ACCOUNTING QCAA EXTERNAL EXAM

Accounting Period Concept

This concept assumes that the life of the business can be divided into arbitrary time periods in order for periodic reporting to be done on the performance of the business

Accounting Entity Assumption

This concept separates the owner from the business and recognises that for the purposes of accounting, all transactions are recorded from the business' viewpoint

Monetary Policy

This principle states that all transactions are recorded in the common monetary unit in use ($ and c)

Going Concern Principle

This principle requires that the business is going to continue its operations indefinitely and is not likely to be liquidated in the foreseeable future.

Historical Cost Principle

This principle states that all assets are initially recorded at the amount paid at the time of acquisition.

Vertical Analysis

Vertical analysis involves reporting an amount on a financial statement as a percentage of another item on the same financial statement

Vertical Analysis Benefits

The benefits include:

- Shows everything as a % of another item

- Shows the trends such as increases and decreases of accounts

e.g. how much COGS make up of net sales

Horizontal Analysis

Horizontal analysis compares account amounts reported on these statements over two or more years to identify changes and trends. (Shows more than one years figures)

Horizontal Analysis Benefits

The benefits include:

- Shows increases and decreases each year from the base (can be amounts or percentages)

- Trends can emerge

Ratio Analysis

Ratio analysis uses calculations and interpretations of financial ratios developed from the firm's financial statements.

The categories:

- Liquidity

- Profitability

- Stability

- Company Specific

Ratio Analysis Benefits

The benefits include:

- Shows trends (increases and decreases in specific parts of the business)

- Allows the business to compare with other firms and industry benchmarks to see how the business is performing

Accural Basis Accounting

Records revenues that are earned but not yet received and expenses when they have been incurred but no paid.

Cash Accounting

Revenues are recorded when the money has been received and expenses are recorded when they have been paid.

Balance Day Adjustments

Adjustments made to a revenue or expense on balance day to show the revenues earned and expenses incurred in a particular reporting period

Balance Day Adjustment Accounts

Unearned Revenue (Liability)

Accrued Revenue (Asset)

Prepaid Expense (Asset)

Accrued Expense (Liability)

Purpose of BDA & Accounting Concept it follows

The purpose of balance day adjustments is so the business can correctly show the health of the business. It matches revenues earned with expenses incurred. The accounting concept it follows is the accounting period concept which assumes the life of the business is divided into arbitrary time periods.

Comparative Financial Statement

Comparative financial statement provides a horizontal analysis and is used to compare financial statements with prior statements. These statements are presented alongside the latest figures in a side-by-side column. Businesses and investors can analyse trends such as increases and decreases in figures.

Two Types of Depreciation

- Straight- line Method

- Reducing balance/ Diminishing Balance

Straight Line Depreciation

- Depreciation in equal amounts each year over the life of the asset

DEPN = Cost - Residual/Salvage ÷ Life of the asset

Diminishing/ Reducing Balance Depreciation

Results in a decreasing depreciation charge over the useful life, depreciation in the early years is greater than the later years.

DEPN = Cost x rate of depreciation %

= Balance

Next Year

DEPN = Balance x rate of depreciation %

Purpose of a Profit and Loss statement

Compares the business' revenues and expenses to determine the overall net profit of the business.

Purpose of a Financial Statement

List the business' assets, liabilities and owner's equity which provides a snapshot of the financial condition of the business. It shows the net worth.

Purpose of Cash Flow Statement

Highlights the operating, investing and financing activities of the business during a period of time.

