Chapter 2: The Accounting Equation Flashcards
Question Bank
What is the accounting equation?
assets = opening capital + profits - drawings + liabilities`
What is the purpose of the financial statement that lists an entity’s total assets and total capital/liabilities?
The financial position of the entity at a particular moment in time.
Which elements of the accounting equation change when a sole trader purchases goods on credit?
Assets will increase as the sole trader has acquired inventory and liabilities will increase as the goods were purchased on credit
Which elements of the accounting equation change when a sole trader who has an overdrawn bank balance receives cash from a credit customer?
Assets and liabilities: the overdrawn liability will decrease and receivables will decrease by an equal amount.
Which elements of the accounting equation change when a sole trader borrows money from a bank?
Assets increase as cash on receipt of the loan funds, and liabilities increase as the loan is a liability
Which elements of the accounting equation change when a sole trader sells goods for more cash than they bought them for?
Assets will increase as cash increases more than inventory decreases, and capital will increase due to the profit
What are the elements of financial statements, as identified by the IASB’s Conceptual Framework?
Income, expenses, equity
Define: Asset
The Conceptual Framework states than an asset is a resource controlled by the entity as a result of past events from which future economic benefits are expected to flow to the entity. Assets are key elements of financial statements.
Examples of assets (7)
- Land and buildings
- Motor vehicles
- Plant and machinery
- Fixtures and fittings
- Cash
- Inventory
- Receivables
Define: Liability
The Conceptual Framework states that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. Liabilities are key elements of financial statements.
Examples of liabilities (4)
- Bank Loan
- Overdraft
- Payables
- Taxation
Define: Business entity concept
A business is a separate entity from its owner
Define: Capital
The Conceptual Framework states that capital (equity) is the residual interest in the assets of the entity after deducting all its liabilities. Equity is a key element of financial statements
Define: Accounting equation (simple)
assets = capital + liabilities
Define: Historical cost
Transactions are recorded at their cost when they were incurred
Define: Profit
The excess of income over expenses
Define: Loss
The excess of expenses over income
Define: Income
Increases in economic benefit over a period in the form of inflows or increases of assets, or decreases of liabilities, resulting in increases in equity/capital. It can include both revenue and gains. Income is a key element of financial statements.
Define: Expenses
Decreases in economic benefits over a period in the form of outflows or depletion of assets, or increases in liabilities, resulting in decreases in equity/capital. Expense is a key element of financial statements.
Define: Drawings
Money and goods taken out of a business by its owner
Define: Creditor
Party to whom a business owes money
Define: Trade payables
The amounts due to credit suppliers
Define: Debtor
Party who owes money to the business
Define: Trade receivables
The amounts owed by credit customers
What is the accruals concept?
The accruals concept requires that income earned is matched with the expenses incurred in earning it
Define: Net assets
Assets less liabilities
Define: Non-current assets
Assets acquired for continuing use within the business, with a view to earning income or making profits from their use, either directly or indirectly, over more than one reporting period
Examples of non-current assets
- Property, plant, and equipment
- Intangible non-current assets, e.g. goodwill
- Long-term investments
Which is the only non-current asset that does not depreciate?
Freehold land
Define: Current assets
An asset is current when it is expected to be realised in, or intended for sale or consumption in, the entity’s normal operating cycle, or it is held for being trader, or it is expected to be realised within 12 months of the date of the statement of financial position, or it is cash or a cash equivalent
Examples of current assets (5)
- Cash
- Trade and other receivables
- Inventory
- Prepayments
- Short-term investments
Define: Non-current liabilities
A debt which is not payable within one year. Any liability which is not current must be non-current
Examples of non-current liabilities (2)
- Loans which are not repayable for more than one year
2. Loan stock or debentures
Define: Current liabilities
Debts of the business that must be paid within one year, or within the entity’s normal operating cycle, or that are held to be traded
Examples of current liabilities (5)
- Loans repayable within one year
- Bank overdraft
- Trade and other payables
- Taxation
- Accruals
Define: Gross profit
Revenue from sales, less cost of sales
Define: Profit for the period
Gross profit less expenses plus non-trading income
Calculate: Gross profit margin
(gross profit/revenue) x 100
Examples of distribution costs (3)
- Salaries, wages, and sales commission of employees
- marketing costs
- The costs of running and maintaining delivery vans, including depreciation on these and any losses on their disposal
Examples of administrative costs (8)
- Management and office staff salaries
- Rent and local business or property taxes
- Insurance
- Telephone and postage
- Printing and stationery
- Heating and lighting
- Irrecoverable debts written off
- The cost of running and maintaining other non-current assets such as office buildings, plus depreciation and losses on disposal of these
Examples of finance costs (2)
- Interest on loans
2. Bank overdraft interest
Examples of income from other sources (4)
- Profit on disposals of non-current assets
- Dividends or interest received from investments
- Rental income from property owned but not otherwise used by the business
- Amounts due in respect of insurance claims
