Financial Accounting: Preparing Financial Statements (UNIT 1) Flashcards
Sole trader advantages and disadvantages
Advantages:
Easy to set up
Few rules and regulations to follow
Owner keeps 100% of the profits
Disadvantages:
Unlimited lability
Limited start up funds and time
Partnership advantages and disadvantages
Advantages:
Limited liability
More skills and expertise/ new ideas
additional resources to generate profit
Disadvantages:
Harder to make decisions
Profits have to be shared
Private limited company advantages and disadvantages
Advantages:
Limited liability
Can disguise the size of the business
Disadvantages:
Financial statements are available to the public
Financial accounts presentation and deadlines
¬Sole traders and partnerships don’t follow and definitive format or any specified submission deadlines for financial statements. (However they must be completed in sufficient time to allow owners to submit their tax return.
¬Limited companies must follow the Companies act and must be in applicable accounting standards, it must also be submitted to the companies house within 10months of the financial year end.
2 key ethical objectives that are most applicable are:
Professional behaviour: Those involved in preparing the financial accounts must ensure they behave professionally and apply applicable accounting standards where applicable.
Professional competence and due care: Those involved in preparing the financial accounts must ensure they have sufficient experience, technical knowledge and qualifications to prepare the final accounts in accordance withe the applicable accounting standards and legislation.
The management of a limited company would use final accounts to compare performance with other businesses in the same sector. T/F
True
Fundamental qualitative characteristics
Relevance - Financial information is relevant if it is capable of influencing a decision made by its users.
Faithful representation - Financial information that is ;
complete
neutral
free from error
What is the accounting equation?
Assets - Liabilities = capital/equity
Assets = Capital/ equity + liabilities
Assets - Liabilities = capital + profit - drawings
Income and expenses
Income = money flowing into a business during the accounting period
Revenue income = Buying and selling goods or services in the normal course of business
Capital income = Sales of non current assets of the business
Expenses = Money flowing out of the business during the accounting period
Revenue expenses = Buying and selling for the purpose of profit.
Capital expense = Purchase of non current assets.
Each account in the ledgers has their own T accounts
If your paying £800 rent then you would have to debit the rent account and credit the bank account simulanteously therefore double entry.
What 2 points identify if the trial balance does not balance?
-One or both sides of the trial balance have been added up incorrectly
-There is an error in the posting of the double entry to the ledgers.
What 3 things contribute to make up the Dr side of the VAT control account
Purchase Day book input VAT
Petty cash expenses input VAT
Paid to HMRC
What 3 things contribute to make up the Cr side of the VAT control account
Sales Day book output VAT
Cash Sales Output VAT
Refund from HMRC
What is the main procedure before any item of capital expenditure is committed?
Authorisation of capital expenditure by an appropriate person within the organisation
It can have a detrimental impact on the cash flow of a business
What are the main methods of acquiring non current assets?
-Cash purchase: can be cash or cheque
-Hire purchase: whereby the cost of the asset is financed by a loan
-Loan: bank loan which is repaid in fixed monthly payments
-Overdraft: bank overdraft
-Finance Lease: allows use of asset but finance company retains ownership
-Part Exchange: turning in old assets to reduce overall cost of new asset
When can subsequent expenditure be allowed?
-If it enhances the value of the asset
-If it is a major overhaul or inspection of the asset
-If a major component of the asset is replaced or restored
What is the accruals principle of accounting?
The accruals concept states that costs incurred in a period should be matched with the income in the same period
This means that some of the non current assets should be charged to the SPL for the year the asset is used.
What is the diminishing balance method?
When the value of the asset within the accounts is reduced by a percentage which is specified by the company itself
E.g. depreciation value is 25%, you take 25% away from the balance at the end of each year.
What is the method of depreciation specifically for production machinery?
Units produced by said machine and thereby reflect its reduction in value based upon actual use.
What is the main role of the asset register?
To reconcile the financial records with the physical existence of the non-current assets
The non-current asset register will be reconciled to the appropriate general ledger balances prior to the financial statements being prepared.
If there is a loss on the sale for the machine disposals account what type of balance would it be?
If there is a gain on the sale on the machine disposals account what type of balance would it be?
A loss would represent a debit balance and on the SPL it is recorded as an expense
A gain would represent a credit balance and on the SPL it is recorded as a form of income.
Why should care be taken when excluding VAT from the asset accounts?
This is because the VAT incurred by the business can be reclaimed, however if the business is not registered for VAT it cannot do so.
