Accounting Flashcards
What is accounting about?
Tax calculation and planning, book-keeping for business, saving money, budgeting, costing, preparing accounts, running a business, Receivership, Consultancy, and Auditing
What is a possible definition for accounting?
The provision of financial information for planning
and control decision making purposes.
Information is required to show:
What has happened in the past,
What the position is now, and
What may happen in the future
What is another possible definition for accounting?
“Accounting is the process of identifying,
measuring and communicating financial
information about an entity to permit informed
judgements and decisions by users of
accounting information” (AAA, 1966)
What is an entity?
Definition:
“A thing with distinct and independent existence”
What are different types of entities which produce accounting information?
Unincorporated businesses
Sole Traders
Partnerships
Incorporated businesses
Limited Liability Partnerships (LLP)
Private Limited Companies (Ltd)
Public Limited Companies (Plc)
Public sector bodies, charities
What accounting information are entities going to produce?
External World:
information and data,
financial reports for external use
The Business: information about transactions and events, the accounting recording system, analysis of information, management accounting reports
Who is going to make use of accounting information?
Investors Lenders Suppliers (business contacts) Employees Customers Government and their agencies The public
What is a third possible definition for accounting?
“Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the results thereof.”
How may financial accounting be defined?
“ the process of designing and operating an
information system for collecting, measuring and
recording an enterprise’s transactions, and
summarising and communicating the results of
these transactions to users to facilitate making
financial/economic decisions.”
What are Financial Statements and how is it done?
ONE set of accounts is produced to satisfy the
needs of ALL user groups.
How is this done?
- conceptual framework
- accounting conventions (also known as concepts and assumptions)
- the audit report
- regulation of the profession
What are sources of accounting regulation?
Self-regulation:
- UK Accounting Standards - International Accounting Standards
Company Law/EU Directives
- Companies Act - The Stock Exchange (the listing rules)
What is the purpose of the IASB Conceptual Framework
for Financial Reporting (2010)?
“sets out the concepts that underlie the preparation and presentation of financial statements for external users”
(Conceptual Framework, 2010)
What is the scope of the IASB Conceptual Framework
for Financial Reporting (2010)?
the objective of financial reporting
- the qualitative characteristics of useful financial information
- the definition, recognition and measurement of the elements from which financial statements are constructed
- concepts of capital and capital maintenance
Who are users of financial statements in terms of the IASB Conceptual Framework?
- existing & potential investors
- lenders
- other creditors
They make informed decisions
What is a possible definition for financial statements?
“the need to reflect……….the effects of transactions and other events on the reporting entity’s financial performance and financial position”
(Statement of Principles, ASB, 1999)
What is meant by Financial Performance and Financial position in relation to Financial Statements?
Financial Performance
Income Statement (IS) or Profit & Loss Account (P&L)
Financial Position
Statement of Financial Position (SFP) or Balance Sheet (BS)
How do we prepare financial statements and what must we ask ourselves?
How do we identify, measure and communicate financial information?
Conceptual Framework
Companies Act
Accounting concepts/assumptions/conventions
What makes a financial statement useful?
Fundamental Characteristics
- Relevance - Faithful Representation
Enhancing Characteristics
- Comparable - Verifiable - Understandable
What can accounting concepts/conventions can be categorised into?
Boundary Rules
limit the amount and type of data to be included in
financial statements
Measurement Rules
state how data should be recorded in the financial statements
Ethical Rules
stipulate a code of conduct on the interpretation of all accounting concepts
What is the balance sheet/ statement of financial position?
a list of assets, liabilities and capital of a business entity on any one particular day
provides information about resources and claims on resources
allows users to evaluate the financial position
What’s the definition of an asset?
“a resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity”
(Resources controlled by an entity)
What are Fixed/ Non Current Assets?
assets acquired by the entity that will be used over a long period of time (usually greater than 1 year).
Land, Property, Furniture & Fittings, Motor Vehicles, Office Equipment, Computer Equipment
What are Current Assets?
assets which frequently change and are held in the business for a short period of time (less than 1 year).
Stock/Inventories, Work-in-Progress, Debtors/Trade Receivables, Bank, Cash Prepayments
What are liabilities?
“a present obligation of the entity arising from past
events, the settlement of which is expected to result in
an outflow from the entity of resources”
(amounts owed to outside parties)
What are current liabilities?
amounts that are payable within 1 year of the balance sheet date
Creditors/Trade Payables,
Bank Overdraft,
Accruals/Accrued Expenses
What are long-term liabilities/Non-current liabilities?
amounts that are payable after more than 1 year of the balance sheet date
bank loans debentures lease liabilities
What is Capital/Equity/Ownership Interest?
