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acounting for business Flashcards

1
Q

what is the purpose of acounting

A

Purpose of Accounting:

* Provide useful accounting information

* Assist users make informed decisions (decision usefulness)
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1
Q

what is acounting

A

Accounting is the process of identifiying,recording,measuring,
classifying,verying,summarising interpreting and communicating financial information.

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2
Q

what are the 2 sides of accounting function

A

Two sides of accounting function

Management accounting
provides information
for managers of an
organisation who
direct and control
its operations.

Financial accounting
provides information
to shareholders,
creditors and others
who are outside
the organization

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3
Q

what is the acounting process

A

The Accounting Process:
- Identification
- Recording
- Communication
- Analyse

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4
Q

what is a Statement of Financial Position – SOFP, SFP (Balance Sheet)

A

What is the accumulated wealth of a business at the end of a period and what form does it take?

provides a snapshot of financial position at a given date

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5
Q

what is an income Statement – (Profit and Loss Account/Statement)

A

How much profit (wealth) was generated?
Measures financial performance over a period

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6
Q

what is a Cash Flow Statement

A

What cash movements took place?

Shows a breakdown of the reasons for changes in cash during a specific period
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7
Q

Statement of financial position explain

A

Statement of financial position
Snapshot of the company’s financial position at a specific moment in time (usually the month-end or year-end –

Reports the assets of the business and the claims against the business (liabilities and equity)

Relies on the Accounting Equation:
Assets (resources held the company) = Liabilities + Equity

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8
Q

what is an asset

A

ASSETS
Resources held by the company as a result of past events,
measurable in monetary terms, expected to result in the future inflow of economic benefit to the organisation.

Assets (resources held the company)= Liabilities + equity

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9
Q

what are non current assests

A

NON-CURRENT ASSETS
Long term in nature More than one business cycle (usually a year)

Can be tangible or intangible

tangible – physical e.g. land, buildings, plant and machinery, motor vehicles

intangible – non-physical e.g. goodwill, patents, trademarks etc.

Assets (resources held the company) = Liabilities + Equity

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9
Q

what are current assets

A

CURRENT ASSETS
Short term in nature
Expected to be sold in one year (normally to do with business operations)
Examples: Inventory (stock), Receivables, Bank, Cash, Prepayments
Key to the liquidity of the organisation (remember this for later in the module!)

Assets (resources held the company) = Liabilities + equity

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10
Q

what are liabilities

A

LIABILITIES
Present obligation,
As a result of past events,
Will result in the outflow of economic benefit from the organisation.

Assets (resources controlled) = Liabilities obligations + Equity

NON-CURRENT LIABILITES
Long Term Loans – Mortgages, debentures, bank loans

CURRENT LIABILITIES
Payables (creditors), accruals, provisions, maturing long term debt (less than one year left until repayment)

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11
Q

what is equity

A

EQUITY
This is the ownership’s claim on total assets
Represents how much of the assets (after liabilities) the owners actually own Includes
Shares (nominal value)
Share premium account
Reserves (could be retained earnings)

Retained Earnings: the accumulation of past profits and losses of the business

Assets (resources controlled)+ Liabilities =Equity(what owners can claim

To improve understanding, companies group similar assets and similar liabilities together

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12
Q

what is a Definition SPL/Income Statement – A Main Financial Statement

A

Definition SPL/Income Statement – A Main Financial Statement

  • Measures the financial performance of the business over a period of time
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13
Q

what is the purpose of spl income statememnt

A

purpose of SPL/Income Statement
Revenues & expenses for the period
Three measures of profit
* Gross profit
* Operating profit
Net profit or Profit for the period , i.e. (Total revenue less total expenses

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14
Q

what is Profit or Loss for the Period

A

Profit (or loss) for the period =

So in simple terms:
* We generate sales revenue from operating our business

  • We incur costs as we conduct our business activities
  • Hopefully, when we take the costs away from the revenue, we make a profit! Otherwise we aren’t going to be in business for a long time!
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15
Q

what is the basis for Reporting Revenues - Accrual Accounting (IFRS)

A

Basis for Reporting Revenues - Accrual Accounting (IFRS)