Bench-marking within an Industry

Benefit include:

- Benchmark to improve performance

- Compare company performance against other companies in the industry

- Use it to identify gaps and opportunities to improve

Factors that complicate caparisons of financial statements

Include:

- Different accounting methods (Accrual/ cash)

- Changes in accounting practices

- Different accounting practices

- Different values

- Intangible assets (Brands, systems)

- Inflation no adjusted for

- No two businesses are exactly the same

- Acquisitions and Disposals

- Different accounting periods (not always 30 June)

Limitations of Financial Statements

All limitations are around estimated figures:

- Inventories, provision fr doubtful debts and depreciation are estimated figures

- How companies use these figures and methods will differ

- Inventories (FIFO/ Weighted average)

- Depreciation (Straight-line/ Reducing balance)

Qualitative Characteristics

What makes financial statements useful:

- Relevance

All information is relevant

- Faithful representation

Information must be complete and unbiased

- Materiality

All material items should be reported properly

- Reliability

The extent to which information accurately reflects a company's resources

- Comparability

Keeping the layout the same so it can be compared from one year to another

- Understandability

Information should be clear and concise

Sole trader

Business owned and operated by one person. Owner gets to keep all profits and liable for all losses (Unlimited Liability)

Company

Business where there is a separate legal entity from its owners (Limited Liability)

Solve Trader vs Company

Sole Trader:

- One owner

- Full control over the business

- Their individual income

- Personally liable for the debts

- Unlimited liabilities

Company:

- Multiple Owners

- Director's duties

- Companies income

- Company liable for the debt

- Directors could be personally liable

- Company can own its own assets

- Limited liabilities

Statement of Profit or Loss Categories

- Revenues (Other operating revenues)

- Expenses (Selling, administration, finance)

Statement of Financial Position

Assets

- Current Assets

- Non- Current Assets (PPE, Intangible & investments)

Liabilities

- Current Liabilities

- Non-Current Liabilities

Owner's Equity

- Capital

- Drawings

- Net Profit

Statement of Cash Flows

Operating

- Inflows

- Outflows

Investing

- Inflows

- Outflows

Financing

- Inflows

- Outflows

Complete Accounting Process

1. Transaction

2. Source Documents

3. Journal and Bank Reconciliation

4. Ledger and Trial Balance

5. Balance Day Adjustments

6. End of Period Reports

7. Closing Entries

8. Reversing Entries

Liquidity Ratios

Measures the short-term ability of a company to meet its short term commitments/obligations.

These Include:

- Current Ratio

- Quick Ratio

- Turnover of Accounts Receivable

- Turnover of Inventories

- Accounts Payable Turnover

Current Ratio

= Current Assets ÷ Current Liabilities

- Goal is 2:1

- Firms should have double the amount of current assets to cover its current liabilities

Quick Ratio

= (Current Assets - Inventories+ Prepayments ) ÷ Current Liabilities

- Goal 1:1 ($1 for every $1 of debt)

- Indicates a firms to meet its immediate financial obligations without having to sell inventories

Turnover of Accounts Receivable

= Net Credit Sales ÷ Average Accounts Receivable

- Goal every 30 days

- Measures the effectiveness of a firms credit policy

- How many times a business receives payments from accounts receivable

- The smaller the number the better

Turnover of Inventories

= Cost of Goods Sold ÷ Average Inventory

- Goal 5-10 times a year

- How quickly inventory is sold

- Indicates liquidity of inventories

- The bigger the number the better

Turnover of Accounts Payable

= Cost of Goods Sold ÷ Average Accounts Payable

- Goal every 30 days (Make use of discounts for early payments)

- How many times a firm pays off its accounts payable during a period

- How efficient a company is at paying its accounts payable

Profitability Ratios

Measures the earning potential of a fir and its capacity to use its resources to maximise its profits.

These Include:

- Gross Profit

- Net Profit

- Return on Owner's Equity

- Rate of Return on Total Assets

Gross Profit

= Gross Profit ÷ Net Sales x 100

- Higher the % the better the company is performing

Net Profit

= Net Profit ÷ Net Sales x 100

- Higher the % the better the company is performing

- For every $1 in sales how much the business makes in profit

Return on Owner's Equity

= Net Profit ÷ Average Owner's Equity x 100

- Higher the % the more money is being returned to investors to see whether to invest or not

Rate of Return on Total Assets

= (Net Operating Profit + Interest Expense) ÷ Average Total Assets x 100

- The higher the ratio the better it is.

