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Financial Accounting > Foundation > Flashcards

Foundation Flashcards

1
Q

What is Financial Accounting?

A

The financial system that tracks and records an organisation’s business transactions and aggregates them into reports.

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2
Q

What is GAAP?

A

Generally Accepted Accounting Principles

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3
Q

What are the 5 basic financial accounting principles?

A

Entity, money measurement, going concern, consistency and materiality.

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4
Q

What are the two important qualities of Financial Accounting?

A

Relevance and Reliability

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5
Q

What are the 3 main financial reports or statements?

A

Balance sheet, Income Statement and Statement of Cash Flows

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6
Q

What is a balance sheet also known as?

A

“Statement of Financial Position”

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7
Q

What does a balance sheet record?

A

Assets, Liability and Owner’s Equity

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8
Q

What does an Income Statement list?

A

Revenues Earned and Expenses incurred

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9
Q

What is an Income Statement?

A

It details an entity’s operating performance over a specific period of time.

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10
Q

What is a Statement of Cash Flows?

A

It details the sources and uses of cash of an entity over a period of time (or accounting period).

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11
Q

Which of the following is prepared at a point in time, and not over a period of time:

  • Balance Sheet
  • Income Statement
  • Statement of Cash Flows
A

Balance Sheet

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12
Q

The Entity Concept states what?

A

Accounts are kept for an entity as distinct from the people who own, run or do business with the entity.

Ie - it is separate from the owner’s personal expenses.

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13
Q

The Money Measurement Concept states what?

A

Financial accounting deals only with the things that can be represented in monetary terms.

For example - whilst employee adds value to firms, the value is difficult to quantify and as a result are not placed on the balance sheet.

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14
Q

The Going Concern concept means what?

A

An entity is expected to remain in operation for the indefinite future, in the absence of evidences for the contrary.

It makes the account avoid the “doomsday” scenario, where all the entity’s resources are valued at their current worth.

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15
Q

The Consistency Concept states what?

A

An entity should use the same account methods and procedures from period to period.

(Unless it has a sound reason to change methods)

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16
Q

What is the Materiality concept?

A

Requires entity’s to apply proper accounting methods to items that are material.

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17
Q

What is the Materiality limit?

A

A limit isn’t specifically set - in general however - an item is material if its disclosure would impact the decisions of the users of the accounts.

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18
Q

The quality of the accounting outputs depend on what?

A

Relevance and Reliability

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19
Q

Relevance refers to what?

A

The timeliness and usefulness

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20
Q

Reliability refers to what?

A

The objectivity and verifiability

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21
Q

Does judgement need to be used to make the trade-off between relevance and reliability?

A

Yes - there isn’t a way to record a transaction that will maximise both these properties.

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22
Q

True of False: Accountants typically favour reliability over relevance?

A

True - despite experts pricing an asset accounts will often revert to the price an entity paid

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23
Q

Accrual accounting focuses on what?

A

the economic characteristics of transactions rather than their cash flows.

It attempts to record the financial effects on a business of transactions that have economic consequences for the business in the accounting period when the transactions occurs, rather than only in the period where cash is received or paid.

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24
Q

What are the two important concepts for the preparation of a balance sheet?

A

Dual Aspect and Historical Cost

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25
Q

What are the four requirements to be recorded as an asset?

A
  • Acquired at a measurable cost
  • Obtained or controlled by the entity
  • Expected to produce future economic benefits
  • Arises from a past transaction or event
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26
Q

What are assets called if they lack physical substance?

A

Intangible

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27
Q

What is a “current asset”

A

An asset that can be expected to be converted into cash or consumed within 12 months

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28
Q

What is a “non-current asset”?

A

An asset that is expected to provide economic benefits for periods longer than a year.

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29
Q

What is a liability?

A

A liability represents an obligation of the entity to other parties

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30
Q

What are the 3 requirements for a liability?

A
  • It involves a probable future sacrifice of economic resources by the entity.
  • The economic resource transfer is to another entity
  • The future sacrifice is a present obligation, arising from a past transaction or event
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31
Q

What is a non-current liability?

A

An obligation that is not expected to become due within 12 months.

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32
Q

What is an Account Payable?

A

Money owed by an entity to its suppliers.

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33
Q

What is a short-term debt?

A

A debt obligation to an entity that is expected to be payed back within 12 months.

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34
Q

Owners’ Equity is also known as?

A

Net Assets

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35
Q

True or False: Owners’ equity can have two accounts, common stock and retained earnings?

