Accounts are the financial records of an organisation that document business performance (income and expenditures) over a past period - typically a year. By law every business is expected to disclose a 'true and fair view' of their financial affairs, and as a result accounts are expected to comprise of several core elements, including a profit and loss account and a balance sheet.
When carefully collated and organised, this financial information can provide a basis for effective future business planning - pinpointing any losses and how these can be resolved and helping to track expenses and control costs. Accounts are particularly beneficial to external users of a business, including employees, authorities, bankers, shareholders and suppliers.
There are many different types of accounts, including company accounts and charity accounts. This page will look at these in-depth - highlighting crucial records required for each - whilst looking briefly into the role of an accountant for helping to ensure accurate organisation of accounts.
Why are accounts needed?
Generally, businesses will be penalised if they fail to keep accurate, up-to-date records of their finances for required periods of time. Account keeping however has numerous internal benefits for the company - providing an advantageous level of transparency that can help in the analysis of a business, whilst ensuring effective tax returns and the prevention of theft or fraud. A company that keeps on top of a good record-keeping system will also be able to:
- pay tax accurately and on time
- apply for additional funding, such as a bank loan or overdraft facility
- efficiently track expenses, debts and creditors
- apply for, and receive benefits and credits
- report on profit or loss easily and quickly when required to do so.
Due to the time consuming nature of account keeping, many businesses choose to hire an accountant to effectively organise all financial information into meaningful sets of data. New businesses may find accountancy particularly beneficial for setting the foundations of a proper record keeping system. Financial records are most commonly stored on a computer, which shows all information in one document and allows for information to be presented in a readable format.
What do accounts consist of?
Financial accounts typically consist of four key elements. These are a profit and loss account, balance sheets, a cash flow statement and a statement of recognised gains and losses - records sourced by important business activity documentation. Examples include invoices, receipts, paying-in books, rent books, bank statements, wages records, and copy sales invoices.
Profit and loss account
This is a summary of business transactions - the profits and losses - over a given period, comprised of documentation on sales and takings and a record of all purchases and expenses. The profit and loss account is produced essentially for business purposes - serving as an indication of business performance to owners, shareholders and/or potential investors. It is also relevant information for HM Revenue and Customs (HMRC) to check a business's tax calculations.
Limited companies are by law expected to produce a profit and loss account, whereas self-employed sole traders and most partnerships are not required to do so. They do however need to keep similar records to complete their self-assessment tax return fully and accurately.
A balance sheet is a basic guide to an organisation's assets (what is owed) and liabilities (what it owes) at a particular date. This financial statement shows how the business is being funded and how these funds are being utilised. There are three ways in which a balance sheet may be used.
- as a business analysis tool to improve the management of a business
- to help owners and other interested parties (shareholders, employees, creditors etc.) to assess the worth of the business at any given moment.
Cash flow statement
This shows how a business has generated or disposed of cash and liquid funds over a given period. Effective management of cash flow is vital for business survival and growth - any costs need to be balanced and carefully timed with incoming funds.
Statement of recognised gains and losses
These refer to records of all gains and losses since the previous set of accounts that are not included in the normal accounts. (i.e. changes caused by currency fluctuations, property revaluation, profits earned by associates and joint ventures etc.)
Types of accounts
Below we have provided a list of the financial records specific businesses should keep.
All self-employed workers need to keep accurately organised accounts that consist of the four key types of documentation. These records will enable them to successfully complete a self-assessment tax return, and answer any questions from the HMRC. For many self-employed workers, account keeping can be time consuming, especially if they have several different sources of income and/or need to register for VAT.
As a result, many choose to hire an accountant to organise their financial records on their behalf. This is particularly beneficial for individuals who may feel uncomfortable handling percentages and money. An accountant is reliable and can offer in-depth advice on all working practices and will be knowledgable of the UK's tax and legal system.
There are a number of ways in which a partnership can be defined, but it typically refers to a business arrangement of two or more individuals. Partnerships mean that ownership rights are divided, and thus each partner will be entitled to separate capital account for investments and his/her share of net income or loss, and a separate withdrawal account.
A withdrawal account tracks the funds taken from the business by the shareholders for personal use. As partners are joint owners of the business, they do not receive a salary but are entitled to withdraw assets up to the level of his/her capital account balance.
A capital account represents the equity a partner receives from a joint business venture - the net income or loss is added to this account in the closing process. Funds increase if the following occurs:
- the partnership earned profits, and a share of the profits was allocated to the partner
- additional investments made by the owner
- guaranteed payments (salaries and interest allowances) made by the owners
- an increase in capital will count as credit in the capital account.
