Accounts and Regulation

Question 1

What are business accounts used for?

Answer 1

Business owners use all the business’ financial records (statements, invoices and receipts) to prepare the business’ accounts

• They provide a summary of the business’ financial position

Two common meanings of accounts

• Day-to-day records of business transactions
• Accounting year end summary (Final Accounts)

Question 2

Who will look at a business’ accounts?

Answer 2

Bankers when deciding to lend

Solicitors if their client is buying the business

HMRC to assess tax

Companies House usually requires company accounts every year

Question 3

What role do accountants play in preparing accounts?

Answer 3

Most businesses will have a firm of accountants to help them prepare the financial records they need to keep, to advise on taxation and to produce accounts

Question 4

What tax records will a business need to keep?

Answer 4

Businesses must keep PAYE and NI records + VAT records

Question 5

How do accounting standards play a role in preparing accounts?

Answer 5

The Financial Reporting Standards ensure uniformity for business accounts

• Might face disciplinary action by the governing body of the professional in question if not followed

Question 6

What information do accounts provide?

Answer 6

They show four categories of information:

1) Income – what the business earns from trading or its services

2) Expenses – items the business has paid for which it needs to incur for the business to operate

• Utilities and stock

3) Assets – what the business owns or has a right to own; they will provide a longer-term benefit to a business

• Machinery, cash, debtors (right to money owed to them)

4) Liabilities – what the business owes (debts)

Question 7

What is double-entry bookkeeping?

Answer 7

Every financial transaction is recorded and there are 2 aspects to each

• The left-hand column in the account is the debit column (DR)
• The right-hand column in the account is the credit column (CR)

Bookkeepers will check the books at the end of its accounting period

• Adding the DR and CR balances on the accounts should result in the same figure if there are no errors
• This process of adding together all DR + CR entries is called preparing the trial balance

Preparing a trial balance is the first step in preparing the business’ final accounts

Question 8

What is the purpose of final accounts?

Answer 8

Final accounts comprise the profit and loss account + balance sheet and show how the business is performing financially

• Profit and loss account – shows how profitable the business is
• Balance sheet – shows what the business is worth, considering assets and liabilities

The P+L account and balance sheet information comes from the trial balance, but the final accounts are easier to understand

Question 9

Give details of the profit + loss account

Answer 9

How profitable a business is, is determined by a calculation

• Income minus expenses = profit

Workings are shown on the left-hand column, and the main figures are shown on the right-hand column

A bracketed figure (£20,000) is used to show a figure to be deducted

Two ways to increase profits:

• Reduce expenses
• Increase income

Question 10

What are ‘trading accounts?’

Answer 10

Businesses which buy and sell goods will also have a trading account

• Income from sales minus cost of sales (cost of stock) = gross profit

Gross profit then moved over to P+L account

Question 11

Give details of the balance sheet

Answer 11

Value of business is determined by a calculation

• Assets minus liabilities = Net worth of the business

Top half of balance sheet shows where the money is now (employment of capital)

Bottom half of balance sheet shows where the money came from (capital employed)

Opening balance is the initial capital contribution by the business owner, so the business could start operating

Net profit is the money the business has made since it started trading

Drawings = money the business owner has taken out of the business since it started trading

Question 12

Give an overview of ‘assets’ within the balance sheet

Answer 12

Split into fixed and current assets

• Fixed assets – used in the business to enable it to run effectively (business premises and machinery)
• Current assets – short term assets (stock, debts and cash)

Fixed assets appear above current assets, as the most liquid assets are at the bottom

‘Net current assets’ = current assets minus current liabilities

• Shows the business’ liquidity

‘Net assets’ = (fixed and current assets) minus (short + long term liabilities)

• Always equal to amount owing to business owner as capital at the end of the year

Question 13

Give an overview of ‘liabilities’ within the balance sheet

Answer 13

Split into current and long-term liabilities

• Current liabilities – repayable in 12 months or less (bank overdraft, invoice owed to supplier)
• Long-term liabilities – repayable more than 12 months from date of balance sheet (bank loan)

‘Capital employed’ shows the balance of the capital account + net profit from P+L account – shows value of the business to the owner

Question 14

What are ‘adjustments’ and when are they necessary?

Answer 14

Final accounts are prepared using the accruals basis

• This means income and expenses are recorded in the period to which they relate, instead of when payment or receipt occurs

Final accounts must include all expenses relating to that accounting period, even if a bill hasn’t been received yet

There will be some adjustments made to the trial balance to ensure the final accounts are on the accruals basis

Question 15

How will outstanding expenses be recorded in the accounts?

