3.4-3.5 Flashcards
Stakeholders that use accounting information 8
- Business managers
- workforce
- banks
- creditors such as suppliers
- customers
- government and tax authorities
- investors and potential investors
- local community
Limitations of accounting information to stakeholders
- One set of accounts is of limited use
- Accounts do not measure items which cannot be expressed in monetary terms
3.The accounts of one business do not allow for comparison
4.Business accounts will only publish the minimum
Information required by cow - Accounts are historic
- Window dressing
Window dressing definition
Presenting the accounts of a business in the best possible, or most flattering, way which could potentially mislead users of accounts
Depreciation definition
The decline in the estimated value of fixed asset over time
Assets definition
Items of monetary value that are owned by a business
Accounts definition
Financial records of business transactions which provide information to groups within and outside on arganization. They help to keep track of assets, liabilities, revenue, and expenses
Accounting fraud
the intentional manipulation of financial statements in a way that’s intended to falsify the appearance of the company’s finances.
Financial misconduct
any misappropriation, mismanagement, waste or theft of the finances of a municipality,
Auditing definition
is the process of examining an organization’s (or individual’s) financial records to determine if they are accurate and in accordance with any applicable rules
Corporate governance
Corporate governance is the system by which companies are directed and controlled.
Insider trading
accountants and financial managers are privy to confidential information. It is therefore essential that those with access to such data and information about a certain company do not misuse this for their personal benefit.
Insider trading occurs when an individual makes a trade on the stock exchange after learning important and confidential information about a particular company for their own personal gain. This information is not, however, available in the public domain.
Principles and ethics of accounting practice
-ethics
-integrity
-objectivity
-confidentiality
-professional conduct
Types of accounts
- The profit & loss (income statement)
- Balance sheet
The profit & loss account definition
This records the revenue, costs and profit (or loss) of a business over given time period
Balance sheet definition
Accounting statement that records the values of a business’s assets, liabilities and shareholders equity at a one paint in time. This shows the net worth of a company: the difference between the value of what company owns (assets) and what it owns (liabilities)
Profit & loss account order of stating
- sales revenue
- Cost of goods sold
- gross profit
- Expenses
- net profit before interest and tax
- Interest
- net profit before tax
- Tax
- net profit after tax and interest
- Dividends
- Retained profit
Trading accounts
Snows gross profit/loss from trading activities of the business
Includes:
Sales revenue
Cost of goods sold
Gross profit
Profit & loss part of income statement
Calculates net profit/loss and profit/loss after taxes are paid
Includes:
Expenses
Net profit before, interest and tax
Interest
Net profit before tax
Tax
Net profit after tax and interest
Appropriation accounts
Shows how profits after tax are distributed (appropriated) to the owners or shareholders
Includes:
Dividends
Retained profit
Cost of Goods sold formula
Cogs = opening stock + purchases - closing stock
Explain the use of profit and loss accounts
• they can be used to measure and compare the performance of a business over time or with other firms - and ratios can be used to help with this form of analysis
• The actual profit data con be compared with the expected profit level of the business
• Bankers and creditors of the business will need the information to help them decide whether to lend the money to the business
• Potential investors way asses the value of investing in a business from the level of profit made. However, when doing this it is essential to try and differentiate between “ low quality” and “high quality” profit
Low quality profit definition
A one-off profit that cannot be repeated - the sale of an asset for example for higher than its balance sheet value
High-quality profit
Profit that can be repeated or sustained
Balance sheet should show two important things
•The organization’s source of finance, including borrowings (part of its liabilities) and equity (internal finance invested by shareholders, and accumulated retained profits)
• The orgenzation’s uses of finance, how business has used its sources of finance, such as the purchase of fixed cessets and current assets for trading
Balance sheet categories
Assets - things the company owns
Liabilities- money the company owes
Types of assets
Fixed-these ave tangible items that will be retained and used by a business for at least a year. Examples are land, buildings and vehicles
Current - items that are seen as liquid easily converted to cash such as inventory, accounts receivable and cash
Working capital definition
The money that the firm has for its daily operations. Also known as net current assets
Working capital formula
Working capital = current assets- current liabilities
Net assets definition
Refers to the overall value of organisation’s assets after all its liabilities are deducted
Net assets formula
Net assets= total assets- total liabilities
Or
Net assets = (fixed assets+ current assets)- (Long- term liabilities + current liabilities)
For a balance sheet to be balanced
Net assets = the value of equity
Equity is compromised of
Share capital and retained profit
Share capital definition
The value of equity in a company that is funded by shareholders, either through initial public offering or via a share issue
Retained profit definition
Is value of equity in a business that is funded by net profit after tax that is not distributed as dividends to shareholders. Instead, it is kept as an internal source of finance for the business to use
It appears in both the balance sheet and profit and loss accounts
Balance sheet order of stating
- Fixed assets
- Accumulated depreciation
- net fixed assets
- Current assets
- Cash
- Debtors
- stock
- Current liabilities
- Overdraft
- Creditors
- short term loans
- total current liabilities
- net current assets (working capital)
- Total assets less current liabilities
- Long-term liabilities (debt)
- Net assets
Financed by:
• share capital
• accumulated retained profit - Equity
Intangible assets definition
Assets that have no physical substance and are not financial instruments (such as bank accounts and accounts receivable). They include assets such as goodwill, copyright, patent, and trademarks
Goodwill definition
The reputation and established networks (know-how) of an organnization, which adds significant above the market value of the firms physical assets
Patent definition
The official rights given to a business to exploit an invention on process for commercial purposes
Copyright definition
Gives the registered owner the legal rights to a creative pieces of work
Trademark definition
Form of intellectual property; give the listed owner the legal and excessive use of the registered brands, logos, and/or slogans
Intangible assets are difficult to value
Due to their subjective nature and in many cases they will not show on the balance street. Thus, they can be used to “window dress” on artificially increase a firm’s value just before a purchase
The market value with many intangible assets
Will be much greater than the balance sheet or book value
Ratio analysis
Quantitive management planning and decision-making tool used to analyse and evaluate the financial performance of a business
These can be further categorized as:
• profitability
• liquidity
• efficiency
Purpose of ratio analysis
- Examine a firm’s financial position
- Asses a firm’s financial performance
- Compare actual figures with projected or budgeted figures
- Aid decision-making
Ratio comparison
- Historical - comparing the same ratio in two different time periods for the same business
- Inter firm - comparing the ratios of businesses in the same industry
You cannot compare ratios of firms in different industries because the level of risk and gross profit margin will differ greatly.
Gross profit margin and net profit margin
Are used to asses how successful the management of a business has been at converting sales revenue into both gross profit and net profit. It is a measure of the percentage of gross profit or net profit a firm earns on each dollar it makes
Net profit margin accounts both direct costs and indirect costs thus it is a better measure of profitability
Gross profit margin formula
Gross profit (%) = (gross profit/sales revenue)*100
Operating profit (net profit or profit before interest and taxation) formula
Gross profit- overhead expenses
Net profit margin formula
Net profit margin (%)= (net profit before tax and interest/ sales revenue)*100
Capital employed formula
Capital employed= loan capital (or long-term liabilities)+share capital+ accumulated retained profit
Gross profit formula
Sales revenue- cost of goods sold
Improving profit margins
Increase selling price
Reduce direct costs (labour and raw materials)
Reduce indirect costs (overhead)
Increase sales through advertising and promotion
ROCE (return on capital employed) definition
Efficiency ratio
Look at how efficiently an organization uses its capital or total assets to create goods and services that are turned into profit
It can be thought of as a measure of reward (profit) for the risk taking by entrepreneurs
The higher the value the better
