Week 2 - Reporting financial performance

Question 1

What does a statement of profit or loss / income statement (SPL) do?

Answer 1

Measures the financial performance of the business over period of time (revenues and expenses)

Question 2

What are the three measures of profit in an SPL?

Answer 2

• Gross profit
• Operating profit
• Net profit

Question 3

Formula for Profit (or loss) for the period

Answer 3

Profit (or loss) = total revenue for the period - total expenses incurred in generating that revenue

Question 4

What is the difference between cost of sales and operating costs?

Answer 4

• Cost of sales are the costs that can be directly associated with the sale of a particular good
• Operating costs are costs to the business that are not costs of sales, but still relate to the business operation

Question 5

How does a statement of financial position and SPL link? (3)

Answer 5

• If a firm was to make a profit or loss the accounts need to show that the owner’s wealth has increased/decreased to this
• Equity section of a statement of financial position shows the ownership interest in a company
• The net profit or loss is added to this section under retained earnings

Question 6

Total equity equation

Answer 6

Total equity = share capital + retained earnings

Question 7

Accounting equation

Answer 7

Assets = equity + sales revenue - expenses + liabilities

Question 8

What is accrual accounting?

Answer 8

It occurs when the organisation records transactions that change a compnay’s financial statements in the period in which the transactions occur

Question 9

How is net profit/profit for the period determined? (2)

Answer 9

• Companies recognise revenues when they perform the services not when the cash is received
• Recording expenses when they are incurred and not when paid

Question 10

Characteristics of revenue (3)

Answer 10

• Measure inflow of economic benefits arising from ordinary operations of the business
• Result from business activities entered into for the purpose of earning income
• Benefits will result in increase in assets or decrease in liabilities

Question 11

Examples of revenue (4)

Answer 11

• Sales
• Fees for services
• Interest received
• Subscriptions

Question 12

What is the prudence convention/concept? (2)

Answer 12

• It focuses on being more conservative in the preparation of accounts
• this may involve: understating profits/revenues/assets and overstating costs/liabilities

Question 13

Impact of accounting issues (4)

Answer 13

• Can lead to employees losing jobs
• Massive losses in shareholder value
• Losing of auditor accreditation
• Pension holders could lose their pension funds

Question 14

Revenue recognition principle

Answer 14

Revenue is recognised in the accounting period in which the performance obligation is satisfied

Question 15

Revenue recognition criteria (3)

Answer 15

• The amount of revenue must be able to be measured accurately reliably
• It is probable that economic benefit will be received
• Ownership and control of the items should pass to the buyer in the case of sale of goods

Question 16

What are expenses? (3)

Answer 16

• Is an outflow of economic benefits arising from the ordinary operations of the business
• Loss of benefits will lead to decrease in assets or increase in liabilities
• There are cash and non cash expenses

Question 17

Examples of expenses (9)

Answer 17

• Cost of sales
• Salaries expense
• Rent
• Heating & light
• Insurance
• Bad debts
• Finance cost/interest
• Depreciation
• Printing & stationary

Question 18

General rule for expense recognition

Answer 18

All expenses of a particular accounting period must be matched with the relevant of that period irrespective of whether the expenses have been paid in cash

Question 19

What are inventories? (2)

Answer 19

• Are assets held for sale in the normal course of business (I.e finished goods)
• In the process of production for sale (I.e. work in progress), or in the form of materials to be consumed in production of goods for sale (I.e raw materials)

Question 20

What is cost of sales?

Answer 20

Includes the cost of inventory sold during the period

Question 21

What is the matching principle of depreciation?

Answer 21

Match the cost of using up of these assets to the revenues the business generates in each period

Question 22

What is depreciation?

Answer 22

Is a non cash expense which involves the spreading got the cost over the life of the asset

Question 23

Four factors that calculate depreciation charge for a period (4)

Answer 23

• The cost (or fair value) of the asset
• The useful life of the asset
• Residual value (disposal value) - how much can we sell it for after its use?
• Depreciation methods

Question 24

3 common depreciation methods

Answer 24

• Straight-line
• Reducing-balance
• Units of production

Question 25

Features of straight-line depreciation (2)

Answer 25

* Proprotion of the same amount of depreciation each year * Accumulated depreciation is the adding of the depreciation year by year

Question 26

Features of reducing balance depreciation (3)

Answer 26

* Start on the carrying amount at the beginning of the year * Accumulated depreciating is also the adding of the appreciation year by year * Carrying amount at the end = carrying amount at the beginning - annual depreciation expense

Question 27

Annual depreciation equation

Answer 27

Units of production x depreciation cost per unit

Question 28

Carrying amount equation

Answer 28

Cost of asset - accumulated depreciation

Question 29

Impact of selling assets before the end of its useful life

Answer 29

This will have implications for income statement, statement of financial position and cash flow statement

Question 30

Formula for profit or loss on disposal

Answer 30

Sale price - carrying value

Question 31

Impact of the disposal of assets on financial statements (3)

Answer 31

* Profit or loss will be reflected in the income statement and will either increase or decrease net profit * The carrying value of the asset will be removed from the SoFP * Cash received will be reflected in cash flow statement

Question 32

Impact of one of the receivables not paying (3)

Answer 32

* Accounts have to be adjusted * Reduce receivables * Increase expenses - as we won't receive value of the sale we have to take this hit to profits

Question 33

Ethical issues in accrual accounting (3)

Answer 33

* Omittion of depreciation expense at the end of the year * Failing to record depreciation would overstate profit as calculated by mandated accrual principles and and disclose a more favourable picture of the businesses financial position actually existed * Some accounts are based on estimates, such as depreciation and revenue and these can be manipulated