Exam Flashcards
What do all companies issue?
Ordinary shares
What is a sole trader
- Owned and operated by one person
- business and owner are one legal entity (business cannot enter contractual agreements, instead relying on the owner)
- limited life: change of owners
- unlimited liability: owner is responsible for obligations and debts
- limited access to funds
Advantages of sole trader
Control (ownership and management combined)
Simple and inexpensive to establish and operate
Profit does not have to be distributed among owners
No formal guidelines for financial report format
What are preference shares
Have preference over ordinary shares eg. Preference shareholders are first to receive dividends up to a maximum value. Higher priority in receiving dividends and/or in event of liquidation
- fixed rate of dividend
- not every company issues these
What is a partnership
Business owned and operated by two or more people
The business and owners are one legal entity (partners enter contractual agreements eg. Borrow, lend, sell)
Not bound by corporations act
Limited life: new partnerships commence when new partners are introduced
Mutual agency: partner responsible for other partner’s actions
Unlimited liability: each partner’s personal assets may be called upon to meet bad debts
Co- ownership of assets and profits
What are ordinary shareholders entitled to?
Undistributed profits and gains
One ordinary share carried one vote on issues affecting company such as voting for managing directirs
What are reserves
Represent ownership interests in assets. Amount set aside out of profits and surpluses which are not designed to meet any liability or commitment eg.
Capital profits reserve( profits made on sale of long term assets)
Dividend equalization reserve (constant dividends over time)
Capital redemption reserve (decision to redeem dividends)
Capital replacement reserve (decision to replace assets)
Revaluation reserve (increases in assets values to fair value due to inflation or other price changes)
If a company pays by cheque, where is this recorded?
Under accounts payable
Why may owner’s equity increase
When there is increase in profit showing an increase in owner’s stake in business
Why may owner’s equity decrease?
When the business makes a loss eg. Des not sell all of inventory
The owner’s stake in the business falls
Also when the owner makes drawings
What kind of acts have increase to regulate partners?
Jurisdictions across Australia have enacted partnership acts to regulate activities of partners in a partnership
When may regulations apply to small proprietary companies?
When requested by at least 5% of their shareholders or by ASIC
What is the directors’ report/ declaration according to corporation act?
A report made by the directors confirming their financial statements comply with relevant accounting standards and give a ‘true and fair’ depiction of the company’s financial performance and position
This is included in the annual report
Also at the declaration’s date whether the company can meet their liabilities as they fall due
what is the role if directors in a company
They are elected by the shareholders to manage the commonly for then.
Small company: board consists of 1 level management whom are all shareholders
Large: contains around 10 directors with thousands of shareholders
What is the role of accounting information
Assist with decision making
What is the role if external auditors
Must audit financial reports produced by companies to ensure the reports are fair, true and comply with statutory and accounting standards requirement
What is an auditor’s report?
Checks credibility and reliability of company’s financial reports in accordance with Australian Auditing Standards
Opinion section: whether the financial reports are a fair and true portrayal or company’s financial performance and position
What happens if the audit reveals the company’s financial statements are not a true reflection of their current performance and position?
In the auditor’s report under the opinion section, the auditor will state the report is ‘qualified’ and will give reasoning and evidence on how the company’s statements sway from their true position, performance, liquidity and accounting standards
What is an unqualified auditing report
When auditor states the business’s financial statements are a true reflection of their current performance and position
This gives assurance to company’s stakeholders in decision making
Do small proprietary companies need external auditors to audit their financial reports?
Usually no unless the ASIC stipulates then to do so
OR
At least 5% of shareholders just agree
Who uses the accounting report?
Accounting report is sent to shareholders and ASIC
Who may use accounting information?
Internal users: management board, managers, employees
External users: general public, potential investors, creditors, suppliers, customers, media and special interest group, government
What is financial accounting?
For external use
Must follow accounting standards
What is management accounting
For internal use
No accounting standards to follow
Are Australian and international conceptual frameworks binding?
No they are not binding but rather act as guidelines
What is the purpose if Australian and international conceptual frameworks
Guide those organizations responsible for the development of legally binding accounting standards
Guide accountants in preparing financial accounts
What conceptual framework does australia use and who set it up?
