Chapter 1 - Accounting Principles and Techniques

Question 1

Accounting Definition

Answer 1

Means by each a business maintains a record of all the financial activities of the firm: large or small, sole trader or multi-national company.

Question 2

Incoming money sources

Answer 2

1. owner
2. third parties - customers, banks and lenders
3. Income from sales
4. other income - rent, interest, investments

Question 3

Money is spent on

Answer 3

1. Assets - items to run a business - machinery, premises, stock, vehicle
2. Expenses - the costs of running a business - wages, advertising, business rates, etc

Question 4

Reason for keeping accounts

Answer 4

To record where the money has come from and where it has gone to

Question 5

Accounts will allow the company to have a record of:

Answer 5

1. what it owns
2. how much it owes to third parties - suppliers, banks, lenders
3. how much it is owed by third parties - customers
4. the costs or expenses incurred in running the business
5. its income from sales and other sources

Question 6

Profit

Income Statement

Answer 6

Increase on the worth of the business in a given period of time.

Accounts enable a business to calculate whether or not they have made a profit.

Profit and loss are shown in Income Statement

Question 7

The Statement of Financial Position

Answer 7

At the end of a period of time this is required so that the company knows their financial position,

Question 8

What accounts record

Answer 8

What business owns, owes, its expenses, its income; and this will enable to determine if the company has made a profit or a loss in a given period of time., and to determine its financial position at the end of a given period.

Question 9

A successful business can

Answer 9

forecast
plan
monitor
control

Question 10

Forecasting

Answer 10

• given past performance, state of the market, competition what growth may be realistically achieved (information will come from statements)
• what cost will it be to run the business next year, based on the costs from last year;
• if it can afford further investment, based on availability of internal funds

Question 11

Planning

Answer 11

Roadmap linking where the business is now and where it wants to be in the future. This is shown in a budget.

Question 12

Monitoring

Answer 12

After planning what it wants to achieve, a company needs to monitor periodically its performance against the plan (budget), and identify where it’s going different from the plan.
Financial records help monitor these.

Cash resources should be monitored closely, this will also help prevent fraud.

Question 13

Controlling

Answer 13

After monitoring it is important to take corrective action where needed.
For instance, amending objectives and targets for the year, more staff may be needed

Question 14

Who are the records for?

Answer 14

Managers of the business.

Sole traders, for instance, will need to know if they are generating enough return to live on.

Managers in larger companies will use this information to make business decisions which may affect thousands of people: employees, shareholders, suppliers and customers.

Question 15

Who are the records for?

Owners

Answer 15

Specially in a small company, where they are the person who runs the business and makes all the decisions.

In large companies, the shareholders (owners) have no involvement in running the business. So accounts will provide them with a measure of protection against mismanagement or fraud. As accounts will provide a ‘report’ on the performance of the business.

Question 16

Who are the records for?

Investors

Answer 16

Individuals and managers are the ones who make investment decisions in large companies.
Even a small amount invested needs to be done with the security that it is likely to bring returns in the form of profits.
Large companies will need detailed financial information to make such decisions.

Question 17

Who are the records for?

Lenders

Answer 17

Lending organizations will needs to know that the firm will have the ability to repay the loan.

The accounts will provide useful information about the financial status of the company, profitability and liquidity.

Question 18

Who are the records for?

Suppliers

Answer 18

Where goods are bought in credit, suppliers will want to ensure they are going to be paid.

Question 19

Who are the records for?

Customers

Answer 19

Customers will want to know who they are purchasing from is reliable, and also that the company will be there for any required sales services and warranties.

Question 20

Who are the records for?

Employees and trade unions

Answer 20

The main concerns will be security and that the company is profitable, which will provide greater job security.

Profitability is however no guarantee that jobs are secure, as competition and the need to drive costs down, may bring no job security.

Trade Unions will use the information to bargain for pay rises or reduced working times.

Question 21

Who are the records for?

Government and their agencies

Answer 21

the government will use this information to determine if correct tax amount is being being paid.

Large companies financial information will also help determine regulation. allocate resources and help develop economic policies.

Question 22

Who are the records for?

Insurance Companies

Answer 22

to review sales revenue and assets owned to assess business insurance premiums.

Question 23

Who are the records for?

The public

Answer 23

To determine if the business is environmentally friendly and how they may impact local issues.

Question 24

Financial statement reporting

Answer 24

Public companies have to submit financial statements within 6 months of their financial year end.

Private companies and limited partnerships have to do so within 9 months of their financial year end.

therefore external users will not be accessing the most up to date information,

Question 25

Financial information

Bookkeeping

Answer 25

Details are recorded on the Day Book related to the date of the activity.

This data is then transferred to accounts in the ledger.

This ongoing process is called bookkeeping

Question 26

Financial information

Accounting

Answer 26

The information from bookkeeping is then used by accountants to produce financial statements, and this process is called accounting.

Question 27

Financial statements frequency

Answer 27

The type and frequency of the financial statements produced for internal use will depend on the size, nature and form of ownership of the business.

But has a basic guide there are usually:

• end of year financial statements produced by the ‘financial accounting’
• internal accounts produced by the ‘management accounting’

Question 28

Financial statements frequency

End of year financial statements produced by the ‘financial accounting’

Answer 28

• profit and loss statement - Income Statement
  it determines if the business has made a profit or loss in the year (financial performance)
• Statement of Financial Position (balance sheet): shows what the business owes and owns at a given date (financial position)
• Cash Flow Statement: shows where the money has come from and gone during the year

Question 29

Financial statements frequency

Internal accounts produced by the ‘management accounting’

Answer 29

Produced within the business and may be or not shared with 3rd parties.

