Accounting Principles and Procedures

Accounting Principles and Procedures for RICS APC Candidates

A guide to the key concepts and skills required for the RICS assessment of professional competence

1 Introduction

Accounting principles and procedures are essential for any construction professional who wants to achieve the RICS APC (Assessment of Professional Competence). The RICS APC is a rigorous assessment that tests the knowledge, skills and ethics of candidates who aspire to become chartered surveyors. One of the core competencies that candidates need to demonstrate is financial management, which covers the following topics:

• Balance sheets/profit and loss account

• Taxation

• Revenue and capital expenditure

• Cash flows

• Auditing

• Ratio analysis

• Credit Control

• Profitability

• Insolvency

• Legislation

In this blog post, we will explain each of these topics and provide some practical examples and references to help you prepare for the RICS APC assessment.

2 Balance sheets/profit and loss account

A balance sheet is a financial statement that shows the assets, liabilities, and equity of a business at a given point in time. It provides a snapshot of the financial position of the business and helps to assess its liquidity, solvency, and efficiency. A profit and loss account is a financial statement that shows the income and expenses of a business over a period of time, usually a year. It provides a measure of the profitability and performance of the business and helps to evaluate its growth potential and risk exposure.

As a RICS APC candidate, you need to understand the basic principles and methods of preparing and interpreting balance sheets and profit and loss accounts, as well as the accounting standards and regulations that apply to them. You also need to be able to analyse and compare the financial statements of different businesses and identify the key factors that affect their financial performance and position. Some of the relevant RICS guidance notes and UK laws that you should be familiar with are:

• RICS Valuation - Global Standards 2017 (the Red Book)

• RICS Professional Statement: Business Valuation, 1st edition

• RICS Guidance Note: Valuation of Buy-to-Let Properties, 1st edition

• Companies Act 2006

• International Financial Reporting Standards (IFRS)

• UK Generally Accepted Accounting Practice (UK GAAP)

A real-life example of how to apply these principles and procedures is the valuation of a property investment company. You would need to examine the balance sheet and profit and loss account of the company, as well as the market value of its properties, to determine its net asset value (NAV) and its earnings before interest, tax, depreciation, and amortisation (EBITDA). You would also need to consider the impact of any debt, leases, contingent liabilities, or goodwill on the company's financial position and performance. You would then use appropriate valuation methods, such as the income approach, the market approach, or the asset-based approach, to estimate the value of the company's equity.

3 Taxation

Taxation is the process of imposing and collecting taxes by the government or other authorities on the income, profits, assets, transactions, or activities of individuals or businesses. Taxes are used to fund public services, redistribute wealth, influence behaviour, or achieve other social and economic objectives. Taxation can have significant implications for the financial and operational decisions of businesses, as well as for their valuation and appraisal.

As a RICS APC candidate, you need to understand the basic principles and types of taxation that affect businesses and property transactions in the UK, as well as the tax reliefs and exemptions that may be available. You also need to be able to calculate and account for the tax liabilities and benefits of different business structures, property ownerships, and investment strategies. Some of the relevant RICS guidance notes and UK laws that you should be familiar with are:

• RICS Guidance Note: Taxation of Commercial Property, 1st edition

• RICS Guidance Note: Taxation of Residential Property, 1st edition

• RICS Guidance Note: Capital Allowances and Land Remediation Relief, 1st edition

• Income Tax Act 2007

• Corporation Tax Act 2010

• Capital Gains Tax Act 1992

• Value Added Tax Act 1994

• Stamp Duty Land Tax Act 2003

A real-life example of how to apply these principles and procedures is the taxation of a property development project. You would need to consider the tax implications of the choice of business entity, such as a sole trader, a partnership, a limited company, or a joint venture, as well as the source and structure of the finance, such as debt, equity, or mezzanine. You would also need to account for the tax treatment of the development costs, such as land acquisition, construction, professional fees, and interest, as well as the tax consequences of the disposal or retention of the completed property, such as income tax, corporation tax, capital gains tax, value added tax, and stamp duty land tax. You would then use appropriate tax planning techniques, such as capital allowances, land remediation relief, or incorporation relief, to minimise the tax burden and maximise the return on investment.

