Topic 1- Financial Analysis and Overview Flashcards
The Entity Assumption is….
the entity on which the financial analysis is conducted is the business and not the owners of that business ie the business is regarded as being separate to the owners of the business.
The Historical Cost Assumption is….
accounting practice where all things of value (assets and services) acquired by the business are recorded at their actual cost whereas all financial commitments owing by the business (liabilities) are recorded at the actual amount owing.
The Matching Assumption is…
in the determination of profit, all expenses are to be matched with the revenues which such expenses help to produce.
The Going Concern Assumption is…
accounting practice is generally based on the assumption that the business will continue its operations indefinitely.
Why do you feel it is important for management to use consistent accounting practices from one period to the next?
The use of consistent accounting practices enables comparability of results over a number of years. If a business uses different accounting methods from one accounting period to the next it will find that over time its accounting information will not be comparable-that is, for example, management and other users will not be able to compare the profit earned in one period with the profit earned in another period, simply because the methods used in determining the information differ.
(Accrual accounting vs cash accounting)
What is accrual accounting?
The accrual basis of accounting refers to accounting practice which is based on the recognition of revenues and expenses at the time they are earned or incurred (irrespective of whether cash has been received or paid at the time) and accounting for them in the period to which they relate.
The cash basis of accounting, on the other hand, refers to accounting practice based on the recognition of revenues and expenses at the point in time when the associated cash is received or paid. When using cash accounting a common practice is to refer to cash receipts or cash income rather than revenue, and to refer to cash payments or cash expenditure rather than expenses.
(Income and expenses)
Explain the meaning of the term income.
The term income refers to amounts earned by the business through the sale of goods and services during the period of time under consideration. Strictly speaking this refers to operating income and should not be confused with capital income.
The term income can be interchanged with the term revenue. It is important to remember that income is considered to have been earned during an accounting period irrespective of whether the money has actually been received. The critical point is that income is earned at the point in time when the transactions, which will result in money or an equivalent being received, takes place.
(Income and expenses)
Classify the following income items according to whether they are operating or capital income:
Wool sales by grazier; Fruit sales by Woolworths; Supermarket; Sale of disused supermarket building by; Woolworths; Cellar door sales of a winery; Receipt of new loan funds following approval of loan application by bank; Interest received from fixed term investment with NAB; Funds received following cashing-in of fixed term investment with NAB
operating, operating, capital, operating, capital, operating, capital.
Distinguish between operating expenses, capital expenses and private expenses, and provide two examples of each.
What is operating expense?
An operating expense can be defined in a number of ways:
• the outflow of resources necessary to produce the income for that period.
• a cost incurred in order to produce the income for the period under consideration.
• the cost incurred when an asset or service acquired is consumed, or used up, in the business operations for the period under consideration.
Examples include fuel, wages and salaries, inputs such as fertilisers and chemicals; and electricity.
Distinguish between operating expenses, capital expenses and private expenses, and provide two examples of each.
What is capital expense?
Capital expenditure is said to have occurred when an asset and/or service is acquired by the business but will be consumed, or used up, over a number of accounting periods. An example of a capital expenditure would be the purchase of a tractor or piece of machinery, assuming that this tractor/machinery will be used for a number of accounting periods (years). Capital expenditure is also said to have taken place when a liability, usually a non-current liability, is reduced by the business paying the amount (or part thereof) which it owes.
Examples include the cost of purchasing machinery, livestock, vehicles; the repayment of a loan.
Distinguish between operating expenses, capital expenses and private expenses, and provide two examples of each.
What is private expense?
Private expenses are those expenses devoted to meeting the private costs of the owners of the business eg medical costs, groceries, private travel and education.
Differentiate between variable expenses and fixed expenses, and provide two examples of each.
What is a fixed expense?
Fixed expenses relate to those expenses which remain constant (or fixed) over a given range or scale of business activities. Thus even if the business produces nothing, fixed expenses are still incurred. Common examples of fixed expenses include permanent labour, insurance and administration expenses. Some people refer to fixed expenses as ‘overhead’ expenses.
Fixed expenses and variable expenses when considered together, are commonly referred to as the business’s operating expenses, that is, those expenses resulting directly from the period’s operations.
Differentiate between variable expenses and fixed expenses, and provide two examples of each.
What is a variable expense?
Variable expenses are those expenses which vary directly with the scale of business activities. Common examples of variable expenses include fertiliser, crop and livestock chemicals, casual labour and machinery expenses.
Fixed expenses are also referred to as indirect expenses, whilst variable expenses can be referred to as direct expenses.
Fixed expenses and variable expenses when considered together, are commonly referred to as the business’s operating expenses, that is, those expenses resulting directly from the period’s operations.
Under what circumstances might an expense which would normally be regarded as a variable expense, be treated as a capital expense?
when the item purchased is not fully used up in that accounting period i.e. all or a portion of the item remains on hand at the end of the year. The value of the quantity of the item remaining unused would be regarded as capital expense whereas the value of the quantity which has been used would be regarded as the variable expenses.
(Accrual accounting vs cash accounting)
What is cash accounting?
The cash basis of accounting, on the other hand, refers to accounting practice based on the recognition of revenues and expenses at the point in time when the associated cash is received or paid. When using cash accounting a common practice is to refer to cash receipts or cash income rather than revenue, and to refer to cash payments or cash expenditure rather than expenses.
