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How do I understand my annual accounts and corporation tax return?

Understanding your set of year end accounts & CT600

You’'ve been working hard all year and hopefully you have been getting paid by your clients and withdrawing that hard earned money out of the company for yourself. Everything seems to be going well, but how well, and how would you compare this to another company? These last two questions are where year-end accounts documents come in - they are there to show a true and fair view of your company’s accounts, and to be comparable year-on-year and to other companies. Every company, from a tiny one with sales of just £100 to the largest corporations listed on stock exchanges throughout the world follow the same accounting conventions and principles and it is this consistency that allows different companies to be compared by external users, ie being assessed by potential investors, and for you as the manager to compare how well you have done this year to last year and possibly areas you need improve, as well as proving your income or assets to other interested third parties, such as banks.

What makes up the full year end accounts, the abbreviated accounts and CT600?
The two most important pages in your year-end accounts are the “Profit and Loss” and “Balance Sheet”.

The Profit and Loss shows the profit you made during a period, usually a year, this is the “how much money you made” part of document.

The Balance Sheet is a snapshot of the value of a company based on its assets and liabilities at the year end date.

The full year end accounts will have both these pages plus a number of additional pages which provides more information to the figures that make up the Profit and Loss and Balance Sheet and also explains the accounting principles that have been applied.

The abbreviated accounts will just show the Balance Sheet of the company with fewer notes as to what made up these figures.

The CT600, or Corporation Tax Return, is its own document as there are different tax treatments of transactions compared to in the accounting treatments. CT600s are limited to periods of 365 days, so if your accounts are longer than this (as they usually are in the incorporation).

The full accounts are attached to the CT600 when filed with HMRC, so HMRC will also have access to more information than other external users of the accounts who will only be able to download the abbreviated accounts from Companies House (unless of course you supply the full accounts, as is often requested by banks when applying for a business loan).

Reading and interpreting these documents
In order to fully understand your year-end documents, it is important to understand the key accounting conventions and concepts:

True and fair view
The reason for producing accounts is so that anyone can determine with a decent degree of accuracy and reliability the value and profit of your company. Deliberately misleading information, or information portrayed in an inconsistent way (to previous years or accepted accounting conventions) hinders an outsider’s (and in-fact anyone’s) ability to do so.

Monetary measurement
Items are not accounted for unless they can be reliably quantified in monetary terms. Such things as workforce skill and brand recognition (goodwill) are not accounted for (unless there is someone prepared to pay for them).

There is a high degree of judgement that comes with preparing a set of accounts and this convention ensures that where a decision is required it is only an issue if it will affect the outcome of an outsiders view of the accounts. This depends on either or both the type of transaction and its size.

This concept is also known as the matching principle - you match expenses to the income it was used for, and you match the income to the year the work was done. This can get surprisingly complicated but some of the most common outcomes of this rule for contractors and small companies is:

  • Fixed Assets, rather than being set off against the profit in the year they are bought they are included as assets on the Balance Sheet and depreciated over their expected useful life which spreads the “expense” over the number of years the asset is used. (This is very different to the current tax treatment of assets which are essentially depreciated fully for tax in the year they are bought if within the AIA).
  • The inclusion of a “Work-in-progress” adjustment to the accounts which brings forward income from the following period on the basis of when the actual work was done. As an example, if your year-end was March, but you did not invoice for the work done in March until the first week of April, expect to see this invoices’s value included in the March accounts.

Going concern
Unless known otherwise accounts are prepared under the assumption that the business is not going to go broke or close down in the foreseeable future. This affects that accounting treatment of assets and liabilities in the accounts.

The Profit & Loss Page
This page shows the headline figures of your accounts - how much money you made. There different ‘profit’ figures which are calculated until you end up with the final ‘Profit for the year’ figure and this is to add more detail to your company’s money is made:

Gross Profit
(Income less Cost of Sales)
This profit figure represents the amount of profit you made on your core trading activity. For example, if your business was selling Product A, which was made by combining Materials B and C, then your gross profit is the money you made from sales on Product A less the cost of Materials B and C. Using the accruals concept it is only the cost of Materials that have actually been used in sales of Product A - unused Materials would not be included in the cost of sales figure until the period in which they used.

Operating profit
(Gross profit less Administrative expenses)
This profit figure represents the amount of profit made by the company after all other running costs. Examples are accountancy costs, travel and subsistence costs and staff costs.

Profit on ordinary activities before taxation
(Operating profit plus finance income less finance costs)
Finance income/expenses are kept separate and added on after operating profit to give the final pre-tax profit figure.

Profit for the year
(Profit on ordinary activities before taxation less tax)
This is the main figure for most people - after tax, how much money the company actually generated in a given period.

The last few lines on the profit and loss page shows the movement of the Profit and Loss account: This year’s profit is added to the profit retained in the company from previous year’s, then any profit taken out of the company as dividends is deducted to leave the Retained profit forward carried forward to future years.

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