Chapter 1 - Introduction to Accounting Flashcards
What is Accounting?
a way of recording, analyzing and summarizing financial data
What is financial data? give examples (3)
the name given to the actual transactions carried out by a business. 1. Sales 2. Purchases 3. Expenses
What happens to transactions?
- Recorded in books of prime entry, 2. Analysed and totals posted in ledger accounts 3. Summarised in financial statements
Q: Accounting only applies to the financial statements produced by a large listed company? A. Yes B. No
B. Accounting is carried out by all businesses, no matter their size or structure.
What are the two types of accounting?
- Financial accounting & 2. Management accounting
Define Financial Accounting (3)
- Method of reporting the results/financial position of a business.
- Not primarily concerned with providing information to improve the business.
- Satisfy information needs and provide a historical record
Define Management Accounting (2)
- Much more detailed than financial accounting
2. Include plans for the future like budgets predicting future revenue/expenditure)
What thing influence the rules around preparing financial statements? (3)
- Company law
- National and international accounting standards
- stock exchange requirements
Define GAAP
Generally Accepted Accounting Principles. includes all rules which govern accounting in a country
What governs the form and content of limited liability companies financial reports?
primarily (1) national legislation but also (2) International accounting standards (IAS’s) and (3)international financial reporting standards (IFRSs).
Where do rules outlined in the GAAP standards derive from? (4)
- Local (national) company legislation
- National and international accounting standards
- Statutory requirements in other countries (US)
- Stock exchange requirements.
What are the fundamental qualitative characteristics of useful financial information? (2)
- Relevance
2. Faithful representation
Define Fair presentation
Cant, its a fluid thing. generally: In International Accounting Standards, the requirement for companies not to obfuscate their financial statements so as to mislead shareholders or the wider market.
What is required for fair presentation? (4)
- Compliance with all applicable accounting standards
- Selection and application of appropriate accounting policies
- Presentation of information to provide relevent, comparable, verifiable, timely & understandable info
- Additional disclosure where required
What is the fair presentation override?
When a company can override the fair presentation rules of a company if it means by following the rule the financials will not give a fair presentation
Define the economic (business) entity assumption
a business entity exists separately from its owner(s). Therefore the financials are prepared separate to the owners regardless of legal position.
What does the business entity assumption mean for movement of money between the business and its owner?
Any money paid into the business is owned by the business as a loan from the owner.
Any money out to pay personal items of the owner is not recorded as a purchase but as money taken out of the business by the owner.
Define monetary unit assumption
accounts can only deal with items expressed in monetary terms. Things such as experience and knowledge of the employees is not an asset of the business as no reliable monetary value can be placed on experience
True or false: Experience is counted as an asset to a business
False. cannot be valued reliably therefore cannot be included as an asset
Define time period assumption
Financial statements should be prepared on a regular basis and for a particular period of time which is normally one year
Define going concern
Entity viewed as a going concern when it has neither the intention nor the need to liquidate or curtail materially the scale of its operations.
What are the assumptions of going concern? (2)
- the business will continue to operate fr the next 12 months.
- Assets should not be valued at their break up value.
Define break up value
value of an asset if sold off in say a liquidation situation.
Define carrying value
Value of an asset over time. Carrying value = cost less the accumulated depreciation charged to date.
If the going concern assumption is valid how is an asset/item valued?
it is valued at the carrying value = cost less the accumulated depreciation charged to date
True or false: an asset should be valued at its sracp price after the first 3 years of operation as this is what it would sell for during a valuation therefore that is all its worth.
False if the going concern assumption is valid. True if the going concern assumption is not valid.
A retailer commences business on 1 January and buys inventory of 20 washing machines, each costing
$100. During the year he sells 17 machines at $150 each. How should the remaining machines be
valued at 31 December in the following circumstances?
a. He is forced to close down his business at the end of the year and the remaining machines will
realise only $60 each in a forced sale.
b. He intends to continue his business into the next year.
(a) If the business is to be closed down, the remaining three machines must be valued at the
amount they will realise in a forced sale, i.e. 3 × $60 = $180.
(b) If the business is regarded as a going concern, the inventory unsold at 31 December will be
carried forward into the following year, when the cost of the three machines will be matched
against the eventual sale proceeds in calculating that year’s profits. The three machines will
therefore be valued at cost, 3 × $100 = $300.
What should be disclosed if going concern assumption is not followed? (3)
- The business is not a going concern
- The basis on which the financials have been prepared
- Reasons why the entity is not considered to be a going concern
Define the accruals assumption
revenue earned is matched against the expenditure incurred in earning it.
When are transactions recorded in financial statements?
when the revenues or expenses are earned or incurred. not when the cash is paid or received.
Define Substance over form
The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form
When does substance over form apply? why?
When the transactions are fairly complicated. stops entities distorting their results by follow the letter of the law and being able to hide certain things. present on commercial reality not always legal form of the transaction
What is cost principle?
items in the financial statements should be valued at cost, however there are different ways of determining cost
Define historical cost
Items are normally stated in accounts at historical cost. known as the amount the business paid to acquire them.
What are the advantages of historical cost? (2)
- Documentary evidence of to prove the amount paid to purchase and item or pay an expense.
