Flashcards
BA3 Pt1
Cards in this deck (200)
- 1What is financial reporting?*Measuring, processing and communication of financial information*
- needs systems in place to manage this efficiently
-Can help businesses identify where money is made (helps with capitalisation/ profitability) - 2What are the types of accounting?1) Management - processing internal information to help management make decisions, budgets, investment appraisals and product/ customer analysis
2) Financial - presentation of information to external parties (banks, shareholders etc) - key is objectivity, clarity and accuracy through financial reporting - 3What are key processes for financial reporting?1) Recording of data - keeping track and organisation of transactions
2) Measurement of data - use standard and repeatable measurements. Can use accounting standards (e.g. depreciation policies). Ensures consistent reporting.
3) Presentation of data - useful and meaningful
4) Summary of data - present overriding view of financial information. Need to make efficient summaries (for financial statements) - 4What is meant by bookkeeping?*Practice of recording monetary transactions for a business at the point they occur*
- Acts as financial history of the business, needs to be precise, accurate and through
- Use of double entry bookeeping (debits and credits) - 5What is meant by stewardship?*Relationship of accountability by one person/ group for their management of resources and decision making on behalf of another (AKA principal)
*Accountant is responsible for the information and resources of the organisation they work for (accountants v. important!) - managers/ directors will provide financial information to their principal/ business owner normally in annual statements
*Accountants need to therefore act professionally and ethically - 6What is a business entity?**An organisation where goods/ services are exchanged for money- a business is an entity that regular enters into transactions that are expected to provide reward measurable in monetary terms**
*Number of different types with different rules...
(e.g. their organisational (legal) structure is different - businesses on stock market will need more stringent rules for how to present financial statements) - 7What are the different types of businesses? (profit making)PROFIT-MAKING:
1) Sole traders - one owner, wholly responsible for finances (unlimited liability for debts)
2) Partnerships - two or more owners, with common view to make profit - wholly responsible for finances (but likely has more financial resource available)
3) Limited liability companies - split into public and private liability. Officially registered and legally distinct from its owners - SEPARATE IDENTITY (considered its own person).
A) Public limited - shares sold publicly (listed on stock exchange), but don't have much day to day involvement in business (instead elect board of directors). Shareholders have capital gains/ dividends
B) Private limited - shares sold privately, fewer owners that are more closely involved in day to day running(e.g. IKEA/ Virgin) - 8What are the different types of businesses? (not profit making)1) Not for profit - no profit for owners, more centered on operating efficiently and cost effectively (charities, Government organisations, clubs and societies)
A) Public Sector - owned by state and responsible to the government (NHS)
B) Private Sector - ethical or societal benefits through their operations - 9Who uses financial reporting?**only registered companies (limited) are LEGALLY required to produce financial statements, as is for the benefit of potential/ current investors**
Reporting - summarises, measures and reports information
Statements - (e.g. SOFP), standard ways of presenting financial information - 10Who uses financial statements?CURRENT AND POTENTIAL:
1) Investors - shareholders to ensure company performance and profitability is assessed. Interest in socio-economic policies also considered (CORPORATE SOCIAL RESPONSIBILITY reports included)
2) Lenders - check whether can be paid back/ performance/ good cash position/ long term - enough asset?
3) Employees - wages, job security/ prospects and pensions (past employees)
4) Business contacts - customers/suppliers. Whether product/ service can be provided in the future/ can you be paid in future
5) Analysts/ advisors - specialists working for investors/ management. Greater technical knowledge than clients so can make decisions for clients.
6) Public - tax payers/ consumers/ interest groups - may be interested in business policies (e.g. fair trade)
7) Government - tax authorities, departments that could use information as statistics/ industry health. Legal obligation to provide the information to the tax authorities.
8) Internal users - (also management accountant role), management/ staff
9) Competitors - 11How can internal stakeholders use financial statements?1) STRATEGIC MANAGEMENT - top level - for long term plans, profitability and longevity (typically board of directors in commercial entities)
2) TACTICAL MANAGEMENT - middle level - implementation of long term plans by shorter term plans to ensure targets met, there is also a personal interest (wanting to ensure continued job security etc)
3) OPERATIONAL MANAGEMENT - lower level - day to day activities to ensure short and long term projects are met. Also have personal interest. Information may by provided in non-financial terms (e.g. hours worked/ units produced etc) - 12What is important when considering financial statements?*STATEMENTS are an insight into business workings (considers the financial position and performance)
*There are strict guidelines to ensure honest information is produced and information is standardised to allow for comparison between businesses
*Statements are often presented at AGMs of limited companies (yearly annual report) - 13What are assets?*Resources owned or controlled that provide money / to gain revenue (through sales or business operations)*
e.g. buildings, machinery/equipment, cash and products (fully made or part made - inventory)
As per conceptual framework - 'a present economic resources controlled by the entity as a result of past events' - 14What are liabilities?*Money owed to externals - the opposite of an asset. Can be seen as a debt. Always or mostly be someone elses asset
e.g. bank loan owed, mortgages on properties, payables for materials, debts
As per conceptual framework - A present obligation on the entity to transfer an economic resource as a result of past events - 15What is equity?1) Equity as shareholder funds - the amount of money owed to shareholders
2) Equity equaling net assets - accounting equation (EQUITY = total assets - total liabilities)
AKA Capital
As per conceptual framework - the residual interest in the assets of the entity after deducting all its liabilities
*Can be considered as the net amount invested by the owners that would be due to them if business activities were terminated - 16What is income?*Incoming money into a business within a set period (usually a year)
*Most commonly from sales - sales income is known as revenue
(other examples are interest/ investment payments)
As per conceptual framework - increases in assets or decreases in liabilities that result in increases in equity (other than those relating to contributions from holders of equity claim) - 17What are expenses?*Money leaving a business to help generate revenue (running costs include cost of sales, wages, rent, machinery repair, purchase of product/ raw materials)
As per conceptual framework - decreases in assets or increases in liabilities that result in decreases in equity (other than those relating to contributions from holders of equity claim) - 18What is the difference between cash and profit?DIFFERENTIATION IS IMPORTANT - the cash balance doesn't always match profit made
CASH - value of notes and coins (including bank balances) an entity has access to at any one time (amount received from customers) - accounted for based on date of reciept/ payment of cash
PROFIT - difference between amount of money company earns and the costs of the earnings (sales revenue - expenses incurred) - accounted for on accrual basis - 19What is key to financial statements?STATEMENTS organise and display the financial information of a company in a useful and understandable manner. Used by externals so must be true and fair views - information must be reliable and factually correct, with bias removed
- 20What is meant by the financial position?STATEMENT OF FINANCIAL POSITION (SOFL) - AKA the balance sheet (where assets should = liabilities + equity) - it is a representation of the accounting equation
Considers:
1) Assets
2) Liabilities
3) Equity
Includes all ledger accounts that still have balances on them (after SOPL?) :
1) Assets/ liabilities at end of a period = assets/ liabilities at the start of the next period - balance c/f and b/f
2) Net profit or loss is transferred from the SOPL to the capital account
3) If there is a drawings account, it is closed off and transferred to the capital account - 21What is the financial performance statement?STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME (AKA profit and loss account)
Considers
1) Profit
2) Expenses
3) Income
income - expenses = profit
Profit is specific for a set period of the business lifetime
*Other comprehensive income will include revalulation of property (the gain or surplus of) - 22What is the statement of changes in equity?*Shows totals and changes in shareholders equity (i.e. ownership interest) over time
*Considers opening vs closing equity values within a period
*Equity is shareholders capital in the corporate entity and comprises 1) share capital and 2) reserves
*Increases with share issue/ total comprehensive income and can decrease with dividends paid
*A summary of SOCIE is shown in the SOFP - 23What is the statement that shows liquidity performance?STATEMENT OF CASH FLOWS - considers what a buisness has done with its cash within a set period (liquidity) - where has cash gone/ come from?
