Business finance - Financial records and accounting requirem...

Learning Outcomes

This article outlines the core legal and practical requirements for business financial records and accounting in England and Wales, including:

• the mechanics and purpose of double-entry bookkeeping, journals, ledgers and trial balances, and how these underpin lawful record-keeping
• the structure, content and exam-significant figures in the profit and loss account, balance sheet and cash flow statement
• statutory obligations under the Companies Act 2006 to keep adequate records, prepare true and fair accounts and retain documents
• directors’ legal responsibilities for approving accounts, ensuring timely filing, implementing internal controls and responding to potential insolvency
• the distinctions between UK GAAP (FRS 102 and the small-entities and micro-entity regimes) and IFRS for listed issuers, with typical exam comparisons
• core accounting concepts such as accruals, going concern, materiality, revenue recognition and “true and fair view”, and how they affect legal compliance
• the availability of audit exemptions, filing deadlines for private and public companies, and the consequences of late or defective filings
• the wider governance and reporting framework, including confirmation statement, PSC register, and for premium-listed issuers, UK Corporate Governance Code expectations
• practical application of these rules to SQE1-style fact patterns, enabling accurate issue-spotting, application of statutory provisions and identification of director liability

SQE1 Syllabus

For SQE1, you are required to understand business finance and accounting requirements from a practical legal standpoint, with a focus on the following syllabus points:

• the principles and purpose of double-entry bookkeeping
• the structure and content of statutory financial statements (profit and loss account, balance sheet, cash flow statement)
• the legal obligations for maintaining accounting records under the Companies Act 2006
• the duties of directors regarding financial reporting and compliance
• the consequences of non-compliance with accounting and filing requirements
• audit requirements and exemptions for small and micro-entities
• annual confirmation statement and PSC register obligations and their interaction with filing at Companies House
• the role of accounting standards (FRS 102 and IFRS) and concepts such as materiality, accruals, going concern, and revenue recognition
• internal controls, board oversight and (for premium listed companies) UK Corporate Governance Code provisions on audit, risk and internal control

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is the fundamental rule of double-entry bookkeeping, and why is it important for legal compliance?
2. Which three main financial statements must UK companies prepare and file under the Companies Act 2006?
3. What are the key statutory duties of directors regarding company accounting records and annual accounts?
4. What are the possible legal consequences if a company fails to file its annual accounts on time?

Introduction

Accurate financial records are essential for all businesses. In England and Wales, the law sets out strict requirements for how companies must keep accounting records, prepare financial statements, and report to Companies House. These rules ensure transparency, protect creditors, and support effective corporate governance. For SQE1, you must understand the legal framework for business finance and accounting, the main types of financial statements, and the responsibilities of directors. You must also be aware of annual filing obligations such as the confirmation statement and the maintenance of a PSC register, the regime for small and micro-entity reporting, and how recognised accounting standards underpin the “true and fair view” required by statute.

Double-Entry Bookkeeping

All businesses must keep records that accurately reflect their financial transactions. The double-entry system is the standard method used.

Key Term: double-entry bookkeeping
A system of accounting where every transaction is recorded in at least two accounts, with equal debits and credits, ensuring the books always balance.

This system ensures that the accounting equation—assets = liabilities + equity—remains true after every transaction. Debits and credits are not inherently “good” or “bad”—they are directional:

• debits increase assets and expenses, and decrease liabilities and equity
• credits increase liabilities, equity and income, and decrease assets

Under double-entry:

• each transaction is first recorded in journals, posted to ledgers (general and subsidiary), and then summarised in a trial balance
• adjusting entries (e.g., accruals, prepayments, depreciation) ensure the accounts reflect the accrual basis for the period
• the trial balance provides a check that total debits equal total credits before financial statements are prepared

Key Term: trial balance
A periodic list of all ledger balances showing total debits equal total credits, used as a control step before preparing final accounts.

