Financial Accounting Flashcards

Question

Where will revenue expenditure be and where will be capital expenditure be?

Answer 1

Revenue expenditure will be on the income statement whereas capital expenditure will be on the balance sheet

Answer 2

Shows the financial position of a business at a specific point in time

Answer 3

Summarises the income and expenditure of a business = profit or loss

Answer 4

1. Dual effect 2. Separate entity concept 3. Accounting equation

Answer 5

Every transaction will have at least TWO effects *one asset goes up, one asset goes down* Business buys a car Business sells goods for cash Business sells goods on credit

Answer 6

A business entity is separate from its owner(s) The activities of the business should be kept separate from the activities of the owner(s)

Answer 7

A ledger is just a book and a ledger account is just a page in that book

Answer 8

- (aka general ledger) has a page (an account) for every item that appears on the Balance Sheet or Income Statement (Profit and Loss account). - Each page (account) has two columns: a debit side on the left and a credit side on the right. Each page is often referred to as a “T” account

Answer 9

**DEADCLIC** *Debit if increase in…* Expense Asset Drawings *Credit if increase in…* Liability Income Capital

Answer 10

Every transaction has two effects on the accounting equation If assets increase, then liabilities or capital must increase or another asset must fall.

Answer 11

Assets and Capital will increase by £3000

Answer 12

Cash asset falls by £2600 so its now £400 Other assets increase by £2600 Assets = Liabilities + Capital Cash 400 Utensils 2600 Total 3000 = 0 + 3000

Answer 13

Profit made is £200 so capital increases by 200

Answer 14

Cash and capital fall by £150 It is classed as Drawings

Answer 15

Assets = Liabilities + Capital Assets = Something the business owns Liabilities = Something the business owes to a third party Capital = Something the business owes to the owner

Answer 16

Both assets and capital

Answer 17

1. Add up debits and credits on an account 2. If one side is greater than the other, insert a ‘balancing’ figure on the lower side 3. Balancing figure called balance carried forward (c/f) or carried down (c/d) 4. Enter total figures on both columns 5. The c/f figure becomes the b/f figure for the next period. Enter this below the total on the opposite side

Answer 18

- Check to ensure Dr = Cr - Errors can still exist even if Dr = Cr - Useful stage in the preparation of final accounts

Answer 19

- Only a Dr or Cr side of a transaction may be posted with the other half being omitted. - A Dr or Cr entry may be made on the wrong side of the ‘T’ account - Different amounts may be posted to the Dr and Cr sides (eg transposition errors) - The ‘T’ account may be added up incorrectly and an incorrect balance transferred to the trial balance - A Dr balance is entered onto the trial balance as a Cr balance or vice versa

Answer 20

If such an error has occurred, the trial balance will not balance so... - We make it balance by creating a suspense account On preparing the year end accounts... - the errors must be found and removed

Answer 21

- If the trial balance does not balance - To comply with the key accounting conventions and assumptions

Answer 22

- Sets out the concepts which underlie the preparation of financial statements

Answer 23

Accruals or Matching - Expenses/Income should be matched to the period they relate and to the income/expenses they generate Going concern - Assume entity will continue to trade for the foreseeable future

Answer 24

- Consistency Of accounting treatment or presentation - Prudence Slow to recognise profits/gains, quick to anticipate losses - Materiality Influence economic decision making of users - Offsetting Report items separately - Comparative information Disclose previous period - Substance over form Report reality, not legal form - Neutrality Free from bias - Completeness No material omissions

Answer 25

- Business entity Separation of owner from the business - Money Measurement Only deal with items to which a monetary value can be attributed - Historical Cost Transactions recorded at cost when occurred - Stable Monetary Unit Eg £ or $ - Assume value of unit is constant - Realisation Recognise income and profits when realised - Duality Every transaction has two effects

Answer 26

- Accruals & Prepayments To match expenses to the period they relate - Inventory (stock) and the cost of sales To match sales with actual cost of those sales - Bad and doubtful debts To be prudent in recognising debts that may not be recoverable - Depreciation To match cost of a non current asset over its useful economic life

Answer 27

Cash flow = Cash in – Cash out Profit = Income – Expenses Income: - Value of goods and services sold during a period Expenses: - value of goods and services consumed in generating income Profit is not a measure of cashflow. A profitable business may need an overdraft. A loss making business may have cash . Income and expenses involve receivables and payables whereas cash is not about credit or what is owed, just what you have or have given out

Answer 28

The aim is to show expenditure in the period to which it belongs, and not to the period when payment is made. - Many expenses ‘overhang’ more than one accounting period. Eg Rent, Rates, Insurance, Licence costs, Electricity, Telephone, accountancy/audit fees etc. - Remember we should recognise an expense when the goods or services are consumed

Answer 29

The accountant will prepare the accounts after the year end and therefore send their invoice after the year end. However the expense is “consumed” in the year and so needs to be accounted for in the year.

Answer 30

Expense incurred but not yet invoiced We need to recognise the expense and also recognise the liability

Answer 31

- Expense paid in advance - We need to remove the prepaid expense and recognise the asset

Answer 32

- The £1,000 rates expense relates to the 10 months to 31st March 2024 (£100 pm) - This expense covers 10 months to 31 March 2024 but we only want the 4 months to 30 September 2023 Susan has prepaid The £150 electric expense relates to the 3 months to 31st August 2023 This expense covers 3 months but we need 4 months to 30 September 2023 Susan needs an accrual for

Answer 33

- Accrual - Increase the expenses in IS and recognise the liability in the BS - Dr Expense (IS), Cr Accruals (liability in BS) - Prepayment - Decrease the expenses in IS and recognise the asset in the BS - Dr Prepayment (Asset in BS), Cr Expense (IS)

Answer 34

- The sales figure is not altered - The loss is recognised as an expense in the IS - A new type of expense appears in the IS alongside electricity, wages, insurance etc