• monthly management accounts: profit and loss and financial position (balance sheet)
• monthly cash flow statements: projected cash flow expectations and actual receipts and payments
• monthly budget figures: forecast income and expenditure against actual performance (budgetary control)

Question 30

Profit and cash

Answer 30

Calculated with the information from bookkeeping.

Profit is then used to measure performance. These need to be compared to pre-existing objectives. This will allow better decision making.

Profit and cash will never be the same.

Question 31

Profit and cash differences

Answer 31

Profit is how much money a business is making once all expenses have been deducted;

Cash is the amount of money on hand to pay due bills

Question 32

Accounts

Answer 32

Accounts are created to record transactions for a customer. There will be further information, such as credit limit, ‘age’ of amounts owing., etc.

Keeping accounts allows:

• monitoring and controlling of amounts of credit for a particular customer
• ensuring customers are settling in due dates

Question 33

Accounts

Information is used to

Answer 33

• chase overdue amounts
• monitor credit limits
• liaise with sales when accounts are overdue
• forecast expected receipts for monthly management figures

This ensures customers adhere to the agreed terms, but it is important to establish if credit should be granted in the first place. Companies have their own criteria.

Question 34

Use of Financial Statements

Answer 34

Small organizations, such as sole traders and partnerships, are not legally required to publish financial statements and the financial information they choose to make available to third parties, is decided by the owners.

Limited Companies and Limited Liability Partnerships are, however, required to lodge financial statements with the Registrar of Companies, and Public Limited Companies must puclish account information.

Question 35

Credit Agencies, information they provide

Answer 35

• whether a company is profitable
• its current long-term borrowing
• availability of cash or items such as stock that can rapidly be converted into cash
• how much it owes to third parties, such as suppliers, that are due to be paid within 1 year

That is, it indicates trading position of the business, and ability to pay its short-term debts.

Question 36

Accounts and Financial Statements

summary of their importance

Answer 36

Accounts provide information about the financial standing and assist in helping decide whether or not credit should be granted.

Results of at least 3 years, preferably 5, should be examined to identify trends,

Accounts can only record measures and matters od monetary value, they don’t account management expertise or competition. Therefore decisions shouldn’t be made on financial information only.

Question 37

The Accounting Equation

Answer 37

The basis of the whole accounting system, including double-entry and book-keeping

Question 38

The Account Equation

Capital
profits and drawings

Answer 38

Money that the owner puts in the business to get it started.

Any profits made by the business is added to the capital.

Any money taking by the owner, is called drawings

Question 39

Business Entity Concept

Owner, capital,

Answer 39

In accounting terms the owner and the business are separate entities, therefore business affairs are kept separate from those of the owner.

The capital is treated as a loan to the business.

A third party loan is repaid in the future, but the owner’s capital is kept permanently until the firm is wound up or sold.

Question 40

The Accounting Equation

Assets

Answer 40

Items of monetary value which are owned and used to operate the business.

Examples: premises, fixtures and fittings, stock of goods, bank, debtors.

Question 41

How Capital is calculated

Answer 41

Assets - Liabilities = Capital (net assets)

Question 42

Assets

Debtors

Answer 42

Traders usually buy and sell on credit, therefore goods are usually paid later, usually within 30 days.

This short term debt is an asset, because it will become cash within a month, and cash is another asset.

Question 43

Liability

Answer 43

Where owner is unable to provide all the funding for setting and expanding the business, and borrowing is needed.

Any form of borrowing is a liability.

Examples of liabilities: creditors, bank loans.

Question 44

Accounting Equation

ALICE

A + E = L + I + C

Answer 44

Assets + Expenses = Liabilities + Income + Capital

Assets and Expenses —–> Debits (A & E Department)

Liabilities Income and Capital ——–> Credits

Question 45

The Statement of Financial Position (Balance Sheet)

Answer 45

The accounting equation is the basis of the Statement of Financial Position.

It is the ‘snapshot’ of the firm’s financial position, usually at the end of the accounting year.

Question 46

Current Asset

Answer 46

An asset that is expected to last or be in use for less than 1 year.

They are continuously turned into cash throughout the year.

Examples: stock or goods, debtors, bank and cash

Question 47

Non-current asset

Answer 47

An asset that is owed by the firm on a long term basis to generate profit.

It will be kept for more than 1 accounting year, so the funds used to buy these are tied up for a long time.

Examples: machinery, premises, fixtures and fittings, motor vehicles, equipment.

Question 48

Capital

Answer 48

Investment made in the firm by the owner, with the intention of earning a return (profit).

The profit made and any additional capital introduced during the period is added to the existing capital.

Capital at the end of the period = capital at the end of the period + any further capital + profit (minus loss) - drawings.

Capital is classed as a liability, because it is seen as a loan to the business, and as it may be paid the the owner in the future. Though it generally only happens if the company is sold or wound up.

Capital is shown separately to other liabilities.

Question 49

Non-current Liability

Answer 49

It’s a debt owed to a third party which will be repaid after the next accounting year.

Examples: bank loans, debenture, mortgage.

Question 50

Current Liability

Answer 50

Short-term debt, which will be repaid within 1 accounting year.

Examples: creditors, bank overdraft, VAT.

Question 51

Statement of Financial Position to identify the working capital

Answer 51

Current assets - Current liabilities = working capital ot Net Current Assets