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MGT388 > Financial Accounting > Flashcards

Financial Accounting Flashcards

1
Q

What is accounting

A

Process of identifying measuring and communicating economic information to permit informed judgement and decisions by users of the information

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2
Q

What is financial accounting

A

provides information to users outside the organisation, the information is contained in an annual report that is published by the organisation
provides information about the financial position what an organisation owns and owes
the field of accounting that deals with the preparation of financial statements that are to be used by users external to an organisation

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3
Q

what does the annual report of financial accounting assume

A

users have some business and accounting knowledge

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4
Q

who uses financial accounting

A

investing in shares - will there be dividends, share price go up
buying or selling to another company asses reliability for payments of delivery ethical standards
seeking employment - wages and salaries staff retention, directors pay, social responsibilities future plans
governments tax revenue, executive pay, diversity, social responsibility

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5
Q

What is the annual report

A

all incorporated businesses must produce an annual report for the shareholders of the company, the annual report is used to make economic decisions so the information is verified by an external audit

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6
Q

What is an audit

A

independent examination of the financial statements to establish that they show a true and fair view , does not guarantee that they are correct just true, and does not cover all info in annual report

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7
Q

What is an income statement

A

profit and loss account, info on financial performance of a company

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8
Q

What is on an income statement

A

revenue, cost of sales, gross profit, distribution expenses, administration expenses, operating profit, other incomes, finance charges, profit before tax, tax, profit of the year

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9
Q

What is gross profit

A

as revenue and cost of sales does not include any one off items, tells you how well core business is doing, compares revenue from selling the product directly with the cost of the production of it

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10
Q

How do you calculate gross profit

A

Revenue - cost of sales

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11
Q

what is operating profit

A

Highlights the profit the business has generated from its operation, more volatile than gross profit figure (as one off purchases) successful business will try and keep tight control of administration and distribution expenses

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12
Q

how you calculate operating profit

A

gross profit - (distribution + administration expenses costs)

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13
Q

What is profit before tax

A

operating profit plus other income that is not from the business such as rent dividends or interest received

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14
Q

How do you calculate profit before tax

A

gross profit + other income - finance charges

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15
Q

What is profit for the year and how is it calculated

A

profit for the year - profit after tax

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16
Q

What is inventory

A

=stock=unsold items, adjusting for unsold items will mean there are the same number of items in sales as there in costs of sales, good the company intend to sell but havent sold yet, will comprise of finished, part finished (work in progress) and raw materials. combination of all three to provide inventory figure

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17
Q

How do you calculate cost of sales

A

opening inventory + purchases - closing inventory + production costs

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18
Q

Profit does not equal

A

cash results

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19
Q

how do you calculate gross profit percentages

A

gross profit/sales x100

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20
Q

what does profit reflect

A

the actual performance of each sale

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21
Q

why is cash important

A

needed for a business to survive

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22
Q

What does profit do

A

it gives a fair reflection of actual performance it is based on the accruals (matching principle)

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23
Q

What are accruals

A

accruals revenues and expenses are recognised when they are earned and incurred not when cash flows in or out of the company

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24
Q

How are profits smoothed

A

using the accruals principle

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25
Q

When will costs be included on the income statement

A

when they have been used to make profits

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26
Q

When something is purchased how will charged against revenue

A

only a portion will initially charged against revenue as an expense ie when you purchase a machine for 30,000 to be used for 3 year, 30,000 cash will leave the business, 10,000 per year for 3 years is take of the profit figure as an expense

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27
Q

What is the issues with how costs are included on the income statement

A

a business may go bankrupt or have liquidity problems initially or during an expansion but still show a profit

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28
Q

how long will you estimate something to be used for

A

an accounting estimates as is that it will be used up equally

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29
Q

What is the statement of financial position

A

or balance sheet, shows the worth of a company its format is based on the accounting equation assets = liabilities + equity

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30
Q

Assets are

A

resources that are controlled by an entity that are expected to bring economic benefit split into two groups current and non current

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31
Q

liabilities are

A

an obligation of an entity arising from past event the settlement of which involves the transfer of resources

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32
Q

Equity represents

A

the residual interest in the assets of the entity after deducting all the liabilities

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33
Q

what are the two sides the statement of financial position

A

one side are assets (everything owned by the company) and the other is everything owed by the company both to the owners of the company and third parties such as banks

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34
Q

What is an example of a non current asset

A

land and buildings, plant and machinery, motor vehicles, intangible assets
are to be owned for longer than 12 months

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35
Q

What is an example of a current asset

A

inventories, trade receivables, prepayment (bills payed in advance), cash
owned at the reporting date but are to be used by the business to make profits in the next 12 months

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36
Q

Equation of total assets

A

current assets plus non current assets

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37
Q

What is equity made up of

A

share capital, share premium, revaluation reserve, retained earnings

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38
Q

What are non current liabilities made up of

A

debentures, loans. Due after 12 months

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39
Q

What are current liabilities

A

trade payables, tax, overdraft. Due within the next 12 months

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40
Q

Does the statement of financial positon show the worth of a company

A

no the assets appear at original cost less depreciation - they do no appear at market value
and items for which no cash has been paid cannot be included, but ideas people and reputation would be included in a valuation of the business

