Introduction To Financial Statements Flashcards
What is the purpose of the statement of financial position?
It shows the accumulated wealth of the business at a particular date, including assets, liabilities, and capital/equity.
Define the business entity convention.
This convention holds that, for accounting purposes, the business and its owners are treated as separate and distinct entities.
What does the prudence convention entail?
Financial statements should err on the side of caution, recognizing revenue and profits only when realized and making provisions for all known liabilities.
What is the going concern convention?
This convention assumes that the business will continue operations for the foreseeable future unless there is reason to believe otherwise.
Explain the matching convention.
In measuring income, expenses should be matched to revenues that they helped generate in the same accounting period.
List the components of a statement of financial position.
- Assets
- Liabilities
- Equity
What is an asset?
A resource held by a business that is expected to provide future economic benefits.
What are the characteristics that must be met for an item to qualify as an asset?
- It must be an economic resource
- The business must have the right to control the resource
- The resource must be measurable in monetary terms
Differentiate between non-current and current assets.
- Non-current assets: Used long-term to generate wealth
- Current assets: Held for a short period of time
What are examples of non-current assets?
- Land and buildings
- Plant and equipment
- Fixtures and fittings
- Motor vehicles
- Computers including software
- Intangible assets like goodwill
Define equity in the context of financial statements.
The amount the owner(s) has invested in the business, which they can claim back.
What are liabilities?
Claims of other parties that represent an obligation to transfer economic resources as a result of past transactions.
What distinguishes current liabilities from non-current liabilities?
Current liabilities are due for payment within the next 12 months, whereas non-current liabilities are due beyond that period.
What is the primary purpose of the income statement?
To measure and report the profit or loss generated by the business during an accounting period.
What is revenue?
A measure of the inflow of assets or reduction in liabilities arising from trading activities.
List the criteria for revenue recognition.
- The revenue amount can be measured reliably
- It is probable that economic benefits will be received
- Ownership and control should pass to the buyer
What are expenses?
A measure of the outflow of assets or increase in liabilities incurred as a result of generating revenues.
What key error did Tesco plc make regarding revenue recognition?
They failed to match revenue and expenses properly, recognizing discounts as income before they were earned.
Describe the relationship between the statement of financial position, income statement, and statement of cash flows.
These statements are linked through the timing and recognition of assets and liabilities, affecting cash position and profit.
What is the accounting equation?
Assets = Equity + Liabilities
Expand the accounting equation to include profit.
Assets = Equity (at start of period) + Profit (for period) + Liabilities
What are drawings in accounting?
Amounts that the owners remove from the business for personal use, reducing owner’s investment or capital.
What mnemonic can help remember the debit and credit rules?
DEAD CLIC (Debits are for Expenses, Assets, and Drawings; Credits are for Liabilities, Income, and Capital)
What do the terms ‘debit’ and ‘credit’ refer to in accounting?
‘Debit’ means ‘left’ and ‘credit’ means ‘right’
