Week 2 Flashcards

1
Q

What is AID and how is it used in balance sheets

A

AID - Asset Increase Debit, is a handy reminder for how to begin a balance sheet.
Similarly, liability increase credit can be used to remember how to start a financial assessment of liabilities.

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2
Q

What falls under the categories of credit and debit within a balance sheet

A

Debit is always an expense or asset, while credit will cover income, liabilities and capital.

DEACLILC

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3
Q

State the accounting equation for balance sheets

A
Assets = Captial + Libailities
or
Liabilities = Assets - Capital 
or 
Capital = Assets - Liabiities
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4
Q

What is an alternative name for the balance sheet

A

SFP = Statement of financial position

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5
Q

On the statement of financial position, assets and claims are usually grouped into categories. What are the two types of assets and how do we classify them?

A

Assets are divided into:

Non-current assets:
This form of assets (also called fixed assets) is used by the business over a period likely exceeding 12 months. Tangible forms of non-current assets are usually:
- Property
- Plant
- Equipment
However, this form of asset can be tangible or intangible. This form of assets will suffer from depreciation as the assets usefulness and effectiveness reduces overtime.

Current assets:
Assets used within the short-term of the business operations and will likely be converted into cash within 12 months. This can also relate to assets used on a day-to-day basis by the business. The following are different examples of Current assets:
- Inventories (work-in-progress or finished goods)
- Trade receivables (Debtors)
- Cash and Bank
- Prepayments

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6
Q

On the statement of financial position, assets and claims are usually grouped into categories. What are the two types of Liabilities and how do we classify them?

A

Similarly to the classification of assets:

Current liabilities are amounts that are due to be settled within the business’s normal operating cycle (typically within 12 months), while a non-current liabilities are liabilities which can remain for periods usually exceeding 12 months. Non-current liabilities will typically concern loans with a long-term repayment plan, usually for the Lender to receive interest.

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7
Q

Define depreciation and explain the ways it can be calculated.

A

Depreciation is an attempt to measure the portion of cost of a non-current asset that has been depleted in generating the revenue recognised during a particular time period.

For our calculations we focus on using the following types of depreciation methods:

Straight line: where a certain percentage of the original cost is depreciated from the value of the asset annually.
Reducing balance: Where a percentage of the assets reduced value after depreciation was calculated for the previous year, is then used to calculate appreciation of the asset.

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8
Q

Depreciation is used to calculate “

Net Book Value”, express the equation for this.

A

Asset value - Depreciation = Net Book Value

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9
Q

Define the following terms related to current assets:

  • Inventory
  • Trade receivables
  • Cash/Bank
  • Prepayments
A
  • Inventory: Good bought and sold by the firm.
    ‘Inventory’ appearing the BS/SFP are the goods bought with the intention of resale that has not yet been sold. They are still owned by the firm

The value of ‘Inventory’ in the BS/SFP refers to the value of stock at the end of the financial year

-Trade receivables:
Sales that the firm has made for which no money has yet been received – i.e. MONEY OWED TO THE FIRM
Sometimes, not all receivables pay up. Their debts would then have to be written off – in other words, reduced to a zero value
The amount for ‘Receivables’ appearing in the BS/SFP shows what the firm is really confident about receiving

  • Cash/Bank:
    This is the actual cash the firm has both in hand and in the bank.
    If the firm has an overdraft, then the bank account will appear as a liability in the BS/SFP
- Prepayments:
This occurs where an entity has paid for goods or services but not yet received all the economic benefits
They are the opposite to Accruals
Most common examples:
Rent paid in advance
Line rentals or service charges
Insurance premiums
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10
Q

What are Accruals

A

Accruals are an expense that is ‘incurred’ but not paid for until sometime later
‘Incurred’ means the entity has had the benefit of the goods or service
Most common examples:
Phone – quarterly or monthly in arrears
Other utilities – gas, electric, water, etc.
Services – legal or accountancy

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11
Q

Show the difference between accruals and prepayments.

