5. Accouting Principles And Procedures

Question 1

What are financial statements?

Answer 1

Formal records of a company’s financial position, performance and cashflow that can be used as an analytical tool.

Question 2

Why does a business keep company accounts?

Answer 2

• Record and measure a companies profitability
• Tax calculation
• Legislation requires
• Informs the business plan

Question 3

What are the 3 types of financial statement?

Answer 3

• Balance Sheet (Position): Asset and Liabilities at a given date.
• Profit & loss/ Income Statement (Performance): Income and expenditure of a company and the resulting profit and loss on annual basis. Includes non-cash items.
• Cashflow Statement (Actual cash): A summary of actual or anticipated inflows or outflows of cash in a firm over the accounting period. Broken down into operating, investing and financing activities. Excludes non-cash items.

Question 4

What is the purpose of a balance sheet?

Answer 4

Shows net worth i.e. the value of everything the company owns, owes and is owed at a given date.

Question 5

Purpose of profit and loss (income) statement?

Answer 5

• Measure company performance/ profitability against market, budget, previous years
• Calculate tax

Question 6

What does a cashflow statement measure?

Answer 6

Measurs liquidity. The short term ability of a company to pay off its debts.

Question 7

What is the difference between a current asset and fixed asset?

Answer 7

Current assets can be converted into cash within one financial year (money owed to company following sales, inventory, cash or cash equivalents).

Non-current assets are all assets expected to provide economic benefits beyond one year, which includes:
1. Fixed assets
2. Intangible assets (e.g., patents, goodwill)
3. Long-term investments

Fixed assets - Fixed assets are tangible items like property, plant, and equipment (PPE) that a company uses in operations and does not intend to sell within 12 months.

Question 8

What are examples of non-cash items?

Answer 8

Accounting entries that represent economic activity or changes in value without exchange of money.

• Depreciation: Spreading the cost of an asset over its useful life (e.g., buildings, equipment).
• Amortisation: Like depreciation but for intangible assets (e.g., patents, goodwill).
• Impairment: Reducing the value of an asset when its market value drops below book value.
• Provisions: Estimated future expenses or liabilities that don’t involve immediate cash outflow
• Stock/Inventory adjustments: Changes in inventory value that don’t involve cash until sale.

Question 9

What is the difference between debtors and creditors?

Answer 9

Creditors - An individual or entity that is owed money (lender). (remember CREDF)

Debtors - An invdiual or entity that owes money (borrowe)

Question 10

Why do chartered surveyors needs to understand company accounts?

Answer 10

• View their own firms accounts.
• Consider tenant covenant strength.
• Consider contractor financial strength.
• Consider borrower financial strength.

Question 11

What is the difference between statutory and management accounts?

Answer 11

Audited / Statutory accounts:
* Prepared by a chartered or certified accountant.
* Legally required and prepared in accordance with accounting standards (e.g. UK GAAP, IFRS).

Management Accounts:
* Prepared for internal use by a business and are not audited or legally required.

i.e. Quarterly reporting – management accounts

Question 12

Other than the three financial statements went else is included in statutory accounts?

Answer 12

• Chairman’s Statement: chairman of board to shareholders, inc. activities, company’s future.
• Auditor’s report: opinion on financial performance and compliance to GAAP or IFRS.
• Corporate governance report: standards, policies, structures.

Question 13

What is IFRS?

Answer 13

International Financial Reporting Standards — a global accounting framework used in the UK and most of Europe

Typically used by REITS, listed corporations and Funds.

Question 14

What is IFRS 13?

Answer 14

IFRS 13 - Fair Value Measurement
* This standard tells companies how to measure the fair value of assets and liabilities.
* Fair value means the price you would get if you sold an asset or paid if you transferred a liability in a normal, open market transaction on the measurement date.

(on balance sheet - assets and liabilities or income statement – capital losses and gains)

Question 15

What is IFRS 16?

