Q1. According to the American Accounting Association, Accounting is the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information. Who are the users of this economic information?
🍄Stakeholders and managers.
Q2. What are the elements of Accounting?
🍄Assets
Assets refer to resources owned and controlled by the entity as a result of past transactions and events, from which future economic benefits are expected to flow to the entity. In simple terms, assets are properties or rights owned by the business. They may be classified as current or non-current.
A. Current assets – Assets are considered current if they are held for the purpose of being traded, expected to be realized or consumed within twelve months after the end of the period or its normal operating cycle (whichever is longer), or if it is cash. Examples of current asset accounts are:
Cash and Cash Equivalents – bills, coins, funds for current purposes, checks, cash in the bank, etc.
Receivables – Accounts Receivable (receivable from customers), Notes Receivable (receivables supported by promissory notes), Rent Receivable, Interest Receivable, Due from Employees (or
Advances to Employees), and other claims
• Allowance for Doubtful Accounts – This is a valuation account which shows the estimated uncollectible amount of accounts receivable. It is a contra asset account and is presented as a deduction to the related asset – accounts receivable.
Inventories – assets held for sale in the ordinary course of business
Prepaid expenses – expenses paid in advance, such as Prepaid Rent, Prepaid Insurance, Prepaid Advertising, and Office Supplies
B. Non-current assets – Assets that do not meet the criteria to be classified as current. Hence, they are long-term in nature – useful for a period longer than 12 months or the company's normal operating cycle. Examples of non-current asset accounts include:
Long-term investments – investments for long-term purposes such as investment in stocks, bonds, and properties; and funds set up for long-term purposes
Land – land area owned for business operations (not for sale)
Building – such as office building, factory, warehouse, or store
Equipment – Machinery, Furniture and Fixtures (shelves, tables, chairs, etc.), Office Equipment,
Computer Equipment, Delivery Equipment, and others
• Accumulated Depreciation – This is a valuation account which represents the decrease in value of a fixed asset due to continued use, wear & tear, the passage of time, and obsolescence. It is a contra asset account and is presented as a deduction to the related fixed asset.
Intangibles – long-term assets with no physical substance, such as goodwill, patent, copyright, trademark, etc.
Other long-term assets
🍄Liabilities
Liabilities are economic obligations or payables of the business.
Company assets come from 2 major sources – borrowings from lenders or creditors, and contributions by the owners. The first refers to liabilities; the second to capital.
Liabilities represent claims by other parties aside from the owners against the assets of a company.
Like assets, liabilities may be classified as either current or non-current.
A. Current liabilities – A liability is considered current if it is due within 12 months after the end of the balance sheet date. In other words, they are expected to be paid in the next year.
If the company's normal operating cycle is longer than 12 months, a liability is considered current if it is due within the operating cycle.
Current liabilities include:
Trade and other payables – such as Accounts Payable, Notes Payable, Interest Payable, Rent Payable, Accrued Expenses, etc.
Current provisions – estimated short-term liabilities that are probable and can be measured reliably
Short-term borrowings – financing arrangements, credit arrangements or loans that are short-term in nature
Current-portion of a long-term liability – the portion of a long-term borrowing that is currently due.
Example: For long-term loans that are to be paid in annual instalments, the portion to be paid next year is considered current liability; the rest, non-current.
Current tax liabilities – taxes for the period and are currently payable
B. Non-current liabilities – Liabilities are considered non-current if they are not currently payable, i.e. they are not due within the next 12 months after the end of the accounting period or the company's normal operating cycle, whichever is shorter.
In other words, non-current liabilities are those that do not meet the criteria to be considered current. Hah! Make sense? Non-current liabilities include:
Long-term notes, bonds, and mortgage payables;
Deferred tax liabilities; and
Other long-term obligations
🍄Capital
Also known as net assets or equity, capital refers to what is left to the owners after all liabilities are settled. Simply stated, capital is equal to total assets minus total liabilities. Capital is affected by the following:
Initial and additional contributions of owner/s (investments),
Withdrawals made by owner/s (dividends for corporations),
Income, and
Expenses.
