Chapter 2

Question 1

What is the main objective of the accounting system?

Answer 1

The main objective of accounting system is to provide information which will help users make better informed business decisions.

Question 2

What are the three main financial statements

Answer 2

• Statement of financial position (also known as the balance sheet)
• Statement of financial performance / Income statement (also known as the Profit and Loss Account)
• Statement of cash flows

Question 3

What is the statement of financial position?

Answer 3

gives us a snapshot of accumulated ‘wealth’ of the firm at a particular point in time. It includes everything the company owns (i.e. assets) and everything the company owes to others (i.e. claims).

Question 4

What would an INDIVIDUAL’s statement of financial position show?

Answer 4

It would show what he OWNS vs what he OWES. When this is calculated if can show his net worth. (Not important)

Question 5

What are Assets?

Answer 5

Assets is everything the company owns.

Question 6

What are the two ways assets can be classified?

Answer 6

• Current assets (short-term assets)
• Non-current assets (long -term assets)

Question 7

What are current assets?

Answer 7

Current assets are basically assets that are held for the short-term. They represent assets that are capable of generating benefits (sales, profit) for the company in the short run, i.e. within a vear.
Current assets are cash or near cash or items held for sale or consumption in the normal operating cycle of business, or for trading, or for the short term.

Question 8

Examples of current assets

Answer 8

• Cash / bank deposits
• Inventories (stock)
-Final product / merchandise
• Trade receivables (debtors)
-Money owed by customers for goods or services supplied on credit (credit sales)
• Short term Investments
- Short term financial investments (such as short-term bonds etc.)
• Prepayments
Expenses paid in advance such as prepaid rent

Question 9

What are non- current assets?

Answer 9

Non-current assets (also called fixed assets) are assets that are held for use
within the business for long-term operations.
To be used for more than one year.

Question 10

Examples of fixed assets (non-current)

Answer 10

Tangible fixed assets (have a physical substance and can be touched)
• Property, plant and equipment
• Motor vehicles
• Fixtures and fittings

Intangible assets (have NO physical substance)
•Long term assets without physical form
•Goodwill; brand names; patents; trademarks
For example, Apple is one of the world’s most valuable brand, with a value of about $260 billion in 2021.

Financial Investments
• Shares in other companies (long-term investment)

Question 11

What are claims?

Answer 11

•Claims are obligations on the part of the business to provide cash, or some other benefit, to outside parties.
•Claims are of two types: the owner’s capital (equity) and liabilities.

Question 12

What are liabilities?

Answer 12

• Liabilities are obligations on the part of business to outside parties, apart from the owner(s).
There are two types:
•Current liabilities (short-term liabilities)
• Non-current liabilities (long-term liabilities)

Question 13

What are current liabilities? Give examples

Answer 13

Current liabilities represent amounts due in the normal course of the business’s operating cycle or due for repayment within 12 months.

Examples:
• Trade payables (creditors)
-Money owed to suppliers (credit purchases)
•Accruals
-Services received but not yet paid for such as rent, electricity, etc.
•Bank overdrafts

Question 14

What are non-current liabilities? Give examples

Answer 14

Non-current liabilities represent amounts that are NOT due within a year.
Non-current liabilities are also called long-term liabilities.

Examples
•Long term borrowings
• Mortgages
•Bonds and debentures

Question 15

What 4 things does a resource need to posses in order for it so be an assets for a business?

Answer 15

To qualify as an asset for inclusion in the statement of financial position, however, a resource must possess the following characteristics:
•It must be an economic resource. This means that it must provide the right to potential economic benefits. These benefits must not, however, be equally available to others. Take, for example, what economists refer to as public goods. Although these may provide economic benefits to a business, others can receive the same benefits at no great cost. A public good cannot, therefore, be regarded as an asset of a business for accounting purposes.
• The economic resource must be under the control of the business. This gives a business the exclusive right to decide how the resource is used as well as the right to any benefits that flow.
• The event, or transaction, leading to control of the resource must have occurred in the past. In other words, the business must already exercise control over it.
• The economic resource must be capable of measurement in monetary terms.

Question 16

What is equity?

Answer 16

is the amount invested by the owners in the firm. This can be in the form of cash or in kind (land, equipment, motor vehicle etc.)
- Also called equity, shareholders equity, capital, net assets, net worth

Question 17

How would u calculate equity at the end of the period

Answer 17

Owner’s equity at the end of period =
Owner’s equity at the beginning of period
+ Additional Investments by the owner
+ Profit for the period
- Or LossIfor the period
- Drawings by the owner

Question 18

What is the accounting equation?

Answer 18

Assets = Liabilities + Owners’ Equity

Question 19

What is the layout of the statement of financial position?

