Financial Accounting Flashcards

Question

Difference between Accrual Accounting and Cash Accounting

Answer 1

Cash accounting, the transaction is recorded when cash changes hands, regardless of the period the transaction occured. Transactions are recorded in the period the cash is received or paid. Accrual accounting on the other hand, the transaction is recorded in the period the transaction occured, regardless of whether or not cash has changed hands.

Answer 2

Under accrual accounting, the following may occur for income: * Income is recognised without receipt of cash (accrued income). E.g., the income has been earned (service provided), but not yet paid for. * Expense is recognised without payment of cash (accrued expense). E.g., yet to pay for an expense that we have consumed or used. Under cash accounting, the following may occur for income: * Cash is received but the income is not recognised (income received in advance). E.g., must remain as a liability, until the income is earned. * Expense is paid but not recognised as an expense (prepaid expense). E.g., paid in advance, and only when the expense is consumed or used up, do we record the expense.

Answer 3

Personal Transactions: * Transactions of the owners, partners or shareholders * Are unrelated to the operation of the business Business Events: * Occurances that will probably affect the entity in some way * Not recoreded as business transactions until an exchange of goods occurs between the entity an outside entity

Answer 4

The Accounting Equation is: Assets (A) = Liabilities (L) + Owner’s Equity (OE) Owner’s Equity (OE) includes: Share Capital: Money invested by owners or shareholders. Retained Earnings: Profits kept after paying dividends. Retained Earnings = Beginning balance + Profit (or loss) - Dividends

Answer 5

Each transaction must cause atleast two changes to the accounting equation, because the equation must be kept balanced. For example: if there is an increase in an asset, then there must be either: * A corresponding increase in either liabilities or equity * Or a decrease in another asset

Answer 6

Explanation: * Transactions have a dual effect effect Example: * The purchase of a motor vechile via a loan: * Cash effect (loan payable -- liability) * Category effect (motor vechile -- asset)

Answer 7

* A balance sheet (a statement of financial position) * A statement of profit or loss (an income statement and included as part of a statement of comprehensive income) * A statement of changes in equity * A statement of cash flows

Answer 8

The balance sheet is a financial statement that documents: * What the entity owns (or controls) at a particular date (assets) * The external claims on the entity's assets (liabilities) * The internal claim on the entity's assets (equity)

Answer 9

* Depreciation Expense (Increase Expenses) * Accumulated Depreciation (Decrease Asset)

Answer 10

Residual Value (Disposal Value): * Likely amount to be received on disposal of the asset. Depreciation Methods: * Straight line * Accelerated Depreciation * Units of production based

Answer 11

Income Statement as an Operating Expense

Answer 12

Share Capital or Contributed Capital: * Represents the total amount invested in the entity by the owners. Retained Earnings: * Represents the cumulative net profit of the entity that has been retained for use within the business and not yet paid out to the owners.

Answer 13

* Profit (loss) for reporting period is added to retained earnings at start of period. * The entity can make distributions from retained earnings and transfers to/from retained earnings. * The balance of retained earnings at the end of the period is included as an equity item in the balance sheet.

Answer 14

Reporting on their environment and social performance in addition to their financial performance.

Answer 15

Income: * It is a broader term than revenue. It includes not only the revenue earned from the business's ordinary activities but also other gains. Gains refer to items that increase economic benefits but are not directly tied to the core operations (e.g., selling an asset at a profit, investment income, etc.). Thus, income encompasses both revenue and these additional gains. Revenue: * This specifically refers to the earnings from the ordinary activities of the business, which is the main source of earnings. It excludes other gains and is usually associated with sales or services the business provides.

Answer 16

Traditional convention golds that income should only be recognised in accounts when it has been 'realised' Realisation is considered to have occured when: * Activities necessary to generate the revenue are substantially complete. * The amount of revenue can be objectively determined. * Reasonable certainty that amounts owing will be received * Any other outstanding items (e.g., returns, warranty) can be determined with reasonable certainty.

