Financial Accounting Answers
Content
Financial Accounting: Finanical Accounting: the process of identifying measuring and communicating information to permit informed judgements and decisions by users of the information. External users: 1) 2) 3) 4) 5) Income statements Cash flow statement Balance sheet Directors report Auditors report NOT TO THE FUTURE
ALL FOCUS ON THE YEARS END – LOOKING BACKWARDS
Internal users: 1) 2) 3) 4) 5) Budgets Cash flow forecasts Profitability review of certain products Pricing Investment appraisal So managers can make decisions for the future!
A business entity, either: 1) 2) 3) 4) 5) A sole proprietorship A sole trader A partnership Limited company A limitied liability partnership
Financial Statements: Profit and loss account or income statement Balance Sheet
The accounting equation is: Assets = liabilities + capital Capital: owners investement Liabilities: money owed to 3rd parties.
Financial Transactions: Assets= Liabilities+Capital+Profit (income-expenses) Balance sheet: a statement of the assets, liabilities and capital of the business at a certain point in time. Cash flow statement: This summarises the physical flow of cash in and out of the business. Income statement (Profit and Loss account): shows the income earned, not necessarily the income received in the period against the expenses occurred. (include’s creditors and debtors) Sole trader accounts: Assets 1) Fixed assets: they are held beyond a year not bought for resale, and are used to generate wealth i.e. factory, vans and equipment. 2) Current assets: Day to day trading activites of the business – easily turned into cash – inventory, cash, bank balance. Liabilities Current Liabilities: The amount owed to outsiders due to be repaid in 12 months i.e. Trade payables for stock. Non-current liabilities: the amount due to outsiders NOT due to be repaid in 12 months (long term bank loan). The entity concept: Accounting transactions relate to the business, not the owner. So in legal terms the business is a separate entity to the owner. The going concern concept: Financial statements: are prepared on the basis that the business will continue in operational existence for the foreseeable future. There is no intention to liquidate the company or drastically reduce the scale of operations. Accruals/matching: Sales and the associated costs of making sales are recognised for accounting purposes when they are earned or incurred. In any accounting period sales made and all their associated are matched as far as possible. (checking everything is accurate) Ledger account Debits: increase in assets and expenses Credits: increases in liabilities and capital income Expenses what is already paid, liabilities is what you OWE.
Consistency Concept: Treatment of like items should be consistently applied from one accounting period to the next. Especially when alternative procedures or valuations exist. The prudence concept: If there is any doubt gains and loss’s should not be overstated or understated, the emphasis is on being neutral. Where alternative valuations of procedures are possible the most cautious presentation of a business’s results or financial position should be selected. (Pretty much if your wrong, get it right don’t guess.) Historical costs concept: Transactions are recorded at the cost (amount) at which the business paid to acquire them so they can be justified. Doesn’t include stuff such as inflation or tax etc. The realisation concept: Revenue and/or profits are recognised as a cash receipt or a reasonably certain cash receipts. So you can make your own handwritten receipts for example and they will be recognised. The money measurement concept: Accounting deals only with items that can be measured in monetary terms. Such as bank accounts, stock etc. You can’t measure things such as morale, good trade union relationships etc. End of period adjustements: Adjustments need to be made to the accounts, Need to check final inventory so you can calculate the cost of goods sold. Depreciation of fixed assets, your car won’t be worth as much at the end. Accruals Pre-payments Bad and doubtful debts Depreciation: On fixed assets with the exception of freehold land. Eventually they will be used up through wear and tear in the process of generating revenue. Straight Line method of depreciation: This method allocates depreciation evenly over the life of the asset. Annual depreciation expense= original cost – residual vaue / estimated useful life
Reducing balance method: This method applies a constant percentage depreciation charge to the netbook value (NBV) The value of the product after the depreciation each year. This method is much higher than the straight line method. Bigger cost incurred in the early years of buying the asset in terms of depreciation. Annual depreciation expense = netbook value at start of year x the percentage (x) i.e. 10% rate. Accrual Expenses: An accrual refers to goods and services received by the business but not accounted by the reporting date. Pre-paid expenses: The prepayment is a payment that has already been made in an accounting period for a service which has not yet been received by the service. Bad-debts: Due to the fact that a large proportion of sales being on credit there is a risk that some customers may never pay. Bad debts are considered a normal business risk and are a normal business expense. LECTURE 6 LOOK IN BOOOOOOOOOOOOOOOOOOOOOOOOOOK. Limited liability company: Owners/shareholders have limited liability. To form a LLC the formal procedure of registration consists of filing for documents with companies house. 4 documents: Form 10: which contains the intended situation of the registered office and the details of the consenting secretary and directors Form12: the decleration of compliance with companies act of 1985 The memorandum of association: which states the company name, situation of registered office and objectives of the company and its liability.
