Financial Accounting

Accounting definition

The process of identifying, measuring and communicating information to permit informed judgements and decisions by users of the information

Financial accounting

Information for the users on the outside of a business. Regulated by company law, is always about the past, not very specific information. Balance sheet of big PLCs

Management accounting

Used for people inside the company. Concerns the future and helps make decisions. Highly technical and specific info, no laws to regulate and helps control resources

Types of organisation

Sole trader - still must file accounts but less regulated

Partnerships- usually law firms and if accounts are reported wrong the liability stands with all partners

Not for profit sector - Charities, Council, Government

Companies - Private Limited Companies (LTD) and Public Limited Companies (PLC)

Limited when regarding business

Means they’re only limited to what their shares are worth in the business when they were purchased

3 financial statements

Statement of financial position (Balance sheet)

Statement of Income (Profit or Loss)

Statement of Cash Flow

Who would use accounting info?

Competitors, Regulators, Shareholders, Employees, Government, Investors, Bank etc

Qualities of Financial Statements

Relevant and Reliable

Comparability, Timelines, Verifiability, Understandability

Statement of Financial Position

Assets= Equity + Liabilities

Assets

Non-Current- Generate income in the long term or must by sold over a long period of time (property)

Current - Cash, can be sold within the next 12 months or near cash

Equity

The amount the owner has invested and is able to claim from the business

Liabilities

Claims from organisations or businesses from outside the business that they cannot avoid.

Current - Settled within 12 months

Non Current - Long term loans

4 Accounting conventions

Business Entity Convention

Prudence

Going concern

Matching

Business entity convention

The owner and the business are treated as separate and distinct

Prudence

Financial statements should err on the side of caution. Should not be approximated without knowing true figures

Going concern

The business will continue operation for the foreseeable future without reasonable doubt of otherwise

Matching

The expenses should match the revenues that they helped generate in the same accounting period as the revenues are released

The Income statement

Measures profit or losses over an accounting period

Revenue

Measure of the inflow of assets or reduction in liabilities which arise from a result of trading activities

Usual source of revenue comes from the sales of goods by retail or manufacturing businesses or the provision of a service in the service industry

Criteria for Revenue

Amount can be measured reliably

Probable that the economic benefits will be received

Ownership and control of the items should pass to the buyer (when the goods are being sold)

Expenses

Measure of the outflow of asset (or the increase of liabilities) that is incurred as a result of generating revenues

This may include salaries, wages, rent etc

The accounting equations

Assets= Equity + Liabilities

This can be extended to

Assets = Equity at start of period + profit at end of period + Liabilities

Profit = Revenue - Expenses

Assets + Expenses + Drawings= Equity + Liabilities + Revenue

On left is debits, on right is credits

Debits and Credits

DEAD CLIC

Debits are expenses, assets and drawings

Credits are liabilities, income, capital

Setup of the Income Statement

Th trial balance

The debits and the credits listed, they must equal one another to be valid

Accruals

A business has not paid all of its expenses for an accounting period.

increase expenses and create a current liability

Prepayments

A business has paid amounts towards purchases in the future past the current accounting period

Decrease expenses and create current assets

Closing inventory

The amount you have left in inventory at the end of the accounting year.

This follows over to the opening inventory the next year

This should always be the lower of two options: what you paid for it and what you can sell it for

Cost of sales adjustment

Cost of sales = open inventory + purchases - closing inventory

Methods of depreciation

Straight line depreciation

Reducing balance depreciation

Unit of production

Straight line depreciation

Simple interest, reducing by the same amount each year

Depreciation is taken as an expense in the income statement

Net book value

Historic cost- accumulated depreciation

This is labelled as an asset in the SFP

Reducing balance depreciation

Compound interest

Cost - accumulated depreciation x n%

How is depreciation recorded

Income statement has a depreciation expense

SFP has accumulated depreciation under non current assets next to the historic cost of the asset

Calculating Trade receivables

Take original amount- irrecoverable debt like ones that will never be paid then take the percentage off of that

5 different adjustments

Accruals

Prepayments

Cost of sales

Depreciation

Bad debts

Scrap/ Residual value

The amount of money you could get from selling the item at the end of its useful life (must be estimated but is usually 0)

Amortisation

Depreciation for intangible assets

Choosing a depreciation method

Accouting regulations don’t tell you what one to use

Difficult to measure how much an asset actually wears out during a year

Unpredictable factors effect wear and tear: how careful operation is, maintenance, intensity and variety of use

Choose and apply consistently and disclose what method you use