“the residual interest in the assets of the entity after deducting all its liabilities”
the amount(s) invested by the owner(s) of the entity
(amounts owed to owners)
What is the Accounting Equation?
Assets - Liabilities = Capital
Liabilities + Capital = Assets
What is The Statement of Profit or Loss / Income Statement?
a summary of trading activities (income and expenses) over a period of time (usually a year)
shows the profit or loss for that period (not cash)
enables users to evaluate performance
Define Income / Revenue / Gains?
“increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants”
Name what Income / Revenue / Gains does and doesn’t include.
Does Not Include:
- monies received for the sale of assets used within the
entity - capital income
Does Include:
- sales (both cash sales and credit sales)
- fee income
- bank interest received
- rental income
- profit/gain made on the sale of assets used within the entity
Define Expenses/Loss
“decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants”
Name what Expenses/Loss does and doesn’t include.
Does Not Include:
- other distributions of profit/loss to owners
Does Include:
- a payment (or promise to make a payment) for a benefit received
- Losses made on the sale of assets used within the entity
What are Capital Expenses?
- Non-Current Asset
- Additions to an Asset
- Expenses incurred in acquiring those assets and preparing them for use
What is Revenue Expense?
monies spent on running the business on a day-to -day basis in order to generate income and benefit the current accounting period.
What is the equation for net profit/loss?
Income – Expenses = Net profit/(loss)
revenue) - (revenue expenses
What is The Statement of Profit & Loss and The Accounting Equation?
Assets = Liabilities + Capital =>
Assets - Liabilities = Capital =>
Assets - Liabilities = Capital + Profit (income - expenses)
What is Book-Keeping?
A systematic way to record financial transactions
Has been in use since early days of trading
Based on the accounting equation principle:
for every financial transaction, two entries are made in the books of account/ledger
An account can be looked upon as a diary or a history detailing the things that happen in relation to a particular item
Manual or computerised
Ledgers or journals
time consuming
What is the Cash Book?
Records bank and/or cash transactions
A record of receipts and payments:
- A bank receipt/deposit represents an increase in
the bank account - A bank payment represents a decrease in the
bank account
What is the Trial Balance?
List of balances taken from the books of account
Can be extracted at any point in time
Tests duality concept
Tests if books of account agree arithmetically
Basis for preparing the financial statements
What does the trial balance not detect?
Errors of Omission
Transaction has been completely omitted
Errors of Commission
Double-entry is made, but to the wrong accounts
Errors of Principle
Double-entry is made, but to the wrong type of account
What does the trial balance not detect? (2)
Compensating Errors
Where an error is exactly compensated by another error in the opposite direction
Errors of Original Entry
The original entry has been entered incorrectly in both accounts
Errors of Transposition
The individual digits making up a number have been written in the wrong order in one of the ledger accounts. A transposition error is always divisible by 9.
What is closing stock/inventory?
Duality concept - For each financial transaction, two entries are made in the books of account
Accounting treatment - Take the inventories from the cost of sales and transfer it to the SFP as a current asset
Cost of Sales Reduce AND Current Assets Increase
Why do Cost of Sales AND Current Assets Increase when looking at the closing stock/inventory?
Why ? - this inventory has not been sold and is still an asset at the year end. It will therefore reduce the COGS/COS (expense), and increase the gross profit.
What is opening stock/inventory?
Duality concept - For each financial transaction, two entries are made in the books of account
Accounting treatment - Take the inventories from the cost of sales and transfer it to the SFP as a current asset
Current Assets reduce AND Cost of Sales increase
Why do Current Assets reduce AND Cost of Sales increase when looking at the opening stock/inventory?
Why? - when we start a new accounting period it is added to the pile of stuff available to be sold, and therefore needs to be shown as a cost of sale in the new accounting period.
What is the Accrual Concept?
“Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period.”
What is Stock / Inventories?
