Business Types and Accounting Overview

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Questions and Answers

What does the Objectivity Theory in accounting emphasize?

Accounting information must be verifiable and reliable. (correct)

Financial statements must include personal opinions.

Only current assets need to be recorded with evidence.

Earnings should always reflect market value.

Which of the following is considered a current asset?

Inventory (correct)

Office equipment

Long-term investments

Commercial buildings

Which type of business is primarily engaged in buying and selling goods to customers?

Retail business

Service business

Trading business (correct)

Manufacturing business

How is owner's equity calculated?

Beginning capital + Additional capital + Profit - Drawings Signup and view all the answers

What is a significant characteristic of a sole proprietorship?

The owner has full control of the business Signup and view all the answers

Which of the following is an example of a non-current liability?

Bank loan due in three years Signup and view all the answers

What does unlimited liability mean for the owner of a sole proprietorship?

Owners risk losing personal assets to cover business debts Signup and view all the answers

What is the primary principle of the double entry accounting system?

Total debits must always equal total credits. Signup and view all the answers

Which of the following expenses would be classified as an income-generating cost?

All of the above Signup and view all the answers

Which role does an accountant NOT play in a business?

Making strategic business decisions Signup and view all the answers

In terms of the expanded accounting equation, profits are defined as?

Income earned minus expenses incurred. Signup and view all the answers

What is a crucial attribute of ethical accountants?

Integrity in professional relationships Signup and view all the answers

Which of the following statements about transactions is incorrect?

Transactions can be recorded only in the cash account. Signup and view all the answers

Which stakeholder is primarily interested in a business's ability to repay loans?

Lenders Signup and view all the answers

What is the role of accounting information in decision-making for stakeholders?

To assist in managing resources and performance Signup and view all the answers

What does a service business primarily provide to its customers?

Services to generate a profit Signup and view all the answers

What is the list price of the inventory sold on credit by the business on January 1, 2020?

$1500 Signup and view all the answers

What cash discount percentage is applied if payment is received within 7 days?

2% Signup and view all the answers

What is classified as a current liability in the statement of financial position?

Income received in advance Signup and view all the answers

How much rent income was received in advance on January 1, 2020, by Daniel's grocery store?

$3000 Signup and view all the answers

What does the adjustment on December 31, 2020, relate to in Daniel's grocery store?

Income received but not yet earned Signup and view all the answers

What was the total annual rent income for the year ended December 31, 2020, for Daniel?

$33000 Signup and view all the answers

Why was $3000 of rent income reversed on January 1, 2020?

Services for this income were provided in 2019 Signup and view all the answers

According to the accrual basis of accounting, what must happen to income received in advance?

It should not be recognized as current income Signup and view all the answers

What is the effect on current assets when commission income receivable of $8000 is not adjusted?

Understated by $8000 Signup and view all the answers

According to the revenue recognition theory, when should revenue be recognized?

When goods are delivered or services are provided Signup and view all the answers

What is the total amount of prepaid rent that should be considered an expense for the financial year ended 31 December 2020?

$92,000 Signup and view all the answers

What is the journal entry interpretation for the entry made on 1 January 2020 regarding prepaid rent?

It reverses prepaid rent that will be incurred this year. Signup and view all the answers

What happens to profit if commission income receivable of $8000 is not adjusted?

Understated by $8,000 Signup and view all the answers

How is prepaid rent classified on the statement of financial position?

As a current asset Signup and view all the answers

What principle explains that revenue should be recorded in the period it is earned regardless of cash receipt?

Accrual basis of accounting Signup and view all the answers

If the prepaid rent as of 31 December 2020 is $2000, what portion is accounted as a rent expense?

$92,000 Signup and view all the answers

What is the effect on Current Assets if prepaid rent is not adjusted?

Understated by $2000 Signup and view all the answers

What impact does not adjusting prepaid rent have on Profit for the period?

Understated by $2000 Signup and view all the answers

What type of account is rent expense payable classified as?

Current Liability Signup and view all the answers

What amount was paid for rent expense by Rachel Stationary for the year ended 31 December 2020?

$20,000 Signup and view all the answers

What is the adjustment related to rent expense payable made on 31 December 2020?

$4,000 Signup and view all the answers

What is the consequence of not adjusting rent expense payable at the end of the financial period?

Net Profit would be overestimated Signup and view all the answers

What theory supports adding the rent expense payable into this year's expenses?

Accrual Basis Accounting Signup and view all the answers

What was the rent expense payable as at 31 December 2020 for Rachel Stationary?

$84,000 Signup and view all the answers

Study Notes

Types of Business

Trading businesses buy and sell goods to customers to make a profit, such as bookshops and supermarkets.
Service businesses provide services to customers to make a profit, such as hairdressing shops and tuition centers.