It will be agreed by the partnership how net income or loss is allocated to the partners. Part of the formula for splitting net income is salary allowances and interest on investments. These are not expenses of the business, and will be immediately transferred to the partners' capital accounts through closing entries - this means they can only receive the cash when they withdraw from the partnership.
If the accrual accounting method is used (i.e. a method that measures the position and performance of a company by recognising economic events regardless of when cash transactions take place), each partner will be required to pay income tax on their share of net income. This is regardless of how much money they withdraw from the partnership during the year.
There is strict criteria of what information must be collated for company accounts and these include records about the company itself and financial accounting records.
The necessary details required to provide information about the company itself include:
- information on directors, shareholders and company secretaries
- promises for the company to repay loans at a specific date in the future ('debentures'), and who they owe this money to
- promises made by the company to make payments if something goes wrong and it's the company’s fault ('indemnities')
- the results of any shareholder votes and resolutions
- transactions documenting when shares in the company are bought
- information of any loans, mortgages, etc., secured against the company's assets.
As for general accounting records, companies must make sure to collate documents on the following:
- all money received and spent by the company
- details of any assets owned by the company
- debts the company owes, or is owed
- all goods bought and sold
- details of who bought and sold goods
- all stocktaking used to calculate the stock figure.
These records need to be kept by the company for at least six years from the end of the company's last financial year.
Like regular businesses, charities must maintain accurate accounting records of income and expenditure throughout the year. In addition, they must make these reports publicly accessible on the Register of Charities where they can be examined by the government and public. The law requires this transparency and accountability.
The ways in which charity financial affairs are organised, maintained and reported depend solely on the size and structure of the organisation, as well as its income, expenditure and gross assets. Typically accounts will consist of the standard records, including invoices and receipts relating to the charity, as well as bank statements, cash books and other relevant documents. Charities registered for Gift Aid have additional record-keeping obligations. They must file away information on Gift Aid declarations as well as details of the donations themselves.
There are typically three different accounting methods used to organise charity accounts:
- receipt and payment accounts
- accrual accounts for small charities
- accrual accounts for larger charities.
Receipts and payments
Charities with a gross income of £100,000 or less can submit abridged accounts known as 'receipts and payments'. These summarise income and expenditures over the financial year. Details of assets and liabilities must also be documented, and many organisations may benefit from hiring an accountant to complete this process properly.
Charities with an income of £100,000 or less must complete their accounts in accordance with the Statement of Recommended Practice (SORP), which is issued by the Charities Commission. This means their accounts must be organised under an 'accruals' basis, thus they need to provide a wider range of information than standard receipts and payments (i.e. a balance sheet). It is the trustees' responsibility to prepare accruals accounts.
Trusts are legal arrangements where one or more 'trustees' are made legally responsible for certain assets (money, investments, antiques, land, buildings etc.). These are placed in trust for the benefit of one or more 'beneficiaries'. The role of the trustee involves managing the trust and carrying out the wishes of the person who has put the assets into the trust (the 'settlor'). These wishes are usually written in the settlor's will or set out in a legal document called 'the trust deed'.
Above all, a trustee must ensure all records and expenses involved in the trust are recorded accurately, as they are important for:
- completion of the Trust and Estate Tax Return
- passing information onto beneficiaries
- dealing with any Inheritance Tax due
- answering any questions that HM Revenue and Customs (HMRC) may have about the trust.
There are several different types of trust and thus the sorts of records that need to be collated for each will vary. Generally however, trust accounts will consist of standard account records, including bank statements, details of expenses and taxes paid by the trustee, stockbroker reports and records of dividends. There must also be records of payments to beneficiaries, details of any savings or bonds, and certificates issued by life assurance companies.
Additional records will be required if the trust sells or buys assets during the year. These are:
- completion statements of property transactions
- contract notes for stocks and shares
- receipts for sale or purchase expenses - including solicitors charges on the sale of a property
- receipts for expenses connected with the property (if that is the asset), including any mortgage interest and annual bills such as water rates
- licence or rent agreements identifying the rent payable
- the amount or market value of the asset received, and the date it was received
- details will also be needed on who made the payment for this asset or who put it into trust.
Records of any important decisions made by the trustees should also be logged, such as minutes of meetings, deeds of appointment and any decisions that may have affected the distribution of capital income.
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