AB11120- Fundamentals of Accounting and Finance.

Question 1

What is accounting?

Answer 1

The process of identifying, measuring and communicating information to permit informed judgements and decisions by users of the information.

Question 2

Define financial accounting.

Answer 2

to provide information about the financial position, performance and changes in the financial position of an enterprise that is useful to a wide range of users in making economic decisions.

Question 3

Define management accounting.

Answer 3

the identification, generation, presentation, interpretation and use of information relevant to: formulating business strategy; planning and controlling activities; decision making: efficient resource usage; etc

Question 4

List the users of financial accounting.

Answer 4

Investors, suppliers, competitors, customers, employees, general public, Government, investment analysts, lenders, managers.

Question 5

List the differences between financial and management accounting.

Answer 5

-Nature of reports produced.
-Level of detail.
-The existence of regulations.
-Reporting interval.
-Time orientation.
-Range and quality of information.

Question 6

Differences in financial and management accounting in terms of the nature of reports produced.

Answer 6

F: Tend to be ‘general purpose, Useful to a broad audience

M: Tend to be for a specific purpose* Used by a particular manager or for a particular E.g. ‘Shall we expand?’,‘How many units do we need to sell to make a profit?

Question 6

Differences in financial and management accounting in terms of level of detail.

Answer 6

F: Provide a broad overview of performance* Information is aggregated* Some detail is lost

M: More detailed, Necessary for decision-making.

Question 6

Differences in financial and management accounting in terms of the existence of regulations.

Answer 6

F: For many businesses, financial reports are subject to regulation* Need to have standard content and format* Need to comply with accounting standards.

M: For internal use only* Often confidential* No regulations* Prepared according to firm requirements

Question 6

Differences in financial and management accounting in terms of the reporting interval.

Answer 6

F: Usually prepared once a year* Big companies also produce shorter,interim reports

M: Produced as frequently as required: monthly, weekly or even daily* Allows for regular checking of progress* Enables action to be taken necessary, Special purpose reports prepared as necessary

Question 7

Differences in financial and management accounting in terms of time orientation.

Answer 7

F: Reflect performance for the previous period* Backward-looking

M: More concerned with future performance,though they do report on past performance

Question 8

Differences in financial and management accounting in terms of range and quality of information.

Answer 8

F: Concentrate on information which can be quantified in monetary terms. Places emphasis on objective, verifiable evidence Errors or misrepresentations can have serious consequences

M: Also produces reports with non-financial information,e.g. stock levels and output* Information may be less objective and verifiable but it is only for internal use* Managers need to work with the best information available – may not turn out to be correct

Question 9

Define sole trader.

Answer 9

A business is owned by a single individual and is not legally separate from the owner, e.g newsagents/corner shops, garages

Question 10

What is a balance sheet ?

Answer 10

provides information on the financial position of a business (its assets and liabilities at a point in time).

Question 11

What is a statement of profit or loss/ income statement?

Answer 11

provides information on the performance of a business (the profit or loss which results from trading over a period of time).

Question 12

What is the statement of cash flow?

Answer 12

provides information on the financial adaptability of a business (the movement of cash into and out of the business over a period of time).

Question 13

what is an asset?

Answer 13

essentially a resource held by a business.

Question 14

what must an asset be to be an asset?

Answer 14

It must be an economic resource. This type of resource provides a right to potential economic benefits. These benefits must not, however, be equally available to others. Take, for example, what economists refer to as public goods. These include resources such as the road system, GPS satellites or official statistics. Although these may provide economic benefits to a business, others can receive the same benefits at no great cost. A public good cannot, therefore, be regarded as an asset of a business for accounting purposes.

The economic resource must be under the control of the business. This gives a business the exclusive right to decide how the resource is used as well as the right to any benefits that flow. Control is usually acquired by a business through legal ownership or through a contractual agreement (for example, leasing equipment).