Answer 15

IFRS 16 – Lease Accounting
* This standard requires companies to put almost all leases on the balance sheet.
* If a company rents property or equipment, it has to show the full cost and liability of those leases in its accounts.
* The obligation to pay rent is recorded as a liability (a debt the company owes).
* Short leases (12 months or less) can be exempt and don’t have to be capitalised.

Question 16

What is UK GAAP?

Answer 16

Generally Accepted Accounting Principles – used by UK companies

Typically used by private companies.

Question 17

What do you understand about Generally Accepted Accounting Principles (GAAP) vs International Financial Reporting Standards (IFRS)?

Answer 17

GAAP (Generally Accepted Accounting Principles) is the accounting framework used primarily in the United States, while IFRS (International Financial Reporting Standards) is used internationally, including in the UK.

Key differences:
* Rules vs Principles: GAAP is more rules-based, while IFRS is principles-based, allowing more interpretation.
* Valuation: IFRS often allows for revaluation of assets to their fair market value, established through valuation reports; whereas under GAAP assets are recorded at original cost, minus depreciation.
* Inventory: GAAP permits LIFO (Last-In, First-Out) of stock; IFRS does not.
* Development costs: IFRS allows capitalisation under certain conditions; GAAP usually expenses them.

Question 18

What is the role of the auditor?

Answer 18

• Review a company’s financial data and check them against GAAP or IFRS reporting frameworks.
• Findings allow auditor to form objective opinion of the financial status.
• Allows transparency (better for investors) and compliance.

Question 19

What are the different opinions of the auditor?

Answer 19

• Clean: no issues and compliant.
• Qualified: Fairly presented except for a specific issue that is not material.
• Disclaimer: inability to obtain sufficient evidence.
• Adverse: not compliant with GAAP, highlights potential fraud.

Question 20

Difference between an asset and a liability?

Answer 20

Asset: Something the company owns or controls that has value (cash, property, equipment, investments)
Liability: Something the company owes to others
(Loans, rent)

Question 21

What is the difference between capitalising and expensing?

Answer 21

Capitalising = Recognising an asset on the balance sheet but recording the cost of it on the P&L/ income statement spread out over time.

Expensing = recording the cost of an asset on the P&L/ Income statement immediately.

Question 22

How is rent owed recorded?

Answer 22

Rent owed by tenants is an accounts receivable asset on your balance sheet until it’s paid.

Question 23

What is Sales?

Answer 23

The total revenue generated from selling goods or services before any costs are deducted.

Question 24

What is Cost of Sales?

Answer 24

The direct costs of producing the goods or services sold (e.g. materials, labour)

Question 25

What is Gross Profit?

Answer 25

Sales minus Cost of Sales. A companies profit before subtracting operating expenses, interests and taxes.

Question 26

What is OPEX

Answer 26

Operating expenditure - Ongoing costs to run the business (e.g. rent, salaries, maintenance) — doesn’t include capital spending.

Question 27

What is Operating Profit?

Answer 27

Operating Profit = Gross Profit – Operating Expenses (OPEX)

Question 28

What is Net Profit?

Answer 28

Net Profit = Operating Profit – Interest – Taxes

Question 29

What is the difference between Gross Profit, Operating Profit, and Net Profit?

Answer 29

Gross Profit shows profit after direct costs. Operating Profit includes overheads but excludes interest and tax. Net Profit is the final bottom-line profit after all expenses, interest, and taxes.

Question 30

What are overheads?

Answer 30

The operating cost of the business that are incurred on an ongoing basis. Can be both fixed (rent, building insurance) or variable (utility charges).

Question 31

What is SG&A (Selling, General & Administrative Expenses)?

Answer 31

A category of OPEX — includes marketing, sales staff, office rent, and admin costs.

Question 32

What is the difference between Cost of sales, Opex and SG&A?

