Financial statements

business entity convention

for accounting purposes, the business and its owner(s) are treated separate and distinct

historical cost convention

assets should be recorded at the value at which it was originally purchased

prudence convention

financial statements should err on the side of caution

going concern convention

we assume the business will continue operations for the forseeable future unless there is a reason to believe otherwise

duel aspect convention

each transaction has two aspects reflected in the financial statements

matching

in measuring income, expenses should be matched to revenues that they helped generate in the same accounting period

what are assets and how are they sorted

uses of funds, sorted into tangible, intangible, current, non-current

what is equity

shareholder funds towards the business

what are liabilities and how are they separated

sources of funds other than equity, split into current and non current

what is the basic accounting equation

liabilities + capital = assets

what does the statement of financial position show

the accumulated wealth of the business at the end of an accounting period

give examples of income

sales and investments

give examples of expenses

cost of sales, operating expenses (e.g heating), tax, finance costs (e.g bank loans)

what does the income statement measure

the profit/loss the business has generated during an accounting period

what is profit

the increase in net assets during an accounting period

what is revenue

a measure of the inflow of assets or reduction in liability

what are expenses

a measure of the outflow of assets or increase in liabilities that is incurred as a result of generating revenue

what 3 topics are on the cash flow statement

net cash from operating activities, net cash from investing activities, net cash from financing activities

give an example of operating activities

day to day operations, tax

give an example of investing activities

purchase of non current assets, interest from investments

give an example of financing activities

paying back loans, payments of dividends

which statement(s) is based on accruals accounting

SFP and IS

which statement(s) is based on cash accounting

CFS

the extended accounting equation

assets+expenses+drawings=capital+liabilities+income

give examples of debits

assets, expenses, drawings

give an example of credits

capital, liabilities, income

what are debits

how the finance is being used

what are credits

sources of finance

what is the trial balance?

the starting point for preparing financial statements. the left is your debits, the right is your credits. Both sides should total the same

what are accruals

when a business has not paid all its expense for an accounting period e.g outstanding bills

what do accruals do on the sfp

create a current liability- expenses have increased

what are prepayments

when a business has paid amounts relating to future accounting period e.g advance payments

what do prepayments do on the SFP?

create a current asset- expenses have decreased

which inventory is on the trial balance?

opening

which inventory is on the SFP

closing inventory

which inventory is used in the income statement

both opening and closing

how do we calculate cost of sales?

take opening inventory and purchases, then deduct closing inventory

how do we use unsold stock in the SFP

considered an asset, recognised as closing inventory

whats the equation for profit

profit= revenue - expenses

which sheet do you do first and why?

income statement, since profit from this becomes capital

what are the different types of profit on the income statement

gross profit, operating profit once taking away operating expenses, profit for the period when adding on any non operating income and deducting any interest payables

what do we do if revenue spans over more than one reporting period

allocate the generated revenue over the relevant periods

how do we calculate net book value

historical cost - accumulated depreciation from the asset we’re referring to

straight line depreciation equation

historic cost - fixed rate

reducing balance depreciation equation

net book value for that year - rate

how do we know which depreciation to used

used fixed if the asset generated the same revenue each year

used reducing if assets wear out and become less productive over time

what must we do for irrecoverable debts

write them off

what do we do for doubtful debts

create an allowance called the allowance for trade receivables

give examples for net cash from operating activities

day to day operations, tax

give examples for net cash from investing activities

purchase/sale of non current assets, interest from investments

give examples of net cash from financing activities

receiving or paying back loans, payment of dividends

what is considered “cash”

cash on hand, on demand deposits like money in till, petty cash

what is considered “cash equivalents”

short term, highly liquidated investments that can be readily convertible to known amounts of cash

equation for profit

income-expenses

equation for cash flow

receipts-payments

what is based on accruals and accruals accounting

revenue, expenses and profit, therefore the SFP and income statement

why is the statement of cash flow important?

• shows the movement of cash during a period

• helps asses the possibility of generating future cash flows

• can also highlight cash problems such as ability to pay suppliers or repay loans

what can a lack of cash result in

businesses going bankrupt

name some sources of cash

• sales revenue

• payments received from trade receivables

• sale of non current assets

• issues of shares

• receipt of long term borrowings

name some uses of cash

• purchases and trading expenses

• payments made to trade payables

• buying of non current assets

• paying dividends

• repaying loans and interest

state the layout for a simple SCF

• operating activities +-

• investing activities +-

• financing activities

• equals the net change in cash and cash equivalents

• then state the cash and cash equivalents at the end of the year

the direct method of operating activities

receipts from customers minus payments to suppliers. Rarely used

the indirect method of operating activities

takes profit from the income statement and makes adjustments for non cash items like depreciation. This arrives at cash generated from operations. Then, adjust for any cash payments of interest and tax to calculate net cash from operating activities

why do most companies use the indirect method

it provides less information to competing companies

detail about net cash flow from investing activities

• outflows- acquiring new non current assets

• inflows- disposal of non current assets, interest and dividends on investments

• often it outflows because non current assets are expensive but needed for growth

detail about net cash from financing activities

• can either be inflows or outflows based on the strategies of the business

• inflows- issues of shares, new borrowings

• outflows- redeeming shares, repaying borrowings, paying dividends

how to calculate profit/loss on a non current asset

NBV of asset-selling price