4 Revenue and capital expenditure

Revenue expenditure is the expenditure that is incurred by a business in the course of its normal operations, such as salaries, rent, utilities, materials, and marketing. Revenue expenditure is usually deducted from the income of the business in the period in which it is incurred and is recorded in the profit and loss account. Capital expenditure is the expenditure that is incurred by a business to acquire, improve, or maintain its fixed assets, such as land, buildings, plant, machinery, and vehicles. Capital expenditure is usually added to the value of the fixed assets in the balance sheet and is depreciated or amortised over their useful lives.

As a RICS APC candidate, you need to understand the difference and distinction between revenue and capital expenditure, as well as the criteria and methods of classifying and allocating them. You also need to be able to assess and justify the benefits and drawbacks of different types of expenditure, such as repairs, improvements, enhancements, or replacements, and their impact on the income, expenses, assets, liabilities, and cash flows of the business. Some of the relevant RICS guidance notes and UK laws that you should be familiar with are:

• RICS Guidance Note: Depreciation of Plant and Equipment, 1st edition

• RICS Guidance Note: Accounting for Leasehold Property, 1st edition

• RICS Guidance Note: Accounting for Service Charges in Commercial Property, 1st edition

• Companies Act 2006

• International Financial Reporting Standards (IFRS)

• UK Generally Accepted Accounting Practice (UK GAAP)

A real-life example of how to apply these principles and procedures is the accounting for a property refurbishment project. You would need to determine whether the expenditure on the project is revenue or capital in nature, based on the nature, purpose, and effect of the work, as well as the accounting policies and standards of the business. You would also need to allocate the expenditure to the appropriate asset or expense accounts, and apply the appropriate depreciation or amortisation rates, based on the expected useful lives and residual values of the assets. You would then evaluate the impact of the project on the profitability, performance, and value of the property and the business.

5 Cash flows

Cash flow is the movement of cash in and out of a business over a period of time. Cash flow is influenced by the income and expenses of the business, as well as by its investing and financing activities. Cash flow is an important indicator of the liquidity, solvency, and viability of the business, as well as its ability to generate returns for its owners and creditors. Cash flow can be measured and projected using various methods and tools, such as cash flow statements, cash flow forecasts, cash flow budgets, and discounted cash flow analysis.

As a RICS APC candidate, you need to understand the concept and importance of cash flow, as well as the sources and uses of cash for different types of businesses and property transactions. You also need to be able to prepare and analyse cash flow statements, forecasts, budgets, and models, using appropriate assumptions, inputs, outputs, and techniques. You also need to be able to evaluate and compare the cash flow performance and potential of different businesses and property investments, using appropriate measures and indicators, such as net cash flow, free cash flow, cash flow from operations, cash flow margin, cash flow return on investment, and internal rate of return. Some of the relevant RICS guidance notes and UK laws that you should be familiar with are:

• RICS Guidance Note: Discounted Cash Flow for Commercial Property Investments, 1st edition

• RICS Guidance Note: Financial Viability in Planning, 1st edition

• RICS Guidance Note: Development Appraisals, 1st edition

• Companies Act 2006

• International Financial Reporting Standards (IFRS)

• UK Generally Accepted Accounting Practice (UK GAAP)

A real-life example of how to apply these principles and procedures is the cash flow analysis of a property development scheme. You would need to estimate the cash inflows and outflows of the scheme, based on the expected revenues, costs, timings, and risks of the project, as well as the financing and taxation arrangements. You would also need to discount the cash flows to their present values, using an appropriate discount rate, to calculate the net present value (NPV) and the internal rate of return (IRR) of the scheme. You would then use these metrics to assess the financial viability and attractiveness of the scheme, and to compare it with alternative options or scenarios.