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41
Q

For all incorporated businesses what must be made

A

an annual report (produced for the shareholders0

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42
Q

How can an incorporated business be registered

A

as a private limited company (Ltd) as a public limited company (plc)

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43
Q

what is the advantage of being a plc

A

a plc can offer its shares for sale to the general public but an ltd can not
this can be done on the stock exchange, these can then retraded meaning the ownership of a plc may be constantly changing,

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44
Q

who may hold shares

A

individuals may hold shares but it is pension funds, insurance companies and other financial institutions which hold large blocks of shares

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45
Q

What are the four main areas of a financial report

A

the income statement
the statement of financial positon
the statement of changes in equity
the statement of cash flow

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46
Q

What regulates the annual report

A

statutory regulations - company acts and european union directives
accounting standards - UK accounting standards board and international
stock exchange regulation more frequent and more detail reporting

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47
Q

what is in the 2006 companies acts

A

requirements to prepare annual accounts prepared in accordance with either international or national accounting standards
details when an audit is required
outlines the company’s duty to file circulate the annual report

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48
Q

What does separate entity mean

A

in company law, the company is a person in it own right, separate legal identity, it is the company that will sue and can be sued

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49
Q

What does double entity mean

A

Every transaction that company enters into affects two accounts

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50
Q

Materiality

A

Items will be reported if they make a difference to the user, no material omissions or misstatements in the accounts

51
Q

accurals/matching

A

expenses are matched to the revenues that they help generate, expenses, costs, income and revenue are accounted for when they are earned or incurred not when cash flows in or out of the company

52
Q

importance of regulation

A

stakeholders can compare set of report with other companies anywhere in the world and establish performance over time
allow investors to make rational decisions

53
Q

what is costs of sales

A

all the expenses/costs that are involved in manufacturing and producing the product the company sells

54
Q

What is distribution expenses

A

includes all the selling marketing and distribution costs incurred by a company

55
Q

administration expenses

A

all the office based costs of a company, accountant and lawyer fees debt collection service invoicing and some director costs

56
Q

What are finance charges

A

payments of interest on loans, leases and overdrafts. business in trouble if this is greater than the operating profit

57
Q

What does the statement of changes in equity provide

A

the shareholders with info as to what has happened to their equity in the last year

58
Q

On which statement are dividends show

A

the statement of changes in equity

59
Q

what are dividends

A

annual payments to shareholders

60
Q

How will a shareholder obtain a return on their investment

A

by way of a dividend or an increase in the value of shares on the stock exchanges, company would like to pay consistent dividends each year and for share price to steadily rise

61
Q

What is a trade receivable

A

money that a company is owed from its customers at the reporting date

62
Q

What are accurals

A

amounts the business owes in respect of bills not yet received, but where the business has used the service or products (outstanding amount on gas/electricity bills)

63
Q

Who does equity belong to

A

owners of the company who are shareholders

64
Q

What is issued share capital

A

money from issued shares

65
Q

what does a share represent

A

basic unit of ownership in a company, each will have a nominal value

66
Q

What is share premium

A

the difference between the nominal share price and the excess price at which the shares are actually issued is held in a share premium account

67
Q

Where is the money invested by owners of the company kept

A

in the share premium and ordinary share accounts

68
Q

when a company goes bankrupt what happens to the owners

A

owners have limited liability, their loss incurred is limited to that they have already invested in acquiring the shares

69
Q

What are reserves

A

two types revenue reserves and capital reserves, represent the profits and gains that the company has made since incorporation

70
Q

what type of revenue can be paid out to shareholders

A

revenue reserves as dividends, (represents the trading profits made by the company since incorporation)

71
Q

What is a revaluation reserve

A

represents the gains made on non current assets such as land that have not been sold by the company, as the gain made on asset it still holds (unrealised gain) it cannot be distributed as a dividend

72
Q

What is the accounting equation

A

Assets = Liabilities + Equity

73
Q

what does the accounting equation mean

A

the assets of a business equals the finance provided by both third parties and the owners

74
Q

from what perspective does accounting equation look

A

follows the separate entity concept, looks at financial position from company perspective , what the company owns (assets) is set against what the company owes to provides of finance (liabilities plus equity)

75
Q

What does the double entry concept stem from

A

the accounting equation - to balance one transaction leads to two entries

76
Q

give an example of a double entry concept

A

company buys a car for cash, the asset motor vehicles will increase and the asset cash will decease by the same amount
if money is borrowed from a bank to buy a car the asst car and the liability loans will both increase

77
Q

example of an intangible asset

A

a brand

78
Q

issues with putting an asset that will be used over a number of years through in one year

A

show very low profits or even losses in one year and high levels of profits in the other years. does not reflect how the company is doing. creates a volatile profit figure - not good for investor confidence

