Accounting terms Flashcards
Ethical considerations
When a business considers the consequences of a decision on the environment and its various stakeholders. Decision makers have a moral obligation to act with honesty and integrity in all human and financial dealings.
Assets
A present economic resource controlled by the entity that has the potential to produce a future economic benefit within 12 months or for longer than 12 months
Liabilities
A present obligation of the entity that will result in the transfer of an economic resource within 12 months or after 12 months
Owner’s Equity
The residual interest in the assets of the entity after deducting all its liabilities. The amount left over for the owner.
Balance Sheet use
Being able to identify the assets, liabilities and owner’s equity of the business as at a point in time in order to assist in planning and decision making, such as assess liquidity, assess stability and assess value of non-current assets
Going Concern Assumption
Financial reports are prepared on the assumption that the existing entity will continue to operate into the future and records are kept on this basis
Accounting Entity Assumption
The records of the entity are to be kept completely separate from those of the owner of the entity as well as from those of other entities. A separate set of accounting records is maintained for each entity
Accrual Basis Assumption
Revenue is recognised when earned and expenses are recognised when incurred regardless of whether cash has been received or paid so that an accurate profit or loss can be calculated
Period Assumption
Reports are prepared for a particular period of time such as a months or a year, in order to obtain comparability of results
Relevance
Relevance states that reports must include all information that is capable of making a difference to the decisions made by the users of the report and exclude information that is not.
Faithful Representation
The information reported must be a faithful representation of the real-world economic event it represents, be complete, free from material error and without bias
Verifiability
Verifiability means that knowledgeable and independent observers can reach a conclusion that reports faithfully represent what they are intended to represent as they are based on verifiable source documents that can be checked through the auditing process.
Comparability
Comparability states that reports should be able to be compared period to period and business to business
Timeliness
Timeliness means having information available to decision-makers in time to be capable of influencing their decisions
Understandability
Understandability requires that information be comprehensible to users with reasonable knowledge of business activities and therefore should be presented clearly and concisely in reports
Liquidity
the ability of the business to meet its short-term debts as they fall due
Working Capital Ratio
A liquidity indicator that measures the ratio of current assets to current liabilities to assess the firm’s ability to meet its short-term debts as they fall due
Working Capital Ratio equation
CURRENT ASSETS/CURRENT LIABILITIES = RATIO
Stability
Ability of the business to meet its debts and continue its operations into the future
Debt Ratio
Measures the proportion of a firm’s assets that are funded by external sources
Debt Ratio Equation
(TOTAL LIABILITIES/TOTAL ASSETS) 100 = %
Sole Proprietorship
Owned and operated by a single individual in their name or a business name. Owner pays tax on their profit.
Sole Proprietorship advantages
The owner receives all profits and has complete control over decision making. Easy and cheap to set up and easy to sell or close down
Sole Proprietorship disadvantages
Owner has unlimited liability and limited access to capital, skills/knowledge/ideas → can only call on owner’s expertise
Heavy workload, stress, hours, etc
Unlimited liability
Owner is personally responsible for all debts and losses therefore can lose personal assets (home, car, etc. if placed under OWN name)
Limited Liability
Shareholders have no responsibility for liabilities or losses of the company and personal assets are safe
Partnership
Owned by 2-20 people and is governed by a partnership agreement. Each partner earns a share of profits or losses and pays tax individually
Partnership Advantages
Easy and cheep to set up with greater access to capital, skills, knowledge, ideas and ability to take advantage of the Tax Free Threshold by splitting income
Partnership Disadvantages
Unlimited liability, shared decision making may lead to conflict and a partnership also has a limited life
Proprietary Company
A separate legal entity with between 1 and 50 stakeholders that pays tax in its own name at a 30% fixed rate
Proprietary Company Advantages
Has limited liability, greater access to capital and knowledge and exists in perpetuity (continues even when shares are bought and sold)
Proprietary Company Disadvantages
High establishment costs and high ongoing/annual accounting and compliance costs alongside a higher level of government regulation
Public Company
A separate legal entity with unlimited shareholders that is listed on the Australian stock exchange.
Public Company Advantages
Limited liability with greater access to capital (millions of dollars) and knowledge, exists in perpetuity and pays tax in its own name at 30% tax rate
Public Company Disadvantages
Establishment costs are high and need to issue a public prospectus.
Ongoing/annual accounting and compliance costs are high and under a higher level of government regulation. Business is also required to have an audit undertaken which is costly.
