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Document Sample
UNDERSTANDING
BUSINESS ACCOUNTS
WHAT DO THEY
REALLY MEAN?
PRESENTED BY
Brian Spence / Martin Berry
NIFA
Network of Independent Forensic Accountants
TOPICS COVERED
- Regulatory framework governing preparation
- What do accounts show?
- Contents of the accounts
- Limited Companies
- Unincorporated businesses
- The Directors’ Report
- The Balance Sheet
- The Profit and Loss Account
- Other relevant information disclosed in accounts
- Limited companies
- Unincorporated businesses
REGULATORY FRAMEWORK
(1) LIMITED COMPANIES AND LLPs
Governed by:-
• Requirements of Schedules 4 and 8 Companies Act 1985
• Financial Reporting Standards(FRS’s) and Statements of
Standard Accounting Practice (SSAP’s)
• Financial Reporting Standard for Smaller Entities(FRSSE)
- Turnover < £5.6 m
- Gross assets < £2.8 m
- No of employees < 50
Any 2 must be satisfied
• UITF abstracts
ACCOUNTS MUST SHOW A TRUE AND FAIR VIEW OF PROFITS
AND THE STATE OF THE COMPANY’S AFFAIRS
REGULATORY FRAMEWORK
(2) UNINCORPORATED BUSINESSES (i.e. sole traders and partnerships)
Expected to have regard to:-
• The FRSSE
• S42 FA 1998 (subject to any adjustment required or authorised
by law in computing profits for tax purposes).
• Inland Revenue Tax Bulletin 38
Inland Revenue’s view is that the FRSSE makes clear that
accounting standards are intended to apply to unincorporated
entities as well as limited companies.
ACCOUNTS SHOULD THEREFORE SHOW A TRUE AND FAIR
VIEW OF PROFITS
WHAT IS MEANT BY TRUE AND FAIR?
• Compliance with accounting
standards,detailed legal
requirements and other evidence
of generally accepted accounting
practice
• Financial statements contain
information sufficient in quantity
and quality to satisfy the reasonable
expectations of the readers to whom
they are addressed.
WHAT IS MEANT BY TRUE AND FAIR? (cont.)
• “True” means financial statements
record valid transactions and
• “Fair” means that they should
present information in an
unambiguous manner and must not
mislead the reader
STATEMENT OF PRINCIPLES OF
FINANCIAL REPORTING
• Sets out the principles that the ASB
believe should underlie the preparation
of financial statements giving a true and
fair view.
• Not an accounting standard.
• Provides a coherent frame of reference
for the development and review of
accounting standards.
STATEMENT OF PRINCIPLES OF
FINANCIAL REPORTING (cont….)
RELIABILITY - accounts are free from bias and material
error
COMPARABILITY - accounts prepared on a consistent basis
year on year in order to identify
trends in financial performance and
financial position
MATERIALITY - information is material to the accounts
if its misstatement or omission might
reasonably be expected to influence the
economic decisions of users
WHAT DO ACCOUNTS SHOW?
• As far as is practicable, the effects of
transactions and other events on the reporting
entity’s financial performance and financial
position.
• Contributions from and distributions to owners.
CONTENTS
LIMITED COMPANIES – accounts should always contain:-
• Directors’ Report
• Balance Sheet
• Profit & Loss Account
• Accounting Policies
• Notes to the accounts in accordance with disclosure
requirements of Companies Act 1985, FRSs and FRSSE
• Statement of Recognised Gains and Losses (SORGL)
where revaluations of assets are made, and the valuation is
incorporated into the accounts
CONTENTS (Cont…)
UNINCORPORATED BUSINESSES
Accounts will always contain:-
• Profit and Loss Account or an
Income and Expenditure Account
BUT
May not contain:-
• Statement of Accounting Policies
• Balance Sheet
• Notes to the accounts
ACCOUNTING POLICIES
Those principles, bases, conventions, rules and
practices applied by an entity that show how the
effects of transactions and other events are to be
reflected in its financial statements through
a) recognising,
b) selecting measurement bases for, and
c) presenting
assets, liabilities, gains, losses and changes to
shareholders’ funds. Accounting policies do not
include estimation techniques.
THE BALANCE SHEET
• It’s a snapshot of the assets and
liabilities of the business……..at
one moment in time – midnight on
the last day of the accounting
period.