  • The organisation records transactions that change a company’s financial statements in the period in which the transactions occur
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16
Q

what is the matching principal

A

Matching Principle

  • To determine net profit/profit for the period:
  • Companies recognise revenues when they perform the services not when cash is received
  • Recording expenses when they are incurred and not when paid
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17
Q

what is revenues

A

Revenues:
Measure of inflow of economic benefits arising form ordinary operations of the business
Result from business activities entered into for the purpose of earning income.
Benefits will result in increase in assets or decrease in liabilities
Examples: sales, fees for services, interest received, subscriptions

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18
Q

what is Prudence Convention/Concept

A

Prudence Convention/Concept

We should be conservative in the preparation of our accounts:
Understate profits/revenues/assets
Overstate costs/liabilities
Also – this dictates our revenue recognition position:
We should only recognise revenues when we are reasonably sure they will be received

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19
Q

Accounting issues including revenue recognition issues contributed to the collapse of Enron which had significant consequences including

A
  • Employees: 4,500 employees lost their jobs
  • Shareholders: loss of $60 billion (US) of share value
  • Auditors: Arthur Andersen lost their auditing accreditation after conviction of obstruction of justice relating to shredding and doctoring documents relating to the Enron audit
  • Pension holders: lost their pension funds

Financial reporting rules improved: Sarbanes-Oxley Act

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20
Q

what is BASIC REVENUE RECOGNITION CRITERIA:

A
  • The amount of revenue must be able to be measured reliably
  • It is probable that economic benefit will be received
    ADDITIONAL CRITERION:
    Ownership and control of the items should pass to the buyer (in the case of sale of goods
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21
Q

what is the basic acounting equation

A
  • The (basic) accounting equation is
    Assets = Equity + Liabilities.
  • Equity is increased by profits
  • decreased by losses made in an accounting period.
  • We know that profit (or loss) is determined by Revenues minus Expenses for an accounting period.
  • So the accounting equation in an expanded form can be stated as:
  • Assets = Equity + (Revenues – Expenses) + Liabilities.
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22
Q

what is the matching concept

A

The matching concept

  • Revenues recognized in an accounting period under a SPL are those which are ‘earned’ within that period (irrespective when cash gets actually collected from the customers).
  • These ‘earned’ revenues are required to be matched with those costs which are incurred for using different resources or services which helped in generating the revenues, such as insurance, rents, utilities, salaries, depreciation, e.g. (irrespective of when these costs are actually paid).
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23
Q

what is the * Revenue recognition principle

A

Revenue is recognised on the performance obligation is satisfied

Recognize revenue in the accounting period in which the performance obligation is satisfied

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24
Q

what is EXPENSE RECOGNITION PRINCIPLE

A

Match expenses with revenues in the period when the company makes efforts to generate those revenues.
“Let the expenses follow the revenues.”

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25
Q

whayt is Prudence Convention/Concept

A

We should be conservative in the preparation of our accounts:
Understate profits/revenues/assets
Overstate costs/liabilities
Also – this dictates our revenue recognition position:
We should only recognise revenues when we are reasonably sure they will be received

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26
Q

what is expenses

A

Expenses
Outflow of economic benefits arising from the ordinary operations of the business
Loss of benefits will lead to decrease in assets or increase in liabilities
Cash & non-cash expenses
Examples: cost of sales, salaries expense, rent, heating & light, insurance, bad debts, finance costs/interest, depreciation, printing & stationary; provisions

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27
Q

what is Recognizing expenses on SPL - Matching Principle

A

XPENSE RECOGNITION PRINCIPLE

Match expenses with revenues in the period when the company makes efforts to generate those revenues.
Recording expenses when they are incurred and not when paid
Means that expenses reported in the SPL may not be the same as the cash paid during the period

  • The expense may be more or less
  • This gives rise to pre-paid expense or accrued expenses
    Recognising Expenses –Example 1

The general rule is:
All expenses of a particular accounting period must be matched with the relevant revenue of that period irrespective of whether the expenses have been paid in cash
John Plc. earned revenues for the period of £15,000. The rent relating to the revenues produced for the period was £1,000.
But John Plc. Only paid rent of £900 to the landlord during the accounting period. How do we account for this?
Income Statement: £1,000 rent expense
SOFP: Current liability of £100.