The Australian accounting standards board (AASB) adopted IASB (international accounting standards) framework since 2005
The IASB set IASB framework
Why did Australian accounting standards adopt IASB?
To conform with accounting standards adopted by trading partners
Describe accounting standards
Set of rules that defines how to measure and report information about an entity’s economic acrivity
What is the objective of accounting standards
Define how to record individual business transactions
Define how to summaries these transactions in a form understandable and useful to users
What does corporations act stipulate in regards to financial statements
Financial statements of companies other than small private companies must comply with accounting standards and regulations
Who oversees the setting of accounting standards
The financial reporting council oversees the Australian accounting standards board
Announced in 2005 australia would adopt IASB
Who sets accounting standards in Australia
Australian accounting standards board sets the accounting standards that is mandatory for all companies and other disclosing companies
What happened in January 2005
Australia adopted International Accounting Standards issued by the international accounting standards board (IASB)
What does the annual report consist of?
General purpose financial report
Directors report (provide management discussion and analysis of financial results, compare with competitors why the economic situation is, internal sales provide explanation to these questions)
Directors statement (declaration)
Auditors report
What must the GPFR contain
Balance sheet Statement of comprehensive income Statement of changes in equity Statement if cash flows Notes to financial statements
What must GPFR comply with
All relevant accounting standards
What is the primary objective of accounting
Provide economic information about entity to assist with decision making
Is management accounting subject to many rules and regulations?
No financial accounting is subject to rules and regulations as it is protested for external users
Is external auditor responsible for preparing GPFR of a company?
No they are responsible for auditing the business’s financial reports to ensure all data entered is true,fair and complies with accounting standards
What are major accounting assumptions?
- Accounting entity assumption
- Monetary assumption
- Historic cost assumption
- Going concern assumption
- Accounting period assumption
What is the accounting entity assumption
Business and owner are separate for accounting purposes eg. Reporting and recording
What is GAAP
General accepting accounting principles that guide Australia’s financial reporting
What is the historic cost assumption
historic cost is the value of asset when it was acquired. i.e. record asset at the value it was acquired
What is monetary assumption
Financial statements contains items that can reasonably be measured in monetary terms
What is an advantage and disadvantage of historic cost assumption
- No need to for subjective opinion on amount paid to acquire asset
- Ignores the fact that value of money and goods change over time
What are examples of measurement alternatives?
Replacement cost
Net realizable value
Describe replacement cost
Amount that would have to be paid to acquire the same or an equivalent item
Describe fair value
Price you would have received to sell an item in an arms length transaction
Describe net realizable value
Selling price less any further costs expected to complete goods and any costs involved in selling and distributing those goods
What is the going concern assumption
Except when firm is insolvent, accountants assume it will continue to exist
Despite the fact many small businesses fail within few years of operation
What are features of accounting period assumption?
Accounting period is the period of time selected for reporting results of operations and changes in financial position
Accountants must ensure revenue and expenses are accounted for in appropriate period
Are all shareholders interested in having managerial roles blo
Some shareholders merely invest to make capital gains
What accounting rules just a company comply with?
Company law (corporations act, accounting standards) International accounting standard Stock exchange rules imposed by ASX
3 characteristics of assets
Inflow of future economic benefits to the entity
Controlled by entity
Transaction occurred in the past
Two types of assets
Tangible
Intangible : copyright, trademark, patent, franchise, goodwill
3 characteristics liabilities must have
Present obligations
Past events
Outflow of economic benefits
Describe drawings in terms of businesses with several partners
Each business owner had their own separate drawing account
Role of income
Increases economic benefits by increasing assets value or decreasing liabilities
Results in increase in equity in non distribution nature
Revenue?
Gross inflow of economic benefits from ordinary activities
Expenses?
Deceased economic benefits in form of decease in assets or increase in liability
Decease in owner’s equity in non distribution nature
Profit
Earnings the business makes over a period of time
Two accounting approaches
Cash and accrual accounting
Features of accrual accounting
Income recorded when earned
Expenses recorded when incurred ( economic benefits used up)
Regardless of date of receipt and payment of cash
Describe cash accounting
Revenue recognized when cash is received
Expense recognized when cash is paid
Regardless of when income is earned or expense has incurred
How May cash accounting distort an entity’s financial performance?
