Cash budget Predict the movements of cash received and paid for over a period of time. Financial statements

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1 Achievement Standard Demonstrate understanding of accounting concepts for small entities ACCOUNTING. Externally assessed 3 credits Accounting (Accounting.) involves the recognition, definition and application of the conceptual basis of accounting, applied to community organisations and sole proprietors. There is one criterion in Achievement Standard (Accounting.), which is divided into the following five main topics. Nature of accounting users and uses of financial information, features of entities, specialised areas of accounting. The purpose of financial statements. The financial elements assets, liabilities, equity, income, expenses. Depreciation and capital or revenue expenditure are included here. The accounting concepts accounting entity, monetary measurement, going concern, period reporting, accrual basis and historical cost. The accounting equation. In this chapter, each section has questions from previous examination papers to give you a good idea of the questions you might be asked. At the end of the chapter, two exam papers are included in their entirety. Essential exam notes Nature of accounting Accounting is a way of communicating financial information so that interested parties can make informed decisions. Financial information is used by internal and external users. A number of people are interested in various uses of accounting information and financial statements. Cash budget Predict the movements of cash received and paid for over a period of time Income Statement Calculates profit for a period of time Financial statements Statement of Cash Flows Shows movement of cash and change in bank account Statement of Financial Position Shows the value of assets, liabilities and equity at a point in time Balance Sheet is an alternative name for Statement of Financial Position. Accounting assists the decision makers in a business. Internal users (Management Accounting) Managers/Supervisors cost centres, cost of goods sold, profitability, budgets vs actual results. Employees job security, ability to pay wages. Members of a club or society to see how their subscriptions are being spent.

2 4 Achievement Standard (Accounting.). There are three important areas to all entities. Liability the responsibility for the debts of the entity. Unlimited liability individuals, sole traders, partnerships and unincorporated clubs have unlimited liability, which means that should the entity get into financial difficulty and not be able to repay its debts, the owners/members are responsible for all the debts. An owner may have to sell personal assets to repay the debt. Limited liability a legal limitation of an owner s responsibility for the debts of a business. The owner s liability is limited to the sum of money invested in the business. Therefore the personal assets of the owner cannot be used to pay the firm s debts if the firm gets into financial difficulties, unless the owner wants to do so. A member will lose only the amount of the subscription they have paid or still owe. This applies to incorporated community organisations and companies. Sources of funds where funds to start up or expand the business come from. Owner s investment capital invested into sole proprietor by the owner. Bank loan amounts loaned from a bank to finance business activities normally in the form of a bank overdraft, but can also be in the form of long-term loans. Bank overdraft a bank allows a business or club to access more funds, up to a limit, than are available in its bank accounts. Normally must be repaid in the short term. Debentures loan by club members to an incorporated organisation, or by the public to a company, to be repaid at a set time, with a stated rate of interest. Subscriptions amounts paid annually by members to belong to a club or society. Ownership Drawings part of an owner s equity that is withdrawn by the owner(s) from the sole trader or partnership. Accumulated funds the excess income over expenditure (surplus) that accumulates in club finances from year to year. (The owner s equity section of a club s Statement of Financial Position.) Purposes, components and limitations of financial statements Functions Financial statements report information to interested parties at the end of each accounting period, e.g. financial statements are presented to owners or managers so that they can analyse how successfully the business has operated in the past year, and to enable them to plan future operations. Other interested parties include the Inland Revenue Department (businesses are legally required to declare their profit or loss), creditors, employees, competitors. Each financial statement has a specific purpose, as follows. Income Statement this financial statement calculates whether a profit or loss has been made for the accounting period so the owner can see if the business s profitability has improved or not. It reports all expenses and income, which are classified in a way appropriate to the business s activities. May also have attached supplementary Statement of Trading or Activity Statements. Statement of Financial Position this measures a business s financial stability at a given point in time (balance day). It shows how equity is made up, namely from the business s assets less liabilities. A user can see whether the entity has more or less liability / asset / equity value than it had last year. Statement of Cash Flows shows all cash movements (where money came from and what it was spent on) the business has had and how the opening bank balance has changed to the closing balance (sometimes this statement is referred to as a Cash Flow Statement or a Statement of Changes in Cash Position). Cash budget this shows the predicted cash receipts and cash payments for a set period of time and predicts the closing bank balance. This allows finance arrangements to be made (e.g. obtaining a loan) or can be used to highlight areas in which less money should be spent in the period for which the budget has been prepared.