includes cash incomings and outgoings from:
1) Operating activities - a company's main activity (e.g. selling products, so sales and supplier payments)
2) Investing activities - money spent on long term assets (often a negative section as high outflows of cash)
3) Financing activities - Money not from products (e.g. interest, business repaying loans)
Added to cash balance brought forward from previous year to show whether they have made or lost cash over the period/ year - 24What is meant as notes to accounts?Accompany financial statements to:
1) Explain accounting practices used
2) More detail on specific areas not included within financial statements - 25What is the accounting equation/*Essential to understanding practice of accountancy
*Assets = capital + liabilities (/ capital = assets - liabilities) - 26What is capital transactions vs revenue transactions?Capital is shareholder funds within the business - what a business owes to shareholders AKA Equity and relates to costs that will affect the entity in the long term. ASSUME this is purchase of NON-CURRENT assets therefore Capital costs/ expenses included as a non-current asset in SOFP (not an expense is SOPL)
Revenue - expenses affecting entity within current accounting period - 27What are ledger accounts?(Ledgers historically big books recording transactions - now computerised)
ACCOUNTS - an account of a businesses transactions (relating to particular customer/ business/ area of business operation/ asset/ liabilities)
LEDGER ACCOUNTS - collection of accounts and holds data needed for the accounting system to function (e.g. the NOMINAL ledger which summaries all a company's transactions for a specific period and the totals are then used in the SOFP/ SOPL) - double entry records for all transactions are kept in these accounts. - 28What are T-accounts?1) Ledger accounts are divided into debits (L-hand side) and credits (R-hand side)
2) Transactions are recorded on each side
3) Debits represent cash being received by a company
4) Credits represent cash leaving the accounts/ company - 29What is double entry bookkeeping?*There are two aspects of every monetary transaction (equal and opposite..!)
*Think DEAD CLIC:
1) debit increases in expenses, assets and drawings (money withdrawn by business owner) or decreases in liabilities
2) credit increases in liabilities, income and capital (shareholder funds) and decreases in assets - 30How would taking out a loan be reflected in double entry bookkeeping?DR - increase in asset (cash), bank account
CR - increase in liability, loan account - 31How would buying stock/inventory (in cash) be reflected in double entry bookkeeping?DR - increase in expense, purchase expense account
CR - decrease in asset, cash account
NB cash and credit transactions recorded slightly differently.
Inventory is hold for sale as part of business operation - 32What is the need for documentation?*Documented evidence is needed for every single business transaction (e.g. receipts)
*There will generally be chains of documentation for each transaction, although different businesses use different documentation chains
*Supporting documentation should confirm that a transaction has taken place and when as well as the value of the transaction - 33What is a typical example of a documentation chain?1) Quotation
2) Purchase order
3) Sales order
4) Goods dispatched notes
5) Goods receipt notes
6) Invoice
7) Remittance advice
8) Credit notes
9) Debit notes
10) Statements
11) Receipts - 34What are quotations?1) Issued by seller to purchaser
2) Details the price of goods for the customer before the product is purchased
REQUIRES: quantity/ description/ details of goods required - 35What are purchase orders?1) Document detailing a purchase request from the customer to the supplier as a request to supply
2) Contains information including price, goods/ quantity/ supplier details, T&Cs of delivery - 36What are sales orders?1) Documents the sale from the seller's perspective
2) Confirms order has been received and seller is willing to fulfill it
3) Similar information documented as a purchase order
4) Copy can sometimes be sent to the customer with the products (e.g. a proforma invoice)
5) The company will put this in their system and could be sent to stores/ warehouse to process the order - 37What are goods dispatched notes (GDN)?1) Documentation confirming all items have been dispatched and tends to arrive before the item does
2) Allows customer to confirm order is correct (tends to be sent via email)
CONTAINS: Details of supplier, quantity and description of goods - 38What are goods received notes (GRN)?1) Where buyer sends note to supplier to confirm goods ordered have been received - matched with GDN from supplier and the PO
- 39What is an invoice?1) A supplier's request for payment (after customer has received goods)
2) For a supplier selling the goods/ services, this is treated as a sales invoice. For the customer receiving the goods/ services it is a purchase invoice
INCLUDES: customer details (name/ address etc) and details of the goods inc. cost breakdown tax etc.) - 40What is remittance advice?1) Follows invoice - a letter to suppliers to confirm invoice has been received and invoice has been paid
CONTAINS: Method of payment/ invoice number/ account number/ date etc.
(also identifies any settlement discounts deducted) - 41What are credit notes?1) Issued by supplier if order cannot be fulfilled or goods are faulty/incorrect
2) Reassurance of a refund - 42What are debit notes?1) Counterpart to a credit note confirming its receipt by a customer
- 43What are statements?1) Purchaser receives a statement breaking down what is owed from the supplier (following deduction of refunds as an adjustment)
*can be checked with other documents to ensure correct amount showing
*includes details such as details of supplier, date, invoice numbers, values, payments made, refunds, amounts owed - 44What are receipts?1) Selling company confirming payment has been received
- 45What are benefits of accounting systems?1) Ease of access - transaction information is easily accessible (where 10000000s) and increases efficiency and decision making. Results in systematic recording and presentation of financial data
2) Relevant information for decision making - from stored transaction details (e.g. resolving discrepancies within bank balances)
3) Help in the preparation of financial statements - ledgers reviewed and closed off after particular periods. The balance is then the total amount attributed to that account at the end of the period. If debits and credits balance the ledger is correct. A correctly balanced account/ledgers can easily be turned into the financial statements - 46What is the importance of the bookkeeping process*Ensures transactions are never entered directly into the nominal ledger/ financial statements to ensure that if errors occur they are picked up early due to number of stages/ opportunity for review
*It is very difficult to rectify errors in the nominal ledger - 47What are daybooks?*During bookkeeping process, transactions are entered AS THEY HAPPEN into daybooks first which are smaller
*information eventually transferred to nominal ledger (totals not individual transactions) - 48What are key ledgers?*Ledgers used on top of daybooks outside of bookkeeping process to help work out :
1) PURCHASE LEDGER - work out money owed to suppliers (all payable accounts)
2) SALES LEDGER - money owed by customers (all receivables accounts)
3) CASH BOOK - bank and cash accounts (also could have separate petty cash book)
4) NOMINAL LEDGER - AKA general ledger, all other accounts
These totals will then be added into the nominal ledger - 49What is meant by a trial balance?*Compiled at end of the accounting year and takes totals from nominal ledger and ensures these are correct before inputting into financial statement (ensures debits and credits are balanced)
- 50What is the bookkeeping process?1) Transactions recorded in daybooks
2) If sales or purchases transactions also noted in purchase/ sales ledgers (exists outside of bookkeeping/ double entry, so no corresponding debits/ credits)
3) Totals of daybooks added to nominal ledger - check there's no errors - reconcile with purchase/ sales ledgers
4) Construct trial balance from totals in nominal ledger - shouldn't be any errors!
