Accounting Concepts, Assumptions, and Financial Indicators

Comprehensive vocabulary flashcards covering accounting assumptions, qualitative characteristics, financial statement elements, liquidity and profitability ratios, and operational strategies.

Strategies to Improve Sales

Methods to boost credit or cash sales, including offering longer or better credit terms, investing in better advertising/marketing, hiring salespersons, and reducing selling prices.

Strategies to Improve Expenses

Cost-management approaches that include purchasing cheaper inventory and changing staff management.

Relevance

A qualitative characteristic stating that all relevant information capable of aiding future decision-making must be included in financial reports, directly assisting users in forming predictions about past, present, and future events, or confirming previous evaluations.

Faithful Representation

A qualitative characteristic requiring financial reports to provide a complete, neutral (free from bias), and error-free representation of real-world economic events to accurately reflect the current condition of the business.

Verifiability

A qualitative characteristic ensuring that knowledgeable and independent observers can reach a consensus that an event is faithfully represented, maintained through source documents verifying transaction occurrence.

Comparability

A qualitative characteristic requiring reports to be produced consistently each period so the business can identify similarities, differences, and improvements by comparing data against previous periods, competitors, or budgeted reports.

Timeliness

A qualitative characteristic stating that financial information must be made available to decision-makers in time to influence decisions, as the older information is, the less useful it becomes.

Understandability

A qualitative characteristic requiring that financial information is presented clearly and is comprehensible to observers with reasonable accounting knowledge.

Accounting Entity Assumption

The assumption that financial records of assets, liabilities, and business activities of an entity must be kept completely separate from the owner's personal affairs and other business entities.

Accrual Basis Assumption

The assumption that revenue is recognised when earned and expenses are recognised when incurred, ensuring that net profit is determined by matching earned revenues with incurred expenses in the period.

Going Concern Assumption

The assumption that the business will continue operating its normal activities into the foreseeable future, serving as the basis for financial reporting.

Period Assumption

The assumption that the life of a business is divided into distinct intervals of time, allowing profit determination at the end of each period by deducting incurred expenses from earned revenues.

Assets

Present economic resources controlled by an entity as a result of past events that have the potential to produce future economic benefits.

Current Assets

Present economic resources held by an entity that are expected to be converted into cash, sold, or consumed within $12\text{ months}$.

Non-Current Assets

Present economic resources controlled by an entity that are not held for resale and are expected to provide long-term economic benefits beyond $12\text{ months}$.

Liabilities

Present economic obligations of an entity to transfer economic resources to other entities as a result of past events.

Current Liabilities

Obligations held by a business that are expected to be settled within $12\text{ months}$.

Non-Current Liabilities

Obligations of a business that are expected to be settled over several years (beyond $12\text{ months}$).

Owner's Equity

The residual interest in the assets of the business after deducting all of its liabilities.

Revenue

An increase in assets or a decrease in liabilities that results in an increase in owner's equity, other than contributions from the owner.

Expenses

A decrease in assets or an increase in liabilities that results in a decrease in owner's equity, other than drawings or withdrawals by the owner.

Cash vs Profit Distinction

Cash represents actual inflows and outflows of money, whereas profit is revenue remaining after deducting expenses; they differ because non-cash revenues/expenses exist (e.g., credit sales, cost of sales) and financing/drawings items affect cash without affecting profit.

Working Capital Ratio (WCR)

Formula: $\frac{\text{Current Assets}}{\text{Current Liabilities}} : 1$. Measures the amount of current assets available to cover every dollar of current liabilities (e.g., $\$1.20$ of assets for every $\$1$ of current liabilities), with a ratio above $1$ considered satisfactory.

Quick Asset Ratio (QAR)

Formula: $\frac{\text{Current Assets} - (\text{Inventory} + \text{Prepaid Expenses})}{\text{Current Liabilities}} : 1$. Measures a business's ability to cover short-term debts immediately without relying on selling inventory or accessing prepaid expenses.

WCR vs QAR Discrepancy

A condition where WCR is satisfactory but QAR is unsatisfactory, indicating that the business relies heavily on converting inventory into cash to meet its short-term debts and manage liquidity.

Cash Flow Cover

Formula: $\frac{\text{Net Cash Flows from Operating Activities}}{\text{Current Liabilities}} : 1$. Evaluates whether a business generates sufficient cash from day-to-day operations to cover current liabilities without needing loans or owner capital contributions.

