Financial Accounting

Question 1

Defintion of accounting

Answer 1

“Accounting is the process of identifying, measuring and communicating information to permit informed judgements and decisions by users of the information”

Question 2

5 important characteristics of good accounting

Answer 2

Accounting should be RR CUM

1. relevant,
2. reliable (trusted and error-free, dependable),
3. comparable,
4. understandable,
5. material (only information which is material to decision-making should be included in financial statements otherwise there is a danger of information overload and confusion in interpretation).

Question 3

financial accounting vs. management accounting

Answer 3

Financial Accounting

• for external users
• financial statements

Management Accounting

• for internal management
• more detailed

Question 4

The three main statements of an financial report

Answer 4

• The Statement of Financial Position (Balance Sheet)
• The Income Statement (Profit & Loss Account)
• The Statement of Cash Flows (Cash Flow Statement)

Question 5

Three main forms of business concerning ownership and legal liability:

Answer 5

• Sole Proprietorship (Soletrader) - no legal distinction between owner and business
• Partnership - legal liability is shared between two or more entities
• Limited (Liability) Company (either LTD or PLC) - shareholders are only responsible for the debts of the company only to the extent of their share price

Question 6

3 criteria assets must meet

Answer 6

• has to have a value
• must give you ownership rights
• brings economic benefits

Question 7

THE Accounting Equation

Answer 7

Assets = Capital/Equity + Liabilities

Also known as the Balance Sheet Equation… (traditional version: Assets - Liabilities = Capital)

How we present the statement of financial position (the balance sheet).

Question 8

Explain the nature and purpose of the Statement of Financial Position (SOFP)

Answer 8

• how much you own (assets)
• how much you owe (liabilities)
  
  • together they are the value of the company

The SOFP sets out the financial position of a company at a given moment in time - a ‘snapshot’.

lt is only valid for the date for which it is produced since potentially all the figures on the SOFP could change within one day.

The SOFP is the statement of the wealth of the company.

Question 9

Main elements of the SOFP

(incl. current and non-current types)

Answer 9

ASSESTS. An asset is a resource controlled and owned by the entity as a result of past events and from which future economic benefits are expected. NON-CURRENT ASSETS — will provide benefit over a period greater than 1 year. CURRENT ASSETS will provide benefit for 1 year or less.

LIABILITY. A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. NON-CURRENT LIABILITIES — the obligation to pay is greater than 1 year. CURRENT LIABILITIES — the obligation to pay in 1 year or less.

CAPITAL/EQUITY. Equity is the residual interest in the assets of the entity after deducting all its liabilities.

Question 10

For every debit there is a …

For every credit there is a …

Answer 10

For every debit there is always a credit. For every credit there is a debit. The equation is always in equilibrium.

Question 11

When selling a sales on account, you created a …

Answer 11

trade receivable (debtor)

Question 12

Is cash profit?

Answer 12

CASH IS NOT PROFT.

Question 13

‘Account’ means…

Answer 13

… no cash is coming in.

… selling on credit.

Question 14

The Income Statement equation

Answer 14

The income statement only records assets and expenses

Question 15

Define

• Prepayments
• Accruals

Answer 15

A prepayment is a current asset, something we have payed in advanced that we haven’t yet used, belonging to next years account.

An accrual is a current liability, something have used but not yet paid for, hence belonging to this years account.

Just because you haven’t paid it, doesn’t mean it’s not an expense.

Question 16

a limited company is characterised by what

Answer 16

issuing shares

Question 17

liabilities

Answer 17

things you owe

Question 18

non-current assets

Answer 18

• expect to last 1+ years
• not in business of selling these
• they just support the core business
  
  • land & buildings
  • funiture …

Question 19

current assets

Answer 19

provides benefits for less than 1 year

(stock inventory, usually)

Question 20

the 3 least liquid things in order

Answer 20

1. the stock (because it hasnt even benen sold)
2. debtors/trade receivables
3. cash & bank account (except if there is an bank overdraft)

Question 21

non-current liabilities

Answer 21

things you owe that are repaided more than 1 year

usually bank loans: business pay the interest every year and then the full amount after 5 or 10 years

Question 22

what is capital in the SOFP (balance sheet) and how is it influenced

Answer 22

Capital is the original money put/invested into the business, and remains unchanged until ou invest more money or take money out (drawings).

Now, if the business uses that capital to buy stock, for example, that will change change assets (increase stock, reduce cash), but the equity, the capital, remains unchanged.

Question 23

trade payables

Answer 23

people you owe money to

(e.g., suppliers)

Question 24

what part of the accounting equation tells you about ownership

Answer 24

capital/equity is basically all the ownership (interest?) in the organisation

assets - liabilities = capital

Question 25

where is profit calculated and what happens with it then

Answer 25

1. profit is calculated in the income statemet first
2. then it gets tranfered to the SOFP under the equity section

Question 26

cost of sales

Answer 26

how much it cost you to get the product

(e.g., buying the apples wholesale for 10€)

Question 27

net profit formula

Answer 27

gross profit + other income - expenses = net profit

Question 28

what can be ‘other income’ for a business

Answer 28

all non-core business incomes:

like dividends

Question 29

gross profit formula

Answer 29

it’s the profit from trading activities

sales - cost of sales = gross profit

Question 30

define ‘purchases’

Answer 30

the things we buy that we are in the business of selling (incl. raw materials)

Question 31

(simplified) formula for cost of sales sold

Answer 31

opening inventory + purchases - closing inventory = cost of sales sold

Question 32

three main ways to value inventory

Answer 32

FIFO - first one in, first one out (supermarkets), good during sinking prices

LIFO - last one in, first one out (raw materials), good during rising prices

AVCO - average cost (liquids: brewing)

Question 33

prepayment vs. accrual

Answer 33

prepayments belong to next year’s account - stated in the SOFP as a current asset

accruals belong to this year’s account (it’s a thing we’ve used but not paid for) - stated in the SOFP as a current liability

Question 34

depreciation

Answer 34

you buy a billion for 10 million but the business spreads the cost over the expected lifespan, so 1 million each year is accounted as an expense

The purpose of depreciation is to match the cost of a productive asset to the revenues earned from using the asset. Since it is hard to see a direct link to revenues, the asset’s cost is usually allocated to (assigned to, spread over) the years in which the asset is used.

Depreciation systematically allocates or moves the asset’s cost from the balance sheet to expense on the income statement over the asset’s useful life.

In other words, depreciation is an allocation process in order to achieve the matching principle; it is not a technique for determining the fair market value of the asset.