Lecture 1 Flashcards
What is the definition of accounting?
The process of identifying, measuring, and communicating financial information about an entity to allow users of the info to make informed judgements and decisions
Tell me about the conceptual framework
A statement of principles that that provide generally accepted guidance for the development of new reporting practices and for challenging and evaluating the existing practices.
They have existed since 1980s
Most widely applicable framework is the framework for the Preparation of Financial Statements issued by the International Accounting Standards Board (IASB)
What is the IASB’s framework?
- The objectives of general purpose financial reporting
- Qualitative characteristics of useful financial info
- Financial statements and the reporting entity
- The elements of financial statements
- Recognition and derecognition
- Measurement
- Presentation and disclosure
- Concepts of capital and capital insurance
What is the process for accounting?
Input -> process -> output
Tell me about internal reporting
Reporting to those who are managing the business on a day to day business
Managers - management accounting
Tell me about external reporting
Reporting to those who are not part of the day to day running of the business
Government, shareholders, society, clients
Financial accounting
What is the main difference between internal and external reporting?
Access to information
Sole trader
Enter into a business alone
May borrow from the bank
Legally, business and owner are two separate entities (can sue business or can sue owner)
Unlimited liability
Partnership
No limit on the number of members but at least 2 people
Partnership is a separate economic entity
Limited liability (cannot get personal belongings, can only get what has been invested)
Joint/several liability
Limited company
Must register the company under Companies Act
Limited liability (personal wealth is safe)
Board of directors elected, they make the decisions for a salary in return
Minimum capital requirement is £2
Private limited company is Ltd
Public limited company is PLC
Sole trader - Who will accounting info be needed for and why?
Government for tax collecting purposes
The bank for the purpose of lending money to the business
A person intending to buy the business when existing owner retires
Partnership - Who will accounting info be needed for and why?
Partners - to ensure they are receiving a fair share of partnership profit
The Inland Revenue - collecting taxes
Banks - provide finance
Other people who may be invited to join the partnership
Limited liability company- Who will accounting info be needed for and why?
Must make accounting info available to the public (annual financial statements)
Management information needs
Need info on performance and position
Past and future
Frequency of reporting is at least monthly
Employee information needs
Ability to pay wages and continuity of employment
Issue associated with the working environment
Lenders information needs
Assess the economic stability and company vulnerability
Suppliers/trade creditors information needs
Credit worthiness of their customers
Customers/trade debtors information needs
Continuity of supply
Governments and their agencies information needs
Governmental planning
National statistics
Tax
Regulation of utilities
Public interest information needs
Impact on local community
Environmental concerns
Agency theory
Describes the agency problem which comes from the separation of owners and managers
Managers need to be held accountable for their own decisions
Resolved by manages having to provide info regularly to owners so decisions and behaviour can monitored/assessed.
General purpose report
Finance accountant won’t make a different report for each user so creates a general one
Management accountant will make reports on specific needs of the manager
Accounting equation
Assets - Liabilities = Ownership Interest/Equity
How do you know whether to include assets or liabilities in a business balance sheet?
It must follow the definition and recognition tests
What is the definition of an asset?
A resource controlled by the entity as a result of past events
A present economic source;
Controlled by the entity (if you can limit others’ access to it, then it’s an asset);
As a result of past events.
What is an economic resource?
A right that is capable of producing economic benefits (make money).
When will something be recognised as an asset in the balance sheet?
- If it meets the definition of an asset
- The info is relevant and gives faithful representation
- Costs of providing info do not exceed benefits
What does relevance mean (in terms of recognising assets)?
If it’s uncertain that asset exists
Or if future flows of economic benefit (cash) will occur
Or that it can be measured
In other words:
Probability - do u have evidence for a future benefit
Is the measurement used reliable?
Are land and buildings recognised as an asset or not, and will it appear on the balance sheet?
Yes, will appear on balance sheet
Are raw materials recognised as an asset or not, and will it appear on the balance sheet?