Answer 15

Unpaid bills will also need to be included in the final accounts

• In the P+L account as an expense
• In the balance sheet as an additional current liability under accruals

Question 16

How will prepayments be recorded in the accounts?

Answer 16

Payments in advance are added to the balance sheet as current assets, labelled ‘Prepayments’

Prepayments also reduce the value of the prepaid item in the expenses section of the P+L account

Question 17

How is work in progress recorded in the accounts?

Answer 17

Work carried out by solicitors for which they have not issued a bill is called work in progress

Appears as additional income in the P+L account and an additional current asset on the balance sheet

Question 18

How is closing stock recorded in the accounts?

Answer 18

Stock remaining at the end of an accounting period is closing stock

Additional current asset in the balance sheet

Question 19

How are bad and doubtful debts recorded in the accounts?

Answer 19

When a debt is written off (bad debt), the debt will be deducted from the debtors figure on the balance sheet

Doubtful debtors, where they may not pay, are entered in the expenses section of the P+L account as ‘provision for doubtful debts’ + are subtracted from the debtors figure on the balance sheet

Question 20

How are depreciation and revaluation of assets recorded in the accounts?

Answer 20

When assets lose value, this is shown in the P+L account as an expense item which reduces net profit

Assets that don’t tend to depreciate appear in the accounts at their acquisition value, but they might need to be revalued and then this figure is added instead

Question 21

How is the disposal of assets recorded in the accounts?

Answer 21

If a business sells an asset for more than the figure in the assets, a profit is added into the P+L account

If sold for less, there is a reduction of net profit in the P+L account

Question 22

What factors are important to consider, to understand the wider context of accounts?

Answer 22

Check the date of the balance sheet – is it up to date?

Look at previous year’s accounts – shows growth or decline

Check how valuations have been carried out and how recently

• Freehold increases in value; machinery might decrease + check how closing stock is valued

Analyse the debtors figure – assets if they pay, but sometimes they don’t

Is there a bank overdraft? - large overdraft might not be an issue, as banks will only ask for repayment if the business is in financial difficulties

Look for exceptional items, which may distort that year’s accounts

Question 23

What general considerations are visible from final accounts?

Answer 23

Main reasons for reading a business’ accounts are to ascertain whether the business is profitable and whether it can pay its debts

Profitability – P+L account may show a profit, but it may be owed by debtors who haven’t paid, so it would be unable to pay its debts

Ability to pay debts – this hinges on the number of current assets, as they are more liquid

• Cash is the most liquid asset and debts are reasonably liquid

Question 24

What records will a partnership need to keep for each partner (in overview)?

Answer 24

Partnerships will need to keep separate records for each partner to show:

• How much capital they contributed – capital account
• How much profit is owed to them
• How much they have withdrawn that year

Question 25

How are profits shared in a partnership and how does an appropriation account relate to this?

Answer 25

Share of profits * Partners share profits and losses in accordance with the partnership agreement, or, if there isn’t one, in equal shares * Partners may also get a salary, which is profit awarded before the remaining profits are divided as they decided The appropriation account * Partnership and LLP P+L accounts are prepared in the same way as for sole traders * There is also an appropriation account showing how net profit is divided between the partners, which also notes if the partners get any interest on capital or salaries

Question 26

Why is a current account needed for partnership accounts?

Answer 26

For partnerships, it is usual to have a separate current account for each partner, where their appropriation of net profit is added and drawings are deducted This separates the capital account, so the original capital contribution of each partner is easily identifiable and unaffected by profits and drawings

Question 27

How does the balance sheet differ for partnership accounts?

Answer 27

The capital and current account balances of each partner are shown separately on the balance sheet in the capital employed section Usually just the balance of each shown and an appendix shows the details

Question 28

How are changes in partners and taxation of partners dealt with in partnership accounts?

Answer 28

1) Changes in partners (a) If a partner leaves or joins part-way through an accounting period, the net profit for that year is apportioned between the period before and the period after the change (b) Two appropriation accounts prepared * 1st – shows allocation of profit earned before the change in membership * 2nd – shows allocation of profit earned after the change in membership 2) Taxation of partnerships * Partners submit their own tax returns, claiming their own personal allowances

Question 29

How does the issuing of shares change how company accounts look?

