Chapter 1: Introduction to Accounting

Question 1

What is ‘accounting’?

Answer 1

Accounting is the art of communicating financial information about an organisation to interested parties.

Accounting can be defined as ‘the process of identifying, recording and communicating economic information to permit informed judgements and decisions by users of that information.

Question 2

What are the two main types of accounting?

Answer 2

1. Financial accounting

2. Management accounting

Question 3

Compare financial and management accounting in terms of their purpose.

(Purpose)

Answer 3

Financial accounting is the production of financial statements for external users for decision-making purposes.

Management accounting is the production of detailed accounts, used by management to control the business and make plans.

Question 4

How frequently are financial and management accounts prepared?

(Frequency)

Answer 4

Financial accounts: usually annually or semi-annually.

Management accounts: as frequently as is required by management. Real-time reporting is increasingly the norm.

Question 5

Why are financial and management accounts prepared?

Stimulus

Answer 5

Financial accounts are required by law.

Management accounts are prepared to aid management decision making.

Question 6

What is the focus of information in financial and management accounts?

(Focus of information)

Answer 6

Financial accounting reflects past performance and current position.

Management accounting includes budgets and forecasts of future activities, as well as reflecting past performance.

Question 7

What is the framework of financial and management accounting?

(Framework)

Answer 7

Regulatory framework for financial accounting dictates the contents of financial statements.

There is no regulatory framework for management accounting. There may be differences between organisations. Information should be useful to managers.

Question 8

Who are the users of financial information?

Answer 8

Investors
Lenders
Suppliers
Customers
Competitors
Employees
Government
Analysts
Public at large

Question 9

What is the key accounting information for an investor?

Answer 9

• Information about growth, sales, volumes
• Profitability (profit margins, overall level of profit)
• Investment in assets, levels of debt
• Business value

Question 10

What is the key accounting information for lenders?

Answer 10

• Levels of existing debt
• Cash flows to ascertain availability of cash when loan repayments are due
• Assets against which the lending may be secured

Question 11

What is the key accounting information for suppliers?

Answer 11

• Cash flow
• Management of working capital
• Terms of trade and payment policies

Question 12

What is the key accounting information for customers?

Answer 12

• Sales growth
• New product development
• Terms of trade
• Investment in business (e.g., production capacity)

Question 13

What is the key accounting information for competitors?

Answer 13

• Level of sales (market share)
• Profit margins
• External debt
• Asset growth

Question 14

What is the key accounting information for employees?

Answer 14

• Sales and profit growth
• Levels of investment in the business
• Overall employment data (numbers employed, wages and salary costs)
• Status and valuation of the company pension schemes/levels of company contributions

Question 15

Why are government agencies and departments interested in accounting information?

Answer 15

• Tax authorities are interested in profitability for tax purposes
• Local government agencies are interested for the purposes of levying local taxes and rates
• They may require information that supports decisions on grants

Question 16

What comprises a complete set of financial statements?

Answer 16

1. Statement of financial position
2. Income statement
3. Statement of cash flows
4. Statement of changes in equity
5. Notes to the financial statements

Question 17

What is the Statement of financial position?

Answer 17

It lists an organisation’s assets, liabilities, and equity at each reporting date.

N.B. - it presents the financial position of the organisation at a single point in time (the reporting date)

Question 18

What is the Income statement?

Answer 18

It presents the income earned and expenses incurred by an organisation during a reporting period.

It’s purpose is to calculate whether the organisation made a profit or loss for the reporting period.

Question 19

What is the Statement of cash flows?

Answer 19

It presents the cash inflow and cash outflows of an organisation during a reporting period.

Question 20

What is the Statement of changes in equity?

Answer 20

It explains how the equity of an organisation has changed during the year.

Question 21

What are the 5 elements of financial statements?

Answer 21

Assets
Liabilities
Owner equity
Income
Expenses

Question 22

What are assets?

Answer 22

Assets are economic resources controlled by the organisation that can be put to productive use for the future benefit of the organisation.
Examples are buildings, equipment, machinery, furniture, etc.

Question 23

What are liabilities?

Answer 23

Liabilities are obligations to third parties that must be settled at some point in the future.
Examples are outstanding bank loans, bank overdrafts and amounts owed to suppliers.

Question 24

What is owner equity?

Answer 24

Owner equity (or owner capital) is the residual amount of assets attributable to the owners of the business once the liabilities are settled.

Question 25

What is income?

Answer 25

Income commonly arises from the provision of goods and services to customers (sales or revenue).

Question 26

What is an expense?

Answer 26

An expense is a cost of carrying on business.

Question 27

An expense can be capital or current in nature. What two factors influence how it is accounted for?

Answer 27

1. The nature of the expense
2. Whether the benefit of the expense will be consumed in its entirety in the current reporting period or will also be consumed in future reporting periods