Principles of Accounting

Limitations of Ratio Analysis

(1) Always hinge on historic data, so inherently fallible for future predictions. (2) Distorted by macroeconomic conditions, especially in periods of high inflation. Economic malaise is particularly likely to affect creditors and debtors collection periods. (3) Different accounting policy choices in different companies will limit the accuracy of any comparison. (4) Certain operational differences will make it difficult to compare like with like; e.g., one company might rent its premises (and so have greater expenses, reducing profits), whereas another might own its premises (and so have more fixed assets, reducing efficiency ratios).

Four Principal Categories of Accounting Ratios

(1) Profitability; assessing the link between profit and sales and measuring profit against capital employed. (2) Efficiency (or 'asset utilisation'); efficient use of assets within a business to generate income. (3) Short-term liquidity; measuring how quickly a company can generate cash in order to settle debts as they fall due. (4) Financing / investing ratios; examining how the business finances its operations (particularly interesting to current & prospective shareholders and creditors).

Interpreting the Cash Flow Statement

(1) The cash flow figure should be positive (i.e., a net inflow), and should be higher than the profit after tax figure in the company's P&L account. Otherwise, the company is failing to convert income into cash. (2) A company should be able to fund its dividend payments from its net cash inflow from operating activities; otherwise, the level of dividend payment is not sustainable. (3) Large increases in stock, debtors, or creditors in the balance sheet — especially if the company's profit is decreasing — can be concerning. These will put a strain on the company's liquidity. (4) Fixed asset acquisitions should be financed out of increase in share capital or loan finance. If there is an increase in share capital or loan finance without the acquisition of fixed assets, we have cause for concern over liquidity.

FRS 102: Qualitative Characteristics

(1) Understandability; (2) Relevance; (3) Materiality; (4) Reliability; (5) Substance over form; (6) Prudence; (7) Completeness; (8) Comparability; (9) Timeliness; (10) Cost-benefit balance.

Stock Turnover Ratio

(Average Stock / Cost of Sales) x 365 days = Stock turnover (days). Shows how long on average stock is held before being sold. (Average stock = (opening stock + closing stock)/2; or, if figures unavailable, simply closing stock). An increase in the stock turnover ratio is highly concerning.

Quick (or 'Acid Test') Ratio

(Current Assets - Stock) / Current Liabilities = Quick Ratio. Shows if a business can meet its short term liabilities with its current assets excluding stock (which is the least liquid asset and can take time to convert into cash). A ratio around 1:1 is regarded as ideal.

Capital Gearing Ratio

(Long Term Liabilities ÷ (Long Term Liabilities + Shareholders' Funds)) x 100% = Capital Gearing Ratio. 'Long-term liabilities' = bank loans, company debentures, and loan stock showing on the balance sheet as creditors due after 1yr. The level of gearing regarded as healthy varies, but a gearing ratio above 50% is regarded as a risky investment.

Return on Capital Employed

(Operating Profit / Capital Employed) x 100%. The 'primary ratio'; shows how much operating profit is generated as a % of capital used to generate those profits. If the ROCE goes down, it is caused either by reduced profitability or reduced efficiency in use of assets. Consult the operating profit margin and the asset turnover to discover which. (But nb. if fixed assets are bought near the end of the year, there may not be time for them to be put to efficient use). Related to other ratios: ROCE = Operating Profit Margin x Asset Turnover. Manufacturing businesses will have a much lower ROCE than service businesses.

Operating Profit Margin

(Operating Profit / Sales) x 100%. This shows the operating profit (before interest & tax) as a percentage of sales income.

Gross Profit Margin

(Sales - Cost of Sales [ie, Gross Profit]) ÷ Sales = GPM. Sales = 100%; GPM = x%; CoS = 100%-x%.

Mark-Up

(Sales - Cost of Sales) ÷ Cost of Sales = Mark-Up. Cost of Sales = 100%; Mark-Up = x%; Sales = 100% + x%.

Debtors Collection Period

(Trade Debtors / Credit Sales) x 365 days = Debtors collection period. Shows how long debtors take on average to pay; the norm for UK credit control is 30 days. (If credit sales is not available, plain old sales should be used instead(.