5) End result is the financial statements (for set financial period (annual)) - 51What are books of prime entry?AKA daybook
*The first place that transactions are recorded after they occur (in sequential order) - periodically totalled
*Daybooks are split into certain groups
*At the end of set periods (e.g. a year) daybooks are totaled and entered into the nominal ledger (double entry accounting system)
*List/ summary of all transactions - does not form part of double entry bookkeeping - 52What types of daybook/ books of prime entry can you use?1) Sales - records goods sold on CREDIT
2) Purchases - goods purchased on CREDIT
3) Returns inward - returns on goods sold to customers on credit (AKA sales returns) - offset against sales income for gross profit
4) Returns outward - returns of purchased goods to suppliers on credit (AKA purchase returns) - offset against purchases for gross profit
5) Cash book - money in/ out of bank
6) Petty cash book - small cash payments
7) Journal - records unusual items/ errors that have occurred and are corrected by the company (e.g. bad debt write off/ accruals/ depreciation charges) - all transactions not recorded elsewhere - 53What are key features of a daybook transaction entry?1) Date - date transaction takes place
2) Doc no. transaction number within a particular daybook
3) Details - could include details of supplier/ customer
4) Value - of transaction (not including TAX)
5) Total value - value + sales tax - 54What is the importance of coding?*Individual companies have their own system for coding
GOOD CODING SYSTEMS NEED
1) To be meaningful (e.g. all customer codes could start with 'C')
2) Unique - all customers/ suppliers/ transaction numbers need to be unique
3) Clear (and useful!) - coding should be efficient and bear some relation to what they are
4) Should be standard size - e.g. 5 digits
5) Should be self-checking - e.g. if all codes are 5 digits, if you had one with 8 digits it would be rejected
6) Be future proof (expandable) - enough digits to allow for number
7) Be compact - balance between enough information and compact enough - 55Why are purchase/ sales ledgers important?FOR TRANSACTIONS ON CREDIT
NOT SUBJECT TO DOUBLE ENTRY (only one entry per transaction)
1) Keeps an eye on who owes what/ what is owed to who
2) Important that individual accounts are kept for each customer/ company (within each ledger it is split into each customer) - 56How are purchase/ sales ledgers constructed?USES T ACCOUNT DEAD CLIC PRINCIPLES (but is not double entry)
1) Date - of transaction
2) Daybook reference - taken from the daybook entry
NB: for purchase ledger - credit liability side from purchases daybook/ debit liability from returns outwards daybook
NB: for sales ledger - debit increase in asseets (take from the credit sales daybook), credit decrease in asset (take from the returns inwards daybook) - 57What are cash books?*A record of cash transactions (those made from a company's bank account).
Totals taken to the Bank Account in the nominal ledger (cash receipts an increase asset, so debited in bank account in nominal ledger/ cash payments are a reduction in asset so credit entries)
Headings in the cash book would be:
1) Date - listed by date
2) Details - e.g. customer/ supplier name
3) Receipts - value of
4) Payments - value of
5) Discounts - value of
6) Total - taken to bank account in nominal ledger
NB can also be used to record early settlement/ prompt payment discounts - 58What is the petty cash book?*For small monetary transactions (e.g. tea/ coffee purchases, a tin with some coins)
*Works on an imprest system - this sets out a predetermined balance which must be adhered to (and is topped up at the end of a period)
*Reciepts/ petty cash vouchers act as payment evidence (e.g. to prevent staff stealing from the tin)
*The book layout is identical to the cash book - 59How is information in daybooks converted to the nominal ledger?*Totals (not each individual entry) in each daybook transferred at end of the period (annual)
*Nominal ledger works on a system of double entry so both aspects of a transaction need recording - 60How are sales and tax shown in the nominal ledger?E.g:
1) Sales account - sales are an income, so credit. Debit any returns.
2) Tax - are an increased liability (payable as tax), so credit. Debit any returns.
3) Receivables - acts as a sales ledger control account, this is the debit side in the double entry system for sales and tax accounts. Credit any returns. - 61How are payables and tax shown in the nominal ledger?E.g:
1) Payables account - payables are an increase in expense, so debit. Credit any returns.
2) Tax - tax on purchases are an asset, so debit. Credit any returns.
3) Payables - acts as a purchase ledger control account, this is the credit side in the double entry system for purchases and tax accounts (as increases liabilities). Debit any returns. - 62What is key to reconciliation with the nominal ledger?*Purchases and sales ledgers can be reconciled with the nominal ledger to ensure that transactions have been correctly recorded within the period
*This provides reassurance against errors that may have occurred, especially if many transactions have occurred - 63What is meant by 'balancing the books'?*To ensure debits and credits add to the same amount - ensures every transaction is properly accounted for
*Need to consider any balances brought forward - 64What is important to note with inventory accounts?Inventory accounts only deal with opening and closing inventory figures - don't need to make adjustments every time we sell/ purchase inventory
*You should NEVER use inventory account for purchases/sales (only ever used at beginning and end of a period)
*At the end of an accounting period the value of inventory at the start of the period is transferred into statement of profit or loss by crediting the inventory account and debiting the statement of profit or loss - 65How would paying off part of a loan be shown in t accounts?CR - bank account
DR - loan account - 66How would paying staff wages be shown in t accounts?CR - bank account
DR - admin expenses/ wages - 67How would receiving interest from the bank be shown in t accounts?CR - Other income (interest earned) account
DR - bank account - 68How would paying bills be shown in t accounts?CR - bank account (decreasing asset)
DR - admin expenses (increase in expense) - 69How can asset accounts be balanced?*Nominal ledger accounts are summarised and balanced at the end of a set time
*Asset accounts need to be balanced (bank, receivables, property etc), with the balances carried forwards calculated
1) Calculate the balance
2) Enter the balance carried down
3) Total up each side - including consideration to balance c/d (a check)
4) Enter balance brought down
5) Ensure debits are assets and credits are liabilities or capital - 70How can we calculate the balance of a t account?BALANCE = TOTAL DEBITS - TOTAL CREDITS
- 71What is meant by the balance 'carried down'?To make both sides of account balance - carry this balance down to the next accounting period
Consider which side has the higher total balance and use the balance carried down figure to balance the two accounts in line with the higher of the two sides
Carry balance down diagonally and call it balance brought forward - 72What is meant by the balance 'brought down'?Essentially the balance to be taken forward in the next set of accounts (for that specific account) (to be the balance carried forward)
- 73How can you ensure debits are assets and credits are liabilities or capital when balancing asset accounts?*To ensure no errors made and all transactions recorded correctly
*Cash in the bank is an asset and is therefore recorded as a debit
*If a negative bank balance is found, this would be a debt (liability) and would have been credited - 74What is key to the capital account when balancing accounts?*Capital accounts is different as it represents money owed to shareholders as a result of profit or loss - DOESN'T SHOW ASSETS OR LIABILITIES
- 75How can income and expense accounts be totaled?NB: Income and expense accounts differ from asset/liability accounts as these are used to create income statement to determine profit/ loss
*ACCOUNTS RELATE TO ONE PERIOD AND TOTALS ARE NOT CARRIED FORWARDS - they record transactions on a period by period basis*
1) Total each account (e.g. purchase expenses, sales, other income (interest earned), admin expenses)
2) Find cost of sales & inventory
3) Cost of sales account needs debits from inventory and purchase expense account
4) cost of sales account needs credit figure from inventory