Answer 35

Slow to recognise profits and gains, but swift to anticipate losses If a business believes a debtor will not pay they should be prudent and recognise this in the accounts Bad debt = debt that is definitely irrecoverable (eg debtor bankrupt Doubtful debt = some chance of recovery, but also a chance of non-payment

Answer 36

- The accountant is being prudent in recognising the risk of non-payment and makes a charge to the IS and some reduction to the value of receivables in the BS - The adjustment may be against a specific debtor, or may be in the form of a general provision set a percentage of total receivables Journal Entry Dr Bad Debt expense (IS) 100 Cr Provision for Doubtful Debts (BS) 100

Answer 37

- Sales are either on credit or for immediate payment - Receivables arise when a business makes a credit sale Sale: Dr Receivables 300 Cr Sales 300 Upon settlement: (payment by debtor/receivable) Dr Cash/Bank 300 Cr Receivable 300

Answer 38

- If the provision is not used/needed it is automatically carried over to the next year. It would appear in the TB as a credit entry. - In the next year Heidi decides to increase the provision to £1,500: - The balance sheet receivables figure will be shown net of the £1,500

Answer 39

1. Write off of Bad Debt Dr Cr Being the write off of the bad debt 2. Calculation of general provision: £75,000 - £2,500 = £72,500 £72,500 @ 3% = £2,175 £2,175 is the final provision needed. Already have £1,500 provision so increase by £675 Dr Cr Being the increase in the general provision 3. Electric Accrual Dr Cr Being the accrual for Oct 23 (£600 x 1/3) 4. Insurance Prepayment: Paid 12m to 31 March 2024 Prepaid Nov, Dec, Jan, Feb, Mar Prepayment = £1,800 x 5/12 = £750 Dr Cr Being the prepayment for Nov - March

Answer 40

Extract from the Balance Sheet _Current Assets_ Receivables 72,500 (75,000 – 2,500) Less provision (2,175) 70,325 Prepayments 750 _Current Liabilities_ Accruals 200

Answer 41

1. Accruals & Prepayments - To match expenses to the period they relate 2. Inventory (stock) and the cost of sales - To match sales with actual cost of those sales 3. Bad and doubtful debts - To be prudent in recognising debts that may not be recoverable 4. Depreciation - To match cost of a non current asset over its useful economic life

Answer 42

Accrual = Dr Expense Cr Accrual Prepayment = Dr Prepayments Cr Expense

Answer 43

- The expenses recognised in the income statement are those related to the sales recorded. i.e. sales should be matched against the cost of those sales

Answer 44

No because profit is not a measure of cashflow. A profitable business may need an overdraft. A loss making business may have cash

Answer 45

Sales should be matched with cost of sales Sale proceeds from selling 80 balls should be matched with the cost of buying 80 balls The 20 balls he has not sold should be removed from the income statement and recognised as an asset in the balance sheet

Answer 46

Sales (80 @ £15) 1,200 Less cost of sales purchases (100 @ £10) 1,000 Less closing inventory (20 @ £10) (200) (800) Gross Profit 400

Answer 47

Opening inventory 20 balls Bought in year (purchases) 550 balls 570 balls Less Closing inventory (125 balls) Balls sold in the year 445 balls

Answer 48

Cost of sales = (opening inventory + purchases) - closing inventory

Answer 49

- Do not confuse no of units with their value. The income statement contains values not units - Cost of sale adjustment ensures we match the sales revenue gained with the costs of the goods which have been sold. Otherwise profit figures would be boosted or reduced depending on whether we had sold more inventory (stock) than we had purchased during the year or vice –versa. - Closing inventory (stock) from one period is always the opening inventory (stock) for the next period. - The opening inventory figure (if there is any) will always appear as a Debit balance in the trial balance. - Opening inventory is an asset but goes on the income statement - Closing inventory goes on the IS and BS

Answer 50

- At the end of the accounting period there will be a stock take. 1. To count the actual quantity of each item 2. To note slow-moving items, damaged goods, obsolete items - Inventory is valued at the lower of cost and Net Realisable Value (NRV) - NRV is the new value of an item and what you can sell it for

Answer 51

- General accounting rule – use historic cost rather than current cost but… - Inventories may comprise homogenous products such as oil, gas, rugby balls etc. - They may be purchased throughout the year at a variety of prices.

Answer 52

FIFO: First in, First out - Goods which arrive first are used first (particularly for perishable goods) LIFO: Last in, First out (Disallowed under International Accounting Standards) - Goods which arrive last are used first WAC: Weighted average cost - Goods are valued at the average price of the inventories held

Answer 53

Only FIFO or WAC may be used in financial accounting. The same method should be used every year = Consistency concept Any method may be used in management accounting

Answer 54

Estimated future selling price less all additional costs to be incurred before sale

Answer 55

- Margin is calculated on sales (sales is the 100% figure) - Mark-up is calculated on cost (cost is the 100% figure) Profit margin = profit/sales Sales = cost + gross profit Margins and mark-ups can@ be used to establish costs and profits

Answer 56

Depreciation in the systematic allocation of a non-current asset over its useful economic life We need it to spread the cost of a non current asset gradually over the years of its use and wearing out

Answer 57

Dr Vehicles 20,000 Cr Bank 20,000 The tractor is now in the balance sheet as a non current asset Each year we now need to take an element of this cost into the income statement as he is using the tractor to generate his sales

Answer 58

**Straight line method** Charge an equal amount of depreciation every year **Reducing balance method** Charge more depreciation in the earlier years of use, less in the later years

Answer 59

Annual Depreciation = Cost – Residual Value/ Estimated useful life Annual Depreciation = 11,000 – 1,000/ 4 = £2,500 p.a.

