Introduction To Accounting PDF

Chapter 1 --- introduction of accounting Types of business: 1. Trading business → Business buys and sells goods to customers to make a profit Eg. bookshop, supermarket 2. service business → Business provides services to customers to make a profit Eg. hairdressing shop, tuition ce...

Chapter 1 --- introduction of accounting Types of business: 1. Trading business → Business buys and sells goods to customers to make a profit Eg. bookshop, supermarket 2. service business → Business provides services to customers to make a profit Eg. hairdressing shop, tuition centres Sole Proprietorship: → Owned by one owner, capital contributed by the owner, less likely for banks to lend money due to lack of personal assets to serve as a guarantee of repayment Risk: Unlimited liability → Full control Formalities: Minimal administrative duties Transferability or ownership: Notify corporate regulatory authority to transfer ownership Lifespan: Exist as long as owner is alive and wish to continue Role of accounting: Accounting is an information system that provides accounting information for stakeholders to make informed decisions regarding the management of resources and performance of businesses. Role of accountants: Accountants prepare and provide a counting information for decision-making. In doing so, accountant sets up an accounting information system and become stewards of business. Accountants adapt, solve problems, think critically and provide accounting and non- accounting information for decision making. Accountants provide timely and relevant information, based on accounting theories, which are easily understood by stakeholders. 1 Professional ethics: Integrity -- Accountant with integrity and straightforward and honest in all professional relationships Objectivity -- Accountant who is objective will not let bias, conflict of interest or undue influence of others override his professional judgement Stakeholders: owners / shareholders -- whether to continue to invest in the business or sell the business. Lenders -- Whether to grant loans to the business (is the business able to repay the loan and interest? suppliers -- whether to sell goods to the business on credit 🡪 postponed payment to a future date the business Government -- whether the business complies with tax regulations and amount of tax to collect from. Manager -- must improve performance of the business Employers -- whether to continue wanting at the business Customers -- whether to buy from the business, depending on business ability to provide goods / after sales service Competitors -- Whether they are comparable to the business and how to improve their own performance Accounting Theories: 1. Accounting entity theory -- The activities of a business are separate from the actions of the owner. All transactions are recorded from the point of view of the business. Eg. When the owner contributes resources into the business, it is recorded as capital. On the other hand, when the owner withdraws resources from the business, it is recorded as drawings. 2  2. Going concern theory -- The business is assumed to have an indefinite life unless there is credible evidence that it may close down. 3. Monetary theory -- Only business transactions that can be measured in monetary terms are recorded. Eg. Business does not record employee’s satisfaction, morale and customer’s loyalty 4. Accounting period theory -- The life of a business is divided into regular time intervals Chapter 2 --- Accounting information system Cash transaction: → A business receives payment from customers immediately upon sale of goods (cash sales) → A business makes payment immediately to its suppliers when buying goods (cash purchases) Credit transaction. → (Trade receivables) A business receives payment at a later date from its credit customers (credit sales) → (Trade payables) A business makes payment at a later date to is credit suppliers (credit purchases) Source Documents: 3 → Source documents provide evidence that transactions have taken place → Information can be verified from source documents and transaction is recorded at the original cost Types of source documents: Accounting cycle -- 4 stages 4  1. Identify and record -- source documents are used to record transactions in the journal and the journal entries are posted to ledger. 2. Adjust -- Any adjusting entries are recorded in the journal and posted to the ledger. 3. Report -- Based on adjusted trial balance, the financial Statements are prepared 4. Close -- After financial Statements are prepared, income, expenses, income Summary and drawings accouris are closed by passing journal entries before posted to ledger. Accounts are, closed at the end of the financial year Accounting Cycle equation: Source Document 🡪 Journal 🡪 Ledger 🡪 Trail Balance 🡪 Financial Statements Accounting Theories : 1. Objectivity Theory -- Accounting information recorded must be supported by reliable and verifiable evidence so that A financial statements will be free prom opinions and biases. 