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MGT388 > Financial Accounting > Flashcards

Financial Accounting Flashcards

1
Q

What is accounting

A

Process of identifying measuring and communicating economic information to permit informed judgement and decisions by users of the information

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2
Q

What is financial accounting

A

provides information to users outside the organisation, the information is contained in an annual report that is published by the organisation
provides information about the financial position what an organisation owns and owes
the field of accounting that deals with the preparation of financial statements that are to be used by users external to an organisation

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3
Q

what does the annual report of financial accounting assume

A

users have some business and accounting knowledge

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4
Q

who uses financial accounting

A

investing in shares - will there be dividends, share price go up
buying or selling to another company asses reliability for payments of delivery ethical standards
seeking employment - wages and salaries staff retention, directors pay, social responsibilities future plans
governments tax revenue, executive pay, diversity, social responsibility

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5
Q

What is the annual report

A

all incorporated businesses must produce an annual report for the shareholders of the company, the annual report is used to make economic decisions so the information is verified by an external audit

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6
Q

What is an audit

A

independent examination of the financial statements to establish that they show a true and fair view , does not guarantee that they are correct just true, and does not cover all info in annual report

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7
Q

What is an income statement

A

profit and loss account, info on financial performance of a company

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8
Q

What is on an income statement

A

revenue, cost of sales, gross profit, distribution expenses, administration expenses, operating profit, other incomes, finance charges, profit before tax, tax, profit of the year

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9
Q

What is gross profit

A

as revenue and cost of sales does not include any one off items, tells you how well core business is doing, compares revenue from selling the product directly with the cost of the production of it

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10
Q

How do you calculate gross profit

A

Revenue - cost of sales

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11
Q

what is operating profit

A

Highlights the profit the business has generated from its operation, more volatile than gross profit figure (as one off purchases) successful business will try and keep tight control of administration and distribution expenses

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12
Q

how you calculate operating profit

A

gross profit - (distribution + administration expenses costs)

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13
Q

What is profit before tax

A

operating profit plus other income that is not from the business such as rent dividends or interest received

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14
Q

How do you calculate profit before tax

A

gross profit + other income - finance charges

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15
Q

What is profit for the year and how is it calculated

A

profit for the year - profit after tax

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16
Q

What is inventory

A

=stock=unsold items, adjusting for unsold items will mean there are the same number of items in sales as there in costs of sales, good the company intend to sell but havent sold yet, will comprise of finished, part finished (work in progress) and raw materials. combination of all three to provide inventory figure

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17
Q

How do you calculate cost of sales

A

opening inventory + purchases - closing inventory + production costs

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18
Q

Profit does not equal

A

cash results

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19
Q

how do you calculate gross profit percentages

A

gross profit/sales x100

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20
Q

what does profit reflect

A

the actual performance of each sale

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21
Q

why is cash important

A

needed for a business to survive

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22
Q

What does profit do

A

it gives a fair reflection of actual performance it is based on the accruals (matching principle)

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23
Q

What are accruals

A

accruals revenues and expenses are recognised when they are earned and incurred not when cash flows in or out of the company

