Module 4, Chapter 12 - Financial Accounting and Management

Question 1

What is the purpose of financial reporting?

Answer 1

Financial reporting is required for an entity to keep itself accountable and inform interested parties (stakeholders) of
its financial performance. This enables stakeholders to make decisions about the business.

Question 2

What is the main way of providing financial information to company stakeholders?

Answer 2

Financial statements or accounts. These are produced annually to a format approved by the government of the jurisdiction
the entity operates in and form a summary of both the entity’s performance over the year and its financial position
at the end of that year.

Question 3

There are two systems of financial reporting that entities must adhere to in the UK. Name them.

Answer 3

1. UK GAAP
2. IFRS

Question 4

What does IFRS stand for?

Answer 4

International Financial Reporting Standards

Question 5

Define IFRS (International Financial Reporting Standards).

Answer 5

IFRS (International Financial Reporting Standards) is a set of internationally-agreed financial reporting and
accounting standards that any type of entity can use. UK listed groups must report using IFRS.

Question 6

What does UK GAAP stand for?

Answer 6

Generally Accepted Accounting Practice

Question 7

In a UK GAAP (Generally Accepted Accounting Practice) report, the level of reporting required depends upon what?

Answer 7

With UK GAAP (Generally Accepted Accounting Practice), entities are split into micro, small, medium and large
based on their turnover, net assets and number of employees. The level of reporting required varies based on which
of these the entity falls under.

Question 8

What are the fundamental qualitative characteristics of useful financial information?

Answer 8

Relevance and faithful representation

Question 9

What are the enhancing qualitative characteristics of useful financial information?

Answer 9

1. Comparability
2. Verifiability
3. Timeliness
4. Understandability

Question 10

What is meant by materiality?

Answer 10

Information is said to be material if omitting, misstating or obscuring it could reasonably be expected to
influence decisions taken by users of financial statements

Question 11

What does ‘faithful representation’ mean?

Answer 11

Faithful representation means financial reports must represent economic events and transactions in a way
that aims to be: complete; neutral and free from error.

Question 12

What is meant by ‘comparability’?

Answer 12

Comparability refers to how well the information in a financial statement can be compared to previous periods
for the same entity or to information about another entity.

Question 13

What is meant by ‘verifiability’?

Answer 13

Verifiability means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.

Question 14

What is meant by ‘timeliness’?

Answer 14

Timeliness means having information available to decision-makers in time to be capable of influencing their decisions.

Question 15

How should information be displayed in order to make it understandable?

Answer 15

Classifying, characterising and presenting information clearly and concisely makes it understandable.

Question 16

Before computers, how did companies record their financial data?

Answer 16

In ledgers and books of prime entry using the double-entry bookkeeping process. These records were filled out by hand.

Question 17

In the modern day, how do companies record their financial data?

Answer 17

Nowadays, books of record are entered into accounting software rather than filled out by hand.

Question 18

What is the equation for accounting?

Answer 18

Assets = Liabilities + Capital

Question 19

Where on the accounts are the assets recorded?

Answer 19

The balance sheet.

Question 20

Complete the sentence. The relationship between assets, liabilities and capital is ….

Answer 20

The relationship between assets, liabilities and capital is always the same, and is the dual effect of accounting.

Question 21

What is the most important ledger within a company’s books?

Answer 21

The most important ledger is the nominal ledger, also known as the general ledger.

Question 22

What is the purpose of the sales ledger?

Answer 22

The sales ledger serves as a record of individual receivables (i.e. people or companies that owe the business money, also known as debtors) as a memorandum.

Question 23

What is the purpose of the purchase ledger?

Answer 23

The purchase ledger is a record of individual payables (i.e. people or companies that the business owes money to, also known
as creditors).

Question 24

Why is the nominal ledger the most important ledger in a double-entry bookkeeping system?

Answer 24

The nominal ledger contains a number of different ‘accounts’ for each type of item, regardless of whether it is an income
or expense item, and is therefore probably the most important ledger in a double-entry bookkeeping system.

Question 25

What are 'books of prime entry'?