Key Term: accrual basis
The accounting principle that income and expenses are recognised in the period in which they are earned or incurred, not when cash is received or paid.

This discipline supports legal compliance because adequate records must “show and explain” transactions and financial position with reasonable accuracy, enabling directors to prepare lawful accounts.

For example, if a company buys equipment for cash, one asset (equipment) increases while another asset (cash) decreases. If a company incurs an expense but hasn’t yet received the supplier’s invoice, an accrual ensures the expense is recognised and a liability is recorded.

Worked Example 1.1

A company pays £2,000 for new computers using its bank account. How is this recorded under double-entry bookkeeping?

Answer:
Debit "Computers" (asset) £2,000; Credit "Bank" (asset) £2,000. The total assets remain unchanged, and the books stay balanced.

Financial Statements

Companies must prepare and file annual financial statements that give a true and fair view of their financial position.

Key Term: financial statements
Formal records summarising a business’s financial activities, including the profit and loss account, balance sheet, and cash flow statement.

Key Term: true and fair view
The statutory requirement that accounts present faithfully the company’s performance and position, applying appropriate accounting standards, with suitable disclosures and judgments.

Profit and Loss Account (Income Statement)

This statement shows the company’s income and expenses over a period, resulting in a net profit or loss.

Key Term: profit and loss account
A financial statement showing a company’s income, expenses, and profit or loss over a specific period.

Key features include revenue, cost of sales (if applicable), gross profit, operating expenses (administrative, distribution), operating profit, finance costs, tax, and net profit. Under the accrual basis, adjustments such as accruals, prepayments, depreciation, provisions for doubtful debts and stock movements ensure the period statement reflects activity, not cash flows.

Balance Sheet

The balance sheet provides a snapshot of the company’s assets, liabilities, and equity at a specific date.

Key Term: balance sheet
A statement of a company’s assets, liabilities, and equity at a particular point in time.

Assets are typically split into non-current (e.g., property, plant and equipment, intangible assets) and current (e.g., stock, receivables, cash). Liabilities are split into current (due within 12 months) and non-current. Equity shows share capital, share premium, reserves and retained earnings. The net assets figure equals total equity.

Cash Flow Statement

This statement tracks the movement of cash in and out of the business, divided into operating, investing, and financing activities.

Key Term: cash flow statement
A financial statement showing how cash enters and leaves a business during a period.

Small companies using the small-entities regime may be exempt from preparing a cash flow statement under UK GAAP, but larger and listed companies must present one.

Statutory Accounting Requirements

The Companies Act 2006 imposes strict duties on companies and their directors regarding accounting records and financial reporting.

Key Term: Companies Act 2006
The main statute governing company law in England and Wales, including accounting and reporting obligations.

Accounting Records

Companies must keep adequate accounting records that:

• show and explain the company’s transactions
• disclose the company’s financial position with reasonable accuracy
• enable directors to ensure that annual accounts comply with the law

Adequate records include day-to-day entries of money received and paid, records of assets and liabilities, and for businesses dealing in goods, records of stock movements and purchases/sales. Records may be kept electronically and must be retrievable and intelligible. Records must be retained for at least six years and kept at the registered office or other permitted location, with directors ensuring they can be produced for inspection and used to prepare accounts.

Key Term: going concern
The assumption that a company will continue in business for the foreseeable future; directors must consider and disclose if this assumption is not appropriate.

Companies must also maintain statutory registers (e.g., members, directors, charges (where applicable), PSC) and minutes of board and general meetings for prescribed periods.

Key Term: PSC register
A register of people with significant control over the company (e.g., holding more than 25% of shares or votes, or the right to appoint/remove a majority of directors).

Annual Accounts

Directors must prepare annual accounts for each financial year. These must:

• give a true and fair view of the company’s assets, liabilities, financial position, and profit or loss
• comply with applicable accounting standards (such as FRS 102 or IFRS)
• be approved by the board and signed by a director

Private companies must file accounts at Companies House within nine months of the year-end; public companies have six months. The accounting reference date will default to the last day of the month of incorporation unless changed (form AA01). Directors must also circulate accounts to members and, except for small and micro-entities, prepare a directors’ report; audit exemptions may apply for small companies.

