Chapter 6 - Accounting Princples And Practices Flashcards
What is financial accounting?
Business discipline which consists of a series of techniques and procedures that are used to identify, measure, record and communicate information including financial information to a range of people who may be interested in the information.
Included in the statutory accounts of quoted companies will be?
- Narrative reports from the chairman and chief executive giving an overview of the governance activities and performance of the company in the previous period.
- A strategic report setting out the strategy, business model, a fair review of the business, future developments, kpi’s, principal risks and uncertainties and corporate and social responsibility matters.
- Financial accounts for the period including the balance sheet, income statement, cash flow position and
- Other legal requirements such as details of directors remuneration.
What does the income statement show?
Results of a company as a consequence of transactions during the accounting period. It sets out income, expenses, tax and most importantly to remember, profit or loss.
What does the balance sheet show?
Statement of financial position of the business at a point in time. I.e the account period or year end date. It is a snap shot of the company’s position at a particular point in time. It lists all the companies assets and liabilities, what is owed and what is owned. What is owed by the company includes the shareholders equity, which is the total of the assets less the total of the liabilities.
What do cash flow statements show?
Recognises that accounting, profit or loss, is not the only indicator of a company’s performance. Cash flow stamens show the sources and use of cash and are a useful indicator of a company’s liquidity.
Cash flow statements are a useful indicator of?
Liquidity
Financial statements are intended to show?
A true and fair view of the economic activities of the organisation, scalable not only to the stakeholders but any one who wishes to review them.
Record making process of accounting is known as?
Book-keeping
Give 3 examples of non monetary information used in management accounting?
- Labour hours
- Raw material used
- Electricity consumed
Whereas financial accounting looks at and records the financial impacts of events on the organisation as a whole, management accounting is naturally segmented and concentrates on…
Processes, individual departments and other areas of responsibility, in terms each manager can understand.
Which type of accounting looks at the historical information and which type of accounting looks at the future?
Financial accounting looks at historical information whereas management accounting is largely concerned with the future.
Companies are not required by law to produce what type of accounts?
Management accounts
Companies are legally required under the companies act to produce what accounts?
Financial accounts
What two types of information beginning with q will the different stakeholders need in regards to financial information of companies?
Quantitative and qualitive
A company will have made a profit if?
There is a positive amount of money left over when all costs and expenses are subtracted from all of the organisations income.
When does a company “break even”?
If the amount left over when all costs and expenses are subtracted from a companies income is exactly zero (expenditure matches income exactly).
Managers will want to know if the company is profitable so they know…
How well they have managed the business.
Why is cash position (liquidity) important?
Cash is vital to a business as this is what pays its costs and expenses. If it cannot manage its liquidity then by running out of cash it will not be able to pay its bills. This can lead to difficulty in trading leading to failure of the business. This can happen even if a business is profitable.
Give examples of how a company’s wealth may be held
Non current assets such as property, equipment and investments, and in current assets such as its debtors and cash.
Working capital is?
Difference between current assets and current liabilities.
Whereas liquidity is a measure of the cash available to a company, solvency is a measure of?
The excess of an organisations assets compared to its liabilities.
If a company’s liabilities exceed its assets it is technically…
Insolvent, and with some exceptions be required to cease trading.
The PRA require insurance companies in the UK to meet a solvency margin, this is the amount…
The value of the insurers assets should exceed the amount of its liabilities.
What is the difference between a trading company to an insurance company regulated by the PRA in terms of becoming insolvent?
In a trading company, if it’s liabilities exceeds it assets, it is technically insolvent, however in an insurance company regulated by the PRA, if the insurance company’s net assets falls below its solvency margin, that can also be classed as insolvent.
The amount of regulatory capital a company holds in excess to its solvency margin is an indication of the company’s…
Financial strength and ability to pay claims to its customers.
What is income? And what can this also be known as?
Income is all of the amounts of money earned by the organisation from any source, including sales, rentals, interest payments and investments. Income generated from sales (excluding vat) is sometimes called revenue or turnover.
What is expenditure?
All the amounts of money incurred to pay for goods or services.
What is profit?