2. Historical Cost Theory -- Transactions should be recorded at their original cast. Chapter 3 --- Elements of financial statements and accounting equation Assets: Are resources a business owns or contras that are expected to provide future benefits Eg. Office equipment, inventory, fixtures and fittings Non-current assets: Benefits last beyond one financial year → Not easily converted to cash Current Assets: Benefits are used within one financial year → Are easily converted to cash 5 Liabilities: Are obligations owed by a business to others that are expected to be settled in the future Eg. Bank Ioan (Amount overdrawn from the bank on credit)/Trade payable (Amount owing to a supplier for the purchase of goods and services) Non-current Liabilities: Due to be paid beyond one financial year Current Liabilities: Due to be paid within one financial year Equity: Is the claim by the owner on the net assets of a business → owners equity = Beginning capital + Additional capital + Profit - Drawings capital (Resources contributed by owner for business use) profits (Income earned (I) - Expenses incurred (E)) Drawings (Assets taken from a business for owner's personal use) income: Amount earned from the activities of a business Eg. Rent, Interest income Expenses: Cost incurred to earn income in the same accounting period Eg. Salaries, Rent expense Accounting Equation: Assets = Liabilities + Equity / Equity = Assets- Liabilities Expanded accounting equation Assets = Liabilities + Capital + Income - Expenses -Drawings Transactions: A business transaction is any activity carried out by the business dual effect of a transaction: → Every transaction must affect at least 2 accounts → The accounting equation always balances *TABLE TO MEMORISE* 6 Chapter 4 --- Double Entry (Journal Entry) 3 rules for the Double Entry system: 1. At least 2 accounts are affected for each transaction 2. One account debited and one account credited 3. Total debits are equal to the total credits recorded Journal entry to record discount allowed: Eg. on 1 January 2020, business sold inventory on credit at a list price of $1500, less trade discount 10%. A cash discount of 2% will be given if payment is received within 7 days. on 5 January 2020, business received a cheque from k Travel in full settlement of the amount owed. Journal entry to record discount allowed: Eg. on 1 January 2020, business bought inventory on credit from supplier ken at list price or 11000, less trade discount 5%. A Cash discount of 2% will be given is 7 payment is received within 5 days. On 4 January 2010, business paid a cheque to ken in full settlement of the amount owed. Chapter 6 --- Revenue and Other Income 1. Income received in advance → Is the amount of income that has been received but has yet to be earn. His classified as a current lability on the statement of financial position as the business owes the customer the goods or services. RCAT question on rent income received in advance Eg. Danial runs a grocery store. On 1 Jan 2020, there was rent income received in advance of $3000. On 31 December 2020, Daniel received rent income $ 36 000 by cheque. Annual rent income for the year ended 31 December 2020 is $33000 - Prepare the journal entries to record transactions relating to rent income for the financial year ended 31 December 2020. 8 (1) Interpret the entry on 1 January 2020 ANS: On 1 January 2020, the business reversed rent income received in advance of $3000. $3000 of the rent income was collected last year (2019) but the services will only be provided this year (2020) Hence, the amount of $3000 rent income received in advance that was adjusted on 31 December 2010 is reversed and added to this year’s rent income on 1 January 2020. (2) Explain the adjustment made on 31 December 2020 and the accounting theory behind it. Ans: On 31 December 2020, the business made an adjustment for rent income received in advance of 96000. According to the accrual basis of accounting, $ 6000 of rent income was collected. this year (2020) but has yet to be earned. Hence, it should not be recognised as this year's (2020) income. - Prepare an extract of the statement of financial performance for the year ended 31 December 2020 - Prepare an extract of the statement of financial position for the year ended 31 December 2020 9 What happens when rent income received in advance is not adjusted? → Effect On CL, CA and P if rent income received in advance$ 6000 is not adjusted Current Liabilities: understated by $6000 Current Assets: No effect Profit: Overstated by 86000 (P = | -E) 2. Income receivable → Is the amount of income that has been earned but has yet to be received in the current financial period. His classified as a current asset on the statement of financial position, as the business has the right to collect payment from customers for goods that have been delivered or services that have been performed. RCAT question on income receivable Eg. Ian runs an Gym. on 1 January 2020, there was commission income receivable of $32 000. on 1 November 2020, Ian Gym received $30 000 cheque far commission income. It had $38 000 commission income that had yet to be