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Author:   Alan Flitcroft Partner, Ernst & Young

Fundamentals of Double Entry Bookkeeping

Some fundamentals of double-entry bookkeeping to remember:

• every credit has a matching debit
• the balance sheet always balances
• revenues and costs should be matched
• accounts should be prepared with prudence: ie. revenues/profits are generally accounted for only when they occur, but costs/losses are generally anticipated as soon as it is reasonable to do so
• accounts must be prepared on a consistent basis year on year

However, despite these fundamentals, there is still a great deal of room for judgment to be exercised in the preparation and analysis of accounts.

Legal requirements

The Companies Act 1985 sets out the legal requirements for all companies in the UK to publish regular accounts with supporting notes. Some key points to remember:

• Section 221(1) of the Companies Act 1985 - every company is required to keep accounting records which are sufficient to show and explain the company's transactions
• Section 221 (6) - any person guilty of an offence under this section (ie. a director of a company that does not maintain such records is liable to imprisonment or a fine or both
• Section 226 (1) - the directors of every company are required to prepare for each financial year of the company a balance sheet as at the last day of the financial year and a profit and loss account for the period
• Section 233 (1) - the annual accounts must be approved by the board of directors and signed on behalf of the board by a director of the company
• Section 235 (1) - the company's auditors must make a report to all of the company's members (shareholders) on their annual accounts and lay the report before a general meeting of the company
• Section 235 (2) - the auditor's report must state whether, in their opinion, the accounts have been prepared in accordance with the Companies Act and give a true and fair view of the company's financial position at the financial year end
• Section 242 (1) - the directors of the company must deliver a copy of the annual audited accounts to the Companies Registrar together with a copy of the directors' report and the auditor's report on the accounts

Some other points to note:

• not all companies require a full audit. There are certain exemptions for small and medium sized companies
• accounts generally have to be submitted to the Companies Registrar within 10 months after the balance sheet date
• all directors are responsible for the company's accounts, not just the director that signs the accounts
• a "true and fair view" means that the accounts have been prepared in accordance with the accounting standards currently applicable in the UK

Guide to Financial Statements

All companies subject to a full audit are required to prepare the following financial statements:

• directors report
• statement of director's responsibilities
• auditors' report
• profit and loss account
• statement of total recognised gains and losses
• balance sheet
• cash flow statement
• notes to the accounts

In addition, PLCs generally include the following additional statements, as well as more marketing based material:

• Chairman's/Chief Executive's statement
• operating and financial review
• remuneration committee report
• corporate governance statement

The audit report for all companies will cover items 4 to 8 as described above. For PLCs, of the additional statements, only part of the remuneration committee report is audited.

The Main Financial Statements

Profit and loss account (P & L): the profit and loss account records the company's performance over a period of time. Some of the key numbers in the statement are:

• turnover: the gross sales for the year (net of VAT)
• operating profit (loss): turnover minus cost of sales
• profit (loss) before interest and tax: operating profit (loss) less any overheads
• interest payable/receivable
• profit (loss) after tax

The presentation of the P & L can vary from company to company, and a number of sub-totals and columns can be used to draw attention to the numbers that the company deem important.

It is not unusual to have exceptional items that are disclosed separately from the underlying company numbers. The exceptionals must be included in the profit and loss analysis but they may be highlighted in a separate column.

Balance sheet: the balance sheet records the company's financial position at a given point in time. It is a statement of what the company owns balanced against what it owes in both the short- and long-term. Some key numbers in this statement are:

• goodwill and intangible assets
• investments
• tangible fixed assets (such as buildings and vehicles)
• current assets (stocks, debtors and cash)
• creditors
• borrowings
• provisions

Cashflow statement: the cash flow statement is the most transparent of the three main accounting statements. It records only flows of cash into and out of the business. And sub divides the cash flows into operating cash flows, and cash spent on other items such as taxation, interest and fixed assets. A reader of the accounts can therefore ascertain how much cash a company is generating and from where, and how that cash is being spent.

Not all companies are required to produce cash flow statements. If a company's cashflows are included in a consolidated cash flow for a parent undertaking and those accounts are publicly available then generally a cash flow statement does not need to be produced.

Accounting in Film Companies

Film companies might be engaged in production, distribution, exhibition or video distribution (or a combination of these). The financial statements for these different companies are likely to look quite different, with, for example, an exhibitor likely to have far more in the way of fixed assets on their books reflecting the cinemas and property they own or hold on long-term leases. Distribution and production companies on the other hand may have libraries of films in which they own the rights and will have to be included in the accounts.

Top Tips

• Every market is different - marketing has to be tailored to each territory.
• The Companies Act 1985 sets out the legal requirements for companies in preparing and filing accounts and having them audited by a properly qualified independent auditor.
• The directors of a company are responsible for the maintenance of proper accounting records and the preparation of annual accounts that show a true and fair view.
• The cash flow, which shows where a company is generating and spending cash is a key statement in understanding how the company is performing. It is possible for a company to show a profit while still spending more cash than it generates - it is running out of cash that forces business into liquidation.
• Accountancy is not black and white. There are a number of areas of judgment that can affect the presentation of financial results. Be aware of the areas of judgment when interpreting accounts.