Financial accounting

Question 1

Accountability

Answer 1

The duty to provide an account of the actions for which one is held responsible.
Representatives are accountable for their actions to those people who have placed them in positions of power.

Question 2

Financial reporting/definitions of accounting

Answer 2

The provision of financial information for planning, control and decision making purposes.
Accounting information is provided so that individuals and organisations can render an account of what they have done with the resources placed in their care.
Accounting summarises numerical data relating to past events and presents this data as information to managers and other interested parties as a basis for both decision making and control purposes.

Question 3

Users of accounting information

Answer 3

Financial accounting is prepared for users external to the business such as;
Shareholders/investors, employees, lenders, suppliers, customers, governments and the public as a basis for making economic decisions.

Management accounting is prepared for internal users in a business to help them manage the business’ activities.

Question 4

What qualities should accounting information possess

Answer 4

Relevance- possess the ability to influence users’ economic decisions otherwise there is no point in producing this information.
-May be predictive and assist users in making predictions about the future or it may be confirmatory by assisting users to assess the accuracy of past predictions.

Reliability- should be free of significant error or bias.
-Can are depended upon to represent faithfully the transactions or events it claims to represent.

Comparability- should be comparable over time.
-The same items should be presented in the same way in financial statements relating to different accounting periods.

Understandability- this characteristic should not be confused with simplicity.
-Should be presented in such a way that those making use of it can understand what it represents.

Question 5

Assets

Answer 5

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.

An asset is any resource owned or controlled by a business or an economic entity. It is anything that can be used to produce positive economic value. Assets represent value of ownership that can be converted into cash.

Question 6

Liability

Answer 6

A present obligation of the entity to transfer an economic resource as a result of past events.
A liability is defined as the future sacrifices of economic benefits that the entity is obliged to make to other entities as a result of past transactions or other past events.

Question 7

Equity

Answer 7

The residual interest in the assets of the entity after deducting all its liabilities (capital / ownership interest).
Equity is ownership of assets that may have debts or other liabilities attached to them. Equity is measured for accounting purposes by subtracting liabilities from the value of the assets.

Question 8

Statement of Financial Position/Balance Sheet

Answer 8

A list of assets and liabilities on any one particular day.
Provides information about resources.
Its purpose is to allow users to evaluate financial position.
Includes assets, liabilities and equity.

Question 9

Income

Answer 9

Increases in assets (or decreases in liabilities) that result in increases in equity other than those relating to contributions from holders of equity claims (revenue/gains).

Question 10

Expenses

Answer 10

Decreases in assets (or increases in liabilities) that result in decreases in equity other than those relating to distributions to holders of equity claims.

Question 11

The Income Statement/Statement of Profit and Loss

Answer 11

A summary of trading activities: revenue less expenses over a period of time (usually a year).
Shows the profit or loss for that period (not cash)
its purpose is to allow users to evaluate performance.
Includes revenue and expenses.

Question 12

Non-current or current asset?

Answer 12

Non-current asset- assets acquired by the entity that will be used over a long period of time (usually more than 1 year). e.g. Land, property furniture & fittings motor vehicles, office equipment, computer equipment
Current asset- assets which frequently change and are held in the business for a short period of time (usually less than 1 year). e.g. Stock/inventories work-in-progress debtors/trade receivables, bank, cash prepayments

Question 13

Non-current or current liability?

Answer 13

Non-current liability- amounts that are payable after more than 1 year of the year end date e.g. bank loans, debentures, lease liabilities
Current liabilities- amounts that are payable within 1 year of the year end date (eg. wh smith must pay amounts owed before 31 august 2020) e.g. creditors/trade payables, bank overdraft, accruals/accrued Expenses

Question 14

Net assets

Answer 14

Net assets = total assets - total liabilities

Question 15

Capital/Equity/Ownership Interest amounts owed to owners

Answer 15

Definition - “the residual interest in the assets of the entity after deducting all its liabilities” 
the amount(s) invested by the owner(s) of the entity or If all assets were sold and liabilities paid, it would be what remains to be paid to the owners.

Question 16

The Statement of Financial Position shows users:

Answer 16

The financial position of an entity on the last day of its accounting year.

It is a snapshot of the entity at one point in time (remember a totally different view would be given if the snapshot were to be taken on any other day).

It shows financially measureable resources (assets) and financially measureable obligations (liabilities) as well as the owners’ investment in the business (capital/equity).

Question 17

The Statement of Financial Position does not show users:

Answer 17

All the assets of the organisation: missing assets include employee knowledge and skills, goodwill, internal brands.

All the liabilities of the business: missing liabilities include costs for environmental damage and claims against the organisation that are not known by the year end.

The market value of an organisation: this is determined by what a third party would pay to acquire the organisation.

Question 18

Purpose of Financial Reporting

Answer 18

“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 19

Statement of Profit or Loss

Answer 19

A summary of trading activities (income & expenses) over a period of time (usually a year).

Shows the profit or loss for that period (income less expenses).

Enables users to evaluate performance.

PROFIT does not equal CASH!