Yes, appears on balance sheet
Are workforce recognised as an asset or not, and will it appear on the balance sheet?
Employees are asset but not on balance sheet
Would a major advertising campaign be recognised as an asset or not, and will it appear on the balance sheet?
Is an asset but not on balance sheet
What are some examples of assets that WOULD appear on the balance sheet?
Land and buildings owned by a business
Raw materials owned by the business
What are some examples of assets that WOULDN’T appear on balance sheet?
Workforce/employees employed by the business
Advertising campaign undertaken by the business
What is the historic cost?
Past value of an asset
What is fair value?
The current value of an asset
What is a CURRENT asset?
Held primarily for the purpose of being traded
Expected to be held for less than a year
Cash or cash equivalent
Expected to be realised or is in intended for sale of consumption in the entity’s normal operating cycle
What is a NON-CURRENT asset?
Also called FIXED assets
Any asset that doesn’t meet the definition of a current asset
Held for continuing use in the business
What are some examples of CURRENT assets?
Inventory
Trade receivables (debtors)
Cash in hand
Raw materials
Work in progress
Finished goods
Prepayments
Accrued income (income that a company will record in journal entires when earned but before cash payment)
Investments held as current assets
Short-term bank deposits
Bank current account (aka cash at bank)
What are some examples of NON-CURRENT assets?
Land
Buildings
Machinery
What is a liability?
A present obligation of the entity to transfer an economic resource as a result of past events.
A present obligation of the entity (legal or as a result of commercial reality);
To transfer an economic resource (cash or other resource leaving the business);
As a result of past events (normally receiving goods or services or borrowing money).
How would you recognise something as a liability?
SAME AS RECOGNITION OF ASSET
- Meets the definition of a liability
- Resulting information is relevant and provides faithful representation
- Costs of providing info do not exceed benefits
What does relevance mean (in terms of recognising liabilities)?
If it’s uncertain that liability exists
Or if future transfers of economic benefit (cash) will occur
Or that it can be measured
What happens to items (liabilities) that fail the recognition test?
They might be reported in the notes to the accounts as a ‘contingent liability’
What’s an example of an item that will NOT be recognised as a liability but may still be mentioned in the notes?
Potential liability for defective products
(Will legal action actually be undertaken?)
What is a CURRENT liability?
Expected to be settled in the entity’s normal operating cycle
Held for the purpose of being traded
Expected to be settles within a year after the reporting period
What is a NON-CURRENT liability?
A.k.a. Long term liabilities
Any liability that doesn’t meet the definition of current liability
What is ownership equity?
Residual amount found by deducting all of the entity’s liabilities from all of the entity’s assets
What does the term ‘net assets’ mean?
Total assets minus total liabilities
How would you recognise something as OI?
Recognition is totally dependant on recognition of assets and liabilities
No separate recognition criteria for OI
What are some causes of change in OI?
Normal business transactions - supplying goods and services to customers
Owner contributing resources to the business - invest cash into the business
Owner withdrawing resources from the business - withdraw cash from the business
What is revenue and what is it’s effect on the accounting equation?
Providing a service to a customer for which a payment is made
Increase in OI (increase in assets are called revenue)
What is expense and what is it’s effect on the accounting equation?
Cost of providing a service to a customer
An asset that is has been completely used up
Decrease in ownership interest (decrease in assets are called expense)
What is the equation to calculate profit?
Revenue - Expenses
What is the equation to calculate change in OI?
Capital contributed/withdrawn + revenue - expenses
What does assets minus liabilities at the end of the period equal?
Assets minus liabilities at the end of the period = OI at the start of the period + capital contributed/withdrawn in the period + profits for the period
What are some examples of current liabilities?
Bank finance (overdraft - negative bank balance)
Trade payables (creditors and suppliers) (usually set conditions for repayment, within 30-60 days. May charge interest on overdue payments)
Tax (a % charge on profits made in the reporting period, payable 9 months after the year end - except the largest companies which pay quarterly)
Unpaid expenses (‘accruals’)
