Understanding of Basic Accounting Terms - Assignment Example

fgfg Interest in doing Accounting I have had my interest in doing accounting since the beginning of my school life as it is a challenging professionand every organization requires an accountant in order to look after the financial affairs of the company. There are a lot of chances of flourishing in this field which is why I have opted for the field of accountancy. Introduction It is necessary for the employees of Altruistic Limited to understand the meaning of the key accounting terms in order to gain understanding of financial statements before their share bonus offer. A general understanding of the commonly used accounting terms which are a part of the financial statements is provided which will allow the employees of Altruistic Limited to understand and interpret the meaning and treatment of each accounting term. Non Current Assets Non Current Assets refers to those assets of the company which have a life of more than one year and cannot be simply converted in to cash. (Investorwords) These Assets mainly include assets which are employed by the company in manufacturing, administrative and technical purposes etc. These Assets may be tangible or intangible. Examples of tangible assets can be Land, building, Furniture, Machinery etc while that of Intangible assets can be Computer software, licenses etc. Depreciation is charged to the assets over their useful life which reduces the cost of the asset proportionately as they are not treated as expense in the period they are acquired. It is mentioned in the Balance sheet of the company under Assets. Current Assets These are also assets of the company but assets which can be easily converted to cash within a period of one year. These assets include inventory which the company sells, short term investments of the company, receivables and other prepayments made and most commonly the cash and bank balance of the company. Accruals Accruals refer to the treatment of those expenses for which the receipt of the invoices has not taken place till the date of the financial statements or which have not been paid till that date. In order to make the accrual concept consistent with accounts, the expenses classified as accrual have to be included in the Profit and Loss of the period as the expense has been charged for them. The company has to show the amount that is still payable on their part so that their liability and obligation can be determined. These are posted in the current liability portion of the balance sheet. Prepayments These are the payments that the company has made in advance against certain expenses which will be incurred during the year or years to come. If the company has rented a building, it may have to pay rent in advance to the landlord who can be deducted proportionately as the time passes and hence the amount of the prepayment reduces and is charged as expense by the company. It is characterized as the current asset of the company. Ordinary Share Ordinary share are the certificates that give the holder of the share an ownership in the company along with the right to share the profits of the company and to vote during decision making of the company. (Money Terms) A £1 ordinary share denotes that the holder of the share certificate has an ownership in the company to the extent of £1, which is regarded as its par value which remains constant throughout the life of the company. The company utilizes that money in the business and when profits are generated, some profits are also distributed to the shareholders in form of dividends. It is classified in the Equity portion of the balance sheet of the company. Share premium The shares of the listed companies are traded at the stock exchanges such that the owner of the share, when in need of money, may sell the share to another person for the value of the share in the stock market which is determined by the profit that the company generates. When shares are issued by the company to the general public and the worth of the share is more than that of its par value, the company issues its shares at a greater amount than that of the par value knows as Share Premium. Accumulated profits When the company carries out business, it generates profit through its business activities and utilizes that profit to further extend the business and to pay off the expenses of the company. Some profits are distributed to shareholders in form of dividend while some are carried forward for use in the comings years which are known as accumulated profits. Issue price of shares When the company plans to issue its shares in order to generate finance, it decides a suitable price at which the shares are to be issued. The issue price may change from time to time whenever the company has decided to issue its shares. Market price of shares When the shares of a company are traded in the stock exchange, people tend to purchase the shares which have better prospects of profits in form of dividends. When the company generates good profits, the demand of the shares rises and therefore the price of the share also rises. The price at which a particular share is traded in the market is the market price which may change from time to time depending on the demand and supply of the share. General Reserve Sum of money, out of the profits of the company, set aside to meet the future losses, liabilities and other unseen events, which may require the outflow of cash and other benefits are known as General Reserves. (Finance Glossary) They form a portion of the Equity of the Balance Sheet. Reducing Balance method of Depreciation This is the method of depreciation used to expense out the fixed asset of the company, such as plant, machinery, vehicles etc. This method tends to charge greater amount