What goes into the financial statements

Question 1

What is the difference between current and non current assets?

Answer 1

Currents assets are assets that are expected to be converted into cash within one year ex: inventory, whereas non-current assets are assets that are expected to provide economic benefits for more that one year ex: land

Question 2

What is a current ratio and what is its equation?

Answer 2

A current ratio is a liquidity ratio shows a company’s ability to cover its short-term obligations due within one year (current assets/current liabilities)

A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts. A current ratio below 1 means that the company doesn’t have enough liquid assets (assets that can be converted to cash within 1 year) to cover its short-term liabilities.

Question 3

where does earnings from interest go?

Answer 3

Income Statement, often under the category of “Other Income” or “Non-operating Income.”
Explanation: Interest income is considered non-operating revenue because it is not generated from the core business operations. Instead, it arises from the company’s investments or financing activities.

Question 4

what is the difference between the Income statements and the Statement of Comprehensive Income and Expenditure?

Answer 4

Income Statement:
1. Focuses on a company’s main operating activities.
2. Shows revenues, expenses, and net income or net loss.
3. Highlights profitability from day-to-day business operations.

Statement of Comprehensive Income and Expenditure:
1. Encompasses a broader range of financial elements.
2. Includes net income and other comprehensive income items.
3. Provides a more comprehensive view of a company’s overall financial performance, considering additional factors that affect equity.

• While the Income Statement looks at the profitability of a company’s core operations, the Statement of Comprehensive Income and Expenditure provides a more inclusive picture by considering items that impact equity beyond just net income, such as gains and losses on investments and changes in the fair value of certain financial instruments.

Question 5

what are the 5 examples of intangible assets?

Answer 5

An intangible asset is a non-monetary asset that cannot be seen or touched.

Goodwill, brands, trademarks, knowledge, patents.

Question 6

what is depreciation and why is it important?

Answer 6

Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life.

It represents the gradual reduction in the value of an asset due to factors such as wear and tear, obsolescence, or the passage of time.

Depreciation is applied to long-term assets, such as buildings, machinery, vehicles, and equipment.

• Depreciation aligns with the matching principle in accounting, where expenses should be matched with the revenue they generate. Depreciation ensures that the cost of an asset is recognized over the periods in which it contributes to revenue generation.
• helps in presenting a more accurate picture of a company’s financial performance by accounting for the wear and tear of assets.
• Depreciation provides a way to reflect the reduced value of an asset on the balance sheet.This helps in maintaining a realistic valuation of assets, which is crucial for understanding the true financial position of a business.

Question 7

With which accounting principles does depreciation align with?

Answer 7

1. Matching Principle:

The matching principle is a fundamental concept in accounting that requires expenses to be recognized in the same period as the revenues they help to generate.

2.

Question 8

what is the formula for straight-line depreciation?

Answer 8

Cost of Asset-Residual Value/ Useful Life

Question 9

what is accumulated depreciation?

Answer 9

Accumulated depreciation is the total amount of depreciation expense that has been allocated for an asset since the asset was put into use.

Question 10

what is goodwill?

Answer 10

Goodwill is the extra value a company has because of intangible things like a good reputation, loyal customers, or skilled employees.

Imagine one company buys another. If the buyer pays more than what the purchased company’s physical things are worth (like buildings and equipment), the extra payment is called goodwill.

Question 11

what goes into a Balance Sheet and why?

Question 12

what goes into an Incomes Statement and why?

Question 13

Why are shareholder interests’ strongly influenced by asset and liability pricing in the B/S?

Answer 13

Shareholders’ interests are tied to how well the company values its assets and liabilities because it directly impacts the overall health of the company, the value of their ownership, and their confidence in the investment.

Question 14

how is stock priced?

Answer 14

Knowing how much your stocks are worth is crucial for figuring out your profit.

Stocks are valued at the lower of their cost (how much it took to make or buy them, including related costs) and their net realizable value (how much they can be sold for). [whichever is lower].

This rule applies not just to regular stocks but also to investments you plan to sell soon.

Big companies might have to estimate their stock values, unlike smaller businesses where it’s easier to keep track.

Question 15

what are irrecoverable debts and how are they recorded?

Answer 15

Irrecoverable debts, also known as bad debts, refer to amounts that a business is unable to collect from its customers or debtors. These debts arise when customers fail to pay their outstanding invoices, either due to financial difficulties, insolvency, or other reasons.