received for the year ended 31 December 2020. (next page) 10 - Prepare the journal entries to record transactions relating to commission income for the financial year ended 31 December (1) Interpret the entry on 1 January Ans: On 1 January 2020, the business reversed $2000 of the commission income receivable. $2000 of the commission income was earned last year (2019) but payment will only be collected this year (2020). Hence, $92 000 commission 11  income receivable that was adjusted an a1 December 2019 was reversed and subtracted from this year's commission income on 1 January 2020. (2) Explain the adjustment made on 31 December 2020 and the accounting theory behind it Ans: On 3) December 2020, the business made an adjustment for commission income receivable of $ 8000. According to the accrual basis of, accounting, $ 8000 of commission income earned but not yet received should be recognised as this year’s commission income. (1) Prepare an extract of the statement af sinancial performance for the year ended 31 December 2020 (2) Prepare an extract of the statement of financial position for the year ended 31 December 2020 What happens when commission income receivable is not adjusted? → Effects On CL, CA and P if commission income receivable $8000 is not adjusted Current liabilities: No effect Current Assets: Understated by $ 8000 Profit: Understated by $8000 (P = I - E) 12 Accounting Theories: (1) Revenue recognition theory -- Revenue is earned when goods have been delivered, or when services have been provided (2) Accrual basis of accounting theory -- Revenue that have been earned should be recorded in the relevant accounting period, regardless of whether cash is received or not. Chapter 7 – Cost of Sales and Other Expenses (1) Prepaid expenses → Is the amount of expenses that has been paid but has yet to be incurred in the current financial period Itis classified as a current asset on the statement of financial position, as the business has the right to receive the goods or services that have been paid for. RCAT question on Prepaid Expenses Eg. Mia Owns Mia Fashion. For the year ended 31 December 2019, the business issued cheques amounting to $13 000 to pay for 13 months of rental up to 3l January 2020. For the year ended 31 December 2020, Mia, Fashion, paid $215000 cheque for rent income; Prepaid rent as at 31 December 2020 is $2000. (next page) 13  - Prepare the journal entries to record transactions relating to the rent expense for the financial year ended 31 December 2020. (1) Interpret the entry on 1 January 2020 ANS: ON 1 January 2020, the business reversed prepaid rent of $1000. $1000 of the rent was paid in advance last year (2019) but it will be utilised this year (2020). Hence, $1000 prepaid rent expense is added to this year (2020) expenses. 14 (2) Explain the adjustment made on 31 December 2020 and the accounting theory behind it Ans: On 31 Dec 2020, the business adjusted prepaid rent expense of $92 000. According to the accrual basis of accounting, $2000 of the rent expense was paid in advance (2020) but not incurred this year (2020). Hence, the prepaid rent expense of $2000 must be deducted from this year's expenses (1) Prepare an extract of the statement of financial performance for the year ended 31 December 1020 (2) Prepare an extract of the statement of financial position for the year ended 31 December 2020 what happens when prepaid rent is not adjusted? → Effects On CL, CA and P if prepaid rent is not adjusted Current Liabilities: No effect Current Assets: understated by $2000 Profit: Understated by $2000 (P = I - E) (2) Expenses payable 15 → Is the amount of expenses that has been incurred but has yet to be paid in the current financial period. It is classified as a current liability on the statement of financial position, as the business has the obligation to pay for the expenses in the next financial period. ACAT question on Expenses payable Eg. Rachel owns Rachel Stationary. on 31 December 2019, there was rent expense payable of $1000. For the year ended 31 December 2020, Rachel Stationary paid $20 000 cheque for rent expense. Rent expense payable as at 31 December 2020 is $84 000. (next page) - Prepare the journal entries to record transactions relating to rent expense for the financial year ended 31 December 2020. 16 (1) Interpret the entry on 1 January 2020 Ans: on 1 January 2020, the business reversed rent expense payable of$1000. $1000 Of the rent expense was owing as at 31 December 2019 and to be paid this year (2020). Hence, the rent expense payable of $1000 was deducted from this year (2020)'s expenses. (2) Explain the adjustment made on 31 December 2020 and the accounting theory behind it Ans: On 1 December 2020, the business adjusted rent expense payable of $4000. According to the accrual basis of accounting theory, $4000 of the rent expense was incurred for the year (2020) but not yet paid. Hence, rent expense payable of $4000 should be added to this year (2020)’s expenses. (1) Prepare an extract of the statement of financial performance for the year ended 31 December 2020 (2) Prepare an extract of the statement of financial performance for the year ended 31 December 2020 what happens when rent expense payable is not adjusted? 