Cash received may relate to goods or services provided earlier (accounts receivable) or future period (subscriptions, service fees received in advance, deposits)
Cash paid relate to earlier (wages, rent in arrears) or future period (prepayments)
3 components it cash flow statement
Operating activities
Investing activities
Financing activities
Cash flow statement
Summary of cash receipts and payment over a period of time
What is another name for balance sheet?
Shows business’s assets and claims against those assets
Cash flow from operating activities
Bet inflow from operations eg. Purchase of inventory, payment of wages
Cash flows from investing activities
Cash payments to acquire additional non current assets and cash receipts from the disposal of such assets through proceeds from sale
Also includes loans made by the business, shares or other investments the business purchased
Describe cash flow from financing activities
How business finances eg. Long term borrowings or equity through share issues and debt repayment and return to equity holders
In exception of very short term credit such as trade credit
Current assets
Used or converted into cash in the next 12 months or within operating cycle
What are non current assets
Held on continuing basis for minimum period of one year, held for generating wealth rather than resale
Why is cash for business to function effectively?
Used to acquire other resources eg. Stock
Satisfy operating expenses
Distribute to shareholders in form of dividends
Limitation or cash flow statements
Inflows and outflows of cash do not reveal profit generated
When does accounting year normally end
30th June
Liquidity of business is important to determine
Whether the business has enough cash on hand to meet short term obligations
Describe duality in double entry bookkeeping
For every debit, there needs to be a credit
In an individual debit account describe debit and credit
Entries made on debit increase amount in asset account
Entries on credit decrease amount in particular account
Ledger accounts are produced from whose point of view?
Banks point of view
What are accruals/ expense payable/ accrued expense ?
Accrued liability is when expense has been incurred before end of accounting period but invoices have not been received and have not been paid
Eg. Interest is not paid until maturity date. Interest expense is accrued
Difference statement of financial position and performance
Financial position: snapshot of business’s wealth at a point of time
Financial performance: wealth generated over a period it time
Statement of changes in equity?
Changes in owners’ interests in net assets of the business as a result of transactions and events during the period
Freight inward and outward differences
Inward: transportation charge paid when important goods from suppliers ( recorded under COGS)
Outward: cost of transportation to deliver to customers ( recorded under selling and distribution expenses)
What expense are discounts
Financial
What expense are administration and sale staff salaries
Administration salaries; administrative and general expenses
Sale staff salaries: selling and distribution expenses
What expense is cash register repair and maintenance
Selling and distribution
What expense is rate
Administration and generals
What expense is inventory insurance?
Selling and distribution
Why may companies be reluctant to provide fully classified income statement
They do not want to provide competitors with company details
Where are unrealized gains recorded?
Other comprehensive income under statement of comprehensive income
Eg. Unrealized gain on revaluation of land
When is income recognized
Probable income has occurred
The inflow can be reliably measured
When are expenses recognized
Probable outflow has occurred
The outflow can be reliably measured
Describe recognition criterion
Change has occurred and the ability to reliably measure the change eg. In construction projects, income is recognized earlier
What are accrual salaries
Salaries not paid during financial period
They are recorded under current liabilities as they will be paid within the next 12 months
Accrual salaries up, expenses up
Once paid, deduct cash and deduct accrual salaries
Why is prepayment a current asset?
Represents future economic benefits
What is the materiality convention
Adopted for accruals and prepayments
Items need to be separately disclosed if they are seen as important to users
Items not deemed to be important enough can be grouped together ($5 stationery ignored when preparing financial statement for that period)
Do non current assets have perpetual existence
No they are consumed during the process of generating economic income for the business
Is it possible to measure consumption of economic benefits of assets during a period?
Through cost allocation managers can determine how much of the economic benefits of the assets have been used up during the period
Describe the cost/ fair value of the asset
All costs to bring the asset to use eg. Cost to acquire, delivery, installation (plant), legal costs incurred in transfer of legal title (eg. Freehold property), any costs incurred in improving or altering the asset
How can physical life of an asset be extended?