Answer 29

1) Company accounts are prepared on the same basis as sole trader’s or partnership’s accounts and they show the same information, but they will look slightly different * Separate legal entity and more closely regulated 2) Issuing shares The **payment of money into the company in return for shares** is recorded in a **share capital account** * Records all shareholders’ contributions in one place The section of the balance sheet which shows **how much the shareholders have contributed** is often headed ‘**capital and reserves**’ Any premium a shareholder pays on shares will be shown in the share premium account Different types of shares are shown on the balance sheet, under the capital and reserves section

Question 30

How does the principle of maintenance of capital work in this context?

Answer 30

Company's capital must be maintained, but they can buy back their own shares, meaning the shares are cancelled Transfers of shares to 3rd parties are not shown in the final accounts

Question 31

How does a company's profit and loss account differ from other business mediums?

Answer 31

Generally, the same as for sole traders When the company pays the directors a salary, this is a company expense and appears as such on the P+L account In a partnership, a salary just means they get some of the profits before they are formally divided between the partners

Question 32

How is appropriation of profit reflected in company accounts?

Answer 32

Company’s net profit is mainly used for taxation, dividends and retention of profits 1) Taxation Companies have their own liability to corporation tax, which is shown in the accounts * They don’t have to pay CT until 9 months after the end of the accounting period, so the P+L account will have a ‘net profit before tax’ and ‘post-tax profit’ figure * Tax due to HMRC will appear on balance sheet as a current liability 2) Dividends * Companies are only permitted to pay dividends from profits (which can include previous years’ accumulated profits) * Once paid, the cash figure will be reduced on the balance sheet, but they aren’t included as an item on the P+L account 3) Retained profit * This is the balance of net profit, after tax and dividends and does not form part of the capital of the company, meaning it could later be distributed as dividends

Question 33

What does the 'capital and reserves' of a company's balance sheet cover?

Answer 33

The ‘capital’ part of ‘Capital and Reserves’ section of the balance sheet will show the company’s different shares and their values The ‘reserves’ part of ‘Capital and Reserves’ section of the balance sheet shows what money would be paid to shareholders if the company was wound up * Capital reserves cannot be distributed to shareholders as they form part of the long-term capital of the company (share premium account is an example) * Revenue reserves can be distributed to shareholders (via dividends for example) - Main revenue reserve is the profit and loss reserve

Question 34

What are 'consolidated accounts?'

Answer 34

Parent companies must produce a consolidate P+L account and balance sheet of the group’s profits, losses, assets and liabilities, in addition to each individual company in the group preparing their own final accounts

Question 35

How does statutory regulation affect company accounts?

Answer 35

Regulation ensures accounts are prepared in a uniform way and comparisons can be made between businesses The CA 2006 requires companies to keep ‘adequate accounting records’ and prepare accounts every financial year * Directors cannot approve them unless they are satisfied, they give a true and fair view of the financial position of the company Companies must file their annual accounts with the Registrar of Companies and send a copy for each financial year to shareholders and debenture holders Must have their accounts audited too

Question 36

What are the aims of accounting principles and how do the UK and international formats differ?

Answer 36

Financial Reporting Standard also aims at achieving consistency in accounts; by specifying certain methods of calculation and what detail must appear on P+L account and balance sheet (FRS 102 statement of best practice) * There are also International Financial Reporting Standards (IFRS) 1) UK format * CA 2006 requires companies to comply with either the UK or international accounting standards - Both require previous year’s accounts to shown alongside the current financial years * A company P+L account does not itemise every expense, but groups them into categories to make it easier to read * On a company balance sheet, current and long-term liabilities are categorised as amounts falling due within 1 year and more than 1 year 2) International format * Very similar to UK format; main difference is in terminology on the balance sheet

Question 37

What additional documents/information are companys required to present with their accounts, in accordance with the CA 2006 or the accounting standards?

Answer 37

CA 2006 and UK/International standards require additional reports and financial statements, in addition to the balance sheet and P+L account 1) Strategic Report – review of company’s business, required by CA 2006; small companies exempt 2) Chair's Report – explains what has happened to the company over the financial year; not a strict requirement 3) Directors’ Report – factual information about the company and a review of company’s business + confirms auditors were given all relevant information * Requirements for report set out in s416 CA and failing to comply is a criminal offence * Small companies don’t need to include some information 4) Auditors’ Report – auditors state whether the accounts give a true and fair view of the financial state of the business 5) Notes – accounts accompanied by explanatory notes