28
Q

what is Cost of Sales Inventory and the Matching Principle

A

Inventories are assets:
* Held for sale in the normal course of business (i.e. finished goods)
* In the process of production for sale (i.e. work in progress), or
* In the form of materials to be consumed in production of goods for sale (i.e. raw materials).

Cost of Sales Inventory and the Matching Principle

  • Cost of sales includes the costs of the inventory sold during the period.
  • This is an application of the ‘matching principle’ i.e. the revenues earned from selling inventories are matched to the costs of the inventories sold.
  • The costs associated with the inventory that remains unsold are carried forward (as current assets) to the next year where they will be recognised when the inventory is sold.
  • INVENTORY IS VALUED AT THE LOWER OF COST OR NET REALISABLE VALUE
29
Q

in cost of sales what do u reciebe prfit from

A

we gain revenue from:

○ Inventory left over from last year (now sold)

○ Inventory bought this year and sold (purchases)

○ But no revenue from inventory we bought that we couldn’t sell, so that is why we subtract this

30
Q

what is depreciation

A

Depreciation – non-cash expense
* Businesses use non-current assets to generate revenues

  • The matching principle requires us to match the cost of using up of these assets to the revenues the business generates in each period.
  • We do this through depreciation: spreading of the cost over the life of the asset
    The allocation of the cost of a plant asset to expense in the periods in which services are received/used from the asset.
31
Q

what are 3 common deprcistion methods

A

3 common depreciation methods:
straight-line
reducing-balance
units-of-production

32
Q

what are reduced receivables

A

REDUCE RECEIVABLES
(they aren’t going to be paid – not as valuable any more, less of an asset)

33
Q

what are increased expenses

A

INCREASE EXPENSES
unfortunately we have to take this hit to profit, as we won’t receive the value of the sale. Therefore record this on the income statement as an expense)

34
Q

what sare the ethical issues in accural accounting

A

Ethical Issues in Accrual Accounting
Accrual accounting provides opportunities for unethical behaviour, for example:

  • A dishonest businessperson could omit depreciation expense at the end of the year.
  • Failing to record depreciation would overstate profit as calculated by mandated accrual principles and disclose a more favourable picture of the business’ financial position than actually existed.
  • Some accruals are based on estimates, such as depreciation and revenue, and these can be manipulated.
35
Q

what is a bad debt

A

Bad Debts
What if one of our receivables accounts doesn’t pay us? I.e. a customer doesn’t pay

  • Risk of some customers not paying- amount owed is bad debt

In the event of this we have to adjust the accounts

36
Q

WHAT IS CASH FLOW STATEMENT

A

● Cash flow statement is:
* - One of the key financial statements (other two are SoFP & SPL).
* - A statement of cash receipts & payments.
* - Shows the movements of cash resources during a particular accounting period.

37
Q

what is cash equivalents

A

Cash equivalents
* - Should be treated as cash.
* - Short term highly liquid investments
* - Readily convertible to known amount of cash
* - Insignificant risk of change in value.

38
Q

what is the pURPOSES OF THE STATEMENT OF CASH FLOWS

A

URPOSES OF THE STATEMENT OF CASH FLOWS
1. Predict future cash flows
2. Evaluate management decisions
3.Determine the ability to pay dividends to Shareholders’and payments to creditors
4. Show the relationship of net income to the business’cashflows

39
Q

what is OPERATIONS ACTIVITIES

A

OPERATIONS ACTIVITIES
* ● It reflects the day-to-day operations that determine the future of an organization
* ● Generated by revenues / gains
* ● Used up by expenses / losses

40
Q

What is OPERATING ACTIVITIES

A

OPERATING ACTIVITIES (INDIRECT METHOD)

● 3 basic adjustments

  1. Add back depreciation expense

2.Add back losses and subtract gains associated with the sale of investment or property, plant, and equipment

3.Adjust for changes incurrent assets and current liabilities associated with operations