Through maintenance and improvements
Why may economic benefits derived from an asset be reduced over time?
Various factors such as change in market demand, new competitors in markets, technological advancement, obsolescence
Differ economic and physical life an asset has
Economic life: how long the asset will be useful towards business in generating income
Physical life: how long asset lasts without breaking
Describe the estimated residual/disposal value
Worth of asset at the end of it’s economic life
Nevertheless the asset might still be useful towards others and the business can receive payment
3 depreciation methods
Straight line depreciation
Accelerated depreciation
Units of production depreciation
Describe straight line
Equal depreciation expense in each period of the asset’s useful life
Accelerated deprecation
Systematically higher depreciation in early periods of asset’s useful life while smaller depreciation expense in the later periods
Eg. Reducing-balance method (fixed percentage rate of depreciation)
Units of production depreciation
Depreciation expense allocated to each period reflects objective measure of the asset’s life (km travelled, units produced)
Formula for calculating fixed depreciation percentage for the accelerated depreciation method eg. Reducing balance method
P= (1- square root n (R/C) x 100%
Formula for straight-line depreciation
Depreciation per annum : cost -residual value / estimated useful life
Formula for reducing-balance method
Cost x fixed percentage of depreciation = depreciation expense for one year
What is the written-down/ carrying/ net book value?
The value of asset after deducing accumulated depreciation from cost
What is a contra asset account?
Account that goes together with another account but represents a reduction in that account eg. accumulated depreciation- equipment
How may a business determine what depreciation method to use?
Reflect the pattern in which asset’s future economic benefits are expected to be consumed by the entity
Why may a business use straight line method?
Benefits constant over time
Why may business use reducing-balance depreciation?
Asset expected to lose efficiency and hence decline in benefits (machinery)
Why may a business use units of production depreciation?
High correlation between activity of an asset and its physical wear and tear
Formula for units of production depreciation
(Cost -residual value) x production units in the period/ total estimated production units over useful life
How will depreciation affect the business?
It is an expense. This will reduce net profit in then reducing dividend distribution and retained earnings
What type of expense is inventory?
Deferred expense as the inventory isoniazid for before recognition of the expense
What is the traditional basis for valuing assets??
Historical cost
Describe the consistency convention
Particular method of accounting is adopted to deal with transaction, this should be applied consistently over time eg. Depreciation and inventory valuation
When is revenue recognized for credit sales?
As soon as goods are passed to and accepted by the customer
How will bad debt affect financial performance and position?
It is written off by reducing ‘accounts receivable- customer’s name’ and increasing expense known as ‘bad debts written off’/bad debts expense
Matching convention requires bad debt…..
Matching convention requires bad debt to be written off in the same period as that of the sale that gave rise to the debt. Income earned in period matches with expenses incurred in generating income
Why may writing off bad debts as an expense be useful?
It can help management review their credit policies
What are doubtful debts?
Debts not expected to be received but are not currently uncollectable
There is risk of nonpayment. They are not bad debts (irrecoverable). It is likely that a significant portion of doubtful debts ultimately prove to be bad
How can a doubtful debt proved to be irrecoverable/ bad debt be written off? When does this normally occur?
Written off by reducing accounts receivable
Reducing allowance for doubtful debts
This normal occurs after the end of accounting period when the business knows that they collect collect the debt from customer
How can business determine doubtful debts
Credit sales approach: past experience and current expectations applied to credit sales figure
Analysis of accounts receivable outstanding: how long the accounts have been outstanding. For each aged category (current, 31-60,61-90) . Different percentage based in past experience and future expectations is applied to each category to determine the amount that is not expected to be collected
Where will doubtful debts be recorded?
Recorded under expenses in the income statement as ‘doubtful debts expense’
Deduction from accounts receivable account labelled ‘allowance for doubtful debts’
What kind or account is doubtful debts?
A contra asset account, ‘allowance for doubtful debts’ is deducted from accounts receivable on the balance sheet
When there is overestimate on allowance for doubtful debts what will happen?