Answer 60

Opening BS value **Depreciation taken to IS** Closing BS value Year 1 £20,000 **£4,000** £16,000 Year 2 £16,000 **£4,000** £12,000 Year 3 £12,000 **£4,000** £8,000 Year 4 £8,000 **£4,000** £4,000 Year 5 £4,000 **£4,000** £NIL

Answer 61

The Net Book Value (NBV) of a non current asset is its **historic cost** minus all depreciation charged to date (**accumulated depreciation**) on that asset Historic cost = original purchase price Accumulated depreciation = total depreciation charged / taken to the Income Statement since purchase of the asset

Answer 62

Apply a constant % of the Net Book Value every year Example: An item costs £12,000 and is to be depreciated at a rate of 25% reducing balance ## Footnote https://newcastle-my.sharepoint.com/:i:/r/personal/c3023551_newcastle_ac_uk/Documents/Pictures/Screenshot%202023-11-26%20003847.png?csf=1&web=1&e=HNHK0G

Answer 63

Dr Depreciation Charge (IS) Cr Accumulated Depreciation (BS) n.b we do NOT credit the non current asset directly

Answer 64

- Cost must be removed - Accumulated depreciation must be removed Anything more than the NBV is a profit Anything less than the NBV is a loss

Answer 65

Standard Rated - most goods and services - rate of 20% Zero Rated - Taxable supplies but 0% - eg. Food production, public transport, children's clothes Exempt - Not taxable supplies - eg. education, land

Answer 66

- VAT registered traders are required to charge VAT on their sales - Output VAT - VAT registered traders can generally reclaim any VAT they have suffered on purchases - Input VAT - VAT registered traders pat over the difference to HMRC - Output - Input = payable to HMRC

Answer 67

Dr Receivables 1200 Cr Sales = 1000 Cr VAT = 200 (liability to pay to HMRC) Dr Purchases = 600 Cr Payables = 600 Cr VAT = 120 (asset as HMRC owe you)

Answer 68

- Trade discounts - Early settlement discounts - VAT is always calculated after all potential discounts and NO adjustment is made even if the discount is not taken up

Answer 69

When a VAT registered business buys a non current asset to use in its trade it can recover the VAT it suffers on the purchase (Input VAT) The non current asset is therefore stated net of VAT in the SoFP and depreciation is then calculated. VAT however cannot be recovered when a VAT registered business buys a motor car. As a result the car is stated including VAT in SoFP and depreciation is then calculated.

Answer 70

- VAT is a tax on most goods and services - VAT is charged by VAT registered businesses - The final burden typically falls on the final consumer - Businesses are collectors of VAT for the government - Every quarter business pays difference between output VAT and input VAT - Figures in the Income Statement generally exclude VAT - Figures in the SoFP generally include VAT

Answer 71

Sole traders: - Personally liable for debts of the business - People who work for themselves - Usually small but could employ many Partnerships: - Usually personally liable for debts of the business - Two or more people trading with a view to making a profit - Risks and rewards are shared Limited liability companies: - Personally liability normally limited to amount paid for shares - Legal entity formed by registration under Companies Act

Answer 72

- The accounting process of inputting transactions and producing financial statements is the same for all business entities - May be differences in volume and complexity of transactions Key differences are in the presentation and regulation requirements

Answer 73

- Liability is limited by shares - Public (plc) – can offer securities (shares, loan stock) for sale to general public on a listed stock market; requires minimum net assets of £12,500 - Private (Ltd) – not allowed to offer shares for sale to general public so cannot be listed on a stock market; no minimum net assets required - Unlimited liability - Liability is limited by guarantee - Liability is limited by shares and guarantee

Answer 74

- Legal nature - Perpetual life - Limited Liability - Legal Safeguards

Answer 75

- A separate legal entity in the eyes of the law - Contrast with sole trader - Memorandum and Articles of Association - Incorporated by registration on the Registry of Companies - Owners = members or shareholders (may be 1 or many)

Answer 76

Continues on death of shareholder(s) - The shares will pass to the beneficiary of his/her estate Shareholders - can choose to end the company The Courts - can force the winding up of a company

Answer 77

Shareholders liability is limited - Owners only lose the amount they invest and any unpaid share capital Creditors/Payables - Can not sue the owners directly (veil of incorporation) - They must sue the company The company itself has unlimited liability for its debts

Answer 78

Limited liability indicated in the name - Creditors/payables trade with a limited company at their own risk – credit checks advisable Restrictions - on withdrawal of equity by shareholders Financial statements - filed with Companies House - publicly available

Answer 79

Advantages of Co.: - Shareholder limited liability - Transfer of ownership - Tax - Kudos / Status Disadvantages of Co.: - Higher costs – formation, annual - Compliance with legislation - CA2006 - Duties of directors Advantages/disadvantages of Co.: - Transparency - Separation of ownership and management

Answer 80

**Ownership interests?** Sole trader - Capital account Company - Equity - Share capital and reserves **Forms of debt capital?** Sole trader - Bank Loans Company - Range of securities **Profit withdrawn by owners?** Sole trader - Drawings Company - Bonus if employee - Dividends **Tax on profits?** Sole trader - Liability of sole trader, not the business Company - Corporation tax on company profits

Answer 81

- Term used to include all owners’ capital - Share capital, shown at nominal value in statements - Reserves (any other amount attributable to owners) - Retained earnings - Share premium reserve - Revaluation reserve - Other reserves Reserves are not a spare pot of money!

Answer 82

- On the date of incorporation, a company will issue ordinary (aka equity) shares to its owners - Each share has a named value shown on the share certificate - Nominal value or Par value - It can be any value: 1p, 2p, 5p, 10p, 25p, 50p, £1 etc. - Issued (or allotted) share capital – par value of the shares issued to shareholders - Called up share capital – amount the company has requested to be paid (company may request payment in instalments) - Paid up capital – the amount actually paid

Answer 83

- Shown within equity on the statement of financial position (SOFP aka balance sheet) - Normally the issued share capital is fully called up and has been fully paid for – figure in SOFP is the issued = called up share capital - If the share capital has not been fully called up then the figure for share capital in the SOFP is the called up share capital - If not all the called up share capital has been paid by the shareholders then the share capital in the SOFP will be the total called up share capital and any unpaid capital is shown as an other receivable within current assets of the SOFP

Answer 84

divide the share capital figure from the ‘Statement of Financial Position’ by the nominal or par value If a company has share capital of £200,000 and has shares with a nominal or par value of 50p, then it has 400,000 shares in issue Quantity of shares X Share’s par value = Share capital

