UNIT 5. Chapter 29: Accounting fundamentals

Question 1

What are the internal uses of accounting information? (2)

Answer 1

• Business managers: To measure performance, to help make decisions, to set targets and budgets, to monitor operations of each departments.
• Workforce: to determine security in their wages and whether it can increase.

Question 2

What are the external uses of accounting information? (5)

Answer 2

• Banks: To decide whether to lend money.
• Creditors (suppliers): to decide whether the business is liquid enough to pay off debts, to decide whether to press early payments.
• Customers: To determine whether they will be assured of future supplies of the goods purchased, whether the business is secure
• Government: to calculate tax, to see if the business is following law, to see if the business creates jobs.
• Local community: Jobs providence.

Question 3

What are the limitations of public accounts?

Answer 3

• They may not contain: research and development plans, any future plans for expansion, performance of each department, future budgets.
• They may not be accurate: data may be outdated before published. Even though accounts are check by auditors, there are things that need judgement to decide on their value such as intangible goods. Therefore the business can still be accused of ‘window dressing’ the account.

Question 4

Def. Window dressing

Common ways of window dressing?

Answer 4

Window dressing is presenting the company accounts in a favourable light - to flatter the business performance.
Ways to window dress:
• Selling fixed assets at the end of the year to improve liquidity position.
• Reducing the amount of depreciation of fixed assets, to raise profit margins.
• Ignoring bad debts.

Question 5

Management vs. Financial Accounting?

Answer 5

• Financial accounting: Published accounts of the business by legal requirements. e.g preparations of income statements, or statements of financial position.
• Management Accounting: Information for internal use by the managers who need financial data. e.g Analysis of internal accounts such as budgets.

Question 6

What do income statements show?

Answer 6

The gross and net profit of the company. Details how the net profit is split up between dividends to shareholders and retained profits.

Question 7

What are the three sections of an income statement?

Answer 7

• The trading account
• The Profit and Loss account section
• The appropriation account

Layout in 1/03/16

Question 8

What is the trading account section?

Answer 8

• Shows how the gross profit is made from the trading activities.

Question 9

Def. Gross profit

Answer 9

Equal sales revenue - cost of sales

Question 10

Def. Sales revenue

Answer 10

The total value of sales made during a trading period.

= selling price x quantity sold

Question 11

Def. Cost of sales

Answer 11

Direct cost of purchasing the goods that were sold during the financial year.
=opening inventory + purchases - closing inventory

Question 12

What is the profit and loss account section?

Answer 12

Shows the net profit and the profit after tax.

Question 13

Def. Net profit (operating profit)

Answer 13

= Gross profit - overhead expenses

Question 14

Def. Profit after tax

Answer 14

= Operating profit - interest costs - tax

Question 15

What is the appropriation account?

Answer 15

It is not always published. It shows how the profit after tax is distributed in dividends and retained profit.

Question 16

What are the uses of income statements?

Answer 16

• Used to measure and compare the performance of a business over time or with other firms.
• Bankers, creditors or investors will need information to decide whether to lend money.

Question 17

Def. Statement of Financial Position

Answer 17

An accounting statement that records the value of a business’s assets, liabilities and shareholders’ equity at one point in time.

Layout in pg. 538

Question 18

Def. Shareholder equity

Answer 18

=total assets - total liabilities

Question 19

Def. Share capital

Answer 19

Total value of capital raised from shareholders by issuing shares

Question 20

Def. Non current assets

Answer 20

‘fixed assets’. Assets to be kept and used by the business for over a year. e.g machinery

Question 21

Def. Intangible assets

Answer 21

Items of value that do not have a physical presence such as patents or trademarks.

Question 22

Def. Inventories

Answer 22

Stock

Question 23

Def. Account receivables

Answer 23

Debtors. The value of payments to be received from customers who have goods on credit.

Question 24

Def. Current Assets

Answer 24

Assets that are likely to be turned into cash before the next balance sheet, less than 1 year. 3 main: Cash, Cash receivables, Inventories.

Question 25

Def. Current liabilities

Answer 25

Debts that have to be paid within 1 year.

Question 26

Def. Account payables

Answer 26

Creditors. Value of debts for goods bought on credit payable to suppliers.

Question 27

Def. Non current liabilities

Answer 27

Value of debts of the business that will be payable after more than 1 year. e.g Loans

Question 28

Def. Goodwill

Answer 28

Arises when a business is value at or sold for more than the balance sheet value of its assets possibly due to its reputation.

Question 29

What are the the two main ratio types?

Answer 29

• Profitability ratios

* Liquidity ratios

Question 30

What are the profitability ratios and their meaning?

Answer 30

• Gross profit margin: =(Gross profit/ Sales revenue) x 100. Shows how much gross profit a business makes for $1 of sales. Shows managing ability of cost of sales.
• Net profit margin: =(Net profit/Sales revenue) x 100.
how much gross profit a business makes of $1 of sales. Show managing ability of cost of sales and overhead expenses.

Question 31

What are the liquidity ratios and their meaning?

Answer 31

• Current ratio: =Current Assets/ Current liabilities. shows the rate the business affords to pay current liabilities out of their current assets.
• Acid test ratio: = (Current Assets - Inventories) / Current liabilities.

Question 32

What are the methods to increase profit margins?

Answer 32

• Increase gross and net profits by reducing direct costs of overhead costs. This can be done by using cheaper materials or cutting labour costs.
• Increase gross and net profits by increasing price.

Question 33

What are the methods to increase liquidity margins?

Answer 33

• Sell off fixed assets for cash then lease these back if needed.
• Sell of inventories for cash which would improve acid test ratio only
• Increase loans to inject cash into the business and increase working capital.