Chapter 1 - Introduction to Accounting

Question 1

What is Accounting?

Answer 1

a way of recording, analyzing and summarizing financial data

Question 2

What is financial data? give examples (3)

Answer 2

the name given to the actual transactions carried out by a business. 1. Sales 2. Purchases 3. Expenses

Question 3

What happens to transactions?

Answer 3

1. Recorded in books of prime entry, 2. Analysed and totals posted in ledger accounts 3. Summarised in financial statements

Question 4

Q: Accounting only applies to the financial statements produced by a large listed company? A. Yes B. No

Answer 4

B. Accounting is carried out by all businesses, no matter their size or structure.

Question 5

What are the two types of accounting?

Answer 5

1. Financial accounting & 2. Management accounting

Question 6

Define Financial Accounting (3)

Answer 6

1. Method of reporting the results/financial position of a business.
2. Not primarily concerned with providing information to improve the business.
3. Satisfy information needs and provide a historical record

Question 7

Define Management Accounting (2)

Answer 7

1. Much more detailed than financial accounting

2. Include plans for the future like budgets predicting future revenue/expenditure)

Question 8

What thing influence the rules around preparing financial statements? (3)

Answer 8

1. Company law
2. National and international accounting standards
3. stock exchange requirements

Question 9

Define GAAP

Answer 9

Generally Accepted Accounting Principles. includes all rules which govern accounting in a country

Question 10

What governs the form and content of limited liability companies financial reports?

Answer 10

primarily (1) national legislation but also (2) International accounting standards (IAS’s) and (3)international financial reporting standards (IFRSs).

Question 11

Where do rules outlined in the GAAP standards derive from? (4)

Answer 11

1. Local (national) company legislation
2. National and international accounting standards
3. Statutory requirements in other countries (US)
4. Stock exchange requirements.

Question 12

What are the fundamental qualitative characteristics of useful financial information? (2)

Answer 12

1. Relevance

2. Faithful representation

Question 13

Define Fair presentation

Answer 13

Cant, its a fluid thing. generally: In International Accounting Standards, the requirement for companies not to obfuscate their financial statements so as to mislead shareholders or the wider market.

Question 14

What is required for fair presentation? (4)

Answer 14

1. Compliance with all applicable accounting standards
2. Selection and application of appropriate accounting policies
3. Presentation of information to provide relevent, comparable, verifiable, timely & understandable info
4. Additional disclosure where required

Question 15

What is the fair presentation override?

Answer 15

When a company can override the fair presentation rules of a company if it means by following the rule the financials will not give a fair presentation

Question 16

Define the economic (business) entity assumption

Answer 16

a business entity exists separately from its owner(s). Therefore the financials are prepared separate to the owners regardless of legal position.

Question 17

What does the business entity assumption mean for movement of money between the business and its owner?

Answer 17

Any money paid into the business is owned by the business as a loan from the owner.
Any money out to pay personal items of the owner is not recorded as a purchase but as money taken out of the business by the owner.

Question 18

Define monetary unit assumption

Answer 18

accounts can only deal with items expressed in monetary terms. Things such as experience and knowledge of the employees is not an asset of the business as no reliable monetary value can be placed on experience

Question 19

True or false: Experience is counted as an asset to a business

Answer 19

False. cannot be valued reliably therefore cannot be included as an asset

Question 20

Define time period assumption

Answer 20

Financial statements should be prepared on a regular basis and for a particular period of time which is normally one year

Question 21

Define going concern

Answer 21

Entity viewed as a going concern when it has neither the intention nor the need to liquidate or curtail materially the scale of its operations.

Question 22

What are the assumptions of going concern? (2)

Answer 22

1. the business will continue to operate fr the next 12 months.
2. Assets should not be valued at their break up value.

Question 23

Define break up value

Answer 23

value of an asset if sold off in say a liquidation situation.

Question 24

Define carrying value

Answer 24

Value of an asset over time. Carrying value = cost less the accumulated depreciation charged to date.

Question 25

If the going concern assumption is valid how is an asset/item valued?

Answer 25

it is valued at the carrying value = cost less the accumulated depreciation charged to date

Question 26

True or false: an asset should be valued at its sracp price after the first 3 years of operation as this is what it would sell for during a valuation therefore that is all its worth.

Answer 26

False if the going concern assumption is valid. True if the going concern assumption is not valid.