Inventory Turnover (ITO)

Formula: $\frac{\text{Average Inventory}}{\text{Cost of Goods Sold}} \times 365$. Measures how many days it takes for inventory to be sold and leave the business; a slower turnover indicates falling sales, lower product demand, or risk of stock expiration.

Accounts Receivable Turnover (ARTO)

Formula: $\frac{\text{Average Accounts Receivable}}{\text{Net Credit Sales}} \times 365$. Measures the average number of days taken by credit customers to pay their accounts; a slower ARTO leads to less cash on hand to settle debts.

Accounts Payable Turnover (APTO)

Formula: $\frac{\text{Average Accounts Payable}}{\text{Net Credit Purchases}} \times 365$. Measures the average number of days the business takes to pay off its short-term debts to suppliers; a slower turnover indicates worsening liquidity.

Operating Turnover Interdependence

A sequential effect where a slower Inventory Turnover leads to lower or delayed sales, causing slower cash receipts from debtors (slower ARTO), which subsequently reduces available cash to pay accounts payable on time (slower APTO).

Return on Owner's Investment (ROI)

Formula: $\frac{\text{Net Profit}}{\text{Average Capital}} \times 100$. Measures profitability per dollar of owner's capital invested; it is typically higher than ROA because capital is the residual interest and is lower than total assets.

Return on Assets (ROA)

Formula: $\frac{\text{Net Profit}}{\text{Average Assets}} \times 100$. Measures how effectively a business has utilized its total assets to generate profit; a lower ROA indicates falling sales volume or less productive assets.

Asset Turnover (ATO)

Formula: $\frac{\text{Net Sales}}{\text{Average Assets}} \times 100$. Measures the efficiency with which a business uses its assets to generate net sales revenue.

Debt Ratio

Formula: $\frac{\text{Total Liabilities}}{\text{Total Assets}} \times 100$. Measures the proportion of total assets financed through external debt; a higher ratio indicates greater reliance on borrowed funds and increased financial risk.

Gross Profit Margin (GPM)

Formula: $\frac{\text{Gross Profit}}{\text{Net Sales}} \times 100$. Measures the percentage of net sales revenue retained as gross profit, highlighting changes in mark-up policy or inventory purchasing costs.

Net Profit Margin (NPM)

Formula: $\frac{\text{Net Profit}}{\text{Net Sales}} \times 100$. Measures the percentage of net sales retained as net profit, serving as an indicator of whether overall operating expense control has improved or worsened.

Relevance

The qualitative characteristic stating that all relevant information must be included in reports to aid user decision-making, assist in forming predictions about past, present, and future outcomes, or confirm previous evaluations.

Faithful Representation

The qualitative characteristic stating that reports must accurately represent real-world economic events, being complete, free from error, and neutral (without bias).

Verifiability

The qualitative characteristic ensuring that knowledgeable and independent observers can reach a consensus that an event is faithfully represented, supported by source documents verifying transactions.

Comparability

The qualitative characteristic requiring reports to be produced consistently over time so users can identify similarities, differences, and trends against previous periods, competitors, or budgets.

Timeliness

The qualitative characteristic stating that financial information must be available to decision-makers in time to influence their decisions, as older information becomes less useful.

Understandability

The qualitative characteristic requiring financial information to be presented clearly and comprehensibly to observers who possess reasonable or basic accounting knowledge.

Accounting Entity Assumption

The assumption that the financial transactions, assets, and liabilities of a business entity must be kept completely separate from the personal affairs of its owner.

Accrual Basis Assumption

The assumption that revenues are recognised when earned and expenses are recognised when incurred, ensuring Net Profit accurately matches revenues earned against expenses incurred in that period.

Going Concern Assumption

The assumption that the business will continue its operating activities into the foreseeable future and that financial reports are prepared on this ongoing basis.

Period Assumption

The assumption that reports are prepared for specific, regular intervals of time, allowing profit determination by deducting expenses incurred from revenues earned during that interval.

Assets

Present economic resources controlled by an entity resulting from past events that have the potential to provide future economic benefits.

Current Assets

Present economic resources controlled by the business that are expected to be converted into cash, sold, or consumed within $12$ months.

Non-Current Assets

Resources not held for resale that are expected to provide economic benefits to the entity over a period longer than $12$ months.

Liabilities

Present economic obligations of an entity to transfer economic resources resulting from past events.