of depreciation in the first year of use and then the depreciation decreases proportionately as the life of the asset progresses. Inventory Inventory is that asset of the company which generates revenue for it. Inventory can be the raw material which the company uses for production, the goods in process and the goods that are ready for sale. (Investopedia) It is a part of the current assets of the company in the balance sheet. Trade Receivables Trade receivables are the receivables that are generated from the sale of the inventory of the entity which have not yet been paid off by their customers. The company records it as their assets since they will receive this amount when the invoice is raised. They form a part of the balance sheet under head of Current Assets. Statement of financial position Statement of financial position is the alternative term used for the Balance sheet of the company. It specifies the Assets, Liabilities, both current and non current, and Equity of the entity as at the end of a particular financial year. It may not mention the items at their fair market value but at their historical cost. (Business Dictionary) Statement of Cash flow The statement of cash flows of the company provides the cash inflow and outflow of the company during the whole financial year as to their operations, financing and investment activities. The cash flow shows the amount of cash that has been used up by the company for purchases, investments, operations and the cash that has been generated throughout the year. Straight-line method of depreciation This method of depreciation depreciates the whole asset equally over its useful life. Assets which usually depreciate evenly throughout the year are depreciated by this method as equal expense is charged against it. Capital Capital, in short, is regarded as the net worth of the business or the wealth of the business. It is the amount which is invested by the owners of the company at the start of the business or subsequently in form of cash and other assets. Drawings Drawings are the amount of capital withdrawn by the owners of the business for their personal use. This money is deduced out of the capital of the entity. These form a part of the Capital as they are deducted from the Capital. Difference between cash inflow and Net profits Cash is considered as the liquid asset of a company while the profit is the income which is earned during a particular period, after the deduction of all the expenses during the period, which may be monetary or non monetary. (Biz Finance) Reducing balance method used for depreciation of Motor Vehicles The reducing balance method of depreciation is employed to depreciate the assets whose value decreases greatly with the course of time such as the motor vehicle, therefore more depreciation is charged in the initial years of the life of the asset in order to write off a greater amount of the asset in the first few years. (E-how) Distinction between allowance for doubtful debts and bad debts An allowance for doubtful debts is the sum estimated by the company which, in the best estimate of the company, will not be discharged by the debtors of the company while the bad debt is the corresponding figure which is charged to the Profit and Loss account as expense. Reduction of bad debts A company can reduce the risk of bad debts by: Carrying out an in depth customer analysis before allowing him any credit Obtaining reliable information regarding the credit history of the customer, future cash flows and paying capacity. The entity may also issue discounts to its customers so that they pay off their debts on time to avail the discounts. Non current assets in the statement of financial position Since the benefit of non current asset is realized in more than one year therefore the portion of benefit which is realized in current year is charged to Income statement as depreciation expense and carrying amount is shown in statement of financial position. Difference b/w “as at” and “for the year ended” with respect to financial statements The statement of financial position is true for a given moment of time where it provides the company’s assets, liabilities and equity from its incorporation to that particular date, while the Income statement provides the details of all the income and expenditure activities during the year as at the date of balance sheet. Assets equality with Capital and Liabilities The assets of the company equal with the sum of the capital and liabilities as the company utilizes its initial capital to purchase the assets of the company and which may generate liabilities, therefore the total assets of the company are equal to the capital and liabilities which is also known as the working capital of the company. Expenses that do not affect the cash flows Certain expenses do not affect the cash flows of the company which include: Depreciation of the fixed assets Amortization of the Intangible assets Gain or Loss on sale of fixed assets These expenses or income do not affect the cash flows because of their non monetary nature and as they are booked on an accrual basis hence they do not generate or cost any cash. References Basic College Accounting. http://basiccollegeaccounting.com/going-concern-concept/. Biz Finance. 2010. http://bizfinance.about.com/od/yourfinancialposition/f/Cash_Flow_vs_Profit.htm. Bized. http://www.bized.co.uk/learn/accounting/financial/sources/prefshares.htm. Business Dictionary. http://business.yourdictionary.com/balance-sheet. Finance Glossary. http://www.financeglossary.net/definition/1698-General_Reserves. Investopedia. http://www.investopedia.com/terms/i/inventory.asp. Investorwords. http://www.investorwords.com/3313/noncurrent_asset.html. Money Terms. http://moneyterms.co.uk/ordinary-shares/. Read More