Question 27

A retailer commences business on 1 January and buys inventory of 20 washing machines, each costing $100. During the year he sells 17 machines at $150 each. How should the remaining machines be valued at 31 December in the following circumstances? a. He is forced to close down his business at the end of the year and the remaining machines will realise only $60 each in a forced sale. b. He intends to continue his business into the next year.

Answer 27

(a) If the business is to be closed down, the remaining three machines must be valued at the amount they will realise in a forced sale, i.e. 3 × $60 = $180. (b) If the business is regarded as a going concern, the inventory unsold at 31 December will be carried forward into the following year, when the cost of the three machines will be matched against the eventual sale proceeds in calculating that year's profits. The three machines will therefore be valued at cost, 3 × $100 = $300.

Question 28

What should be disclosed if going concern assumption is not followed? (3)

Answer 28

1. The business is not a going concern 2. The basis on which the financials have been prepared 3. Reasons why the entity is not considered to be a going concern

Question 29

Define the accruals assumption

Answer 29

revenue earned is matched against the expenditure incurred in earning it.

Question 30

When are transactions recorded in financial statements?

Answer 30

when the revenues or expenses are earned or incurred. not when the cash is paid or received.

Question 31

Define Substance over form

Answer 31

The principle that transactions and other events are accounted for and presented in accordance with their substance and economic reality and not merely their legal form

Question 32

When does substance over form apply? why?

Answer 32

When the transactions are fairly complicated. stops entities distorting their results by follow the letter of the law and being able to hide certain things. present on commercial reality not always legal form of the transaction

Question 33

What is cost principle?

Answer 33

items in the financial statements should be valued at cost, however there are different ways of determining cost

Question 34

Define historical cost

Answer 34

Items are normally stated in accounts at historical cost. known as the amount the business paid to acquire them.

Question 35

What are the advantages of historical cost? (2)

Answer 35

1. Documentary evidence of to prove the amount paid to purchase and item or pay an expense. 2. Are objective (unlike valuations which vary depending on what they are for)

Question 36

Define replacement cost

Answer 36

amount needed to replace an item with an identical item

Question 37

AB Co purchased a machine five years ago for $40 000. It is now worn out and needs replacing. An identical machine can be purchased for $60 000. What is the a) historical cost and b) replacement cost?

Answer 37

a. $40 000 | b. $60 000

Question 38

Define Net realisable value

Answer 38

The expected price, less any costs to be incurred in getting the item ready for sale or selling it.

Question 39

AB Co's machine from the example can be restored to working order at a cost of $10 000. It can then be sold for $20 000. What is its net realisable value?

Answer 39

Net realisable value = $20 000 – $10 000 | = $10 000

Question 40

Define Economic Value

Answer 40

The value derived from the assets ability to generate income. ie. the profit an asset is expected to make in the remainder of its useful life.

Question 41

Suppose that a company buys a new machine for $40 000. It is estimated that the new machine will generate profits of $9000 per year for its useful life of seven years. What is its economic value?

Answer 41

Economic value = $9 000 x 7 | = $63 000

Question 42

What is defined as relevant information?

Answer 42

information that is capable of making a difference to the decisions made by its users.

Question 43

When is financial information considered capable of influencing decisions? (3)

Answer 43

if it has a predictive or confirmatory value or both. is often used as a way to predict the future or confirm past performance

Question 44

What is defined as a perfectly faithful representation? (3)

Answer 44

When it is: 1. complete 2. neutral 3. free from error

Question 45

In which two ways must financial information be comparable?

Answer 45

1. Through time to identify trends 2. With other entities statements to evaluate their relative financial position, performance and changes in financial position.

Question 46

When is information defined as verifiable?

Answer 46

when different knowledge and independent observers can agree that this particular way is right.

Question 47

What is an example of direct and indirect verification?

Answer 47

direct - counting cash | indirect - checking through calculations

Question 48

Define the importance of timeliness when regarding financial reports.

Answer 48

information must be available to users tin time to influence their decisions. Usually the older information is the less useful it is however historical data can help identify trends

Question 49

Define understandability in the context of financial reporting

Answer 49

users must be able to understand financial information however complex matters should not be left out simply due to the difficulty in understanding them

Question 50

What are the main elements of financial statements? (3)

Answer 50

1. Statement of financial position 2. Statement of profit or loss 3. Statement of changes in equity

Question 51

Define a statement of financial position (2)

Answer 51

1. is a list of all the assets owned and the liabilities owed by a business. 2. a snap shot in time.