Answer 85

A company can issue preference shares - another form of finance for a company - These entitle the owner to be paid preference dividends out of company profits before equity shareholders are entitled to any equity dividends Irredeemable preference shares: - Company not entitled to buy back (redeem); treat as part of equity Redeemable preference shares: - Company is entitled to buy back (redeem); treat as debt

Answer 86

Equity shares: - Entitled to vote - Volatile dividends - Rank last in winding up (risk v reward) Preference shares - Normally not entitled to vote - Fixed dividend - Rank higher than equity shares in winding up (less risky)

Answer 87

- Limited companies are a separate legal entity (veil of incorporation) - Limited companies are owned by their shareholders - The shareholders have limited liability (contrast with sole traders) therefore more regulation needed to protect investors and creditors - Equity (share capital and reserves) theoretical amount due to owners - Various types of shares (ordinary, preference) with various rights - Shares are issued at a nominal or par value – issued v called v paid

Answer 88

- Represents accumulated retained earnings. When profits are made, they can either be paid out as dividends (after tax) or reinvested in the business - It represents all profits less all losses less all dividend payments since the company began trading

Answer 89

MOST similar to sole trader’s capital account Note: Company Law does not allow dividends to be paid which exceed accumulated profit reserve. This account cannot go *overdrawn* which is protection for creditors

Answer 90

- Non-current assets (NCA) are normally carried in the ‘Statement of Financial Position’ at historical cost less accumulated depreciation - NCA may be revalued to market value - Most often done for land and buildings as property values can rise steeply over time

Answer 91

- A company may require more finance and decide to issue more shares - The market value of these shares may be significantly different from the nominal/par value - Any such difference should be shown in the share premium reserve - Shares can be issued for more than the nominal or par value (a premium), but never less than it - Restrictions on use of the share premium reserve (maintain capital)

Answer 92

Rights Issues - Issuing shares to new shareholders risky and expensive - Rights issues allows existing shareholders to buy shares at discount to market value Bonus issues Aka capitalisation issue or scrip issue - An issue of shares to existing owners free of charge in proportion to existing holding - Adjusts companies’ capital structures by utilising share premium and/or accumulated profit reserves – no cash involved

Answer 93

Equity dividends - Amount is decided by the board of directors, usually quoted in terms of the pence amount each share receives - E.g. a company has 10,000 £1 equity shares in issues and during the year paid a dividend of 5p per share. Total paid = £500 Dividend paid out of the retained earnings reserve - Dividend paid out of the retained earnings reserve - Only the amount of equity dividend paid in a year is recorded in the financial statements (in the statement of change in equity) - No accrual is made for proposed equity dividends at the year end

Answer 94

- Usually expressed as a fixed percentage and paid ahead of equity dividends - A 7% preference share with a par value of 50p will receive a dividend of 3.5p per year - Record the dividend due for the period, making accrual if required - Irredeemable preference dividends – paid from retained earnings reserve (just as equity dividends). - Redeemable preference dividends – treated as a finance cost (like interest) and deducted through Income Statement

Answer 95

- A company has access to bank loans and can also borrow in the form of debt securities (eg loan stock, debentures) - These securities often have a par value, interest payments and a redemption date - Interest (paid and accrued) is a finance cost in Income Statement - Redeemable preference shares are a form of debt capital - Accounted for under IFRS9 Financial Instruments

Answer 96

- Loan stock and debentures (aka corporate bonds) are effectively loans to the company that carry a fixed rate of interest based on the nominal value and usually repayable at some future date. - Interest paid ahead of dividends - Can be secured (fixed charge on specific asset or floating charge on group of assets) or unsecured. - Can be convertible (at the option of the holder) into equity shares at some point in the future

Answer 97

- A company is a separate legal entity and is liable to pay corporation tax on its profits - Tax is therefore another expense in the Income Statement - As the tax liability is finalised after the year end, estimated tax liabilities are calculated and included within current liabilities - Dr tax charge (IS), Cr tax payable (SOFP) with estimated liability - Any under/over provisions are corrected in the following year - During year, record tax paid and record year end estimated liability

Answer 98

Method 1: - Post tax paid in year to the tax liability and adjust for any under or over provision in the previous year (Dr tax payable Cr Tax charge/expense if over provision, Dr tax charge/expense Cr tax payable if under provision) Method 2: - Clear the opening tax liability to the tax charge/expense account (Dr tax liability, Cr tax charge/expense). Post tax paid to the tax charge/expense account (Dr tax charge/expense Cr Bank). Post estimated year end liability (Dr tax charge/expense Cr tax liability). - In this method you don’t have to calculate the under or over provision as it automatically comes through in the tax charge account

Answer 99

- Companies are owned by their shareholders who hold shares - Various types of shares (ordinary, preference) with rights - Equity (capital and reserves) theoretical amount due to owners - Owners entitled to share of profits in the form of dividends - Shares are issued at a nominal or par value - Shares may be issued at a premium (but never a discount) to par - Non-current assets may get revalued - Companies have access to debt capital as a form of finance - Companies are liable to and must account for corporation tax

Answer 100

Term used to include all owners’ capital - Share capital, shown at nominal value in statements - Reserves (any other amount attributable to owners) - Retained earnings - Share premium reserve - Revaluation reserve - Other reserves

Answer 101

- Separation of control from ownership - Directors need to account for their stewardship over the year - Limited liability of shareholders - Creditors need protection in addition to limited liability warning - Social justice - Large companies have extensive economic power. If they fail, many people are usually adversely affected

Answer 102

Legislation – The Companies Act 2006 Rules: - Accounting Profession – Accounting Standards - Stock exchange listing rules

Answer 103

- All UK limited liability companies must prepare and publish financial statements annually (audited if large company) - The statements must give a true and fair view of the performance and position of the company - They must be prepared in accordance with either UK GAAP (Generally Accepted Accounting Practice) or IFRS Standards - These statements must be approved by the shareholders at a general meeting and then filed with Registrar of Companies where open to inspection for a nominal fee.

