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Intro to accounting > Intro to accounting sem1 > Flashcards

Intro to accounting sem1 Flashcards

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1
Q

Accounting definition

A

identifying, measuring and communicating economic info to allow informed decisions by the info users.

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2
Q

Investors needs

A

Timing mismatch between investments (cash outflows) and returns (cash inflows); SOPL fixes this

Investors needed reporting that focused on the commercial substance of transactions rather than cash flows;

Created the need for a Statement of Profit and Loss bringing revenues and expenses together to give meaningful values for profit compare potential investment

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3
Q

Need for accounting standards:

A

Accountability- consistent definitions means management cannot defraud owners (regular reports rules empowered by legal force)

Investors need to compare firm performance- ensures running of the economy as allocation of resources rely heavily on credible info

Need for cost-effective financial reporting (efficiency) since preparers and auditors only need to learn one set of rules

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4
Q

Features of U.S GAAP

A

U.S standard
FASB branch of the us sec
Rules based
25,000 pages

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5
Q

Features of IFRS

A

IAS(International accounting standard) not for profit board in London financed by firms
EU initiative now international
144 out of 167 judiciaries across Asia, Africa and Eu require use of the IFRS
Principles based
2000 pages

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6
Q

IFRS Standards are developed in the context of a framework which sets out

A

Objectives of financial reporting and principal user groups;

Key financial statements;

Qualitative characteristics of useful information;

Fundamental concepts, principles and conventions.

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7
Q

User groups

A

Investors, current and potential

Fixed income (bond) investors

Commercial banks

Suppliers

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8
Q

Three primary financial reports

A

Statement of financial position

Statement of profit and loss

Statement of cashflow

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9
Q

Features of the statement of financial position

A

Oldest statement
At a moment in time
Assets=liabilities +equity

What the firm has? (left side)
Non-current assets
Investments
Current assets

Where did the money come from? (right side)
Current liabilities
Noncurrent liabilities
Equity and reserves

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10
Q

Features of the Statement of Profit and loss

A

Based on commercial substance rather than cashflows

For a stated period of time- an accounting period

Revenue

Expenses

Profit

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11
Q

Statement of cashflow features

A

Cashflows into and out of the business

For an accounting period

Cashflows from operating activities

Cashflows form investing activities

Cashflows from financing activities

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12
Q

Entity concept

A

bus money and owner money are separate

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13
Q

Going concern assumption-

A

investors should be safe for the foreseeable future

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14
Q

Historical cost convention

A

assets, liabilities, and equity to be recorded at their original purchase cost, rather than their current market value or any adjusted value

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15
Q

Accrued Income

A

Money owed from customers (no invoice)

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16
Q

Trade Receivable

A

Money owed from customers (invoiced)

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17
Q

Why is accounting needed

A

accountability
Investment

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18
Q

Benefits of international accounting standards

A

Investment diversification

MNCS facilitates the process for preparing financial reports for subsidiaries

Maintenance of accounting standards- due to constant evolution and financial innovation maintenance requires expensive specialists skills it is more efficient for adaptation to be carried out by a single international body

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19
Q

Accrual principle

A

Revenue and expenses are recognized as they are earned and incurred irrespective of when they change hands

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20
Q

Principle of prudence

A

Revenue should only be recognized when there is reasonable certainty it will be received assets should not be overstated and expenses and liabilities should not be understated