In accounting terms, any excess of income over expenditure incurred in running the business that earns that income.
What is shareholders equity?
This is the stake the shareholders have in a company. It is calculated as the total value of all the assets in the business less the total value of all the liabilities.
What is capital?
Sum of the equity and long term debt used to finance the business.
What tier of capital does equity count of and why is this better?
Tier 1 and this is the best sort of capital because it gives the greatest protection to policyholders.
Depending on the structure of the debt, particularly repayment terms, long term classified debt may be either?
Tier 1 or tier 2
What is the advantage of having regulatory debt capital in addition to equity?
The cost of regulatory debit capital is normally lower than the cost of equity.
What is an asset?
Resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.
What is a tangible asset?
One that is physical and real such as cash, land, buildings, machinery or investments.
What is an intangible asset?
One that is not physical such as a trademark, a copyright or goodwill.
When machinery or equipment for example loses its value of time, in accounting terms, their loss of value is called?
Depreciation
What is purchased goodwill?
Difference between the amount paid for acquiring a business and the value of the net assets of that business when acquired.
In accounting language, what is a liability?
An amount owed by an organisation.
What is a creditor?
An individual or organisation to whom a debt is owed, e.g a supplier.
What is a debtor?
Any organisation or person who owes a debt to a company.
Debt owed to a company is considered as what on the balance sheet?
Current assets
When adjustments are made to the value of assets over their useful lives to reflect that they will deteriorate or become obsolete, this is known as?
Depreciation
What do accountants do to take into account depreciation?
They write down the cost of an asset over time, using a recognised method, leaving a notional value of the asset in the organisations balance sheet at any one point in time.
What is the formulae for straight line depreciation?
Coat of asset - scrap or residual value (both) / the life of the asset
Assets = equity + liabilities is what?
The accounting equation
What are raised to show amounts owed to the business?
Invoices
To keep records of expenditure, what will be retained?
Receipts
What does the double entry principle show?
Two fold effect on the accounting equation by reflecting that the business both receives and gives value in each transaction
The balance sheet is a statement of the…
Net wealth of a business at a particular time.
The difference between a companies total assets and total liabilities is called its…
Shareholders equity
Who does shareholders equity belong to?
Owners of the business
What are non current assets?
Items of wealth that are controlled by the business that the company intends to keep for more than one year.
Give examples of non current assets
Goodwill and other intangible assets, property and investments. These intangible assets include parents, brands and licenses. Property includes freehold and leasehold property and land uses by the business for trading. Investments include property if held for investment rather than used by the business for trading, equities, government bonds and corporate bonds.
What are current assets?
Items of wealth that the business controls and intends to use within the next twelve months.
Give examples of current assets
Cash in hand and cash held in the business bank accounts including deposits held up for to to three months from the balance sheet date. Stock, such as raw materials, works in progress and finished goods. Finally debtors, these are an item of wealth as customers owe them money and are expected to pay.
If a liability has to paid out within 12 months what is it classed as and similarly what is is classed as if it has to pay outside of 12 months?
Current liability If required to pay within 12 months and non current liability if have over 12 months to pay.
What are examples of current liabilities?
Bank overdrafts as these have to be paid within 12 months and banks usually have the right to call in an overdraft at 24 hours notice. Also trade creditors, these arise when the business has bought goods or services from a supplier but has yet to pay the suppliers invoice.
Give examples of non current liabilities
Bank loans, mortgages and bond issues.
Reserves are the accumulated profits of the business that have been…
Reinvested into the business.
Any profit that a business makes (after tax and liabilities have been discharged) belongs to the owners of that business. Because of this, profits of the business are owned by…
The shareholders and not the business itself.
How do share capital and reserve differ from liability?
No requirement to repay these amounts
What is working capital?
Money used to finance day to day trading activities. Working capital is used to pay for wages and raw materials and overheads such as utility bills.
On the balance sheet, how is working capital calculated?
Subtracting current liabilities from current assets. Working capital is known as net current assets.
What are assets employed?
Calculated by adding non current assets to working capital (net current assets)
Gross profit is calculated by subtracting…
Cost of sales from turnover
What is revenue?