6 Auditing

Auditing is the process of examining and verifying the financial statements and records of a business by an independent and qualified person or firm, known as an auditor. Auditing provides assurance and confidence to the users of the financial statements, such as shareholders, creditors, regulators, and tax authorities, that the financial statements are true and fair, and that they comply with the relevant accounting standards and regulations. Auditing can also identify and report any errors, fraud, or mismanagement that may affect the financial position and performance of the business.

As a RICS APC candidate, you need to understand the purpose and scope of auditing, as well as the roles and responsibilities of the auditors and the audited. You also need to be aware of the types and methods of auditing, such as internal and external auditing, statutory and voluntary auditing, and financial and operational auditing. You also need to be familiar with the standards and procedures of auditing, such as the auditing framework, the auditing cycle, the auditing evidence, the auditing opinion, and the auditing report. Some of the relevant RICS guidance notes and UK laws that you should be familiar with are:

• RICS Guidance Note: Audit Procedures for Monitoring the Quantity Surveyor's Cost Management Role, 1st edition

• RICS Guidance Note: Audit of Service Charge Accounts, 1st edition

• RICS Guidance Note: Audit of Project Management Services, 1st edition

• Companies Act 2006

• Auditing Standards issued by the Financial Reporting Council (FRC)

• International Standards on Auditing (ISA)

A real-life example of how to apply these principles and procedures is the audit of a property management company. You would need to examine and verify the financial statements and records of the company, such as the income and expenditure accounts, the balance sheet, the cash flow statement, and the service charge accounts. You would also need to check the compliance of the company with the relevant accounting standards and regulations, such as the RICS Service Charge Residential Management Code, the RICS Professional Statement: Service Charges in Commercial Property, and the Landlord and Tenant Act 1985. You would then form and express an opinion on the truth and fairness of the financial statements, and report any findings or recommendations to the users of the financial statements.

7 Ratio analysis

Ratio analysis is a technique that uses financial data to evaluate the performance, efficiency and solvency of a business. Ratios are calculated by dividing one financial figure by another, and they can be used to compare different businesses or periods of time. Some of the common ratios that RICS APC candidates need to know are:

• Liquidity ratios: These measure the ability of a business to meet its short-term obligations, such as current ratio and quick ratio.

• Profitability ratios: These measure the ability of a business to generate profits from its revenues, assets and equity, such as gross profit margin, net profit margin and return on equity.

• Efficiency ratios: These measure the ability of a business to use its resources effectively, such as asset turnover, inventory turnover and receivables turnover.

• Solvency ratios: These measure the ability of a business to meet its long-term obligations, such as debt-to-equity ratio and interest coverage ratio.

Ratio analysis can help RICS APC candidates to understand the financial health and performance of a business, and to identify its strengths and weaknesses. For example, a high current ratio indicates that a business has enough current assets to pay its current liabilities, while a low net profit margin indicates that a business has low profitability or high expenses. Ratio analysis can also help candidates to compare different businesses or projects and to make informed decisions.

However, ratio analysis also has some limitations that candidates need to be aware of. For example, ratios can vary depending on the accounting methods and policies used by different businesses, such as depreciation, inventory valuation and revenue recognition. Ratios can also be affected by external factors, such as inflation, exchange rates and industry trends. Therefore, candidates need to use ratios with caution and to supplement them with other sources of information, such as financial statements, budgets and forecasts.

The RICS guidance note on financial management provides more details and examples on how to use ratio analysis for RICS APC candidates. Candidates can also refer to the following sources for further guidance:

• Accounting for Non-Accountants: A Manual for Managers and Students by David Horner

• Financial Management for the Construction Industry by Robert L. Frick and Richard L. Frick

• Financial Management in Construction Contracting by Andrew Ross and Peter Williams

8 Credit control

Credit control is a process that involves managing the credit terms and collection of payments from customers. Credit control is important for any construction business, as it affects the cash flow, profitability and risk of the business. Poor credit control can result in late payments, bad debts and insolvency, while effective credit control can improve the liquidity, profitability and reputation of the business.