17 → Effects On CL, CA and P if rent expense payable $84 000 is not adjusted Current liabilities: understated by $4000 Current assets: No effect Profit: Overstated by $4000 (P = I - E) Accounting theories: (1) Matching Theory -- Expenses incurred must be matched against income earned in the same period to determine the profit for that period (2) Accrual basis of accounting theory -- Expenses incurred by the business, regardless of whether they have been paid for or not, must be recorded in the relevant accounting period 18 Chapter 9 –- Inventory Inventory refers to: → Refer to goods bought by businesses to sell to their customers. → A business buys sufficient goods to keep on hand to prevent a stock out situation, which results in loss of sales. Ways business manages inventory: 1. Keep proper records to track inventory 2. Keep physical inventory in the warehouse 3. Buy insurance to insure inventory How is the cost of Inventory purchased calculated? (costs of inventory purchased includes): 1. cost price of the goods 2. All cost to bring in and get them ready for sale → Transport → custom duties → racking materials → Insurance → wages for employees involved in repacking of the goods How's the cost of sales calculated?: → Cost of sales is determined using the First in First Out (FIFO) basis. This means that the cast of goods that are purchased First are assumed to be sold first. Eg. A firm has the following information about its inventory of ladies' cardigans: 19 The business uses the FIFO system to value its inventory (a) Calculate the value se ending inventory (1400+4000+3500+2800) - (1400+4000+3500) = $15 5404 (2800 units) Ending inventory = $ 15 540 (ans) (b) calculate the gross profit for the three months ending March 2014 Gross Profit = Net sales revenue - cost of sales = (11 480+38 000+41 650) - (6300+18 400 +17 325) = $419 105 (ans) inventory account example: Eg. Bob commenced business on 1 January 2019 buying and selling pianos on credit sales transactions for the year are as follows: 20 (next page) - Prepare the inventory account for the year ended 31 December 2019 - Prepare an extract of statement of financial performance for the year ended 31 December 2019 21  - Prepare an extract of statement of financial performance for the year ended 31 December 2019 What happens when the value of inventory palls below its cost? → Inventory is to be valued at the lower of cost or net realisable value. → When the net realisable value of inventory is below cost price, the business records the loss as an expense called impairment loss on inventory. Eg. on 31 December 2014, goods costing $3000 has a net realisable value of $2800 Accounting Theory: 1. Prudence Theory -- The accounting treatment chosen should be the one that least overstates assets and profits and least understates liabilities and losses. 22 → According, to Prudence Theory, inventory is valued at the lower of cost or net realisable value to ensure that inventory cost is not overstated. A business may buy insurance to reduce the potential loss arising prom damaged inventory. What happens when impairment loss on inventory is not adjusted?: Expenses: Understated Current asset: overstated Profit: overstated 23 Chapter 5 Statement of financial performance 24 Statement of financial position It is a financial report that: → List the assets, liabilities and equity of a business at a specified date → Provides information on how resources are contained and used in a business and the claim by the owner on the net assets of the business as at a point in time → Represents the accounting equation: Assets = Liabilities + Equity For sole proprietor, equity is calculated by: Equity = Beginning Capital + Additional Capital + Profit for the year - Drawings 25 26 Chapter 11 -- Non - current asset Depreciation: Is the allocation of cost of a non-current asset over its estimated useful life (recorded as an expense in the statement of financial performance) Causes of Depreciation: → Physical wear and tear → obsolescence (outdated) → Usage ( Depletion of natural resources → Legal limits (lease) Methods to calculate Depreciation: Straight Line Method 𝑜𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑐𝑜𝑠𝑡−𝑠𝑐𝑟𝑎𝑝 𝑣𝑎𝑙𝑢𝑒 Annual Depreciation Expense = 𝑢𝑠𝑒𝑓𝑢𝑙 𝑙𝑖𝑓𝑒 (𝑦𝑒𝑎𝑟𝑠) OR Annual Depreciation Expense = Rate of depreciation (%) x (cost of non current Benefits of Straight Line method: → Non-current assets depreciate at an equal amount for every non-current asset year of its useful life. This assumes that are equally useful throughout its entire useful life. → The benefits from the non-current assets tend to be the same over the years. 