Chapter 1: Introduction to Accounting Flashcards
Question Bank
What is capital expenditure?
Capital expenditure relates to the acquisition of, or improvement of the earning capacity of, non-current assets
What are examples of capital expenditure?
Legal fees incurred on the purchase of a building
According to the IASB’s Conceptual Framework, what are aspects of relevance?
Nature or materiality
According to the IASB’s Conceptual Framework, which qualitative characteristics enhance the usefulness of information that is relevant and faithfully represented?
Comparability, understandability, timeliness, verifiability
Who would be interested in the financial statements of a small private company?
Company employees, the company’s bank, suppliers
In relation to the business of a sole trader, what does the government and its agencies need to be able to do?
Establish levels of tax revenue and produce national statistics
In relation to the business of a sole trader, who needs to assess whether the business will continue to exist?
The sole trader, its suppliers, customers, and employees
In relation to the business of a sole trader, who is interested in assessing the owner’s stewardship?
Only the sole trader
In relation to the business of a sole trader, who takes decisions about their investment?
Only the sole trader
Where is information about an entity’s financial position primarily provided in?
The statement of financial position
According to the IASB’s Conceptual Framework, what can help users identify the reporting entity’s financial strengths and weaknesses?
Information on the economic resources it controls and the entity’s claims/liabilities
According to IAS 1, Presentation of Financial Statements, what are the objectives of financial statements?
- To show the results of management’s stewardship of the resources entrusted to it
- To provide information about the financial position, financial performance and cash flows of an entity that is useful to a wide range of users in making economic decisions
According to the IASB’s Conceptual Framework, when is financial information capable of making a difference in decisions?
When it has predictive and confirmatory value
Which accounting principle tends to understate asset values and overstate profits in times of rising prices?
The historical cost convention
In times of rising prices, what effect does the use of the historical cost concept have on a company’s asset values and profit?
Asset values understated and profit overstated: profit will be overstated due to depreciation based on understated assets, and cost of sales based on understated inventory
In accordance with IAS 1, Presentation of Financial Statements, how is fair presentation described?
The financial statements are reliable in that they reflect the effects of transactions, other events, and conditions
In accordance with IAS 1, Presentation of Financial Statements, how is the going concern concept in accounting described?
The directors do not intend to liquidate the entity or to cease trading in the foreseeable future
When does a specific disclosure requirement of an IAS need not be satisfied?
If the information is material
According to the IASB’s Conceptual Framework, when is financial information useful?
When it is either relevant or faithfully represented
What does materiality mean?
That only items having a physical existence may be recognised as assets
According to IAS 1, Presentation of Financial Statements, what does compliance with International Accounting Standards and International Financial Reporting Standards normally ensure?
That the entity’s financial position, financial performance, and cash flows are presented fairly
According to IAS 1, Presentation of Financial Statements, when are omissions or misstatements of items material?
If they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements.
What are fundamental principles of the IESBA Code of Ethics for Professional Accountants?
Integrity, objectivity, and confidentiality
Who does the ICAEW Code of Ethics apply to?
The ICAEW’s members, employees of ICAEW member firms, and ICAEW students
Describe ethical guidance in the UK
Ethical guidance is a framework containing a combination of rules and principles, the application of which is dependent on the professional judgement of the accountant based on the specific circumstances
Define sole trader
People who work for themselves and own their business
Define partnership
Partnerships occur when two or more people decide to share the risks and rewards of a business together
Define limited liability company
LLCs are incorporated to take advantage of ‘limited liability’ for their owners (shareholders); they are only responsible for the amount to be paid for their shares
What financial information do managers and directors need about a company?
Managers and directors need information about the company’s present and future financial situation, which enables them to manage the business efficiently and to make effective decisions about matters such as pricing, output, employment, and financing
What financial information do owners of a company need about the company? (5)
- Owners of a company want to assess management performance
- They provide capital for the company so are interested in the risk to their capital and the return they will get for taking that risk
- They need information to help them determine whether they should buy, hold, or sell shares
- They want to know how profitable the company’s operations are and how much profit is available for distribution to shareholders through a dividend
- The value of their investment in the company is affected by the company’s profitability
What financial information do suppliers need about a company?
Suppliers want to know about the company’s ability to pay its debts
Trade creditors are likely to be interested in an entity over a shorter period than lenders, unless they are dependent upon the continuation of the entity as a major customer
What financial information do customers need about a company?
Customers need to know that the company is a secure source of supply, so that repeat purchases and after-sales care will be available
What financial information do finance providers need about a company?
A bank wants to ensure that the company is able to keep up loan payments.
What financial information do HM Revenue and Customs need about a company?
HMRC want to know about business profits in order to assess the company’s tax liabilities
What financial information do employees need about a company?
Employees and their representative groups need information about the stability and profitability of their employers, so they can assess the entity’s ability to provide remuneration, retirement benefits, and employment opportunities
What financial information do financial analysts and advisers need about a company?
Financial analysts and advisers need information for their clients or audience
What financial information do stockbrokers need about a company?
Stockbrokers need information to advise investors
What financial information do credit agencies need about a company?
Credit agencies want information to advise potential suppliers of goods to the company
What financial information do journalists need about a company?
Journalists need information for their reading public
What financial information do government agencies need about a company? (2)
- Government agencies are interested in the efficient allocation of resources and therefore in the activities of enterprises
- They also require information in order to provide a basis for national statistics
What financial information does the Financial Conduct Authority need about a company?
The FCA requires information to ensure compliance with regulations and the law
How can external users of financial statements access accounting information about a company?
