Topic 2: Financial Statements (Income Statements)

Question 1

What is the definition of an Income Statement?

Answer 1

The Income Statement is a general purpose report which shows the financial performance of the firm over the accounting period.

Question 2

What happens when Revenue is greater than Expenses?

Answer 2

The business records a profit.

Question 3

What happens when Expenses are greater than Revenue?

Answer 3

The business records a loss.

Question 4

What is the Accounting Period Concept?

Answer 4

The life of the business must be divided up into equal reporting periods to measure the performance of the business.

Question 5

What are some limitations of the Accounting Period Concept?

Answer 5

1. If we choose a period that is too short, we could have problems of seasonal factors affecting business performance.
2. Some Firms may need a longer period to gain a more consistent measure of performance.

Question 6

What is Revenue?

Answer 6

Inflow of resources (cash) relating to goods or services during the accounting period.

Question 7

What are Expenses?

Answer 7

A cost to the business (outflow of resources associated with the earning of revenue during the accounting period)

Question 8

What is classified under ‘Revenue’?

Answer 8

The inflow of cash from the main activity of the business that occurs from its day-to-day operations.
Examples: Sales, Sales Return

Question 9

What is classified under ‘Other Revenue’?

Answer 9

Minor sources of inflow that are a result from activities that are not part of the businesses day to day operations.
Examples: Commission Received, Interest Received

Question 10

What is classified under ‘Cost of Goods Sold’ (COGS)?

Answer 10

Cost of buying the goods, bringing the goods into the store and getting them ready for sale.

Question 11

What is classified under ‘Selling Expenses’?

Answer 11

The costs incurred in selling the goods.

Examples: Advertising, Promotions, sales staff salaries

Question 12

What is classified under ‘Admin Expenses’?

Answer 12

Costs relating to the office or general running of the business.

Question 13

What is classified under ‘Financial Expenses’?

Answer 13

Costs associated with the borrowing of money and extension of credit to customers.
*Costs associated with Loans and Debtors.

Question 14

How are COGS written in the income statement?

Answer 14

1. Opening Stock
2. (Plus) Purchases
3. Closing Stock - MUST BE LAST

Question 15

What is the only item that appears in both financial statements?

Answer 15

Closing Stock:
Income Statement - (negative value in COGS)
Balance Sheet - Current Assets

Question 16

Why do Service Firms not have COGS classification?

Answer 16

The business does not buy goods, they provide a service.

Question 17

What is Gross Profit?

Answer 17

The profit resulting from the buying and selling of goods.

Question 18

What is Profit?

Answer 18

The final profit figure for the period after deducting all day to day operating expenses.

Question 19

What is Discount Allowed associated with?

Answer 19

Sales (Revenue)

*Negative Figure

Question 20

What is Discount Received associated with?

Answer 20

COGS.

*Negative Figure

Question 21

What is the (Individual) Expense Ratio and what is its acceptable range?

Answer 21

Measures the impact of the expense against the sales of the business.
Acceptable Range: The lower the result the better - needs to be compared to past trends

Question 22

What is the Gross Profit Margin and what is its acceptable range?

Answer 22

Measures the rate of return from the buying and selling of goods and the margin of profit available to cover operating expenses.
Acceptable Range: The higher the result the better - Must be compared to past performances and industry average.

Question 23

What is Accrual Accounting?

Answer 23

Records transaction when it occurs and in the period it relates to.

Question 24

What is Cash Accounting?

Answer 24

Records the transaction when cash is paid or received.

Question 25

What is the main difference between Cash and Accrual Accounting?

Answer 25

Time: Will show a difference in profit during an accounting period. HOWEVER, over the life of the business the profit figure will be exactly the same. *No one system is better than recording profit over the life of the business.

Question 26

What are the two concepts related to Accrual Accounting of Revenue and Expenses?

Answer 26

1. Faithful Representation | 2. Accounting Period Concept

Question 27

What is Faithful Representation?

Answer 27

All financial information produced must accurately reflect the true financial position of the business. (Complete, Error-free and Unbiased)

Question 28

What is the Accounting Period Concept?

Answer 28

The life of the business must be divided up into equal reporting periods to measure the performance of the business.

Question 29

What is the Going Concern Assumption?

Answer 29

A business has an unlimited life and will continue to operate indefinitely.

Question 30

What is the issue when abandoning the Going Concern Assumption TOO LATE?

Answer 30

Business is misleading creditors and shareholders, by continuing to use credit knowing they will not be able to pay it back. They will be committing fraud.

Question 31

What is the issue when abandoning the Going Concern Assumption TOO EARLY?

Answer 31

Creditors and Shareholders will stop issuing credit, demand repayment and withdraw equity from the business. *Lead to a definite closure of the business.

Question 32

What is Relevance?

Answer 32

Accounting information must be meaningful, significant and timely to be included in financial reports.

Question 33

What is the Materiality Assumption?

Answer 33

Accountants record the amounts/values in the financial statements in a form that are still significant to assist decision making. *Extent of materiality depends on size of business

Question 34

What is the Consistency Doctrine?

Answer 34

A firm should use the same accounting methods and procedures from one accounting period to another. *Easier to make more meaningful comparisons over previous year's reports.

Question 35

What is the Major Limitation of the Consistency Doctrine?

Answer 35

The business will change over a number of years and will need to change the reporting methods to reflect the changes in the business.

Question 36

What evidence exists in the Balance Sheet that would confirm Accrual Accounting is being used?

Answer 36

Debtors and Creditors

Question 37

What evidence exists in the Income Statement that would confirm Accrual Accounting is being used?

Answer 37

1. Bad and Doubtful Debts | 2. Credit Purchases/Sales

Question 38

What is the definition of the Return on Total Assets Ratio and what is the acceptable range?

Answer 38

Measures the rate of return based on the businesses assets. Measures how well the business assets are performing and being used. Acceptable Range: The higher the result the better. However, must be checked against past performances and industry average.

Question 39

Where is 'Discount Allowed' classified in the Income Statement?

Answer 39

REVENUE - NEGATIVE FIGURE | *Form Net Revenue Value.

Question 40

Where is 'Discount Received' classified in the Income Statement?

Answer 40

COGS - NEGATIVE VALUE

Question 41

Where is 'Donation to Charity' classified in the Income Statement?

Answer 41

ADMIN EXPENSES