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24
Q

How are profits smoothed

A

using the accruals principle

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25
When will costs be included on the income statement
when they have been used to make profits
26
When something is purchased how will charged against revenue
only a portion will initially charged against revenue as an expense ie when you purchase a machine for 30,000 to be used for 3 year, 30,000 cash will leave the business, 10,000 per year for 3 years is take of the profit figure as an expense
27
What is the issues with how costs are included on the income statement
a business may go bankrupt or have liquidity problems initially or during an expansion but still show a profit
28
how long will you estimate something to be used for
an accounting estimates as is that it will be used up equally
29
What is the statement of financial position
or balance sheet, shows the worth of a company its format is based on the accounting equation assets = liabilities + equity
30
Assets are
resources that are controlled by an entity that are expected to bring economic benefit split into two groups current and non current
31
liabilities are
an obligation of an entity arising from past event the settlement of which involves the transfer of resources
32
Equity represents
the residual interest in the assets of the entity after deducting all the liabilities
33
what are the two sides the statement of financial position
one side are assets (everything owned by the company) and the other is everything owed by the company both to the owners of the company and third parties such as banks
34
What is an example of a non current asset
land and buildings, plant and machinery, motor vehicles, intangible assets are to be owned for longer than 12 months
35
What is an example of a current asset
inventories, trade receivables, prepayment (bills payed in advance), cash owned at the reporting date but are to be used by the business to make profits in the next 12 months
36
Equation of total assets
current assets plus non current assets
37
What is equity made up of
share capital, share premium, revaluation reserve, retained earnings
38
What are non current liabilities made up of
debentures, loans. Due after 12 months
39
What are current liabilities
trade payables, tax, overdraft. Due within the next 12 months
40
Does the statement of financial positon show the worth of a company
no the assets appear at original cost less depreciation - they do no appear at market value and items for which no cash has been paid cannot be included, but ideas people and reputation would be included in a valuation of the business
41
For all incorporated businesses what must be made
an annual report (produced for the shareholders0
42
How can an incorporated business be registered
as a private limited company (Ltd) as a public limited company (plc)
43
what is the advantage of being a plc
a plc can offer its shares for sale to the general public but an ltd can not this can be done on the stock exchange, these can then retraded meaning the ownership of a plc may be constantly changing,
44
who may hold shares
individuals may hold shares but it is pension funds, insurance companies and other financial institutions which hold large blocks of shares
45
What are the four main areas of a financial report
the income statement the statement of financial positon the statement of changes in equity the statement of cash flow
46
What regulates the annual report
statutory regulations - company acts and european union directives accounting standards - UK accounting standards board and international stock exchange regulation more frequent and more detail reporting
47
what is in the 2006 companies acts
requirements to prepare annual accounts prepared in accordance with either international or national accounting standards details when an audit is required outlines the company's duty to file circulate the annual report
48
What does separate entity mean
in company law, the company is a person in it own right, separate legal identity, it is the company that will sue and can be sued
49
What does double entity mean
Every transaction that company enters into affects two accounts
50
Materiality
Items will be reported if they make a difference to the user, no material omissions or misstatements in the accounts
51
accurals/matching
expenses are matched to the revenues that they help generate, expenses, costs, income and revenue are accounted for when they are earned or incurred not when cash flows in or out of the company
52
importance of regulation
stakeholders can compare set of report with other companies anywhere in the world and establish performance over time allow investors to make rational decisions
53
what is costs of sales
all the expenses/costs that are involved in manufacturing and producing the product the company sells
54
What is distribution expenses
includes all the selling marketing and distribution costs incurred by a company
55
administration expenses
all the office based costs of a company, accountant and lawyer fees debt collection service invoicing and some director costs
56
What are finance charges
payments of interest on loans, leases and overdrafts. business in trouble if this is greater than the operating profit
57
What does the statement of changes in equity provide
the shareholders with info as to what has happened to their equity in the last year
58
On which statement are dividends show
the statement of changes in equity
59
what are dividends
annual payments to shareholders
60
How will a shareholder obtain a return on their investment
by way of a dividend or an increase in the value of shares on the stock exchanges, company would like to pay consistent dividends each year and for share price to steadily rise
61
What is a trade receivable
money that a company is owed from its customers at the reporting date
62
What are accurals
amounts the business owes in respect of bills not yet received, but where the business has used the service or products (outstanding amount on gas/electricity bills)
63
Who does equity belong to
owners of the company who are shareholders
64
What is issued share capital
money from issued shares
65
what does a share represent
basic unit of ownership in a company, each will have a nominal value
66
What is share premium
the difference between the nominal share price and the excess price at which the shares are actually issued is held in a share premium account
67
Where is the money invested by owners of the company kept
in the share premium and ordinary share accounts
68
when a company goes bankrupt what happens to the owners
owners have limited liability, their loss incurred is limited to that they have already invested in acquiring the shares
69
What are reserves
two types revenue reserves and capital reserves, represent the profits and gains that the company has made since incorporation
70
what type of revenue can be paid out to shareholders
revenue reserves as dividends, (represents the trading profits made by the company since incorporation)
71
What is a revaluation reserve