The goods that have been purchased or produced by an entity for resale that have not yet been sold
Can be Finished Goods, Work-in-Progress and Raw Materials
Stock/Inventories counted and valued at least once a year (usually at the end of a financial year)
Valued in accordance with IAS 2: Inventories
IAS 2: Inventories
What’s shown on the Statement of Financial Position should be the lower of cost and net realisable value
(Prudence concept)
Net realisable value is the estimated selling price less estimated selling costs, including cost
Cost is on basis of FIFO or weighted average
What is The Accrual /
Accrued Expense?
an expense that has been incurred, but for which an invoice has not yet been received or paid or charged
similar to a creditor/trade payable
Common where services are paid in arrears
gas – electric – phone – wages
Duality concept – accounting for accrued expenses
(1) Expense account (I/S) Increases AND (2) Accrual account (SFP) Increases
What is Accrued Income?
income that has been earned, but for which an invoice has not yet been sent out
similar to a debtor/trade receivable
revenue recognition
Duality concept – accounting for accrued income
(1) Income account (I/S) Increases AND (2) Accrued Income account (SFP) Increases
What is The Prepayment?
an expense which has been incurred, but the benefit from it will not be provided until the following accounting period
it is an asset/resource waiting to be used
common where services are paid for in advance
Duality concept – accounting for the prepayment
(1) Expense account (I/S) Decreases AND (2) Prepayment account (SFP) Increases
What is a Bad Debt?
A bad debt is a debtor who you know will not be able to settle their balance with you.
Reasons may be : - Insolvency
- Death
Must be written off
Duality concept – accounting for a bad debt
(1) Bad debt w/off (expense) Increase AND (2) Receivables account Decrease
What is a doubtful debt?
A doubtful debt is a debtor who you suspect will not be able to settle their balance.
Often a business will provide for a certain percentage of their debtors as being doubtful
A doubtful debt provision is created
What is Capital Expenditure and its characteristics?
Definition: Expenditure that will benefit more than one accounting period.
Characteristics:
- expenditure is likely to be substantial - benefits of it are difficult to define & allocate - helps to achieve organisations long term objectives
Examples: Land & Buildings, Plant , Motor Vehicles
What is the difference in revenue expenditure and capital expenditure?
The cost of expenditure ought to be charged to the income statement in the accounting period that benefits from it.
Revenue expenditure – charged to the current accounting period
Capital expenditure – may have to be allocated over several accounting periods → via depreciation
What is Depreciation?
Depreciation is the allocation of cost of a non-current
asset to the income statement which benefits from the use
of that non-current asset.
IAS 16 definition:
“ the systematic allocation of the depreciable amount of an
asset over its useful life”
Depreciable amount is “the cost of the assets, or other
amount attributed to that asset less its residual value”
What is Purchasing a non-current asset?
Duality concept : (1) Non-current asset – increases
(2) Bank account – decreases
Non-Current Asset shown in the Balance Sheet/SFP
- benefits of it are difficult to define and allocate - helps to achieve organisations long term objectives - therefore all ultimately expensed to the Income Statement
What are Tangible Fixed Assets and Intangible Fixed Assets?
Tangible Fixed Assets/NCA
- assets that have physical substance
- held for use in the production or supply of goods or
services or administrative purposes
- expected to be used in more than one period
Intangible Fixed Assets/NCA
“identifiable non-monetary assets without physical substance”
patents trademarks copyrights brands
What are the definitions for cost, residual value and depreciable amount?
Cost: cost directly attributable to bringing the asset into working condition for its intended use
Residual value: the net realisable value of an asset at the end of its useful economic life. Residual values are based on prices prevailing at the date of the acquisition (or revaluation) of the asset and do not take account of expected future price changes
Depreciable amount: the cost of a tangible non-current asset less its residual value
What is the one method of accounting for depreciation?
Duality concept: (1) Depreciation (expense) – increases
(2) Accumulated depreciation – increases
Cost of Asset – Accumulated Depreciation = NBV of Asset
The Net Book Value (NBV) is the figure that will appear in the Statement of Financial Position, and be included in the Total Assets
What are methods of calculating depreciation?
Straight Line Method: allocate an equal amount of depreciation to each year of the useful life, easy to use, most common in UK
d = (cost – residual value)
useful economic life of asset
Reducing Balance Method: applies a constant percentage to each year’s Net Book Value (NBV) to calculate depreciation for year, so a progressively smaller amount of depreciation is charged
d = NBV x RB%
Usage or output
How does The Disposal of Non-Current Assets work? (1)
Part 1 - the sale proceeds
Duality concept: (1) Bank account – increases
(2) Disposal account – decreases
How does The Disposal of Non-Current Assets work? (2)
Part 2 - the disposal of the asset
(a) Remove the original cost of the asset
(1) Non-Current Asset account – decreases
(2) Disposal account – increases
(b) Remove the accumulated depreciation of the asset
(1) Accumulated Depreciation account – decrease
(2) Disposal account – decreases
You should be left with a gain or loss on disposal
What is the objective of financial reporting?