Answer 104

- In business, different people may interpret the same situation in a different way. - Professional judgement is often required creating subjectivity and accounting standards were developed to try to limit this to allow comparability between different organisations - Historically many countries developed their own accounting standards - As business and investment became increasingly global, clear need developed for harmonisation of standards

Answer 105

- Listed companies are required to apply IFRS Standards - Unlisted can choose either IFRS or UK GAAP

Answer 106

- Financial statements are prepared under UK GAAP for most private unlisted companies - UK GAAP: The rules, from whatever source, that govern accounting and financial reporting in the UK. - Company law (CA2006) - UK accounting standards (FRS100-105) set by Financial Reporting Council (FRC) - Effects of stock exchange listing requirements - Effects of IFRS standards - It’s a dynamic changing concept, not always easy to define - Some differences between UK GAAP and IFRS in terms of treatment, presentation and terminology

Answer 107

Generally jurisdictions around the world are moving towards harmonizing global standards Why? - Allows comparability, easier fund raising, reduces costs, provides legitimacy Any drawbacks to harmonization? - Threat to national identity & culture, lack of flexibility, costly to change, still need local standards as inappropriate for SME Any drawbacks to financial statements? - Too general, lack non financial information, largely historical

Answer 108

Asset - 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 Liability - A present obligation of an entity to transfer an economic resource as a result of past events. An obligation is a duty or responsibility that an entity has no practical ability to avoid. Equity - Residual interests in the assets of an entity after deducting all its liabilities 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 Expense - Decreases in assets or increases in liabilities that result in decreases in equity other than those relating to distributions to holders of equity claims

Answer 109

- CSR describes how entities adopt/integrate social and environmental concerns in their business operations to benefit stakeholders - Could include policies on local communities, employees, customers, the environment, general ethical code - Help recruitment and retention of employees, good risk management, build brand and reputation, may reduce costs - Accusations of greenwashing and just a marketing ploy - Sustainability and ESG (environmental, social and governance) more favoured now

Answer 110

In 2021 the International Sustainability Standards Board (ISSB) was formed by the IFRS Foundation Aim? To provide users with information to understand the entity's environmental, social and governance risks and responses to them Why? Users increasingly interested in sustainability issues How? Develop IFRS Sustainability Standards to provide consistency in disclosure Initial two standards issued in 2023 (IFRS S1 and IFRS S2) designed to set a global baseline about sustainability related risks and opportunities useful for investor decision making – effective reporting periods beginning from 1 January 2024

Answer 111

IFRS S1 – General requirements for disclosure of sustainability related financial information - Disclosure requirements to enable companies to communicate to investors about sustainability related risks and opportunities over the short, medium and long term - How it manages its sustainability related risks and opportunities IFRS S2 – Climate related disclosures - Specific climate related disclosures designed to be used with IFRS S1

Answer 112

- Code of Ethics issued by International Federation of Accountants (IFAC) in 2005 - Applies to all members of professional accountancy bodies - Based on 5 fundamental principles, the spirit of which must be complied with at all times Members must - Identify threats - Evaluate the significance of a threat - Implement safeguards to eliminate / reduce threats

Answer 113

**Fundamental Principles** - Integrity - Objectivity - Professional competence and due care - Professional behaviour - Confidentiality **Threats** - Self-interest - Self-review - Advocacy - Familiarity - Intimidation **Safeguards** - Profession, legislation or regulation - Work environment

Answer 114

- Fulfil legal obligations to shareholders - Allows the directors to explain what has happened during the year and also provide an outline of the strategy going forwards - Used to help persuade

Answer 115

Strategic Information - Overall review - Strategy - Chairman's report - Risk analysis - Key performance indicators - CSR reports Directors Information - Directors report - Governance report - Audit committee - Directors remuneration and responsibilities Financial Information - Auditors report - Financial statements - Notes to the accounts - 5/10 year summary

Answer 116

- combined into one statement – “statement of comprehensive income” - or split into two, one showing the profit and loss for a period, the other showing the other comprehensive income for the period

Answer 117

Cost of sales: - Opening inventory (raw materials, - WIP, finished goods) - Carriage inwards - Purchases - Manufacturing expenses - Closing inventory (raw materials, WIP, finished goods) Distribution costs: - Advertising - Carriage outwards - Delivery vehicle expenses - Expenses relating to warehousing of finished goods ready to be sold - Selling costs Administration expenses - Auditor fees - Irrecoverable receivables - Discount received - Directors remuneration - Office costs Finance costs: - Bank overdraft/loan interest - Debenture interest - Loan stock interest - Redeemable preference share dividends - Discount allowed

Answer 118

- IAS1 provides recommended formats but they are not mandatory - Specifies that certain items must be shown in the statement, other items can be shown in the notes - Must separate current from non current assets and liabilities

Answer 119

Property, Plant and Equipment - Tangible non current assets - The face of the SoFP should contain the overall carrying value (net book value). IAS16, Property, plant & equipment requires a note showing the reconciliation of movements in each class of asset IAS 16 PPE – PPE includes assets held for use in the production or supply of goods or services, or administrative purposes, and are expected to be used during more than one period

Answer 120

Include: - Purchase price - Delivery costs - Installation costs - Professional fees (e.g. architect) - Subsequent capital expenditure Exclude: - Administration costs - Staff training costs - General overhead costs - Repairs and maintenance costs

Answer 121

IAS 38 – Intangible assets are “identifiable non-monetary assets without physical substance” Examples: - Goodwill (Difference between the amount paid for an investment and its net assets) - Patents, copyrights, trademarks - Development costs (Costs spent on developing a new product with commercial viability e.g. software, drugs development)

Answer 122

- The statement of changes in equity explains how the equity section of the statement of financial position has changed in the reporting period.ie it reconciles the opening and closing position. - The SOCIE uses the information already contained in the statement of profit or loss and the statement of financial position to explain how equity has changed in the period. - You need to use the information relating to transactions and balances already recorded in order to prepare the statement of changes in equity.

