Financial Accounting Flashcards
Accounting consists of three basic activities:
Identify, Record and Communicate
Internal users and External users
Internal - managers
External users - investors (owners) buy/hold/sell ownership shares, creditors (suppliers and bankers) evaluate the risks of granting credit or lending money
Managerial accounting and Financial Accounting
1) Provides internal reports to help users to make decisions about their companies
2) Provides economic and financial information to external users
Ethics
Effective financial reporting depends on sound ethical behaviour
International Accounting Standards Board (IASB)
International Financial Reporting Standards (IFRS)
Financial Accounting Standards Board (FASB)
Generally Accepted Accounting Principles (GAAP) in most companies in US
Convergence
Process of reducing the difference between IFRS and US GAAP in order to increase comparability .
IFRS’s measurement principles - Historical cost principle and Fair value principle
1) Dictates that companies record assets at their cost; even if the value of the asset changes over time, the original cost is reported
2) Assets and liabilities should be reported at fair value
Monetary unit assumption and Economic entity assumption
1) Only transaction data that can be expressed in terms of money; quantify economic events, excludes information that cannot be quantified
2) An economic entity can be any organisation or unit of society, activities of the entity be kept separate and districts from the activities of its owner and other economic entities
Organisations that use accounting
Companies: proprietorship, partnership and corporation
Non-profit organisations
Government organisations
The basic accounting equation
Assets = Liabilities + Equity
Assets
Capacity to provide future services or benefits. 1) Cash 2) Inventory 3) Buildings 4) Equipment 5) IT systems 6) Patents 7) Trademarks 8) Accounts receivable Assets are claimed by either creditors or shareholders
Liabilities
Claims against assets - existing debts and obligations.
1) Accounts payable (purchasing on credit from suppliers)
2) Note payable (borrowing money from the bank)
3) Salaries and wages payable (employees)
4) Taxes payable (amounts owed to the tax authorities)
5) Bonds
Creditors
All of the people or entities to whom the business owes money. May legally force the liquidation of a business that does not pay its debts.
Equity
The value of the corporation to its owners. It is what belongs to shareholders.
Component 1) Share capital-ordinary
Component 2) Retained earnings
Share capital-ordinary
Amounts paid in by shareholders for the ordinary shares they purchase.
Retained earnings
Income from previous periods not yet paid out as dividends.
Retained earnings = Revenues - Expenses - Dividends
Revenues
Gross increases in equity resulting from business activities entered into for the purpose of earning income.
Expenses
Costs of assets consumed or serviced used in the process of earning revenue. Decreases in equity that result from operating the business
Dividends
Distribution of cash or other assets to shareholders.
Gross
Without deduction of tax or other contributions.
Value of equity can change from
1) Operations - revenues and expenses resulting in a net income
2) Transactions with owners:
Shareholders can invest in the firm (buy shares)
Shareholders can be paid by the firm (receive dividends)
Expanded basic accounting equation
Assets = Liabilities + Share capital-ordinary + Revenue - Expenses - Dividends
Bookkeeping
Process of registering transactions, recording activity
Financial statements
The annual reports of companies contain five financial statements
- Income statement - net income or net loss
- Statement of financial position/Balance sheet - reports of assets, liabilities and equity
- Retained earnings statement - changes in retained earnings
- Statement of cash flows - cash inflows/receipts and outflows (payments)
- Comprehensive income statement
Public accounting
Auditing, taxation and management consulting
Private accounting
Cost accounting, budgeting, internal auditing, accounting information system design and support, tax planning and preparation.
Government accounting
Tax authorities, law enforcement agencies and corporate regulators
Forensic accounting
Investigations into theft and fraud. Money-laundering, identity theft and tax evasion
Timing issue
Companies allocate the costs to the periods of use.
Airplane used for 5 years
Time period assumption
Accountants divide the economic life of a business into artificial time periods
Interim periods
Monthly and quarterly time periods
Fiscal year
Accounting time period that is one year in length
Calendar year
January 1 to December 31
Accrual-basis accounting (IFRS)
Companies record transactions that change a company’s financial statements in the periods in which the events occur.
Recognise revenues/expenses when they perform the services/incurred, rather than receiving cash/getting paid
Cash basis accounting
Companies record revenue at the time when they receive cash and they record an expense at the time they pay out cash.
Performance obligation
When a company agrees to perform a service or sell a product to a customer
Revenue Recognition Principle
Companies recognise revenue in the accounting period in which the performance obligation is satisfied
Expense Recognition Principle / Matching principle
Expenses are recognised in the accounting period in which the company generates revenues because of these expenses
Adjusting entries
Ensure that the revenue recognition and expense recognition principles are followed. They ensure that revenues and expenses are recognised in the period to which they belong
Types of adjusting entries
Deferrals and Accruals
Deferrals
1) Prepaid expenses: expenses paid in cash before they are used or consumed
2) Unearned revenues: cash received before services are performed
Accruals (before)
1) Accrued revenues: revenues for services performed but not yet received in cash or recorded
2) Accrued expenses: expenses incurred but not yet paid in cash or recorded
The recording process
- Analyse transactions in terms of effects on the accounts
- Enter the transaction information in a journal
- Transfer the journal info to the appropriate accounts in the ledger
The journal
Book of original entry. Record transactions in the chronological order
Several contributions to the recording process:
1) chronological order
2) discloses in one place the compete effects of a transaction
3) helps to prevent and locates error
Journalising
Entering transaction data in the journal. Consists of: 1) date of transaction 2) amounts to be debited and credited 3) a brief explanation
What happens after the journals are made?
They are transferred to the General Ledger
Simple entry
Involves only two accounts - one debit and one credit
Compound entry
Requires three or more accounts - one bed it and two credit
Ledger
The entire group of accounts maintained by a company
General ledger
Contains all assets, liabilities and equity accounts
Posting
Transferring journal entries to the ledger account
The recording process in general
- Analyse each transaction
What type of count is involved
What decreased and increased and by how much
Translate them into debits and credits - Enter the transactions in the journal
- Post the journal entries to the ledger
The trial balance
List of accounts and their balances at a given time. Debit, credit and balance
Prepaid expenses
An debit to an expense account and a credit to an asset account
Supplies
Insurance: prepaid insurance and cash, insurance expense and prepaid insurance Cr
Depreciation: depreciation expense and Cr Accumulated depreciation-Equipment
Unearned revenue
Debit to the liability account and credit to revenue account
Accrued revenue
A debit to an asset account and a credit to a revenue account
Accounts receivable and service revenue, revenue for services perform
Accrued interest
Face value * annual interest rate * time in terms of year = Interest