1. Accounting Treatment:
   In accounting, when it becomes evident that a debt is irrecoverable, the business needs to recognize the loss. This is done by recording a bad debt expense in the income statement and reducing the accounts receivable on the balance sheet.
2. Write-Off:
   The specific debt is often referred to as being “written off.” This doesn’t mean the business has given up on collecting it, but rather that it has acknowledged the unlikelihood of recovery and has adjusted its accounts accordingly.

Income Statement:

Irrecoverable debts are recognized as an expense on the income statement. This expense is known as the “Bad Debt Expense” or “Uncollectible Accounts Expense.” It represents the portion of sales revenue that the company expects will not be collected.

Bad Debt Expense (Income Statement)
Bad Debt Expense (Income Statement)

Balance Sheet - Allowance for Doubtful Accounts:
Many companies maintain an “Allowance for Doubtful Accounts” or a “Bad Debt Reserve” on their balance sheet. This is a contra-asset account that offsets the accounts receivable to reflect the estimated amount of doubtful debts.
Allowance for Doubtful Accounts (Balance Sheet)
Allowance for Doubtful Accounts (Balance Sheet)

Balance Sheet - Accounts Receivable:
When a specific debt is deemed irrecoverable, it is written off against the allowance for doubtful accounts, reducing both the allowance and the accounts receivable.
Allowance for Doubtful Accounts (Balance Sheet)
→
Accounts Receivable (Balance Sheet)
Allowance for Doubtful Accounts (Balance Sheet)→Accounts Receivable (Balance Sheet)

Impact on Net Income:

The recognition of bad debt expense reduces the company’s net income for the period. This reflects the economic reality that not all sales revenue is expected to be collected.
Cash Flow Consideration:

While the income statement reflects the bad debt expense, the actual cash flow from operations might be impacted only when the company writes off specific accounts. The cash flow impact occurs when cash collections are less than the initial sales.

Question 16

What are doubtful debts and how are they recorded?

Answer 16

Doubtful debts are amounts owed to a business by customers or debtors that are uncertain of collection. They are considered doubtful when there is uncertainty about the ability of customers to pay, but they have not yet been classified as completely irrecoverable.

Adjusting Journal Entry:

An adjusting journal entry is then made to record the estimated amount of doubtful debts.

This entry increases the Allowance for Doubtful Accounts (a credit entry) and recognizes the bad debt expense on the income statement (a debit entry).

Bad Debt Expense (Income Statement) → Allowance for Doubtful Accounts (Balance Sheet)

Bad Debt Expense (Income Statement)→Allowance for Doubtful Accounts (Balance Sheet)

Question 17

how are monetary items priced?

Answer 17

1. Clear Money Amounts:

Cash and most liabilities have exact, clear money amounts attached to them. For example, if a company owes money, it’s a specific, known amount.

2. Estimates for Some Liabilities:

However, for certain liabilities, like building maintenance provisions, the exact amount may not be known. Companies need to make an estimate of how much they might need.
3. International Scene and Foreign Currencies:

For international companies with assets and liabilities in different countries, there’s an added complexity. Some liabilities might be in currencies other than the parent company’s currency.
Exchange Rates:

To deal with the issue of different currencies, one approach is to use the exchange rate at the date of the balance sheet. This rate helps convert foreign currencies into the company’s reporting currency.

4. Foreign Currency Impact:

This foreign currency challenge applies not just to liabilities but also to assets. The value of both assets and liabilities can change based on exchange rates.

Summary:
In simpler terms, when a company has stuff or owes money in different countries, the values might not be in its home currency. To deal with this, the company uses exchange rates to convert these values to its reporting currency, especially at the date of the balance sheet. This helps keep the financial statements accurate and reflective of the company’s true financial position.

Question 18

what are accruals?

Answer 18

Payments in advance

Question 19

what are prepayments?

Answer 19

Amount owing for which we have not received an invoice

Question 20

What is the Memorandum of Association?

Answer 20

This is a fundamental document for a company since it specifies why the company is formed and contains the rights, privileges and powers of the company

Question 21

What are the types of share Capital?

Answer 21

Certainly! Let’s simplify the explanations:

1. Ordinary Shares:
   What they are: Ordinary shares are like the regular, common shares that most people think of when they hear “stock.”

Key Points:
Voting Rights: Ordinary shareholders usually have a say in company decisions through voting.