Answer 123

The users of financial statements Per Conceptual Framework - Investors (existing and potential) - Lenders - Other creditors But also - Customers, - employees, - general public, - Government etc

Answer 124

Performance - What is the profitability? - How well have assets been used to generate profits Financial position - Can immediate debts be paid? How well is working capital being managed? - Can the business survive? Investment / Risk - Returns for shareholders and company

Answer 125

The previous period - Is current year better or worse Budgeted figures - Has current activity matched expectations? Competitors & The industry average - Is our business performing as well as another (or the industry?

Answer 126

1. Start with information directly in the statements 2. Calculate ratio’s from figures within the statements 3. Compare and contrast to expectations, competitors, industry averages etc 4. Use the above to make sense of the story

Answer 127

Vertical analysis - Within one time period - Shows relative size of an account compared to a total - Eg. cost of sales were x% of turnover Horizontal analysis - Shows percentage change over time - Eg sales revenue grew by x% in the year

Answer 128

- Both companies are profitable in 20X2 - Dougal generates approximately 2.5x the revenue of Ted but less than 1.5x the operating profit - Dougal incurs high distribution costs compared to Ted (4x) - Dougal incurs high finance costs compared to Ted (17x)

Answer 129

- Dougal is better than Ted in using its PPE to generate revenue - Both companies have positive equity - Inventory and payables in Dougal high compared to Ted - Ted has large cash balance. Dougal has a large bank overdraft – can expect high interest costs - Dougal has high long term borrowings – can expect high interest costs

Answer 130

- Both generate cash inflows from operations - Ted has decreased cash in the year but has invested in NCA and repaid borrowings. Both these should improve future profits and cash flow - Dougal has increased cash balances but has issued more equity and debt which will decrease future retained earnings

Answer 131

- There are many ratio’s that could be calculated, and for some, different ways of calculating them. - Each user will select ratio’s, and the method of their calculation, that would be useful to them. - Important to know how the ratio’s are calculated and what they tell us. - Important to note that ratio’s in isolation do not give a full picture. They should be compared to other relevant benchmarks.

Answer 132

Assets = Liabilities + Equity Equity = total owner investment + reserves = total capital Total capital = Total assets – Total liabilities Total capital = NCA + CA – CL – NCL Capital employed = NCA + CA – CL Working capital = CA – CL

Answer 133

**Performance** - Gross profit % - Operating profit margin - Return on capital employed - Asset turnover - Non current asset turnover **Financial position** - Inventory turnover - Inventory days - Receivable days - Payable days - Current ratio - Quick ratio **Investment / risk** - Capital gearing - Dividend cover - Interest cover - Earnings per share - Price earnings ratio

Answer 134

**Gross profit** - (𝑮𝒓𝒐𝒔𝒔 𝒑𝒓𝒐𝒇𝒊𝒕)/𝑹𝒆𝒗𝒆𝒏𝒖𝒆 x 100% - Effectively shows the percentage of revenue that’s generated from the main trade of the organisation. Very industry specific. **Operating profit margin** - (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒑𝒓𝒐𝒇𝒊𝒕)/𝑹𝒆𝒗𝒆𝒏𝒖𝒆 x 100% - Shows a measure of profit that is generated per £1 of revenue that can contribute towards tax and finance costs. Very industry specific. **Return on capital employed (‘ROCE’)** - (𝑷𝒓𝒐𝒇𝒊𝒕 𝒃𝒆𝒇𝒐𝒓𝒆 𝒕𝒂𝒙 𝒂𝒏𝒅 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕)/(𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔 𝒍𝒆𝒔𝒔 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔) = - (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝒑𝒓𝒐𝒇𝒊𝒕)/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅) x 100% - Indicates how efficiently and effectively a company has utilised its assets during a period in generating profit **Asset turnover** - 𝑹𝒆𝒗𝒆𝒏𝒖𝒆/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅) - Expressed as a number of times per annum - Effectively shows the sales revenue generated for every £1 of capital employed. - Measure of the level of activity and productivity. **Non current asset turnover** - 𝑹𝒆𝒗𝒆𝒏𝒖𝒆/(𝑵𝒐𝒏 𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝑨𝒔𝒔𝒆𝒕𝒔) - Expressed as a number of times per annum - Effectively shows the sales revenue generated for every £1 of non current asset. - Measure of the level of activity and productivity.

Answer 135

**Inventory turnover** - (𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔)/(𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚) - How many times inventory is turned over in a year **Inventory days** - (𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚)/(𝑪𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔) 𝑿 𝟑𝟔𝟓 - How long on average inventory is stored before it is sold **Receivables’ days** - (𝑻𝒓𝒂𝒅𝒆 𝒓𝒆𝒄𝒆𝒊𝒗𝒂𝒃𝒍𝒆𝒔)/(𝑪𝒓𝒆𝒅𝒊𝒕 𝒔𝒂𝒍𝒆𝒔) 𝒙 𝟑𝟔𝟓 - How long it takes on average to collect receivables **Payables’ days** - (𝑻𝒓𝒂𝒅𝒆 𝒑𝒂𝒚𝒂𝒃𝒍𝒆𝒔)/(𝑪𝒓𝒆𝒅𝒊𝒕 𝒑𝒖𝒓𝒄𝒉𝒂𝒔𝒆𝒔) 𝒙 𝟑𝟔𝟓 - How long it takes on average to pay payables **Current ratio** - (𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔)/(𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔) - Measure of extent current liabilities are covered by current assets **Quick ratio** - (𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔 𝒍𝒆𝒔𝒔 𝒊𝒏𝒗𝒆𝒏𝒕𝒐𝒓𝒚)/(𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔) - Measure of ability to cover liabilities with most liquid current assets

