The main accounts-10 Flashcards
The statement of financial position provides a summary of a company’s financial position at a specific point in time. It consists of two main lists:_______and ________
assets (everything owned by the business) and liabilities (sources of finance used to fund acquisitions).
The accounting equation establishes a relationship between assets, liabilities, and equity: Assets =
Assets = Equity + Liabilities. This equation must always be in balance.
The statement of financial position can be presented in different formats, including Assets = Equity + Liabilities, Assets - Liabilities = Equity, or Non-current assets + Net current assets =
Equity + Long-term liabilities.
Non-current assets are long-term assets intended for use in the business. They are often referred to as fixed assets. Examples include
property, plant, and equipment.
Tangible non-current assets are valued at cost less depreciation, while intangible non-current assets are non-physical assets like
goodwill, patents, and brand names.
Tangible non-current assets are recorded at cost _________accumulated depreciation.
less
Depreciation is an
expense that allocates the cost of an asset over its useful life. Land is an exception, as it is typically assumed to have an infinite life and does not depreciate.
Intangible non-current assets include assets that cannot be physically touched, such as
goodwill, research and development costs, patents, trademarks, and brand names. To qualify as an intangible asset, it must be identifiable and provide economic benefits.
Investments in other companies can be classified as non-current assets if they are
intended to be held for a reasonable period. Investments are usually shown at market value.
Revaluation is a process of
periodically adjusting the value of non-current assets, such as land and buildings, to reflect their current market value. This helps address the limitations of valuing assets solely at cost less depreciation.
Current assets are items that can be
easily converted into cash within the normal course of business. Examples include inventories (stocks), trade receivables (amounts owed by customers), and cash. Inventories are valued at a lower cost and net realizable value.
Equity represents the net value of the company contributed by shareholders through shares and reserves. It consists of
share capital, other reserves (e.g., share premium and revaluation reserves), and retained earnings (profits not distributed as dividends).
Liabilities are classified based on their maturity date. Current liabilities are due within ______, while non-current liabilities are due after__________.
one year
Current liabilities include trade payables such as
(amounts owed to suppliers), short-term borrowings, current portion of long-term borrowings, current tax payable, and short-term provisions.
Non-current liabilities encompass
long-term borrowings (e.g., loans and debentures) and long-term provisions (e.g., deferred taxation and pension commitments).
Contingent liabilities are
potential liabilities that are not included in the statement of financial position but must be disclosed in the notes to the accounts. Examples include guarantees and potential court claims.
To prepare a statement of financial position, the values of assets, liabilities, and equity are listed. Each item is
categorized appropriately, and the accounting equation (Assets = Equity + Liabilities) must be in balance.
State whether each of the following items, which can appear in a financial statement, is a noncurrent asset (NA), a current asset (CA), a non-current liability (NL), a current liability (CL) or
capital (C):
Cash Trade receivable
Building Tax due
Trade payable Land
Inventories Ordinary share capital
Debenture
Solution
Cash CA Trade receivable CA
Building NA Tax due CL
Trade payable CL Land NA
Inventories CA Ordinary share capital C
Debenture NL.
The following data was taken from the records of ABC plc and relates to the values of the
company’s assets, liabilities and equity at 31 December 20XX.
Prepare the company’s statement of financial position (its balance sheet) as at 31 December 20XX
using these items.
£000s
Inventories 135
Trade payables 65
Machinery (cost) 347
Machinery (accumulated depreciation) 132
Cash 56
Long-term loans 289
Ordinary share capital 200
Trade receivables 195
Tax provision 67
Retained earnings 230
Land 350
Other reserves 100
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The statement of comprehensive income includes two main components: the
statement of profit or loss and other comprehensive income.
The statement of profit or loss provides information about a company’s trading activities by comparing
the income generated from trading with the associated costs, resulting in the profit or loss for the year.
Other comprehensive income includes items that are not recognized in the profit or loss but contribute
to a comprehensive picture of the organization’s income.
The statement of profit or loss follows a specific format and includes various elements: these are
Revenue: Recorded when earned, representing turnover or sales.
