An A–Z of accounting practice for APC

All APC candidates need to know about the mandatory level 1 competency, Accounting principles and procedures. At this level, they must understand the basic principles and how to interpret company accounts. Some candidates may take it to a higher practical level as a technical competency, and this will require practical experience of doing at level 2 or advising at level 3.

Auditing: a report prepared by an auditor as an independent party confirms that the financial accounts of a company are fair and true. Under the Companies Act 2006, such reports must be prepared for all public limited companies (PLCs), unless they are dormant, or where companies' articles of association or shareholders require them. However, small companies and micro entities may be exempt from the need for audits because of the reduced size and risk of these entities. The requirements for the exact parameters of the size of companies can be found on the UK government website.

Balance sheet: this is one of three key financial statements, alongside those for cash flow and for profit and loss. A balance sheet shows a company's assets, liabilities and equity at a specific point in time. It can be used to assess its financial position or health, and be compared with previous balance sheets to identify trends.

Cash flow statement: this shows cash moving into and out of a company for a specific period, and is generally broken down into cash relating to operations, to investment and to financing. The statement will show the net cash-flow position, which helps assess liquidity and shows changes in assets, liabilities and equity. 

Deadlines: Companies House sets strict filing deadlines; specifically, nine months from the accounting reference date (ARD) for private companies and six months for PLCs. Financial penalties apply if accounts are filed late, ranging from £150 for private company or limited liability partnership (LLP) accounts up to a month in arrears, to £7,500 for PLC accounts that are more than six months overdue. Penalties are doubled if accounts are filed late in two consecutive financial years. If accounts are not filed at all, a company can be struck off the register or dissolved, which can in turn lead to all company assets becoming property of the crown. In these circumstances directors can face the separate criminal offence of not delivering company documents, for which they could incur an unlimited penalty and run the risk of a criminal record. So it is not worth falling foul of the deadlines set by Companies House.

Equity: this is a key term in accounting, also known as owner's equity. It is effectively the value that the owner – such as a company director – has in the business. This can be calculated by deducting total liabilities from total assets on a company balance sheet.

Financial accounts: all private limited companies and PLCs in the UK must file annual accounts with Companies House, in line with the requirements of the Companies Act 2006. These accounts are publicly available, albeit sometimes at a charge. Each set of accounts should relate to a specific financial year, which generally runs for 12 months ending on the annual return date. Companies must keep accurate records of all income, expenditure, assets and liabilities. These must be kept for three years, or six if the company is a PLC. In some cases, the accounts should be accompanied by a director's report, unless the company is defined as small (see the above explanation in Auditing), and an auditor's report unless it is exempt.

Gearing ratio: this is a type of financial ratio that helps when analysing a company's capital structure and financial leverage. It represents the proportion of debt finance relative to equity held in a company. Typically, a high gearing ratio is above 50%, a low ratio is below 25%, and an optimal one is somewhere in between – although this will depend on the type of company. 

Hurdle rate: in accounting, this is the minimum rate of return required on an investment. A company may have a minimum hurdle rate that it wants to achieve on projects or investments, compared to the potential or actual rate of return. This can inform investment decisions, and could be established using a discounted cash-flow model or even an appraisal for development or refurbishment projects. 

International Financial Reporting Standards (IFRS): RICS Valuation – Global Standards: UK National Supplement 2018 includes valuation practice guidance – application (VPGA) 1 relating to valuations for financial reporting. This sets out the two financial reporting frameworks adopted by UK companies: the IFRS and UK Generally Accepted Accounting Practice (GAAP). PLCs must follow the IFRS when preparing their group company accounts, but may adopt either these or UK GAAP for individual parent company accounts. 

Joint venture (JV): the International Accounting Standard (IAS) 31 Interests in Joint Ventures defines a JV as 'a contractual arrangement whereby two or more parties undertake an economic activity that is subject to joint control'. A JV is just one type of company structure among others such as alliances, consortiums, and mergers and acquisitions. Accounting for JVs is complex and requires specialist advice from a skilled accountant.

Key performance indicator (KPI): KPIs are used in all areas of a business to measure performance and plan for the future. There are various KPIs that can be used in accounting to provide essential financial information on a company, such as budget variance, turnover by department, working capital and operating cash flow. 

Leases: leases are dealt with by IFRS 16 Leases, which took effect in January 2019 and essentially brought all leases more than 12 months long on to the balance sheet. The aim of IFRS 16 is to ensure accurate reporting of lease transactions and to allow more accurate analysis of related cash flows. RICS has also recently published an insight paper on this issue.