41
Q

what is the Purpose of Financial Statement Analysis

A

Purpose of Financial Statement Analysis

  • Every item in financial reports represents something important or material.
  • Its significance can be determined only in relation to something else – single numbers on their own do not provide useful information.
  • Most of the information contained in financial statements is expressed in monetary terms.
    £ amounts are important BUT not particularly useful for comparative purposes between entities
42
Q

what are the Limitations of Dollar Value Comparisons

A

Limitations of Dollar Value Comparisons
The current year’s profit needs to be compared with other information such as:

  • last year’s profit
  • the current year’s sales
  • the profits of other entities in the same industry

the value of assets used to generate the profit

43
Q

what is a Financial Statement Analysis

A

Financial Statement Analysis
To overcome this, financial statement analysis is a technique used by analysts to achieve information useful for decision making including:

  • Assessing the financial health of a business.
  • To compare current performance with past performance.
    To compare and benchmark against industry competitors and even across other industries

What is financial statement analysis?

  • Relative figures (instead of absolute figures)
  • Single items on financial statements don’t tell the whole story
  • For critical analysis we need relative figures i.e. ratios
44
Q

what is a comparative analysis

A

Comparative Analysis
Types of useful comparative information:

  • Intra-entity basis:
    • Comparisons within a single entity (detects changes in financial relationships and trends).
  • Industry averages:
    • Between entities in same industry (determines position relative to others).
  • Inter-entity basis:
    • Between other entities (indicates competitive position).
45
Q

what are the Objectives of Financial Statement Analysis

A
  • Investors use financial statement analysis to
    • Predict expected returns
    • Assess the risks associated with those returns
  • Equity investors are more concerned with profitability and future security prices
  • Creditors are primarily concerned with
    • Short-term liquidity – how much cash a company has on hand to meet current payments when due
      Long-term solvency – a company’s ability to generate cash to repay long-term debts when
46
Q

what are the Types of Financial Statement Analysis

A
  1. Cross-sectional analysis (inter-company analysis)
  2. Time series analysis (intra-company analysis)
  3. Vertical analysis (common size statements
47
Q

what is Vertical Analysis

A
  • Evaluates financial statement data by expressing each item as a percentage of a base amount to indicate relative magnitude.
  • Useful for comparing companies of different sizes.
  • Calculated percentages can also be tracked over time to determine patterns of change.

Vertical analysis (common size statements)

Example on Vertical analysis (common size statements)- Mo Coffee Ltd Income Statement

48
Q

what is a ratio analysis

A

Ratio Analysis

  • Ratios are important tools that can be used to evaluate the financial performance and health of a business.
  • Ratios are of more use when used with something we can compare to (i.e. industry benchmarks and trends from prior years).
  • Ratios must be interpreted in context (industry, size, economic conditions).

Ratio Analysis
Financial ratio analysis will provide warning signs that could allow a business to solve problems before they become significant, such as:

* Inconsistent movement of sales, inventory and receivables;

* Earnings problems;

* Decreased cash flow;

* Too much debt;

* Inability to collect receivables; Build-up of inventories

Ratio Analysis

  • Ratios are clues, not answers.
  • Ratios can be calculated in different ways.
    • many analysts have their ‘own’ formulae.
    • sometimes there are different industry practices.
    • can use end of year balance sheet data (highlights change across the year) or average between start and finish (gives a smoothed long term trend).
  • Ratio analysis can be used to make both:
    • Intra-company comparisons.
    • Inter-entity comparisons.

Remember a few slides before! Classification/categories of Ratios

49
Q

what is a Profitability Ratios

A

Profitability ratios measure the profit or operating success of an entity for a given period of time.

  • Size of entity’s profit affects its:
    • Ability to obtain debt and equity financing.
    • Liquidity position.
    • Ability to grow.
  • Profitability is often regarded as the ultimate test of management’s operating effectiveness.
  • Long term survival of a business depends on its ability to generate profits.
50
Q

what is liquidity ratio

A

Liquidity Ratios
Liquidity ratios measure the short-term ability of an entity to pay its debts and meet unexpected needs for cash.

Important to bankers, suppliers and other short-term creditors.

