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Questions and Answers
What is the detailed recording of all the financial transactions of a business?
What is the detailed recording of all the financial transactions of a business?
Book-keeping
What is the purpose of accounting?
What is the purpose of accounting?
To prepare financial statements and assist in decision making.
What are the two main ways of presenting accounts?
What are the two main ways of presenting accounts?
What is the accounting equation?
What is the accounting equation?
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What does the term 'capital' represent in the accounting equation?
What does the term 'capital' represent in the accounting equation?
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The double entry system of book-keeping involves making a debit entry and a credit entry for each transaction.
The double entry system of book-keeping involves making a debit entry and a credit entry for each transaction.
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What is the acronym used to classify accounts in the double entry system?
What is the acronym used to classify accounts in the double entry system?
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What is the purpose of a ledger account?
What is the purpose of a ledger account?
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What are the three categories of ledger accounts?
What are the three categories of ledger accounts?
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What is the purpose of a trial balance?
What is the purpose of a trial balance?
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Which of the following errors are not shown by a trial balance?
Which of the following errors are not shown by a trial balance?
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What is a suspense account?
What is a suspense account?
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What is the consequence of overstating the closing inventory?
What is the consequence of overstating the closing inventory?
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What is the purpose of a cash book?
What is the purpose of a cash book?
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What is the purpose of a petty cash book?
What is the purpose of a petty cash book?
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What is the purpose of a sales journal?
What is the purpose of a sales journal?
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What is the purpose of a purchases journal?
What is the purpose of a purchases journal?
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What is the purpose of a sales returns journal?
What is the purpose of a sales returns journal?
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What is the purpose of a purchases returns journal?
What is the purpose of a purchases returns journal?
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What is the purpose of the general journal?
What is the purpose of the general journal?
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What is the primary purpose of a bank reconciliation statement?
What is the primary purpose of a bank reconciliation statement?
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Study Notes
0452 Accounting Revision Notes
- Purpose of Accounting: Book-keeping is detailed recording of all financial transactions of a business. Accounting uses book-keeping records to prepare financial statements and assist decision-making. The role of accounting is to provide financial information for decision-making purposes. Measuring business profit and loss helps determine owner return on investment, assess fund availability for business expansion, and decide whether to close the business if returns are insufficient. Checking fund availability ensures sufficient funds for running the business.
The Accounting Equation
- Assets: Resources owned or controlled by the business for its activities.
- Liabilities: Amounts owed by the business to other businesses or individuals.
- Owner's Equity: The amount contributed by the owner and profit made by the business. In accounting, Assets = Equity (Capital) + Liabilities; Capital = Assets - Liabilities; and Liabilities = Assets - Capital. Anything provided for a business by the owner is capital, which is not always in the form of money.
Double-Entry System of Book-Keeping
- Double Entry System: The process of making a debit entry and a credit entry for each transaction.
- Steps to Record Double Entry: Identify two accounts, classify accounts according to ALICE (Assets, Liabilities, Income, Capital, Expense), determine which accounts go to "+" and "-" symbols, and determine which accounts go to "Dr" (Debit) and "Cr" (Credit).
Business Documents/Source Documents
- Business Documents/Source Documents: Used by businesses to record transactions. They provide evidence of transactions and details.
- Types: Invoices (request for payment), debit notes (reducing invoice amounts), credit notes (notifying invoice reductions), cheques (written order to bank for payment), cheque counterfoils (payment records), pay-in slips (evidence of payments), and receipts (acknowledgement of payment).
- Statements of Account: Documents summarizing monthly transactions for credit accounts.
Books of Prime Entry
- Books of Prime Entry: A book where transactions are initially recorded before entering the ledger.
- Types: Cash book (records all cash transactions), petty cash book (low-value cash payments), sales journal (credit sales), purchases journal (credit purchases), sales returns journal (credit sales returns), purchases returns journal (credit purchases returns), and general journal (all other transactions).
- Advantages of using Journals: Prevents overcrowding of general journals, allows different staff to work each journal to improve efficiency, and useful for preparing control accounts.