Answer 32

Cost of Sales are the direct costs to produce goods or services sold. OPEX are all operating expenses, including SG&A, which covers indirect costs like admin, marketing, and office overheads.

Question 33

What is SG&A split out under Opex costs?

Answer 33

Splitting SG&A from OPEX helps businesses clearly identify and control overhead costs (regular costs) separately from other operating expenses.

Question 34

Name four different types of accounting ratios?

Answer 34

1. Liquidity ratios - A companies ability to pay their SHORT TERM debt obligations. Example: Current Ratio 2. Solvency ratios - Assess a company’s ability to meet LONG TERM debt obligations and remain financially stable. Examples: Debt-to-Asset Ratio, Interest Coverage Ratio 3. Profitability ratios - Assess an organisation’s ability to generate profits from its sales operations and shareholding equity. Examples: Net Profit Margin, Return on Equity (ROE), Return on Assets (ROA) 4. Gearing ratios - Measure the proportion of a company’s capital financed by debt versus equity (financial leverage). Examples: Debt-to-Equity Ratio, Equity ratio

Question 35

What is Current Ratio?

Answer 35

Current Ratio = Current Assets/Current Liabilities It shows whether a company has enough assets that can be quickly converted to cash to cover its short-term liabilities; a ratio above 1 generally indicates good short-term financial health.

Question 36

Quick Ratio (Acid Test)?

Answer 36

Quick Ratio= Current Assets−Inventory​ / Current Liabilities It tests liquidity strength by showing whether a company can pay its current obligations using only its most liquid assets: - Cash - Cash equivalents - Receivables Inventory is excluded because it may take time to sell and convert into cash. ≥ 1: The company can cover its short-term liabilities without selling inventory. < 1: The company may struggle to pay obligations quickly without liquidating stock.

Question 37

Operating Profit Margin?

Answer 37

The Operating Profit Margin tests how efficiently a company’s core operations generate profit before considering financing costs and taxes. Operating Profit Margin = Operating Profit (EBIT)​ / Revenue ×100

Question 38

What is your understanding of Tax Depreciation?

Answer 38

* Where the declining value of an asset is offset against a companies taxable profit. * The depreciation in value can be recorded as an expense in order to reduce the amount of taxable income. * Can be applied on plant, tools, vehicles, computers, furniture, buildings....

Question 39

What are capital allowances?

Answer 39

Capital allowances allow/ companies to gain tax relief on capital expenditure (acquisition + subsequent works), allowing them to deduct the cost of from their taxable profits. Applies to plant and machinery, structures and buildings etc.

Question 40

What are key signs of insolvency in company accounts/ credit checks?

Answer 40

* Low credit rating. * Current ratio below 0.75 * Falling working capital indicates potential over trading: growing too fast without sufficient cash. Working Capital = Current Assets − Current Liabilities

Question 41

How would you assess the financial strength of an entity, e.g. for a valuation?

Answer 41

* Seek advice from an expert. * Review Statutory Accounts, e.g. Net Asset Value, Net Profit, Liquidity Ratios, Solvency Ratios. * Review Credit Rating Agencies, e.g. Fitch, Experian.

Question 42

What is an Escrow account?

Answer 42

A separate bank account that is controlled by a a third party intermediary. Used as financial instruments in transactions. Money released once both parties have met their contractual obligations.

Question 43

Tell me about the CPD you completed on Financial Modelling and Accounting in Nov 2023?

Answer 43

I learnt the difference between a balance sheet, income statement, and cash flow statement.

Question 44

Why is a lease an Asset under IFRS?

Answer 44

Because you control the "Right-of-Use", even if you don't own it legally.

Question 45

Why is a lease an asset and a liability on the balance sheet?

Answer 45

Debt Ratios: Banks and investors want to see the Liability. If you owe £1 million in rent over 10 years, that is a massive debt they need to know about before lending you more money. Asset Intensity: It shows how many "tools" (assets) you actually need to run your business, even if you don't own them outright.