Intro to Accounting Flashcards
What are the Income Statement and Balance Sheet also known as?
- Income Statement = Statement of Profit or Loss
- Balance Sheet = Statement of Financial Position
What can the Income Statement and Balance Sheet tell us about the financial position of a business?
- Income Statement = is the entity able to earn a profit from selling goods/services?
- Balance Sheet = What is the position of the entity anad how has it changed from the previous period?
How are Revenue Expenditure and Capital Expenditure classified?
- Revenue expenditure = expense
- Capital expenditure = Asset
What is capital expenditure in a few bullet points?
- Costs of purchasing a non-current asset (NCA)
- Costs of improvement to the asset
- Benefits last for several accounting periods
- Assets
On what basis is profit/loss measured?
On an accruals basis
What is an Accruals basis?
Income and expenses are recognised as they occur, not when the cash is received or paid
What is the Accounting Equation?
Total Assets = Total liabilities + Equity
How are current and non-current liabilities defined?
- Non-current = >1 year
- Current = < 1 year
What is the definition of Equity?
Equity is the residual assets remaining after deducting all obligations due to third parties - sometimes called “Net Assets”
How is Equity calculated?
Equity = Capital - Drawings + Retained Profit
What are the 5 different things that impact equity and in what way do they affect it?
- Drawings (-)
- Retained profits (+/-)
- Income (+)
- Capital (+)
- Expenses (-)
What are the 6 key financial statements elements from lecture 1?
Assets, Drawings, Expenses, Liabilities, Capital, Income
What is the general ledger divided into?
Accounts
What are examples of accounts?
- Cash
- Trade receivables
- Interest on loan
- Drawings
- Sales
- Purchases
- Capital
- more
What is double-entry bookkeeping?
Each transaction is recorded in two accounts in the ledger
What is the Duality/Dual Effect concept?
Each transaction needs to be recorded in both the ‘source’ account and the ‘destination’ account so that botht effects are accounted for
What are the accounts where increases are Debited?
- Assets
- Drawings
- Expenses
What are the accounts where increases are Credited?
- Liabilities
- Capital
- Income
What does a Debit entry represent?
Represents the Destination of economic benefit in a given transaction
What does a Credit entry represent?
Represents the Source of economic benefit in a given transaction
What is a credit transaction?
Payment is received or made some time after the delivery of the goods or services
How are income and expenses recognised?
On an accruals basis
What are trade payables?
A liability
What is the double-entry in a return from a cash sale?
DR Sales/returns (Income down)
CR Bank (Asset down)
What is the double-entry in a return from a sale made on credit?
DR Sales returns (Income down)
CR Trade receivable (asset down)
What is a contra-account?
An account whose sole function is to reduce the value of another main account when the two are netted together
What is sales returns in regards to type of account?
Sales returns is a contra-income account used to reduce the values of the Sales accoutn
As a contra-income, what type of entry is sales returns?
A debit account
What is the double-entry when returning goods from a cash purchase?
DR Cash (Asset up)
CR Purchases returns (expenses down)
What is the double-entry when returning goods from a credit purchase?
DR Trade payables (liability down)
CR Purchases returns (expenses down)
What type of account is purchases returns?
Purchases returns is a ‘contra-expense’ account used to reduce the value of the purchases account
What is a trade discount?
Discount given by the seller to the buyer at the time of the sale - already reflected in the lower price charged by the seller, as stated on the invoice (credit transactions) or receipt (cash transactions)
Do we need to record trade discount separately?
No
What is a cash discount?
Reduction in the amount of a given credit a customer has to pay, provided that the payment is made within a given period stipulated by the seller at the time of sale
Is a cash discount entry in the accounts needed?
Yes
How is a cash discount allowed to a credit customer recorded in the double-entry?
DR Discount allowed (expense up)
CR Trade receivables (Asset down)
How is a cash discount received from a credit supplier recorded in the double-entry?
DR Trade payables (liability down)
CR Discout received (income up)
When are cash discounts recorded?
At the time when payment is made/received, not the time of sales/purchase
What are the rules of contra-accounts?