Answer 136

**Capital Gearing** - (𝑳𝒐𝒏𝒈 𝒕𝒆𝒓𝒎 𝒍𝒐𝒂𝒏𝒔)/(𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅) - Gearing or leverage is relationship between fixed interest capital (debt) and total capital (debt and equity). - Measure of financial risk **Dividend Cover** - (𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙)/(𝑬𝒒𝒖𝒊𝒕𝒚 𝒅𝒊𝒗𝒊𝒅𝒆𝒏𝒅) - Measure of ability of company to pay current dividend **Interest Cover** - (𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑷𝒓𝒐𝒇𝒊𝒕)/(𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕 𝒄𝒐𝒔𝒕) - Measure of ability of company to pay current interest **Earnings per share** - (𝑷𝒓𝒐𝒇𝒊𝒕 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙)/(𝑵𝒐. 𝒐𝒇 𝒆𝒒𝒖𝒊𝒕𝒚 𝒔𝒉𝒂𝒓𝒆𝒔) - Useful for shareholders to evaluate performance over time **Price Earnings Ratio** - (𝑴𝒂𝒓𝒌𝒆𝒕 𝒑𝒓𝒊𝒄𝒆 𝒐𝒇 𝒔𝒉𝒂𝒓𝒆)/𝑬𝑷𝑺 - Reflects risk – effectively number of years taken to cover the cost of buying a share

Answer 137

Are you comparing like-with-like? - Accounting policies - Exact competitors - Environments of periods compared - Time value of money Appropriateness of ratios used - Industry characteristics

Answer 138

Cash flow = Cash in – Cash out Profit = Income – Expenses Income = Value of goods and services sold during a period Expenses = value of goods and services consumed in generating income Profit is not a measure of cash flow and... Cash flow is not a measure of profit

Answer 139

_Some transactions involve cash only (no impact on profit)_ E.g. a company issues 10,000 £1 ordinary shares for £3.50 each What is the double entry? Dr Bank 35,000 Cr Ordinary share capital 10,000 Cr Share premium reserve 25,000

Answer 140

What is the double entry at the year end? Dr Audit (PoL – admin expense) 40,000 Cr Accruals Affects profit this period 40,000 What is the double entry when the fee is paid ? Dr Accruals* 40,000 Cr Bank 40,000 Affects cash next period

Answer 141

1. Purchase of new land for cash Profit = No effect Cash Flow = Decrease 2. Sale (£300) of inventory (cost £200) for cash Profit = Increase by £100 Cash Flow = Increase by £300 3. Obtain a bank loan Profit = No effect Cash Flow = Increase 4. Buy purchases on credit Profit = No effect Cash Flow = No effect 5. Write off an irrecoverable debt Profit = Decrease Cash Flow = No effect

Answer 142

**Cash flow is vital for the survival of a company** - Allows growth as opportunities can be taken - Good relationship with suppliers and customers **You can be highly profitable but still go bust** - Overtrading – business runs out of cash due to rapid growth and poor cash management **Cash more easily understood** **Cash less easily manipulated**

Answer 143

- IAS1 requires a statement of cash flows to be included in a set of financial statements for a company - IAS7 sets out the presentation requirements - The cash flow statement analyses changes in ‘cash and cash equivalents’ during a period. - Direct and Indirect methods can be used – Indirect most common and used for ACC1010

Answer 144

- Statement of cash flows are needed to provide information about liquidity, viability and financial adaptability. - They are prepared from the statement of financial position and the statement of profit or loss. - Therefore not new information - Highlights how the business has raised cash and paid out cash over the year - To make more useful, breaks down cashflows arising from operating activities, investing activities and financing activities

Answer 145

- Per IAS7 cash flows from interest and dividends paid and received must be - disclosed separately in a statement of cash flows - treated as either operating, investing or financing activities - classified in a consistent manner from one year to the next - In this module always treat as follows - Interest paid and dividends paid on redeemable preference shares as an operating activity - Interest received and dividends received as an investing activity - Dividends paid on ordinary shares and irredeemable preference shares as a financing activity

Answer 146

- Shows users how much cash has been - Generated from normal trading activities - Paid in tax and interest - Useful to users - Shows ability to generate sufficient cash to meet normal demands

Answer 147

- Shows users how much cash has been - invested in resources - received from past investments - Useful to users - To predict future income and cash flow generation

Answer 148

- Shows users how much cash has been - Used to repay debt - Received from new finance - Useful to users - To predict claims on future cash flow e.g. interest, dividends

Answer 149

SOFP and PoL BUT Need actual cash flow so some adjustments may be needed

Answer 150

Derived from a reconciliation

Answer 151

- Accounts are prepared under the accruals basis following the matching principle - Therefore statement of profit or loss shows revenue earned in a period, not the cash received from sales. - Similarly, it shows the expenditure incurred in generating the revenue, not the cash actually paid - he statement of cash flows ignores accruals and simply looks at cash in versus cash out

Answer 152

**Increases in inventory or receivables:** - Increase in inventory means more cash has been spent on buying inventory therefore the company has less cash - Increase in receivables means more of the revenue in the PoL has not been collected therefore the company has less cash - an increase in inventory or receivables must be subtracted from operating profit (cash OUTflow) **Increases in payables:** - Increase in payables means more of the purchases in the PoL have not been paid therefore the company has more cash - an increase in payables is added to operating profit (cash INflow)

Answer 153

_Inventory_ **Increase** during the year = Cash **Outflow** **Decrease** during the year = Cash **Inflow** _Receivables_ **Increase** during the year = Cash **Outflow** **Decrease** during the year = Cash **Inflow** _Payables_ **Increase** during the year = Cash **Inflow** **Decrease** during the year = Cash **Outflow**

Answer 154

- The tax charge in the statement of profit or loss represents the estimated liability for that year. *(Plus potentially any under/over provisions from previous year) - It does not represent what was actually paid. - To find the tax actually paid adjustments have to be made for the opening and closing tax payable (current liability)

Answer 155

Not just the difference between the two Statement of Financial Position figures for non-current assets = purchases for the year: because we have to allow for depreciation and disposals.