• It is NOT a statement of assets at
their market values
• It records assets & liabilities at their
accounting (“book”) values
• It does show the ownership interest
LIMITED COMPANY
Balance Sheet
as at 28 February 2004
2004 2003
Notes £ £ £ £
Fixed Assets
Tangible assets 10 734,869 759,861
Investments 11 24,625 24,625
_______ _______
759,494 784,486
Current Assets
Stocks 12 211,143 157,332
Debtors 13 1,091,637 2,332,856
Cash at bank and in hand 2,978,250 2,185,710
_______ _______
4,281,030 4,675,898
Creditors: amounts falling
due within one year 14 (1,217,363) (589,035)
_______ _______
Net Current Assets 3,063,667 4,086,863
_______ _______
Total Assets Less Current Liabilities 3,823,161 4,871,349
Creditors falling due after one year -
Provisions for Liabilities and Charges 15 (25,440) (21,500)
_______ _______
Net Assets 3,797,721 4,849,849
_______ _______
Capital and Reserves
Called up share capital 17 10,000 10,000
Profit and loss account 3,787,721 4,839,849
_______ _______
Equity Shareholders' Funds 18 3,797,721 4,849,849
_______ _______
The financial statements were approved by the Board on 25 March 2003 and signed on its behalf by
PARTNERSHIP BALANCE SHEET AS AT 31 MARCH 2004
2004 2003
£ £ £ £
Fixed Assets
Tangible assets 50,251 52,865
Current Assets
Stocks 530 550
Debtors 216 -
Cash at bank and in hand 4,082 941
4,828 1,491
Current Liabilities
Other creditors 187 196
Accruals 3,530 1,731
3,717 1,927
Net Current Assets/(Liabilities) 1,111 (436)
Total Assets less Current Liabilities 51,362 52,429
Creditors
Amounts falling due after more than
one year (15,100) (20,500)
NET ASSETS £ 36,262 £ 31,929
Financed by:
Partners' capital account 25,000 25,000
Partners' current account 11,262 6,929
£ 36,262 £ 31,929
BALANCE SHEET
Net Assets = Amount invested and retained in the business
by the owners (= total assets less total
creditors)
Amount invested and retained in the business is:-
(Ownership interest)
For a Limited company - The share capital and retained post tax profits
For a Partnership / Sole Trader - The capital account(s)
BALANCE SHEET
Limited Company:
Retained Profits may be used for:-
(i) Distribution of future dividends
(ii) Company purchase of own shares
(iii) Issue of bonus shares
THESE ARE POST TAX PROFITS
BALANCE SHEET
Unincorporated Business
CAPITAL ACCOUNT = OWNERSHIP INTEREST
• Represents undrawn profits and monies introduced
• The balance may or may not be stated after provision for
income tax and C4 NIC on the profits for the year
(Note that tax on a company’s profits is always provided
for in the profit and loss account)
THEREFORE DOES THE CAPITAL ACCOUNT REPRESENT
THE TRUE WORTH OF THE INTEREST OF THE OWNER(S)?
BALANCE SHEET
Remember:-
Whether retained profits or balances on capital accounts can
be withdrawn will depend on:-
• the liquidity of the business
• the working capital requirements of the business
Debtors & cash at bank – creditors < 1 year is a measure
of liquidity
THE TERMINOLOGY
• Fixed assets are those assets that
are held for permanent use in the
business – buildings, plant and
machinery, fixtures, fittings,
vehicles
• There are also intangible fixed
assets such as goodwill, patent
rights, intellectual property
THE TERMINOLOGY
• Current assets are those assets that
result from the trading activities:
stocks of unsold goods, raw materials,
customers who owe us money and
balances held in cash and at the bank.
• Current liabilities are those liabilities
that will be settled within the 12 months
following the balance sheet date.
FIXED ASSETS
• Land & buildings, plant & machinery,
vehicles etc
• Usually recorded at cost of bringing the
asset into working condition
• Annual depreciation charge against
profits on cost less residual value over
economic life to apportion cost over
usage of the asset
• Review for impairment i.e a reduction in
the recoverable amount of a fixed asset
below its carrying value.