Contra-accounts follow the opposite rules of the main account it is associated with
What is the Trial Balance?
A list of account balances in the ledger at the end of the accounting period
Where is the Profit/Loss on the Income Statement transferred to?
The Equity section on the Balance Sheet
How is Gross Profit calculated on the Income Statement?
Sales - COGS
How is COGS calculated?
COGS = opening inventory + purchases - closing inventory
What are the key components of COGS, and what is their impact on it?
- Purchases (+)
- Purchases returns (-)
- Cost of handling goods (+)
- Opening inventory (+)
- Closing inventory (-)
How is net profit calculated?
Total Income - Total Expenses
What is the final expense to be deducted to derive net profit/loss?
Tax/ Corporation Tax
What is the Balance Sheet?
A list of the entity’s Assets, Liabilities and Equity
How is Equity calculated for the sole trader?
Capital - Drawings + Profit/Loss
What type of account is Capital?
Permanent Account (cumulative like assets and liabilities)
What type of account is drawings?
Temporary account - account balance at period end is transferred to capital
What is equity represented by for the sole trader?
By the capital accoutn
What happens to the value of equity at period end for the sole trader?
This balance will be carried down to the next period and become the opening capital for next period’s balance sheet
How is the Equity of limited companies calculated?
Equity = Share Capital + Reserves
What are reserves?
Reserves: including retained profits where profits from the current period and prior periods are kept - dividends (-) are distributed from retained profits
What 4 items are accounted for in period-end adjustments?
- Inventory (unsold goods)
- Depreciation of an NCA
- P.f.d.d
- Accruals and Prepayments
What has to be deducted from COGS on the Income Statement for year 1?
Closing inventory
What is the matching concept? *this is why we adjust for inventory and COGS at period end
Income must be recognised in the period in which it is earned: the expenses incurred in achieving said income must also be recognised in the same period
How must all NCAs be recorded?
At historical cost
What does the historical cost consist of?
- Cost paid to acquire the asset
- Cost of putting the asset into working order e.g. installation costs
How is NBV (net book value) calculated?
Cost - accumulated depreciation
What is the depreciable amount?
“The cost of an asset, or other amount substituted for cost, less its residual value”
What is residual value?
The estimated amount that the entity would obtain from disposal of the asset
How is depreciation recorded in the double-entry?
DR Depreciation (expense up)
CR Accumulated depreciation (Asset down - via contra-asset up)
What does the depreciation account record?
Depreciation account records the annual depreciation amount charged against the NCA
What type of financial element is the depreciation account?
It is an expense - shown on the Income Statement and follows the rules of a Debit account
What does the accumulated depreciation account store?
The annual depreciation amounts accumulated up to the Balance Sheet date
What type of account is accumulated depreciation?
It is a contra-asset account; its purpose is to offset the relevant NCA account
- Shown on the Balance Sheet
- Follows the ‘rules’ of a credit account
How is annual depreciation charged on the Income Statement?
As an expense
What rules does Accumulated Depreciation follow as a contra-asset account?
It follows the rules of a Credit account. It is increased (CR) when annual depreciation is charged and decreased (DR) when a disposal of an NCA occurs
How is the depreciable base calculated?
Depreciable base = Cost of the Asset - Residual Value
What is useful economic life?
Number of years which the asset is estimated to remain in service for generating income
What are the 2 ways we spread the depreciable base over the asset’s useful economic life?
- Straight-line method
- Reducing Balance method
How does the straight-line method work?
Given % rate x historical cost
What does the cost method assume?
Assumes residual value to be zero
How does the reducing-balance method work?
Given % rate x opening NBV
How is opening NBV calculated?
Opening NBV = Cost - accumulated depreciation at start of FY
What are 2 effects of depreciation?
- Expenses increase
- Asset at NBV decreases via an increase in accumulated depreciation
What are the 4 steps to recording a disposal of an NCA?
- Proceeds received from disposal
- Remove NCA
- Remove accumulated depreciation on the NCA
- P/L on disposal
What is ‘proceeds from disposal?
Cash or other resources received in exchange for the asset sold (assume cash)
How is NBV at disposal calculated?