Limited liability companies are required to make accounting information public. This is done by filing information centrally, as a Companies Act 2006 requirement.
What does GAAP stand for?
Generally Accepted Accounting Practice
What does IFRS stand for?
International Financial Reporting Standards
What does IASB stand for?
International Accounting Standards Board
What is the IASB responsible for?
The International Accounting Standards Board is responsible for setting international financial reporting standards
According to the IASB’s Conceptual Framework, what is the purpose of financial reporting?
‘The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors, in making decisions about providing resources to the entity.’
What is UK GAAP derived from? (2)
- The Companies Act 2006
2. UK and international accounting and financial reporting standards
What comprises the standards and interpretations issued by the IASB? (4)
- International Financial Reporting Standards (IFRS)
- International Accounting Standards (IAS)
- IFRS Interpretations committee
- SIC Interpretations
According to the Conceptual Framework, under what conditions is financial information useful?
Financial information is useful when it is relevant and faithfully represents what it purports to represent
According to IAS 1, Presentation of Financial Statements, what is a complete set of financial statements for a reporting period? (6)
- A statement of financial position at the end of the reporting period
- A statement of profit or loss and other comprehensive income for the reporting period
- A statement of changes in equity for the reporting period
- A statement of cash flows for the reporting period
- Notes comprising a summary of significant accounting policies and other explanatory information
- A statement of financial position as at the beginning of the earliest comparative period when an entity applies an accounting policy retrospectively, makes a restatement of items in its financial statements, or reclassifies items
Define capital expenditure
Capital expenditure is expenditure that results in the acquisition of non-current assets or an improvement or enhancement of their earning capacity
Where is capital expenditure presented in the statement of financial position?
Under non-current assets
Define non-current assets
Assets which will be kept in the entity for more than one year
Define revenue expenditure
Expenditure that is incurred either for trade purposes or to maintain the existing earning capacity of non-current assets
Where is revenue expenditure charged to?
Statement of profit or loss of a period
Define capital income
Proceeds from the sale of non-current assets
Where are profits or losses from the sale of non-current assets included?
In the statement of profit or loss for the reporting period in which the sale takes place
Define revenue income
Income derived from the sale of trading assets, the provision of services, interest and dividends received from business investments
Why is the distinction between capital and revenue items important?
Calculating profit for any reporting period depends on the correct and consistent classification of revenue or capital items
What does the Conceptual Framework identify as the fundamental qualitative characteristics of useful accounting information?
Relevance and faithful representation
When is financial information relevant?
When it is capable of making a difference in the decisions made by its users
When does financial information make a difference to decisions
When it has predictive and confirmatory value
Define predictive value
It can be used to predict future outcomes
Define confirmatory value
It provides feedback about previous evaluations
What is the relevance of financial information affected by?
Its nature and materiality
When does financial information provide a faithful representation?
When it is complete, neutral, and free from error
When is financial information complete?
When all information necessary for a user to understand the transactions or events being depicted is included
When is financial information neutral?
When it is unbiased
When is financial information free from error?
Free from error in the context of faithful representation does not mean the information is perfectly accurate in all respects. Instead it means there are no errors or omissions in the description of it and the process used to produce the reported information has been selected and applied with no errors in the process
How can the qualitative characteristics on financial information be enhanced?
By the following enhancing qualitative characteristics:
- Comparability
- Verifiability
- Timeliness
- Understandability
Define comparability
Comparability is the qualitative characteristic that enables users to identify and understand similarities in, and differences among, items
Define verifiability
Verifiability helps to assure users that information is a faithful representation of the transactions or events it purports to represent; it can be proven
Define timeliness
Timeliness means having information available to decision-makers in time to be capable of influencing their decisions
Define understandability
Information is understandable if it is classified, characterised, and presented clearly and concisely
Define fair presentation
The faithful representation of the effects of transactions, other events, and conditions, in accordance with the Conceptual Framework
Define going concern
The entity is viewed as continuing in operation for the foreseeable future. It is assumed the entity has neither the intention nor the necessity of liquidation or ceasing to trade
Define accrual basis of accounting
Items are recognised as assets, liabilities, equity, income, and expenses, when they satisfy the definitions and recognition criteria for those elements in the Conceptual Framework
Define cash accounting basis of acocunting
Under this method, a company records customer receipts in the period that they are received, and expenses in the period in which they are paid.
Define material
omissions or misstatements of items are material if they could, individually or collectively, influence the economic decisions of users taken on the basis of the financial statements
Define the historical cost convention
The monetary amount at which items are often measured in financial statements is at historical cost; the amount the business paid to acquire them
What does the IESBA Code of Ethics for Professional Accountants describe?
The five fundamental principles of professional ethics that accountants must adhere to
What are the five fundamental principles of professional ethics that accountants must adhere to
Integrity, objectivity, professional competence and due care, confidentiality, and professional behaviour
Define integrity
A professional accountant should be straightforward and honest in all professional and business relationships
Define objectivity
A professional accountant should not allow bias, conflict of interest, or undue influence of others to override professional or business judgements
Define professional competence and due care (2)
- A professional accountant has a continuing duty to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice legislation, and techniques.
- A professional accountant should act diligently and in accordance with applicable technical and professional standards when providing professional services
Define confidentiality
A professional accountant should respect the confidentiality of information acquired as a result of professional and business relationships and should not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose
Define professional behaviour
A professional accountant should comply with relevant laws and regulations and should avoid any action that discredits the profession
