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BUSN1002 > First Half > Flashcards

First Half Flashcards

1
Q

What is an asset?

A

A resource controlled by the entity as a result of past events and from which economic benefits are expected to flow to the entity

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2
Q

What are the different types of assets? (generally)

A

Tangible & intangible

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3
Q

What are intangible assets?

A

Assets that have no physical substance but still represent potential benefits

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4
Q

What are the types of intangible assets?

A
  • Identifiable

* Unidentifiable

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5
Q

What are identifiable assets, what are examples of them and what happens to them over time?

A
  • Intangible assets that have a separate existence
  • Trademarks, Franchise, Patents, Copyright
  • Succumb to amortisation (depreciation) over their useful life
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6
Q

What are unidentifiable assets, what are examples of them and what happens to them over time?

A
  • Intangible assets which cannot be attributed to particular event or transaction
  • Goodwill - only recorded when the purchase price of a business is larger than the net assets of the business
  • Not amortised
  • Required to be valued and any impairment (reduction) in the value of the asset has to be expensed. Any increase in the value of the asset is not recorded
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7
Q

What are the methods for dealing with bad debts?

A
  • Provision For Doubtful Debt

* Direct Write Off Approach

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8
Q

How are bad debts recorded with the direct write off approach?

A
  • Deducts the debt from the accounts receivable
  • Adds a bad debt expense
  • Does not estimate any bad debt expense when goods are sold
  • Are recorded when it is realised the debt will not be paid
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9
Q

How are bad debts recorded with the provision for doubtful debt method?

A
  • In the period the goods are sold
    • Accounts Receivable - Provision for doubtful debts (contra asset account) = Net accounts receivable
  • In the period when it is determined a customer will not pay
    • The owed figure is deducted from accounts receivable (customers name)
    • The owed figure is deducted from the provision for doubtful debts
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10
Q

How is depreciation calculated using the reducing balance method?

A

Annual depreciation expense = carrying amount x reducing balance rate

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11
Q

How is depreciation recorded?

A
  • Accumulated Depreciation for the period is calculated
  • (Bracketed) in the non current assets section
  • Expense is incurred
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12
Q

What is impairment and what must happen concerning it?

A

If a NC asset’s recoverable amount falls below its carrying amount, the asset must be reduced to its recoverable amount, and the loss is reflected in the comprehensive income statement

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13
Q

What is recoverable amount?

A

higher of an asset’s net realisable value and it’s value in use

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14
Q

How is impairment calculated?

A

Impairment loss = carrying cost - recoverable amount

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15
Q

How are inventories valued?

A

At the lower of cost or net realisable value

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16
Q

What is net realisable value?

A

The estimated selling price less the estimated costs of completion (manufacturing) and estimated costs necessary to make the sale

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17
Q

What is a liability?

A

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

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18
Q

How is unearned revenue recorded?

A
  • Cash received before revenue earned
    • Cash (asset) increases
    • Unearned revenue (liability) increases
  • Goods delivery (revenue earned)
    • Revenue increases
    • Unearned revenue (liability decreases)
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19
Q

How are accounts payable (purchases) recorded?

A
  • Purchase on credit
    • Accounts Payable (liability) increases
    • Inventories (asset) increases
  • Made payment
    • Accounts payable (liability) decreases
    • Cash (asset) decreases
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20
Q

What are accruals and what category do they normally fall into?

A
  • When expenses have been incurred before the end of an accounting period but invoices have not been received and have not been paid
  • Salaries, electricity, gas, interest
  • Normally a current liability
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21
Q

How are accruals recorded?

A
  • Incurred or estimated expense added to Accruals

- Incurred or estimated expense reduced from P/L (O.E)

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22
Q

If dividends are declared and paid…

A

Retained earnings (equity) decreases & cash decreases

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23
Q

If dividends are declared and not paid…

A

etained earnings (equity) decreases & dividends payable (liability) increases

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24
Q

Assets =

A

Owners’ Equity + Liabilities

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25
Q

What are the limitations of the balance sheet?

A
  • Only concerned with one point in time
  • Only provides past information
  • Considerable discretion is allowed when it comes to how to record transactions
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26
Q

What is the balance sheet useful for evaluating?

A
  • The liquidity of the business
  • The current/non-current mix of assets held by the business
  • The financial structure of the business
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27
Q

Income is…

A
  • Increase in economic benefits
  • In the form of: increases in assets or decreases in liabilities
  • Results in increases in equity
  • Excluding contributions from equity participants
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28
Q

Income =

A

Revenue + Gains

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29
Q

Revenue is…

A
  • Is a subset of income
  • Gross inflows of economic benefits arising in ordinary activies
  • Only recorded when it is earned
  • e.g. Sales, Interest from investments, rent from properties
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30
Q

Gains are…

A
  • Net inflows normally from non-ordinary activities

- Shown in other comprehensive income

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31
Q

Expenses are…

A
  • Decreases in economic benefits
  • In the form of: decreases in assets or increases in liabilites
  • Results in decreases in equity
  • Excludes distributions to owners or shareholders
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32
Q

When are expenses recorded in the income statement?

