Week 1

Question 1

What is the purpose of Financial Accounting

Answer 1

Provides information to shareholders, creditors and others outside the organisation to assist them with financial decisions

Question 2

What is the purpose of Management accounting

Answer 2

Provides information to internal managers in order to help them direct and control the organisation’s operations

Question 3

What is the role of Accounting

Answer 3

Accounting – a process of planning, recording, summarising, analysing and reporting financial information

Provides information to those who need to make decisions, plans and exercise control

Assists in decision making for scarce resources.

Impacts economic decisions about the future by analysing past information

Question 4

Define Relevance

Answer 4

Relevant financial information is capable of making a difference in the decisions made by users. Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both.

Relevant information influences the decisions of users. It either helps users to predict how a business will perform (future) or understand (confirm) how it has performed (past)

Question 5

Define Faithful Representation

Answer 5

To be useful, financial information must not only be relevant, but it must also represent faithfully the phenomena it purports to represent. This fundamental characteristic seeks to maximise the underlying characteristics of completeness, neutrality and freedom from error. Information must be both relevant and faithfully represented if it is to be useful.

Faithful representation means that the information included in financial statements (accounts) should be:
Complete
Unbiased (neutral)
(Reasonably) accurate (free from error)

Question 6

Define Comparability

Answer 6

Information about a reporting entity is more useful if it can be compared with a similar information about other entities and with similar information about the same entity for another period or another date. Comparability enables users to identify and understand similarities in, and differences among, items.

Comparability allows users to understand business performance by:
Identifying similarities and differences between
- different businesses (for the same period)
- different periods (for the same business)

Question 7

Define Verifiability

Answer 7

Verifiability: Helps to assure users that information represents faithfully the economic phenomena it purports to represent. This means that different knowledgeable and independent observers could reach consensus, although not necessarily complete agreement, that a particular depiction is a faithful representation.

Assures users that (knowledgeable and independent)observers would broadly agree that faithful representation has been achieved

Question 8

Define Timeliness

Answer 8

Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions.

Question 9

Define Understandability

Answer 9

Classifying, characterising and presenting information clearly and concisely makes it understandable. While some phenomena are inherently complex and cannot be made easy to understand, to exclude such information would make financial reports incomplete and potentially misleading. Financial reports are prepared for users who have a reasonable knowledge of business and economic activities and who review and analyse the information with diligence.

It is fair to assume that users of financial information:
have a reasonable knowledge of business and economic issues; and that they review and analyse the information carefully. Thus, they will understand financial information.

Question 10

Define Going Concern

Answer 10

This convention assumes that a business will continue in operation for the foreseeable future.

If a business is not continuing in existence, the value of its assets would be different.

Question 11

Define Accruals

Answer 11

Revenue is recognised when it is earned and the expenses that are incurred in earning that revenue are deducted to calculate profit

In other words, all revenue and expenditure relating to an accounting period should be taken into account irrespective of whether the cash has been received or paid.

Simply an Accrual is when a cost is incurred but not paid.

Question 12

Define Consistency

Answer 12

The consistency principle requires entities to treat the same item in the same way from one period to the next, or to signal and justify a change in treatment.

Accounting standards and regulations aim to enhance the consistency of accounting treatment across entities.

Question 13

Define Materiality

Answer 13

An item is material if including it or leaving it out influences a decision-maker

An item must make a difference, otherwise, it does not need to be disclosed

Materiality is subjective and will depend on several things e.g. the size of the entity.

Question 14

Define Money Measurement

Answer 14

Assets and Liabilities are measured in terms of money.

Accepted as objective and reliable in reporting an entity’s performance and position

The difficulty is that not all transactions or events can be measured in terms of money and may be relevant in communicating the performance of the organisation

Question 15

Define Substance over form

Answer 15

Substance of the transaction will take precedence over the legal form
Need to see through any superficial legal arrangement and look at the real economic effects e.g. hire purchase/leases.

Question 16

Explain the difference between income and expenses.