Management accounts: these differ from the financial accounts submitted to Companies House each year, and are instead produced for the owners or managers of a business on a monthly or quarterly basis to inform decision-making and business planning. Typically, they will include a profit and loss statement and a balance sheet, but can be tailored to the requirements of the company and do not have to meet formal reporting requirements. 

Net asset value (NAV): this is a financial ratio that shows the net value of an entity's assets minus its liabilities, divided by the number of outstanding shares. It is typically used by mutual funds and exchange-traded funds and it changes daily, so it can be used to calculate the price to buy or sell shares in the particular fund or entity.

Ordinary shares: some UK limited companies are described as 'limited by shares', so shareholders own the business and have certain rights over the company. The alternative is to be limited by guarantee, which is typically used by not-for-profit organisations or charities. Companies that are limited by shares must have at least one shareholder, who is usually a director. These shares are typically ordinary shares, which permit one vote each on company decisions and the right to receive dividends. 

Profit and loss statement: also known as the income statement, this is the third of the three key financial statements. It shows the income and expenditure of the company over a specific period, culminating in the net profit or loss made. The profit and loss statement can be used to calculate the company's profit margin; that is, how efficiently the company is converting revenue into profit. 

Quarter days: when accounting for rent or service charge payments on a lease, it is essential to know the quarter days if this is the payment frequency stated. In England, these are 25 March, 24 June, 29 September and 25 December. However, they are different in Scotland, being 28 February, 28 May, 28 August and 28 November. In the USA, the quarter days are 1 January, 1 April, 1 July and 1 October.

Return on capital employed (ROCE): another common financial ratio, ROCE is a measure of profitability and the efficiency with which a company uses its capital. It is calculated by taking earnings before interest and tax and dividing by capital employed, being total assets minus current liabilities. It can be used to assess a company's financial health and performance alongside other key metrics. 

Size: in the UK, four size classifications affect the preparation of financial accounts. These are micro entity, small, medium and large, and are defined according to thresholds for turnover, balance sheet totals and average employee numbers. Essentially, the smaller the company the fewer the requirements for preparing and filing accounts. For example, micro entities can file a balance sheet with less detail, and they are also exempt from auditing. 

Taxation: accounting is intrinsically linked with taxation, which for UK companies includes corporation tax. This is paid on a company's profits in any financial year, with a 2022 main rate of 19% and a special rate for unit trusts and open-ended investment companies of 20%. Companies will also pay corporation tax on chargeable gains; that is, profits from the disposal of business assets such as land, property, equipment and machinery. Capital allowances can be claimed against chargeable gains, with specialist advice being required in these circumstances. 

UK GAAP: this is the financial reporting framework adopted by some companies in the UK. It is issued by the Financial Reporting Council and has seven Financial Reporting Standards (FRS): 100, 101, 102, 103, 104 and 105. These provide guidance on the way financial reports are set out, with FRS 102 covering how property included in accounts is to be valued.

Vetting: financial reports, alongside credit reports, can be used when vetting suppliers, tenants or contractors. Typically, a credit report will show information about a company, a credit risk score and any issues relating to insolvency, credit defaults or debt repayments. Surveyors should always refer clients to an accountant for specialist advice, recognising their scope of competence. 

Working capital: another key accounting term, working capital represents the amount available to a company for day-to-day use and describes the ability of a company to meet its current liabilities. It is calculated by the difference between current assets and current liabilities. Current assets include cash, funds in saving accounts, liquid securities such as bonds and stocks, and inventory (of goods or items of value). They do not include long-term or less liquid assets such as land and property. Current liabilities include day-to-day running costs such as rent, rates and utility costs. 

Yield: in its simplest form, this is the rate of return on an investment. In accounting terms, a key yield definition to understand is interest rates. An example is the Bank of England interest rate, or base rate, which is the amount it charges to lend money to commercial banks, and which is built into the interest rates that these banks in turn offer to consumers for mortgage lending. 

Zero-rated: this is a rate of value-added tax (VAT) that is essential to know about for accounting purposes. VAT is a consumption-based tax that must be charged on top of the price of goods and services, if a supplier is registered. The supplier can then also recover VAT on purchases made. Some goods and services are exempt from or outside the scope of VAT, such as Royal Mail postage costs. The standard VAT rate is 20%, and there are reduced rates of 5% and 0%; for instance, the installation of air conditioning units has been zero-rated since 1 April 2022.