Petty Cash Book
- Imprest System: Restoring the amount spent each period so the petty cash cashier starts each period with the same amount. This system helps control petty cash expenditure, providing awareness of expenditure, and preventing fraud.
The Trial Balance
- Trial Balance: A list of account balances in the ledger at a specific date. It checks for arithmetical accuracy in double-entry bookkeeping. Useful for preparing financial statements.
- Limitations: Does not guarantee error-free double-entry bookkeeping; balances even with errors (commission, omission, compensating errors).
Correction of Errors
- Adjusting Profit after Correction of Errors: Errors in income and expense items affect profit. Debit adjustments reduce profit, while credit adjustments increase profit.
- Effect of Correction of Errors on Financial Position: Corrections to profits may affect the capital section of the financial position statements and other items.
Bank Reconciliation
- Reasons for Differences: Timing differences in recording transactions, errors in recording by one party.
- Purpose: Reconcile cash book balance with bank records to ensure differences are legitimate and deter fraud. Identify errors in bank statements or cash at the bank during the reconciliation process.
Control Accounts
- Purpose: Assist in locating bookkeeping errors, providing assurance of arithmetical accuracy of the ledgers, and aid in preparing income statements and balance sheets.
Capital and Revenue Expenditure and Receipts
- Capital Expenditure: Purchases, improvements, or extensions of non-current assets; these costs appear in the statement of financial position.
- Revenue Expenditure: Daily or operational costs that appear on the income statement.
- Capital Receipts: Non-trading-related money transactions.
- Revenue Receipts: Trading-related money transactions.
Depreciation and Disposal of Non-Current Assets
- Depreciation: Estimate of non-current asset loss in value over its useful life.
- Methods of Calculating Depreciation: Straight-line method (fixed annual reduction in value), reducing balance method (higher depreciation in initial years). Revaluation (revaluing at given date to determine depreciation).
- Journal Entries for Disposal of Non-Current Assets: Record gain or loss from the disposal.
Other Payables and Receivables
- Accrued and Prepaid Expenses: Expenses recognized when incurred; income when earned, regardless of payment. Matching expenses with revenues in the same accounting period helps determine correct profit.
- Accrued and Prepaid Income: Income recognized when earned; expenses when incurred. Matching ensures correct profit.
Irrecoverable Debts and Provision for Doubtful Debts
- Irrecoverable Debts: Amounts owed to a business that will not be paid.
- Provision for Doubtful Debts (PFDD) Estimates of the amount a business may lose in a financial year due to uncollectible debts
- Journal Entries for Irrecoverable Debts: These entries adjust for debts that are no longer expected to be collected, making necessary adjustments to financial statements.
Inventory Valuation
- Inventory Valuation: Inventory is valued at the lower of its cost or net realizable value (NRV). Cost is the actual purchase price plus any additional costs. NRV is the estimated sale price less costs to completion and sale.
- Overvaluation: Overstating inventory affects gross profit and profit for the year (values are overstated).
- Undervaluation: Understating inventory affects gross profit and profit for the year (values are understated).
Sole Traders
- Sole Trader Structure: A business run and controlled by a single individual.
- Service Businesses: Businesses that don't buy and sell goods (travel agents, accountants, etc.).
- Trading Businesses: Businesses that buy and sell goods.
- Format of Income Statement: Shows business performance over a specific period, presenting revenue and expenses to calculate profit or loss.
- Format of Balance Sheet: Provides summary of a business's financial position at a particular point. Lists assets, liabilities, and owner's equity
Partnerships
- Partnership Structure: A business run by two or more individuals. Partnership agreement outlines capital contributions, profit/loss sharing, interest rates on capital and/or drawings, and potential upper drawing limits.
- Format of Partnership Accounts: Shows profit or loss division among partners, interest on capital, and partner salaries.
Limited Companies
- Limited Companies: Separate legal entities from their shareholders; limited liability for company debts.
- Advantages: Easier to raise capital (shares) and easier to transfer ownership.
