Accounting Concepts Flashcards
Explain the accruals concept and provide TWO examples to highlight why and how it is important during the
preparation of financial statements.
The Accruals concept states that income and expenses must be recognised in the accounting period to which they relate rather than on cash basis. Expenses are ‘matched’ with the revenue earned in an accounting period.
Examples:
- accruals and prepayments
- depreciation
- treatment of inventory in the SOPL
- allowance for doubtful debts
Explain the going concern concept and provide TWO examples to highlight why and how it is important during the
preparation of financial statements.
The Going Concern concept means that financial statements are prepared assuming that the business entity will continue to operate in the foreseeable future, without the need/intention to liquidate the entity.
Examples:
- revaluation of NCA
- depreciation to spread the cost of NCA’s - carried out on book value (NBV)
- Goodwill - intangible assets such as Goodwill are not included in the SOFP.
Explain the roles of a financial accountant and an auditor.
Accounting is related to the collection, recording, analysis and interpretation of financial transactions. Financial statements are prepared to report profitability (SOPL), financial position (SOFP), equity (SOCIE) and cash flows (SOCF).
Auditing refers to the examination of books of accounts along with the evidential documents. An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud of error.
The auditors form an opinion of whether or not the financial statements give a true and fair view of the financial position of the company.
Why are year-end adjustments necessary? Give TWO examples.
Year-end adjustments are accounting entries made at the end of the year accounting year to bring various general ledger accounts in compliance with the accrual basis of accounting. They are necessary to provide a complete and accurate view of a company’s financial position and performance.
- Accruals and prepayments : revenue and expenditure are recorded in the period they are earned/incurred, rather than when the money is received or paid.
- Depreciation: the cost of NCA needs to be spread over their useful life. Year-end adjustments are made to record the depreciation expense for the year.
Why are financial statements drawn up?
Financial Statements are important as they provide a snapshot of a company’s financial performance, thus allowing stakeholders to make informed decisions about investments, budgeting and more.
Annual financial statements provide an overview of a company’s financial position, including its revenues, expenses, profits, and losses and include information about assets, liabilities, and equity, as well as cash flows.
Mention TWO errors that don’t affect the trial balance.
- Error of Omission: a transaction is completely left out from the book.
- Error of Commission: the correct amount is entered but in the wrong account.
What is a contingent liability and how is it accounted for?
A contingent liability is a potential liability that may occur in the future, such as a pending lawsuits. If it is likely to occur and the amount can be reasonably estimated - so it is recorded as a liability in the SOFP.
Describe the Business Entity Concept.
The business entity concept, which the business is to be treated as being completely separate from the owner of the business. The items recorded in the books of the business are restricted to the transactions of the business.