This is the total value of all sales invoiced during the year. Also known as turnover.
What is cost of sales?
This is the cost of the stock bought in during the year that has subsequently been sold. Cost of sales does not include money spent on stock that has yet to be sold.
What is finance income?
Income earned on any investments held during the year
What are finance costs?
Cost of loans made to the company such as bank loans, mortgages and corporate bonds.
What are overheads?
Expenses incurred by a company such as management, administration staff and office accommodation.
All businesses have to pay what tax on their profits?
Corporation tax
Reserves will increase by ???? And decrease by ????
Profit for the year, and dividends paid to shareholders.
What are the biggest liability to insurance brokers?
Premiums owed to insurance companies.
What is outward reinsurance premium?
Outward reinsurance (reinsurance purchased to protect the account) should be accounted for in the same period as the premiums for reinsurance business. This gives an indication as to the amount of reinsurance purchased to protect the underwriting book of business.
Which component of a company’s financial statements is the best indicator of liquidity?
Cash flow statement
Working capital is the difference between?
Current assets and current liabilities
The main difference between income and revenue is …
Income includes all monies earned from any source
Sunk costs are?
Costs which are the product of past decisions
Give 7 differences between management and financial accounting
- Financial is external whereas management is for internal planning
- Financial is highly structured for legal regulatory requirements whereas management is formulated in many different ways to shit different purposes
- Financial looks at and records the financial impact of events on the organisation as a whole, whereas management includes both monetary and non monetary quantitive information broken down by area of responsibility.
- Financial is based on historical whereas management is largely focused on the future
- Financial is prepared in accordance with accounting standards, whereas management has no external regulatory constraints
- Financial must be filed at companies house whereas management is usually not made publicly available
- Financial must be audited (over a certain company size) whereas management does not have to be externally audited.
Claims are shown on the income statement as net of…
Reinsurance. There is a gross share, reinsurers share and then net of reinsurance.
What are acquisition costs?
Amounts paid to brokers and other intermediaries who have placed business with the company and other direct costs of acquiring the business such as policy issue costs.
Reinsurance liabilities will include…
Amounts due to reinsurers such as reinsurance premiums.
What do reinsurers share of insurance contract liabilities relate to?
Potential reinsurers recoveries available on the technical provisions in the liability section of the balance sheet.
What does the cash flow statement record?
Movements of cash in and of cash out that took place during the last financial year. Also shows the company’s net cash flow for the year.
A cash flow statement analyses the cash flows into those arising from…
Operating activities, investing activities and financing activities.
What constitutes cash flows from operating activities?
Deals with how much cash the business managed to generate or consume as a direct consequence of its trading activities including tax paid, interest received and paid and dividends received. The financial statements will show a reconciliation of the cash generated from operations to net profit before tax.
What does cash flow from investment activities show?
Includes sales of investments including associates and subsidiaries purchased and outflows will include investments made.
What will cash flows from financing activities show?
Deals with changes to loan and share capital and payment of dividends to shareholders. If business has raised cash by new loans or issuing more shares, an inflow is shown. If the business has paid back some loan capital during the year, an outflow of cash is shown. Cash outflows can also incur when a business decides to redeem or buy back some of its share capital.
What is the primary objective of management accounting?
Help managers take the appropriate decisions to enable the company to achieve its business objectives.
For a service company, the management accounts might give information on:
- customer service
- quality of the service provided
- cost of the service analysed as appropriate for the business
- financial performance of each of the various distribution channels such as direct sales force, outsourced call centres and web
If a profit centre is charged for the number of invoiced raised and the numbers of queries raised, and this technique makes it clear to the business the cost of queries and incentivise mangers to improve the accuracy of their billing and hence the cost to the profit centre, what is this method called?
Activity based costing.
What are sunk costs?
Product of past decisions. They have been incurred by the company but are not necessarily relevant to future decisions.
What should be considered when starting a new line of business, based on the example of a individual or team?
If the team works on the new line of business, they will not be able to do other work. These are opportunity costs.
What are opportunity costs?
The opportunity foregone by not being able to do other work instead.
