Accountancy 1A

Deferred income + what is it recorded as?

Cash received but not earned - recorded as a liability

What is the journal entry for deferred income?

DR Bank, CR Deferred Income

Accrued Income + what is it classified as?

Revenue that has been earned but not yet invoiced for cash by the end of the accounting period - classified as an ASSET

What is the journal entry for Accrued Revenue?

DR Accrued Revenue, CR Sales

Which accounting standard deals with revenue recognition?

IFRS15

Are estimates/judgements involved in measuring and recognizing assets?

YES - financial reporting based on accruals and future expectations, which is uncertain and requires estimates

Which aspects require estimation/judgement?

Useful life, residual value, Impairment testing, allowance for doubtful receivables, fair value measurement

What principles/ guidelines should be used in making those judgements/estimates?

The conceptual framework - Faithful representation principle, relevance, use of reasonable and supportable assumptions, consistency, neutrality, PRUDENCE, materiality

Creative Accounting

The deliberate manipulation of financial statements within the letter of the law but against its spirit using accounting choices, estimates, presentation techniques etc. to make the financial performance or position look better than it actually is in the best interest of the producers or company

Which presents the greater risk? Asset OVERSTATEMENT or UNDERSTATEMENT?

overstatement - more harmful towards external users, goes against the law seeing as IFRS is designed specifically to prevent it

What is the WAVCO formula?

Total cost of goods available / Total units available

In periods of steadily rising prices,
however, which inventory method will result in the highest closing inventory valuation?

FIFO

Why is LIFO banned in IFRS countries?

It understates assets, profits and costs, thereby not faithfully representing their values

What is Net realisable Value

the estimated selling price of inventory minus the costs of completion and costs necessary to make the sale

How do you make an inventory adjustment when presented with NRV?

DR CoS, CR Inventory with write-off difference between asset purchase cost and NRV

Returns OUT

Business returns goods to suppliers for being damaged, incorrect, etc. They are subtracted from purchases in COS calculation

Returns IN

customers return goods to business - value is subtracted from Sales figure in income statement

Carriage IN

Cost of transporting purchased goods into the business - added to purchases figure in COS calculation

Carriage OUT

cost of transporting goods to customers - considered an operating expense in income statement

Where does other operating income go on an income statement

Added after gross profit

Purchases

Goods bought for resale

What do web development costs classify as in the SFP?

Intangible non-current assets

What is a bank deposit and what does it classify as in the SFP?

cash in bank - current asset

Liability

Present obligation of the entity to transfer an economic resource as a result of past events

What are ANY of the criteria a current liability must satisfy?

• expected to be settled in entity’s normal operating cycle

• held primarily to be traded

• due to be settled within 12 months after SPF date

Debenture

long-term loan issued by a company - written document acknowledging a debt that a company took out from INVESTORS, not a bank - comes with interest

What is the primary risk concerning liabilities?

UNDERstatement - boots profits

What are the criteria for a liability to be recognized?

1. sufficient evidence exists that a liability has been created

2. cost/value can be measured with sufficient reliability

Bank overdraft + what is it recorded as in SFP?

short-term borrowing allowing business to withdraw more money from bank account than it actually has, thus creating a negative bank balance - CURRENT liability

How is an overdraft created?

No overdraft account - whenever you pay for more than what you have in the bank, you automatically go into overdraft, creating a credit balance for the bank a/c

Accruals

Expenses that have been INCURRED but not yet paid

Prepayments

expenses which have been PAID but not yet incurred

Matching/Accrual concept

Revenue earned during a period needs to be matched with the expenses incurred to GENERATE that revenue, regardless of whether cash is received or paid

Why does matching exist in accounting?

Ensures that profit for period is accurate and faithfully represented, giving TRUE and FAIR view of performance

What is the alternative to the accruals concept and what does it mean?

CASH basis accounting - revenue is recorded only when cash is received and records expenses only when cash is paid

is cash basis used by any business entities or organisations?

YES - but only by very small and typically unincorporated businesses - in the UK only sole traders with turnover under £150,000 can

Provision

Liability of UNCERTAIN timing or amount

What is the journal entry for provisions?

