Accounting Flashcards
Sales Revenue (turnover)
This is the income realised from selling goods or services before deductions for expenses for an accountancy period. Sometimes referred to as revenue or sales.
Cost of Sales (Cost of goods sold)
This represents direct costs incurred by businesses for the process of selling goods or services. For example, the cost of materials for manufactured goods or cost of labour for services. In a manufacturing company this can be calculated by:
Opening stock + purchases - closing stock
Profit for the financial year
This represents the ‘bottom-line’ measure of financial performance i.e. it is the profit that has been produced for the shareholders of the business after deducting both interest and corporation tax expenses.
Dividends and retained earnings
Published income statements also show dividends for the year (received by the shareholders) and the remaining profit which is retained by the business (retained earnings). The owners’ claim (equity capital) is therefore increased by the profit for the year but reduced by the dividend distributed during the year, i.e. the retained earnings reserve in the balance sheet increases if profit for the year is greater than dividends for the year and decreases if profit for the year is less than dividends for the year. If the company makes a loss (retained earnings is negative) then this amount is subtracted from the retained earnings reserve in the balance sheet.
Expenses
Expenses represent resources that are used up in achieving the revenues (plus any costs written off in accordance with the conservatism concept). Thus, cost of sales and other operating expenses will contain material and about costs, electricity costs, rent and rates charges, payments to service providers etc. used to generate the revenues for each year. In the example income statement, expenses are represented by the cost of sales, other operating expenses, interest and tax.
Expenditure
Expenditure leads to the acquisition of resources in order to help generate future revenues. Thus purchasing a machine, new land and plant etc, represents cash spending, not expenses. The ‘deterioration’ through use of a machine (i.e. depreciation) is the expense against revenue in the income statement, but the purchasing of a machine is simply cash spending, where one asset (cash) is converted into another asset (fixed asset) on the balance sheet.
Losses
Arise from peripheral and/or incidental transactions of the firm with other commercial, governmental or private entities.
Revenues
Sales revenue is recognised in the income statement when a sale is made. Credit sales are therefore recognised in the income statement before cash has been received from the customer and any cash owed by customers for goods supplied at the closing balance sheet date are shown as ‘debtors’ in the current asset section of the balance sheet.
N.B. While many businesses provide credit to their customers and therefore make sales in advance of the actual receipt of cash, some businesses receive cash from their customers before they have supplied the goods or services. In this case, the accruals concept requires that the sale be recognised when the goods or services are supplied and not before.
Receipt
A receipt is any amount of cash received from sales, services, investing activities etc.
Gains
Arise from peripheral and/or incidental transactions of the firm with other commercial, governmental or private entities.
Cash flow from operations
Represents the difference between the cash receipts from selling the firm’s products and the cash payments on operations. These payments include production and selling activities such as payments to suppliers and wages to staff.
Cash flow from investments
This represents the difference between the inflow and outflow of cash from investing activities. Inflows could come from sources such as fixed assets (e.g. property) or investments. Outflows could come from transaction such as the purchase of fixed assets or investments.
Cash flow from financing
This represents the difference between the inflow and outflow of cash from financial activities. Inflows could come from sources such as cash from investors (new equity introduced) or new loan capital raised. Outflows could come from transactions such as payment of dividends to shareholders, loan repayments and the interest on loans.
Current Assets
Those assets that would normally be expected to be converted into cash (or otherwise used up) during the company’s accounting year.
Cash
On a balance sheet includes all cash held in tills or cash boxes plus any surplus in current accounts at the bank.
Accumulated Depreciation
Fixed assets such as plant and equipment and industrial buildings are depreciated over their expected life i.e. each year a portion of the original cost is written off (annual depreciation). Accumulated depreciation is that amount of the original cost that has been written off by accountants (note that this is completely independent of considerations of market value or actual wear and tear).
Debtors
The amounts owed to the company by its customers for goods that have been sold on credit. Also known as accounts receivable in the U.S.