Owner contributions and income increase capital. Withdrawals and expenses decrease it.
The terms used to refer to a company's capital portion varies according to the form of ownership. In a sole proprietorship business, the capital is called Owner's Equity or Owner's Capital; in partnerships, it is called Partners' Equity or Partners' Capital; and in corporations, Stockholders' Equity.
In addition to the three elements mentioned above, there are two items that are also considered as key elements in accounting. They are income and expense. Nonetheless, these items are ultimately included as part of the capital.
🍄Income
Income refers to an increase in economic benefit during the accounting period in the form of an increase in an asset or a decrease in liability that results in an increase in equity, other than the contribution from owners.
Income encompasses revenues and gains.
Revenues refer to the amounts earned from the company’s ordinary course of business such as professional fees or service revenue for service companies and sales for merchandising and manufacturing concerns.
Gains come from other activities, such as gain on sale of equipment, gain on sale of short-term investments, and other gains.
Income is measured every period and is ultimately included in the capital account. Examples of income accounts are Service Revenue, Professional Fees, Rent Income, Commission Income, Interest Income, Royalty Income, and Sales.
🍄Expense
- Expenses are decreases in economic benefit during the accounting period in the form of a decrease in an asset or an increase in liability that result in a decrease in equity, other than distribution to owners.
- Expenses include ordinary expenses such as Cost of Sales, Advertising Expense, Rent Expense, Salaries Expense, Income Tax, Repairs Expense, etc.; and losses such as Loss from Fire, Typhoon Loss, and Loss from Theft. Like income, expenses are also measured every period and then closed as part of the capital.
- Net income refers to all income minus all expenses.
Q3. Explain the difference between the fixed assets and current assets.
🍄Key Differences Between Fixed Assets and Current Assets
The difference between fixed assets and current assets can be drawn clearly on the following grounds:
- The non-current assets which the entity owns for the purpose of continuous use, to generate income, is called a fixed asset. Current assets are defined as the items which are held for the purpose of resale and that too for a maximum period of one year
- The conversion of a fixed asset into cash cannot be done easily. On the contrary, current assets are converted into cash immediately.
- Fixed assets are used by the company to produce goods and services. Thus they are held for more than one year. Conversely, companies kept current assets, in the form of cash or in such form that can be easily converted into cash. Therefore such assets are held for less than one year.
- Fixed assets are valued at net book value, i.e. original cost of the asset less depreciation. As against this, the valuation of a current asset is at cost or market value whichever is lower.
- As the investment in fixed assets requires huge capital investment, so long term funds are utilised for its acquisition. Unlike current assets, which require short-term financing for its acquisition.
- Fixed assets cannot be pledged while current assets can be pledged, as collateral for granting loans.
- The fixed charge is created on fixed assets whereas current assets are subject to a floating charge.
- When the company sells current assets, the profit earned or loss suffered is of revenue nature. On the other hand, selling of fixed asset will result in a capital profit or loss to the company.
- Revaluation reserve is created, when there is an appreciation in the value of a fixed asset, whereas no such reserve is created in the case of appreciation in the worth of current assets.
Q4. Explain the difference between Tangible assets and Intangible assets.
🍄Definition of Tangible Assets
Tangible assets refer to the long-term physical resources owned by the corporation, which has certain economic value. Corporation acquires such assets in order to carry out business operations smoothly and not for the purpose of sale. It includes plants & machinery, tools & equipment, furniture & fixtures, building, vehicles, land, computers, building, etc. These assets suffer the risk of loss due to fire, theft, accident or any other disaster.
Tangible assets have a useful economic life, after which it becomes obsolete. Depreciation is a method used by the firm to spread the part of asset’s expense over its economic life.
🍄Definition of Intangible Assets
Intangible assets, as its name suggests are the long-term incorporeal resources owned by the company, which have a definite commercial value. It includes goodwill, trademark, copyright, patent, intellectual property, licensing agreements, brand, blueprint, Internet domains, etc.
Such assets are expected to create future cash flows and earnings. They are reported at their net book value, i.e. the gross value of the asset less accumulated amortisation.