Internal sources of Finance
Capital contribution, retained earnings
External Sources of finance
Trade credit, Bank overdraft, Term loan, Leasing
Capital contribution
Funds contributed by the owners
Retained earnings
Past funds generated by the business
Trade credit
Buying goods on credit so a business can generate sales before paying for goods but can only be used to purchase inventory from suppliers
Bank overdraft
Facility provided by the bank whereby they allow a business to withdraw more than the funds they have available in the account
Term loan
Bank lends for a major purchase in which principal and interest is then repaid over a term
Leasing
A form of rental agreement in which a business have use of an asset but do not own it and makes monthly payments
Goods and Services Tax
GST is a 10% tax levied by the federal government on sales of most goods and services
RIPD
Receiving GST increases the amount owing, and Paying GST decreases balance
Return on Owner’s Investment
profitability indicator that measures how effectively a business has used owner’s capital to earn profit
Return on Owner’s Investment Equation
Net Profit/Average owner’s equity X100 = %
Strategies to Improve Return on Owner’s Investment
Increase Net profit by increasing sales or decreasing expenses. Decrease average owner’s equity by increase drawings to lower owner’s equity
Source Documents
Source documents are printed or electronic documents that provide evidence that a transaction has occurred
Cash receipt journal
records all money received
Cash payments journal
records all money paid
Advantages of preparing a cash journal
Summarises all similar transactions for a period of time into meaningful columns in one journal and cross checking mechanism
Disadvantages of preparing a cash journal
Time and cost as preparation may need a professional which costs money
Cash Flow Statement
Reports all cash flows during a period from operating, investing and financing activities and calculates the change in the bank balance during the period
Operating activities
Cash sales, interest received, GST received, GST refunded, receipts from accounts receivable, cash expenses, expenses, GST paid, GST settlement, payments to Accounts payable
Investing Activities
Purchases and sales of non-current assets
Financing Activities
loans received, cash contribution, loans repaid, cash drawings
Benefits of Preparing a cash flow statement
Aid decision-making about the firm’s cash activities, assist in planning for future activities and assess whether or not the business is meeting its cash targets.
Cash Flow Cover
A liquidity indicator which measures the ability of a firm to pay short term debts out of operating cash flows
Cash Flow Cover Equation
Net Cash Flow from Operations/average current liabilities
Strategies to improve CFC
Improve cash flow from operating activities by reducing cash expenses or increasing cash sales and reducing average Liabilities
Internal Control Procedures
Policies and procedures designed to protect the firm from fraud, loss and theft
Separation of Duties
split the responsibility for receiving cash and recording the cash in the cash journals
Rotation of Duties
rotate staff between jobs to help identify irregularities by the previous person
Careful Hiring Practices
check references & carefully assess new staff for honesty and integrity
Physical/Preventative Safeguards
security cameras, alarm systems, safes
Cash Controls
use pre-numbered source documents, verify balance of cash register against the cash register roll, bank cash daily and change banking procedures regularly to avoid predictable behaviour
Credit Transactions
When a service is performed or goods are exchanged but the cash relating to the transaction is not exchanged until a later date.
Accounts Payable
A supplier who is owed a debt by the business for goods or services purchased from them on credit
Accounts receivable
A customer who owes a debt to the business for goods or services sold to them on credit
The Income Statement
an accounting report which summarises revenues earned and expenses incurred during the reporting period
Revenue
Increases in assets (or decreases in liabilities) that result in increases in owner’s equity, other than capital contributions from the owner
Expenses
Decreases in assets (or increases in liabilities) that result in a decrease in owner’s equity, other than those relating to drawings by the owner
Use of the Income Statement
Aids decision making and planning by evaluating revenues, expenses and profit and allows the owner to identify where changes may be necessary to take corrective action and improve
Items which affect Cash Flow but not Profit
GST, Receipts from Accounts Receivable, Payments to Accounts Payable, Cash purchase or sale of a Non-current asset, Loans received, Loan repayments, Capital contributions, Drawings
Calculate bank for the balance sheet
OB + cash recipts - cash payments = CB
Calculate inventory for the balance sheet
OB + cred purch of inventory (No GST) + cash purch of inventory (No GST) + contribution of inventory - inventory consumed - drawings = CB
Calculate Accounts receivable for the balance sheet
OB + credit sales - receipts from accounts receivable = CB
Calculate Equiptment for the balance sheet
OB + purchase (no GST) + contribution - drawings = CB
Calculate GST for the balance sheet
OB + GST received on cash sales + GST charged on credit sales + GST refund - GST paid on cash - GST charged by suppliers - GST settlement = OB
Calculate Accounts Payable for the balance sheet
OB + Credit purch - payments to accounts payable = CB
Calculate Bank loan for the balance sheet
OB + new loan - loan repayments = CB (split C and NC)
Calculate Owner’s equity for the balance sheet
OB + Net profit + capital contribution - drawings = CB