Answer 17

No, they are not an expense of the period because there is no reduction in equity associated with the transaction. However there may be related depreciation and/or impairment expenses.

Answer 18

Income Recognition: Definition: Income is recognized when there is an increase in assets or a decrease in liabilities that results in an increase in equity, except for contributions from equity holders. Process: If this definition is met, evaluate if the recognition provides relevant information to users. Consider the following factors: Uncertainty regarding the existence of the asset or liability. Low probability of inflow of economic benefits. Measurement of uncertainty in the valuation. If the information is relevant, then recognize the income. If not, do not recognize it in the statement of profit or loss. Expense Recognition: Definition: Expenses are recognized when there is a decrease in assets or an increase in liabilities that results in a decrease in equity, except for distributions to equity holders. Process: If this definition is met, evaluate if the recognition provides relevant information to users. Consider the same factors: Uncertainty regarding the existence of the asset or liability. Low probability of outflow of economic benefits. Measurement of uncertainty in the valuation. If the information is relevant, then recognize the expense. If not, do not recognize it in the statement of profit or loss. The decision process is aimed at ensuring that only items providing relevant information are recognized in financial statements.

Answer 19

Gross Profit: Formula: Revenue - Cost of Goods Sold (COGS) Definition: The profit made from core business operations, after deducting only production costs (COGS). Purpose: Measures how efficiently a company produces goods or services. Location on Income Statement: Listed after revenue and COGS. Net Profit: Formula: Revenue - Total Expenses (COGS + Operating Expenses + Taxes + Interest) Definition: The final profit remaining after all expenses, including operating costs, taxes, and interest, are deducted. Purpose: Reflects overall profitability and financial health. Location on Income Statement: Found at the bottom, referred to as the "bottom line."

Answer 20

Profit ≠ Cash Flow: Profit doesn’t always match changes in cash during an accounting period. Accrual Accounting: * Records revenue when earned and expenses when incurred. * Cash flow can occur at different times than these recorded transactions. * Non-cash expenses (e.g., depreciation, bad debts) affect profit but not cash. Non-Income Cash Flows: * Some transactions impact cash but not profit: * Asset purchases: Reduce cash without affecting profit. * Drawings: Decrease cash but not profit.

Answer 21

Non-cash transactions are transactions that do not directly involve cash. Most relate to the 'operating activity' sectiuon fo the cash flow statement. Examples: Depreciation, revaluations, doubtful debts, accruals (receivables, inventory, prepayments, payables, gains or losses on disposal of non-current assets). Some relate to the 'investing and financing activity' section. Examples: direct exchanges such as shares for assets, non-current assets for reduction in debt, bonus issues from reserves, etc.

Answer 22

Cash flows from operating activities: * Represents net inflows from operations, only cash received and paid, not expenses and revenue featured. Cash flows from investing activities: * Concerned with cash payments to acquire additional non-current assets, and cash receipts for disposal of such assets, e.g., plant and machinery, shares, etc. Cash flows from financing activties: * Deals with fianncing the business excluding short-term credit, e.g., debt and equity sources, share issues, repayment of debt, etc.

Answer 23

Operating activities are the core day-to-day business functions that generate cash. Cash Inflows: * Sales of goods/services * Interest and dividends received Cash Outflows: * Payments to suppliers/employees * Taxes and interest paid * Purpose: Shows cash generated/used from core operations, reported in the cash flow statement.

Answer 24

Investing activities involve the purchase and sale of long-term assets and investments. Cash Inflows: Sale of property, equipment, or investments Proceeds from asset disposals Cash Outflows: Purchase of property, equipment, or investments Loans made to others Purpose: Reflects cash used for or gained from investments, reported in the cash flow statement.

Answer 25

Financing activities relate to raising or repaying funds to finance the business. Cash Inflows: * Issuing shares or bonds * Borrowing funds (loans) Cash Outflows: * Repaying loans or bonds * Dividends paid to shareholders Purpose: Shows cash flows from funding sources, reported in the cash flow statement.