Chapter 6 - Accounting Princples And Practices Flashcards
What is accounting known as in a wider context?
The analysis and interpretation of information that affects the performance and financial position of the business.
What is financial accounting?
Business discipline which consists of a series of techniques and procedures that are used to identify, measure, record and communicate information including financial information to a range of people who may be interested in the information.
The interested people in financial accounts are known as stakeholders and it it important that information is reported externally to the stakeholders by means of…
Statutory accounts
Included in the statutory accounts of quoted companies will be?
- Narrative reports from the chairman and chief executive giving an overview of the governance activities and performance of the company in the previous period.
- A strategic report setting out the strategy, business model, a fair review of the business, future developments, kpi’s, principal risks and uncertainties and corporate and social responsibility matters.
- Financial accounts for the period including the balance sheet, income statement, cash flow position and
- Other legal requirements such as details of directors remuneration.
The terms “statement of financial position” and “income statement” come from?
International financial reporting standards
The terms “balance sheet” and “profit and loss account” come from?
UK generally accepted accounting principles and the companies act 2006
The companies act 2006 includes regulation on accounting such as:
- Requirement to keep adequate accounting records
- Directors duty to prepare accounts for a company.
- Directors duty to prepare accounts for a group of companies and the consistency of financial reporting within a group.
- Requirements to show accounts that show a true and fair view.
Other than small companies, companies legislation also requires?
Companies to have their financial year end accounts audited by an independent auditor.
What does the income statement show?
Results of a company as a consequence of transactions during the accounting period. It sets out income, expenses, tax and most importantly to remember, profit or loss.
What does the balance sheet show?
Statement of financial position of the business at a point in time. I.e the account period or year end date. It is a snap shot of the company’s position at a particular point in time. It lists all the companies assets and liabilities, what is owed and what is owned. What is owed by the company includes the shareholders equity, which is the total of the assets less the total of the liabilities.
What do cash flow statements show?
Recognises that accounting, profit or loss, is not the only indicator of a company’s performance. Cash flow stamens show the sources and use of cash and are a useful indicator of a company’s liquidity.
Cash flow statements are a useful indicator of?
Liquidity
Financial statements are intended to show?
A true and fair view of the economic activities of the organisation, scalable not only to the stakeholders but any one who wishes to review them.
Whether they are in the industry or not, to enable fair comparisons can be made across companies, financial accounts must be produced within a?
Highly regulated legal framework
In preparing their consolidated accounts, companies listed on the London stock exchange have to follow?
International financial reporting standards
Other companies on the UK not listed on the London stock exchange can adopt international standards or can continue to use the?
UK generally accepted accounting principles, referred to as UK GAAP.
The true and fair view in financial accounts is similar to what concept and why is this relevant?
Substance over form concept which is that financial statements should show the economic substance of transactions rather than the legal form.
Record making process of accounting is known as?
Book-keeping
Financial accounting is concerned with providing what type of information to external stakeholders and interested parties?
Historic
Management accounting is concerned with?
Internal planning and control of an organisation to enable its managers to make sound decisions. It aims to show managers how the organisation is performing in comparison with anticipated outcomes; and, if there is any deviation, what corrective action should be taken.
Financial accounting is highly structured around the?
Accounting equation
In financial accounting, to enable stakeholders to compare the company’s performance from one year to the next and also against other companies in the sector, information is prepared within a?
Framework
To suit many purposes, management accounting can be?
Formulated in many different ways
As well as using day to day source transactional data captured for financial accounting, management accounting will also incorporate…
A variety of other information sources to enable managers to fulfil their responsibilities
If financial position is shown within the balance sheet, what is shown through profit or loss in the income statement?
Performance
Management accounting systems are not just concerned with?
Money
Give 3 examples of non monetary information used in management accounting?
- Labour hours
- Raw material used
- Electricity consumed
Whereas financial accounting looks at and records the financial impacts of events on the organisation as a whole, management accounting is naturally segmented and concentrates on…
Processes, individual departments and other areas of responsibility, in terms each manager can understand.
Which type of accounting looks at the historical information and which type of accounting looks at the future?
Financial accounting looks at historical information whereas management accounting is largely concerned with the future.
The framework companies must use to present their financial statements ensures?
Informational on the cm panties financial position and performance are comparable with previous years and with other companies.
Stewardship management enables?
Users to assess the quality of the managers who take responsibility for safeguarding the assets of the company on behalf of its owners the shareholders.
Management accounting has no external…
Regulatory constraints
Companies are not required by law to produce what type of accounts?
Management accounts
Companies are legally required under the companies act to produce what accounts?
Financial accounts
Which type of accounting is usually private?
Management accounting
Management accounts do not have to be ???? Externally
Audited externally, although some auditors may want to examine some management accounts to help their assessment of audit risk.
If an organisation has an internal audit department, it will have delegated responsibility from the audit committee or senior management to…
Report on the adequacy of the systems of control.