Overestimate should be written back in the next accounting period as ‘doubtful debts expense written back’
- Reducing allowance for doubtful debts
- Increasing revenue or deduct expense
Describe impairment loss
Assets are labeled as ‘impairment loss’ when they are written down to the recoverable amount this occurs when the recoverable amount of the asset is less than the carrying amount
What is another name for doubtful debts expense
Impairment loss on accounts receivable
On contra debtors account, may be changed to ‘allowance for impairment loss’
Double entry
Every business transaction is recorded in at least two accounts
What is unearned revenue/ prepaid income
Liability account. When a company has received cash in advance of earning it. Company has cash but also has obligation to perform the service, deliver the product or return the cash
Results to increase in cash and increase in unearned revenue under liability. As it is earned, it is added to revenue
How do we recognize sales?
no set method but it is often said that a sale is recognized when the risks and rewards are transferred to the customer. In other words, when the customer receives the good/ service
High proportion of funding for expansion comes from?
Retained profits
Approximately cash flow from operating activities - dividends
How would you record $70 credit sales that cost $20?
Increase AR by 70
Increase sales revenue by 70
Decrease inventory by 20
Increase COGS by 20
How can you express bad and doubtful debts in an income statement
Bad and doubtful debts expense
What is the net accounts receivable
Accounts receivable the business can expect to collect after deducting allowance for doubtful debt and bad debts
When is provision for doubtful debts and bad and doubtful debts expense normally recorded?
At the end of accounting period
What are prepayments? (Prepaid expenses)
How do you record it when cash is paid and how do you record it at the end of accounting period?
Amount paid for future benefits
Generates future economic benefits
cash paid before expense is incurred: reduce cash, increase prepayment
End of accounting period: record expense doer the amount of benefits consumed
Prepayment decrease, expense increase
How would you alter unearned revenue after the good has been delivered/ service is performed (earned revenue)?
Record revenue
Revenue increases
Unearned revenue decreases
How do you record accruals?
Increase accruals/ expense payable
Increase expense
When dividends at declared and paid?
Retained earnings falls
Cash falls
Dividends declared and not paid?
Dividends payable increases
Retained earnings fall
How are intangible assets recorded?
At historic cost
What are identifiable intangible assets?
Separate existence eg. Trademarks, franchises and parents
Assets with finite life are amortized over useful life
What is amortization?
Systematic allocation of depreciable amount of an intangible asset over it’s useful life
Same meaning as depreciation
What are unidentifiable intangible assets?
Cannot be attributed to particular event or transaction
Eg. Goodwill because it is only recorded by business that purchases another enterprise. Excess of the cost to purchase another business over the fair value of its net assets
Internally generated goodwill shall not be recognized as an asset
Are unidentifiable assets required to be valued each year?
Yes they are required to be calked each year and any impairment (reduction) in the value of asset has to be expensed
Increase in value of asset not recorded (accounting conservatism)
Why may asset be revalued.
Recorded as their far value
Increase in asset revaluation reserve
Increase in asset
Are intangible assets allowed to be revalued to their fair value?
No
Impairment loss
Carrying amount- recoverable amount
What is asset impairment
If non current asset’s recoverable amount falls below it’s carrying amount, the asset must be reduced to it’s recoverable amount and the impairment loss is recorded in the comprehensive income statement
What are gains?
Bet Inflows from non ordinary activities
What are formats of the income statement?
Descriptive format: classify expenses according to their nature normally used by service businesses
Functional format: classify expenses according to their function. Used by retail and manufacturing firms
Describe the responsibilities for external and internal reporting
External reporting: reporting cycle is normally one year. Listed companies required to provided half yearly reports
Internal functions: profit figures prepared on monthly basis
What are consolidated financial statements?
Financial statements of a group presented as those of single entity
What is a group in terms of consolidated financial statements
Parent and it’s subsidiary
What is a parent in terms of consolidated financial statements
Entity with one or more subsidiaries
What is a subsidiary in terms of consolidated financial statements
Entity controlled by another entity (parent)
What is control in terms of consolidated financial statements
Power to govern financial and operating polices of entity so as to obtain benefits from its activities
What is non controlling interest (minority interest) in terms of consolidated financial statements
Subsidiary is not wholly owned by parent
