Financial Accounting
Financial Accounting is the domain that tests whether you can prepare and present financial statements that comply with accrual accounting and the recognition and measurement rules in IFRS. MATSEC IM questions typically ask for a sole trader's, partnership's or small company's statement of profit or loss and statement of financial position from a trial balance, with year-end adjustments.
Core rules
- Revenue and expenses are recognised when earned or incurred, not when cash moves. Accruals, prepayments, closing inventory, depreciation, irrecoverable debts and allowances for doubtful debts must be posted before the statements are drawn up.
- Depreciation allocates the depreciable amount of a non-current asset over its useful life; it is an expense, not a cash payment.
- Inventory is measured at the lower of cost and net realisable value (IAS 2).
- Capital expenditure creates or enhances a non-current asset; revenue expenditure is charged to profit or loss.
Worked example
A sole trader has revenue €180,000, cost of sales €110,000 and administrative expenses paid €22,000. The €22,000 includes rent prepaid €1,500. Wages accrued €2,000 are unrecorded, and depreciation for the year is €6,000.
Correct expenses = 22,000 − 1,500 + 2,000 + 6,000 = €28,500. Net profit = 180,000 − 110,000 − 28,500 = €41,500. The prepayment reduces this year's expense and becomes a current asset; the accrual increases the expense and becomes a current liability.
Marks-losing traps
- Adding the prepayment instead of deducting it, or ignoring the accrual because no invoice has arrived.
- Charging asset purchase costs to profit or loss.
- Deducting depreciation from the cash book rather than showing it as a non-cash expense.
- Forgetting that closing inventory reduces cost of sales and appears in current assets.
- In a partnership, splitting profit using the opening capital ratio rather than the agreed profit-sharing ratio.