income statement and statement of financial position

Question 1

how can private sector businesses be structured

Answer 1

1. partnerships
2. limited liability companies
3. sole traders

Question 2

what are sole traders businesses

Answer 2

owned by a single person
- no legal formalities involved and all profits go to the owner

Question 3

what are the advantages and disadvantages of having a sole traders business

Answer 3

advantage: any accounts that are prepared are only provided to the owner and the tax authority

disadvantage:
it is hard to raise finance and since such a business has no separate legal personality, the owner has unlimited liability
- anyone owed money by a sole trader can recover the sum not only from the business but the owner of the business

Question 4

what are partnerships businesses

Answer 4

similar to sole trader but there is more than one owner

Question 5

what are the advantages and disadvantages of having a partnership business

Answer 5

advantage:
- difficulty in raising finance is mitigated to the degree that more owners have access to more capital
- no legal requirements to provide accounts except for the tax authorities

disadvantage
- partners are ‘jointly and severally’ liable for the debts of the business if business is unable too meet the debts of the business

Question 6

what is a limited liability company

Answer 6

company has its own ‘legal personality’
- owners are shareholders who appoint directors to manage the business

Question 7

what is a limited liability company

Answer 7

company has its own ‘legal personality’
- owners are shareholders who appoint directors to manage the business

Question 8

what are the advantages and disadvantages of having a limited liability company

Answer 8

advantage
- owners (shareholders) have limited liability - anyone owed money by such a business can only recover the sum owed from the company itself - cannot recover debt from the shareholders

disadvantage:
- director have a legal obligation to produce accounts containing specific information to be sent to the shareholders and to companies house within a specified time limit === anyone can download those accounts ========the activities, performances and state of affairs of the company are in the public domain and no longer private

Question 9

what is the purpose of the 3 main financial statements

Answer 9

to report the business’s financial performance and position to external users of the accounting info

Question 10

what are the 3 main financial statements

Answer 10

1. statement of financial position (SOFP)/ balance sheet
2. income statement (IS)
3. cash flow statement (CFS)

Question 11

what does the statement of financial position show

Answer 11

the financial position of the business at a single point in time
- shows assets, liabilities and equity or the finance provided by the owners or shareholders

Question 12

what does the income statement show

Answer 12

the financial performance of the business in the past accounting period ( usually 1 year) so that profits can be determined
- shows revenue or sales or turnover of the business less its expenses = which is the profits

Question 13

what does a cash flow statement provide

Answer 13

provides a better understanding of the position and performance of the business in terms of the availability and generation of the cash

• prepared on a cash basis and shows the inflows and outflows of cash during the year
• used to demonstrate sources and application of funds over the accounting period
• provides info on the liquidity of the business — cuz it explains what has happened to cash balance from one SOFP to the next

Question 14

what is an asset

Answer 14

resource controlled by the enterprise as a result of past transactions or events and from which future economic benefits are expected to flow to the enterprise

Question 15

what are current and non current assets

Answer 15

current assets
- cash or other assets which are expected to become cash within one year

non-current assets
- assets which are not acquired with the intention to sell them and are expected to be held for more than one year

Question 16

what is a liability

Answer 16

an obligation to be paid by the business as a result of prior transactions

Question 17

what are current and non current liabilities

Answer 17

current liabilities
= sums owing to suppliers who have supplied goods or services to the business but have not yet been paid

non-current liabilities
- liabilities which are repayable after more than one year

Question 18

what are provisions

Answer 18

found in a balance sheet
- estimated figures either used to make reductions in the value of an asset, or are liabilities where the amount or timing of the payment is uncertain

Question 19

what is owners’ equity

Answer 19

capital paid into the business by the owners together with the profits made by the business on behalf of the owners

• a type of liability of the business that is owed by the business to the owners
• consists of the original capital invested in the business to the owners and any profits made which have been retained (reserves) or reinvested

Question 20

what is the balance sheet equation

Answer 20

assets = liabilities + owners’ equity

rewritten =
non-current assets + current assets = ( current liabilities + long term liabilities) + capital + reserves

Question 21

how can the SOFP be presented

Answer 21

1. horizontal format
   - all the assets are listed in one column on the left, and all the claims (liabilities and owners’ equity) are listed in another column on the right
2. vertical format

Question 22

how can the SOFP be presented

Answer 22

1. horizontal format
   - all the assets are listed in one column on the left, and all the claims (liabilities and owners’ equity) are listed in another column on the right
2. vertical format