Cost of sales: Reflects the costs incurred in producing the goods sold, including raw materials, components, wages, salaries, depreciation, and changes in inventory levels.
Gross profit: The difference between revenue and cost of sales.
Other operating income: Income from investments, such as rent, interest, and dividends.
Distribution costs: Costs associated with sales, distribution, and advertising.
Administrative expenses: Costs related to administration, wages, salaries, and directors’ remuneration.
Operating profit: Profit earned after all expenses except finance costs.
Finance income: Income from investments, such as interest and dividends.
Finance costs: Interest payments made on loans.
Profit before tax: Operating profit adjusted for financing costs and income.
Tax expense: The tax charge on adjusted profit figures, taking into account potential disputes, negotiations, and tax adjustments.
Profit for the year: Profit after deduction of tax.
Earnings per share (EPS) is a key metric that companies calculate and disclose on their statements of profit or loss. It
represents the earnings attributable to ordinary shareholders divided by the number of ordinary shares in issue.
Realized capital gains or losses occur when a company sells an asset for a different amount than its recorded value,
affecting the operating profit. Realized capital gains are subject to capital gains tax.
Other comprehensive income includes income and expenses that are not recognized in the profit or loss but contribute to a
comprehensive understanding of the organization’s income.
Examples include
gains/losses from revaluation of assets, currency translation differences, actuarial gains/losses on pension schemes, and losses/gains on cashflow hedges.
Revaluation involves recording
non-current assets at the market or fair value.
If the asset is used in the company’s business, an upward revaluation increases the revaluation reserve
in the equity section and has no impact on the profit or loss.
Earnings per share (EPS) is a key metric that companies calculate and disclose on their statements of profit or loss. It
represents the earnings attributable to ordinary shareholders divided by the number of ordinary shares in issue. represents the earnings attributable to ordinary shareholders divided by the number of ordinary shares in issue.
A company’s statement of profit or loss shows that it has generated substantial profits but its
cashflow statement indicates that it has suffered a large outflow of cash during the same period.
The figures are reliable and free from distortion.
Explain whether this set of circumstances warrants any major concern. [5
Profit could look healthier than cash because:
the full value of goods and services sold on credit is credited under sales revenue, and will
therefore contribute to profit, even though cash may not be received for some time [1]
inventories (the stock of materials, components, work-in-progress and finished goods) are
only treated as a cost when the they are used to produce the goods sold, so the build up
of inventories will reduce cash by more than it will reduce profit. [1]
In addition, cash balances are affected by items that do not affect the statement of profit or loss,
eg the purchase of a non-current asset. [1]
Cause for concern
It is quite normal for a new business to show substantial profit and yet experience large cash
outflows as it invests in new equipment, builds up stock and sells on credit, and so the
discrepancy between the profit position and the cash position may not be a cause for concern. [1]
However, many profitable businesses fail because they run out of cash and/or exceed their
overdraft limits. [1]
Therefore, although a discrepancy between profit and cash is inevitable and not a problem in
itself, a large cash outflow is potentially a cause for concern. [1]
Companies should forecast and monitor their cash positions and should take action to remedy
any unplanned shortages. [1]
[Maximum 5]
Explain why financial statements must be supplemented and supported by notes to the accounts.
[5
The notes give detailed explanations and additional information to provide shareholders with a
better understanding of the position of the company by helping them gain a true and fair view. [1]
Many of the disclosures in the notes are required by law or by accounting standards. [1]
Notes might deal with qualitative matters and disclosures that could not be reflected in the
financial statements. For example, descriptions of contingent liabilities could be vitally important,
as could information about post-balance sheet events. [1]
The notes will also cover details of the accounting policies used in the preparation of the
statements, which will make the accounts more useful to users, eg aiding comparisons between
companies. [1]
Providing an overview in the main statements and supplementing that with the notes gives
shareholders and other readers the choice of reading further if they wish. [1]
Notes and appendices avoid burdening the statement of financial position and statement of profit
or loss with excessive information