Key Term: accounting reference date
The date to which annual accounts are prepared; it defaults to the last day of the month of incorporation and can be changed by filing AA01.

Key Term: small company
A company meeting thresholds for turnover, balance sheet total and employees, qualifying for certain reporting simplifications and audit exemption.

Key Term: micro-entity
An entity meeting very small thresholds, permitted to use highly simplified micro-entity accounts under FRS 105.

In addition to annual accounts, every company must file an annual confirmation statement.

Key Term: confirmation statement
An annual filing (form CS01) confirming that company information on the public register is up to date; filed within 14 days of the “confirmation date” (the anniversary of incorporation).

Worked Example 1.2

A private company’s financial year ends on 31 December. By what date must it file its annual accounts at Companies House?

Answer:
By 30 September of the following year (nine months after year-end).

Directors’ Legal Duties

Directors are personally responsible for ensuring the company complies with its accounting and reporting obligations.

Key Term: directors’ duties
Legal obligations imposed on company directors, including the duty to keep proper accounting records and file annual accounts.

Directors must:

• approve the annual accounts and confirm they are true and fair
• ensure accounts are filed on time
• maintain adequate internal controls to prevent errors or fraud

Failure to keep adequate accounting records is a criminal offence. Failure to file accounts attracts automatic civil penalties and may lead to prosecution and, for persistent defaults, potential disqualification. Directors must also consider stakeholder interests under general duties (e.g., s.172 CA 2006) and, if insolvency is likely, prioritise creditors’ interests.

Exam Warning

Failing to file accounts or keep proper records is a criminal offence for both the company and its directors. Penalties include fines, prosecution, and possible disqualification from acting as a director.

Accounting Standards

Companies must prepare accounts in accordance with recognised accounting standards.

Key Term: accounting standards
Rules and guidelines (such as FRS 102 or IFRS) that set out how financial statements must be prepared and presented.

• FRS 102 applies to most UK companies, with Section 1A providing a simplified regime for small entities; micro-entities may use FRS 105.
• IFRS is required for listed companies and may be used by others.

Key Term: FRS 102
The main UK GAAP standard for most entities, with a small entities regime (Section 1A) enabling reduced disclosures.

Key Term: IFRS
International Financial Reporting Standards, required for UK listed companies’ consolidated accounts and often more detailed than UK GAAP.

These standards govern how items such as revenue, expenses, assets, and liabilities are recognised and measured. The “true and fair view” is achieved by applying the relevant framework, materiality, and appropriate accounting judgments, with sufficient disclosure.

Materiality and Revenue Recognition

Two key accounting concepts are materiality and revenue recognition.

Key Term: materiality
The principle that only information that could influence users’ decisions must be disclosed in financial statements.

Key Term: revenue recognition
The rules for determining when income is recorded in the accounts, usually when goods or services are delivered and control passes to the customer.

Under IFRS 15, revenue recognition typically follows a five-step model (identify the contract, identify performance obligations, determine transaction price, allocate price, recognise revenue when/as performance obligations are satisfied). Under FRS 102, revenue from the sale of goods is recognised when the significant risks and rewards of ownership transfer; service revenue is recognised by reference to the stage of completion when outcomes can be reliably measured.

Incorrect application of these principles can lead to misleading accounts and potential legal consequences. Materiality also influences disclosures—immaterial items may be aggregated or omitted without obscuring the true and fair view.

Worked Example 1.3

A company receives payment in advance for services to be provided next year. When should it recognise the revenue?

Answer:
Revenue should be recognised when the services are performed, not when the cash is received. Until then, recognise a contract liability (deferred income).

Worked Example 1.4

At year-end, the company has benefited from £3,000 of utilities but received invoices for only £2,200. How should the missing £800 be treated under the accrual basis?