The event, or transaction, leading to control of the resource must have occurred in the past. In other words, the business must already exercise control over it

The economic resource must be capable of measurement in monetary terms. Often, an economic resource cannot be measured with a great deal of certainty. Estimates may be used that ultimately prove to be inaccurate. Nevertheless, it can still be reported as an asset for inclusion in the statement of financial position as long as a reasonably faithful representation can be produced. There are cases, however, where uncertainty regard- ing measurement is so great that this cannot be done. Take, for example, the title of a magazine (such as Hello! or Vogue) that has been created by its publisher. While it may be extremely valuable to the publishing business, any attempt to measure this resource would be extremely difficult: it would have to rely on arbitrary assumptions being made. As a result, any measurement produced is unlikely to be useful. The publishing title will not, therefore, appear as an asset in the statement of financial position.

Question 15

What are the sorts of items that appear as assets?

Answer 15

property;
■ plant and equipment;
■ fixtures and fittings;
■ patents and trademarks;
■ trade receivables (debtors); and
■ investments outside the business.

Question 16

define claim

Answer 16

A claim is an obligation of the business to provide cash, or some other form of benefit, to an outside party. It will normally arise as a result of the outside party providing assets for use by the business

Question 17

what is a tangible asset

Answer 17

Assets that have a physical substance and can be touched (such as inventories)

Question 18

what is an intangible asset

Answer 18

Assets that have no physical substance but which, nevertheless, may provide future benefits (such as patents)

Question 19

define equity

Answer 19

This represents the claim of the owner(s) against the business. This claim is some- times referred to as the owner’s capital.

Question 20

define liability

Answer 20

Liabilities represent the claims of other parties, apart from the owner(s). They involve an obligation to transfer economic resources (usually cash) as a result of past transactions or events. Liabilities normally arise when individuals, or organisations, sup- ply goods and services, or lend money, to the business.

Question 21

what is the accounting equation

Answer 21

Assets = equity + liability

Question 22

what is a current asset

Answer 22

Current assets are assets with a short-term nature, meeting specific criteria. They are either intended for sale or use in the normal operating cycle, expected to be sold within a year, primarily held for trading, or consist of readily marketable, short-term investments, including cash or near-cash equivalents.

Question 23

what is a non-current asset

Answer 23

Non-current assets, also known as fixed assets, differ from current assets in that they are intended for long-term use. They can be tangible, like property, plant, and equipment, which encompass land, buildings, machinery, motor vehicles, and fixtures and fittings. The distinction between current and non-current assets is essential for assessing the asset mix a business holds, with most businesses requiring a balance of both to operate efficiently.

Question 24

what is a current liability

Answer 24

Current liabilities are obligations set to be settled in the short term. They are defined by conditions like the expectation of settlement within the business’s operating cycle, primarily arising from trading activities, due for settlement within a year after the financial statement date, and having no option to defer settlement beyond a year after the statement date.

Question 25

what is a non-current liability

Answer 25

represent amounts due that do not meet the definition of current liabilities. They are, essentially, longer-term liabilities.

Question 26

how is the order of categories decided on a financial statement

Answer 26

The categorisation of assets in financial statements, whether non-current or current, follows a specific order based on liquidity, with the least liquid assets appearing first and the most liquid ones last. In non-current assets, property is listed at the beginning, as it’s typically harder to convert into cash, while motor vans, which are usually easier to sell, are listed last. In the case of current assets, the sequence is from inventories to trade receivables, and finally, cash, reflecting the typical conversion process. This order remains consistent regardless of the financial statement’s layout. Additionally, subtotals are provided for non-current assets and current assets, as well as for non-current liabilities and current liabilities when there are multiple items within these categories.