Current Liabilities

Obligations of the business that are reasonably expected to be settled within $12$ months.

Non-Current Liabilities

Obligations of the business that are expected to be settled over several years (longer than $12$ months).

Owner's Equity

The residual interest in the assets of the business after deducting all of its liabilities.

Revenue

An increase in assets or decrease in liabilities that leads to an increase in owner's equity, other than contributions made by the owner.

Expenses

A decrease in assets or increase in liabilities that leads to a decrease in owner's equity, other than drawings or distributions to the owner.

Cash vs Profit Distinction

Cash represents actual inflows and outflows of money (including non-revenue items like loans, drawings, and capital), whereas profit is the residual revenue remaining after expenses, regardless of cash timing (due to credit sales and cost of sales).

Working Capital Ratio (WCR)

Calculated as $\frac{\text{Current Assets}}{\text{Current Liabilities}} : 1$. Measures how many dollars of current assets are available to cover each dollar of current liabilities, with a benchmark over $1$ considered satisfactory.

Quick Asset Ratio (QAR)

Calculated as $\frac{\text{Current Assets} - (\text{Inventory} + \text{Prepaid Expenses})}{\text{Current Liabilities}} : 1$. Measures the business's ability to cover short-term debts without relying on the sale of inventory or prepaids.

WCR and QAR Divergence

An indicator that occurs when WCR is satisfactory but QAR is unsatisfactory, suggesting the business over-relies on inventory conversion into cash to meet short-term liquidity needs.

Cash Flow Cover

Calculated as $\frac{\text{Net Cash Flows from Operating Activities}}{\text{Current Liabilities}} : 1$. Measures whether day-to-day operations generate enough cash to settle current obligations without relying on loans or capital injections.

Inventory Turnover (ITO)

Calculated as $\frac{\text{Average Inventory}}{\text{Cost of Goods Sold}} \times 100$ (expressed in days). Measures the average duration required to sell inventory, where a higher day count indicates slower demand, reduced sales, or potential stock obsolescence.

Accounts Receivable Turnover (ARTO)

Calculated as $\frac{\text{Average Accounts Receivable}}{\text{Net Credit Sales}} \times 365$. Measures the average time in days taken to collect cash from credit customers; slower turnover restricts available operating cash.

Accounts Payable Turnover (APTO)

Calculated as $\frac{\text{Average Accounts Payable}}{\text{Net Credit Purchases}} \times 365$. Measures how many days on average the business takes to settle trade debts with suppliers, where longer times signal worsening liquidity.

Turnover Interrelationship (ITO to ARTO to APTO)

A chain reaction where slower inventory sales result in lower or delayed credit sales and cash collections (slower ARTO), leading to insufficient cash to settle supplier balances promptly (slower APTO).

Return on Owner's Investment (ROI)

Calculated as $\frac{\text{Net Profit}}{\text{Average Capital}} \times 100$. Measures how profitably the owner's capital is deployed; it exceeds ROA because capital is smaller than total assets.

Return on Assets (ROA)

Calculated as $\frac{\text{Net Profit}}{\text{Average Assets}} \times 100$. Measures management's efficiency in using total asset resources to generate profit; lower values suggest underperforming sales volume or less productive assets.

Asset Turnover

Calculated as $\frac{\text{Net Sales}}{\text{Average Assets}}$. Measures how effectively a business utilises its total asset base to generate revenue volume.

Debt Ratio

Calculated as $\frac{\text{Total Liabilities}}{\text{Total Assets}}$. Indicates the proportion of business assets funded by external debt, showing the business's level of financial risk and dependency on borrowing.

Gross Profit Margin

Calculated as $\frac{\text{Gross Profit}}{\text{Net Sales}} \times 100$. Measures the percentage of sales revenue retained as gross profit, reflecting product mark-up and direct cost efficiency.

Net Profit Margin

Calculated as $\frac{\text{Net Profit}}{\text{Net Sales}} \times 100$. Measures the percentage of sales revenue remaining as net profit after deducting all expenses, reflecting expense control efficiency.

Strategies to Improve Sales

Operational adjustments to enhance sales volume, including offering more flexible credit terms, investing in marketing/advertising, employing salespersons, and reducing selling prices.

Strategies to Improve Expenses

Cost-reduction initiatives aimed at lowering operational outflow, such as sourcing cheaper inventory and modifying staff management structures.