A
  • Only recorded when it is incurred

- When an asset (prepayment) is used up

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33
Q

What is other comprehensive income and what does it consist of?

A
  • Comprises items of income and expenses that are not recognised in profit or loss
  • Changes in revaluation surplus
  • Actuarial gain and losses on benefit plans
  • Gains and losses from translating financial statements of foreign operation
  • Gains and measures on remeasuring available-for-sale assets
  • Effective portion of gains and losses on hedging instruments
34
Q

What are the formats of the income statement and when are they most applicable?

A
  • Descriptive Format
    • Classify expenses according to their nature
    • Service businesses
  • Functional Format
    • Classify expenses according to their function
    • Retail businesses
35
Q

What is the descriptive format layout?

A
  • Sales Revenue
  • Other Income
  • Total Income
  • (Expenses)
  • Profit before income tax expense
  • Income tax expense
  • Profit after income tax expense
36
Q

What is the functional format layout?

A
  • Sales Revenue
  • (Cost of Sales)
  • Gross Profit
  • Other income
  • (Other Expenses)
  • Profit before tax expense
  • Income Tax expense
  • Profit after income tax expense
37
Q

What is the fundamental rule concerning ratios?

A

When comparing a figure from the balance sheet and one from the income statement, the average of two year end balance sheet figures is used as it is more directly comparable to figures from the income statement

38
Q

What are factors to consider when choosing benchmarks?

A
  • Industry
  • Relative size of companies
  • Similar accounting policies & periods
  • Geographical location
  • Mix of products or services provided
39
Q

What is EBIT?

A
  • Earnings/net profit before interest & tax

- Net profit + interest expense + tax expense

40
Q

What are the financial ratio categories?

A
  • Profitability
  • Efficiency
  • Liquidity
  • Leverage/Gearing
  • Investment
  • Market Based
41
Q

What do profitability ratios measure?

A

Measure of success in wealth creation

42
Q

What are the profitability ratios?

A
  • Return on Assets
  • Return on Equity
  • Net Profit Margin
  • Gross Profit Margin
43
Q

What is ROA and how is it calculated?

A
  • Measures an entity’s performance in using assets to generate earnings
  • EBIT / Average total assets
  • Considered by many to be a primary measure of profitability
44
Q

What is ROE and how is it calculated?

A
  • Measures how well a company has used the capital form its shareholder to generate profits
  • (Net profit - preference dividends) / Average ordinary shareholders’ equity
45
Q

What is net profit margin and how is it calculated?

A
  • Measures profit produced by each dollar of sales

- EBIT / Sales

46
Q

What is gross profit margin and how is it calculated?

A
  • Measures an entity’s ability to control the level of C.O.G.S relative to sales
  • Gross profit (sales - C.O.G.S) / Sales
47
Q

What are the efficiency ratios and what do they measure?

A

Effectiveness of utilisation of resources

  • Asset Turnover (period)
  • Inventory Turnover (period)
  • Accounts Receivable Turnover
  • Accounts Payable Turnover
48
Q

Turnover in times =

A

days in the period / turnover in days

49
Q

What is asset turnover and how is it calculated?

A
  • Measures how efficiently assets are used to generate sales

- (Average total assets / Sales) x days in the period

50
Q

What is inventory turnover and how is it calculated?

A
  • Shows the average number of days to convert inventories to sales
  • (Average inventory / Cost of sales) x days in the period
51
Q

What is accounts receivable turnover and how is it calculated?

A
  • Shows the average time taken to collect accounts receivable
  • (Average accounts receivable / sales) x days in the period
52
Q

What is accounts payable turnover and how is it calculated?

A
  • Shows the average time taken to pay accounts payable

- (Average accounts payable) / Purchases) x days in the period

53
Q

Purchases =

A

closing inventory - opening inventory + C.O.G.S

54
Q

How can a conclusion be drawn from asset turnover?

A

A lower turnover suggests that assets are being used more productively in the generation of revenue, however a very low turnover period may suggest that the business is overtrading on it’s assets - it has insufficient assets to match the level of sales achieved

55
Q

How can a conclusion be drawn from inventory turnover?

A

Business normally prefers a low inventory period as funds tied up in inventory cannot be used for other purposes

56
Q

What is true of accounts receivable turnover?

A

Because it uses an average acc receivable figure, can be badly distorted by a few customers who are very slow payers

57
Q

What is true of accounts payable turnover?

A

Because it uses an average acc payable figure, can be badly distorted by the payments period taken by one or two large suppliers

58
Q

What do the liquidity ratios measure and what are they?

A
  • Asses how well the business can meet short term obligations or claims when they fall due
  • Current Ratio
  • Quick Ratio
  • Cash Flow operations to current liabilities ratio
59
Q

What is gearing?

A
  • Gearing - the existence of fixed payment bearing securities (loans) in the capital structure of a company
  • Occurs when a business is partly financed by outside parties
60
Q

What is the current ratio and how is it calculated?

