Financial accounting Flashcards
Accountability
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.
Financial reporting/definitions of accounting
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.
Users of accounting information
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.
What qualities should accounting information possess
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.
Assets
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.
Liability
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.
Equity
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.
Statement of Financial Position/Balance Sheet
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.
Income
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).
Expenses
Decreases in assets (or increases in liabilities) that result in decreases in equity other than those relating to distributions to holders of equity claims.
The Income Statement/Statement of Profit and Loss
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.
Non-current or current asset?
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
Non-current or current liability?
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
Net assets
Net assets = total assets - total liabilities
Capital/Equity/Ownership Interest amounts owed to owners
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.
The Statement of Financial Position shows users:
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).
The Statement of Financial Position does not show users:
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.
Purpose of Financial Reporting
“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.”
Statement of Profit or Loss
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!
Capital Expenditure
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
The matching/accruals concept
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
What is depreciation?
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”
Definitions: COST
Cost directly attributable to bringing the asset into working condition for its intended use.
Definitions: RESIDUAL VALUE
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.