5) total debits and credits to calculate amount carried down
6) Calculate balance brought down in inventories (balance c/f in next period for inventory) - 76How can cost of sales be calculated?(opening inventories + purchases) - closing inventories
NB cost of sales is an expense on the income statement (forms part of the income statement) - 77What is a trial balance?Summary of company's accounts created before financial statements
Intermediary between nominal ledgers and financial statements
Ensures:
1) Accounts are balanced/ identify if they are not - the total of all the accounts with debit balances (assets/ expenses) should equal the total of all accounts with credit balances (liabilities, capital or income) - drawings represent a reduction in capital
2) a balanced summary makes it easier to input figures into financial statements
TRIAL BALANCE = total of balanced and totaled ledger accounts
NB errors are still possible if DR = CR however reassurance that transactions have been treated correctly if balances - 78How are income and expense accounts dealt with at the end of a period?*Transactions are not carried forward
*Accounts are closed off, emptied and balances are taken to a the ledger account "statement of profit or loss"
*New double entries are then to the 1) income statement and 2) statement of profit or loss
*There is no balance c/d, b/f - the balancing figure is put on the smaller side labelled profit or loss - 79What is shown in the statement of profit and loss (AKA INCOME STATEMENT)?CR side - total of income (inflow of economic benefits)
DR - total of expenses (outflow of economic benefits)
*Balancing figure also added - profit (taken to capital)*
Balancing figure indicates profit or loss - balancing figure on DR side is a profit and on the CR side is a loss
Income - Expenses = profit (or loss)
Two parts: 1) trading account - used to calculate gross profit and 2) profit or loss account to calculate net profit - 80How is income transferred to the capital account?Capital account shows money owed to shareholders - equity is shareholders funds
Total profit is transferred from the income statement account into the capital accounts
**Increase in capital is a CR - any profit is on CR side**
*This stage can be checked by updating the trial balance and removing income and expense accounts - 81How can the SOPL (income statement) be created?Income statement calculates profit or loss within a given period - subtracts sales and expenses from income (AKA SPoL)
Derived from statement of profit or loss - summarises this T account in a table gives the income statement:
1) take sales revenue generated
2) subtract cost of sales (AKA cost of goofs sold - direct costs)
3) This gives gross profit (profit made directly from selling the product/ service - costs of the unused inventory should not be included in this figure)
4) add other income
5) subtract other expenses
6) this then gives net profit - profit after any other income/ expenses - 82What is the trading account?*Can be produced from the SOPL (income statement)
*Adds inventory and purchases to the top half of the income statement
*Presents how cost of sales is calculated as part of the income statement
1) take sales
2) less cost of sales (opening inventories + purchases - closing inventories)
3) calculate gross profit
(IT IS A SUBSECTION OF THE STATEMENT OF PROFIT OR LOSS)
NB Manufacturing companies still have a trading account which brings together opening inventory of finished goods + costs of goods manufactured less closing inventory of finished goods - 83What is the statement of financial position?*Based on principles of the accounting equation which can be used to create SoFP
*Lists all business's assets liability and equity balances
1) Take final trial balance and then show assets and liabilities in table form, organised by assets (top half), liabilities and capital (bottom half)
(without income/ expenses as these are closed)
2) Top and bottom half should match, (i.e. balance sheet) - a final test for recording accuracy
*Assets and liabilities are split into current and non-current assets
(Can be horizontal where it shows balance as if a set of scales or vertical, where assets are listed first and totalled before capital + liabilities are listed) - 84What are non-current assets/ liabilities?Those due to be paid off in more than one year
e.g. buildings, property, plant and equipment (assets)/ loans (liabilities) - 85What are current assets and liabilities?Due to be paid off within the year
e.g. receivables (assets)/ payables (liabilities) - 86How is statement in changes in equity generated?*Changes in shareholder's equity over time*
Includes:
1) balance b/f
2) income for the period - changes in equity (e.g. profit)
3) dividends paid - also a change in equity
4) balance c/f
Balance b/f could be split into 1) share capital, 2) share premium, 3) retained earning
(IF A COMPANY HAS A STATEMENT OF CHANGES IN EQUITY - will be limited as has shareholders paid via dividends) - 87What is share capital?- Shares will have a nominal value (e.g. £1) - share capital is then based on this nominal value
- 88What is share premium?This is the extra paid on top of the share capital (the share nominal value)
- 89What is meant by reserves?Items on both the statement of changes in equity and statement of financial position
1) Capital reserves - share capital/ premium- owners pay this capital into a business. Cannot be distributed as dividends. e.g. share premium
1a) Revaluation reserve - changes in capital when assets are revalued (form of capital reserve)
2) Revenue reserves (retained earnings) - earnings not paid out to owners or shareholders (aren't necessarily cash sums - can be in the equity section of financial position) available for payment of dividends if decided - 90When is double entry used?In nominal ledger (not in daybooks/ individual sales/ purchases ledgers)
- 91What are the methods of transaction?*Applicable to businesses/ individuals*
1) Cheques
2) BACS
3) Direct debits
4) Bank initiated transactions - 92What are key points of cheques?*Written by a drawer to pay a payee
*Cheque payee holds is worthless without it being paid into the bank (this brings in the monetary value)
*Bank checks drawers account for funds in place and then draws for the payee
*Cheques clear unless there are insufficient funds which will write of the cheque as being 'dishonored' - 93What are key points to BACS?Banker's Automated Clearing System
*Faster than cheques - transfers are immediate
*List of automated payments provided to bank at specific time
*Downside - can only be used for one off transactions - 94What are key points of direct debits?(AKA Standing Order)
*similar to BACS - automatic payment with immediate transfers
*totally automatic in nature - payments can be scheduled indefinitely/ term of standing order - 95What are key points of bank-initiated transactions?*Transactions the bank will make on its own for charges incurred using their services
(e.g. overdraft fees/ account maintenance fees) - 96What are the different account types?DEAD CLIC - key to understanding double entry transactions:
*Assets and liabilities easy to distinguish - 97What DEAD (of DEAD CLIC) accounts are there?D - debit an increase in:
1) Expense accounts e.g. purchase of stock/ payments for rent (administrations/ office supplies)
2) Asset accounts - company owns with monetary value (inventory/ buildings/ cars/ cash (PPE - plant, property etc.) etc)
3) Drawings - money taken out of business from its owners - 98What CLIC (of DEAD CLIC) accounts are there?C - credit and increase in:
1) Liabilities - money company owes to others (e.g. payables account/ bank loans)
2) Income - money coming into business from goods/ services (e.g. sales account/ interest)
3) Capital - money invested by or due to owners (e.g. if company's owner injects money into business/ retained earnings (cash business owns not paid out to shareholders/ owners e.g. an increase in profit) - 99How are discounts recorded in accounts?*Reduction in price of product or service*
- can be offered or received-
1) TRADE DISCOUNTS - discounts on products to be some on (e.g. newspapers at corner shop) - net value AFTER discount applied is recorded in company's account - e.g. £300 if product is £400 with 25% off
2) CASH DISCOUNTS - discounts applying for a limited time, encourages cash payments at time of sale (rather than a credit sale) - essentially encourages businesses to pay at point of sale. Often taken after original transactions booked so might need extra transactions to remove any credit purchase made first.