The articles of association: which give internal management affairs. Private Companies: There are a lot more private companies than public. They are often smaller and cannot offer their shares for subscription to the public at large. They have LTD after their names. Public companies: They have an authorised share capital of at least 50000 pounds and have PLC after their name. They have the opportunity to offer shares for sale on the stock exchange. LIMITED COMPANY = pay dividends Sole trader= drawings Share Capital: This is how much capital has been subscribed by shareholders i.e. how much finance has been provided to the business by its owners. There are two main types of share: Ordinary (equity): these are the most important and an annual dividend with annually be paid to shareholders as reward for their investment. Directors decide how much the dividend should be. Preference shares: the holders of these shares get an agreed percentage rate of dividend before the ordinary shareholders receive anything. Reserves: These are part of the shareholders funds, they represent profits of various kinds owed to shareholders but not yet returned to them. Share premium: the only time a company benefits from shares, is when they are issued at which time would be shareholders subscribe (pay) for them. Retained Profits: as a business trades and makes profits some of the profits will be paid out to shareholders as dividends the rest will be retained in the business and reinvested. The legal context: The guidance document issued by companies house states that generally accounts must include a profit and loss account, balance sheet signed by a director, an auditors report signed by the auditor, a directors report signed by a director, notes to the accounts and group accounts. Why limited companies have to produce accounts:
1) The owners shareholders are not always the managers – therefore shareholders need information to make sure the company is meeting its objectives 2) Potential investors need information to make balanced judgements 3) Because limited companies have limited liability, creditors need information regarding the company so they can make balanced judgement on whether or not to supply goods labour finance or services. 4) Organisations actions have a significant impact on the environment and community so society has a right to the information as well.
Interpretation of accounts: When trying to interpret and understand a companies performance and position, there are various sources of data that are available. Ratio analysis is useful for financial data analysis, current and acid. Trend or horizontal analysis: What has improved and what has got worse. Use percentages to establish trends and this can help evaluate performance. Basically can compare year A with B and note the difference and percentage change. Common size or vertical analysis: You show each line of a financial statement in relation to a baseline figure. So compare years x y and z with year A. Financial ratios: When analysing and interpreting company information, it is important to be clear who the target users are and why they need the information. E.g. shareholders, ROCE. 1) Profitability: this provides an insight into the degree of success for shareholders 2) Efficiency: this measures the efficiency with which particular resources have been used 3) Liquidity: the availability of sufficient liquid resources is vital to a business so that it can pay its debts. 4) Gearing: this is the relationship between the owners of the business and the amount contributed by others (loans). 5) Shareholders investment: assessing returns and performance of shares held.
ALL FOCUS ON THE YEARS END – LOOKING BACKWARDS
Internal users: 1) 2) 3) 4) 5) Budgets Cash flow forecasts Profitability review of certain products Pricing Investment appraisal So managers can make decisions for the future!
A business entity, either: 1) 2) 3) 4) 5) A sole proprietorship A sole trader A partnership Limited company A limitied liability partnership
Financial Statements: Profit and loss account or income statement Balance Sheet
The accounting equation is: Assets = liabilities + capital Capital: owners investement Liabilities: money owed to 3rd parties.
Financial Transactions: Assets= Liabilities+Capital+Profit (income-expenses) Balance sheet: a statement of the assets, liabilities and capital of the business at a certain point in time. Cash flow statement: This summarises the physical flow of cash in and out of the business. Income statement (Profit and Loss account): shows the income earned, not necessarily the income received in the period against the expenses occurred. (include’s creditors and debtors) Sole trader accounts: Assets 1) Fixed assets: they are held beyond a year not bought for resale, and are used to generate wealth i.e. factory, vans and equipment. 2) Current assets: Day to day trading activites of the business – easily turned into cash – inventory, cash, bank balance. Liabilities Current Liabilities: The amount owed to outsiders due to be repaid in 12 months i.e. Trade payables for stock. Non-current liabilities: the amount due to outsiders NOT due to be repaid in 12 months (long term bank loan). The entity concept: Accounting transactions relate to the business, not the owner. So in legal terms the business is a separate entity to the owner. The going concern concept: Financial statements: are prepared on the basis that the business will continue in operational existence for the foreseeable future. There is no intention to liquidate the company or drastically reduce the scale of operations. Accruals/matching: Sales and the associated costs of making sales are recognised for accounting purposes when they are earned or incurred. In any accounting period sales made and all their associated are matched as far as possible. (checking everything is accurate) Ledger account Debits: increase in assets and expenses Credits: increases in liabilities and capital income Expenses what is already paid, liabilities is what you OWE.
