Financial Accounting Flashcards
Defintion of accounting
“Accounting is the process of identifying, measuring and communicating information to permit informed judgements and decisions by users of the information”
5 important characteristics of good accounting
Accounting should be RR CUM
- relevant,
- reliable (trusted and error-free, dependable),
- comparable,
- understandable,
- 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).
financial accounting vs. management accounting
Financial Accounting
- for external users
- financial statements
Management Accounting
- for internal management
- more detailed
The three main statements of an financial report
- The Statement of Financial Position (Balance Sheet)
- The Income Statement (Profit & Loss Account)
- The Statement of Cash Flows (Cash Flow Statement)
Three main forms of business concerning ownership and legal liability:
- 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
3 criteria assets must meet
- has to have a value
- must give you ownership rights
- brings economic benefits
THE Accounting Equation
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).
Explain the nature and purpose of the Statement of Financial Position (SOFP)
- 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.
Main elements of the SOFP
(incl. current and non-current types)
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.
For every debit there is a …
For every credit there is a …
For every debit there is always a credit. For every credit there is a debit. The equation is always in equilibrium.
When selling a sales on account, you created a …
trade receivable (debtor)
Is cash profit?
CASH IS NOT PROFT.
‘Account’ means…
… no cash is coming in.
… selling on credit.
The Income Statement equation
The income statement only records assets and expenses
Define
- Prepayments
- Accruals
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.
a limited company is characterised by what
issuing shares
liabilities
things you owe
non-current assets
- expect to last 1+ years
- not in business of selling these
- they just support the core business
- land & buildings
- funiture …
current assets
provides benefits for less than 1 year
(stock inventory, usually)
the 3 least liquid things in order
- the stock (because it hasnt even benen sold)
- debtors/trade receivables
- cash & bank account (except if there is an bank overdraft)
non-current liabilities
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
what is capital in the SOFP (balance sheet) and how is it influenced
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.
trade payables
people you owe money to
(e.g., suppliers)
what part of the accounting equation tells you about ownership
capital/equity is basically all the ownership (interest?) in the organisation
assets - liabilities = capital
where is profit calculated and what happens with it then
- profit is calculated in the income statemet first
- then it gets tranfered to the SOFP under the equity section
cost of sales
how much it cost you to get the product
(e.g., buying the apples wholesale for 10€)
net profit formula
gross profit + other income - expenses = net profit
what can be ‘other income’ for a business
all non-core business incomes:
like dividends
gross profit formula
it’s the profit from trading activities
sales - cost of sales = gross profit
define ‘purchases’
the things we buy that we are in the business of selling (incl. raw materials)
(simplified) formula for cost of sales sold
opening inventory + purchases - closing inventory = cost of sales sold
three main ways to value inventory
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)
prepayment vs. accrual
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
depreciation
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.
