Accounting topic 1 Flashcards
(8 cards)
What is the accounting period concept
The Accounting Period Concept divides the life of an enterprise into arbitrary time periods, generally a month, quarter, six months or a year, for the purpose of profit determination. This is necessary as the true profit or loss made by a business can only be determined after the liquidation of a business, when it ceases operating. Many parties are interested in regular periodic review of the financial results of an organisation, e.g. owners, ATO, creditors. It is therefore the aim for every accounting period to calculate an accurate profit figure by matching the revenues earned with the expenses incurred in earning those revenues.
Explain the difference between income and revenue
Income is defined by the AASB Framework as: “increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants”. Revenue is further defined by the AASB Framework as “increases in economic benefits arising in the course of ordinary activities of an entity”. Therefore income includes both revenue earned and gains made which are shown in a Statement of Comprehensive Income.
Explain the difference between accrual and cash accounting
The accrual basis of accounting, which is used by most businesses, recognises transactions and events when they have an economic impact on the entity, rather than when the associated cash flows occur as recognised in cash accounting. The adoption of accrual accounting will necessitate balance day adjustments being made to ensure that assets, liabilities, revenues and expenses are recognised in the correct reporting period, when the effects of transactions occur, i.e. when revenue is earned and expenses are incurred. This is in contrast to cash accounting where the effects of transactions are recognised only when cash is received or paid.
Describe the statement of profit or loss
A Statement of Profit or Loss is prepared outside the ledger for presentation to interested parties to gain insight into how the business is operating or performing, The difference between revenues earned and expenses incurred for the period of time is found to calculate the resultant profit or loss.
Describe the statement of financial position and explain the interrelationships between the elements of the accounting equation and the statement of financial position
The statement of financial position is a list of all assets (items of value owened or contributed by a business), liabilities (amounts owed by a business to external parties) and owner’s equity (owner’s interest or investment in the business) of an organisation in order to show the financial position at a particular point in time. It can be presented in either a narrative or T account format. The statement of Financial position is a more detailed expression of the accounting equation, giving details of particular assets, liabilities and owner’s equity. As a result, its is of particular importance to all parties interested in the assesment of the net worth of the business
Describe the statements of cash flows
The statement of cash flows demonstrates where the business received cash during the period and how that cash was spent. There are 3 sources and uses for the cash during that period: operating activities, financing activities and investing activities. . The Statement of Cash Flows assists management in understanding changes in financial position, and external users in making decisions concerning capital contributions or loans. It also should assist in: assessing the ability of an entity to generate cash flows in the future, developing and evaluating investment expenditure programs and obtaining external financial where necessary.
Describe net profit ratio
Net profit occurs when the revenue earned by a business is greater than the expenses incurred in generating that revenue. Most businesses determine profit
Using the accrual basis of accounting. This can often mean that although profit has been recognised, no cash has been recieved. The business may not be able to meet its financial commitments, with many businesses failing due to their inability to get their timing of cash inflows (reciepts) and outflows (payments) correct and their net cash from operations is negative for the period.
Describe the return on owners equity
The rate of return on owner’s equity is the ratio or percentage of net profit to average owner’s equity over the period. The ratio indicates the rate of return on owner’s equity invested in the business. This rate should be considered relative to current interest rates and the degree of risk taken in order to evaluate profitability.