Sole Proprietorship

Owned by one individual who contributes capital.
Banks may be less likely to lend money due to limited personal assets as a guarantee.
Risk: Unlimited liability for the owner.
Owner has full control and minimal administrative duties.
Ownership transfer requires notifying corporate regulatory authorities.
The business lifespan is tied to the owner's life and their desire to continue.

Role of Accounting

Accounting is an information system providing financial data to stakeholders for informed decisions about resource management and business performance.
Accountants prepare and provide accounting information for decision-making.
Accountants establish accounting information systems and act as stewards of the business.
Accountants adapt, solve problems, think critically and provide both accounting and non-accounting information for decision-making.
They ensure timely and relevant information is provided, adhering to accounting theory, making it easily understood by stakeholders.

Professional Ethics

Integrity: Accountants must be honest and transparent in all professional relationships.
Objectivity: Accountants must remain impartial, avoiding bias, conflict of interest, or undue influence that could affect their professional judgment.

Stakeholders

Owners/Shareholders: Determine whether to continue investing or sell their shares.
Lenders: Evaluate the business's ability to repay loans and interest before lending.
Suppliers: Decide whether to provide goods on credit (postponed payment).
Government: Ensure the business complies with tax regulations and collect the appropriate tax amount.
Managers: Use the information to improve business performance.
Employees: Decide whether to continue working at the business based on its performance.
Customers: Determine if they want to buy from the business based on its ability to provide goods and services.
Competitors: Assess their performance compared to the business and develop strategies for improvement.

Accounting Theories

Objectivity Theory: Accounting information should be backed by reliable and verifiable evidence to ensure financial statements are free of opinions and biases.
Historical Cost Theory: Transactions are recorded at their original cost.

Elements of Financial Statements and the Accounting Equation

Assets: Resources a business owns or controls, expected to provide future benefits.
- Non-current Assets: Provide benefits beyond one financial year and are not easily converted to cash (e.g., office equipment, fixtures, fittings).
- Current Assets: Provide benefits within one financial year and are easily converted to cash (e.g., inventory).
Liabilities: Obligations owed by a business to others, expected to be settled in the future.
- Non-current Liabilities: Due to be paid beyond one financial year.
- Current Liabilities: Due to be paid within one financial year (e.g., bank loan, trade payable).
Equity: The owner's claim on the net assets of a business.
- Owners' Equity = Beginning Capital + Additional Capital + Profit - Drawings
  - Capital: Resources contributed by the owner for business use.
  - Profit: Income earned - Expenses incurred.
  - Drawings: Assets taken from the business for the owner's personal use.
Income: Amount earned from business activities (e.g., rent, interest income).
Expenses: Costs incurred to earn income within the same accounting period (e.g., salaries, rent expense).

Accounting Equation:

Assets = Liabilities + Equity
Equity = Assets - Liabilities

Expanded Accounting Equation:

Assets = Liabilities + Capital + Income - Expenses - Drawings

Transactions:

Business transactions have a dual effect, affecting at least two accounts.
The accounting equation remains balanced for every transaction.

Double Entry (Journal Entry)

Three rules for the double-entry system:
- At least two accounts are affected by each transaction.
- One account is debited, and one account is credited.
- Total debits equal the total credits recorded.

Revenue and Other Income:

Income Received in Advance:
- Refers to income received but not yet earned.
- Classified as a current liability on the statement of financial position because the business owes the customer the goods or services.
Commission Income Receivable (Un-adjusted):
- No effect on current liabilities.
- Current assets are understated by the amount of unadjusted commission income.
- Profit is understated by the unadjusted income amount.

Accounting Theories for Revenue:

Revenue Recognition Theory: Revenue is earned when goods are delivered or services are provided.
Accrual Basis of Accounting Theory: Revenue earned is recorded in the relevant accounting period, regardless of whether cash is received.

Cost of Sales and Other Expenses

Prepaid Expenses:
- Expenses paid but not yet incurred in the current financial period.
- Classified as a current asset on the statement of financial position as the business has the right to receive the goods or services paid for.
Prepaid Rent (Un-adjusted):
- No effect on current liabilities.
- Current assets are understated by the amount of unadjusted prepaid rent.
- Profit is understated by the unadjusted prepaid rent amount.
Expenses Payable:
- Expenses incurred but not yet paid in the current financial period.
- Classified as a current liability on the statement of financial position because the business has an obligation to pay for the expenses in the next financial period.
Rent Expense Payable (Un-adjusted):
- No effect on current assets.
- Current liabilities are understated by the amount of unadjusted rent expense payable.
- Profit is overstated by the unadjusted rent expense payable amount.

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Description

Explore the different types of businesses such as trading and service sectors, as well as the characteristics of sole proprietorships. Learn about the essential role of accounting in informing stakeholders and making financial decisions. Test your knowledge on these foundational business concepts.