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21
Q

Financial accounting

A

Backward looking

Key users are outside the firm

Reports are highly standardised and regulated

Published according to regular schedule

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22
Q

Management accounting

A

Forward looking

Key users inside the firm

Free-form report and unregulated

Ad hoc, real time or published when required

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23
Q

Internal audit

A

Controls and procedures for recordkeeping and to protect and safeguard assets

Deter, prevent and detect fraud

Give reasonable assurance

Ensures financial reports are accurate and inline with regulation

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24
Q

Role of the external audit

A

Provides an opinion further assurance that financial reports are all inline

review work of the internal audit

report any major problems

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25
Accounting equation
Assets=liabilities + equity
26
Assets
What the firm has
27
Liabilities and equity
Where the money comes from
28
Asset recognition requirements
Controlled by the firm (in many cases ownership but not necessarily) Measurable value or cost those that cant be quantified can not be included
29
The entity concept
A business is a separate legal person from it’s owners they are treated as two separate parties Business transactions for the firm/ assets/liabilities are separate to the owner Financial statements represent firm affairs of the firm
30
Importance of the entity concept
Expenses- owner could use private expenses as firm expenses reducing profit and tax liability To protect creditors- due to disposal proceeds going to the firm and withdrawals have to be treated as a loan or reduction in equity as this needs to be subject to legal restrictions
31
Double entry
Every transaction affects at least two accounts so the same amount must be recorded at least twice
32
The going concern principle
assume that the business will operate for the foreseeable future .
33
What the statement of profit and loss shows
Snapshot of cumulative assets, liabilities and equities of a company Summary of a company’s revenue and costs over a period Not directly linked to cashflows
34
Statement of profit and loss
financial report showing the revenue and other income that a firm has earned as well as expenses incurred during an accounting period.
35
Why can’t we use cashflows as a reliable indicator of profit?
The timing mismatch between payments from sales and the related costs make it impossible to use as a meaningful indicator of profit
36
IFRS revenue recognition requirements
Based on satisfying contractual obligations The rights to all economic benefits from a product or service and risks have been transferred to the buyer The amount of revenue and associated costs can be measured reliable For goods the transfer usually requires delivery.
37
Payment means for goods and services
Cash on delivery- paid at the time goods and services are consumed/received Paid in arrears- goods and services consumed delivered and paid later effects on statement- invoice at time of delivery revenue in SPL and trade receivables Paid in advance- goods/services ordered and paid in advance
38
Types of cost
Product costs All the costs expended on a good or service that are needed to generate revenue For goods this comprises of: direct costs(labour and raw materials) and manufacturing overheads Period costs Not easily linked to direct production processes therefore difficult to match to revenue Corporate overheads(rental costs of head office) and manufacturing overheads
39
How are credit losses accounted as
Impairment allowance (reduce gross trade receivables) Impairment charge (expenses in spl)
40
How are un-invoiced credit sales accounted as
supplier- Estimated amount recorded as accrued income revenue on SPL and accrued income as current asset SFP Customer- estimated record as accrued expense on SPL accrued expense SFP
41
How is prepayments accounted
Supplier- unearned income (Current liability on SFP) cash increase on SFP Customer- prepaid expense current asset on SFP Cash reduction on SFP
42
Value of PPE
Value given at original cost if PPE used in trading activities Original cost depends on how firm acquired the asset: historic purchase cost or construction cost If assets are acquired through mergers or takeovers they are recorded at appraised value
43
How is PPE treated
Is a cost Annual depreciation charge recognised as operating expense to reduce revenue in SoPL Depreciation (accumulated depreciation) reduces gross value of PPE to show net asset value in SoFP
44
Assets held at fair value and right of use assets
Property can be held for trading or investment purposes Investment properties will be reported at the current appraised value with gains or losses taken through financial statements
45
Right of use (leased) assets
Lessee owns leased asset thus should be recognised as an asset in the statement of financial position Substance of lease agreement is as a collateralised loan therefore a matching liability is created
46
Intangible assets
No physical form but whose value is measurable, but the firm can be expected to gain future economic benefit If developed internally can not be measure as an asset as costs can not be measure easily
47
Goodwill
Internally generated goodwill can not be recognised as an asset If the goodwill is acquired from business combination it represents the difference between the price paid by the acquirer- net assets of the target
48
Issues with LIFO
Does not reflect business practices since part of firm’s inventory is never sold Understated inventory and book values Investment comparison harder Incentivises bad inventory management since it incentivises larger stock to keep a Lifo buffer | Mo Kudus
49
Why use LIFO
FIFO and AVCO are both permitted under IFRS and US GAAP LIFO permitted in the US but prohibited under IFRS Most US oil firms chose LIFO Lower profits to pay tax on
50
Unrealized gains
An increase in the value of an asset that has not been sold
51
Why a business may sell stock for less than it costs
Physical impairment Fall in value
52
Net realisable value
Value of an asset that sellers expect to get minus cost or expenses on selling or disposing of an asset
53
Statement of cashflow
Shows net cash flow form operating, financing and investment activities Not based on accrual principle Harder to manipulate
54
Statement of cashflow benefits
Helps to assess liquidity and solvency Assesses financial adaptability Future cash flows Highlights how cash is being generated
55
Drawbacks of statement of cashflow
Historic cashflows no info on future No interpretation of SOCF is provided within the accounts Noncash transactions i.e. depreciation are not highlighted in SOCF
56
What’s cash under IAS 7
Cash Cash equivalents- highly liquid, insignificant value change and held with purpose of meeting (not investment purposes) Short-term borrowing from bank
57
Structure of statement of cash flows
Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities
58
Indirect method of cash flow
Start with PBIT minus investment income Minus interest paid Add back non cash charges(depreciation) Adjust for changes to non-cash working capital
59
The direct method
Cash inflows from customers and outflows to suppliers, employees and tax authorities
60
Benefits of direct method