Question 20

Capital Expenditure

Answer 20

Definition: expenditure that will benefit more than one accounting period.

Characteristics:

- expenditure is likely to be substantial
- Benefits of it are difficult to define & allocate
- Helps to achieve organisations long term objectives

Examples: land & buildings, plant , motor vehicles

Question 21

The matching/accruals concept

Answer 21

The cost of expenditure ought to be charged to the Statement of Profit or Loss in the accounting period that benefits from it.

Revenue expenditure (eg inventory sold) – charged to the current accounting period

Capital expenditure – may have to be allocated over several accounting periods → via depreciation

Question 22

What is depreciation?

Answer 22

Depreciation is the allocation of cost of a non-current asset to the SOPL which benefits from the use of that non-current asset.

“ The systematic allocation of the depreciable amount of an asset over its useful life”

Depreciable amount is “the cost of the asset…less its residual value”

Question 23

Definitions: COST

Answer 23

Cost directly attributable to bringing the asset into working condition for its intended use.

Question 24

Definitions: RESIDUAL VALUE

Answer 24

The net realisable value of an asset at the end of its useful economic life. Residual values are based on prices prevailing at the date of the acquisition (or revaluation) of the asset and do not take account of expected future price changes.

Question 25

Definitions: DEPRECIABLE AMOUNT

Answer 25

The cost of a tangible non-current asset less its residual value.

Question 26

Calculating depreciation: STRAIGHT LINE METHOD

Answer 26

Allocate an equal amount of depreciation to each year of the useful life, easy to use, most common in UK.
d = (cost – residual value)/ useful economic life of asset

Question 27

Calculating depreciation: REDUCING BALANCE METHOD

Answer 27

Applies a constant percentage to each year’s carrying amount /NBV to calculate depreciation for year, so a progressively smaller amount of depreciation is charged each year.
d = NBV x RB%

Question 28

The disposal of non-current assets

Answer 28

When a non-current asset is sold there is likely to be a profit or loss.
profit/loss = proceeds – Carrying amount(NBV) of assets

Question 29

The Matching/Accruals Concept

Answer 29

“Accrual accounting depicts the effects of transactions and other events and circumstances on a reporting entity’s economic resources and claims in the periods in which those effects occur, even if the resulting cash receipts and payments occur in a different period”

The cost of expenditure ought to be charged to the Statement of Profit or Loss in the accounting period that benefits from it. This requires year end adjustments for:

• Accrued expenses/Accrued Income
• Prepayments
• Irrecoverable debts

Question 30

The accrual/accrued expense

Answer 30

An expense that has been incurred, but for which an invoice has not yet been received or paid or charged.

Similar to a creditor/trade payable.

Common where services are paid in arrears e.g. gas, electric, phone, wages

Question 31

Accrued income

Answer 31

Income that has been earned, but for which an invoice has not yet been sent out.

Similar to a debtor/trade receivable.

Revenue recognition.

Question 32

The Prepayment

Answer 32

An expense which has been incurred, but the benefit from it will not be provided until the following accounting period.

It is an asset/resource waiting to be used.

Common where services are paid for in advance.

Question 33

BAD DEBT/IRRECOVERABLE DEBT

Answer 33

A bad debt is a trade receivable who you know will not be able to settle their balance with you.
Reasons may be : - insolvency
- Death
Must be written off.

Question 34

Doubtful debt

Answer 34

A doubtful debt is a debtor who you suspect will not be able to settle their balance.

Often a business will provide for a certain percentage of their trade receivables as being doubtful.

A doubtful debt provision is created.

Question 35

Financial Statements summarised

Answer 35

Statement of Financial Position
Assets employed by the organisation
Liabilities to be paid

Statement of Profit or Loss
Income earned
Expenditure incurred

Statement of Cash Flows
How profit is turned into cash - meeting liabilities and expenses when they fall due.

Question 36

The value of the Statement of Cashflows

Answer 36

Cash flow statements assist users to:

• Assess how quickly profits are turned into cash
• Assess entities’ cash flow management
• Assess entities’ financial position
• Determine actual cash generated and spent

Question 37

Sources of Cash Flow

Answer 37

Cash Flows from operating activities:
-This is cash generated from the normal activities of the company
-Usually calculated by looking at profit and making adjustments for non-cash expenses and movements in working capital
Cash Flows from investing activities:
-These are arise from the purchase or disposal of non current assets
Cash Flows from financing activities:
-Financing activities alter the long term funding of the company

Working Capital = Current Assets – Current Liabilities

Question 38

Calculating cashflow from Operating Activities

Answer 38

Direct Method:

• Records direct cash Receipts from trading activities
• Deducts direct payments for trading activities

Indirect method:
-Uses net profit for the year and adjusts it for non-cash transactions

Question 39

What to look for in a cash-flow statement

Answer 39

• has the cash flow increased in the period?
• did the cash from operations cover interest, tax and dividends paid
• what happened to the long term funding?
• did the company make significant investment in long term assets? how were these funded?
• how well has the company managed its working capital?
• is the final cash balance likely to be adequate for a company to continue to operate?