Income from discounts received is included in P&L immediately after gross profit and before expenses incurred - 100How is a trade discount recorded?1) If you are the one purchasing something at discount to pass onto customers:
*Increased expense, so debit purchase expense account
*Credit the amount to complete the double entry (e.g. if paid on credit, this is increasing liability)
2) If you are the supplier giving the discount
*Owed money, so increase in asset - DEBIT receivables account
*The increased income is a CREDIT - use sales account - 101How is a cash discount recorded (AKA SETTLEMENT OR PROMPT PAYMENT DISCOUNT - DISCOUNT ALLOWED)?1) If you are the one purchasing something at discount to pass onto customers: you have a decrease in asset (CR) in the bank account. Reduction in liability is a debit (if already put in a transaction to make on credit). DISCOUNTS RECEIVED should be recorded as a memorandum item in cash payments book
2) If you are the supplier giving the discount - discount allowed amount will be considered an expense (debit) (a reduction in revenue)
NB - if goods are sold with a trade discount as well as an offer of a settlement discount, the trade discount must be applied first - 102What is sales tax?*Most items have a sales tax included - in the UK, most items have VAT included in the item price
*In US sales tax added onto the bill when the transaction is made
*Businesses pay on purchases and receive from sales - tax received goes directly to taxation authorities
*Sales taxes are indirect taxes and are not directly deducted from income
*Business likely needs to register with tax authority, if non-registered (smaller companies), they will not be allowed to add sales tax or claim sales tax on purchases - 103How can sales tax be calculated?*Final amount of tax = price before tax times 1+tax rate
*Sales value before tax = amount after tax/ 1+ tax rate - 104What is tax reclaimable on purchases?*Where registered businesses may have paid sales tax on purchases can be reclaimed (e.g. buying a bike from supplier to sell on)
*Businesses will keep track what they owe and what they are owed - transactions tend to offset eachother so a net amount is either reclaimed or owed to authorities - 105What is output tax?*Tax a company receives from its customers*
*A registered entity will charge its customers for goods and services supplied + sales tax (this is a liability to be paid to the tax authorities)
(paid out of business to a government as tax received from sales) - 106What is input tax?*Tax companies pay suppliers*
Incurring sales tax on goods/ services that it buys from other registered entities (it is recoverable)
Tax coming into company (from authorities) when reclaim from these purchases
Input tax can be offset against output tax collected with the net amount collected from the tax authority - 107How is sales tax accounted for?*Value of goods recorded separately from the tax - cost of goods used in income statement and if includes tax could impact profit/ loss*
1) Calculate trade discount rate
2) Find sales tax amount (on any discounted amount)
3) Record amount of cash leaving bank account (or credit for liabilities), splitting stock and the tax. For the product, debit the purchase expense and credit bank. Sales tax account is an asset account (owed to authorities) - so debit sales tax and credit bank account
INPUT AND OUTPUT SALES TAX ARE IN SEPARATE LEDGER ACCOUNTS - 108What happens to transactions with sales tax when a product is purchased from the company?1) Calculate amount paid including sales tax
2) debit bank account the sales and sales tax separately (DR increased assets)
3) Credit the sales account with the relevant amount (double entry - increased income)
4) Credit the sales tax account (double entry as the transaction is a decrease in tax assets)
(show sales tax seperately - expenses and sales are posted net) - 109What happens if there is a debit account balance in the sales tax account at the end of a given period?(Difference between debit and credit entries ,with higher debit balance) - company has tax reclaimable from the tax authorities
- 110What is meant by non-account assets and expenses?*Companies are able to reclaim tax on long term assets (not just limited to short term, current assets)
*There are regional exceptions - e.g. in the UK entertainment expenses are exempt from tax reclamation (e.g. cannot reclaim for a staff party) or in the UK passenger cars
*Any supplier cost should therefore cannot be reclaimed - 111What are tax returns?Summary of a companies tax position over time
Submitted to tax authorities who check taxes paid and received (these are listed separately) - 112What happens to businesses that are non registered for tax exemptions?Small businesses that are not registered don't charge sales tax for purchases but cannot claim sales tax for purchases (input tax)
These businesses won't separate out tax in a separate sales tax T-account and will just use the +tax amount in their accounts - 113What are zero rated / exempt supplies?Some goods for which businesses don't have to charge sales tax, but can reclaim tax refunds from purchases of products from wholesaler (input tax)
(e.g. books - 0% rate)
Some products exempt all together (e.g. private healthcare) - 114What is corporation tax?*Tax corporate entities pay on taxable profits (for sole traders, tax is a personal expense)
*Tax needs to be shown in financial statements for limited companies - tax expense and liability accounts needed (NB for sole trader tax is a personal expense) - 115What is meant by tax estimates?Where payments don't relate to the accounting periods in which they are made - very applicable to tax returns
Delays from submission of tax returns to final tax value, but financial statements need to show tax.
There are therefore two elements of tax charges in accounts:
1) Tax payable for current accounting period - amount submitted in tax return (not yet clarified by tax authority)
2) Adjustments for previous periods - differences between estimate submitted in tax return and the final tax amount clarified by tax authority - 116How can the two elements of tax charge be shown in a company's accounts?1) Taxation expense account - DR coropration tax to tax expense account - closed off and sent to statement of financial postition.
2) Taxation liability account -This can be a debit or credit depending on business owing or owed tax
*At the end of each year an estimate is made by the entity for the taxation liability and an accrual is made as above - 117How do adjustments in the tax accounts get made?*If an amount is owed to the tax authorities, debit the increase in expense in tax expense account - close this off at year end and put in income statement (profit and loss account)
*CR a tax liability on the statement of financial position
*If actual final tax payable is higher than the estimate for Yr 1, adjustments in Yr 2 need to be made with the difference - 118What are assumptions of accounting?*Accounting is based on underlying assumptions - principles upon which financial statements and conceptual frameworks are based on*
1) Materiality
2) Going concern
3) Accrual basis
4) Substance over form
5) Business entity convention
6) Prudence
7) Consistency convention
8) Fair presentation
9) Historic cost convention
10) Money measurement convention
11) Stable monetary unit convention
12) Dual aspect convention - 119What is mean by materiality concept as an assumption of accounting?Only including relevant information in the financial statement (items less than 5% of net profit considered immaterial) - if omission meant there would be a different judgement made, it would need to be considered (rounding etc needs to be considered as do summaries)
(e.g. a company doesn't need to include accounting for storage boxes as a net asset) - 120What is mean by going concern concept as an assumption of accounting?Assumption that a business will continue activities at similar level for the foreseeable future - if not financial statements need to reflect this so as not to mislead users
- business situation needs to be disclosed in the accounts - 121What is meant by accrual basis as an assumption of accounting?*Transactions are matched to the period they occur in, not when cash is paid or received
*Everything related to a specific transaction should be recorded in the same period - 122What is meant by substance over form as an assumption of accounting?Transactions in accounts reflect true economic realities, even overriding legal form
e.g. leasing a warehouse, but treat as an asset that is owned in financial records - 123What is meant by business entity convention as an assumption of accounting?*Separates a business from the individuals involved in it (e.g. Ltd company is different to its shareholders and staff - accounts prepared independently) - fair representation of business made
*Accounts for sole traders will be prepared differently - 124What is meant by prudence as an assumption of accounting?PRUDENCE CONCEPT
Fair presentation of a company's accounts - being realistic (or slightly pessimistic) is preferred - e.g. bad debts should be shown in the accounts immediately
-assets should not be overvalued, liabilities not undervalued
- revenue and assets should not be recognised unless they can be reliably measured and it is probable future economic benefits will be received