51
Q

what are the diffrent types of ratios

A
  • A high current ratio indicates that the business has sufficient current assets to maintain normal business operations and pay their current liabilities.
  • A high ratio is considered favourable to creditors, but may indicate excessive investment in working capital items that may not be producing profits.
  • a low current ratio may indicate inability to meet short-term debts in an emergency (i.e. not enough current assets to meet current liabilities).
  • The quick ratio (or acid-test ratio) tells us whether the entity could pay all its current liabilities if they came due immediately.
  • A quick ratio of 0.9:1 to 1:1 is considered acceptable for most industries.
  • A lower ratio may indicate that, in an emergency, the entity would be unable to meet its immediate obligations.
  • Generally, the higher the ratio the better but not too high above 1:1.
    Gearing ratios
52
Q

what are the Limitations of Financial Statement Analysis

A

Limitations of Financial Statement Analysis
Different accounting policies results in misleading comparisons.
Historical cost data distorts comparisons.
Performance criteria/yardsticks are not appropriate for all types of industries.
Comparisons using ratios need to consider some factors.
A single ratio provides limited information.

53
Q

what are the limitations of Financial Statement Analysis

A

Estimates:

  • Financial statements contain many estimates, such as:
    • allowance for doubtful debts.
    • depreciation expense.
    • costs of warranties.

If estimates are inaccurate, the financial ratios and percentages will also be inaccurate.

54
Q

what is rato analysis and the big picture

A
  • Remember that ratios will not always tell the whole story.
  • To complete a thorough business analysis, the process would include more than just a financial review.
  • Consideration of issues such as economic factors, competitive market influences, global events and trends and other information on business operations would be relevant.
  • The other information in the annual report is vital to gaining a proper understanding.
55
Q

what is the Analysis of Non-Financial Data

A

Analysis of Non-Financial Data

  • The non-quantitative parts of the annual report may hold important information than the financial statements.
  • If the business is currently undergoing expansion, it may borrow money to enable expansion.
  • The chairman’s report may describe a turnover of top managers.
  • The management discussion and analysis will reveal management’s opinion of the year’s results.
    The auditor’s report may indicate a major problem with the company
56
Q

what is the return on capital employed (ROCE)

A
  • An important profitability ratio
  • Primary measure of business’ performance (efficiency)
  • Compares inputs (capital employed) with outputs (operating profit)
  • Expresses relationship between operating profit (PBIT) and the average long term capital employed
  • Return to investors & lenders before deductions for interest, tax and dividends
  • Widely used by businesses when establishing targets for profitability
57
Q

How useful is ROCE as an indicator of a company’s performance?

A

Good baseline measure of a company’s performance:

* Showing how efficiently a company makes use of its available capital by looking at the profit generated in relation to every pound of capital utilized by the company

* Comparing certain types of business

* When it is used in conjunction with other performance measures
58
Q

what are The main elements of the ROCE ratio

A

The ROCE ratio can be divided into two elements:

1. Operating profit to sales revenue
	
	○ £1 revenue ---- how much return? (Profitability)

2. Sales revenue to capital employed
	
	○ £1 capital ---- how much revenue? (Efficiency) By analysing ROCE in this way, we can see the influence of both profitability and efficiency on this important rati
59
Q

why is a higher asset turnover ratio preferred

A
  • A higher asset turnover ratio is preferred to a lower one, indicating that the assets are being used more effectively and productively to generate revenue.

Overtrading, however, may occur with a very high ratio since assets maybe insufficient to sustain the high level of revenue generation

60
Q

Limitations of Traditional Financial Statements (a)

Historic Nature of Accounting

A
  • The financial statements report the effects of historic transactions and events.
  • The financial statements are therefore entirely backwards looking.
  • Investors and lenders make decisions to provide financial capital to a business based upon the returns that they expect to receive in the future.
  • It is therefore questionable whether the information provided in the financial statements is relevant, i.e. capable of influencing those decisions.
61
Q

Limitations of Traditional Financial Statements (b)