Question 27

what is the standard layout on a financial statement

Answer 27

Assets: Non-current, Current
Total Assets.
Equity+ non-current liabilities + current liabilities = Equity and liabilities

Question 28

what is a business entity convention

Answer 28

In accounting, businesses and their owners are treated as separate entities, with owners considered as claimants against their own business investments. This concept, known as the business entity convention, is distinct from the legal framework governing the relationship between businesses and their owners. In sole proprietorships and partnerships, there is no legal separation between the business and its owner(s). However, in the case of limited companies, a clear legal distinction exists, and they are regarded as having a separate legal existence. Nevertheless, for accounting purposes, these legal distinctions are disregarded, and the business entity convention applies uniformly to all types of businesses.

Question 29

what is historic cost convention

Answer 29

The historic cost convention dictates that the value of assets on financial statements should be based on their historic cost or acquisition cost, minimizing issues of measurement reliability as this value is typically factual. It enhances information credibility by avoiding reliance on opinions. However, the problem with historic cost is that it might not be relevant, as assets’ historic costs can quickly become outdated compared to current market values, potentially leading to misleading financial position assessments.

Some argue that valuing assets at their current market value would offer a more realistic view and be relevant for a wide range of decisions. However, a current value system introduces its own challenges, as “current value” can be defined in multiple ways, such as current replacement cost or current realisable value, leading to potential variations in figures. The terms “replacement cost” and “realisable value” also have different interpretations, necessitating clarity about the specific approach to current value accounting.

Question 30

what is prudence convention

Answer 30

The prudence convention advises a cautious approach in preparing financial statements. While it seems logical to exercise caution, its application has sparked debate over the years. The controversy lies in how it’s often used, potentially leading to a bias favoring the understatement of financial strength. Proponents argue that understating is better than overstating, as overstatement can mislead financial statement users into making poor decisions.

The bias towards understating financial strength was developed to counteract managerial optimism but can also have negative consequences, like underselling a business, loan denials, and more. Therefore, the convention’s application is a matter of balancing caution without leading to misleading financial representations.

Question 31

what is the going concern convention

Answer 31

the financial statements should be prepared on the assumption that a business will continue operations for the foreseeable future, unless there is evidence to the contrary. In other words, it is assumed that there is no intention, or need, to sell off the non-current assets of the business.

Question 32

what is the dual aspect convention

Answer 32

asserts that each transaction has two aspects, both of which will affect the statement of financial position. This means that, for example, the purchase of a computer for cash results in an increase in one asset (computer) and a decrease in another (cash). Similarly, the repayment of borrowings results in the decrease in a liability (borrowings) and the decrease in an asset (cash).

Question 33

define goodwill

Answer 33

is often used to cover various attributes such as the quality of the products, the skill of employees and the relationship with customers. The term ‘product brands’ is also used to cover various attributes, such as the brand image, the quality of the product, the trademark and so on.

Question 34

what does finite and infinite mean in terms of non current asset

Answer 34

Those with a finite life provide benefits to a business for a limited period of time, whereas those with an indefinite life provide benefits without a foreseeable time limit. This distinction between the two types of non-current assets applies to both tangible and intangible assets.

Question 35

What is the significance of recognizing depreciation in financial accounting, and how is it reflected in a company’s statement of financial position (balance sheet)?

Answer 35

In managing assets with finite useful lives, it’s crucial to acknowledge that their value diminishes over time due to various factors like market fluctuations and wear and tear. This reduction in value, known as depreciation (or amortization in the case of intangible non-current assets), must be quantified for each reporting period during which the assets are held. While an in-depth examination of depreciation is deferred to a later chapter, it’s essential to understand that when an asset undergoes depreciation, its impact must be reflected in the statement of financial position, often referred to as the balance sheet.

The reflection of this depreciation involves subtracting the total accumulated depreciation from the asset’s initial cost. This net figure, known as the “carrying amount,” also goes by names like net book value or written-down value. Importantly, this accounting practice does not contravene the historic cost convention. Instead, it simply acknowledges the reality that a portion of the historic cost invested in the non-current asset has been utilized over time in the pursuit of generating benefits for the business. This recognition ensures that financial statements offer a more accurate representation of an asset’s value as it evolves over time.