*Investors should be prepared for a worst case scenario - 125What is meant by the consistency convention (concept) as an assumption of accounting?*Ensures items are treated consistently between accounting periods (e.g. keep same policy for depreciation of assets)
- 126What is meant by the fair presentation as an assumption of accounting?Financial statements should be a fair presentation of the financial performance, position and cash flows of a company
(ensures readers fully understand transactions which have occured)
These should follow international Financial Reporting Standards to ensure fair presentation - 127What is meant by the historic cost convention as an assumption of accounting?Price of assets are shown as nominal (original) costs
(even if resale value increases or decreases) - original cost should include any costs for getting the asset (e.g. piece of machinery) to its current location/condition - 128What is meant by the money measurement convention as an assumption of accounting?*Items should only be included in financial statements IF the item can be reliable measured in monetary terms
*e.g. ownership of a brand can be hard to reliably value in a monetary sense so would not be included in the financial statement - 129What is meant by the stable monetary unit convention as an assumption of accounting?Assumption that monetary units are stable and dependable - essentially inflation can be ignored
- 130What is meant by the dual aspect convention as an assumption of accounting?Underlies practice of double entry bookkeeping - every transaction should have two aspects to be recorded (in the DR and CR)
- 131What is the regulatory framework?UNDERLINES FINANCIAL REPORTING
Financial reporting is process of using financial statements to convey information to potential investors
STRICTLY REGULATED TO ENSURE CONSISTENCY/ COMPARABILITY
*Achieved by accounting standards (which can vary globally)
*IAS 1 - Presentation of Financial Statements provides guidelines for financial statements - 132What are conceptual frameworks?Details broad accounting principles to develop accounting standards occurs from this point
- 133What are reporting issues dealt with by the conceptual framework?1) Objectives and users of financial statements
2) Useful characteristics of information
3) Basic elements of financial statements (assets, equity etc)
4) Recognition and measurement of transactions
(*Specific rules for areas like this are then created with the frameworks in mind*) - 134What are local regulatory frameworks (national accounting standards)?*Govern accounting practices for companies within specific country, considering typically:
1) Accounting requirements of national law (e.g. Companies Act in UK, which includes guidance on corporate governance, auditor liability, preparing and submitting financial statements etc)
2) Accounting standards applying in local jurisdictions (e.g GAAP in the UK - Generally Accepted Accounting Practice)
3) Accounting requirements of a country's stock exchange e.g. UK companies must follow IFRSs
4) Professional accounting bodies usually have some form of recognition as a supervisory/ regulatory body with authorisation to issue/ revise accounting standards - 135What international regulations need to be abided by?*International regulations need to be abided by on top of any local dimensions of regulation:
1) Requirements of relevant international bodies
2) International Financial Reporting Standards (IFRS), International Accounting Standards (IAS)
3) A conceptual framework developed on an international level
NB use of international standards between countries does vary between countries - international trade is easier if everyone follows consistent rules (adopting the standards is hard, so gradual approach taken) - 136Why is there a gradual approach to international convergence of regulations?*Can take time to implement in countries not already following international standards
*Process of transition / adaptation required and expected
*Harmonisation needed to ensure reports can be compared and conclusions drawn
*International standards have benefits including consistency, but can also cause issues between international standards and the traditions. development of an individual country - 137What is GAAP?Generally Accepted Accounting Practice
*In any given country there are generally agreed approaches to accounting - GAAP employed to describe specific accounting rules, procedures and practices in a certain country
*GAAP is therefore relevant to a particular jurisdiction (e.g. UK) and varies between countries - 138What is the International Accounting Standards Board?Responsible for:
1) Setting standards
2) Implementing standards
3) Enforcing standards
IFRS Foundation is essentially a board of directors for a number of regulatory bodies:
1) International Accounting Standards Board (IASB)
2) IFRS Interpretations committee
3) IFRS Advisory Council - 139What is the IFRS Foundation?International Financial Reporting Standards
*Essentially a 'board of directors' who oversee all other bodies
*Standards are global standards
*IFRS Foundation has ultimate responsibility for developing standards to ensure financial statements are clear and easily comparable to other companies - 140What are the core objectives of the IFRS Foundation?1) Developing a single set of reporting standards based on clear principles that are high quality, enforceable and globally accepted
2) To promote usage and rigorous application of standards
3) In fulfilling the above, to take account of diverse range of economic settings the standards are put onto (e.g. consider there are many sizes of business operating in many markets) - standards should not be restrictive
4) To promote and facilitate the adoption of IFRS (rather than individual countries) - 141Who makes up the IFRS Foundation?1) TRUSTEES - 22 people responsible for appointing members to other bodies/ subsidiary boards. Need to be geographically adverse (certain numbers from EU/ USA/ China etc). Should also represent interested groups (e.g. accountancy firms/ academics etc.). They are not involved with technical matters/ setting the standards
- 142How is the IFRS Foundation funded?From:
1) International Federation of Accountants (IFAC)
2) Professional accountancy organisations (e.g. CIMA/ ACCA)
3) Financial institutions/ accountancy firms - 143What is the International Accounting Standards Boards (IASB)?*Responsible for developing and managing the international accounting standards
*Issue exposure draft for public comment
*Prepare and publish the IFRS Standards/ Framework
*Approves the interpretations from the interpretation committee
*Communicate directly with national accounting standards boards to try and get everyone to follow the international standards - 144What is the difference between IAS and IFRS?IAS - International Accounting Standards - are the old accounting standards under previous financial regulation and are adopted by the IASB
IFRS - current system of preparing accounting standards
Can be interchangably used and IFRS assumes IFRS reports and IAS reports - 145What is the IFRS Interpretations Committee (IFRS IC)?*Role is to deal with the different interpretations of different standards
*Issue guidance in the context of particular standards
*Promotes a more uniform application of standards
*Essentially a quality control to ensure consistent and correct application of the standards removes any potential ambiguity/ errors in using the standards
*meetings are open to the public
(standards are very technical to apply interntionally!) - 146What is the IFRS Interpretations Committee procedure?1) Issue draft interpretation to the public for comment
2) 12 voting members take a decision on finalising the interpretation
3) If 3 or fewer voting members oppose, it goes forward to the IASB
4) Once IASB approval met, interpretations are published and must be adhered to - 147What is the IFRS Advisory Council (IFRS AC)?*Have at least 30 members who serve for at least 3 years
*Provides link betweeen IASB and the wider public
*Communicates to the IASB of the wider view on projects or revised standards
*Advises the IASB projects and priorities that need to be addressed - 148What is the importance of quantitative characteristics of financial information?*Ensures standards can be applied globally
*IASB provides 6 qualitative characteristics of financial information:
FUNDAMENTAL:
1) Relevane
2) Faithful representation
ENHANCING:
3) Verifiability
4) Understandability
5) Comparability
6) Timeliness
(also needs to be cost effective and enable recipient to make effective decisions) - 149What regulations does 'understandability' as a Qualitative Characteristic of financial Information cover?Information within financial statements needs to be easy for the user to interpret
A level of user understanding is however assumed - complex information can be included if necessary to aid understanding of financial position of the company - 150What regulations does 'relevance' as a Qualitative Characteristic of financial Information cover?Information must be relevant to users of the statements - must help users make investment/ other economic decisions
To aid fair judgement of current and future of the company
Information also needs to be complete