Creditors Payment Period

(Trade Creditors / Credit Purchases) x 365 days = Creditors payment period. Shows how long the business takes on average to pay its trade creditors. Ideally, a balance is struck between promptness and making full use of the credit period. (Credit purchases to be used in preference to purchases if possible; cost of sales also acceptable).

Bonus Issue of Shares: Double Entries

A bonus issue is an issue of shares to existing shareholders without any money due in return. Dr P&L Reserve; Cr Share Capital (with nominal value of shares issued).

Input VAT

A business may incur VAT as part of the cost of its purchases; since it can usually be reclaimed from HMRC, it is not normally an expense. The accounting entry is: Dr Expenses or Purchases (w/ VAT exclusive amount); Dr VAT control (w/ VAT amount); Cr Bank or Debtors (w/ VAT inclusive amount).

FRS 102: Provisions

A provision is a liability of uncertain timing or amount. A provision should be recognised (through the placement of a liability onto the BS and an expense onto the P&L) when: (1) An entity has an obligation at the reporting date as a result of a past event; (2) It is probable (i.e., more likely than not) that a transfer of economic benefits is required to settle the obligation; and (3) A reliable estimate can be made of the amount of the obligation. Example: commitment to make repairs to property damaged in the course of work.

Straight Line Method of Depreciation

Annual Charge = (Cost - Residual Value) / Useful Life. This results in an equal depreciation charge against each year of the asset's useful life. Accordingly, it's appropriate where the asset is likely to yield even and consistent use throughout its lifetime.

Reducing Balance Method of Depreciation

Annual Depreciation = (Cost - Accumulated Depreciation to Date) x Depreciation Percentage. This is appropriate for assets that are likely to depreciate more quickly towards the beginning of their lives; since the depreciation charge functions as the application of a percentage to an accumulated total, the amount of the depreciation will decrease each year.

Bad Debts

Arises when a debtor is known to be unable or unwilling to pay the invoice. The debt must be removed from the books; this is an expense charged to P&L. The relevant double-entry is: Dr Bad debts expense; Cr Debtors. (If the cash then ends up being received, the double entry is Dr Bank; Cr Bad debts expense). The bad debts expense is closed off: Dr P&L; Cr Bad debts expense.

Doubtful Debts

Arises when it becomes uncertain whether money will be received. Here, it remains an asset in the books, but with a provision created against it: Dr Bad debts expense; Cr Provision for doubtful debts. This provision is always reviewed at the end of the year and may have to be increased (Dr Bad debts expense; Cr Provision for doubtful debts) or decreased (Dr Provision for doubtful debts; Cr Bad debts expense). If a debt is provided against but unexpectedly recover: Dr Bank; Cr Debtors. (Then provision may be adjusted at the end of the year).

Asset Turnover Ratio

Asset Turnover Ratio = Sales / Net Assets. (Net assets = fixed assets + net current assets = capital employed.) Shows how many times the value of net assets is turned into sales.

Efficiency Ratios

Asset Turnover. Shows how many times the value of net assets is turned into sales. Stock turnover (days). Shows how long on average stock is held before being sold. Debtors collection period (days). Shows how long debtors take on average to pay. Creditors payment period (days). Shows how long the business takes on average to pay its trade creditors.

Year-End Valuation or Continuous Inventory

Businesses have a choice between: (1) Physical stock count at the end of the year with each type of article valued at some suitable price, e.g. the most recent price paid; or (2) Stores ledger system, showing for each type of unit the quantities in, out, and remaining, and the cost of those units.

Financing/Investment Ratios

Capital Gearing Ratio, which shows how much of the business is financed by long-term debt. The higher the gearing %, the more at-risk a company is, because debt takes priority over dividends and is likely to be secured on a business's assets. But a mix is necessary, since debt is paid at lower rates. Interest Cover (Times), which shows how many times interest payments are covered by operating profit. Earnings Per Share (EPS), which shows the post-tax profits earned by each share.