- Disadvantages: More complex and expensive to set up, and shareholders receive only a portion of profits as dividends.
- Types of Shares: Ordinary Shares (vary in dividend value according to company performance), Redeemable Preference Shares (dividend specified and included in the income statement as finance cost), and Non-redeemable Preference Shares (dividend's value included in the statement of changes in equity and reserve).
- Statement of Changes in Equity: Shows how profit for the year is used, summarizing changes to ordinary share capital, retained earnings, and general reserve throughout the period.
- Format of Balance Sheet: Summarizes the company's financial position at a given time. Lists assets, liabilities, and equity.
Clubs and Societies
- Club and Society Structure: Organizations providing facilities and services to members, not formed for profit.
- Differences with Businesses: Using receipts and payments account, focusing only on revenue items in income and expenditure account, and not accounting for accruals or prepayment adjustments.
Manufacturing Accounts
- Manufacturing Accounts: Used for businesses creating and selling goods from raw materials.
- Elements of Cost: Direct materials, direct labor (wages paid for directly manufacturing the product), and direct expenses. Indirect costs like factory rent, rates, depreciation, indirect expenses, etc.
- Manufacturing Income Statement: Shows detailed costs of raw materials, direct labor, direct expenses, factory overheads, cost of production, and the profit earned.
Incomplete Records
- Incomplete Records: Circumstances with missing double-entry book information.
- Four Techniques for Incomplete Records: Capital Comparison, Construction of Cash/Bank Summary, Use of Control Accounts, and Use of Mark-up, Margin, & Inventory Turnover.
Accounting Ratios
- Profitability Ratios: Measure a company's profitability.
- Gross Profit Margin: Percentage of revenue that exceeds sales' cost.
- Profit Margin: Ratio of revenue to profit.
- Return on Capital Employed (ROCE) Measures profitability in relation to capital employed.
- Liquidity Ratios: Measure a company's ability to pay short-term debts.
- Current Ratio: Liquidity ratio assessing a company's current assets (liquid assets like cash, inventory) to current liabilities.
- Acid-Test Ratio (Quick Ratio) A more stringent assessment than the current ratio; looks at liquid assets (cash or cash equivalents, net current receivables) to current liabilities.
- Inventory Turnover Rate: Calculates the average inventory used over a period. Indicator of how efficiently a company manages inventory levels.
Interpretation of Accounting Ratios
- Improving Ratio Performance: Strategies to improve accounting ratios like raising product prices, sourcing from cheaper vendors, or limiting expenses.
Inter-firm Comparison
- Comparing the financial performance of different businesses over multiple years.
Interested Parties
- Internal Users: Owners and managers.
- External Users: Banks, lenders, trade payables, customers, and governmental agencies.
- Goal: Understanding Financial Position and Performance by Interested Parties -Understanding a company's performance to gauge its future potential and provide financial security/liquidity.
Limitations of Accounting Statements
- Historical Cost: Accounting data reflects actual costs at the time of the transaction, not adjusted for inflation.
- Different Definitions: Different businesses may use different definitions of "profit" or other measurements.
- Accounting Policies: Different businesses adapt different accounting policies which can significantly affect comparison.
- Time Factor: Accounting statements record past events, not informing the future or current position of a business.
Accounting Principles
- Matching Principle: Matching expenses to revenues in the same accounting period.
- Business Entity Principle: Treating a business as a separate economic entity distinct from the owner(s).
- Consistency Principle: Continuing to use the same accounting method from one period to another.
- Going Concern Principle: The business will operate for a foreseeable future.
- Historical Cost Principle:Recording assets at their original cost, not current market value.
- Materiality Principle: Significant transactions; immaterial transactions can be omitted from financial statements.
- Money Measurement Principle Accounting data will only ever be recorded in terms of money.
- Prudence Principle: Never overstate profits, but accurately account for potential losses.
- Realisation Principle: Revenue is only recognized when the ownership and control of the goods/services is transferred from seller to buyer.
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