Stock
On a balance sheet, are the goods that the company is in the business to sell. They also include raw materials and partly manufactured goods.
Prepaid Expenses
Typically services that have been paid for but not yet used up. An insurance policy, paid for in advance, can be thought of as a right to insurance cover over the term of the policy. If rent is paid in advance, the right to use the premises until payment is again due is regarded as an asset.
Fixed Assets
These include tangible, long lived assets bought for running the business in the long term such as factories, offices, equipment etc. Property and land are also classed as fixed assets. Intangible assets such as patents, goodwill and research and development may also appear as fixed assets on the balance sheet. Except in the special case of an asset revaluation, fixed assets are shown in accounts at their original cost. Also known as non-current assets.
Marketable Securities
Refers to short-term investments (shares or money market deposits) used for earning profits on surplus cash.
Net Fixed Assets
This is equal to the original cost of ‘non-depreciating’ fixed assets (such as property and land) plus the original cost less accumulated depreciation (i.e. net book value) of ‘depreciating assets’ such as plant equipment and industrial buildings. Also known as net book value of fixed assets.
Current Liabilities
Claims that are expected to be satisfied in the next year.
Creditors
The total money owed to suppliers at the balance sheet date for stocks purchased but not yet paid for. This is categorised as a current liability on the balance sheet. Also known as accounts payable.
Overdraft
Short term bank borrowings
IOU
Promissory note giving the bearer the right to claim the stated amount on the date specified.
Provision for Tax
Taxes on sales and profits are paid after the year end because the exact figures for sales and profits (hence taxes) are not known until the accounts are finalised after the end of the financial year, so some tax is often found to be owing when the accounts are finally produced. This is categorised as a current liability on the balance sheet. Also known as taxes payable in the U.S.
Long-term Debt
Loans and obligations with a maturity longer than one year, usually accompanied by interest payments. These can include long-term loans and mortgages.
Debentures
These are loans issued in small denominations such as £10, £100, etc. They are issued in large numbers as a way of getting small scale lenders to lend to the company. Conditions such as the term (life), interest rate etc will be specified. Debentures may be traded on the stock exchange, but they do not represent ownership of the company, although they may have an option to convert into ordinary share capital at some future date.
Called Up Share Capital
The face value of the money (or assets) that the ordinary shareholders have put into the business on a permanent basis.
Share Premium Account
When ordinary shares are issued on the stock market, it is likely that the issue price will exceed the par value of the shares. If the investors pay the company an excess over the par value of the shares, than the excess is recorded in a share premium account.
Revaluation Reserve
A company may revalue some fixed assets (e.g. property). In this case, the increase in value in the assets is matched by an increase in claims through the creation of a revaluation reserve.
Retained Earnings Reserve
The accumulated annual retained earnings. This figure is a total of all previous years retained earnings and is entered into the balance sheet.
Realisation Concept
This states that the profit on an asset is reported in the income statement only when the asset is sold (i.e. we cannot include increases in value of an asset in reported profit until the asset is sold). It is not, however, necessary to wait until the receipt of cash in order to recognise a profit. This concept (by requiring a sale to be made before the revenue of profit is recognised but not requiring that we wait until we actually receive the cash from the buyer) strikes a balance between the criteria of relevance, objectivity and feasibility.
Matching Concept
The matching concept states that the revenues and expenses in a transaction should be shown together (matched) in the same accounting period regardless of the actual timing of cashflows for these.
Accruals Concept
This states that when dealing with revenues and expenses it is important to reflect the rights and obligations to make and receive cash, and not the actual cashflows themselves. Thus, for example, revenue on this income statement shows not only cash receipts from customers but also those sales on credit that have been made.
Accrue
Accrue is a term used to describe the ability for something to accumulate over time, and is most commonly used when referring to the interest, income or expenses of an individual or business. Interest in a savings account, for example, accrues so that over time, the total amount in that account grows. The term “accrue” is often related to the concepts of accrual accounting, which has become the standard accounting practice.