Cash Flows from Operating Activities

Cash received from sales - Cash paid for the purchases of goods & other trading expenses = Cash flows from operating activities. Begin with profit before tax. Remove non-cash transactions: + depreciation expense, + loss on sale of fixed assets (or - profit on same), + interest expense, + decrease in stock (or - increase in same). Subtract dividends received; this appears under cash flows from investment activities. Then add in the cash inflows/outflows: + decrease in debtors (or - increase); + increase in creditors (or - decrease). This gives the cash generated from operations, from which interest paid and taxation paid are deducted to give the net cash from operating activities.

Income Tax Deducted at Source by a Company

Companies must deduct income tax at source from certain payments, including patent royalties and annual interest on debentures. This is then paid over to HMRC to satisfy the recipient's liability. Dr Interest or Patent royalty expense (w/ gross amount); Cr Bank (net amount); Cr Income tax control account (w/ income tax amount). When the company pays HMRC, the entry will be Dr Income tax control account, Cr Bank.

FRS 102: Contingencies

Contingent liabilities are liabilities not meeting the recognition criteria, either because it is possible rather than probable, or because it cannot be reliably measured. They should not be recognised in the account, and a disclosure note should be included instead. (e.g. company guarantees tenant's liability). Contingent assets arise where the inflow of economic benefits is probable but not virtually certain; these are not recognised on the balance sheet, but disclosed in a note. If the contingency is remote, there is no recognition *and* no disclosure note.

Current Ratio (or 'Working Capital Ratio')

Current assets ÷ current liabilities = Current ratio. (Current assets = cash + debtors + stock. Current liabilities = short-term creditors, incl. HMRC) Shows whether a business is able to meet its short term liabilities with its current assets. No specific standard figure, but 2:1 ratio generally regarded as acceptable. Possible for a current ratio figure to be too high, representing an unnecessarily high amount of tied-up capital.

Accounting for Deferred Tax

Deferred tax is used to correct the distortion between accounting profit and taxable profit by better matching the tax cost in the accounts with the revenues to which it relates. Differences between the expected tax and the actual charge can result from both permanent differences and timing differences; timing differences can be reconciled through deferred tax.

Accounting for Timing Differences

Deferred taxation deals with timing differences by adjusting the tax liability up or down by an amount reflecting the value of the timing difference. The timing difference calculation: (Capital allowances - Depreciation) x CT Rate = Tax on Timing Difference. So the double-entry for a tax charge lower than expected is: Dr Deferred taxation charge (P&L); Cr Deferred taxation provision (BS creditor). (In a subsequent year, if the tax charge is *higher* than expected: Dr Deferred taxation provision (BS); Cr Deferred taxation charge).

The Financial Equation for Finance Loans and Hire-Purchase Arrangements

Deposit + Instalments = Finance lease (or HP) price. Finance lease (or HP) price - Cash price = Total interest.

Transactions With No Effect on Cash Flow

Depreciation charges — these just spread the cost of an asset over its estimated useful life. Credit sales — at the point of sale, there is no receipt of cash. The inflow occurs when the money is paid into the business. Credit purchases — as above, the cash outflow does not occur at the point of sale, but when the business pays.

The Appropriation Statement

Distinguishes partnership P&L accounts from those of a sole trader. It is common for a partners to be allocated a 'salary', then a pre-agreed payment of interest on capital (neither are expenses), with the remainder of the profit divided according to a profit-sharing ratio.

Patent Royalties Receivable by a Company

Dr Bank (net amount); Dr Income tax control account (income tax amount); Cr Patent royalty income (gross amount).

Double-Entry for Finance Lease or Hire-Purchase

Dr Fixed asset cost (asset); Cr Loan creditor account (loan liability) [representing cost of asset if purchased outright]. Dr Loan creditor; Cr Bank [representing amount of any deposit]. Dr Loan creditor account; Cr Bank [representing each periodic payment made to the loan provider]. Dr Finance expense; Cr Loan creditor account [representing the periodic allocation of interest].