(NB materiality is an aspect of relevance and depends on the size of the size of the item - information is material if its omission could influence the economic decision taken) - 151What regulations does 'faithful representation' as a Qualitative Characteristic of financial Information cover?Information in financial statements must be reliable
Information should not have any errors or biased assumptions - be neutral
Present information in accordance with their substance/ economic reality and not merely in the legal form
*Information must be complete, neutral (no bias) and free from error (within bounds of materiality) - 152What regulations does 'comparability' as a Qualitative Characteristic of financial Information cover?Investors deciding to invest must be able to compare the financial performance of different companies and of the same company over different time periods
When comparing different companies the financial policies used to prepare statements must be explained to allow for comparison and appropriate conclusions to be drawn
Should really account for things in the same way year on year to allow for these comparisons (where this makes sense) - 153What regulations does 'verifiability' as a Qualitative Characteristic of financial Information cover?Helps to ensure users the information provided shows what it claims to show
Must be verified by an external source (e.g. audit) - could be direct (cash counting) or indirect (checking inputs to a model etc)
Financial information should be supported by real evidence e.g. invoices/ receipts which can be checked to ensure reliability - information should be faithfully represented - 154What regulations does 'timeliness' as a Qualitative Characteristic of financial Information cover?Information should be provided to decision makers in time for them to make their decisions - if late it might loose value to decision makers
- 155What is the role of governance and financial reporting?*Management/ Directors play a key role in adhering to financial regulation and are ultimately responsible*
SOLE TRADERS/ PARTNERSHIPS - it is the owners responsbility to regulate accounts
LTD COMPANIES - Managers mange on behalf of company owners and need to work in the best interests (STEWARDSHIP FUNCTION - where need to ensure assets maintained, procedures in place, accounting systems are effective, expenditure is controlled and statements provided in line with legislation/ accounting standards etc) - 156What is key to accruals and prepayments?*Items are not accounted for when they are billed - accounted for when they are used
*Accrued expenses - goods and services received but not yet paid for (short term, current liabilities on the financial statement)
*Prepayments are goods/ services paid for but not yet received (e.g. rent in advance) - short term assets as amounts are not yet cashed in on - 157How are accruals/ prepayments accounted for?*Businesses tend to make estimates of accruals when accounting
*For prepayments payments are broken down over a period of time and assumed to be evenly spread (e.g. if insurance is normally £12k per year, can charge £1k per month to the expense account - 158What is meant by matching concept?*Accounting for expenses when they occur, regardless of when payment is due
*Considers the basis upon which income and expenses are recognised (realisation concept) in the statement of profit or loss
*Income recognised when it has been earnt (not when cash received) expenses when they are incurred not when supplier is paid - 159How are accruals/ prepayments recorded?*In accruals account, consider liability of previous bill yet to be charged to CR the accruals as a 'balance b/d' figure
*In accruals account the charge for the bill is then added DR in accounts with the double entry in the CR of the expense account
*Consider the year end accrual from previous bills (e.g. if done in quarters). In the expense account put a DR entry of the year end accrual - 160How can income be accrued?ACCRUED INCOME - MONEY EARNED BUT NOT YET RECEIVED
*Therefore record income in SOPL and create asset in SOFP
DR - accrued income account (SOFP)
CR - income account (SOPL)
ACCOUNTING FOR ACCRUED INCOME INCREASES PROFIT - 161How can income be prepaid?INCOME RECEIVED BUT NOT YET EARNED
e.g. if end of period it has earned 12 months rent, but paid for 13 months
*Therefore, remove this excess income from the SOPL for the current year and create a corresponding liability within liabilities of SOFP
DR - income account (SOPL)
CR - prepaid income (SOFP)
ACCOUNTING FOR PREPAID INCOME THEREFORE REDUCES PROFIT - 162What is key about employee pay?*All companies pay employees wages/ salaries, but these are subject to various taxes
*Workers may also opt into voluntary expenses (pensions/ cycle to work etc)
*GROSS EARNINGS - amount before any deductions made (deductions include income tax which is normally a percentage over a threshold)
*NET PAY - amount recorded in employer's ledgers - 163How is employee pay shown in accounts?It is the NET PAY that is shown in accounts
*Wages - an expense account, so DR the wages payable account, the corresponding double entry is an increase in liabilities to staff so CR in wages payable (expense in the SOPL)
*Not all net pay goes to employee, so we DR tin the wages payable account tax etc as these are reductions in liabilities to the employee - to double entry CR tax payable/ pension schemes/ cycle to work scheme accounts (these are paid over to the government etc) - 164Once deductions made, what is key to do with the wages payable account?CLOSE IT OFF
1) calculate balance c/d - (this is essentially the amount paid to the employee) - 165What are bad debts?*Credit/ payment plans encourage buy now/ pay later - this does mean there is some uncertainty whether the debt will be repaid
*Businesses therefore allocate portion of receivables never to be paid off (bad debt) - 166How can bad debts be accountedfor?*If customer found to be unable to pay full amount of debt, transaction value is removed from receivables and added to a bad debt account
1) Debit initial sale (full amount) in receivables account (e.g. with corresponding CR in sales)
2) Add in any part payments as normal - CR receivables and DR bank
3) Add bad debt to receivables (CR). The corresponding DR is in the bad debt account.
4) Ensure bad debt is expensed to the income statement at year end - CR bad debt account and DR income statement - 167What happens if a bad debt is then repaid?1) Reinstate the bad debt in receivables account - DR (as an increase in asset) - double entry CR in bad debt account
*The amount of bad debts are then netted off with other bad debts - 168What is meant by doubtful debts?*An allowance for receivables*
If a business knows a customer may not be able to pay debts (defaulting on several payments in a row)
Can estimate doubtful debts through
1) Specific allowances - calculated against a specific company
2) General allowance - applied to total receivables when bad debts are written off or specific allowances are deducted (average used to calculate this) - 169How can general allowances be estimated?USE THE AGED RECEIVABLES SCHEDULE
*Shows the recievables owed to a company listed in order of age with a percentage of the doubtful debts. Also considers total doubtful debts allocated as an allowance to cover bad debts - 170How would you account for an allowance in receivables?*DR bad debts account (increase in expenses)
*CR corresponding liability in an allowance for receivables account - 171How would you calculate for a change in allowance for receivables?*If allowance reduced (e.g. reduced sales)
*Difference in the balance brought/down and the expected bad debts for a year is shown as a DR in the 'allowance for receivables account' and a corresponding CR in the 'bad debts' account
*Then need to balance accounts - 172What is meant by inventory?*Anything that makes up the basis for what a business sells or provides*
Goods carried forwards in inventory are classified as assets on the SOFP
The carrying forwards of unused inventory is an application of the matching concept (inventory costs matched against the revenues they generate) - 173What is the International Accounting Standard for inventories?IAS2
sets out that inventories are assets of one of:
1) assets held for sale during the ordinary course of the business (e.g. books in a bookstore)
2) assets in the process of being produced to be sold (cars in a car factory)
3) materials or supplies to be consumed during production process (e.g. cleaning supplies) - 174How are inventories recorded?*NB Differences do exist between opening inventory, closing inventory and purchases*
OPENING - value of business's inventory at start of a reporting period
PURCHASES - amount spent on new inventories planned to be sold on
CLOSING - the remaining inventory in stock at the end of a reporting period - 175How is inventory measured (ie manufacturing company)?IAS 2 states inventory has the be valued as the lower of either cost or NRV (net realisable value)
NB inventory can decrease in value - 176How is inventory valued using cost?The total cost incurred to a business for getting a product to its current location and condition
Includes purchase, material costs, import duties, freight, cost of conversion (direct costs and production overheads)
