prepayment?
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.
It occurs 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.
What is a bad debt?
A debt is a ‘bad debt’ when a business knows with certainty that it is never going to receive it.
The debt is therefore removed from the ‘Receivables’ entry in the accounts as it will not be paid.
What is a doubtful debt? How does it differ from a bad debt?
A doubtful debt occurs when a business is providing for the possibility that a debt or debts may not be paid.
A doubtful debt differs from a bad debt in that the business is not writing off the debt completely. It is just making sure that the accounts accurately reflect the fact that the business may not receive all of the money owed to it.
What are the two ways of ‘being doubtful’ about debts?
Specific and general doubtful debts
SPECIFIC - A business may know that a particular debtor is in trouble financially or is disputing its liability to pay the debt.
GENERAL - A business may not have any information on a specific debtor but knows that the market generally is not doing well and wants to make a general provision for a certain percentage of its debtors not to pay
How can a business quantify its doubts and express them as an actual figure?
Show the figure as the ‘Provision for Doubtful Debts’
The amount allocated to the provision for doubtful debts account is set afresh at each year-end. It might increase, reduce or stay the same compared with the previous year’s provision.
How is the provision for Doubtful Debts treated on the Balance sheet?
as a liability, and is matched to the asset is most directly affects, the receivables asset account
How do partnerships correctly show their capital on the Balance Sheet?
Prepare a profit appropriation statement.
This records how the profits of the business for the relevant accounting period are divided between the partners.
In partnerships accounts, what are ‘Drawings’?
withdrawals of profit by the partners during the year, to pay themselves - based on the estimate of the partner’s share of expected profits for the year.
if they draw too much, they could be liable to contribute a balancing payment back to the partnership.
What are the 2 accounts for partners within a partnership?
CAPITAL account - for long-term capital.
Represents the partner’s original investment in the partnership. This cannot be withdrawn in normal circumstances.
CURRENT account - for capital that can be withdrawn at the partner’s discretion.
Records the partner’s share of the ongoing business profits.
What is a company’s accounting reference date (ARD)?
the last day of the month in which the anniversary of its incorporation falls