“to provide financial information about the reporting entity that is
useful to existing and potential investors, lenders, and other
creditors in making decisions about providing resources to the
entity”
(IASB, Conceptual Framework for Financial Reporting, 2010)
What is the use of Financial Ratio Analysis and what categories are there?
“Financial ratios have been long used as a tool to evaluate the overall financial performance of a company.”
What are measures and ratios of profitability?
Measures:
- the relative success or failure of an entity - management performance
Ratios
1. Gross Profit Ratio 2. Net Profit Ratio 3. Return on Equity (ROE) 4. Return on Capital Employed (ROCE)
What is the purpose of gross profit and net profit ratios?
reviews the relationship between the gross/net profit and the sales/revenue
small changes can be significant
benchmark for industry for comparison
Gross Profit Ratio = gross profit x 100 = %
sales/revenue 1
Net Profit Ratio = PBIT x 100 = %
revenue
PBIT = Profit before Interest & Tax
What is Return on Equity (ROE)
Return on Capital Employed (ROCE)?
indicates how efficiently and effectively a business has used its assets during a given accounting period
can be a measure of management performance
ROE net profit after tax x 100 = %
shareholders funds 1
ROCE net profit b4 i&t x 100 = %
capital employed 1
Capital employed = shareholders funds + long term debt
What is Short Term Solvency and Liquidity?
Measures:
- the extent to which an entity can comfortably cover
its liabilities
- how much cash the entity has in the short-term
- the management of cash
Ratios:
1. Current Ratio 2. Quick/Acid Test Ratio
What is the current ratio?
Indicates the extent to which the short-term assets should meet the short-term liabilities of the business
Current Ratio = Current Assets
Current Liabilities
Or
Current Ratio = Current Assets : Current Liabilities
What is the Quick/ Acid Test Ratio?
Assumption that inventories/stock takes the longest to turn into cash
Indicates the ability to pay short-term creditors quickly
Quick Ratio = Current Assets - Inventories
Current Liabilities
What are the measures and ratios for Efficiency Ratios?
Measures:
- the extent to which short-term assets and liabilities are
being managed and utilised within the entity
- how effectively the business is being managed
Ratios:
1. Inventory Days/Turnover Period 2. Trade Receivable Days/Collection Period 3. Trade Payable Days/Payment Period
What are inventory days?
measures the average number of days the stock is held before being sold
Important where management of stock is of prime importance to a business
Stock/Inventory Days = inventory x 365
cost of sales
What are Trade Receivable and Trade Payable days?
Trade Receivable Days
Measures the average period of credit taken by credit customers :
trade receivables x 365 = no of days
credit sales/revenue
Trade Payable Days
Measures the average period of credit received from credit suppliers
trade payables x 365 = no of days
credit purchases
What are the measures and ratios for long term solvency and stability?
Measures:
- the proportion of long term debt to share capital and
its affect on the shareholders
- the higher the debt the riskier the investment
Ratio:
1. Gearing Ratio
What is the Gearing Ratio?
looks at relationship between the amount of fixed interest capital and the amount of equity capital
Fixed interest capital / Debt
debentures, loans, preference shares etc
Equity capital / shareholders funds
ordinary shares, share premium, retained profits etc
Gearing Ratio = Debt x 100
Debt + Equity
What is Earnings per share?
the amount that is theoretically available per share
dividends are the amounts actually paid per share
can investors expect consistent returns
to calculate:
EPS = profits attributable to equity shareholders
number of equity shares in issue
What is meant by ratio analysis?
One of the methods used to interpret financial information.
Enables the user to construct a financial profile of an entity over a period of time
Compare entity’s results against that of another entity within the same industry
Can assess entity’s past, present and possibly future strengths and weaknesses.
Serve only as indicators and must be used carefully, not in isolation.
What are limitations of ratio analysis?
Comparisons may be misleading due to:
different accounting policies adopted
calculations based on historical data, therefore effects of
inflation not accounted for
some data not disclosed in published financial statements
performance criteria differing between industries
general economic situation not considered
strategic decisions by management not considered
only single ratio available
What must be considered when interpreting financial statements?
What are you trying to achieve?
Compare ratios
What additional information will be useful?
Comment on the strengths and weaknesses of results
Check accounting policies between companies/years
Watch out for revaluation of assets
- will reduce profits due to increased depreciation and
increase capital employed (revaluation reserve)
impact on ROCE and gearing