RICS APC candidates need to understand the principles and procedures of credit control, and how to apply them in practice. Some of the key aspects of credit control that candidates need to know are:

• Credit policy: This is a set of rules and guidelines that a business follows to grant credit to its customers, such as credit terms, credit limits, credit checks and credit ratings.

• Credit terms: These are the conditions and agreements that a business offers to its customers regarding the payment of invoices, such as payment period, payment method, discounts and penalties.

• Credit limits: These are the maximum amounts of credit that a business allows to its customers, based on their creditworthiness and risk profile.

• Credit checks: These are the methods and sources that a business uses to verify the identity, financial status and credit history of its customers, such as credit reference agencies, trade references and bank references.

• Credit ratings: These are the scores and grades that a business assigns to its customers, based on their creditworthiness and risk profile, such as AAA, BBB, CC and D.

Credit control can help RICS APC candidates to manage the cash flow and risk of a business, and to avoid or minimise the impact of late payments and bad debts. For example, a business can offer different credit terms and limits to different customers, depending on their credit ratings and payment history. A business can also use credit checks and credit ratings to screen and monitor its customers, and to identify any potential problems or issues. Credit control can also help candidates to communicate and negotiate with customers and to resolve any disputes or queries.

However, credit control also has some challenges and costs that candidates need to consider. For example, credit control can require a lot of time, resources and expertise to implement and maintain, and it can affect the relationship and trust between a business and its customers. Credit control can also be influenced by external factors, such as market conditions, legal regulations and customer behaviour. Therefore, candidates need to balance the benefits and costs of credit control and to adapt it to the specific needs and circumstances of the business.

The RICS guidance note on financial management provides more details and examples on how to use credit control for RICS APC candidates. Candidates can also refer to the following sources for further guidance:

• Credit Management by Glen Bullivant

• Credit Management Handbook by Brian Coyle

• Credit Control for Small and Medium-Sized Enterprises by John Hargreaves

9 Profitability

Profitability is a measure of the ability of a business to generate profits from its revenues, costs and investments. Profitability is one of the main objectives and indicators of success for any construction business, as it affects the growth, sustainability and value of the business. Profitability is also a key factor that influences the decisions and actions of various stakeholders, such as owners, managers, investors, lenders, customers and suppliers.

RICS APC candidates need to understand the concepts and methods of profitability, and how to calculate and analyse it for different purposes. Some of the common profitability measures that candidates need to know are:

• Gross profit: This is the difference between the revenue and the cost of goods sold (COGS) of a business, and it represents the profit that a business makes from its core operations, before deducting any overheads or taxes.

• Net profit: This is the difference between the gross profit and the operating expenses (OPEX) of a business, and it represents the profit that a business makes from its core operations, after deducting any overheads or taxes.

• Operating profit: This is the difference between the net profit and the interest and taxes (I&T) of a business, and it represents the profit that a business makes from its core operations, after deducting any interest and taxes.

• Profit margin: This is the ratio of the profit to the revenue of a business, and it represents the percentage of the revenue that a business retains as profit, after deducting any costs or expenses.

• Return on investment (ROI): This is the ratio of the profit to the investment of a business, and it represents the percentage of the investment that a business earns as profit, after deducting any costs or expenses.

Profitability can help RICS APC candidates to evaluate the performance and efficiency of a business, and to identify its strengths and weaknesses. For example, a high gross profit margin indicates that a business has a high mark-up or a low COGS, while a low operating profit margin indicates that a business has a high OPEX or a low net profit. Profitability can also help candidates to compare different businesses or projects and to make informed decisions.