Answer 156

P/L sale of NCA = sale proceeds - CV Sale proceeds = CV + profit on sale (Deduct if loss on sale)

Answer 157

* Cash flow and profit are not the same * Cash is vital – life blood of a business, easy to understand and more difficult to manipulate * Statement of cash flows * required by IAS 1, presentation details in IAS 7 * provide information about the liquidity, viability and financial adaptability of a company. * Three cash flows identified – from operating activities, investing activities and financing activities * A reconciliation of profit before tax to cash flows from operations must be shown

Answer 158

“The relationship which subsists between persons carrying on a business in common with a view of profit” The Partnership Act, 1890 - Must be at least 2 partners - Partners are jointly and severally liable with each other - A partnership agreement or deed is usually in place - A partner is equally and independently liable

Answer 159

Bold are used to work out overall profit split **- Profit share ratio (PSR) - Salaries and drawings - Interest on capital and drawings** - Long term capital introduced by each partner - Procedures to change the agreement - Authority of partners to bind others

Answer 160

All partnerships should have an agreement which is usually in writing and referred to as a partnership deed If not, provisions of the Partnership Act 1890 apply: - Profits shared equally by partners - No interest on capital or drawings - No partners’ salaries - Loans by partners attract interest at 5% pa

Answer 161

- Usually consist of a balance sheet, income statement and an appropriation of profit statement - Income statement - same as for a sole trader - Appropriation of profit statement shows the split of the overall partnership profit to each partner - In a partnership there is a current and capital account for each partners to represent owners equity within the balance sheet.

Answer 162

- A further section is added to the income statement which is known as the appropriation statement. - This shows the net profit for the period and the division of that profit according to the partnership agreement/deed. - Remember the deed may contain information on salaries, interest on capital, interest on drawings, and profit share ratios. - Salaries, interest on capital and interest on drawings do not go through the income statement. They are just an appropriation (allocation) of profit.

Answer 163

**Capital account** - For long term - Few transactions – only capital introduced / withdrawn. **Current account** - For short term - Regularly changes as profit share from appropriation account and drawings are entered here.

Answer 164

- Rather than injecting money into the partnership through a capital account a partner may make a loan to the partnership at an agreed rate of interest. - This loan is shown in the balance sheet as a non current liability *Dr Bank Cr Loan to partner (non current liability)* - and interest on the loan is allowed as a normal business expense in the income statement. *Dr interest expense Cr Partners Current account*

Answer 165

- Process by which a business can record, process and store financial information - Today nearly all accounting systems are computerised – but it is essential accountants understand the processes. - Accounting software – can be as simple as a spreadsheet, or an off the shelf programme (eg Sage, Xero) or bespoke software - Cloud computing (accounting) – service giving a business access to software (accounting) via the internet

Answer 166

- Setting-up the computerised accounting system can be challenging - Standing data (data that does not regularly change) needs to be entered correctly and be tightly controlled - Account codes need to be set up in a logical fashion for all items that could appear in the financial statements - Need to determine which source documents are input, when they are input and how they are input - Need controls and checks in place and regular reviews

Answer 167

- In a manual system its not practical to record transactions directly into the nominal/general ledger - Instead, transactions are categorised and recorded in BOPE then transferred periodically into the nomial/general ledger - Typically there are five BOPE, often referred to as the day books - Even though manual systems are rarely used today, the terminology of the BOPE is still often used in computerised systems

Answer 168

- Sales Day Book (SDB) - Record credit sales and returned sales - Purchase Day Book (PDB) - Record credit purchases and returns - Cash Book (CB) - Recording bank receipts and payments - Petty Cash Book (PCB) - Record petty cash transactions - Journal Book (JB) - Record unusual and period end adjustments

Answer 169

The Journal is a book of prime entry and is used for the following; - Recording entries to open a new set of ledger accounts - Recording purchase and sale of non current assets on credit (if not entered in SDB or PDB) - Recording year end adjustments - Correcting errors

Answer 170

- Errors of omission - Transaction not recorded (both or one side missing) - Errors of commission - Correct theory but error by bookkeeper - Post repairs to rent, addition or transposition error - Errors of principle - Dr or Cr to completely wrong account - Drawings to wages, repairs to non current asset additions - Compensating errors - Two unrelated errors which balance each other out

Answer 171

- Individual transactions are categorised and entered into the respective BOPE (SDB, PDB, CB etc) - The BOPE are totalled and entered via double entry into the nominal ledger - Problem – not clear how much is owed to individual creditors/payables or from individual debtors/receivables - Solution – keep additional ledgers, one for all credit sales, one for all credit purchases

Answer 172

- In the traditional manual accounting system there would be three ledgers (general, sales and purchase) - Debtors (receivables) in the general ledger should equal the total of all the individual debtors in the sales ledger - Debtors in the general ledger sometimes referred to as the sales ledger control account - Creditors (payables) in the general ledger should equal the total of all the individual creditors in the purchase ledger - Creditors in the general ledgers sometimes referred to as the purchase ledger control account

Answer 173

A reconciliation is a checking procedure, whereby two figures that should equal are compared and any differences are investigated.

Answer 174

- Bank statements (transaction list) provide an independent record of the bank balance. - As a control measure we should be able to tie in the cash book balance to the bank statement / transaction balance. - The aim of a bank reconciliation is to show that any differences are due to perfectly proper and explainable reasons. - Bank reconciliations are performed to provide an independent check on the completeness, accuracy and validity of the cash book and ultimately the cash figure included on the balance sheet.

Answer 175

- Timing differences - Unpresented cheques (cheques written but not appearing on bank statement) - Unrecorded lodgements (money banked but not appearing on bank statement) - Errors by the business - Omissions (eg direct debits, bank charges) - Transposition (£521 entered instead of £512) - Errors by the bank

Answer 176

Assuming there are funds in the account - The bank account is an asset and therefore a debit balance - From the bank’s perspective the bank account is a credit balance Why? It is a liability of the bank

Answer 177

- Tick off items appearing in cash book and bank statement / transaction listing - Perform the reconciliation - Reconcile the balance per the cash book to the balance per the bank statement - Adjust for any errors or omissions