Question 36

what are fair values

Answer 36

market based. They represent the selling price that can be obtained in an orderly transaction under current market conditions. The use of fair values, rather than cost, provides users with more up-to-date information, which may be more relevant to their needs.

Question 37

what is impairment loss

Answer 37

amount by which the asset value is reduced

Question 38

what are the reasons why financial statements may help users?

Answer 38

It provides insights about how the business is financed and how its funds are deployed.

It can provide a basis for assessing the value of the business.

Relationships between assets and claims can be assessed.

Performance can be assessed.

Question 39

what is revenue

Answer 39

is simply a measure of the inflow of economic benefits arising from the ordinary operations of a business. These benefits result in either an increase in assets (such as cash or amounts owed to the business by its customers) or a decrease in liabilities.

Question 40

how do you work out profit/loss for a period?

Answer 40

Total revenue for the period − Total expenses
incurred in generating that revenue

Question 41

how do you work out assets at the end of period?

Answer 41

Equity (amount at the start of the period
+ (Sales revenue − Expenses) (for the period))
+ Liabilities (at the end of the period)

Question 42

on what statement is gross profit found

Answer 42

income statement

Question 43

what is gross profit

Answer 43

represents the profit from buying and selling goods, without taking into account any other revenues or expenses associated with the business.

Question 44

where is the operating profit found (on what statement0

Answer 44

income statement

Question 45

what is operating profit

Answer 45

Operating expenses (overheads) incurred in running the business (salaries and wages, rent, insurance and so on) are deducted from the gross profit. This represents the wealth generated during the period from the normal activities of the business.

Question 46

what is the profit for the period

Answer 46

This final measure of wealth generated represents the amount attributable to the owner(s) and will be added to the equity figure in the statement of financial position. It is a residual: that is, the amount remaining after deducting all expenses incurred in generating the sales revenue and taking account of non-operating income and expenses

Question 47

What are the different approaches businesses use to determine their cost of sales, and how does the choice of method depend on the nature and scale of the business?

Answer 47

Businesses employ varying methods to determine their cost of sales. In some cases, such as with large retailers and high-value item producers, the cost of sales for each individual sale is identified at the time of the transaction, often through point-of-sale devices, matching every sale with the corresponding cost of the goods sold. However, smaller retailers may find this impractical and, instead, identify the cost of sales after the reporting period ends. The choice of method depends on the nature and scale of the business, with larger retailers and high-value item producers often opting for real-time cost matching, while smaller retailers may use post-period calculations.

Question 48

what is the layout of an income statement

Answer 48

Cost of sales
=
Gross profit
-
Operating expenses
=
Operating profit
-
Non-operating expense
+
Non-operating income
=
Profit for the period

Question 49

What are the key principles that guide businesses in recognising revenue in their transactions with customers, and what are the important indicators that help determine when revenue should be recognised?

Answer 49

Businesses recognise revenue when they transfer control of goods or services to the customer, signifying the fulfillment of their obligations. Key indicators for this recognition include the transfer of physical possession, payment rights, customer acceptance, legal title, and significant risks and rewards of ownership to the customer. These indicators play a crucial role in determining the appropriate time for revenue recognition in business transactions.

Question 50

When does the transfer of control of goods or services to a customer occur gradually over time rather than as a single event, and how is the total revenue recognised in such situations? What methods are available for measuring progress in transferring goods or services over time?

Answer 50

The transfer of control of goods or services to a customer over time can happen in scenarios like service contracts, asset creation or improvement, and special orders. In such cases, the total revenue is recognised over the contract’s duration, spread across reporting periods. To determine the appropriate revenue for each period, various methods are used to measure progress, including output-based milestones and input-based measurements of resources or labour.

Question 51

When might methods based on input be preferred for recognising revenue over time, and how does this process work? Can you provide an example to illustrate revenue recognition over time using a specific case, including the stages involved and how revenue is recognised at each stage?