Excludes (overheads - apart from production overheads), selling costs, storage costs, abnormal waste of materials, labour etc, admin overheads - 177How is inventory valued using NRV?AKA fair value
price at which product is expected to be sold for minus any costs relating to selling the items (e.g. delivery and packaging)
Key if we realise a product will make a loss we can forecast this (prudence) before the revenue comes in at a loss - 178How would you decide between calculating inventory at cost or NRV?*Depends on which is of lower value*
Inventories valued at whichever factor has the lowest value (NB if inventory decreases in value, it could become the other) - 179Why is it important to consider age of inventory?*This can affect the total purchasing costs due to cost of items purchased/ produced may have been impacted by inflation - therefore if the recently purchased goods are sold first, there are higher purchase costs associated
*Inventory therefore needs valuing - 180How can inventory be valued (in terms of age of inventory)?1) First in/ First out (FIFO) method - assumes items purchased the longest time ago are sold first (this is assumption made for cost/ valuation purposes only and may not happen on the ground). Cost of closing inventory is cost of most recent purchases of inventory
2) Last in/ First out (LIFO) method - assumes items brought last are first to be sold (this is assumption made for cost/ valuation purposes only and may not happen on the ground) - tends to generate higher cost of sales and therefore a lower gross profit (due to inflation on items purchased most recently). Cost of closing inventory is the cost of the oldest remaining items - THIS IS NOT AN ACCEPTABLE METHOD FOR FINANCIAL ACCOUNTING IN IAS 2 - 181What makes a cost for inventor?E.g. ingredients and delivery both contribute to costs
- 182What are the components of costs?1) Purchasing Costs - items price + other costs of acquisition (e.g. freight charges/ customs charges/ non-recoverable tax)
2) Financing Costs - costs from borrowing money to fund production/ purchases
3) Conversion costs - costs incurred when goods are produced internally (e.g. direct costs (raw materials/ direct labour) and production overheads (fixed/ variable)
4) Expenses not in inventory valuation - not treated as costs, but expenses in the period in which they are incurred - 183What are production overheads?1) VARIABLE production overheads - indirect costs fluctuating with the level of business activity (e.g. cleaning supplies)
2) FIXED production overheads - indirect costs which don't change throughout the production process - business level could fluctuate around this (e.g. warehouse rate) - a fixed overhead rate determined at start of the period is used to calculate fixed overhead - 184What is meant by expenses not in inventoy valuation?Costs not treated as costs, but expenses in the period in which they are incurred e.g:
COSTS NOT RELATED TO PRODUCT
1) costs of abnormal wastage levels
2) costs associated with storage not related to production (e.g. a broken machine rather than stock waiting to be sold)
3) selling and distribution costs - managing logistics for sale/ delivery
4) admin costs not related to production - e.g. training meeting for staff - 185What disclosures are needed for inventories?In IAS 2:
*Requires the following disclosures companies need to make for inventories in financial statements:
1) The accounting policies adopted in measuring inventories need to be disclosed (including cost formula etc)
2) Total amount of inventories in classifications appropriate to the business
3) The carrying amount of inventories, valued at Net Realisable Value - 186What is an asset?*Something or someone of use or value to a company which holds it
*Important for the accounting equation
*Can be tangible (physical, building/ car, machinery etc) or intangible (no physical presence, copyrights/ brands/ patents). Intangible non-current assets e.g goodwill, development costs, licenses - 187What can tangible assets be split into?1) Current assets - reasonably expected to be sold, used or consumed within one year (cash/ inventories/ receivables/ short term investments)
2) Non-current assets - longer term assets held for 12 months or longer. Harder to convert to cash and used to help business generate money (e.g. a warehouse) in the main operations of the company. Can be leased externally so long as remain recorded in parent company accounts. Not normally acquired for resale. Not normally liquid assets - 188What is the definition of a non-current asset as per accounting standard IAS16?*IAS 16 is Property, Plant and Equipment*
1) All non-current assets are either property, plant or equipment (PPE)
2) PPE are tangible assets that are held by an entity for use in the production or supply of goods and services, for rental to others, or for administrative purposes and are expected to be used during more than one period
3) Any amount incurred to acquire the asset and bring it to working condition - 189What is the difference between capital and revenue expenditure?NB a business needs to spend money to make money - different costs result in different kinds of expenditure from accounting perspective
1) CAPITAL EXPENDITURE - expenditure on non-current assets (aims to increase future earning capability)
2) REVENUE EXPENDITURE - Expenditure on current assets (aims to use money spent to keep company in business)
NB maintenance spending on non-current assets still considered revenue spending
- need to consider whether costs are part capitalised, part revenue (e.g. capital part if enhances benefit of the asset) - 190What is meant by recognition criteria for non-current assets?*How and when to record PPE in accounts and financial statements*
For the asset to be recognised in the financial statements, needs to meet the two criteria:
1) Must have some future economic benefit flow to or from the entity
2) The cost/ value should be reliably measured - 191What is meant by future economic benefit flow to or from the entity for non-current assets?1) Concerns when do entities recognise assets (for confirming probable that economic benefit flows to the entity)
2) Concerns what are the assets economic benefits (for identifying risk and reward and also whether benefit is direct or indirect)
3) Establishing control of the asset - who? (to determine recognition) - 192What is meant by reliably measuring cost/ value for non-current assets?*Cost needs to be reliably measured - cost attached to the asset
*Can be considered in terms of whether it is created or purchased
*Costs include:
1) the purchase price of the asset
2) bringing the asset to its working location (e.g. import taxes/ freight/ cartage)
3) making the asset operational (installation/ machine assembly)
4) labour changes
*Total costs are recognised in the financial statements* - 193How can an assets subsequent value be measured (if changes over time)?*Assets need to be revalued either using:
1) Historic cost model
2) Re-evaluation model
(NB costs could also be recorded as 'fair value' - considered market value or 'net realisable value' - selling price - any costs to sell) - 194What is the historic cost model for re-subsequent costs of assets?AKA cost model
*Assets are recorded at time of acquisition either as:
1) Amount paid at time transaction takes place
2) Consideration given
- Whatever the increase is fair value with depreciation and impairment losses only adjustments
- Is easy to understand, usually easy to reliably identify (e.g. an invoice amount), is objective but may not be relevant/ may become out of date (inflation) and presumes historical cost is based on stable unit of currency - 195What is the revaluation model for re-subsequent costs of assets*Assets are subsequently recorded at their fair value (not original cost)
REVALUED AMOUNT = FAIR VALUE AT REVALUATION - DEPRECIATION AND IMPAIRMENT
Initially the assets is recorded at original cost, subsequent movement in fair value is later then recognised - 196With the revaluation model, how is an increase in value reflected?1) Increase in value - added amount recognised in revaluation reserve (CR revaluation reserve and DR in the PPE account) - revaluation reserve account shown in the income statement
- 197With the revaluation model, how is an decrease in value reflected?*The difference is only recorded in other comprehensive income provided there is a balance in the revaluation reserve to cover it (CR in PPE account, DR the expense directly to the income statement (where there is no balance in revaluation reserve to cover it)
- 198With the revaluation model, how is an decrease in value reflected when there is an insufficient balance in the revaluation reserve?*There is a small amount to cover a small part of the decrease of the assets value
*The difference offsets as much of the account balance as possible with remainder expensed in the income statement directly - CR balance in revaluation reserve is cleared first - 199When do assets need revaluing?*Assets must be revalued regularly - usually annually
*Assets carrying value always includes changes in value
*When conducting subsequent measurements using revaluation requires fair use of land/buildings to be professionally appraised (market related) - 200What is meant by depreciation?
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- Flashcards on BA3 Pt1, created by P H on 03/01/2023.
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