Returns: They might get dividends, but these can vary, and they get what’s left after other obligations.

Risk and Reward: They’re considered riskier but potentially offer higher returns.

2. Redeemable Shares:
   What they are: Redeemable shares are shares that the company can buy back or redeem at a predetermined price.

Key Points:
Buyback Option: The company has the right to purchase these shares back.

Flexibility: It gives the company flexibility in managing its capital.
Duration: Often used for short-term needs or specific financial strategies.
3. Preference Shares:

What they are: Preference shares are a bit special, offering some preferential treatment compared to ordinary shares.

Key Points:
Fixed Dividends: They might get fixed dividends, providing a stable income stream.

Priority in Assets: In case of liquidation, they might get paid back before ordinary shareholders.
No Voting Rights: Usually, they don’t get to vote on company matters.
In simpler terms:

Ordinary shares are the regular ones, with voting rights and a share in profits after other obligations are met.

Redeemable shares can be bought back by the company, giving flexibility in capital management.

Preference shares come with some special perks like fixed dividends and priority in getting money back, but no voting rights.

Question 22

what are short-term liabilities?

Answer 22

Current liabilities are a company’s short-term financial obligations: bills that are due within one year or within a normal operating cycle. Ex:

1. Accounts Payable:

Amounts owed to suppliers or vendors for goods and services purchased on credit.

2. Short-Term Debt:

Loans or borrowings that are due to be repaid within one year.

3. Accrued Liabilities:

Liabilities for expenses that have been incurred but not yet paid, such as accrued wages, accrued interest, or accrued utilities.

4.Income Taxes Payable:

Taxes that the company owes to tax authorities but has not yet paid.
Short-Term Portion of Long-Term

5. Debt:

The portion of long-term debt that is due to be repaid within the next year.

6. Dividends Payable:

Amounts declared as dividends to shareholders but not yet paid.

7. Bank Overdrafts:

Negative balances in the company’s bank accounts, indicating a short-term borrowing from the bank.

8. Customer Deposits:

Payments received in advance from customers for goods or services to be delivered in the future.

Question 23

what is Equity?

Answer 23

This is the value of the company to the company shareholders who have rights to the residual value after all prior rights have been met.

Equity = Ordinary shares + reserves.

Question 24

what is future taxation?

Answer 24

Taxes due for payment on the business’ profits later than a year from the date of the Balance Sheet. This is commonly expressed as “Corporation Tax due on ………”

Question 25

what is deferred taxation?

Answer 25

Deferred taxation is about the time differences in how money is counted for accounting and taxes. Here’s the idea: Sometimes, what a company says it earned or spent in its financial reports doesn’t match what it reports to tax authorities. This can happen because of timing issues. For example, the company might claim an expense now for accounting but only get the tax benefit later. Or, it might record income for accounting but pay taxes on it in a different time. Deferred taxation helps balance this out, making sure the company pays the right amount of taxes at the right time. It’s like a way of saying, “We’ll pay the tax for this money, just not right now.”

Question 26

what is the difference between revenue and capital expenses?

Answer 26

Revenue Expenditure:

Nature of Expense:
Revenue expenditure represents the costs incurred in the day-to-day operations of a business to maintain its earning capacity.

Timing of Benefits:
The benefits of revenue expenditure are typically enjoyed in the short term (usually within the same accounting period).

Accounting Treatment:
These expenses are fully recognized in the income statement of the period in which they are incurred. They are considered expenses because they contribute to the generation of revenue during that period.

Examples:
Routine maintenance, repair costs, wages, rent, utility bills, and other operational expenses are examples of revenue expenditures.

Capital Expenditure:

Nature of Expense:
Capital expenditure involves the acquisition or improvement of long-term assets that contribute to the company’s earning capacity over an extended period.

Timing of Benefits:
The benefits of capital expenditure are expected to be realized over several accounting periods, extending beyond the current fiscal year.

Accounting Treatment:
Unlike revenue expenditure, capital expenditure is not fully expensed in the income statement immediately. Instead, it is capitalized, meaning the cost is recorded on the balance sheet as an asset. The cost is then gradually expensed over the asset’s useful life through depreciation or amortization.

Examples:
Purchases of property, plant, and equipment (PP&E), investments in long-term projects, and significant improvements or upgrades that enhance the value of an asset are examples of capital expenditures.