However, profitability also has some limitations and challenges that candidates need to be aware of. For example, profitability can vary depending on the accounting methods and policies used by different businesses, such as revenue recognition, cost allocation and depreciation. Profitability can also be affected by external factors, such as market conditions, competition and customer demand. Therefore, candidates need to use profitability with caution and to supplement it with other measures of performance, such as cash flow, quality and customer satisfaction.

The RICS guidance note on financial management provides more details and examples on how to use profitability for RICS APC candidates. Candidates can also refer to the following sources for further guidance:

• Construction Accounting and Financial Management by Steven Peterson

• Construction Financial Management by S. L. Tang, Syed M. Ahmed and Raymond T. Aoieong

• Profitable Partnering for Lean Construction by Clive Thomas Cain

10 Insolvency

Insolvency is a situation where a business is unable to pay its debts when they are due, or where its liabilities exceed its assets. Insolvency is a serious risk and challenge for any construction business, as it can lead to legal actions, financial losses and reputational damage. Insolvency can also have a negative impact on the stakeholders of the business, such as owners, managers, employees, customers, suppliers and creditors.

RICS APC candidates need to understand the causes and consequences of insolvency, and how to prevent and manage it in practice. Some of the common causes of insolvency that candidates need to know are:

• Poor cash flow management: This is when a business fails to manage its inflows and outflows of cash, and to maintain a positive cash balance, resulting in a shortage of funds to pay its debts.

• Poor credit control: This is when a business fails to manage its credit terms and collection of payments from its customers, resulting in late payments, bad debts and reduced cash flow.

• Poor profitability management: This is when a business fails to manage its revenues, costs and investments, and to generate sufficient profits, resulting in reduced cash flow and increased liabilities.

• Poor risk management: This is when a business fails to identify, assess and mitigate the potential risks and uncertainties that can affect its operations, such as market fluctuations, contract disputes, project delays and quality issues, resulting in increased costs and liabilities.

• Poor stakeholder management: This is when a business fails to communicate and collaborate with its stakeholders, such as owners, managers, employees, customers, suppliers and creditors, resulting in conflicts, disputes and loss of trust.

Insolvency can have serious and lasting consequences for a business and its stakeholders, such as:

• Liquidation: This is when a business is wound up and its assets are sold to pay its debts, resulting in the termination of the business and the loss of its value.

• Administration: This is when a business is placed under the control of an administrator, who tries to rescue the business or sell it as a going concern, resulting in the suspension of the business and the loss of its autonomy.

• Receivership: This is when a business is placed under the control of a receiver, who tries to recover the debts owed to a secured creditor, resulting in the sale or disposal of the business or its assets.

• Company voluntary arrangement (CVA): This is when a business reaches an agreement with its creditors to repay its debts over a period of time, resulting in the continuation of the business and the reduction of its liabilities.

• Individual voluntary arrangement (IVA): This is when an individual reaches an agreement with his or her creditors to repay his or her debts over a period of time, resulting in the protection of his or her assets and the reduction of his or her liabilities.

Insolvency can be prevented and managed by applying the principles and procedures of financial management, such as cash flow management, credit control, profitability management, risk management and stakeholder management. RICS APC candidates need to demonstrate their competence and skills in these areas, and to provide evidence and examples of how they have dealt with insolvency issues in their practice.

The RICS guidance note on financial management provides more details and examples on how to prevent and manage insolvency for RICS APC candidates. Candidates can also refer to the following sources for further guidance:

• Insolvency in the Construction Industry by Mark Watson-Gandy

• Construction Insolvency by John Hughes and Ian Brown

• Construction and Insolvency by Jonathan Lewis and Andrew McGee

11 Legislation

Legislation is a set of laws and regulations that govern the activities and operations of a business. Legislation is important for any construction business, as it affects the rights, obligations and responsibilities of the business and its stakeholders, such as owners, managers, employees, customers, suppliers and creditors. Legislation also provides a framework and a mechanism for resolving any disputes or conflicts that may arise between the parties.