Gross Profit
Sales - Cost of Sales
Net Profit
Gross Profit (+ any other income) - any other expenses
What are the limitations of balance sheets?
1) Collection of assets and liabilities which are not measured at market value.
2) Significant capital missing such as human capital and internally generated brands.
What are the limitations of an income statement?
Many estimates and assumptions mean profit is inherently subjective (matching, estimations, changing prices, wearing out of assets)
Assets
= Liabilities + Stockholder Equity
or
= Liabilities + Capital + Prior Retained Earnings + Revenues - Expenses - Dividends
Stockholders’ Equity
= Capital + Retained Earnings
Retained Earnings
= Prior Retained Earnings + Net Income - Dividends
Net Income
= Revenues - Expenses
Three Fundamentals to Bookkeeping
1) Assets = Liabilities + Stockholders’ Equity
2) Sum of Debits = Sum of Credits
3) Beginning Account Balance + Increases - Decreases = Ending Account Balance
Rules of Debits and Credits
1) Every transaction must have at least one debit and one credit
2) Debits must equal credits for all transactions
3) No negative numbers are allowed
T-Account
A record of all changes in accounting quantity. Debits are listed on the left side of the T and credits are listed on the right hand side.
What are the three activities in cash flow statements?
1) Operating
2) Investing
3) Financing
Companies Act 1985
An operating and financial review which must be a balanced and comprehensive analysis, consistent with the size and complexity of the business.
Non-Financial (Operating) Information required
1) Development & Performance of the business
2) Position of the company at the end of the year
3) Main trends and factors underlying development and performance
4) Main trends and factors likely to affect future performance
Return on Capital Employed
Profit before interest and tax / Equity + Non-current liabilities
Measures the effective use of capital.
Operating Profit / Assets - Current Liabilities
Net Profit Ratio
Measures bottom line return
Net Profit Before Taxation / Revenue
Gross Profit Ratio
Measures direct returns on sales
= Gross Profit / Revenue
Debt Collection Period
Measures how long it takes customers to pay
= Average Trade Receivables / Cost of Sales per Day
Creditor Payment Period
Measures how long it takes to pay suppliers
= Average Trade Payables / Credit Purchase per Day
Inventories (Stock) Turnover Ratio
Measures how quickly stock moves through the business
= Cost of Sales / Average Inventory
Asset Turnover Ratio
Compares Revenue (Turnover) to total assets employed
= Revenue / Average Total Assets
Current Ratio
Measures short term liquidity
= Current Assets / Current Liabilities
Quick Ratio
Measures extreme short term liquidity
= Current Assets - Inventory / Current Liabilities
Gearing
Measures the relationship between long-term borrowings and total capital
Long-term Borrowings / Total Capital = Fixed Return Finance / Total Capital
Long-Term Borrowings
= Debentures + Preference Share Capital
Dividend Yield
Dividend related to market price
= Dividend Per Ordinary Share / Share Price
Dividend Cover
How many times profit covers dividends
= Profit After Tax - Preference Dividends / Ordinary Shares
Earnings Per Share
Earnings related to the number of shares
= Profit After Tax - Preference Dividends / Number of Ordinary Shares
Price Earnings Ratio
Relates the Earnings Per Share to market share
= Share Price / Earnings Per Share
Interest Cover
How many times over does profit cover interest
= Profit before interest and tax / Loan Interest
Profit Ratios
1) Return on Capital Employed (ROCE)
2) Gross Profit Ratio
3) Net Profit Ratio
Efficiency Ratios
1) Debt Collection Period
2) Creditor Payment Period
3) Inventories Turnover Ratio
4) Asset Turnover Ratio
Liquidity Ratios
1) Current Ratio
2) Quick Ratio
3) Gearing
Investment Ratios
1) Dividend Yield
2) Dividend Cover
3) Earnings Per Share
4) Price Earnings Ratio
5) Interest Cover