3 Demonstrate understanding of accounting concepts for small entities 5 NCEA practice Question One Questions Nature of accounting Yours to View is a DVD rental shop, owned by Brian. a. Brian has recently received an Income Statement of Yours to View from his accountant. What is the purpose of an Income Statement?. Year 2008 Ans. p. 95 b. Brian s business, Yours to View, has been described as a sole proprietor business. State ONE advantage of being a sole proprietor. c. Brian knows that a sole proprietor has unlimited liability. Describe what is meant by the term unlimited liability. d. Brian is considering expanding Yours to View. Name TWO sources of finance that Yours to View could access in order to carry out the expansion plans. () (2) e. When Brian received an invoice from his financial accountant, he found a brochure attached outlining other accounting services offered. Each of the following statements relates to a separate specialist accountant. Match each statement with the specialist accountant who would provide that service. The specialist accountants are listed below, and an example has been done for you. A Calculates and controls the costs of producing goods and services. B Provides financial information from within the business s operations. C Helps to record and prepare accounts and statements. D Prepares, analyses and interprets financial reports. E Prepares tax returns and provides taxation advice. F Checks financial records to ensure that they show a true and fair view of the organisation s financial results. i. Financial accountant D iv. Management accountant ii. Taxation accountant iii. Cost accountant v. Auditor vi. Accounting technician

4 38 Achievement Standard (Accounting.3).3 Example : Trading Entity Income Statement (Business Name) Income Statement for the year ended 3 March 20 Revenue XXX Less returns (XX) Net sales XXX Less Cost of goods sold Opening inventory XX Plus Purchases XX Less Purchase returns (XX) XX Plus Freight inwards X Customs duty X Goods available for sale XX Less Closing inventory (XX) Cost of goods sold (XX) Gross profit XX Add Other income (List) X X X XXX Less Expenses Distribution costs (List) X X XX Administrative expenses (List) X X XX Finance costs (List) X X XX Total expenses (XXX) Profit/Loss for the year $ XX The portion of the Income Statement that measures gross profit can sometimes be reported on separately, and is referred to as a Trading Statement. Classification of the Income Statement for a trading entity Income Revenue Other income All other revenues/income and gains. Examples interest, dividends, rent, commission received.

5 Expenses Distribution costs Administrative expenses Finance costs Prepare financial statements for sole proprietors 39 Costs incurred in transferring ownership of finished goods to the consumer. These expenses are those incurred through the promotion, storage, selling and delivery of the inventory for sale. Examples advertising, sales salaries/wages, vehicle expenses, shop electricity, shop rent, delivery expenses, depreciation on shop fittings/vehicles. Costs associated with the administration of the entity as a whole. Examples office salaries/wages, rent, insurance, telephone, accountancy fees, depreciation on office equipment/buildings. Costs that arise from an entity financing its operations from external sources i.e. interest costs. Examples interest on overdraft, interest on loan, interest on mortgage..3 NCEA practice Question Income Statement retail entity Kerryn Ridley owns Blenheim Building Supplies, a shop in Blenheim selling tools and equipment for builders and carpenters. The business is registered for GST on the payments basis. The following trial balance was prepared for Blenheim Building Supplies at the end of the financial year. Note: Blenheim Building Supplies rents out part of its building to an accounting firm. Blenheim Building Supplies Trial balance as at 3 March 200 Dr Cr Advertising 2000 Capital Bank 3200 GST payable 3200 Building (cost) Rent received 6500 Drawings Freight inwards 8000 Mortgage (0% due 2020) General expenses Accumulated depreciation Goodwill 9000 Building 2000 Insurance 600 Interest on mortgage 5000 Inventory /4/ Land (cost) Office wages Purchases salaries Additional information. Inventory on hand 3/3/0 $ Rent received in advance $ Depreciation on building is $ 000 per year 4. Invoices on hand for purchases $ 040 including GST 5. Invoices on hand for sales $ 960 including GST 6. Split Insurance 60% Distribution, 40% Office ESA Publications (NZ) Ltd, Freephone

