Financial accounting

Income statement

Show the profit or loss for the period of time under consideration. Excludes investments by owners and distributions to owners.

Triple bottom line

environmental, social, and financial

Income

revenue earned by the business, plus other gains. Income should only be recognised in the accounts when it has been ‘realized’ 

Revenue

earnings from ordinary activities (no expenses)

Realisation

when activities necessary to generate the revenue are substantially complete, the amount of revenue can be objectively determined, and there’s reasonable certainty that amounts owing will be received.

Expense by entity

small entities - often list all expenses

larger entities - group expenses into classes for reporting

reporting entities - required to classify their expenses by nature or function

Gross profit

measures revenue remaining after deducting the cost of sales

Net profit

actual profit after the working expenses have been removed from gross profit

EBIT

earnings before interest and taxation

EBITDA

earnings before interest, tax, depreciation and amortisation

Cash flow

identifies the sources and uses of cash during the year. Highly reliable and less subject to manipulation than accrual accounting.

3 key components of a cash flow

operating activities - inflow from operations

investing activities - cash payments to acquire additional non-current assets and cash receipts for disposal os such assets

financing activities - finance excluding short term credit

Cash flow red flags

• cash received < cash paid

• operating outflow

• cash receipts to customers < cash payments to suppliers and employees

• net cash from operations < profit after tax

• proceeds of share capital are used to finance operating activities

• inflows from investments are inconsistent

• proceeds from borrowing are continually much greater than repayment of borrowings

Deprecation (amortisation)

the systematic allocation of the cost of a tangible asset, over its useful life. 

Accumulated depreciation

the total depreciation that has been charged to a statement of profit or loss in relation to an asset

PPE

plant, property, equipment

4 aspects of depreciation to consider

1. cost/value of asset

2. useful life of the asset

3. estimated residual value

• the likely amount to be received on disposal of the asset

4. depreciation method

• straight line

• accelerated (slope down curve)

• units of production (zig zag)

4 statements within a financial report

balance sheet, statement of profit or loss (income statement), statement of changes in equity, and a statement of cash flows

The accounting equation

Assets = liabilities + equity

Balance sheet

shows investing decisions, financing decisions. Provides snapshot of financial position, all assets, liabilities and equity accounts belong on it.

t-format balance sheet

Assets of left, liabilities on right. usually used for smaller entities

Narrative format balance sheet

assets, liabilities and equity presented down the page. Comparative information allows users to see the change in financial position between periods

Balance sheet limitations

• only shows one particular point

• entities value is not reflected since items that generate future benefits are not recognised

• takes management choices, judgements and estimations.

Statement of changes in equity

shows the movements that have taken place in an entitys equity during the financial period.

Equity

invested funds, two main categories:

1. share capital or contributed capital that represents the total amount invested in the entity by the owners

2. retained earnings; represents the cumulative net profit of the entity that has been retained for use within the business and not yet paid out to the owner

Accrual accounting

A function of time, recording the transactions in the period they occur, regardless of whether cash has been received or paid. Typically used in annual reports.

Cash accounting

transaction is recorded when cash changes hands, regardless of the period the transaction occurred, so transactions are recorded in the period the cash is received or paid

Accrual accounting: income types

• income recognised without receipt of cash (income has been earned - service provided - but not yet paid for)

• Cash is received, but income is not recognised (must remain a liability until income is earned)

Accrual accounting: expense types

• expense is recognised without payment of cash (yet to pay for an expense that we have not consumed or used)

• expenses is paid but not recognised as an expense (paid in advance, and only when the expense is consumed or used up, do we record the expense)

Accrued income

income that has been earned but not recieved in cash or recorded in the books

Revenue received in advance (deferred revenue)

occurs when a company receives cash before providing goods or services

Accrued expenses

costs that have been incurred but not yet paid or recorded in the financial books (receive service/thing before payment is made)

Prepaid expenses

payments made in advance for goods or services to be received in the future

Entity concept

every entity must keep records of its business

Double entry accounting

each transaction must cause at least 2 changes to the accounting equation, because the equation must be kept balanced

Errors in recording business transactions

1. single entry error (when double entry fails)

2. transposition error

3. incorrect entry

• recording 2 increases/decreases on one side

• recording an increase to one side and a decrease to the other

Big 4

KPMG, Deloittes, PWC, EY

5 elements of accounting

assets, liabilities, equity, income and expenses

current asset

held for no more than a year (one accounting period)

Non-current asset

held for longer than the normal operating cycle, or permanent nature

Provision

A liability of uncertain timing or amount

contingent liability

a possible obligation depending on whether some uncertain future event occurs, or a present obligation, but payment is not probable or the amount cannot be measured reliably

Retained earnings

the cumulative net profit thats been retained for use in the business and not paid out to owners

Drawings

withdrawls of goods or cash from the business for personal use

Financial accounting RTDU

Regulations: more, bound by GAAP

Timeliness: historical picture and outdated by distribution

Detail: quantitive nature, less detailed

Users: suit a variety of users

Management accounting RTDU

Regulations: less regulated, more informal

Timeliness: can be historical or projection

Detail: more detail and tailored

Users: mainly owners/managers of the entity

Materiality

the concept used to determine what information is important enough to include in the financial statement

Accounts receivable

the money owed by its customers for goods or services that have been sold on credit

Asset examples

• accounts receivable

• buildings (cost)

• cash at bank

• cash floats

• inventory

• accumulated depreciation

Liabilities

• accounts payable

• dividends payable

• income tax payable

• long-term debt payable

• salaries and wages payable

Equity

• share capital

• retained earnings

• dividends paid

Expenses

• selling and administrative expense

• bad debts expense

• COGS

• depreciation expense

• income tax expense

• insurance expense

• salary and wages expense

Income

• sales revenue

• interest revenue