Why will owners of the business be important stakeholders and therefore have an interest in a company’s financial information?
Need to know how the business is performing to be able to know whether to continue or increase their capital investment. This applies especially to shareholders in public limited companies in which investment decisions are often taken on a purely financial basis.
Why will directors and managers need an interest in a company’s financial information?
These have overall responsibility for managing the business so will need to know whether or not the organisation has met its strategic objectives and have been making the best use of its resources. They will also need to know the company has enough capital and liquidity to enable it to carry out its plans, whether some parts of the business are more successful than others and whether the company has behaved as a responsible part of the community.
Why will employees require financial information about a company?
Usually concerned how secure their jobs are. Use financial information to decide if they think the company can continue to pay their wages. Employees can also be shareholders so may have conflicting stake holder objectives.
Why will the public be interested in financial information about a company?
Can be both potential investors and shareholders as well as people considering applying to work for an organisation.
Why will tax authorities want to know financial information about a company?
They will want to know the organisation is paying the appropriate level of tax.
Why will financial analysts be interested in the financial information about a company?
Can be for example independent financial advisors who will want to know whether they should advise shareholders and potential shareholders to buy or sell shares in an organisation. They use financial information to track the organisations performance. Others may be journalists for example who provide info to the public at large. Also rating agencies for wanting to know they are meeting their financial obligations by seeing the companies financial strength.
Why will creditors and lenders be interested in the financial information about a company?
They will need to make a judgement about whether they should extend credit to an organisation and if so, what limit they should set.
Why will competitors of a company be interested in its financial information?
Can use financial information to be able to help them readily understand its strengths and weaknesses.
Why will brokers be interested in the financial information of a company?
Brokers will want to know the companies they deal with are financially strong.
Why will customers be interested in the financial information of a company?
They will want to know they are insured with a reputable company who will be able to pay claims.
Why will the prudential regulation authority and the financial conduct authority be interested in the financial information of a company?
These are the regulatory bodies so they will need to know this information to know which action if any to take, with the PRA regulating the prudential issues, as the FCA regulating the conduct of businesses.
What two types of information beginning with q will the different stakeholders need in regards to financial information of companies?
Quantitative and qualitive
Information, despite being clearly available on the published accounts will need to be ???? For stakeholders to arrive at an informed judgement?
Interpreted and analysed
As stakeholders are becoming more socially aware, companies are now placing emphasis on how they are meeting?
Social obligations.
As people will want to know how an organisation has been doing in the last year, financial statements often contain narrative about the organisations activities, outlining areas of particular…
Success or failure, and covering new or discontinued projects, as well as directors assessment of risk and objectives for the current and future management of the company.
Many companies now provide information on how they undertake their ???? Responsibilities to the wider community?
Social e.g how they are addressing environmental issues or helping to reduce the impacts of climate change.
In very very simplistic terms, what is the short definition of profitability?
The company’s ability to make money.
A company will have made a profit if?
There is a positive amount of money left over when all costs and expenses are subtracted from all of the organisations income.
When does a company “break even”?
If the amount left over when all costs and expenses are subtracted from a companies income is exactly zero (expenditure matches income exactly).
Managers will want to know if the company is profitable so they know…
How well they have managed the business.
Rising profits may reflect rising dividends for shareholders, management may instead however…
Retain profits to fund future expansion.
Why would a life assurance policyholder be concerned with a company’s profitability?
Will want to know the company’s record for bonuses, as it may affect their decision to enter a long term policy.
What is cash position (liquidity)?
The amount of cash a business has, or has access to, is known as its liquidity.
Why is cash position (liquidity) important?
Cash is vital to a business as this is what pays its costs and expenses. If it cannot manage its liquidity then by running out of cash it will not be able to pay its bills. This can lead to difficulty in trading leading to failure of the business. This can happen even if a business is profitable.
Why is income and expenditure important?
Helps build up a picture of the volume of sales from one year to the next, to see if they have gone up or down overtime.
One measure of an insurers size is?
Premium income
A measure of a brokers size may be?
Amount of premium income it managers, it’s fee income or a combination of both.
Information on wages, raw materials, rent or company cars can all be gathered under the heading?
Expenditure
Net claims, reinsurance premiums, acquisition costs and operating costs are all examples of?
An insurance companies expenditure.
Give examples of how a company’s wealth may be held
Non current assets such as property, equipment and investments, and in current assets such as its debtors and cash.
Working capital is?
Difference between current assets and current liabilities.
When a company has a decreasing working capital, this could be a short term problem or an indication of?
Poor management
Working capital can also show
Result of growing business
Whereas liquidity is a measure of the cash available to a company, solvency is a measure of?
The excess of an organisations assets compared to its liabilities.
If a company’s liabilities exceed its assets it is technically…
Insolvent, and with some exceptions be required to cease trading.
The PRA require insurance companies in the UK to meet a solvency margin, this is the amount…
The value of the insurers assets should exceed the amount of its liabilities.
