Week 2- The Accounting Equation & Financial Statements

Question 1

What is an asset?

Answer 1

A present economic resource controlled by an entity as a result of past events.

Question 1

What is an economic resource?

Answer 1

A right that has the potential to produce economic benefits

Question 1

Describe a current asset and give examples

Answer 1

• Held for short term (less than a year)
• Used as part of normal business cycle
• Inventory, trade receivables, cash

Question 1

Describe a non-current asset and give examples

Answer 1

• Held for long term operations (more than a year)
• May be tangible, intangible, or investments
• Property, plant and equipment, fixtures and fittings, patents and trademarks

Question 2

What is a liability?

Answer 2

A present obligation of the entity to transfer an economic resource as a result of past events

Question 3

Describe a current liability and give examples

Answer 3

• Due in the short term (less than a year)
• Obligation cannot be avoided
• Trade and other payables, tax due

Question 4

Describe a non-current liability and give examples

Answer 4

• Due in the long term (more than a year)
• Obligation cannot be avoided
• Loan, long term provisions

Question 5

What is equity?

Answer 5

The residual interest in the assets of the entity after deducting all its liabilities (Assets - Liabilities = Equity)

Question 6

What are the three components of equity?

Answer 6

• Share capital
• Share premium
• Retained earnings
• (this applies to limited companies and plcs, sole traders and unincorporated entitles have a capital account)

Question 7

What is the accounting equation?

Answer 7

The total sum of assets - the total sum of liabilities = equity

Question 8

What are the three main financial statements?

Answer 8

• Income statement (profit & loss account)
• Statement of financial position (balance sheet)
• Cash flow statement

Question 9

Describe income statements

Answer 9

• Provide an insight into a company’s trading activities
• Compares the income generated from trading with the costs associated with earning that income, the difference being the profit or loss for the year

Question 10

How do you calculate the cost of goods sold?

Answer 10

Cost of goods sold = opening inventory + purchases - closing inventory

Question 11

How do you calculate gross profit?

Answer 11

Gross profit = sales - cost of goods sold

Question 12

How do you calculate profit/(loss)?

Answer 12

Profit/(loss) = sales - cost of goods sold - expenses

Question 13

What do statements of financial position consist of?

Answer 13

• A list of everything owned by the business at the year end (assets)
• A list of the various sources of finance used to fund these acquisitions (liabilities & equity)

Question 14

Why do statements of financial position always balance?

Answer 14

Because they are based on the accounting equation

Question 15

What do cash flow statements show?

Answer 15

Company’s cash inflows and outflows for the year