Week 1 Questions Flashcards
Define an asset
- An asset is a resource that is controlled by an entity as a result of a past transaction that is expected to bring economic benefits, (generate profits).
Assets can be split into two categories:
Non-current assets – are to be owned for longer than 12 months.
Buildings , furniture, machinery and motor vehicles. These are tangible assets.
Brands, patents and goodwill. These are intangible assets.
Current assets – owned at the reporting date but are to be used by the business to make profits in the next 12 months. Inventory=stock Trade receivables= Debtors
Define an expense
An expense is a period cost. It is costs that are incurred in the year and that the business has benefited from in the year. They have no future economic benefit. For example electricity cost, advertising, accountancy fees and training costs.
Outline the matching or accruals concept.
Accruals concept - expenses are matched to the revenues that they help generate. Expenses, costs , income and revenue are accounted for when they are earned or incurred not when cash flows in or out of the company. For example the cost of a non-current asset is spread over the years that are expected to benefit from its use.
The company you work for is knowledge based and in order to recruit a highly sought after computer engineer you will have pay her an upfront sum of £500,000 with a 10% fee to a recruitment agency.
Should the golden handshake and agency fee be regarded as an asset or an expense?
- The golden handshake must be recognised as an expense.
Generally training costs and golden handshakes cannot be recognised as an asset.
The problem is that to be regarded as an asset the entity must control the asset and there must be expected economic benefits. It is very difficult for an organisation to control an employee and how do you quantify the future benefits.
Please note football clubs do regard players’ contract fees as an asset and the cost is written off over the duration of a contract. An exception.
- The company you work for has won a contract to build a tunnel under the Pennines. The work will be completed over 8 years, with payments made to your company every 2 years. How should this project be accounted for? When can you recognise any sales revenue? Will you keep all the costs as work-in-progress within inventory until the completion of the project?
- This is an example of the accruals concept.
It would not show a true and fair view of the contract if costs and revenues were not recognised in the income statement until the end of the project.
Investors would not get a complete picture of the organisation.
An accounting standard (IAS 11) for long term contract is in operation and sets out how a business should account for revenue as a project proceeds.
This is important if all businesses follow the accounting standard which they are required to do by company law it provides a consistency of approach and so a company engaged in long term contracts can be compared with others and investors can make rational investment decision.
The company has to make a realistic assessment of the stage of completion of the contract at each reporting date. Having done this it can then recognise an appropriate amount of sales revenue and costs within the income statement. Normally revenue would not be recognised in advance for fear of a company misrepresenting its profits but for long term contracts it is an appropriate treatment.
- A simple business is set up where through a contact specialised lab safety equipment can be bought for only £300 each. The market in the UK is such that each item can be sold for £380.
In the first month the company buys 500 items and sells 200, in the second month the company buys 1,000 items and sells 800 and in the third month the company buys 1,200 and sells 1,700.
For each month calculate the profit and cash position.
see week 2 answers on mole