- Measure how profitable the business is compare the assets they own.

- Indicates if the asset the business owns, generating revenue of the business.

Stability Ratios

Measures the ability of the business to pay off all its debts and how the owner has financed the business's assets as opposed to using an alternative source of income i.e. loans

These Include:

- Debt Ratio

- Debt to Equity Ratio

- Equity Ratio

- Times Interest Earned

- Shareholder Equity Ratio

- EBITDA Margin Ratio

Debt Ratio

= Total liabilities ÷ Total assets

- The way in which the business is financed

- The extent of the firm's borrowings in relation to its assets

- The relationship between the firm's total liabilities and total assets.

Debt to Equity Ratio

= Total liabilities ÷ Shareholders equity

- Indicates the relative proportion of shareholders' equity and debt used to finance a company's assets.

Equity Ratio

= Total Equity ÷ Total Assets

- Ratio is expressed as a percentage

- Indicates what proportions of every dollar of assets has been paid for by the owner

Times Interest Earned

= Earnings before income tax and interest ÷ Interest expense

- Indicator of a company's ability to meet the interest payments on its debt

- The larger the times interest earned ratio, the more likely that the companies can make its interest payments.

Shareholder Equity Ratio

= Total shareholder equity ÷ Total assets

- Ratio is expressed as a percentage

- Indicates what proportions of every dollar of assets has been paid for by the owner

Earnings before Interest, Tax, Depreciation, Amortisation Ratio (EBITDA)

= Earnings before interest, tax, depreciation, amortisation ÷ Total revenue

- Higher the % the better

- Measures how much in earnings a company is generating before interest, taxes, depreciation, and amortization, as a percentage of revenue.

Company Specific Ratios

Ratios relating to companies and not sole traders

These include:

- Earnings per share

- Price to earnings ratio

- Dividends yield ratio

Earnings Per Share

= Operating profit after tax - Preference dividends

÷ Average number of ordinary shares

- Represented as a %

- The profit earned on each share

Price to Earnings (P/E) Ratio

= Market Price Per Share ÷ Earnings Per Share

- The number of times the market price per share covers profit per share

- Helps investors determine whether the stock of a company is overvalued or undervalued compared to its earnings.

Dividends Yield Ratio

= Dividends Per Share ÷ Market Price Per Share

- Goal is 30-50%

- The dividend received per share expressed as a percentage return on the market price per share

- Measures the return on investment in stocks and shares

- If too high means it is paying investors too much instead of growing the company

Interrelationships between:

- Statement of Profit or Loss

- Statement of Financial Position

- Statement of Cash Flows

1. Net income from the bottom of the income statement links to the FPOS and cash flow statement. On the balance sheet, it feeds into retained earnings and on the cash flow statement, it is the starting point for the cash from operations section.

2. Capital expenditures add to the PPE account on the FPOS and flow through cash from investing on the cash flow statement.

3. Purchasing an asset appears on the FPOS and outflows from investing.

4. Profit from the PL statement appears on the FPOS

Inventory adjustments and Purpose

Inventory adjustments (DR) are adjustments made when the actual quantity of items does not match the recorded quantity. Purpose of inventory adjustments is to ensure the inventory count in the books of the business reflect the physical stock count.

Reversing Entries

Journal entries, made at the beginning of the next accounting period, that are the exact opposite of the adjusting entries made in the previous period.

How results from ratio analysis is useful for internal/ external stakeholders

These Include:

- Helps stakeholders understand and compare the figures presented in the profit and loss, financial position and cash flow statement

- Allows the stakeholders to draw conclusions on the performance of the company in a given period of time.

- Allows stakeholders to see how well the company is performing against other companies

- Can assist in whether stakeholders should invest o not

Dividends Per Ordinary Share

Ordinary Dividends (dividends payable) / number of ordinary shares (Share capital)