Chapter 2: Business structures and financial reporting

Question 1

Liabilities

Answer 1

Liabilities are a present obligation of the entity (i.e. a debt) to transfer an economic resource as a result of past events

Question 2

Equity

Answer 2

Equity is the residual interest in the assets of an entity after deduction of its liabilities

Question 3

Income

Answer 3

Income is increases in assets, or decreases in liabilities, that result in increases in equity, other than those relating to contributions from holders of equity claims

Question 4

Sole trader

Answer 4

A one-owner business

The business and the owner are not seen as separate legal entities and as such, if the business gets into difficulties the owner is liable for all the debts of the business

Question 5

Partnership

Answer 5

A relationship that exists between two or more people to carry on a business in common with a view to profit

A partnership is not regarded as a legal entity separate from the partners who comprise it

Question 6

Company

Answer 6

Recognised as a separate legal entity quite distinct from its owners and as such, debts incurred in the normal course of business are those of the company

Companies can be private or public

Question 7

Consolidated financial statements

Answer 7

Report the results and financial position of the combination of the parent entity and other entities it controls

The purpose is to give a view of the parent entity and its control entities as if they were one entity (the economic entity)

They provide information about the performance, financial position and cash flows of an economic entity

Question 8

Conceptual framework

Answer 8

An attempt to develop some basic concepts of accounting to help accountants determine how transactions should be accounted for when there are no accounting standards

Question 9

General-Purpose Financial Report

Answer 9

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 relating to providing resources to the entity

Question 10

Accrual

Answer 10

Refers to transactions being recognised when they occur and not when cash is paid or received

Question 11

Accrual accounting

Answer 11

The method of accounting whereby revenues and expenses are identified within a specified period of time and are recorded as incurred, along with acquired assets, without regard to the date of receipt or payment of cash

Question 12

Going concern

Answer 12

The assumption that an entity will continue to operate into the foreseeable future and is not in the process of liquidation

Financial statements are prepared on this basis

Question 13

Qualitative characteristics of financial information

Answer 13

General-purpose financial reports should provide all the financial information that is relevant and can be faithfully represented subject to the constraint that the benefit of providing the information exceed the costs of providing the information

The information is enhanced by comparability, verifiability, timeliness and understandability

Question 14

Materiality test

Answer 14

Assesses whether omission, misstatement or non-disclosure of an item of relevant and reliable information could affect decision making about the allocation of scarce resources by the users of the general-purpose financial reports of an entity

Question 15

Unrealised loss

Answer 15

A loss which is yet to be realised by way of a transaction

E.g. a decrease in the value of an asset represents an unrealised loss until the asset is sold, at which time the loss would be realised

Question 16

Unrealised gain

Answer 16

A gain which is yet to be realised by way of a transaction

E.g. an increase in the value of an asset represents an unrealised gain until the asset is sold, at which time the gain would be realised

Question 17

Asset

Answer 17

An asset is a present economic resource controlled by the entity as a result of past events

An economic resource is a right that has the potential to produce economic benefits

Question 18

External audit

Answer 18

Purpose of an external audit is to add credibility to the reports presented by the directors of public companies

The external audit aims to provide assurance to absentee owners (i.e. shareholders) that the financial statements of the company provide a fair and true view of the company’s financial position, performance and cash flows

Question 19

Auditor independence

Answer 19

Means that the auditor must be independent of the client for whom the audit is conducted so that they are able to express a truly objective opinion about the financial statements