- Are objective (unlike valuations which vary depending on what they are for)
Define replacement cost
amount needed to replace an item with an identical item
AB Co purchased a machine five years ago for $40 000. It is now worn out and needs replacing. An identical machine can be purchased for $60 000. What is the a) historical cost and b) replacement cost?
a. $40 000
b. $60 000
Define Net realisable value
The expected price, less any costs to be incurred in getting the item ready for sale or selling it.
AB Co’s machine from the example can be restored to working order at a cost of $10 000. It can
then be sold for $20 000. What is its net realisable value?
Net realisable value = $20 000 – $10 000
= $10 000
Define Economic Value
The value derived from the assets ability to generate income. ie. the profit an asset is expected to make in the remainder of its useful life.
Suppose that a company buys a new machine for $40 000. It is estimated that the new machine will generate profits of $9000 per year for its useful life of seven years. What is its economic value?
Economic value = $9 000 x 7
= $63 000
What is defined as relevant information?
information that is capable of making a difference to the decisions made by its users.
When is financial information considered capable of influencing decisions? (3)
if it has a predictive or confirmatory value or both. is often used as a way to predict the future or confirm past performance
What is defined as a perfectly faithful representation? (3)
When it is:
- complete
- neutral
- free from error
In which two ways must financial information be comparable?
- Through time to identify trends
- With other entities statements to evaluate their relative financial position, performance and changes in financial position.
When is information defined as verifiable?
when different knowledge and independent observers can agree that this particular way is right.
What is an example of direct and indirect verification?
direct - counting cash
indirect - checking through calculations
Define the importance of timeliness when regarding financial reports.
information must be available to users tin time to influence their decisions. Usually the older information is the less useful it is however historical data can help identify trends
Define understandability in the context of financial reporting
users must be able to understand financial information however complex matters should not be left out simply due to the difficulty in understanding them
What are the main elements of financial statements? (3)
- Statement of financial position
- Statement of profit or loss
- Statement of changes in equity
Define a statement of financial position (2)
- is a list of all the assets owned and the liabilities owed by a business.
- a snap shot in time.
Define an asset
An Asset is something which is of value to the business, which the business owns or has use of
What are some examples of assets?
factories, office buildings, warehouses, delivery vans, lorries, machinery, computer equipment, office furniture etc
Define a liability
A liability is an amount which is owed to someone else. ‘liabilities’ is the accounting term for the debt of a business
What are some examples of liabilities?
amounts owed to suppliers, amounts owed to the bank, bank overdraft, tax owed
What do we call the amounts invested into a business by the owner?
capital
In a limited liability company what is the name given to the capital
Share capital is known as equity
In what order does a financial statement list capital liabilities and assets?
Assets, capital & liabilities
What do the assets always equal?
the assets will always be equal to liabilities plus capital (or equity)
Define a statement of profit or loss
P & L is a record of the income generated and expenses incurred over a given period. shows whether the business has more income than expenses (in profit) or more expenses than income (loss)
If a business has more income than expenses is it running at a profit or at a loss?
profit
Define income
Money or other benefits flowing into a business during an accounting period
Define revenue
Revenue is money earned from customers by selling goods & services to them
Define gains (2)
(1) profits from selling assets such as building or machines that have been used long term by the business in operations rather than in trading. (2) can also include increases in value of non trading assets such as property or investments
Define expenses
Expenses are the money or other benefits that flow out of a business during the accounting period.
What are the main types of expenses incurred by a business?
mostly running costs of the business like salaries and wages. can also included losses from non trading assets.
Define a statement of changes in equity.
A statement which chows the change in the amount in owner of the business has invested during a given period. includes the net profit or loss, any capital produced and any amounts returned to the owner.
True or false both sole traders and limited liability companies produce statements of changes in equity.
Mostly false. sole traders usually display changes in equity the ‘capital’ section of the financial position
Define the accounting equation
Assets = capital + liabilities
Define drawings
Drawings are amounts of money taken out of a business by its owner
Which is correct: A Capital = Assets + Liabilities B Capital = Liabilities – Assets C Capital = Assets – Liabilities D Capital + Assets = Liabilities
C Capital = Assets – Liabilities because Assets = Capital + LIabilities
Define a ‘payable’. what is another name for a payable?
A person to whom the business owes money. often known as a creditor
Define a trade payable
A person to whom the business owes money for debts incurred in the course of trading operations
In the accounts of a business, unpaid debts which arise from the purchase of materials, components or goods ‘payables’ for resale are called…?
Trade Accounts Payable/Accounts payable/payables
What is a accounts receivable or debtor?
A customer who buys goods without paying cash for them immediately
Define trade accounts receivable.
Amounts owed by receivables (customers) for services already provided
True or False: A Trade account receivable is a liability
false it is an asset. when that is paid it turns into a cash asset
Which key elements make up a financial statement? (5)
Assets, Liabilities, equity (capital), Income & Expenses
How would purchasing $800 worth of inventory on credit affect the accounting equation?
- Increase in assets inventory) $800
- Increase in liabilities (payables) $800
How would paying the telephone bill $25 Affect the accounting equation?
Decrease in assets (cash) $25
Decrease in capital (profit) $25
How would selling $450 worth of inventory for $650. affect the accounting equation?
Decrease in assets (inventory) $450
Increase in assets (cash) $650
Increase in capital (profit) $200
How would paying $800 to the supplier affect the accounting equation?
Decrease in assets (cash) $800
Decrease in liabilities (payables) $800