A
  • Measures an entity’s ability to meet its short term obligations using liquid assets
  • Current assets / Current liabilities
61
Q

How can conclusions be drawn form the current ratio?

A
  • Different types of businesses require different current ratios
  • A manufacturing business will often have a relatively high current ratio because it must hold stocks of finished goods, raw materials and works in progress. it will also normally sell goods on credit, thereby incurring accounts receivable
  • A supermarket chain will have a relatively low current radio as it will hold only fast moving stock of finished goods and will generate mostly cash sales
62
Q

What is the quick ratio and how is calculated?

A
  • A more stringent test of liquidity, only assets that can quickly be converted into cash are included
  • Current assets - inventory / Current liabilities
63
Q

What can be true of the quick ratio?

A

In some types of business where cash flows are strong it is not unusual for the acid test ratio to be below 1.0 without causing liquidity problems

64
Q

What is the Cash Flow operations to current liabilities ratio and how is it calculated?

A
  • Measures liquidity for a period of time, and overcomes the problems of using current assets and liabilities at point in time
  • Cash flow from operations / Average current liabilities
65
Q

How can conclusions be drawn from the Cash Flow operations to current liabilities ratio?

A
  • The higher this ratio, the better the liquidity of the business.
  • Operating cash flows for a period usually provide a more reliable guide to liquidity than the current assets held at the reporting date
66
Q

What are the leverage/gearing ratios?

A
  • Debt to total assets
  • Cash flow from operations to total liabilities
  • Interest cover ratio
67
Q

What is the debt to total assets ratio and how is it calculated?

A
  • Measures the portion of an entity’s assets that is provided by creditors
  • Total liabilities / total assets
68
Q

What is the Cash flow from operations to total liabilities ratio and how is it calculated?

A

Cash flow from operations / Average total liabilities

69
Q

What is the interest cover ratio and how is it calculated?

A
  • Measures the amount of profit available to cover interest

- EBIT / Interest expense

70
Q

What are the investment ratios and what do they measure?

A
  • Measure of the returns and performance of shares

* Earnings Per Share

71
Q

What is earnings per share and how is it calculated?

A
  • Measures the return to ordinary shareholders

- Net profit - Preference dividends / Weighted average number of ordinary share

72
Q

How is earning per share useful?

A
  • Used to assess the investment potential of a company’s shares
  • Only important in comparison to previous EPS, not other companies EPS
  • Widely used indicator of performance
73
Q

What are the market based ratios?

A
  • Price/Earnings

* Dividend Yield

74
Q

What is price/earnings, how is it calculated and when is it useful?

A
  • Reflects the markets expectations for a company’s growth
  • Market price per share / earnings per share
  • Usefull for comparing different companies, however differences in companies accounting policy choices can lead to different profit and E/S figures.
75
Q

What is dividend yield, and how is it calculated?

A
  • Measures the percentage of a share’s market value returned as dividends to shareholders each period
  • Dividends per ordinary share / market price per ordinary share
76
Q

What are the relations between the different ratio groups?

A
  • Profitability & Efficiency
  • Profitability & Liquidity
  • Profitability & Leverage
  • Liquidity & Leverage
77
Q

What is the profitability and efficiency ratio relationship and what does it imply?

A
  • ROA = Net profit margin x Asset turnover (in times)
  • A relatively low net profit margin can be compensated for by a relatively high asset turnover ratio
  • A relatively low net asset turnover can be compensated for by a relatively high net profit margin
78
Q

What is the profitability & liquidity ratio relationship?

A
  • Profit is one of the major sources of funds and therefore profit can increase liquidity
  • Nevertheless there may be an inverse relationship:
    • Liquid assets such as cash, accounts receivable and inventories may produce relatively little profit
    • Illiquid assets such as plants and machinery can substantially increase profit
79
Q

What is the profitability & leverage ratio relationship?

A
  • Profit increases the level of equity and therefore changes the leverage ratio
  • If returns generated from the borrowed funds exceed the interest cost of borrowing, the higher the leverage the better the profitability
  • If returns generated from the borrowed funds are lower than the cost of borrowing, the higher the leverage the lower the profitability
80
Q

What is the liquidity & leverage ratio relationship?

A
  • The higher the level of liquidity the higher the level of leverage that an entity can safely sustain
  • Because if creditors seek their funds the organisation can more readily pay them without selling non current assets
  • Organisations need to be careful about the impact of changes in liquidity on leverage levels
81
Q

What are the limitations of financial ratio analysis?

A
  • Only as accurate as the financial statemtns
  • Offer only a relative view
  • Need benchmarks to be usefull
  • No two businesses are identical and the greater the differences, the greater the limitations
  • Operating and financing decisions may impact on the ratio results
  • Any ratios based upon balance sheet figures will not be representative of the whole period
82
Q

How are items expressed using common size statements?

A
  • Express balance sheet items as a percentage of total assets
  • Express income statement items as a percentage of sales
  • Express the cash flow statement items as a percentage of cash receipts from customers

BUSN1002 (7 decks)

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