RICS APC candidates need to understand the relevant and applicable legislation that affects the financial management of a construction business, and how to comply with it in practice. Some of the key legislation that candidates need to know are:

• Construction Act 1996: This is an act that regulates the payment terms and dispute resolution procedures for construction contracts in England, Wales and Scotland.

• Housing Grants, Construction and Regeneration Act 1996: This is an act that amends and supplements the Construction Act 1996, and introduces changes to the payment terms and dispute resolution procedures for construction contracts in England, Wales and Scotland.

• Local Democracy, Economic Development and Construction Act 2009: This is an act that amends and supplements the Construction Act 1996 and the Housing Grants, Construction and Regeneration Act 1996, and introduces further changes to the payment terms and dispute resolution procedures for construction contracts in England, Wales and Scotland.

• Construction Contracts (Northern Ireland) Order 1997: This is an order that regulates the payment terms and dispute resolution procedures for construction contracts in Northern Ireland.

• Construction Contracts (Amendment) (Northern Ireland) Order 2011: This is an order that amends and supplements the Construction Contracts (Northern Ireland) Order 1997, and introduces changes to the payment terms and dispute resolution procedures for construction contracts in Northern Ireland.

• Insolvency Act 1986: This is an act that regulates the insolvency procedures and outcomes for businesses and individuals in the UK.

• Enterprise Act 2002: This is an act that amends and supplements the Insolvency Act 1986, and introduces changes to the insolvency procedures and outcomes for businesses and individuals in the UK.

Legislation can help RICS APC candidates to protect the interests and rights of a construction business and its stakeholders, and to avoid or minimise the risks and liabilities of the business. For example, the Construction Act 1996 and its amendments provide a statutory right to payment and a statutory right to adjudication for construction contracts, which can help to ensure timely and fair payment and to resolve disputes quickly and cheaply. The Insolvency Act 1986 and its amendments provide a range of insolvency options and outcomes for businesses and individuals, which can help to rescue or wind up a business and to repay or write off debts.

However, legislation also has some challenges and complexities that candidates need to consider. For example, legislation can vary depending on the jurisdiction, sector and type of contract, and it can change over time due to amendments and updates. Legislation can also be subject to interpretation and application by the courts and tribunals, which can create uncertainty and inconsistency. Therefore, candidates need to keep up to date with the current and relevant legislation and to seek professional advice and guidance when necessary.

The RICS guidance note on financial management provides more details and examples on how to comply with legislation for RICS APC candidates. Candidates can also refer to the following sources for further guidance:

• Construction Law by John Uff

• Construction Law Handbook by Vivian Ramsey and Stephen Furst

• Construction Contracts: Law and Management by John Murdoch and Will Hughes

12 Conclusion

In conclusion, the comprehensive understanding and application of financial principles and procedures outlined in this guide are paramount for RICS APC candidates. Through the examination of balance sheets, profit and loss accounts, taxation, revenue and capital expenditure, cash flows, auditing, ratio analysis, credit control, profitability, insolvency, and legislation, candidates gain a holistic perspective on financial management within the construction industry.

These concepts and skills enable candidates to assess the financial health, performance, and risks of businesses and property transactions effectively. Furthermore, they empower candidates to make informed decisions, implement sound financial strategies, and mitigate potential challenges such as late payments, bad debts, and insolvency.

By adhering to relevant RICS guidance notes and UK laws, candidates ensure compliance with industry standards and regulations, fostering trust and confidence among stakeholders. Moreover, the ability to navigate complex financial landscapes and adapt to changing legislative frameworks underscores the professionalism and expertise expected of RICS APC candidates.

In essence, mastery of financial management principles and procedures equips candidates with the competencies needed to navigate the intricacies of the construction industry successfully. As they progress in their careers, these skills will remain invaluable, enabling them to contribute meaningfully to the financial sustainability and growth of businesses and projects in the built environment.