79
Q

what is depreciation vs amortisation

A

allocation of a non current asset to the years that benefit from its use for tangible assets is depreciation, and amortisation for intangible assets

80
Q

which is more volatile cash or profit

A

cash

81
Q

total cash generated

A

= total profit generated

82
Q

What is the return on capital employed ratio (ROCE)

A

Operating profit/ Equity funds + non current liabilities

will give you a percentage for the return on every £1 put in

83
Q

what does the ROCE ratio indicate

A

indicates how successful the management are using the funds provided to them by shareholders and debentures holders, helps investors as it indicates how well funds provided in the past have been used (in terms of generating profits)

84
Q

Why might a higher return be required (ROCE)

A

its a higher level of risk

85
Q

What cases a high ROCE ratio

A

profitability - gross profit and operating margins and/or efficient utilisation of assets (net asset turnover)

86
Q

Operating profit margin =

A

operating profit/turnover

87
Q

why might operating profit margin change

A

expense may have increased/decreased, cost control by management might not be very good

88
Q

What is the net asset turnover ratio

A

turnover/ equity + non current liabilities

89
Q

What is net asset turnover ratio used for

A

can be compared over time against companies in same industry to assess if management are utilising resources at their disposal to generate revenue

90
Q

issues with net asset turnover

A

non current assets subject to depreciation, company with old assets will have low figure for assets, but will be high when initially replaced
investment in assets may not translate to increased revenuse, may be time lag between investment and improved net asset ratio

91
Q

what is turnover

A

revenue

92
Q

what may be a more useful ratio than net asset turnover for labour intensive company

A

turnover to staff costs/no of employees

shows revenue per employee

93
Q

What other ratios is ROCE equal to

A

Operating profit margins * net asset turnover

94
Q

why is the ROCE so important

A

key ratio to how a company is performing, is a product of the companys profitability and efficiency

95
Q

What is liquidity

A

ability of a business to generate sufficient cash to pay liabilities as they fall due

96
Q

what is liquidity directly linked to

A

short term solvency of a business, business will go bankrupt if it cannot pay its debts

97
Q

what will a company will good working capital management be able to do

A

meets the debts as they fall due

98
Q

what does working capital equal

A

current assets - current liabilities

99
Q

what is working capital management

A

not holding too much inventory for too long
prompt payment of trade payables
good collection policy on trade receivables

100
Q

what may inadequate and inefficient working capital policies lead to

A

an overdraft which is an expensive form of finance

101
Q

what is the working capital cycle

A

purchase inputs -> production -> inventories -> sales -> trade receivables -> cash -> purchase inputs

102
Q

What is the current ratio =

A

current assets / current liabilities

103
Q

what does the current ratio indicate

A

whether debts could be met when they fall due

104
Q

is a high current ratio good

A

too high can mean inefficiency a company should not hold large reserves of cash (should be invested and generating profits0
high levels of inventory and trade receivables will indicate they are not being efficiently managed cash will be tied up

105
Q

Acid test ratio

A

(current assets - inventory) / current liabilities

want to remove inventory as time lag between inventory into cash

106
Q

inventory holding period

A

(closing inventory/ cost of sales) * 365 days, gives result in days

107
Q

collection period

A

(trade receivables / revenue) *365

108
Q

issue with too long a collection period

A

may indicate poor collection policy

or unsatisfied customers who are refusing to pay, poor quality product

109
Q

issue with too short a collection period

A

may lose customers to competitors who offer better credit terms
may be offering discount for prompt payment which effects margins

110
Q

payment period

A

trade payables/cost of sales *365

111
Q

the trade receivable collection period should match

A

trade payable payment period

112
Q

is a long payment period good

A

if pay on timely basis may receive discount which will help profitability
if too high may have poor relationship with suppliers - effects supply in future

113
Q

what is the risk to investors

A

risk not receiving an annual return on their investment and also not having their investment repaid

114
Q

how can solvency of a business be assessed

A

by looking at its gearing

115
Q

what does financial gearing look at

A

how a company is financed

116
Q

if a business has a high level of non current liabilities (DEBT) what might this cause

A

potential risk medium long term these loans cannot be repaid

117
Q

What is debt

A

includes non current liabilities and normally preference shares

118
Q

What is equity

A

ordinary share capital plus the reserves

119
Q

What is gearing ratio

A

Debt/Equity = Loans + overdrafts/ Share capital + reserves

120
Q

what is the interest cover ratio

A

operating profit/interest payable

121
Q

what is an interest cover ratio used for

A

to assess the financial risk of a business not being able to meet the interest payments

122
Q

why does a highly geared firm have greater financial risk

A

interest charge is fixed and must be repaid no matter what the level of profits

123
Q

what are the benefits of debt

A

if expanding financing by debt will not dilute the share ownership of the company
interest and repayment period can be negotiated and are known
the interest charge is deducted from profits being calculating tax, interest payments therefore have the effect of shielding income from tax
dividends are paid out after tax

MGT388 (8 decks)

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