Answer 19

Question 20

An example of a current liability is:
a) Accounts receivables
b) Mortgage
c) Owner’s equity
d) Bank overdraft

Answer 20

d) Bank overdraft

Question 21

Non-current assets include
a) Cash at bank
b) Accounts receivables ( Trade debtors)
c) Mortgage
d) Equipment
e) Inventory

Answer 21

d) Equipment

Question 22

• Inventory, trade receivables and cash are classified as:
a) Current liabilities
b) Long-term liabilities
c) Non-current assets
d) Current assets

Answer 22

d) Current assets

Question 23

If liabilities increase €3,000 during a given period and owners’ equity decrease
£1,000 during the same period, the assets must have:
A) Increased by €3,000
B) Increased by €2,000
C) Decreased by f3,000
D) Decreased by f2,000

Answer 23

B) Increased by £2,000

Question 24

What are the 5 accounting conventions influencing the statement of financial position.

Answer 24

1. Historic cost convention
2. Going concern convention
3. Prudence or Conservatism
4. Monetary measurement
5. Business entity concept

Question 25

What is the accounting convention historic cost convention

Answer 25

Assets should be shown on the statement of financial position at the cost of purchase at the date of acquisition (original cost) instead of current value (market values).

Question 26

What are the pros and cons of historic cost convention?

Answer 26

Advantage: historic cost is relatively easy to determine and can be verified.

Disadvantage: subsequent to the date of acquisition, the continued reporting of historic cost based values does not reflect any changes in market value.

Question 27

What is the going concern convention?

Answer 27

• In the absence of contrary information, a business entity is assumed to have a long life.
• Financial statements are prepared on the assumption that the company will continue in business for the foreseeable future, which, generally is for a period of 12 months. Because of this convention, outside parties enter into long-term contracts with the company.

Question 28

What is the prudence or conservatism convention?

Answer 28

• Prudence or Conservatism principle is a key accounting principle that requires the recording of all losses in full and applies to both actual losses and expected losses. Profits, on the other hand, are not recognised until they are realised (that is, when the goods are actually sold).

•The prudence principle in accounting is many times described using the phrase
“Do not anticipate profits but provide for all possible losses.” In other words, it takes into consideration all prospective losses but NOT the prospective profits.

•In other words, Prudence means that profits should only be recognized when they are certain (i.e. a sale is made). By contrast, losses are recognised when they become probable.

•The convention counteracts the excessive optimism of some managers and owners, which results in an overstatement of financial position.

Question 29

What is the monetary measurement convention?

Answer 29

Only those items that can be expressed in monetary terms (e.g. in pound sterling or any other currencies) can be accounted for.
* Therefore, transactions of qualitative nature, even though of great importance to business are not considered. If nothing has been paid, then there is no recognition of values in the statement of financial position, e.g. customer loyalty and human capital.

Question 30

What is the business entity concept convention?

Answer 30

• Business Entity means tha a business has a separate identity from its owners. This concept states that financial statements are prepared for the business rather than for the owners. This means that the statement of financial position should reflect the financial position of the business as a separate entity.
• Any funds contributed by the owner will be seen as coming from outside the business and will appear as a claim against the business in its statement of financial position.
• Any personal income and personal expenses of the owners) should not be untreated as the incomes and expenses of the business.

Question 31

What are the uses of the statement of financial position?

Answer 31

• Can be used to analyse company performance
• Asset / Capital management
- Analysis of relationship between assets and liabilities
- The nature of assets
- The size of liabilities
•Liquidity
- Analysis of relationship between current assets and current liabilities
• Profitability / Efficiency
- Analysis of relationship between output and resources
• Ratio analysis

Question 32

What are the limitations of the statement of financial position?

Answer 32

• Limited usefulness given that it reflects the financial position of the company at a certain point in time (past)

• Statement of financial position’s figures are at historical prices
-No adjustment for inflation, market prices of investments

• Real value of business depends on its ability to generate income and not on the individual asset and liability values.

Question 33

Which one of the following statements best describes the purpose of a statement of financial position [balance sheet]?
a) The resources owned by the business and who contributed those resources
b) The current value of the business
c) The assets of, and the claims against, the business
d) The value of the owner’s investment in the business

Answer 33

C) The assets of, and the claims against, the business

Question 34

Which one of the following is the convention that assumes that the value of money does not change over time.

a) Business entity
b) Conservatism or prudence
c) Stable monetary unit
d) Money measurement

Answer 34

C) Stable Monetary unit

Question 35

Kye started a business with £190,000 capital invested. During the year, he withdrew £40,000 in cash & goods for his own use. At the end of the first year he had a capital balance of £170,000. What was the profit/loss for the year?
a) Loss £60,000
b) Loss £50,000
c) Profit £20,000
d) Loss £20,000

Answer 35

C) Profit £20,000
Answer:
opening capital + profit - drawings = closing capital
190,0000
+ profit - 40,000
= 170,000
So
Profit =20,000