Week 2 - Reporting financial performance Flashcards
What does a statement of profit or loss / income statement (SPL) do?
Measures the financial performance of the business over period of time (revenues and expenses)
What are the three measures of profit in an SPL?
- Gross profit
- Operating profit
- Net profit
Formula for Profit (or loss) for the period
Profit (or loss) = total revenue for the period - total expenses incurred in generating that revenue
What is the difference between cost of sales and operating costs?
- Cost of sales are the costs that can be directly associated with the sale of a particular good
- Operating costs are costs to the business that are not costs of sales, but still relate to the business operation
How does a statement of financial position and SPL link? (3)
- If a firm was to make a profit or loss the accounts need to show that the owner’s wealth has increased/decreased to this
- Equity section of a statement of financial position shows the ownership interest in a company
- The net profit or loss is added to this section under retained earnings
Total equity equation
Total equity = share capital + retained earnings
Accounting equation
Assets = equity + sales revenue - expenses + liabilities
What is accrual accounting?
It occurs when the organisation records transactions that change a compnay’s financial statements in the period in which the transactions occur
How is net profit/profit for the period determined? (2)
- Companies recognise revenues when they perform the services not when the cash is received
- Recording expenses when they are incurred and not when paid
Characteristics of revenue (3)
- Measure inflow of economic benefits arising from ordinary operations of the business
- Result from business activities entered into for the purpose of earning income
- Benefits will result in increase in assets or decrease in liabilities
Examples of revenue (4)
- Sales
- Fees for services
- Interest received
- Subscriptions
What is the prudence convention/concept? (2)
- It focuses on being more conservative in the preparation of accounts
- this may involve: understating profits/revenues/assets and overstating costs/liabilities
Impact of accounting issues (4)
- Can lead to employees losing jobs
- Massive losses in shareholder value
- Losing of auditor accreditation
- Pension holders could lose their pension funds
Revenue recognition principle
Revenue is recognised in the accounting period in which the performance obligation is satisfied
Revenue recognition criteria (3)
- The amount of revenue must be able to be measured accurately reliably
- It is probable that economic benefit will be received
- Ownership and control of the items should pass to the buyer in the case of sale of goods
What are expenses? (3)
- Is an outflow of economic benefits arising from the ordinary operations of the business
- Loss of benefits will lead to decrease in assets or increase in liabilities
- There are cash and non cash expenses
Examples of expenses (9)
- Cost of sales
- Salaries expense
- Rent
- Heating & light
- Insurance
- Bad debts
- Finance cost/interest
- Depreciation
- Printing & stationary
General rule for expense recognition
All expenses of a particular accounting period must be matched with the relevant of that period irrespective of whether the expenses have been paid in cash
What are inventories? (2)
- Are assets held for sale in the normal course of business (I.e finished goods)
- In the process of production for sale (I.e. work in progress), or in the form of materials to be consumed in production of goods for sale (I.e raw materials)
What is cost of sales?
Includes the cost of inventory sold during the period
What is the matching principle of depreciation?
Match the cost of using up of these assets to the revenues the business generates in each period
What is depreciation?
Is a non cash expense which involves the spreading got the cost over the life of the asset
Four factors that calculate depreciation charge for a period (4)
- The cost (or fair value) of the asset
- The useful life of the asset
- Residual value (disposal value) - how much can we sell it for after its use?
- Depreciation methods
3 common depreciation methods
- Straight-line
- Reducing-balance
- Units of production
Features of straight-line depreciation (2)
- Proprotion of the same amount of depreciation each year
- Accumulated depreciation is the adding of the depreciation year by year
Features of reducing balance depreciation (3)
- Start on the carrying amount at the beginning of the year
- Accumulated depreciating is also the adding of the appreciation year by year
- Carrying amount at the end = carrying amount at the beginning - annual depreciation expense
Annual depreciation equation
Units of production x depreciation cost per unit
Carrying amount equation
Cost of asset - accumulated depreciation
Impact of selling assets before the end of its useful life
This will have implications for income statement, statement of financial position and cash flow statement
Formula for profit or loss on disposal
Sale price - carrying value
Impact of the disposal of assets on financial statements (3)
- Profit or loss will be reflected in the income statement and will either increase or decrease net profit
- The carrying value of the asset will be removed from the SoFP
- Cash received will be reflected in cash flow statement
Impact of one of the receivables not paying (3)
- Accounts have to be adjusted
- Reduce receivables
- Increase expenses - as we won’t receive value of the sale we have to take this hit to profits
Ethical issues in accrual accounting (3)
- Omittion of depreciation expense at the end of the year
- Failing to record depreciation would overstate profit as calculated by mandated accrual principles and and disclose a more favourable picture of the businesses financial position actually existed
- Some accounts are based on estimates, such as depreciation and revenue and these can be manipulated