27  Reducing Balance Method Annual Depreciation Expense = Rate of depreciation (%) x (cost – accumulated Benefits of reducing balance method: → Amount of depreciation expense decreases each year, a higher amount is charged in the earlier years and a lower amount in the later year. This assumes that the non-current assets provide more benefits in the earlier years of its useful life. → There tends to be more benefits from the non-current assets during the first few years of its usage Accounting theory: consistency theory -- once an accounting method, is chosen, this method should be applied to all future accounting periods to enable meaningful comparison of the net book value of the non-current assets over time. Eg. on 1 January 2022, XYZ business bought a motor vehicle for $80000. It was decided to depreciate the asset at 10% per annum using the reducing balance method. XYZ's financial year ends on 31 December. Record the depreciation expense in journal, ledger and show how it appears in the financial statement in year 2022 and 2023. Journal entries: 28 Financial statements: Chapter 14 -- Accounting for owner’s equity Presentation of equity 29 Reasons for change in owner's equity → Additional capital by the owner → Profit / Loss incurred by the business during the year → Drawings by the owner Closing of Drawings and Capital Accounts Eg. Atika runs a toy shop. The following transactions took place during the financial year ended 31 December 2023 Jan 1 Atika started business with $50 000 in the business bank account Feb 8 Atika contributed her personal laptop worth of $4000 to be used in the Dec 30 Atika withdrew $100 worth of toys from the business to be used as gift for her Dec 31 The business earned a profit of $20 600 for the year (a) Prepare journal entries on the following dates. Narrations are required. i) Jan 1 ii) Feb 8 iii) Dec 30 iv) To transfer drawings to capital account V) To transfer profit for the year to capital account 30 Chapter 11 -- Capital Expenditure VS Revenue Expenditure 31 What happens when Capital Expenditure Is wrongly recorded as Revenue Expenditure? Non-current Assets: understated Profit for the year: Understated What happens when Revenue Expenditure is wrongly recorded as capital Expenditure? Non- current Assets: Overstated Profit for the year: overstated Accounting Theory: Materiality Theory -- If the amount spent on a non-current asset is insignificant to decision making when compared to the size of the business, it does not need to be recorded as a non-current asset in the statement of financial position. Instead, it can be treated as an expense in the Statement of financial performance. Inventories Scenarios -- Based Questions [Format for scenarios – based question]: Decision State clearly which product the business should buy [1m] (LEAVE A LINE) 32 Point 1 Paraphrase evidence from the question to support your decision [1m] Elaboration Explain the evidence [1m] (point 1) (LEAVE A LINE) Point 2 Paraphrase evidence from the question to support your decision [1m] Elaboration Explain the evidence [1m] (point 2) (LEAVE A LINE) Point 3 Paraphrase evidence from the question to support your decision [1m] Elaboration Explain the evidence [1m] (point 3) (LEAVE A LINE) Explain how the evidence can lead to benefits of the business: Evidence Benefits to business Product that lowers cost Result in lesser cash out flow in purchasing products price and business can reserve more cash for other operational purposes. when the product is sad, the lower cost of sales will, also lead to higher gross profit for the business; Product that can be sold at Higher gross profit and profit for the year a higher selling price Product that aligned with Higher sales volume, as demand for products customer’s preference increases and therefore higher gross profit Product that does not Will not require the purchase of additional require special type of non-current assets to store products storage Product that has a longer Lower impairment loss on inventory as it is less likely life span to unite down inventory below its costs Product that is exclusive or Increase Footfall at the store and hence able to not commonly found in command a higher mark-up or selling price to other competitors stores increase gross profit When a business purchase inventories from a supplier, it has to consider both accounting and non- accounting information 33 Information to consider when buying inventories Accounting information: ✔ Cost of inventory ✔ Storage cost ✔ Gross profit margin (the profit remaining after subtracting the cost of goods sold) ✔ Rate of inventory turnover [times] (the number of times a company has sold and replenished its inventory over a specific amount of time) ✔ Days sales in inventory [days] Non-accounting information ✔ Nature of product - Refers to a feature, attribute or quality of the product - Some products come with a variety of components to cater to customers’ preferences Eg. Modular sofa system that enables owner to mix and match ✔ Types of storage - Different goods may require special type of storage Eg. Ice cream requires refrigerator ✔ Customer preference - Motivations and behaviours which influence the customers’ purchasing decisions - As the demographics of a country changes, the demand for certain products changes 34 Eg. Big-screen IT products are more popular among elderlies / Ai products are more popular among the youths 35