Consistency Concept: Treatment of like items should be consistently applied from one accounting period to the next. Especially when alternative procedures or valuations exist. The prudence concept: If there is any doubt gains and loss’s should not be overstated or understated, the emphasis is on being neutral. Where alternative valuations of procedures are possible the most cautious presentation of a business’s results or financial position should be selected. (Pretty much if your wrong, get it right don’t guess.) Historical costs concept: Transactions are recorded at the cost (amount) at which the business paid to acquire them so they can be justified. Doesn’t include stuff such as inflation or tax etc. The realisation concept: Revenue and/or profits are recognised as a cash receipt or a reasonably certain cash receipts. So you can make your own handwritten receipts for example and they will be recognised. The money measurement concept: Accounting deals only with items that can be measured in monetary terms. Such as bank accounts, stock etc. You can’t measure things such as morale, good trade union relationships etc. End of period adjustements: Adjustments need to be made to the accounts, Need to check final inventory so you can calculate the cost of goods sold. Depreciation of fixed assets, your car won’t be worth as much at the end. Accruals Pre-payments Bad and doubtful debts Depreciation: On fixed assets with the exception of freehold land. Eventually they will be used up through wear and tear in the process of generating revenue. Straight Line method of depreciation: This method allocates depreciation evenly over the life of the asset. Annual depreciation expense= original cost – residual vaue / estimated useful life
Reducing balance method: This method applies a constant percentage depreciation charge to the netbook value (NBV) The value of the product after the depreciation each year. This method is much higher than the straight line method. Bigger cost incurred in the early years of buying the asset in terms of depreciation. Annual depreciation expense = netbook value at start of year x the percentage (x) i.e. 10% rate. Accrual Expenses: An accrual refers to goods and services received by the business but not accounted by the reporting date. Pre-paid expenses: The prepayment is a payment that has already been made in an accounting period for a service which has not yet been received by the service. Bad-debts: Due to the fact that a large proportion of sales being on credit there is a risk that some customers may never pay. Bad debts are considered a normal business risk and are a normal business expense. LECTURE 6 LOOK IN BOOOOOOOOOOOOOOOOOOOOOOOOOOK. Limited liability company: Owners/shareholders have limited liability. To form a LLC the formal procedure of registration consists of filing for documents with companies house. 4 documents: Form 10: which contains the intended situation of the registered office and the details of the consenting secretary and directors Form12: the decleration of compliance with companies act of 1985 The memorandum of association: which states the company name, situation of registered office and objectives of the company and its liability.
The articles of association: which give internal management affairs. Private Companies: There are a lot more private companies than public. They are often smaller and cannot offer their shares for subscription to the public at large. They have LTD after their names. Public companies: They have an authorised share capital of at least 50000 pounds and have PLC after their name. They have the opportunity to offer shares for sale on the stock exchange. LIMITED COMPANY = pay dividends Sole trader= drawings Share Capital: This is how much capital has been subscribed by shareholders i.e. how much finance has been provided to the business by its owners. There are two main types of share: Ordinary (equity): these are the most important and an annual dividend with annually be paid to shareholders as reward for their investment. Directors decide how much the dividend should be. Preference shares: the holders of these shares get an agreed percentage rate of dividend before the ordinary shareholders receive anything. Reserves: These are part of the shareholders funds, they represent profits of various kinds owed to shareholders but not yet returned to them. Share premium: the only time a company benefits from shares, is when they are issued at which time would be shareholders subscribe (pay) for them. Retained Profits: as a business trades and makes profits some of the profits will be paid out to shareholders as dividends the rest will be retained in the business and reinvested. The legal context: The guidance document issued by companies house states that generally accounts must include a profit and loss account, balance sheet signed by a director, an auditors report signed by the auditor, a directors report signed by a director, notes to the accounts and group accounts. Why limited companies have to produce accounts:
1) The owners shareholders are not always the managers – therefore shareholders need information to make sure the company is meeting its objectives 2) Potential investors need information to make balanced judgements 3) Because limited companies have limited liability, creditors need information regarding the company so they can make balanced judgement on whether or not to supply goods labour finance or services. 4) Organisations actions have a significant impact on the environment and community so society has a right to the information as well.
Interpretation of accounts: When trying to interpret and understand a companies performance and position, there are various sources of data that are available. Ratio analysis is useful for financial data analysis, current and acid. Trend or horizontal analysis: What has improved and what has got worse. Use percentages to establish trends and this can help evaluate performance. Basically can compare year A with B and note the difference and percentage change. Common size or vertical analysis: You show each line of a financial statement in relation to a baseline figure. So compare years x y and z with year A. Financial ratios: When analysing and interpreting company information, it is important to be clear who the target users are and why they need the information. E.g. shareholders, ROCE. 1) Profitability: this provides an insight into the degree of success for shareholders 2) Efficiency: this measures the efficiency with which particular resources have been used 3) Liquidity: the availability of sufficient liquid resources is vital to a business so that it can pay its debts. 4) Gearing: this is the relationship between the owners of the business and the amount contributed by others (loans). 5) Shareholders investment: assessing returns and performance of shares held.