A

ACCRUALS –
Increase the Expense in the Income statement/Statement of Comprehensive Income
Increase the Accruals in the Current Liabilities – balance sheet/Statement of Financial Position
PREPAYMENTS
Decrease the Expense in the Income statement/Statement of Comprehensive Income
Increase the Prepayments in the Current Assets – balance sheet/Statement of Financial Position

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12
Q

Explain the following terms:

  • Capital/Equity
  • Net Profit
  • Drawings
A
  • Captial/Equity: The claims of the owner(s) against the business
    Depends on the type of firm:
    If firm not listed, simply the owner’s capital
    Limited firms = share capital (‘equity’)
  • Net profit: Profit for the year after all deductions
    Final retained profits for the year are added to the capital to give a subtotal = forms a new balance on capital going forward
  • Drawings: Money taken out of the business by its owners, but is not an expense, rather an appropriation of the firm’s funds
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13
Q

Does the Balance sheet/SFP tell you what the business could sell for?

A

It does because it doesn’t take into account the following aspects:

  • Historic Cost
  • Element of judgement in items such as provisions, depreciation, inventories and write-down values
  • Doesn’t take the non-financial elements such as goodwill or experience/reputation of the business
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14
Q

What are the limitations of the BS/SFP

A

Does not tell you the market value of a business – a ‘snapshot’ of the firm at a point in time
Assets are not valued at market value as depreciation does not accurately measure the loss in value of non-current assets
Maybe hiding relevant details
Only represent the situation of the business on a particular day

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15
Q

Identify the specific cases where you would use a statement of financial position.

A

You use a statement of financial position to express the following information for the following reasons.

  • Assessing Financial Position
  • Viewing Trend Analysis
  • Communicating with those outside the business
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16
Q

State the calculation used for generating the cost of sales

A

Opening inventory + Purchases - Purchase returns - Closing inventory
= Cost of sales.

or
(opening inventory + Purchases) - (Purchase returns + Closing inventory)

17
Q

What are Dividends

A

Dividends = a share of the firm’s profits

Can be ‘paid’ or ‘proposed’

Paid: Appropriation of profit (an expense)

Proposed dividend = not actually been paid

However, firm has declared it will pay a dividend and so now OWES it – included under payables in the firm’s SFP (current liabilities)
Deemed to be an appropriation of profit – not an expense

Typically dividends are owned by shareholders of a company, allowing them to receive a share of the firm’s profit.

18
Q

What are the three main ways in which a business entity may grow

A

Three main ways in which an entity may ‘grow’
Raise more capital
Borrow more
Make and retain its profits

19
Q

Answer the following question relating to a sole trader/Partnership and Limited liability companies:

  • What type of liability does the business have
  • Is the business separate from its owners
  • How is capital produced by the business
  • How is the business taxed
A

A sole trader/Partnership has:

  • Unlimited liability
  • The business is not a separate legal entity from its owners.
  • It is the owners that introduce capital into the business.
  • The owner of the business is taxed as an individual.

A limited liability company (LTP) has:

  • Limited liability
  • Is treated as a separate legal entity from its owners7
  • Capital is raised through the sale of shares. shares traded, nominal share value, market share value and share value premium will generate the capital income.
  • This business will be taxed as a company.
20
Q

What is Share capital

A

Share premium is the excess of the issue price of shares over the nominal value

It is a capital reserve and thus cannot be distributed as a dividend

When a firm issues shares potential shareholders subscribe (i.e. pay) for them.

If a firm issues a share with a €1.00 nominal value at a price of €1.40 per share, €1.00 is added to the firm’s share capital while the €0.40 is added to share premium.

21
Q

If a company sells 400,000 shares for £15 each, while they only had a nominal value of £5, show how this will impact a balance sheet at the end of the business year

A

In the Balance sheet/SFP:

INCREASE Share Capital by €2 million [400,000 x €5]

INCREASE Share Premium by €4 million [400,000 x (15 – 5)]

INCREASE Cash by €6 million [400,00 x 15]

22
Q

identify the calculation for Net assets

A

All Assets - all Liabilities = Net worth of Business (Capital)

in terms of the accounting equation:
- Assets - Liabilities = Capital