1. Introduction and The Statement of Financial Position (Balance Sheet)

Question 1

What is the definition of “accounting”?

Answer 1

The process of identifying, measuring, analysing and communicating (reporting) economic information to permit informed judgements and decisions by the users of the information.

Question 2

What is the definition of “finance”?

Answer 2

Finance is concerned with how a business raises funds from investors and then uses those funds to make investment in order to create wealth.

Question 3

What are the 3 main pillars of financial management?

Answer 3

1) Investment
2) Financing
3) Liquidity

Question 4

What does “investment” refer to?

Answer 4

Investing into land, machinery, labour, IT, R&D….

Question 5

What does “financing” refer to?

Answer 5

Internal sources of funding - eg. Owner’s equity, retained earnings
External sources of funding - eg. debt, equity

Question 6

What does “liquidity” refer to?

Answer 6

Cash, inventory, stock…

Question 7

What is “working capital”?

Answer 7

a firm’s short term assets less liabilities (net current assets)

!! Working capital is used to fund operations and meet short-term obligations !!

Question 8

What does “limited liability” refer to?

Answer 8

The owner and the business have separate legal identities. The personal possessions of the owner can’t be force sold to repay company debts.

Question 9

What does “unlimited liability” refer to?

Answer 9

The owner and the business have the same legal identity. If the business goes bankrupt the owners personal possessions may be sold off to repay the debt.

Question 10

What is the difference between “financial accounting” and “management accounting”?

Answer 10

Financial accounting refers to recording of monetary transactions and prepation of financial statements, management accounting however provides information for management to aid planning, control and decision making.

Question 11

When we refer to the “quality” of the financial statements, what are some factors which may impact this?

Answer 11

• Relevance
• Faithful representation
• Comparability
• Verifiability
• Timeliness
• Understandability

Question 12

What are the three criteria that are required for an asset to be included in the SFP? (Statement of Financial positions)

Answer 12

• It must be an economic resource
• The economic resource must be under the control of the business
• The economic resource must be capable of measurement in monetary term

Question 13

What is another name for the Statement of Financial positions

Answer 13

Balance Sheet

Question 14

What is a “liability”?

Answer 14

It is a claim of the other parties - usually involves the obligations transfer economic resources as result of past transactions of events (liabilities and equity).

Question 15

How do we classify assets into “current” or “non-current”?

Answer 15

Current assets are HELD for sale or consumption during the business’ operating cycle. They are held principally for trading and are expected to be sold within the next 12 months.
–> Cash, Inventory, Receivables

Non-current assets do not meet the definition above. Remember, goodwill is a non-current asset, and is intangible.

Question 16

How do we classify liabilities into “current” or “non-current”?

Answer 16

Current liabilities are expected to be settled within the business’ normal operating cycle. They are held principally for trading purposes and are due to be settled within the following 12 months.

Non-current liabilities do not meet the above definition.

Question 17

What are “accounting conventions”?

Answer 17

Accounting conventions are guidelines used to help companies determine how to record business transactions not yet fully covered by accounting standards.

(Sometimes, there is not a definitive guideline in the accounting standards that govern a specific situation. In such cases, accounting conventions can be referred to.)

Question 18

What are the 5 accounting conventions covered in the course?

Answer 18

1. Business entity convention
2. Historic cost convention
3. Prudence convention
4. Dual aspect convention
5. Going concern convention

Question 19

What is the “Going Concern” convention?

Answer 19

Financial statements should be prepared on the assumptions the business will continue operations for the foreseeable future.

Going concern is an accounting term for a company that is financially stable enough to meet its obligations and continue its business for the foreseeable future. Certain expenses and assets may be deferred in financial reports if a company is assumed to be a going concern.

Question 20

What is the “Business Entity” convention?

Answer 20

For accounting purposes the business and its owner(s) are treated as being separate/distinct. That’s why owners are treated as claimants against their business vis the “shareholder’s/owner’s Equity Account in the Balance Sheet.

(By doing so, there is no intermingling of personal and business transactions in a company’s financial statements.)

Question 21

What is the “Historic Cost” convention?

Answer 21

The value of the assets in the Balance sheet should be shown on their historic cost i.e. acquisition cost.

Valuing assets at historical cost prevents overstating an asset’s value when asset appreciation may be the result of volatile market conditions. For example, if a company’s main headquarters, including the land and building, was purchased for $100,000 in 1925, and its expected market value today is $20 million, the asset is still recorded on the balance sheet at $100,000.

Furthermore, in accordance with accounting conservatism, asset depreciation must be recorded to account for wear and tear on long-lived assets. Fixed assets, such as buildings and machinery, will have depreciation recorded on a regular basis over the asset’s useful life. On the balance sheet, annual depreciation is accumulated over time and recorded below an asset’s historical cost. The subtraction of accumulated depreciation from the historical cost results in a lower net asset value, ensuring no overstatement of an asset’s true value.

Question 22

What is the “Dual Aspect” convention?

Answer 22

Each transaction has a dual impact and there must be two entries, one DEBIT one CREDIT entry.

DEBIT = record incoming money
CREDIT = record outgoing money

Example:
The business owes a supplier £4,000. It pays him £1,000 from the bank account.

CREDIT - Bank account (cash) down by £1,000
DEBIT - Accounts Payable (Current Liabilities) down by £1,000

(the amount owed to James will go down by £1,000) Credit - bank account which will also go down by £1,000

Question 23

What is the “Prudence” convention?

Answer 23

Under the prudence concept, do not overestimate the amount of revenues recognized or underestimate the amount of expenses. Also, one should be conservative in recording the amount of assets, and not underestimate liabilities. The result should be conservatively-stated financial statements.

only record a revenue transaction or an asset when it is certain, and record an expense transaction or liability when it is probable. In addition, you would tend to delay recognition of a revenue transaction or an asset until you are certain of it, whereas you would tend to record expenses and liabilities at once, as long as they are probable.

Question 24

What are “accruals”?

Answer 24

Example, sales commission expense is 6000. But you only paid 5000 by the end of the year. So the expense is marked as 6000 in your income statement. 5000 is marked in your statement of cash flows (as it cost 5000). Then you create an “accruals account” in your statement of financial position. This is part of current liabilities. It refers to the fact that the 1000 has not been paid yet.

Question 25

What are “prepayments”?

Answer 25

Prepayments - A prepayment is when you pay an invoice or make a payment for more than one period in advance. For example, you may pay for your rent for three months in advance but want to show this as a monthly expense on your profit and loss.

Is a CURRENT ASSET