Accounting Principles and Methods Quiz

External Financial Statements

• This study unit is the first of six on external financial reporting decisions
• The relative weight assigned to this topic in the exam is 15%
• This study unit covers fundamental concepts in financial accounting, crucial for understanding subsequent units (2-5).
• Key topics include accounting users, accrual accounting, basic financial statements, the accounting equation, and equity transactions.
• There are six total study units in this section

Study Unit 1: External Financial Statements

• The objective of general-purpose financial reporting is to provide useful financial information for resource allocation decisions.
• The reporting relates to an entity's economic resources, claims to resources (financial position), and changes in these resources and claims.
• Useful information allows users to evaluate liquidity, solvency, financing needs, and the probability of obtaining financing.

Users of Financial Statements

• External users (investors, creditors, financial advisors, analysts, stock exchanges, and regulatory agencies) determine the firm's businessworthiness.
• Internal users (management, employees and the board of directors) utilise financial statements to manage business operations.

Features of Financial Statements

• Financial statements are the primary means for communicating financial information to external parties.
• Notes to the financial statements are an essential part, providing additional detail and explanations of information presented.
• The first footnote often outlines accounting policies, estimates used, assumptions, and policies for revenue recognition and asset allocation.

Financial Statement Relationships

• The financial statements complement each other, providing a comprehensive view of a company's economic decisions.
• Components like net income (statement of income) are reflected in the retained earnings portion (statement of financial position).
• The statement of cash flows reconciles the statement of financial position and changes to the cash account.
• Items like inventory and depreciation (statement of income) are represented as asset and liability balances (statement of financial position).

Accrual Basis of Accounting

• Financial statements are prepared using an accrual basis, accounting for transaction impacts when they happen, not necessarily when cash is exchanged.
• Revenues are recognized when earned, despite future cash receipt
• Expenses are recognized when incurred, regardless of future cash payment
• Matching principle: expenses and revenues are connected and recognized in the same time frames.

Statement of Financial Position (Balance Sheet)

• Reports assets, liabilities, and equity at a point in time.
• Assets represent probable future economic benefits.
• Liabilities represent probable future outflows of economic resources.
• Equity is the residual interest in assets after deducting liabilities (assets = liabilities + equity).

Income Statement

• Reports the results of operations over a period of time.
• Key components include revenues, gains, expenses, and losses.
• Income is calculated as: (Revenues + Gains) - (Expenses + Losses)
• Reports various aspects of sales like cost of goods sold to help determine gross and net profits.

Cost of Goods Sold

• Calculates the cost of goods sold using beginning inventory, purchases, and ending inventory.
• Manufacturers need to consider cost of goods manufactured and finished goods inventory to determine cost of goods sold.

Other Expenses

• General and administrative expenses: unrelated to a specific function (e.g., office rent, utilities, salaries...)
• Selling expenses: related to marketing or sales (e.g., sales staff salaries, advertisement...)
• Interest expense: calculated based on the passage of time. (e.g., bonds, notes, finance leases...).

Statement of Changes in Equity

• Shows changes to equity accounts over a period.
• Key components: net income, net loss, distributions to owners, issuance of common stock, and changes from other comprehensive income and treasury stock.

Prior Period Adjustments

• Involves the cumulative impact of changes in accounting principles or prior-period errors.
• These adjustments are applied retrospectively to previous periods' financial statements.
• Changes in estimate are treated prospectively.

Stock Dividends and Stock Splits

• A stock dividend represents additional shares issued to existing shareholders.
• A stock split increases the number of outstanding shares, but the overall equity of the company is not changed.
• The treatment and calculation for stock dividends and stock splits differ based on the % increase in shares.

Cash Dividends

• Cash dividends are distributions of cash to shareholders.
• Key dates: Declaration date (board of directors decides), record date (stockholders are officially listed as receiving the dividend), and payment date (cash is sent).

Property Dividend

• A dividend involving transfer of tangible property to shareholders.
• The property is revalued at the declaration date which is treated as a gain or loss on the income statement.
• The carrying value is reduced to reflect the property's fair value.

Statement of Cash Flows

• Shows the cash inflows and outflows related to operating, investing, and financing activities.
• Useful to assess liquidity, solvency, and financial flexibility.
• Can use indirect (adjusting net income) or direct methods (accounting for each cash transaction).

Consolidation Accounting

• Used when one entity controls another entity.
• Consolidating financial statements present the parent and subsidiary as if they're a single economic entity.
• Eliminates intraentity balances, items like investment in subsidiary and dividends paid are eliminated.