NBV at disposal = Cost - accumulated depreciation at disposal
How do find out if it is a profit or loss on disposal?
- Profit on disposal if: Proceeds > NBV at disposal
- Loss on disposal if: Proceeds < NBV at disposal
What is profit on disposal recognised as?
As income -> increase in net profit
What is loss on disposal recognised as?
As an expense -> decrease in net profit
How does disposal of a NCA impact the Balance Sheet?
- Cash/Bank increase
- Asset sold is removed from the balance sheet
- Asset at cost decreases
- Accumulated depreciation on asset decreases
What is it important to check for before calculating depreciation for the year?
Check for any NCA disposals and deal with them before calculating depreciation for the year
What are bad debts also called?
Irrecoverable debts
How is a bad debt recorded in the double-entry?
DR Bad debts (expense up)
CR Trade receivables (asset down)
What is doubtful debt?
Money you predict will be uncollectible and turn into bad debt
What is the prudence principle?
Potential bad debts should be recognised to prevent profits and assets from being overstated
How do we record doubtful debts?
In a contra-asset account: Provision for doubtful debts
What type of account is p.f.d.d.?
A credit account - follows opposite rules of trade receivables
How is a newly created provision for doubtful debts recorded?
DR bad debt (expense up)
CR p.f.d.d (contra-asset up)
What is p.f.d.d. subtracted from on the balance sheet?
Trade Receivables
If p.f.d.d = a, and p.f.d.d from prev yr = b, how is a > b recorded in the double-entry?
i.e. p.f.d.d has increased
DR bad debt a - b (expense up)
CR p.f.d.d a - b (contra-asset up)
- Only the increase in provision, i.e. a-b needs to be recorded
If p.f.d.d = a and p.f.d.d from prev yr = b, how is a < b recorded in the double-entry?
i.e. p.f.d.d has decreased?
DR p.f.d.d b - a (contra-asset down)
CR bad debts b - a (expense down)
- Only the decrease in provision, i.e. b - a needs to be recorded in the double-entry
What does on an accruals basis mean?
A business records income and expenses when they are earned or incurred, rather than when money is exchanged
What are some examples of accrued expenses?
* Due but not yet paid
- Electricity
- Wages
- Interest on borrowings
What are accrued expenses recorded as?
As year-end adjustments - not recorded in the ledger when the Trial Balance is extracted
How are accruals/accrued expense recorded in the double-entry?
DR relevant expense account (expense incurred)
CR Accruals (liability up)
How should this be recorded in the double entry:
- Mike estimates that an accrual of £900 for utilities expenses is needed?
DR Utilities expenses £900
CR Accruals £900
What do prepayments made for future expenses have to be removed from?
Have to be removed from current year’s expenses
What is prepayment treated as?
As a current asset
What is the double-entry for a prepayment?
DR Prepayment (current asset)
CR Relevant expense account (remove from current year expense)
What double-entry should be made on this interest problem:
Bank loan is repayable in full in 2030. Interest due on the loan is 8% per annum; interest due in the current FY has not been paid.
Principle loan amount = 150,000
0.08 x 150,000 = 12,000
DR Interest expense £12,000
CR Accrual £12,000
What are the financing options of a sole trader?
- Owner’s capital
- Borrowings - bank loan, loan from friend
What are the financing options of limited companies?
- Issue ordinary shares
- Issue preference shares (not on this unit)
- Borrowings - loan, debentures
What is limited liability?
- In the even the company is insolvent and goes bankrupt, credit can only recover their debt from the assets of the company and have no claim on the owner’s personal assets
- The owner’s liability for outstanding debts of the company is limited to the capital they have invested in the company
What is a debenture?
A type of loan agreement between a lender and a borrower that gives the lender security over the borrower’s assets
What are 3 different aspects of Equity seen in accounts of limited companies?
- Ordinary share capital
- Share premium
- Retained earnings aka retained profits
How is interest on debentures classified?
As an expense
How is a share issue recorded in the double-entry?
DR Cash (asset up)
CR Ordinary share capital (Equity up)
How is share premium calculated?