Tangible fixed assets
Plant and Fixtures, Motor Total
Factory machinery fittings vehicles
equipment
£ £ £ £ £
Cost
At 1 March 2003 525,546 444,967 110,169 360,646 1,441,328
Additions 1,261 845 8,094 20,814 31,014
Disposals - (1,764) (1,764)
_______ _______ _______ _______ _______
At 28 February 2004 526,807 445,812 116,499 381,460 1,470,578
_______ _______ _______ _______ _______
Depreciation
At 1 March 2003 - 358,016 85,339 238,112 681,467
On disposals - - (441) - (441)
Charge for the year - 13,053 7,094 34,536 54,683
_______ _______ _______ _______ _______
At 28 February 2004 - 371,069 91,992 272,648 735,709
_______ _______ _______ _______ _______
Net book values
at 28 February 2004 526,807 74,743 24,507 108,812 734,869
_______ _______ _______ _______ _______
At 28 February 2003 525,546 86,951 24,830 122,534 759,861
_______ _______ _______ _______ _______
CURRENT ASSETS
Realisable in less than a year, and include
– Stock and WIP
– Debtors
– Cash and bank
• Stock and WIP must be stated at the lower of cost and
net realisable value
• Debtors must be stated at recoverable amounts
CURRENT LIABILITIES
• Amounts falling due for payment within 12 months
of balance sheet date,(disclosed separately from amounts
due for payment after 12 months from balance sheet date).
- Trade creditors
- Bank overdraft
- Accruals
- VAT, PAYE
• Should not include “provisions” - defined by FRS12 as
liabilities of uncertain timing or amount.
These should be disclosed separately.
BALANCE SHEET
Provisions For Liabilities
FRS12 – A provision should be recognised if:
• Business has a present obligation (legal or constructive)
• The obligation results from a past event
• A transfer of economic benefits will be required to settle
the obligation
Unless all conditions are met, no provision must be recognised
Examples:-
Warranties
Refunds for returned goods
BALANCE SHEET
Contingent Assets
Not normally recognised because this could result in the
recognition of profit that may never be realised –
BUT
Recognise if:-
• A past event has occurred
• There is a possible asset whose existence will be
confirmed by the occurrence of one or more uncertain
events not wholly within the entity’s control and,
• The inflow of economic benefits is virtually certain.
e.g. a legal claim
THE PROFIT & LOSS ACCOUNT
• The P&L is the “history book” of all the
transactions in the accounting period.
– It accumulates all the sales, all the purchases and all the
expenses during the period
– It deducts the costs from the income to arrive at a profit or
loss
• But remember: the accounts are
usually signed off long after the
year end – up to 10 months earlier.
So they are history!
PROFIT –V- CASH FLOW
• The P&L records income when the business
becomes entitled to it, not when it receives it –
– Thus sales are recorded when the business
has performed its contractual obligations and
is entitled to the amount agreed
– The P&L, therefore, contains
• “settled transactions” eg those sales made to customers who
have paid up and
• “unsettled transactions” – sales made to customers who
haven’t paid yet and are debtors
• The P&L records expenditure as it is incurred,
not as it is paid – the “accruals concept”
PROFIT & LOSS ACCOUNT
Limited Companies
• Statutory P & L
• Also a detailed P & L for management and
the Inland Revenue
• Ensure you obtain the detailed version
EXAMPLE OF STATUTORY PROFIT AND LOSS ACCOUNT
2004 2003
£ £ £ £
Sales 3,684,968 3,298,955
Cost of sales (2,066,665) (2,035,959)
_______ _______
Gross profit 44% 1,618,303 38% 1,262,996
Distribution costs 97,123 85,285
Administrative expenses 1,122,402 1,083,853
_______ _______
(1,219,525) (1,169,138)
_______ _______
Operating profit 398,778 93,858
Interest receivable 110,807 187,382
_______ _______
Profit on ordinary activities before taxation 509,585 281,240
Taxation (161,713) (82,675)
_______ _______
Retained Profit 347,872 198,565
_______ _______
THE TERMINOLOGY
•Turnover is the amount of sales,
excluding VAT
•Cost of sales represents the cost price to
the business of the items sold
- Opening stock plus purchases less closing
stock
GROSS PROFIT = Turnover – cost of
sales
•Overheads are the expenses incurred as a
result of trading – rent, rates, advertising,
legal fees and accountancy
EXAMPLE OF DETAILED TRADING AND PROFIT AND LOSS ACCOUNT
2004 2003
£ £
Sales 3,684,968 3,298,955
Cost of Sales (2,066,665) (2,035,959)
Opening stock 157,332 188,376
Purchases 1,361,618 1,289,333
Wages and salaries 696,213 656,911
Employer's NI contributions 62,645 58,671