Question 23

what are the 2 versions of the SOFP in a vertical format

Answer 23

1. first
   - all the assets in the top section to arrive at the total assets
   - liabilities and owners’ equity in the bottom section

2nd: used for smaller companies and sole traders and partnerships
- assets less liabilities in the top section
- owners’ equity on the bottom section

Question 24

what is essential in the presentation of SOFP

Answer 24

1. 2 columns of numbers = easier to read
2. lines used whenever subtotal is calculated
3. cuz SOFP is a snapshot of the business at a single point, the title of it should include the date
4. brackets used sometimes to denote the amount deducted

Question 25

how is the presentation of owners’ equity in a company and in a sole trader/ partnership different

Answer 25

company: it is divided between the capital injected by the owners (termed ‘share capital’) and the retained profits made by the company since its formation sole traders/ partnership: - shown as one figure without any distinction with both the capital introduced and any retained profits lumped tgth (termed ‘owners’ capital)

Question 26

what is gross profit

Answer 26

the profit that the business earns by trading - difference between sales revenue and cost of sales cost of sales (calculated as opening inventory at the beginning of the accounting period) + purchases of goods for resale ( or production costs) - closing inventory (at the end of the accounting period)

Question 27

what is profit before tax

Answer 27

the profit that the business earns after adding + additional income and - further business expenses

Question 28

what is profit for the year / profit after tax

Answer 28

the profit before tax - the tax calculated on the profit

Question 29

what is retained profits for the year

Answer 29

final profit figure after deducting distribution to owners (drawings - for sole traders/ partnerships) (dividends - for businesses) if no distributions : retained profit = the profit for the year the income statement ends with the profit for the year — calculation shown in “statement of changes in equity”

Question 30

what is the link between income statement and the statement of financial position

Answer 30

final profit: shown in ‘statement of changes in equity’ SOCE - added to retained profits brought forwards at the beginning of the year - income statement + SOCE explains how retained profit is earned and retained - cumulative retained profit appears in owners’ equity in SOFP - assuming no changes to any other reserves, difference in owners’ equity from previous SOFP to current SOFP = retained profit for the year

Question 31

what is overdraft

Answer 31

negative cash balance - a form of short term borrowing - appear as current liabilities in the SOFP — cuz bank can requires the business to repay the amount at any time

Question 32

why is the IS and SOFP prepared on an accrual basis

Answer 32

results in the recognition of sales revenue when goods are sold even if payments for them are made to the business at a later date - cost of businesses are not shown as an expense when they are paid but when theyre incurred

Question 33

why is cash different to profit

Answer 33

the CFS is prepared on a cash basis - the cash flow statement records actual cash flows into and out of the business throughout the accounting period the IS records income and expenses matched to the accounting period in which it is earned or incurred

Question 34

what are the different accounting characteristics and concepts on which financial statements are prepared

Answer 34

1. duality - theres 2 effects from any economic event that’s reflected in accounting using the double-entry book-keeping - ultimate result = connection between SOFP and IS 2. objectivity - accounting info should be provided in a manner that’s free of bias 3. materiality - significant items should be given more emphasis than insig ones - item — material if its disclosure is likely to affect users’ decisions == they should always be disclosed in financial statements - immaterial items may sometimes be excluded

Question 35

how are accounting characteristics and concepts divided into several categories

Answer 35

1st 4 qualitative characteristics: 1. relevance 2. reliability 3. comparability 4. understandability 2nd: boundary rules —used to determine what should/ should not be reported 1. entity 2. periodicity 3. going concern 3rd: how data should be recorded 1. money measurement 2. cost 3. realisation 4. accruals 5. matching 6. duality 7. materiality 4th: ethical rules to limit data manipulation 1. prudence 2. consistency 3. objectivity

Question 36

what are accounting standards

Answer 36

prepared by regulators to assist both preparers and users of financial statements have to be applied by companies and other entities where there is public interest in financial statements sole traders and partnerships dont need to follow accounting standards

Question 37

what are the advantages of accounting standards

Answer 37

1. improved comparability between financial statements of different business 2. reduced cost to users ( in terms of understanding ) and preparers (in terms of applying) diff policies and definitions

Question 38

what are the disadvantages of accounting standards

Answer 38

1. some choice is often still allowed — still difficult to compare financial statement s under diff policies 2. if no choice at all = companies forced to apply inappropriate accounting policies 3. usually hard to write accounting standards so that unscrupulous businesses cannot find a way to manipulate the rules to mislead readers 4. economic and reporting environment is rapidly changing so new standards are constantly required 5. new standards ma be inconsistent with old ones 7. diff to get everyone’s approval on new accounting standards