Share premium = Issue price - nominal value
Where is the premium for share issue recorded?
Share premium account
What type of account is a share premium account?
A reserve account
Why does equity increase in a credit account when shares are issued?
Equity increases in a credit account when shares are issued because the company’s assets increase
What are reserves?
Portions of surpluses or profits set aside for general or specific purposes
What rules do reserves follow?
Follow the rules of credit accounts, as they are requity accounts
What are the 2 types of reserves?
Capital reserves and Revenue Reserves
What are 3 types of capital reserves?
- Share premium
- Revaluation reserve
- Capital redemption reserve
Can capital reserves be distributed as dividends?
No - they can’t be distributed as dividends
What does the revenue reserve contain?
Accumulated, undistributed profits from current and prior years
Can revenue reserves be distributed as dividends?
Yes
What does retained earnings accumulate?
Undistributed profits from prior years
What does equity consist of for limited companies?
Ordinary share capital and individual reserve accoutns
How is dividend payment calculated?
Dividend per share x number of ordinary shares
How are dividends paid recorded in the double-entry?
DR Retained earnings (equity down)
CR Cash (asset down)
How are dividends proposed but not yet paid recorded in the double-entry?
DR Retained earnings (Equity down)
CR Accrual (liability up)
What are debentures treated as?
Liabilities (non-current)
What is annual interest due on debentures treated as?
Expense
How is the issue of a new debenture recorded in the double-entry?
DR Cash (asset up)
CR Debenture (liability up)
How is the repayment of a debenture recorded in the double-entry?
* Principal
DR Debenture (liability down)
CR Cash (asset down)
How do you record interest due and paid on debentures in the double-entry?
DR Interest expense/finance cost (expense up)
CR Cash (asset down)
How do you record interest due but not yet paid on debentures in the double-entry?
DR Interest expense/finance cost (Expense up)
CR Accrual/interest payable (Liability up)
What is tax treated as?
An expense
How is tax recorded in the double-entry?
DR Tax (expense up)
CR Accrual/tax payable (Liability up)
What are are the 5 different types of financial ratio analysis?
- Performance analysis
- Liquidity ratios
- Efficiency ratios
- Investor ratios
- Lending ratios
What tare the 5 profitability ratios?
- Gross Profit Margin
- Operating profit margin
- Return on equity
- Net profit margin
- Return on capital employed (ROCE)
What are the 2 liquidity ratios?
- Current ratio
- Quick (acid test) ratio
What are the 5 efficiency ratios?
- Non-current asset turnover
- Inventory turnover
- Inventory turnover in days
- Trade receivables in days
- Trade payables in days
What are the 3 investor ratios?
- Dividend per share
- Earnings per share
- P/E ratio
What are the 2 lending ratios?
- Gearing
- Interest cover
How is the Gross Profit Margin calculated?
Gross Profit / Revenue
How is Operating Profit Margin calculated?
Operating Profit (PBIT) / Revenue
How is return on equity calculated?
ROE = Profit after tax / Equity
How is return on capital employed (ROCE) calculated?
ROCE = Operating Profit / (Long-term liabilities + Equity)
What does the Gross Profit margin tell us?
GPM tells us how efficiently a company produces and sells its goods - higher the GPM the more money a company retains from each dollar of sales to cover other expenses
What does the Operating Profit Margin tell us?
OPM tells us how efficiently a company manages its core business operations and is an indicator of operational profitability
What does return on equity tell us?
ROE tells us how effectively a company uses the money invested by its shareholders to generate profits
What does return on capital employed (ROCE) tell us?
ROCE tells us how effectively a company is using both equity and debt to produce profits
How is the current ratio calculated?
Current Assets / Current Liabilities
What does the current ratio calculated?
Measures a company’s ability to pay off its short-term liabilities with its short-term assets
How is the Quick (acid test) ratio calculated?
(Current Assets - Inventory) / Current liabilities
What does the Quick (acid test) ratio measure?
It is a more stringent measure of liquidity
How is the non-current asset turnover ratio calculated?
Revenue / Non-current assets
What does the non-current asset turnover ratio tell us?