Answer 16

Income – revenue earned by a business. Can also be called sales or turnover
Expenses – costs incurred in the running of a business

Question 17

Define an Asset

Answer 17

Asset - Owed by a business
Assets are resources controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity

Physical form is not essential but it must be capable of being measured in monetary terms e.g. machinery, land & buildings

Question 18

Define a Liability

Answer 18

Liability - Owed by the business
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Question 19

Explain the difference between Capital (equity), Recieavables and Payables

Answer 19

Capital (Equity) – represents the claim of the owner(s) against the business

Receivables – an individual/organisation who owes the business money

Payables – amounts owed by the business to organisations/individuals

Question 20

Explain the following accounting concepts:
Historical cost
Business entity
Dual Aspect
Time interval

Answer 20

Historical cost concept:
Assets are normally shown at cost price, this is the basis for valuation of assets

Business entity concept:
Affairs of business treated separately to the non business activities of the owners.
“Owners’ money (capital) buys things for the business (assets)”

Dual Aspect concept:
Every transaction has two effects. For example, if you spend £20,000 cash on a car, the business loses £20,000 but gains a £20,000 asset. This information must be shown within a balance sheet or income statement. For every debit there is a credit.

Time interval concept:
Time interval or periodicity states that financial statements are prepared at regular intervals such as monthly or annually.

Question 21

What accounting equation calculates assets

Answer 21

Assets = Capital + Liabilities

Question 22

identify why internal management requires financial information.

Answer 22

The managers of businesses may need accounting information to decide whether to:
•Develop new products or services.
•Increase or decrease the price or quantity of existing products or services.
•Borrow money to help finance the business.
•Increase or decrease the operating capacity of the business.
•Change the methods of purchasing, production or distribution.

The information provided should help in identifying and assessing the financial consequences of these sorts of decisions.

Question 23

Discuss the principle characteristics, together with the advantages and disadvantages, of the following types of business organisations:

i. Sole trader
ii. Partnership
iii. Limited company

Answer 23

Sole trader - Small business:
Advantages: Simple administration and Privacy.
Disadvantages: Tax inefficient at higher profits and Unlimited liability

Partnership - Two or more people carrying on a trade with a view to making a profit. Often professional practices.
Advantages: Simple administration and Privacy.
Disadvantages: Tax inefficient at higher profits and Unlimited liability

Limited company - An organisation owned by its shareholders whose liability is limited to their share capital.
Advantages: Tax efficient at higher profits, Shares may be bought & sold to raise finance and Limited liability.
Disadvantages: Strict rules & regulations

Question 24

What are the benefits of understanding accounting

Answer 24

Accountants collect a great deal of information about an entity’s activities and then translate it into monetary terms – a language that everyone understands. The information that is collected can help non-accountants to do their job more effectively because it provides them with better information with which to make decisions. It should be noted, however, any eventual decision is still theirs.

Furthermore, all managers must be aware of the statutory accounting obligations to which their organisation has to adhere if they are to avoid taking part in unlawful acts.

Question 25

Identify external parties that would be interested in a business’s financial information and explain why.

Answer 25

External interested parties may use financial statements to decide whether to:
•Invest or disinvest in ownership of the business.
•Lend money to the business.
•Offer credit facilities.
•Enter into contracts for the purchase of products or services.

Specific external interested parties would include:

Shareholders The main target of financial statements. They will wish to ensure the investment they have made is doing well.

Customers: Customers will want to check if the company is likely to remain in business for the foreseeable future so that there is a definite source of supply.

Suppliers: Suppliers will want to ensure the company is likely to remain in business for the foreseeable future so that there is a definite customer for their goods. They will also be interested in how long it takes the company to pay its bills and how committed they are with other loans.

Lenders: Lenders will want to see how committed the company are with regard to other loans, how strong their cash flows are and what assets the company has to use as security against the loans.

Government: Government will want to ensure the company is paying the appropriate amount of tax and is complying with legislation and codes of conduct.

Employees: Employees will want to check for continued employment and also the company’s ability to offer pay rises and their ability to meet pension commitments.

Community: The community will be concerned with the continued employment the company can offer, what the company does for the community and any plans which may have environmental impacts.

Competitors: Competitors may look at claims regarding market share and any other information which may be of use, Eg R&D projects, overseas expansion etc.

Question 26

What are the limitations of Financial accounting

Answer 26

There is substantial degree of classification and aggregation of transactions
No focus on the significance of non-financial effects of transactions and non-financial information in general
Information is historical, does not reflect future events that may impair or enhance operations.
Does not meet all the needs of users - other sources of information is needed