Question 52

Define an asset

Answer 52

An Asset is something which is of value to the business, which the business owns or has use of

Question 53

What are some examples of assets?

Answer 53

factories, office buildings, warehouses, delivery vans, lorries, machinery, computer equipment, office furniture etc

Question 54

Define a liability

Answer 54

A liability is an amount which is owed to someone else. 'liabilities' is the accounting term for the debt of a business

Question 55

What are some examples of liabilities?

Answer 55

amounts owed to suppliers, amounts owed to the bank, bank overdraft, tax owed

Question 56

What do we call the amounts invested into a business by the owner?

Answer 56

capital

Question 57

In a limited liability company what is the name given to the capital

Answer 57

Share capital is known as equity

Question 58

In what order does a financial statement list capital liabilities and assets?

Answer 58

Assets, capital & liabilities

Question 59

What do the assets always equal?

Answer 59

the assets will always be equal to liabilities plus capital (or equity)

Question 60

Define a statement of profit or loss

Answer 60

P & L is a record of the income generated and expenses incurred over a given period. shows whether the business has more income than expenses (in profit) or more expenses than income (loss)

Question 61

If a business has more income than expenses is it running at a profit or at a loss?

Answer 61

profit

Question 62

Define income

Answer 62

Money or other benefits flowing into a business during an accounting period

Question 63

Define revenue

Answer 63

Revenue is money earned from customers by selling goods & services to them

Question 64

Define gains (2)

Answer 64

(1) profits from selling assets such as building or machines that have been used long term by the business in operations rather than in trading. (2) can also include increases in value of non trading assets such as property or investments

Question 65

Define expenses

Answer 65

Expenses are the money or other benefits that flow out of a business during the accounting period.

Question 66

What are the main types of expenses incurred by a business?

Answer 66

mostly running costs of the business like salaries and wages. can also included losses from non trading assets.

Question 67

Define a statement of changes in equity.

Answer 67

A statement which chows the change in the amount in owner of the business has invested during a given period. includes the net profit or loss, any capital produced and any amounts returned to the owner.

Question 68

True or false both sole traders and limited liability companies produce statements of changes in equity.

Answer 68

Mostly false. sole traders usually display changes in equity the 'capital' section of the financial position

Question 69

Define the accounting equation

Answer 69

Assets = capital + liabilities

Question 70

Define drawings

Answer 70

Drawings are amounts of money taken out of a business by its owner

Question 71

``` Which is correct: A Capital = Assets + Liabilities B Capital = Liabilities – Assets C Capital = Assets – Liabilities D Capital + Assets = Liabilities ```

Answer 71

C Capital = Assets – Liabilities because Assets = Capital + LIabilities

Question 72

Define a 'payable'. what is another name for a payable?

Answer 72

A person to whom the business owes money. often known as a creditor

Question 73

Define a trade payable

Answer 73

A person to whom the business owes money for debts incurred in the course of trading operations

Question 74

In the accounts of a business, unpaid debts which arise from the purchase of materials, components or goods 'payables' for resale are called...?

Answer 74

Trade Accounts Payable/Accounts payable/payables

Question 75

What is a accounts receivable or debtor?

Answer 75

A customer who buys goods without paying cash for them immediately

Question 76

Define trade accounts receivable.

Answer 76

Amounts owed by receivables (customers) for services already provided

Question 77

True or False: A Trade account receivable is a liability

Answer 77

false it is an asset. when that is paid it turns into a cash asset

Question 78

Which key elements make up a financial statement? (5)

Answer 78

Assets, Liabilities, equity (capital), Income & Expenses

Question 79

How would purchasing $800 worth of inventory on credit affect the accounting equation?

Answer 79

- Increase in assets inventory) $800 | - Increase in liabilities (payables) $800

Question 80

How would paying the telephone bill $25 Affect the accounting equation?

Answer 80

Decrease in assets (cash) $25 | Decrease in capital (profit) $25

Question 81

How would selling $450 worth of inventory for $650. affect the accounting equation?

Answer 81

Decrease in assets (inventory) $450 Increase in assets (cash) $650 Increase in capital (profit) $200

Question 82

How would paying $800 to the supplier affect the accounting equation?

Answer 82

Decrease in assets (cash) $800 | Decrease in liabilities (payables) $800