If day one investment is 100 and return is 110 in a years time the internal rate of return is?
10%
Reserves are the accumulated profits of the business that have been…
Reinvested into the business
Gross profit is calculated by subtracting cost of sales from…
Turnover
Acquisition costs are?
Cost paid to intermediaries to acquire the business such as commission and other direct costs in acquiring the business such as policy issue.
What are assets defined as?
Resources controlled by the entity as a result of past events and which future economic b benefits are expected to flow to the entity.
How are assets employed calculated?
Calculated by adding non current assets to working capital (net current assets)
What is an associated company?
Where a company owns more than 20% share but a 50% or less share in another company it is said to be an associated company.
What is capital?
Sum of the equity (shares) plus long term debt (bank loans and financing agreements) used to finance the business.
What are claims incurred?
Claims paid in the year plus the cost of outstanding claims carried forward to the next year, minus the cost of outstanding claims brought forward from the year before (can be gross or net of reinsurance contributions)
Who/what are creditors?
Organisations or individuals to whom the company owns money.
Current assets are?
Items of wealth that the business controls and intends to use within the next twelve months, e,g debtors.
What are current liabilities?
Those liabilities that must be paid back within 12 months e.g creditors, overdraft
Who are debtors?
Organisations or individuals that owe money to the company.
What does the double entry principle show?
Two fold effect on the accounting equation which shows businesses both give and and receive value in each transaction.
What is expenditure?
The amounts of money incurred to pay for goods and services.
What are finance costs?
Costs of loans made to the company I.e the interest. Bank loans corporate bonds etc. cost appears as expenditure on the income statement.
What is finance income?
Income earned on any investments held during the year (shows as income on the income statement)
What are financing activities?
Cash changes following changes to loan or share capital and / or payment of dividends to shareholders. ( an inflow by issuing more shares or outflow if loan part paid off)
What is gross profit?
Difference between revenue / turnover less the cost of sales ( direct cost of making the product before deducting overheads, wages, tax ,interest etc.)
What is gross written premium?
Written premiums are the gross amount payable by the insured to which the insurer is contractually bound within the accounting period, regardless of the period of cover (excluding IPT) I,e the premiums relating to policies incepted/renewed in the financial year.
What is IBNR?
Claims that have occurred but have not yet been reported must be accounted for. An additional percentage is included in the claims cost for this.
What is income.?
Amount of money earned by the organisation from any source, including investments, rentals, interest payments and investments.
In regards to investment activities on the cash flow statement, what will be the cash inflows and outflows?
Inflows received from sales of investments including subsidiaries or associates, outflows will be result of investments bought/made
What is liquidity?
The amount of cash that is held or accessible immediately.
What is net profit or profit for the period?
Gross profit minus all other expenses such as overheads, interest paid and tax.
What is net written premium?
Gross written premium minus outward reinsurance premiums.
Cash received from operating activities will be…
Cash generated or consumed as a direct consequence of the businesss trading activities(including tax paid, interest paid or received and dividends received.
What is outward reinsurance premium?
Premiums paid to reinsurers for policies written during that financial period.
What are overheads?
Other expenses incurred by the company such as cost of management, admin staff, office accommodation (which appears as expenditure on the income statement)
What is a realised loss or gain?
A loss or gain that you have made when you seek a share or other investment
Reinsurance liabilities will be?
Amounts due to reinsurers for the protection that has not yet been paid.
What is reinsurers share of insurance contract liabilities?
Potential recoveries from reinsurers. These go as an asset on the balance sheet.
What are retained earnings?
Amount of net income left in a business after dividends have been paid. This appears on the balance sheet as part of equity.
Solvency is?
Amount of difference between total assets and total liabilities.
The difference between current assets and current liabilities is known as?
Working capital
If a company has paid back some of its loan capital during the year, how will this be shown in its cash flow statement?
A outflow of cash under financing activities
Activity based costing is used to…
Charge profit centres for the services of cost centres
Which component of a company’s financial statements is the best indicator of liquidity?
Cash flow statement
Sunk costs are
Costs which are the product of past decisions