DEBIT Expense account, CREDIT Provision for that account

What happens is a liability does not meet the recognition criteria?

It may be shown as a NOTE in the financial statements but no amount included in the financial statements themselves aka CONTINGENT LIABILITY

Contingent Liability (2 types)

a POSSIBLE obligation that depends on a future uncertain event OR a present obligation that cannot be measured reliably and does therefore not meet the recognition criteria

Which accounting standard sets out the 2 possible types of contingent liabilities?

IAS37

What type of balance is deferred income?

CREDIT

Ownership Interest/Equity/Capital & Reserves

The residual amount found by deducting all of the entity’s liabilities from all of the entity’s assets

What are the main reasons for changes in equity? (4)

1. Making a profit/loss through business operations

2. Issuing new shares

3. An asset which increases/decreases in value

4. A liability which increases/decreases in value

Share capital

amount of money invested in a company by its owners in exchange for shares (partial ownership of company)

Share certificates

legal document issued by a company to a shareholder as evidence of ownership of a specific number of shares in the company - proof of ownership

Par/Nominal Value

fixed face value of a share stated in the company’s constitution. Represents minimum price at which share can initially be issued

When is par/nominal value determined?

When a company is FORMED

What is the standard journal entry for the issue of shares?

Bank DR £ price x number of shares issued

Share Capital CR £ nominal value x number issued

Share Premium CR £ Price total - Nominal total

How does an increase in share price benefit the issuing company?

1. Improved market value - company appears stronger and attracts more investors

2. easier and cheaper to raise new capital

3. increases borrowing capacity - higher share price enhances perceived company financial health and lowers perceived risk of failure, making it easier for company to secure loans and credit and negotiate better credit terms

4. Makes acquisitions cheaper and more attractive

5. Attracts and retains employees - employee shared purchase plans etc.

6. protects company from takeovers

7. improves reputation

Can a company issue shares below established nominal value?

NO that would be illegal under legal capital protection rule

What affects the price of a share?

1. Company performance - revenue growth, profit margins, earnings per share, cash flow strength, dividend payments. debt levels, return on equity

2. Future expectations - if investors expect higher profits, successes, market expansion, etc. share price goes UP

3. Economic conditions - interest rates. GDP growth, exchange rates, government policies…

4. Supply and demand - if shares are in high demand, their price rises - also relates to number of dividends

5. Global events

Dividends

Distributions of a company’s profits to its shareholders, usually paid in cash, as a return on their investment

Where do dividends appear in financial statements and what do they reduce?

Statement of changes in equity - reduce retained earnings

Where do drawings appear and what do they reduce?

Appear in statement of financial position - reduce owner’s capital

What is the journal entry for when a dividend is declared?

Retained Earnings DR

Dividends Payable CR

What is the journal entry for when a dividend is PAID?

Dividends Payable DR

Bank CR

What are the 4 journal entries required to record an asset disposal?

1. Remove asset cost - DR Disposal Account, CR Asset Account

2. Remove the provision for depreciation for the asset - DR Provision for Depreciation, CR Disposal Account

3. Record sale proceeds - DR Bank, CR Disposal Account

4. Transfer gain/loss on disposal to Income statement - IF IT IS A LOSS, DR loss on disposal and CR Disposal Account; if it is a GAIN, DR Disposal Account, CR gain on disposal

What is the journal entry for paying carriage-in costs?

DR Carriage in, CR Bank

What is the journal entry for returning goods to a supplier and receiving a refund from them?

DR Bank, Returns OUT

What is the journal entry for returning goods to a supplier where goods were bought on credit and the amount is still outstanding?

DR Trade Payables, CR Returns OUT

What is the journal entry for paying transportation costs of delivering goods to customers?

DR Carriage OUT, CR Bank

What is the journal entry for accepting returned goods from a customer and paying a refund on the amount previously received?

DR Returns IN, CR Bank

What is the journal entry for accepting returned goods from a customer who has purchased on credit where the amount was still outstanding?

