Topic 2: Financial Statements (Income Statements) Flashcards
What is the definition of an Income Statement?
The Income Statement is a general purpose report which shows the financial performance of the firm over the accounting period.
What happens when Revenue is greater than Expenses?
The business records a profit.
What happens when Expenses are greater than Revenue?
The business records a loss.
What is the Accounting Period Concept?
The life of the business must be divided up into equal reporting periods to measure the performance of the business.
What are some limitations of the Accounting Period Concept?
- If we choose a period that is too short, we could have problems of seasonal factors affecting business performance.
- Some Firms may need a longer period to gain a more consistent measure of performance.
What is Revenue?
Inflow of resources (cash) relating to goods or services during the accounting period.
What are Expenses?
A cost to the business (outflow of resources associated with the earning of revenue during the accounting period)
What is classified under ‘Revenue’?
The inflow of cash from the main activity of the business that occurs from its day-to-day operations.
Examples: Sales, Sales Return
What is classified under ‘Other Revenue’?
Minor sources of inflow that are a result from activities that are not part of the businesses day to day operations.
Examples: Commission Received, Interest Received
What is classified under ‘Cost of Goods Sold’ (COGS)?
Cost of buying the goods, bringing the goods into the store and getting them ready for sale.
What is classified under ‘Selling Expenses’?
The costs incurred in selling the goods.
Examples: Advertising, Promotions, sales staff salaries
What is classified under ‘Admin Expenses’?
Costs relating to the office or general running of the business.
What is classified under ‘Financial Expenses’?
Costs associated with the borrowing of money and extension of credit to customers.
*Costs associated with Loans and Debtors.
How are COGS written in the income statement?
- Opening Stock
- (Plus) Purchases
- Closing Stock - MUST BE LAST
What is the only item that appears in both financial statements?
Closing Stock:
Income Statement - (negative value in COGS)
Balance Sheet - Current Assets
Why do Service Firms not have COGS classification?
The business does not buy goods, they provide a service.
What is Gross Profit?
The profit resulting from the buying and selling of goods.
What is Profit?
The final profit figure for the period after deducting all day to day operating expenses.
What is Discount Allowed associated with?
Sales (Revenue)
*Negative Figure
What is Discount Received associated with?
COGS.
*Negative Figure
What is the (Individual) Expense Ratio and what is its acceptable range?
Measures the impact of the expense against the sales of the business.
Acceptable Range: The lower the result the better - needs to be compared to past trends
What is the Gross Profit Margin and what is its acceptable range?
Measures the rate of return from the buying and selling of goods and the margin of profit available to cover operating expenses.
Acceptable Range: The higher the result the better - Must be compared to past performances and industry average.
What is Accrual Accounting?
Records transaction when it occurs and in the period it relates to.
What is Cash Accounting?
Records the transaction when cash is paid or received.
What is the main difference between Cash and Accrual Accounting?
Time: Will show a difference in profit during an accounting period. HOWEVER, over the life of the business the profit figure will be exactly the same.
*No one system is better than recording profit over the life of the business.
What are the two concepts related to Accrual Accounting of Revenue and Expenses?
- Faithful Representation
2. Accounting Period Concept
What is Faithful Representation?
All financial information produced must accurately reflect the true financial position of the business. (Complete, Error-free and Unbiased)
What is the Accounting Period Concept?
The life of the business must be divided up into equal reporting periods to measure the performance of the business.
What is the Going Concern Assumption?
A business has an unlimited life and will continue to operate indefinitely.
What is the issue when abandoning the Going Concern Assumption TOO LATE?
Business is misleading creditors and shareholders, by continuing to use credit knowing they will not be able to pay it back. They will be committing fraud.
What is the issue when abandoning the Going Concern Assumption TOO EARLY?
Creditors and Shareholders will stop issuing credit, demand repayment and withdraw equity from the business.
*Lead to a definite closure of the business.
What is Relevance?
Accounting information must be meaningful, significant and timely to be included in financial reports.
What is the Materiality Assumption?
Accountants record the amounts/values in the financial statements in a form that are still significant to assist decision making.
*Extent of materiality depends on size of business
What is the Consistency Doctrine?
A firm should use the same accounting methods and procedures from one accounting period to another.
*Easier to make more meaningful comparisons over previous year’s reports.
What is the Major Limitation of the Consistency Doctrine?
The business will change over a number of years and will need to change the reporting methods to reflect the changes in the business.
What evidence exists in the Balance Sheet that would confirm Accrual Accounting is being used?
Debtors and Creditors
What evidence exists in the Income Statement that would confirm Accrual Accounting is being used?
- Bad and Doubtful Debts
2. Credit Purchases/Sales
What is the definition of the Return on Total Assets Ratio and what is the acceptable range?
Measures the rate of return based on the businesses assets. Measures how well the business assets are performing and being used.
Acceptable Range: The higher the result the better. However, must be checked against past performances and industry average.
Where is ‘Discount Allowed’ classified in the Income Statement?
REVENUE - NEGATIVE FIGURE
*Form Net Revenue Value.
Where is ‘Discount Received’ classified in the Income Statement?
COGS - NEGATIVE VALUE
Where is ‘Donation to Charity’ classified in the Income Statement?
ADMIN EXPENSES