6 Ans. p Achievement Standard (Accounting.3) You are required to prepare a fully classified Income Statement for Blenheim Building Supplies for the year ended 3 March 200. Use relevant information from the trial balance and additional information. Do not use abbreviations. Use the space provided that follows..3 Blenheim Building Supplies Income Statement for year ended 3 March 200

7 Achievement Standard Interpret accounting information for sole proprietors ACCOUNTING.5 Externally assessed 4 credits Achievement Standard (Accounting.5) involves interpreting information for a sole proprietor or sole proprietors. These are limited to service businesses and/or trading businesses that use a periodic inventory system and that are registered for GST on the payments basis. A calculator is required, as you will be required to calculate the analysis measures. Ratio and percentage formulae will be provided. Round calculations to either or 2 decimal places as instructed. Essential exam notes Ratios and percentages Once the financial statements have been prepared, it is important to analyse them to allow sound decisions to be made for the future. Analysing information involves calculating analysis measures formulae will be provided. Interpreting information involves: explaining analysis measures recognising satisfactory/unsatisfactory ratios, percentages or trends explaining reasons for trends making, justifying and stating the consequences of recommendations explaining relationships between analysis measures. Analysis measures are used to measure: profitability mark-up %, gross profit %, expenses %, profit %, percentage changes, comparisons of dollar amounts liquidity current ratio, liquid ratio financial stability equity ratio. Income Statement The following examples are for Skateboys Rollerblade Club, whose information is shown in the table alongside. Note: Net sales is calculated by returns Skateboys Rollerblade Club Income Statement for year ended 3 March 20 Net sales Less Cost of goods sold Gross profit Less Expenses Distribution costs Administrative expenses Finance costs Profit for the year $6 740

8 72 Achievement Standard (Accounting.5) Interpreting financial information presented in graphs Pie charts, bar graphs, pictograms, pictures, and other graphics can all be used in financial reports in an endeavour to make the report more easily understood or to emphasise key features. The analysis is identical, but pictures are often easier to understand than numbers..5 Look at a graph closely and read the axes carefully. Try to identify trends, because many graphs show information over time. In the graph alongside: Trend wage expense is decreasing. Wage expenses $0 000 in 203. $ Statement of Financial Position Graphical summary 0 R Jason Wage Expense Analysis Pie graphs show shares of a total. Calculate the total. In the graphs alongside: Total liabilities = $ , plus equity = $ Total assets = $ Liabilities and Equity Bank overdraft $5 000 Accounts payable $8 000 Accrued expenses $6 000 Term loans $ Equity $ Mortgage $ Assets Accounts receivable $ Inventory $ Property, plant $ and equipment Intangible assets $ Industry averages Sometimes you are provided with industry averages and expected to use them when commenting on trends or recommendations. You do not need to worry about this they are there to help you answer the question. Think about whether the business result is better or worse that the industry average and what that might mean. Example: Your business Industry average Distribution costs % 2% 6% Profit for year percentage 20% 22% One possible reason for your business having a lower profit for the year than the industry average is that it did not spend enough on advertising, compared with its competitors, to encourage more customers and more sales, which decreased the business profit and profit percentage.