The 3 rules for dealing with depreciation
-All non-current assets having a known useful life are to be depreciated
-The depreciation methods include the straight line basis and the reducing balance method/diminishing balance method
-Depreciation will normally be based upon the cost of the non-current asset, where the non-current assets are revalued then depreciation is based on the revalued amount.
In which standard is the accounting treatment for property, plant and equipment covered in, and what standard number directly relates to these assets?
The international accounting standards, IAS16
What is the accruals basis of accounting?
This requires that transactions should be reflected in the financial statements for the period they occur, not necessarily when they are paid or received.
(Same for an accrued expense, expense that has been incurred during the accounting period, however not yet paid therefore its a liability).
An e.g. of accruals basis of accounting (Q)
If electricity bill is £450 for 3 months but the 3rd month goes over the accounting period end date then only count 2 months of payment so
450/3= 150x2(2 months)= £300 of that accounting period is what needs to be paid
What are the journal entries the previous examples accrual?
Electricity account (to increase the expense in the SPL) Debit £300
Accruals account (shown as a liability in the SFP) Credit £300
What is the accruals basis of accounting for prepaid expenses e.g.
Rent payment (£1500) for 12 month period 1st June 2022 to 31st May 2023
The period in this bill which doesn’t relate to accounting period is up to 31st December 2022
1st Jan - 31st May which is 5/12 of full rental payment of £1500
This requires a prepayment for rent to be introduced into the financial accounts of £625
What are the journal entries for the previous example of prepayment?
Prepayments accounts (as a current asset in the SFP) Debit £625
Rental account (to decrease the expense in the SPL) Credit £625
What does prepaid income mean? e.g.
Works similar to prepayment
£600 paid by student for course on 1st October 2022, financial year end is 31st December 2022
This means that pre-paid income relates for the 9/12 months in the new financial period, 9/12 x £600 = £450
What are the journal entries to reflect the prepayment of income?
Income from student fees account (to reduce the income in the SPL) Debit $450
Prepaid income account (shown as a liability in the SFP) Credit £450
What is an allowance for a specific debt?
A general allowance for doubtful debts is not specific to any individual debt, a general allowance will be applied to the total figure of the company trade receivables, usually as a percentage based on their previous history of bad debts.
How are irrecoverable debts written off?
Irrecoverable debts are usually credited to the receivables ledger account of whoever the client is, and debited in the irrecoverable debts account as the persons account name
They are written off to the profit and loss account at the end of the accounting period.
How would you record a bad debt which has already been written off but eventually gets paid?
Opposite entries have to be made
- debit to the bank account for the amount received
- credit to the “bad debts recovered account”
which will be transferred to the profit and loss account as a credit item.
What is the IAS 2
-IAS 2 deals with how inventory should be valued in the financial statements and applies to all inventories.
-The overriding principle is that inventories are to be valued at the lower cost of net realisable value (NRV).
What is NRV?
-Net Realisable Value is the estimated or known selling price of the item net of the trade discounts but before settlement discounts.
-Any additional costs such as marketing, selling and distribution.
Explain FIFO and AVCO :
FIFO: First in first out, is first stock received is the stock that will satisfy the next order, which means inventory is valued at the most recently received item leading to profit.
AVCO: Average cost, unit cost is calculated as an average of the remaining inventory and as new inventory is received the average cost is revised based upon the total inventory then held.
What is the extended trial balance?
It is a working paper which takes the initial trial balance and enter al the required adjustments that are required for the preparation of the final financial statements.
Where should each balance appear in the financial statements?
SPL - any incomes or expenses
SFP - any assets, liabilities or capital
What is the equation to calculate capital?
Opening capital + Profit for the year - Drawings = Closing Capital
What is sundry income ?
Business income generated from sources other than normal trade of the business. Rent received , commission received , interest received
What should you do if sales returns and purchase returns appear on the trial balance?
They should be deducted from the net value of the sales/purchases and then later included into the SPL
What are the advantages and disadvantages of new partner admissions in a partnership?
Advantages:
- Additional capital
- New skills and expertise
-Additional time and funds (resources)
Disadvantages:
- New agreement will need to be drawn up
- A goodwill adjustment must be made in the final accounts.
What is goodwill and the admission of a partner?
Capital introduced :
- To purchase a share of the recorded net assets
- This is to compensate the existing partners for the goodwill they have built up prior to the new partner’s admission