The Cash Flow Statement

Especially important in larger organisations, a cash flow statement shows us how a business has generated and spent cash during an accounting period and therefore indicates whether a business is sufficiently liquid. Cash flow is largely obscured by the accruals basis, so a separate statement is needed. Most companies *must* prepare a cash flow statement under FRS 102; sole traders and partnerships need not but may wish to.

Stock Cost Valuation Methods

Evaluating the cost of stock is a necessary preliminary step before valuing the stock. Three methods: 'First in, first out' (FIFO): assumes oldest stock is sold first. Average cost: takes an average purchase price over a period of time and allocates this to the stock. Weighted average cost: takes a weighted average purchase price, calculated after each purchase and sale over the course of year.

Companies' Presentation of P&L

FRS 102 permits companies to choose between presenting its P&L either in one statement ('statement of comprehensive income') or two separate statements ('income statement + 'statement of other comprehensive income').

Profit Reconciliations

FRS 102 requires companies to produce a reconciliation between the expected tax charge based on the accounting profit and the taxable profit. This simply requires us to identify the differences between the accounting profit and taxable profit, split them out into timing and permanent differences, and then list them out.

Government Grants

First, necessary to determine whether it's a capital or revenue-related grant. If revenue (e.g. contrib. towards wages), recognised in P&L in year when the expenses are incurred: Dr Bank; Cr Grant income account. If capital, held on balance sheet as a type of deferred income with the relevant portion released to P&L annually. Initial cash receipt: Dr Bank; Cr Grant account (Deferred income BS). Each release: Dr Grant account (BS); Cr Grant income account (P&L).

Calculating the cost of fixed assets bought during the year

Fixed asset cost on this year's balance sheet + Cost of fixed assets sold during the year - Fixed asset cost on last year's balance sheet = Fixed asset additions during the year.

Composition of Capital in a Company's Balance Sheet

For companies, the balance sheet will show a 'Shareholders' funds' section, comprised of accounts for : (1) Share capital; (2) Share premium; (3) Profit and loss reserve; and (4) Revaluation reserve. (Changes in the opening and closing shareholders' funds are usually reconciled by a third financial statement, the 'Statement of Changes in Equity').

Sale of Fixed Assets: Cash Flow Statement

From a cash flow point of view, an adjustment has to be made, because depreciation is a non-cash transaction. Accordingly, depreciation is added back to the 'cash flows from operating activities' calculation, and then the loss on the sale of the fixed asset is added (or the profit subtracted). Then, the actual cash proceeds of the sale of a fixed asset are recorded under 'cash flows from investing activities'.

Profitability Ratios

Gross Profit Margin. Shows gross profit as a % of sales income. Operating Profit Margin (or 'Return on Sales'). This is similar to GPM, but also includes administrative and other additional costs. Return on Capital Employed (ROCE). Shows how much operating profit is generated as a percentage of the capital used to generate those profits. This is the 'primary ratio'.

Rights Issue of Shares

Here, existing shareholders are given the rights to take up a new issues at a specific, usually favourable price. Dr Bank; Cr Share Capital; Cr Share Premium.

Double Entry for Issuing Share Capital

If a company issues 1,000 shares at £1 par value each is: Dr Bank (£1 x 1,000); Cr Share capital account (£1 x 1,000). If the shares are issued at a premium (say, £1.60): Dr Bank (£1,600); Cr Share capital account (£1000); Cr Share premium account (£600).

Revenue Recognition for Service Businesses

If a service, e.g. legal advice, is completed within one accounting period, it should all be recognised in that period. But if it spreads across several periods, it should be recognised at the stage of completion. Businesses can adopt any prudent policy to ensure this, but must then apply it consistently.

Erroneous Estimates of Corporation Tax Charge

If the estimate of the CT charge is wrong, the under- or over provision is dealt with by increasing or decreasing the following year's corporation tax charge. For under-provisions: Dr CT charge (P&L); Cr CT creditor. For over-provisions: Dr CT creditor; Cr CT charge (P&L).

Debits and Credits

In a double-entry: Debits represent assets, expenses, or drawings; Credits represent liabilities, income, or capital.