9 Interpret accounting information for sole proprietors 73 NCEA practice Questions examination Interpreting accounting information In the examination, you will be provided with a Table of Analysis Measure Formulae like the one below to assist you in calculating percentages and ratios. Analysis Ratios Formulae Sheet Mark-up % Gross profit Cost of goods sold 00 Profit for year % Profit for the year 00 Current ratio Liquid ratio Equity ratio Current assets Current liabilities Current assets Inventory Current liabilities Secured bank overdraft Equity Total assets.5 Gross profit % Gross profit 00 Distribution cost % Distribution cost 00 Administrative expense % Finance cost % Individual expense % Percentage change in sales Administrative expense 00 Finance cost 00 Individual expense Year 2 Year Year 00 Note: If a service business, replace sales with fees received.

10 96 Answers and explanations d. Interest received is income to Aronui Marae because the interest received increased the asset Bank when the money was put into the bank account. It increases equity by increasing the net profit (Surplus) and the interest is not a contribution by the members. (M/E) e. Aronui Marae depreciates the equipment to systematically allocate the cost of the equipment over its estimated useful life. (M) Not market value / measure loss.. The accounting equation Question One a. Ashleigh s Performance Studio accounting equation Bank Accounts receivable Musical equipment Expenses Accounts payable A Loan Equity Income p. 3 i (A) ii (A) iii (A) iv (M) v (M) Answers b. i. Paid studio electricity $200; paid for musical supplies $200 (NOT bill / account); (paid any relevant expenses for a performance studio). (A) ii. Ashleigh took $300 cash for personal use (or Cash drawings $300 or Owner paid personal expenses with business money $300) (A) iii. Purchased new stereo (or other musical equipment) costing $900. Paid $00 deposit and put the rest on credit. (M) iv. The business received $70 in full settlement of $80 account (giving a $0 discount). (M) v. Sold musical equipment (e.g. old stereo) which had originally cost $250, for $300 on credit (making a gain of $50 on the sale). (M) Question Two a. Assets will increase as van will increase in Merv s Movers accounts by $ (A) Liabilities will increase as Merv s Movers purchased the van on credit, so accounts payable increases by $ (A) b. Assets will decrease by $360 as the asset Bank will decrease when Merv s Movers pays its workers. (A) Expenses will increase by $360 as Wages increase. (A) c. Asset Bank will increase by $ (A) Income will increase by $3 200 as Fees received will increase. (A) d. Assets will decrease as Bank will decrease by $ (A) Equity will decrease as Drawings will increase by $ (A) (A element increasing or decreasing, M A plus correct amount and account). Accounting concepts Many questions in this section can be graded as either Merit or Excellence. Students will achieve a Merit grade if their answer defines concepts, but there is insufficient linkage of the concept with the context of the question. An Excellence -level answer is one that fully integrates examples that are relevant to the context of the question into the definition, and so clearly answers what has been asked examination Accounting concepts Question One p. 7 p. 7 Part A a. Accountancy fees, depreciation on cooking equipment, interest on mortgage, purchases, wages (3 = A) b. is an income for Better Burgers because the sales increase the asset bank when customers buy burgers and chips. The sales increase Better Burgers profit, which increases the equity, and the sales are not a contribution from George, the owner. (A definition, M including some context, e.g. bank and/or profit and business name, E all how/why ) c. Assets this will decrease the asset bank by $500 Liabilities this will decrease the mortgage by $500 (A) d. The wages owing will increase the wages expense by $460 in the Income Statement this year for Better Burgers because the workers cooked the burgers this year so the wages relate to this year. The wages owing will also create Accrued expenses $460 in this year s Statement of Financial Position as a current liability because Better Burgers will pay the wages next year. (A Decrease wages / create accrued expenses, M relates to the statements and business and $, E merit plus the why ) Part B a. The purpose of the Statement of Financial Position for Better Burgers is to allow George to see the value of the assets, liabilities and equity at a point in time / on balance day. (A) b. The purchase of the drink machine is capital expenditure because the purchase creates a new asset that Better Burgers will use for more than one period. It is a one-off payment. The cleaning of the machine is revenue expenditure because it is a recurring/regular expense that decreases Better Burgers profit for the year / is a benefit in the current year only. (A definition includes two features, M definition relates to three features and Better Burgers)

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