allows analysts to work out how much reported revenue and costs has been paid in cash
61
Rationale for indirect method
Cashflow will be equal to operating profits less tax if: All revenue and expenses are paid for in cash when earned or incurred All inventory is sold in the period when its produced It has no current assets investment income or disposable gains/ losses
62
Advantage of indirect method
Shows the relationship between cash flows that have been generated directly from trading activities and those that have come from changes in non cash working capital
63
Why is indirect method used most
inertia/costs of switching Commercial sensitivity- allows competition to see what they receive form customers and pay to suppliers Avoid investment scrutiny
64
Features of Revenue disclosure
Not standardised analysts have to work with what firm discloses Some firms provide multiple disclosures Can be challenging to compare firms directly
65
Why firms in the same industry have different operating margin
Different operating efficiency Econs of scale
66
Overhead rate
Overhead rate the percentage of revenue that goes on paying for the costs of running the business
67
Cost income ratio
the percentage of gross profits that go on running the business
68
Operating cost ratio dependents
Econs of scale Different business models i.e. innovation, automation, location etc Economic conditions
69
Working capital
Current asset-current liability= working capital
70
Operating asset
reflects the assets a company uses in its core business to generate revenue
71
Asset turnover
Measures how good companies operating assets are at generating revenue
72
Factors that may affect asset turnover:
Marketing and sales Utilisation of PPE Inventory management
73
ROCE
Key measure for comparing performance between firm’s ROCE can be used to evaluate a company’s profitability and efficiency in using capital As cap employed is equal to operating assets, ROCE also shows profitability of operating assets.
74
Tensions between components of ROCE
Actions to increase profit margin may have a negative impact on sales turnover Low margin high turnover High margin low turnover
75
What does return on equity show
Annual accounting return to the owners of the firm
76
How does gearing affect ROE
Higher gearing larger ROE but at the cost of a higher break even point
77
Day sales outstanding
Shows how many days on average it takes the firms customers to pay them only meaningful when most sales are on credit
78
High days purchasing analysis
Large credit risk
79
How to approach days sales/purchasing outstanding
Planned or unplanned likely reasons Impact on firm
80
What a current ratio shows
whether working capital operations require financing (above one) or is a source of financing
81
True view
Financial statements are factually correct Prepared in accordance with financial standards No errors/omissions
82
fair view
No bias portrays economic reality
83
Limitations of financial reporting
Backwards looking- statements are for past accounting periods Asset values reflect forward looking assumptions i.e. trade receivables Partial- some items not shown in financial statements i.e. employees Subjective so is prone to manipulations/ fraud
84
Objective values
one value regardless of who does the counting
85
subjective values
value can be determined in several ways
86
How current assets are subjective
trade receivables, accrued income depend on “satisfying contractual obligations impairment allowances Inventory (FIFO or AVCO), method of overhead allocation and imapirments Pre-paid expenses- supplier ability to deliver
87
Noncurrent asset subjectivity PP&E
Historic vs fair value Initial recognition- purchase cost, construction cost and appraised value Choice of depreciation value- residual value, useful economic life and or depreciation rate
88
How are Intangible assets subjective
Accounting treatment (in house/purchased) Intellectual property Software Goodwill
89
Subjectivity and liabilities
Most liabilities represent contractual obligations Unearned income- dependent on revenue recognition rules Non-current liabilities- fair value, historic cost
90
Subjectivity implications for profit
Revenue driven by revenue recognition rules with management judgement of when performance have been discharged Expenses driven by asset costs- inventory, PP&E, depreciation and impairments
91
Fraud triangle model
Incentives- greed Opportunity- subjectivity, bad internal controls or lack of owner participation Attitudes or rationalization- corporate culture, fear or compensates for low salary
92
Common reporting goals
Higher profits, cashflows from operating activities and higher book values by: Bring forward revenue recognition Push back expense recognition Proactive management of non-cash working capital.
93
How can management improve end of year results?
Operational methods- Accelerating revenue recognition, early delivery of goods that have already been ordered, reduce unnecessary spending and gains from non-recurring disposals (selling securities at historic cost for a profit while holding on to the ones showing a loss) Window dressing
94
Accounting fraud:
Management and insiders Misrepresentation Overstating earnings Going concern assumption
95
Revenue recognition fraud
Delaying closing books Bring forward revenues not yet earned Booking revenues from fictitious sales Selling of goods to a third party with buy back agreement Booking loans received as revenue Bundling one-off gains into items reported as recurring income Failing to recognise receivable impairments
96
PP&E and intangibles fraud
Accounting estimates and impairments inflated Selling toxic assets with repurchase agreements
97
Inventory fraud
Falsifying stock, ignoring obsolescence/ impairment
98
Expenses fraud
Treating expenses as prepayments Capitalising expenses Bundling recurring expenses into one off charges
99
Role of the board of directors
Strategic direction Responsibilities Safeguarding assets Record keeping Accounting policies and estimates Report presentation Going concern assumption EU law true and fair view Financial statements sign off
100
Audit committee
Independent of the main board Non-executive independent directors Oversees audit and compliance functions Audit tenders Recommend appointment/ reappointment of the external auditor Appointments approved by share holders Auditors responsible to shareholders
101
External auditor’s roles
Review firms financial systems, risk management and internal controls Obtain info to form an opinion and review
102
Why we need auditors
Conflict of interests- check statements are true and fair Consequences of errors- users of statements wish to know whether info is reliable and safe to work on Practicality and remoteness
103
An audit will be deemed to have failed if:
Financial statements have material misstatements They fail to comply with regulation The auditor signed of the directors going concern assumption without qualification
104
Why audits fail
self interest Familiarity threat
105
which statements are based on the accrual principle (values are the full amount regardless of when they come out)
Statement of cashflow is what has actually been paid Income statement is the total regardless of when paid except advance sales where its what has been delivered
106
How to calculate unrealised gains
replacement cost-actual value
107
5How to calculate realised gains
profit at replacement-inventory valuation

Intro to accounting (1 decks)

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