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LIMELEGAL AA Network of independent Forensic Accountants

VIEWS: 5 PAGES: 43

									   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

								
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