The Timing of Financial Statements

A
  • By the time the financial statements are published they are already out of date. In the UK public companies have 6 months to publish them.
    • For example, if your year-end is 31 December 2022 you have until 30 June 2023 to publish them and send them to the users.
    • Is out of date information relevant to decision makers?
  • The statement of financial position is a ‘snapshot’ of a company at the year-end.
    • For example, if your year end is 31 December 2022 your statement of financial position lists the assets and liabilities on that day only. It does not represent the position throughout the year.
    • Does this, therefore, faithfully represent the normal level of assets and liabilities in a business?
62
Q

Limitations of Traditional Financial Statements (c)

Accounting Flexibility

A
  • There is huge scope for flexibility: estimates and policy choice.
  • Accounting values may not necessarily reflect true economic values.
  • For example, do the values of buildings (which have been depreciated on an annual basis) in the financial statements reflect how much those assets are truly worth, for example if they were sold?
  • Scope for earnings management.
  • This increases the risk that financial statements are not faithfully represented.
  • Each country can select the accounting principles to be applied in that country.
  • If each country uses different principles this makes their financial statements less comparable.
63
Q

Limitations of Traditional Financial Statements (d)

Context of the Information Provided

A
  • Financial statements provide little context for understanding a business.
    • For example, they report what the sales and expenses for the year were but they do not report why these have changed in comparison to previous years, how management strategy has affected these etc.
  • They only report things that can be quantified in monetary terms. There are many aspects of a business that are important to their financial performance and position that cannot be expressed in £ or $.
    • For example: Apple relies heavily on the expertise of their research and development team. This expertise is not valued in the financial statements.
      i.e. there is other relevant information that is not presented in the financial statements
64
Q

what is a stake holder group

A

stakeholder Groups

A person, group or organization that has interest or concern in an organization. Stakeholders can affect or be affected by the organization’s actions, objectives and policies.

65
Q

what is the Financial reporting developments

A

1960 - In the 1960 the focus was mainly on producing financial statements for external users.
The 1980s saw increasing interest on the need to include complimentary reports which includes management commentary, governance and remuneration and environmental reporting.

2000 - 1980s 1990s and 2000s saw a shift on the need to include complimentary reports which includes management commentary, governance and remuneration and environmental reporting.

2020 The future is to integrate all report in one report ‘Integrated Report’.

66
Q

what is Integrated Reporting (a

A

Integrated Reporting (a

  • It is reporting method that brings together material information about an company’s strategy, governance, performance and prospects in a way that reflects the commercial, social and environmental context within which it operates.
67
Q

what is the benefits associated to integrated reporting:

A
  • Encouraging your organisation to think in an integrated way
    • Clearer articulation of strategy and business model
    • A single report that is easy to access, clear and concise
    • Creating value for stakeholders through identification
      and measurement of non-financial factors
    • Linking of non-financial performance more directly
      to the business
    • Better identification of risk and opportunities
    • Improved internal processes leading to a better
      understanding of the business and improved decision
      making process.
68
Q

Why Integrated Reporting

A
  • The macro perspective:
    • Financial stability
    • Sustainability
  • In practical terms:
    • Concise communication of value – more than financial capital
    • Focus on strategy and future orientation
    • Reduce volume
    • Promote connectivity of information
69
Q
  • An integrated report therefore aims to provide insight about:
A
  • The external environment that affects an organization
    • The resources and the relationships used and affected by the organization, which we refer to as capitals
    • How the organization interacts with the external environment and the capitals to create value over the short, medium and long term.
  • The external environment, including economic conditions, technological change, societal issues and environmental challenges, sets the context within which the organization operates.
  • At the core of the organization is its business model, which draws on various capitals as inputs and, through its business activities, converts them to outputs (products, services, by-products and waste). The organization’s activities and its outputs lead to outcomes in terms of effects on the capitals.
  • Continuous monitoring and analysis of the external environment in the context of the organization’s mission and vision identifies risks and opportunities relevant to the organization, its strategy and its business model.
  • The organization’s strategy identifies how it intends to mitigate or manage risks and maximize opportunities. It sets out strategic objectives and strategies to achieve them, which are implemented through resource allocation plans
    The value creation process is not static; regular review of each component and its interactions with other components, and a focus on the organization’s outlook, leads to revision and refinement to improve all the components
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HR & business management (4 decks)

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