Week 1 Flashcards
What is the purpose of Financial Accounting
Provides information to shareholders, creditors and others outside the organisation to assist them with financial decisions
What is the purpose of Management accounting
Provides information to internal managers in order to help them direct and control the organisation’s operations
What is the role of Accounting
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
Define Relevance
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)
Define Faithful Representation
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)
Define Comparability
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)
Define Verifiability
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
Define Timeliness
Timeliness means that information is available to decision-makers in time to be capable of influencing their decisions.
Define Understandability
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.
Define Going Concern
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.
Define Accruals
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.
Define Consistency
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.
Define Materiality
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.
Define Money Measurement
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
Define Substance over form
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.
Explain the difference between income and expenses.
Income – revenue earned by a business. Can also be called sales or turnover
Expenses – costs incurred in the running of a business
Define an Asset
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
Define a Liability
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.
Explain the difference between Capital (equity), Recieavables and Payables
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
Explain the following accounting concepts: Historical cost Business entity Dual Aspect Time interval
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.
What accounting equation calculates assets
Assets = Capital + Liabilities
identify why internal management requires financial information.
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.
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
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
What are the benefits of understanding accounting
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.