🌺Key Differences Between Tangible and Intangible Assets
The points given below are noteworthy, so far as the difference between tangible and intangible assets is concerned:
- Assets acquired by the firm which is having monetary value and is materially present is called tangible assets. Incorporeal assets which have a certain useful life and economic value is called intangible assets.
- Tangible assets are the assets which are present with the company in their physical form. On the other hand, intangible assets are the assets which do not exist physically rather they are abstract.
- While the reduction in the value of tangible assets is termed as depreciation, intangible assets are amortised.
- Due to the material presence of tangible assets are readily convertible into cash in case emergency. Conversely, it is a bit difficult to sell intangible assets.
- Salvage value is the residual or scrap value of the asset after it is completely depreciated. Tangible assets have salvage value, but intangible assets do not have a salvage value.
- Tangible assets are accepted by the lenders while granting a loan to the firm. As against this, intangible assets cannot be used by the firm as collateral to raise loans.
Q5. Which combination is the most suitable example for the current liability & long term liability respectively?
a) Long-term bank loans, Debentures
b) Debentures, Long-term bank loans
🌺c) Bank OD, Long-term bank loans
d) Bank OD, Personal funds
Q6. Which of the following are shown under the wrong headings?
Q7. Which one is the most suitable example for a capital?
e) Long-term bank loans
f) Debentures
g) Bank OD
🍄h) Personal funds
Q8. Explain the difference between income and expense.
🍄Income items connect with operating expenses through a corporate income statement, although both concepts are distinct. An income statement is a report you review to determine what's going on in a company's records on the profitability front.
If you own a business, combing through the corporate income sheet keeps you abreast of operating developments, enabling you to weigh in on everything from marketing and sales strategy to operational tactics, expense management, product branding and financing.
Q9. Complete the gaps in the following table:
🍄Assets = Liabilities + Capital
Q10. Briefly explain the different internal and external source of finance.
🍄Definition of Internal Sources of Finance
In business, internal sources of finance delineate the funds raised from existing assets and day to day operations of the concern. It aims at increasing the cash generated from regular business activities. For this purpose, evaluation and control of costs are made, along with reviewing the budget. Moreover, the credit terms with customers are verified, so as to effectively manage the collection of receivables.
Internal sources of finance include selling of surplus inventories, ploughing back of profit, accelerating collection of receivables, and so on.
🍄Definition of External Sources of Finance
External sources of finance refer to the cash flows generated from outside sources of the organization, whether from private means or from the financial market. In external financing, the funds are arranged from the sources outside the business. There are two types of external sources of finance, i.e. long term source of finance and short term sources of finance. Further on the basis of nature, they can be classified as:
🍭Debt financing: The source of finance wherein fixed payment has to be made to the lenders is debt financing. It includes:
- Bank loans
- Corporate Bonds
- Leasing
- Commercial Paper
- Trade Credit
- Debentures
🍭Equity Financing: Equity is the major source of finance for most of the companies which indicate the share in the ownership of the firm and the interest of the shareholders. The firms raise capital by selling its shares to the investors. It includes:
- Ordinary shares
- Preference shares
🌺Key Differences Between Internal and External Sources of Finance
The points are given below explain the difference between internal and external sources of finance:
- When the cash flows are generated from sources inside the organization, it is known as internal sources of finance. On the other hand, when the funds are raised from the sources external to the organization, whether from private sources or from the financial market, it is known as external sources of finance.
- Internal sources of finance include Sale of Stock, Sale of Fixed Assets, Retained Earnings and Debt Collection. In contrast, external sources of finance include Financial Institutions, Loan from banks, Preference Shares, Debenture, Public Deposits, Lease financing, Commercial paper, Trade Credit, Factoring, etc.
- While internal sources of finance are economical, external sources of finance are expensive.
- Internal sources of finance do not require collateral, for raising funds. Conversely, assets are sometimes mortgaged as security, so as to raise funds from external sources.
- Amount raised from internal sources is less and they can be put to a limited number of uses. On the contrary, large amounts can be raised from external sources, which have various uses.