Directors' Remuneration

In lieu of traditional salary, directors will often draw on a loan account as and when needed. Drawings from the loan account: Dr Directors' loan account; Cr Bank. Salary and bonuses then go through the loan account to offset the amount withdrawn: Dr Salaries; Cr Directors' loan account.

Disposal of a Fixed Asset

It is necessary to move all of the information regarding the disposed-of asset into a single asset disposal account. Dr Disposal account; Cr Fixed asset cost account (transferring original cost of asset when acquired). Dr Provision for depreciation account; Cr Disposal account (transferring accumulated depreciation). Dr Bank; Cr Disposal account (recording cash receipt of sale). Finally, the disposal account is closed off by transferring the balance (representing a profit or loss) to the P&L account.

FRS 102: Performance

Performance is the relationship between the income and expenses of an entity over a given reporting period, shown on the P&L account. Income: transactions and events increasing equity, other than capital contributions from the owners. Includes revenue (income in the ordinary course of business) and gains (non-revenue income, including profit on sale of investments). Expenses: costs to and losses of the business (other than distributions to the owners).

Irrecoverable VAT

Main examples of irrecoverable input VAT are business entertaining and cars — in these cases, the VAT inclusive amount (i.e., the full price) is debited to the relevant expense or asset account.

The Accounting Equation

Net assets = proprietor's funds Assets - Liabilities = Capital + Profit [or - Losses] - Drawings

Payment of Corporation Tax

Not paid immediately, but payable nine months after the year end (or, in the case of large companies, by instalments. The accounting entries are as follows: When the charge arises: Dr Corp tax charge (P&L); Cr Corp tax creditor (BS). This is an estimated amount. When the tax is paid: Dr Corp tax creditor; Cr Bank.

FRS 102: Offsetting

Offsetting is only allowed where required or permitted by accounting standards; otherwise, both figures will be understated, which will affect the information's relevance and completeness.

Interest Cover Ratio

Operating Profit ÷ Interest Payable = Interest Cover (Times). Shows how many times interest payments are covered by operating profit. The higher the interest cover, the more of a cushion for decreasing profits before interest payment becomes a concern. Because interest payable hinges on the amount of debt finance, this will be closely linked to the gearing ratio.

Leases

Operating lease — short term, simply involves the lessee paying rent over a period substantially less than the asset's useful life. Treated as a revenue expense: Dr Operating lease expense; Cr Bank. Finance lease — long-term, likely to be for the major part of the asset's economic life. Very similar to hire-purchase, but with no purchase option at the end of the term. The difference in accounting terms from an outright purchase is the necessity of recording interest, which should be charged as an expense to the P&L account.

Research Expenditure

Original investigations for new scientific or technical knowledge, etc. Always written off -- ie, expensed as it is incurred (except for expenditure on tangible fixed assets to provide research facilities).

Earnings Per Share (EPS)

Post-tax profit for the year ÷ Number of issued ordinary shares = EPS Shareholders will want this to increase year on year, and the amount represented will either be reinvested in the business or paid out in dividends.

Partners' Accounts

Profits and drawings are included in the partners' accounts (capital and current) which are themselves included on the balance sheet. The capital account shows fixed capital: original capital introduced + subsequent introducts. Partners cannot withdraw until they leave the partnership. This is the amount to which the interest rate is applied. The current account contains the partner's share of any profit (increasing the balance) and any drawings (reducing the balance). In order to allocate the profit to the current account: Dr P&L; Cr Partners' current accounts. In order to reflect drawings made by the partners: Dr Partners' current accounts; Cr Bank. (Undrawn profits will be a balance b/f in the current account's credit column).

Cash Flows from Investing Activities

Represents the acquisition and disposal of long-term assets and other investments; mainly fixed term assets and things like shares and debentures. Calculation: Cash proceeds from sale of fixed assets & investments - purchases of fixed assets and investments + interest received + dividends received = Net cash from investing activities. (Cash inflows are positive numbers; cash outflows are negative numbers.)

IFRS 102 Section 18

Requires all intangible assets to be assigned a finite useful life, and where a reliable estimate is impossible it shall not exceed ten years.