Answer 51

Input-based methods for recognizing revenue over time are favored when output-based methods are unreliable or unavailable. In such cases, there is no one-size-fits-all method, and the choice depends on specific circumstances. To illustrate this process, let’s consider a builder entering into a three-year contract to construct a factory with distinct stages:

Stage 1: Clearing, levelling, and foundations.
Stage 2: Wall construction.
Stage 3: Roof installation.
Stage 4: Window installation and interior completion.
When a particular stage’s performance obligations are fulfilled, the builder can recognise the agreed proportion of the total contract price for that stage as revenue. This revenue recognition is reflected in the income statement for the respective year. Typically, the contract specifies that the client pays the builder the appropriate proportion of the total contract price after successfully completing each stage.

Question 52

what is the matching convention

Answer 52

This convention states that expenses should be matched to the revenue that they helped to generate. In other words, the expenses associated with a particular item of revenue must be taken into account in the same reporting period as that in which the item of revenue is included.

Question 53

what is the materiality convention

Answer 53

This convention states that, where the amounts involved are trivial, we should consider only what is expedient. This will usually mean treating an item as an expense in the period in which it is first recorded, rather than strictly matching it to the revenue to which it relates.

Question 54

what is the accruals convention

Answer 54

asserts that profit is the excess of revenue over expenses for a period, not the excess of cash receipts over cash payments. Leading on from this, the approach to accounting that is based on the accruals convention is frequently referred to as accruals accounting.

Question 55

what are the 4 factors when considering depreciation over a time period ?

Answer 55

the cost (or fair value) of the asset;
■ the useful life of the asset;
■ the residual value of the asset; and
■ the depreciation method.

Question 56

what is the straight-line method

Answer 56

This method simply allocates the amount to be depreciated evenly over the useful life of the asset. In other words, there is an equal depreciation expense for each year that the asset is held.

Question 57

what is the reducing-balance method

Answer 57

This method applies a fixed percentage rate of depreciation to the carrying amount of the asset each year. The effect of this will be high annual depreciation expenses in the early years and lower expenses in the later years.

Question 58

how do you derive the the fixed percentage rate for reducing balance method

Answer 58

P=(1- n(on square root)(square root)R/C*100%)

P = the depreciation percentage
n = the useful life of the asset (in years)
R = the residual value of the asset
C = the cost, or fair value, of the asset.

Question 59

what are the three assumptions when calculating the cost of inventories?

Answer 59

first in, first out (FIFO), in which inventories are costed as if the earliest acquired inventories held are the first to be used;
■ last in, first out (LIFO), in which inventories are costed as if the latest acquired inventories held are the first to be used; and
■ weighted average cost (AVCO), in which inventories are costed as if inventories acquired lose their separate identity and go into a ‘pool’. Any issues of inventories from this pool will reflect the weighted average cost of inventories held

Question 60

what is bad debt

Answer 60

Where it is reasonably certain that a credit customer will not pay, the debt is regarded as ‘bad’ and written off.

Question 61

what is a limited company?

Answer 61

has been described as an artificial person that has been created by law. This means that a company has many of the rights and obligations that ‘real’ people have. It can, for example, enter into contracts in its own name. It can also sue other people (real or corporate) and it can be sued by them. This contrasts sharply with other types of businesses, such as sole proprietorships and partnerships (that is, unincorporated businesses), where it is the owner(s) rather than the business that must enter into contracts, sue and so on. This is because those businesses have no separate legal identity.

Question 62

describe London stock exchange

Answer 62

acts as both an important primary and secondary capital market for public companies. As a primary market, its function is to enable companies to raise new finance. As a secondary market its function is to enable investors to sell their securities (including shares and loan notes) with ease.

Question 63

describe corporate governance

Answer 63

The term is used to describe the ways in which companies are directed and controlled. The issue of corporate governance is important because, with larger companies, those who own the company (that is, the shareholders) are usually divorced from the day-to-day control of the business.