Week 1-6 Flashcards
Accounting equation
Liabilities + Equity = Assets
Accounting equating also presented as
Assets - liabilities = equity
What is equity made up of
Share capital
Retained Earnings
Retain Earnings equation
Revenues - Expenses - Dividends
How to decide if events should be recorded
Criterion, is the financial position of the company changed?
Double entry book keeping
Each transaction has a dual effect on the accounting equation so the equality of assets and liability is preserved (two side of equation must always be equal)
How to analyse Statement of Financial position
Strong = high equity
Weak = low equity
Income statement def
Reports the profitability of the company’s operation over a specific period of time.
Statement of profit or loss def
A record of income and expenditure over a given period of time
- provides a basis for predicting future performance
- helps assess the risk and uncertainty of achieving future cash flow
The accrual concept
Accountants divide the economic life of a business into artificial time periods
Accrual Basis Accounting
Revenue and costs must be recognised as they are earned or incurred, not as money is received or paid
- revenue recognised when earned rather than when cash is received
- expenses are recognised when incurred, rather than when paid.
Cash - basis accounting
Revenue are recognised when cash is received
Expenses are recognised when cash is paid
- cash basis accounting is not in accordance with international financial reporting standards (IFRS)
Depreciation
depreciation represents the loss in value of this asset over time
Methods of depreciation:
- Straight line
- Reducing balance
Straight line depreciation
the loss of value will be spread equally over the useful life of an asset. So the depreciation amount is the same each year.
Reducing balance method
For each year you work out the depreciation charge as a percentage of the accounting value brought forward.
Bad debts
A lot of businesses offer their goods and services on credit but will be given a set number of days to settle the debt
However, they might go bankrupt
If the debtors could not settle the debt, the amount that cannot be recovered is known as bad debt.
Considered an expense to the business.
Investing activities
Financing activities
Changes in non current liabilities and equity
Investing activities
Changes in investments and non current assets
Operating activities
Income statement items, revenue and expenses from main activities of the business.
Ordinary share capital
- capital invested in a company by its owners
- Treated as equity in the SoFP
- Ordinary shares comes with voting rights at general meetings and AGMs
- The larger your ordinary shareholding, the more control you have over the company
- Owning >50% of OS makes you the majority shareholder
Share premium account
- treated as equity in SoFP
- All ordinary shares have the same nominal value, determined by the company constitution e.g. 1, 50p, £2 etc.
- But a company can sell issued shares for a higher price than the nominal value
- Any amounts received in addition to the nominal value of the shares goes into the share premium account
Retained earnings
-The amount of a business’s net income that is kept within its accounts, rather than paid out to shareholders
-This account can be used to pay dividends to shareholders
-Retained earnings can be negative if the company made a loss
General capital reserves
- company can choose to move their retained earnings (revenue reserves) into a separate capital reserve account
- This means that these reserves are no longer available to pay dividends to shareholders
- Capital reserves could be used for further investments, or to save as a ‘buffer-zone’ for future years
Types of ratio analysis
- profitability rations
- Liquidity ratios
- Efficiency ratios
- Gearing ratios
Limitations of ratio analysis
- lack of standard ratio definitions
- Closing balance in the statement of financial position may be unrepresentative of the average position throughout the year
- Accounting policies may differ resulting in misinterpretation
- Corroboration and more granular further information will needed to make well informed decisions