Answer:
Recognise an accrual: Debit utilities expense £800; Credit accruals (current liability) £800. This ensures the expense reflects the full benefit consumed in the period.

Internal Controls and Corporate Governance

Effective internal controls help ensure the accuracy of financial records and compliance with legal requirements.

Key Term: internal controls
Systems and procedures put in place by a company to ensure the reliability of financial reporting and compliance with laws.

Directors must implement controls to detect and prevent errors or fraud. Controls include segregation of duties, reconciliations (e.g., bank), authorisation procedures, and oversight by the board. Larger companies may have an audit committee to oversee financial reporting and liaise with auditors.

For companies with a premium listing, the UK Corporate Governance Code sets principles and provisions on board leadership, division of responsibilities, composition, and “audit, risk and internal control.” Provisions operate on a “comply or explain” basis; premium-listed companies must explain application of Principles and compliance or non-compliance with Provisions in their annual report. Breaches of the Listing Rules (e.g., failure to report Code compliance statements) can result in FCA sanctions.

Consequences of Non-Compliance

Failure to comply with accounting and reporting requirements can have serious legal and commercial consequences:

• Late filing of accounts results in automatic financial penalties.
• Persistent failure can lead to prosecution of the company and its directors, and in serious cases, to disqualification.
• Companies House may initiate strike-off for repeated non-compliance with filing obligations.
• Inaccurate accounts can result in claims for damages, regulatory action, or breach of directors’ duties.
• For premium-listed issuers, non-compliance with Listing Rules reporting (e.g., corporate governance statements) can lead to public censure or fines.

Worked Example 1.5

A company fails to file its accounts for two consecutive years. What are the possible consequences?

Answer:
The company and its directors may be fined, prosecuted, or struck off the register. Directors may also be disqualified.

Worked Example 1.6

A listed company recognises revenue on shipment even though the contract transfers control only on customer acceptance testing. What is the likely effect and compliance issue?

Answer:
Revenue is overstated and recognised prematurely, breaching IFRS 15. This can undermine the “true and fair view,” risk restatements, damage market credibility, and, if disclosures are deficient, trigger Listing Rule concerns.

Key Point Checklist

This article has covered the following key knowledge points:

• The double-entry bookkeeping system is the legal standard for business accounting in England and Wales, supporting accurate ledgers, trial balance and accrual-based adjustments.
• Companies must prepare and file annual financial statements: profit and loss account, balance sheet, and (for most) cash flow statement giving a true and fair view.
• The Companies Act 2006 sets out strict requirements for accounting records, annual accounts, and directors’ duties, including retention and adequacy of records.
• Filing timelines: private companies within nine months; public companies within six months; confirmation statements must be filed annually.
• Directors are personally responsible for ensuring compliance with accounting and filing obligations, and for internal controls and governance.
• Companies must apply recognised accounting standards (FRS 102 or IFRS) and key principles such as materiality, accruals, going concern, and revenue recognition.
• Small companies may qualify for audit exemption and reduced disclosures; micro-entities may use micro-entity accounts.
• Companies must maintain a PSC register and statutory registers, and keep minutes of meetings; information can be kept electronically if retrievable.
• For premium-listed companies, the UK Corporate Governance Code requires reporting on application of Principles and compliance with Provisions on a comply-or-explain basis.
• Failure to comply can result in fines, prosecution, disqualification, or the company being struck off, and can attract FCA sanctions for Listing Rule breaches.

Key Terms and Concepts

• double-entry bookkeeping
• trial balance
• accrual basis
• financial statements
• true and fair view
• profit and loss account
• balance sheet
• cash flow statement
• Companies Act 2006
• directors’ duties
• accounting standards
• FRS 102
• IFRS
• small company
• micro-entity
• accounting reference date
• confirmation statement
• PSC register
• materiality
• revenue recognition
• going concern
• internal controls