FRS 105

Sets out simplified accounting rules for micro entities. Available to companies that: (1) have a turnover under £632k; (2) have total assets under £316k; and (3) have an average number of employees under 10. To qualify, 2 out of 3 of the above criteria must be satisfied.

CA 2006

Sets out the framework (format, basic disclosures, etc.) for companies' financial statements. However, accounting standards are necessary for providing the details on how to account for specific kinds of transaction; hence the importance of GAAP.

FRS 102

Sets out the main accounting rules for most companies; the focus of the exam.

FRS 100

Sets out the overall reporting framework.

Short-Term Liquidity Ratios

Shows the ability of a business to meet its liabilities as they fall due. Obvious synergy with cash flow statement. Current ratio (or 'working capital ratio'), which shows whether a business is able to meet its short-term liabilities with its current assets. Quick (or 'acid test') ratio, which shows if a business can meet its short-term liabilities with its current assets excluding stock, which is the least liquid current asset.

Stock Valuation

Stock should be valued at the lower of: (i) Cost (i.e., all costs of purchase and conversion incurred to get stock to its present location and condition); or (ii) Net realisable value (ie, estimated selling price less costs to complete and sell). Takes into account further pre-sale costs like distribution.

Recording Depreciation

The P&L account includes a 'depreciation expense account' which is closed off to the P&L account at the end of the year, set against the debit balance on the asset cost account to produce the NBV. The double entry is Dr Depreciation expense account (P&L); Cr Provision for depreciation account (BS).

Output VAT

The VAT charged by a seller via increased prices on standard-rated goods is output tax and must be paid over to HMRC; the amount received by way of VAT should thus not be included in the value of sales or turnover. The accounting entry is: Dr Bank or Debtor (w/ VAT inclusive amount); Cr Sales (w/ VAT exclusive amount); Cr VAT control (w/ VAT amount).

Contents of the Cash Flow Statement

The cash flow statement can be broken down into three headings: (1) Cash flows from operating activities; (2) Cash flows from investing activities; (3) Cash flows from financing activities. The sum of each of these headings is then added together to provide a figure for the 'net increase or decrease in cash and cash equivalents.

The VAT Control Account

The difference between output VAT and input VAT, which will be shown by the balance on the VAT control account, must be paid over to HMRC. The credit column shows output tax; the debit column shows input tax.

FRS 102: Financial Position

The financial position of the entity is shown in its balance sheet by its assets, liabilities, and equity. An asset: a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity (e.g. debtors, machines). A liability: a present obligation arising from past events, expected to result in an outflow of economic benefits from the entity (e.g. a credit purchase). Equity: the residual interest in the assets after deducting the liabilities — the net assets.

Accounting for Closing Stock

The required double-entry is Dr Stock (Balance Sheet); Cr P&L. It now reflects an asset and profits are increased to reflect that not all stock has been sold. This is then reversed at the end of the next period of trading: Dr P&L; Cr Stock (Balance Sheet). This reflects an expense to trading.

Development Expenditure

The use of scientific or technical knowledge to produce new or substantially improved [things] prior to the commencement of commercial production. Treated as research (i.e., written off), unless it can be clearly related to a project which is technically feasible and commercially viable. Capitalisation is therefore only allowed if the business is virtually certain that the expenditure will result in future economic benefits.

Goodwill

The value of the goodwill is the difference between the value of the business as a whole and the sum of the values of the individual assets on the business's balance sheet. Nearly impossible to value while business is ongoing; but possible to value at the moment when the business is bought. When this is done, it should be capitalised and classified as an intangible fixed asset on the balance sheet and amortised over the course of its life. Particularly important to review for impairments.

Cash Flows from Financing Activities

These are cash flows from activities affecting the company's equity and borrowings; includes share issues, cash proceeds from issue of debentures or increase of loans, and cash payments to repay debentures and loans. The calculation is: Proceeds from share issues - repayment of share capital + proceeds from issuing debentures & increasing loans - repayment of debentures & loans = net cash used in financing activities.

Expenses Accrued

These are expenses that have been incurred but not paid. They decrease profits by increasing expenses for the relevant period, so the relevant double entry is: Dr Expense Account, Cr Accruals.