How efficiently a company uses its non-current assets to generate revenue
How is inventory turnover calculated?
Cost of sales / Average inventory
What does the inventory turnover tell us?
Tells us how effectively a company can convert inventory into sales
How is inventory turnover in days calculated?
(cost of sales/average inventory) x 365 days
What does inventory turnover in days tell us?
Average number of days it takes a company to sell its inventory
How is trade receivables in days calculated?
(trade receivables/revenue) x 365 days
How is trade payables in days calculated?
(trade payables/COGS) x 365 days
How is dividend per share calculated?
Dividend for the year / number of shares in issue
How is Earnings per share (EPS) calculated?
(profits after tax attributable to ordinary shareholders) / (number of shares in issue)
How is the P/E ratio calculated?
Price per share / Earnings per share
How is the gearing ratio calculated?
Debt / Equity
How is Interest Cover calculated?
PBIT / Interest
What does a high level of gearing mean?
Means a company must pay out relatively high interest - interest is paid out of profits therefore it is riskier for shareholders
MANAGEMENT ACCOUNTING
MANAGEMENT ACCOUNTING
What is a cost object?
Any activity for which a separate measurement of cost is required
What are the 2 steps to the cost collection system?
- Accumulate costs by classifying them into certain categories
- Assign costs to cost objects
What are direct costs?
Costs that can be specifically and exclusively identified with a given cost object
What are indirect costs?
Costs that can’t be specifically and exclusively identified with a given cost object
What is the Break-Even point?
Where sales = total costs
What does it mean if sales volume > breakeven volume?
Profit
What do we assume is constant when finding the BEP?
- Selling price per unit
- Variable cost per unit
- Fixed costs
What is contribution per unit?
Contribution per unit = Price (per unit) - Variable costs (per unit)
How is “sales volume to reach required profit level” calculated?
(Fixed costs + Required profit) / Unit contribution
How is Margin of Safety (%) calculated?
[ (Budgeted sales volume - Breakeven sales volume) / (budgeted sales volume) ] x 100
What are limiting factors?
Limiting factors are constraints on sales or production
If a company produces more than one product, what do we need to do in regards to limiting factors?
We need to find the product mix which maximises profit given this limited factor
What are the 3 steps to maximising contribution in regards to finding limiting factors?
- Determine limiting factor by producing to maximum demand
- Rank products by contribution per unit of limiting factor
- Prepare a production plan
What are the 7 steps to maximising production mix?
i) Identify constraints on key resources
ii) Maximise throughput i.e. prioritise this resource
iii) Work out contribution per product
iv) Work out contributioon per limiting factor e.g. per labour hr, per kg of raw material etc
v) Rank products based on the highest contribution per limiting factor
vi) Prioritise confirmed/essential orders
vii) Make as much of the highest contribution product and if there are resources left make as much of the second product as you can etc
What are indirect overheads?
Costs incurred in the course of production that can’t be traced directly to the product or service
What are traditional costing systems?
Use unsophisticated methods to allocate indirect costs to cost objects
What are activity-based costings?
Use sophisticated methods to allocate indirect costs to cost objects
What is absorption costing?
A method of costing (in addition to direct costs) that assigns all, or a proportion of, production overhead costs to cost units by means of one or a number of overhead absoprtion rates
What is activity-based costing?
An approach to costing and monitoring of activities which involves tracing resource consumption and costing final outputs. Resources are assigned to activities and activities to cost objects based on consumption estimates - the latter uses cost drivers to attach activity costs to outputs
What are relevant costs and revenues?
Future costs and revenues that will be changed by a decision
What are irrelevant costs and revenues?
Irrelevant costs and revenues will not be changed by a decision
What are avoidable costs?
Costs that can be saved by adopting a given alternative
What are unavoidable costs?
Costs than cannot be saved
What are sunk costs?
Sunk costs are the costs of resources already acquired and are unaffected by the choise between the various alternatives (e.g. depreciation)
What are sunk costs irrelevant for?
Irrerlavent for decision-making
What are opportunity costs?
Measure the opportunity that is lost or sacrificed when the choice of one course of action requirers that an alternative course of action be given up