Answer 25

These are where the business’s main financial transactions are recorded and fed through to the accounts in the nominal ledger.

Question 26

What records are kept within the books of prime entry? List 5.

Answer 26

1. The sales day book 2. The purchases day book 3. The cash book 4. The petty cash book 5. The journal

Question 27

What is meant by 'double-entry bookkeeping'?

Answer 27

Double-entry bookkeeping is based on the concept that every economic transaction has two parts – a positive entry and a negative entry, and will therefore affect two ledger accounts. Double-entry accounting makes up the foundation of all businesses’ recorded financial transactions.

Question 28

On a balance sheet, what is meant by 'assets'?

Answer 28

Assets are things that the business either owns or expects to receive monetary amounts from (such as cash, debtors or work in progress that will be sold once finished).

Question 29

On a balance sheet, what is meant by 'net assets'?

Answer 29

Net assets are the amount of assets that are left after all liabilities have been accounted for (i.e. net assets = assets – liabilities).

Question 30

On a balance sheet, what is meant by 'capital'?

Answer 30

Capital is, broadly speaking, the money that is injected into the business or that is used to keep the business operating.

Question 31

On a balance sheet, what is meant by 'the closing balance sheet amount'?

Answer 31

The closing balance sheet amount (also known as the closing capital) is a reconciliation of how the capital in the business has changed over the period – it adds any new capital injections and profit to the opening capital figure, then subtracts total drawings or business loss to get the closing capital figure (or closing balance sheet figure).

Question 32

True or false? The net assets figure is equal to the closing balance sheet figure.

Answer 32

True! The balance sheet’s net assets figure – all assets minus all liabilities – is always equal to the closing balance sheet (closing capital) figure and illustrates how the balance sheet is a representation of the accounting equation in action.

Question 33

What is a 'trial balance'?

Answer 33

The trial balance is a list of all the balances on the all the accounts in the nominal ledger. The total of all debit balances must be equal to the total of all the credit balances – if they are not, then it means a mistake has been made in the bookkeeping entries.

Question 34

There are two ways of accounting for transactions in the books. List them.

Answer 34

Under the cash basis and under the accruals basis. Most businesses use the accruals basis.

Question 35

What are 'year-end adjustments'?

Answer 35

Year-end adjustments are made where necessary before the figures are used to make up the financial statements.

Question 36

Define 'financial statements'.

Answer 36

Financial statements are a formal record of a business’s financial performance over a period of time.

Question 37

There are four basic reports that make up the financial statements. List them.

Answer 37

1. The statement of profit or loss and other comprehensive income 2. The statement of financial position 3. The statement of cash flows 4. The statement of changes in equity

Question 38

Define 'assets'.

Answer 38

Assets are things that a business owns that either generate cash or have the potential to do so. They may be tangible or intangible, fixed or current.

Question 39

Define 'liabilities'.

Answer 39

Liabilities are things that a business owes. They may be either long-term or current.

Question 40

How do you work out a company's equity?

Answer 40

The company’s total assets - its total liabilities = its equity

Question 41

There are three basic types of analysis that can be performed on financial statements. List them.

Answer 41

1. Horizontal – where you compare values on the same row of a financial statement. 2. Vertical – often expressing items as a percentage of turnover within the same column. 3. Ratio analysis – which includes the return on assets and return on equity ratios.

Question 42

What can the 'income statement' be used to calculate?

Answer 42

Profitability ratios such as: gross profit, operating profit, net profit and profit margins.

Question 43

What can the 'the statement of financial position' be used to calculate?

Answer 43

Business liquidity ratios: working capital, current ratio, quick ratio and gearing.

Question 44

What is the 'working capital cycle' made up of? List the three ratios.

Answer 44

The working capital cycle is made up of the following three ratios: debtors’ turnover, creditors’ turnover, and inventory turnover.

Question 45

In order to be considered solvent, a business needs enough working capital to do what?

Answer 45

1. Pay its staff 2. Pay its debts as they fall due and benefit from any discounts offered for prompt payment by its suppliers