represents the gains made on non current assets such as land that have not been sold by the company, as the gain made on asset it still holds (unrealised gain) it cannot be distributed as a dividend
72
What is the accounting equation
Assets = Liabilities + Equity
73
what does the accounting equation mean
the assets of a business equals the finance provided by both third parties and the owners
74
from what perspective does accounting equation look
follows the separate entity concept, looks at financial position from company perspective , what the company owns (assets) is set against what the company owes to provides of finance (liabilities plus equity)
75
What does the double entry concept stem from
the accounting equation - to balance one transaction leads to two entries
76
give an example of a double entry concept
company buys a car for cash, the asset motor vehicles will increase and the asset cash will decease by the same amount if money is borrowed from a bank to buy a car the asst car and the liability loans will both increase
77
example of an intangible asset
a brand
78
issues with putting an asset that will be used over a number of years through in one year
show very low profits or even losses in one year and high levels of profits in the other years. does not reflect how the company is doing. creates a volatile profit figure - not good for investor confidence
79
what is depreciation vs amortisation
allocation of a non current asset to the years that benefit from its use for tangible assets is depreciation, and amortisation for intangible assets
80
which is more volatile cash or profit
cash
81
total cash generated
= total profit generated
82
What is the return on capital employed ratio (ROCE)
Operating profit/ Equity funds + non current liabilities | will give you a percentage for the return on every £1 put in
83
what does the ROCE ratio indicate
indicates how successful the management are using the funds provided to them by shareholders and debentures holders, helps investors as it indicates how well funds provided in the past have been used (in terms of generating profits)
84
Why might a higher return be required (ROCE)
its a higher level of risk
85
What cases a high ROCE ratio
profitability - gross profit and operating margins and/or efficient utilisation of assets (net asset turnover)
86
Operating profit margin =
operating profit/turnover
87
why might operating profit margin change
expense may have increased/decreased, cost control by management might not be very good
88
What is the net asset turnover ratio
turnover/ equity + non current liabilities
89
What is net asset turnover ratio used for
can be compared over time against companies in same industry to assess if management are utilising resources at their disposal to generate revenue
90
issues with net asset turnover
non current assets subject to depreciation, company with old assets will have low figure for assets, but will be high when initially replaced investment in assets may not translate to increased revenuse, may be time lag between investment and improved net asset ratio
91
what is turnover
revenue
92
what may be a more useful ratio than net asset turnover for labour intensive company
turnover to staff costs/no of employees | shows revenue per employee
93
What other ratios is ROCE equal to
Operating profit margins * net asset turnover
94
why is the ROCE so important
key ratio to how a company is performing, is a product of the companys profitability and efficiency
95
What is liquidity
ability of a business to generate sufficient cash to pay liabilities as they fall due
96
what is liquidity directly linked to
short term solvency of a business, business will go bankrupt if it cannot pay its debts
97
what will a company will good working capital management be able to do
meets the debts as they fall due
98
what does working capital equal
current assets - current liabilities
99
what is working capital management
not holding too much inventory for too long prompt payment of trade payables good collection policy on trade receivables
100
what may inadequate and inefficient working capital policies lead to
an overdraft which is an expensive form of finance
101
what is the working capital cycle
purchase inputs -> production -> inventories -> sales -> trade receivables -> cash -> purchase inputs
102
What is the current ratio =
current assets / current liabilities
103
what does the current ratio indicate
whether debts could be met when they fall due
104
is a high current ratio good
too high can mean inefficiency a company should not hold large reserves of cash (should be invested and generating profits0 high levels of inventory and trade receivables will indicate they are not being efficiently managed cash will be tied up
105
Acid test ratio
(current assets - inventory) / current liabilities | want to remove inventory as time lag between inventory into cash
106
inventory holding period
(closing inventory/ cost of sales) * 365 days, gives result in days
107
collection period
(trade receivables / revenue) *365
108
issue with too long a collection period
may indicate poor collection policy | or unsatisfied customers who are refusing to pay, poor quality product
109
issue with too short a collection period
may lose customers to competitors who offer better credit terms may be offering discount for prompt payment which effects margins
110
payment period
trade payables/cost of sales *365
111
the trade receivable collection period should match
trade payable payment period
112
is a long payment period good
if pay on timely basis may receive discount which will help profitability if too high may have poor relationship with suppliers - effects supply in future
113
what is the risk to investors
risk not receiving an annual return on their investment and also not having their investment repaid
114
how can solvency of a business be assessed
by looking at its gearing
115
what does financial gearing look at
how a company is financed
116
if a business has a high level of non current liabilities (DEBT) what might this cause
potential risk medium long term these loans cannot be repaid
117
What is debt
includes non current liabilities and normally preference shares
118
What is equity
ordinary share capital plus the reserves
119
What is gearing ratio
Debt/Equity = Loans + overdrafts/ Share capital + reserves
120
what is the interest cover ratio
operating profit/interest payable
121
what is an interest cover ratio used for
to assess the financial risk of a business not being able to meet the interest payments
122
why does a highly geared firm have greater financial risk
interest charge is fixed and must be repaid no matter what the level of profits
123
what are the benefits of debt
if expanding financing by debt will not dilute the share ownership of the company interest and repayment period can be negotiated and are known the interest charge is deducted from profits being calculating tax, interest payments therefore have the effect of shielding income from tax dividends are paid out after tax

MGT388 (8 decks)

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