2,277,808 2,193,291
Closing Stock (94,202) (92,483)
Closing Work in progress (116,941) (64,849)
_______ _______
Gross Profit 1,618,303 1,262,996
Distribution costs
Wages and salaries 25,958 24,960
Carriage outwards 18,060 12,994
Motor running expenses 53,105 47,331
_______ _______
(97,123) (85,285)
Administrative expenses
Wages and Salaries (including employers NI) 555,824 506,692
Directors' remuneration 45,333 43,000
Staff pension costs 37,735 36,313
Rent 41,870 47,959
Rates 83,489 43,784
Insurance 35,084 37,597
Light and heat 24,502 28,300
Repairs and maintenance 6,805 7,542
Printing,stationery, telephone and postage 45,926 38,703
Motor expenses 104,919 101,424
Legal and professional 43,322 86,464
Audit 14,850 8,500
Bank charges and interest 20,878 3,184
Profit/loss on exchange (36,620) -2,668
General expenses 28,219 31,243
Charitable donations - other 736 350
Depreciation and profit/loss on disposal of tangible assets 50,910 65,509
_______ _______
(1,122,402) (1,083,853)
_______ _______
Operating Profit 398,778 93,858
Interest receivable 110,807 187,382
_______ _______
Net Profit 509,585 281,240
_______ _______
PROFIT AND LOSS ACCOUNT
Accounting Policies And Bases
Must be applied consistently to facilitate comparison of profit
from one period to the next, for example:-
• Income recognition and matching costs
• Capitalisation policy (fixed assets or repairs)
• Stock write downs
• Provisions for bad debts
• Depreciation and asset lives
• Research and development
to name but a few
GROSS PROFIT
Should be determined by only including in cost of sales:-
• manufacturing wages
• materials used in production (and not privately!)
• depreciation of assets directly used in production
• other “direct” overheads/expenses
Other wages and overheads should be classified as administrative
overheads or distribution costs
BUT – Accounts may incorrectly include all wages under
administrative expenses
THE GROSS PROFIT PERCENTAGE SHOULD BE REASONABLY
CONSTANT
GROSS PROFIT
Gross Profit
A proper comparison of Gross Profit
percentage over a period of time is
essential for valuing a business
Significant variations can be indicative
of major changes taking place in the
business
PROFIT AND LOSS ACCOUNT
Administrative Expenses
Must be accounted for year on year on a consistent
basis
Comparability may be affected by:-
- Accelerating costs (including items of capital within
repairs and renewals in the P/L account or
accelerating depreciation)
- Over-accruing for costs( e.g. audit,legal)
- Including private expenditure
(entertaining,travel,legal)
- Bad debt provisions
- Exceptional items of expenditure
OTHER RELEVANT INFORMATION
DISCLOSED IN ACCOUNTS
OTHER RELEVANT INFORMATION DISCLOSED
ACCOUNTS OF UNINCORPORATED BUSINESSES
Information normally disclosed in addition to that included in the
detailed profit and loss account and balance sheet:
• Detailed analysis of owners / partners’ capital accounts
comprising:-
- Share of profit
- Interest on capital (if any)
- Capital introduced
- Drawings
- Private proportions of expenses paid by the business
and debited to drawings
- Income tax and C4 NIC paid/payable
• Analysis of debtors,creditors and fixed assets.
OTHER RELEVANT INFORMATION DISCLOSED
ACCOUNTS OF UNINCORPORATED BUSINESSES (Cont)
In practice you may not get details of :-
- Separate capital accounts
- Profit shares
- Capital introduced (netted off against drawings)
- Tax paid / payable (included in drawings)
- Private proportions (included in drawings)
This would apply particularly to husband and wife partnerships
especially if the wife is only a partner for tax purposes.
OTHER RELEVANT INFORMATION DISCLOSED
ACCOUNTS OF LIMITED COMPANIES
Additional information not normally found in the accounts
of unincorporated businesses:-
• Related Parties
- The names of the related parties
- Description of their relationship
- A description of the transactions
- The amounts involved
- Amounts owing between the parties at the
balance sheet date
- Amounts written off in the period in respect
of debts due to or from related parties
OTHER RELEVANT INFORMATION DISCLOSED
ACCOUNTS OF LIMITED COMPANIES (cont)
• Details of exceptional items
• Taxation charge and deferred tax
• Revaluation gains and losses
• Number of directors to whom retirement benefits are accruing
• Pension commitments
• Market value of investments
• Post balance sheet events
• Capital commitments
• Contingent liabilities
• Details of provisions
• Details of security and personal guarantees
• Ultimate controlling party