DR Returns IN, CR Trade Receivables

What is the journal entry for earning an amount of other income but not yet receiving it?

DR Income receivable, CR Other income

What is the journal entry for issuing debentures?

DR Bank, CR Debentures

What happens when I am the one to issue a debenture?

I am taking out a loan from an investor but i must later pay interest on it which is typically fixed

What is the journal entry for paying cash back to debenture holders?

DR Debentures, CR Bank

What is the journal entry for creating a provision for obsolete inventory?

DR Obsolete inventory Expense, CR Provision for obsolete inventory

What is the journal entry for creating a provision for a potential loss in a court case?

DR Legal damages expense, CR Provision for legal damages

What is the journal entry for creating a provision for potential warranty claims?

DR Warranty claims, CR Provision for warranty claims

Decommissioning

The process of dismantling, removing and restoring a site after a long-term asset has reached the end of its useful life (ex. oil rig, nuclear plant, etc.)

What is needed for a partnership to formed?

Verbal agreement from partners

Do all public limited companies HAVE to be listed on a stock exchange?

NO

How does the disposal of an asset for less than NBV affect the elements of the accounting equation?

1. SOME cash increase

2. REDUCED PROFITS

3. reduced EQUITY - profits affect retained earnings

Revaluation

The process of adjusting the carrying amount of a non-current asset to reflect its current FAIR value instead of historical cost

What are the types of assets that can be revalued?

Land, buildings, plant and equipment

What are the 2 types of revaluation?

1. Upwards revaluation - value increases

2. Downwards revaluation - value decreases

Is revaluation a profit?

NO

How does the disposal of a revalued asset work?

You have to add a step to the disposal procedure which involves removing the revaluation reserve - DR Revaluation Reserve, CR Retained earnings

How does revaluation affect the accounting equation?

Increases assets and reserves, meaning the equation remains balanced

What is the journal entry for revaluation?

DR Asset account, CR Revaluation reserve

Statement of changes in equity

financial statement showing how each component of equity has changed during the reporting period

What are the 4 primary components of the statement of changes in equity?

1. Ordinary share capital

2. Share premium

3. Revaluation reserve

4. Retained earnings

Ordinary shares

Basic ownership of a company. Owners have voting rights. Higher risk and higher reward

Preference shares

holders have preferential rights to dividends can capital repayment usually at a fixed rate; do not have voting rights

What makes ordinary shares high risk high reward?

High risk - last ones to get paid in liquidation

High reward - share price has the potential of growing indefinitely

Redeemability + which shares hold this characteristic

company can or must buy the share back from the holder in the future at a pre-agreed price - preference shares

Insolvency

financial state in which an individual or business is unable to pay their debts when they fall due

Venture capitalist

investors providing capital to start-ups and small businesses with a high growth potential in exchange for an equity stake within their company

Are there some companies that are not allowed to pay dividends?

UK Companies Act 2006 - a company is not legally allowed to issue dividends unless it has sufficient distributable profits

UK Companies Act 2006

the primary legislation governing the formation, operation, management, and reporting of companies in the UK. Sets out the legal framework that all UK companies must follow

What are the primary functions of the UK Companies Act 2006?

1. Company formation

2. Shareholders’ rights

3. Chare capital rules

4. Accounts and financial reporting requirements

5. Corporate governance and transparency rules

6. regulations and enforcement

IASB

International Accounting Standards Board - independent, international body responsible for developing and issuing IFRS, guiding how companies around the world prepare and present financial statements

Offer for sale

A method of issuing shares to the public in which a company sells its shares to an issuing house (ex. investment bank) which then offers them to the public

Why do companies employ offer for sale?

• raise capital from public

• transfer risk of unsold shares to the issuing house

• simplicity

• when company is BIG and needs to delegate this process

Bonus issue of shares/Capitalisation Issue

The free issue of additional shares to existing shareholders, in proportion to their existing holdings,

What does a bonus share issue convert into what?

Converts a part of the company’s reserves into share capital

What is the journal entry for a bonus shares issue?

DR Retained earnings, CR Share capital