What is the difference between a trading company to an insurance company regulated by the PRA in terms of becoming insolvent?
In a trading company, if it’s liabilities exceeds it assets, it is technically insolvent, however in an insurance company regulated by the PRA, if the insurance company’s net assets falls below its solvency margin, that can also be classed as insolvent.
The amount of regulatory capital a company holds in excess to its solvency margin is an indication of the company’s…
Financial strength and ability to pay claims to its customers.
What is income? And what can this also be known as?
Income is all of the amounts of money earned by the organisation from any source, including sales, rentals, interest payments and investments. Income generated from sales (excluding vat) is sometimes called revenue or turnover.
What is expenditure?
All the amounts of money incurred to pay for goods or services.
What is profit?
In accounting terms, any excess of income over expenditure incurred in running the business that earns that income.
What is shareholders equity?
This is the stake the shareholders have in a company. It is calculated as the total value of all the assets in the business less the total value of all the liabilities.
What is capital?
Sum of the equity and long term debt used to finance the business.
Long term debt in an insurance company can only be classed as regulatory capital if?
It meets stringent rules set out by the PRA.
What tier of capital does equity count of and why is this better?
Tier 1 and this is the best sort of capital because it gives the greatest protection to policyholders.
Depending on the structure of the debt, particularly repayment terms, long term classified debt may be either?
Tier 1 or tier 2
The PRA impose what on tier 1 and 2 debt?
Limits on the amount this can be classified as regulatory capital.
If debt is classified as regulatory capital, what will this improve for an insurance company and why?
Will improve the solvency margin because this debt does not count as a liability for regulatory purposes.
What is the advantage of having regulatory debt capital in addition to equity?
The cost of regulatory debit capital is normally lower than the cost of equity.
What would shareholders expect if the company has tier 1 and tier 2 debt compared to only holding equity?
Higher earnings per share
What is an asset?
Resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.
What is a tangible asset?
One that is physical and real such as cash, land, buildings, machinery or investments.
What is an intangible asset?
One that is not physical such as a trademark, a copyright or goodwill.
When machinery or equipment for example loses its value of time, in accounting terms, their loss of value is called?
Depreciation
What is purchased goodwill?
Difference between the amount paid for acquiring a business and the value of the net assets of that business when acquired.
In accounting language, what is a liability?
An amount owed by an organisation.
In insurance terminology, what can a liability refer to?
An insurers acknowledged commitment to pay an amount of money arising out of a claim under a policy, or to a class of business or subsection of a policy.
What is cash?
Money that is available to the business and includes money deposited at the bank or cash retained on the premises e.g petty cash.
What is a creditor?
An individual or organisation to whom a debt is owed, e.g a supplier.
What is a debtor?
Any organisation or person who owes a debt to a company.
Debt owed to a company is considered as what on the balance sheet?
Current assets
When adjustments are made to the value of assets over their useful lives to reflect that they will deteriorate or become obsolete, this is known as?
Depreciation
Why does an assets full cost not come under expenditure in the year of purchase?
Reported profits would fluctuate widely from year to year.
What do accountants do to take into account depreciation?
They write down the cost of an asset over time, using a recognised method, leaving a notional value of the asset in the organisations balance sheet at any one point in time.
What is depreciation in reality and what is it important to note with regards to cash flow?
A book keeping entry with the company setting up a depreciation provision account. It is important to note no cash actually leaves the organisation as depreciation is incurred so it does not affect cash flow.
It is important to recognise that the amount recorded as a non current asset in the balance sheet is not necessarily (regarding deprecation)…
The amount that would be realised should the item be sold.
What is the formulae for straight line depreciation?
Coat of asset - scrap or residual value (both) / the life of the asset
Assets = equity + liabilities is what?
The accounting equation
The accounting equation is a logical way of?
Looking at financial transactions and explaining how the income and expenditure relate to the value of the company.
The accounting equation forms the basis of the accounting entries that make up the?
Income statement and balance sheet
Paper based book keeping has been replaced mostly by what and how can this be obtained?
Electronic book keeping systems and accounting packages can be bought of the shelf which include these systems.
Not all transactions are for immediate cash, this can be classed as being bought on?
Credit
Organisations require systems for recording transactions such as buying items and such on credit. The nature of the system will depend on?
The type of business.
What are raised to show amounts owed to the business?
Invoices
Invoices show when a transaction has occurred and record details such as…
Amount of debt incurred, who owes the money, organisation to whom debt is owed, date when debt was incurred, when payment is due, way debt was calculated, ancillary information such as VAT.
To keep records of expenditure, what will be retained?
Receipts
Money received and cash payments made are recorded in a …
Cash book. A balance will be calculated frequently to monitor liquidity.
All financial transactions are recorded in the books of account using which principle?
Double entry principle
What does the double entry principle show?
Two fold effect on the accounting equation by reflecting that the business both receives and gives value in each transaction