A

True

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36
Q

What is the Retained Earnings on a Balance Sheet

A
  • the retained earnings represents the cumulative earnings of the entity to date, less any distribution of earnings to owners of the entity.
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37
Q

The Accounting Equation is what?

A

Assets = Liabilities + Owners Equity

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38
Q

On a Balance Sheet, what does the right side of the sheet represent?

A

Total Liabilities plus Owners’ Equity, represents the sources of the resources that form the assets

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39
Q

True or False: the concepts of dual-aspect and historical cost are particularly relevant to balance sheets?

A

True

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40
Q

What is the dual-aspect concept?

A

It formalises the idea that there are two sides to every accounting transaction.

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41
Q

What is recording of both sides of each transaction known as?

A

Double-entry bookkeeping

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42
Q

What does the dual-aspect concept imply?

A

After both sides of each accounting transaction are recorded on the entity’s books, the basic accounting equation should remain balanced.

43
Q

What is the Historical Concept?

A

It provides guidance as to the amount at which a transaction should be reported initially in the entity’s accounts. It requires that transactions be recorded in terms of their actual price or cost at the time the transaction occurred.

44
Q

True or False: If an owner provides cash to start up the dual accounting concept considers this as an asset and a liability?

A

False - it is considered as Owners’ Equity as there is no obligation to repay the financing.

45
Q

With Financial Statements, what are ratio’s used for?

A

To assess the financial position and performance of an entity.

46
Q

What are the two common simple ratios?

A

Current Ratio and Long-term-debt-to-equity ratio

47
Q

What is the Current Ratio?

A

It is a measure of current assets / current liabilities, and it measures the entity’s ability to meet maturing short-term obligations.

48
Q

True or False: concerns may arise around a entity’s ability to meet its obligations if it has a low current ratio?

A

True

49
Q

What is debt?

A

Capital that accrues interest and has to be repaid to lenders

50
Q

What is equity?

A

Capital that does not demand interest and does not have to be repaid.

51
Q

What is the difference between Debt and Equity?

A

If an entity runs into tough times and fails to repay its debt obligations the debt holders can force the entity into bankruptcy. Equity capital on the other hand, is a residual claim on the entity’s assets.

52
Q

What is the Total Debt to Equity Ratio?

A

Total Debt / Total Equity

53
Q

What 3 concepts are also applicable to Income Statements?

A

Realisation, matching and conservatism

54
Q

What 2 rations are important measures of operating performance?

A

gross margin and return on sales percentages

55
Q

What is an Income Statement?

A

A financial description of an entity’s operating performance during an accounting period.

56
Q

What does an Income Statement report?

A

Sales, Expenses and net income or loss for the period

57
Q

What is the basic equation for an Income Statement?

A

Sales minus Expenses equals Net Income

Sales - Expenses = Net Income

58
Q

What is the Gross Margin?

A

The Sales minus the Cost of Goods Sold (COGS)

59
Q

On an Income Statement, what are the 3 items listed below the Gross Margin

A

Operating Expenses, Interest Expenses, and Income Tax Expenses

60
Q

What are Operating Expenses?

A

Expenses that relate to the operation of the business. This includes marketing, admin etc.

61
Q

What is Operating Income?

A

It is the Gross Margin - Operating Expenses which yields Operating Income. It is a measure of the profit generated from the day-to-day running of the business/

62
Q

True of False: Operating Profit - Interest Expense = Income before income taxes?

A

True

63
Q

What is Net Income?

A

Sales less all operating expenses, including interest repayments and taxes.

64
Q

How are Income Statements linked to Balance Sheets?

A

Through the Retained Earnings item

65
Q

What two events change the retained earnings account during an accounting period?

A 
Net Income (loss) - increase (decrease)
Dividends - reduce the retained earnings account
66
Q

What two conditions must be satisfied for Realization of Revenue?

A

1 - The revenue must be earned, typically meaning the customer has received the good or service. Ie - if something has been ordered, it must have been received by the customer.
2 - the customer has paid or is expected to pay the merchandise

67
Q

Timing of expense recognition is important, what does the Matching Concept stipulate?

A

Expenses should be recognised in the same period as the relevant revenues are recognised.

68
Q

The Matching Concept infers what about costs that are not directly related to a sale.

A

Costs that are within a certain periods activities, but are not directly related to a product/sale, are expensed in the period they are incurred.

69
Q

The Conservatism Concept recommends what?

A

prudence be exercised in recording revenues and expenses.

This means, revenues should be recognised only when reasonably certain, but expenses should be recognised as soon as reasonably possible.

70
Q

What is the Net Book Value?

