Accounting 2

Question 1

What are the objectives of financial accounting?

Answer 1

To provide information about an entity’s financial performance, position and changes therein

Question 2

How do we group/classify in accounting?

Answer 2

Classify elements into 5 categories: Assets, Liabilities, Equity, Income and Expenses.

Question 3

What is an asset?

Answer 3

An economic resource, arising from past events, which is presently controlled and from which future economic benefits are expected to flow. Needs to be relevant and faithfully represented and can be measured in monetary terms.

Question 4

How are assets classified?

Answer 4

Non-current (fixed) - are held for long term, usually purchased to facilitate income generation.
Current - generally have a life span of less than 12 months

Question 5

What are the main components of a Statement of Financial Position?

Answer 5

Non-current assets sorted into Tangible, Intangible and Investments, Current assets, Current and non-current liabilities and equity.

Question 6

SOFP - What are tangible non-current assets?

Answer 6

Four types: Land and buildings, Plant and machinery, Fixtures and fittings, Motor Vehicles. Assets have depreciation spread the purchase cost over asset’s life. Straight-line or reducing balance depreciation used and many companies revalue fixed assets.

Question 7

SOFP - What are intangible non-current assets?

Answer 7

Examples: Licences, patents, brands, goodwill. Amortisation spreads the purchase costs across the asset’s life

Question 8

SOFP - What are investment non-current assets?

Answer 8

Example: Investment in the shares of a company

Question 9

SOFP - What are current assets?

Answer 9

1. Inventory Types: Raw materials, work in progress, finished goods. Valued lower of cost and net realisable value.
2. Trade receivables: sales where customer have not paid yet, doubtful and bad debts (Uncertainty or will not be paid)
3. Prepayments: Goods or services paid in advance
4. Cash and bank

Question 10

What is an accounting liability?

Answer 10

An obligation from past events at present date will result in future outflow of economic benefits. Included in financial statements when it provides relevant and faithfully represented info, can be measured in monetary value.

Question 11

What are the classifications of liabilities?

Answer 11

Current: payment due within 1 year of financial statements date
Non-current: payment due more than 1 year from financial statements date

Question 12

SOFP - What are current liabilities?

Answer 12

1. Trade payables: purchases where suppliers not paid yet
2. Accruals: Amounts owing for services
3. Bank loans/overdraft

Question 13

SOFP - What are non-current assets?

Answer 13

Long term debt and Provisions

Question 14

SOFP - What is equity?

Answer 14

Share capital, retained earnings, other reserves

Question 15

What are provisions?

Answer 15

Are estimates of possible liabilities that may arise but where it is uncertainty over the amount owed or timing. E.g. Warranty claims and Legal claims

Question 16

What is equity?

Answer 16

The residual interest in the assets of the entity after deducting all its liabilities. Assets - Liabilities = Equity

Question 17

What are some further features of equity?

Answer 17

1. Could be funds contributed to business by its owner, who could be a sole trader, partnership, shareholders or another company. Business always treated as separate entity.
2. Drawings - When owners take some capital for personal use the amount is deducted from equity (sole trader or partnership)
3. Reserves or retained earnings - profit generated from capital by the business will be added to original capital.
4. Ownership interest may increase by earning revenue, new capital contributed by owners
5. Owners interest may decrease by incurring expenses, capital withdrawn by owner

Question 18

What is a statement of financial position?

Answer 18

Is a snapshot of a business at a particular point in time.
Business gets money from owners (Capital, Equity) and Lenders (liabilities).
A business invests money in assets
Assets - Liabilities + Equity
Equity = Assets - Liabilities

Question 19

What is working capital?

Answer 19

Working capital = Net current assets

Question 20

What are some limitations of statements of financial position?

Answer 20

1. SOFP is a collection of individual assets and liabilities at a time point which are not valued at market value
2. Significant assets are missing

Question 21

What is income (revenue) in accounting?

Answer 21

Income = increases in economic benefits that result in increases in equity (wealth)

Question 22

What are expenses in accounting?

Answer 22

Expenses = decreases in economic benefits that result in decreases in equity (wealth)

Question 23

What are the elements of income statements?

Answer 23

Revenue, expenditure, gross profit, operating profit and net profit.

Question 24

What is gross profit?

Answer 24

Difference between revenue and cost of sales. Represents profit from buying and selling without taking into account any other revenues or expenses.

Question 25

What is operating profit?

Answer 25

Gross profit minus other expenses (overheads) that have been incurred in operating the business.

Question 26

What is net profit?

Answer 26

Operating profit plus any non-operating income (e.g. interest receivables), minus any interest payable on borrowings made by business. This is income that is attributed to owners and hence will be added to equity.

Question 27

What are some classification of expenses in financial statements?

Answer 27

Distribution costs, Administrative expenses, Depreciation

Question 28

What are distribution costs?

Answer 28

The costs related to selling products/services e.g. advertising, salesmen salaries, marketing agents.

Question 29

What are administrative costs?

Answer 29

The running costs of business (overheads) e.g. salaries, heating and electricity.

Question 30

What is depreciation?

Answer 30

Process of apportioning cost of non-current tangible assets to the periods the assets benefited from the use. Intangible assets have process called amortisation.

Question 31

What are key conventions in income statements?

Answer 31

Revenue recognition and matching.

Question 32

What is revenue recognition?

Answer 32

Question of timing. Revenue should be recognised once control of goods or cervices is transferred to customer.

Question 33

What is matching?

Answer 33

Expenses should be matched to revenue they help generate.
When expense in not the same as cash paid this result in accruals and prepayments.

Question 34

What are accruals?

Answer 34

Accruals are where you have used a service in a period but not yet paid for it. E.g. Electricity was not paid for the last two months of the year, This belongs to the 2023 financial year and hence must be adjusted for or accrued. Accruing done by: Increase electricity expense in income statement, increase current liabilities in statement of financial position by equivalent amount of the accrual.

Question 35

What are prepayments?

Answer 35

Where you have paid for a service before using it/ benefiting from it.
E.g. you paid for insurance in the previous year in full until march on the next year. Three months do not belong to 2023 financial year and must be adjusted for prepayments. Prepayments done by: decreasing insurance expense in income statement and increasing current assets in statement of financial positioning by equivalent amount of prepayment.

Question 36

What is depreciation?

Answer 36

Depreciation depends on:
1. Original cost of assets
2. Estimated asset life
3. Estimated residual value of asset
4. Choice of method of spreading anticipated fall in value over life of asset
Basic methods: Straight line (Equal periodic amount) and reducing balance (percentage of reducing net book amount)

Question 37

How do you do straight-line method depreciation?

Answer 37

1. Look at the useful life of the asset, the cost and residual value to get the amount depreciated
2. Deduct the amount depreciation each year
   C - RV/L = Depreciation
   Not every asset has residual value so it may not be needed for every calculation.

Question 38

How do you use the reducing balance method of depreciation?

Answer 38

Take a constant % of the reducing net book value.
E.g. a machine costs £100K and depreciation is at 33%
After year 1 the value is £67K, after 2 years £44.89K, etc until the end of the useful life. At the end you should get a residual value for the asset.