Expenses Prepaid

These are expenses that have been paid in advance for consideration not yet received. They increase profits by decreasing expenses for the relevant period, so the relevant double entry is: Dr Prepayments (an asset); Cr Expense.

Loan Capital Instruments

These are usually payable after a term longer than a single year, so they are presented as long-term creditors in the accounts. For the loan monies received: Dr Bank; Cr Creditor. For the annual interest paid: Dr Interest paid; Cr Bank.

Timing Differences

These arise arise when certain types of income and expenditure are recognised in different periods for accounting and taxation purposes. These can be reconciled through deferred tax. Example: depreciation charges (capital allowance regimes are designed to match depreciation over the course of an asset's lifetime, not year on year).

Permanent Differences

These arise when certain types of income/expenditure are recognised in the accounts but can never appear in the tax computation as an item of taxable income or an allowable expense. Classic example: business entertaining (expense), income (dividends received).

Flat Rate Scheme

This is a VAT simplification available to small businesses and designed to reduce compliance costs. It enables businesses to pay VAT simply by calculating its VAT payment as an HMRC-set percentage of its VAT-inclusive turnover (usually without input tax deducted).

Income Accrued

This is income earned but not yet received. It increases profits by increasing the income earned for the relevant period. The double entry is: Dr Accrued Income; Cr Income.

Income Deferred

This is income received but not yet earned. It decreases profits by decreasing income earned for the relevant period. The double entry is: Dr Income; Cr Deferred Income.

P&L Reserve Account

This represents the cumulative total of the company's retained profits, i.e., the profits less losses made by the company, less any amounts paid out by the company to the shareholders as dividends. For each accounting period, the double entry will be: Dr P&L account (P&L); Cr P&L account reserve (Balance Sheet).

FRS 102: Recognition of Assets, Liabilities, Income & Expenses

To include an asset, liability, income or expense on the balance sheet or P&L account: (1) It must meet the relevant above definition; (2) It must be probable [in the case of assets, 'virtually certain'] that future economic benefit will flow to or from the entity; (3) The item must have a cost or value capable of reliable measurement (incl. reliable estimates).

Hire-Purchase

Treated for accounting purposes as an outright purchase of the asset with a loan provided by the hire-purchase company; the periodic payments are treated as repayments of the loan.

The Income Tax Control Account

When a company has patent royalties both payable and receivable, the balance on this account will indicate whether money is owed by or owing to HMRC. A credit balance represents income tax payable to HMRC; a debit balance represents income tax receivable on the excess of receipts over payments and repayment to the company is effected through an offset against the company's corporation tax liability.

Settlement Discounts Allowed

When a trader gives a settlement discount to a customer for prompt payment that is subsequently exercised, two double entires are made: For the original sale: Dr Debtors; Cr Sales. For the exercise of the discount: Dr Bank (amount received, e.g. 90); Dr Discounts allowed (expense, e.g. 10); Cr Debtors (discharging the liability, e.g. 100).

Settlement Discounts Received

When a trader receives a settlement discount that is subsequently exercised, the double-entry is as follows: For the original purchase: Dr Purchases / Expenses; Cr Creditors. For the exercise of the discount when the payment is made: Dr Creditors (e.g. 100); Cr Bank (amount paid; e.g. 90); Cr Discounts received (income; e.g. 10).

FRS 102: Going Concern

When preparing accounts, management should consider whether the business is a going concern (which it will be unless management intends to liquidate the entity / cease trading). This requires management to take into account all available information about the future.

Part-Exchange Allowances

When the proceeds of the disposal of an asset are not cash but rather a part exchange allowance against the purchase price of the new asset, the 'Dr Bank; Cr Disposal' step is replaced with the following double entry: Dr Fixed asset cost account; Cr Disposal account [with the part exchange allowance]. (And then Dr Fixed asset cost account; Cr Bank [with payment of balance for the new fixed asset]).

Calculation of the VAT Element

Where amounts are given inclusive of VAT, it is possible to determine the VAT element through the following calculation: (VAT rate / (100 + VAT rate)) x VAT inclusive amount = VAT element.