2. Principles and Concepts

Question 1

What are the fundamental characteristics of financial information?

Answer 1

1. Relevance (material and influences decisions)

2. Faithful representation (complete, neutral and free from error)

Question 2

What are the enhancing qualities of financial information?

Answer 2

1. Comparability (period to period / different entity)
2. Verifiability (independent observers agree of faithful representation)
3. Timeliness
4. Understandability

Question 3

What is the underlying assumption of the financial statements?

Answer 3

That the company is a going concern - it will continue to operate for the foreseeable future.

Question 4

What is materiality?

Answer 4

Information is material if omitting it or misstating it could influence the decisions that users might make based on a set of financial statements (due to size or nature).

Question 5

What is the substance over form concept?

Answer 5

Faithful representation implies that financial information should reflect the economic substance, even where this is different from the legal form.

Question 6

What is the separate legal entity concept?

Answer 6

The business is a separate entity from its owner.

Question 7

What is the accruals concept?

Answer 7

Income and expenses should be recognised in the period in which they have been earned or incurred, rather than when cash is received or paid.

Question 8

What is the consistency concept?

Answer 8

A business should use the same accounting treatment for similar events and transactions over a period of time (leads to comparability)

Question 9

What is the prudence concept?

Answer 9

The exercise of caution when making judgements under conditions of uncertainty.

Question 10

What is the historic cost concept?

Answer 10

Transactions are recorded at their historic cost (the amount paid or invoiced)

Question 11

What are the benefits and limitations of the historic cost concept?

Answer 11

Benefits: Enhances verifiability and understandability
Limitations: limits relevance and comparability

Question 12

In periods of rising prices, what is the impact of the historic cost concept on profits and asset values?

Answer 12

Overstates profits and understates asset values

Question 13

What is an asset?

Answer 13

A present economic resource which is controlled by the entity

Question 14

What is a current asset?

Answer 14

One which continually flows through the business and are generally used with one year (e.g. inventory, receivables and cash)

Question 15

What is a non-current asset?

Answer 15

Assets used over a period of more than one year (can be tangible or intangible)

Question 16

What is capital?

Answer 16

The owners’ stake in the business / what the business owes the owner

Question 17

What is a liability?

Answer 17

A present obligation to transfer an economic resource i.e. owing something to someone else (current e.g. payables or non-current e.g. bank loan)

Question 18

What is equity?

Answer 18

The residual interest in the assets of an entity after deducting all it’s liabilities

Question 19

What are the two calculations for equity? (The accounting calculations)

Answer 19

EQUITY = ASSETS - LIABILITIES
EQUITY = NET ASSETS = SHARE CAPITAL + RESERVES

Question 20

What is the calculation represented in the Statement of Financial Position?

Answer 20

ASSETS = EQUITY + LIABILITIES

Question 21

What are the main limitations of accounting and financial statements?

Answer 21

1. They are only historical (not forward looking)
2. Do not include values of internally generated brands, goodwill or knowledge
3. Do not include any information about effects on the natural environment

Question 22

What is an integrated report?

Answer 22

A report to stakeholders on the strategy, performance and activities of an organisation to create and sustain value over the short, medium and long term.