A

Net Book Value = Historical Cost - Accumulated Depreciation

71
Q

Is Depreciation included within an Income Statement?

A

Yes - within the Operating Expenses. It needs to be to balance a decrease in asset amount on the Balance Sheet

72
Q

What is Amortization?

A

The cost from using a INTANGIBLE non-current asset

73
Q

True or False: Amortization has an accumulated account on a balance sheet?

A

False - amortization is deducted from the intangible non-current asset and is not accumulated.

74
Q

True of False: Repayment of a principle loan amount has no effect on the Income Statement?

A

True - the payment of the principle is balanced on the Balance Sheet alone

75
Q

What happens to the interest expenses of a loan if they are deferred to a different payment period?

A

The interest expenses should be accrued in an interest payable liability account during the periods between interest payments. Reduce this when it is paid to the bank.

76
Q

What is the technical (formula) definition of Gross Margin Percentage?

A

Dollar Gross Margin / Sales x 100%

77
Q

What does the Gross Margin represent?

A

The mark up on the cost of the products sold by a company.

78
Q

What is the technical (formula) definition of Return on Sales Percentage?

A

Net Income / Sales x 100%

79
Q

True or False: In terms of Profitability, a higher Return on Sales Percentage is preferable?

A

True

80
Q

True or False: In terms of Profitability, a higher Return on Sales Percentage is preferable?

A

True

81
Q

What is a Ledger?

A

A ledger is a grouping of transaction information by account.

82
Q

What are the accounts in the Ledger classified as?

A

Either Balance Sheet accounts (eg. the cash account) or Income Statement accounts (eg. the sales account).

83
Q

True of False: the Double-Entry Accoutning Principle applies to Journal Entries?

A

True

84
Q

What happens after a Journal Entry is made?

A

It is posted to the Ledger, which contains T-accounts, one for each account.

85
Q

What is a T-Account, and why is it used?

A

An account that helps track changes (debit and credits) to different accounts, and when used correctly, it ensures that the basic accounting equation holds after each transaction.

86
Q

True of False: Each T-Account is associated with a single account?

A

True - such as Cash, Accounts Payable, Common Stock etc.

87
Q

If an Asset Account is increased it is?

A

Debited

88
Q

If an Asset Account is decreased it is?

A

Credited

89
Q

If a Liability or Owners’ Equity Account is increased it is?

A

Credited

90
Q

If a Liability or Owners’ Equity Account is decreased it is?

A

Debited

91
Q

If a Sales account is increased it is?

A

Credited

92
Q

If an Expense Account is increased it is?

A

Debited

93
Q

If an Expense Account is decreased it is?

A

Credited

94
Q

True of False: a journal entry is prepared using the rule that debits indicate increase in assets and in expenses, and credits indicate increases in liabilities, owners’ equity and sales.

A

True

95
Q

The Statement of Cash Flows can be presented in what two formats?

A

The Direct method and the Indirect method.

96
Q

The Direct Method of Statement of Cash Flows does what?

A

Summarises the transactions that have been posted to the cash ledger account during the period.

97
Q

What 3 categories presents the information in a Direct Method Statement of Cash Flows?

A

Operating, Investing and Financing

98
Q

What category is an “interest repayment” lodged under on a Statement of Cash Flows?

A

Operating

99
Q

What is the difference between a Direct Method Statement and an Indirect Method Statement

A

The two statements differ in one area - the format and information included in the cash flows from operating activities.

The investing and operating cash flow sections remain the same for both types of Statements.

100
Q

How to do you calculate the net income for an Indirect Method Statement?

A

Start with the Accrual Accounting NET INCOME amount, which is the economic result of operations during the period. Then we apply a number of “de-accruals” or reversals that explain the difference between the economic and cash impact of various operating transactions during the period. Ultimately, arriving a the cash impacts during the period.

101
Q

Why use the Indirect Method Statement?

A

Because the operating section of the indirect method statement explains the difference between the net income and the operating cash flows of the period.

102
Q

True of False: Depreciation and Amortization expenses increases the net income?

A

False

103
Q

What is the De-accrual process for Depreciation and Amortization?

A

The Balance Sheet considers the economic value of the cash flows. To evaluate the operating cash flows, we must add back the Depreciation and Amortization amount

104
Q

What is the indirect method statement compilation?

A 
Net Income
   \+ Depreciation and Amortization Expenses
   - Change in Accounts Receivable 
   - Change in Inventories 
   \+ Change in Accounts Payable
   - Change in Prepaid Expenses
   \+ Change in Other Payables

= Net Cash Provided (Used) by Operating Expenses

Financial Accounting (11 decks)

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