Books of original entry and ledgers What is the name of the document sent to a customer by a supplier at the end of the month showing the amount payable for credit sales? Statement (of account) Tahir Ali is a trader who keeps a full set of accounting records. He divides his ledger into three specialist areas nominal (general) ledger, purchases (creditors) ledger and sales (debtors) ledger. State one advantage of dividing the ledger into these three areas. Work can be shared between several people Easier for reference as same type of accounts are kept together Easier to introduce checking procedures Cash book,petty cash book and bank reconciliation. Explain what is meant by the imprest system in relation to petty cash books. The petty cashier starts each period with the same amount of money (the imprest). At the end of the period the chief cashier will make up the cash remaining so that it is equal to the imprest amount (1) Give two examples of adjustments made in a bank reconciliation statement. Outstanding lodgements uncredited or unpresented cheques Items found in updating cash book, e.g. direct debits, bank interest, charges, dishonoured cheques, bank or cash book errors State two reasons, other than finding errors, why Jane should reconcile her cash book with the statement received from the bank. Ascertain the true bank balance at a certain date Assist in detecting fraud and embezzlement Identify any stale cheques Demonstrate that any differences between the cash book balance and that on the statement are due to genuine reasons such as standing orders, bank charges, credit transfers 1
Explain why items are recorded on the opposite side of the cash book to that on which they appear on the bank statement. The bank statement is a copy of the account of the business as it appears in the books of the bank. This is from the viewpoint of the bank the business depositing money is a creditor of the bank. The bank account in the cash book is prepared from the viewpoint of the business the bank is a debtor of the business which has deposited the money. Explain the difference between capital expenditure and revenue expenditure. Capital expenditure is money spent on acquiring, improving and installing fixed assets. Revenue expenditure is money spend on running a business on a day-to-day basis. Explain the difference between capital receipts and revenue receipts. Capital receipts are amounts received from the sale of fixed assets Revenue receipts are sales and other items of income which are recorded in the trading and profit and loss account. Control accounts State advantages of preparing control accounts. Assist in the location of errors Provide instant totals of debtors/creditors Proves the arithmetical accuracy of sales/purchases ledgers Enable the Balance Sheet to be prepared quickly Provide a summary of the transactions relating to debtors/creditors Provide an internal check on sales/purchases ledgers may reduce fraud State advantages of preparing a sales ledger control account other than the location of errors. Provides instant total of debtors Proves the arithmetical accuracy of sales ledger Enables the Balance Sheet to be prepared quickly Provides a summary of the transactions relating to debtors for the period Provides an internal check on the sales ledger may reduce fraud Explain what is meant by a contra entry in connection with control accounts. A contra entry is where a transfer is made from an account of a person/business in the sales ledger to an account of the same person/business in the purchases ledger. This may occur when a person/business is both a customer and a supplier. 2
State two reasons why it is possible to have a debit balance on a purchases ledger control account. Overpayment of amount due Cash discount not deducted before payment made Returned goods after payment of amount due Payment made to creditor in advance State one reason why it is possible to have a credit balance brought down on a sales ledger control account. Overpayment of amount due by debtor Cash discount not deducted by debtor before payment made Goods returned by debtor after payment of amount due Payment made in advance by debtor Explain why the information used to write up Susan s purchases ledger control account is obtained from books of prime (original) entry and not from the purchases ledger. A purchases ledger control account acts as a check on the purchases ledger. If there is an error in the purchases ledger it will not be revealed by a control account prepared from the individual accounts in that ledger. Partnerships accounts Ann and Fay are in partnership They invited Kim to join the partnership; State one disadvantage to Ann and Fay of Kim joining the partnership. Ann and Fay lose a degree of control Ann and Fay will have to share any future profits with Kim The risk of conflict of opinion is increased May involve extra costs (accommodation/staff support etc.) Explain to Kim two advantages of joining the partnership. Will have a share in the profits Can take part in decision-making Prospects for the future Explain to Kim two disadvantages of joining the partnership. Will be personally liable for the debts of the firm Will have greater responsibility Will probably have to invest capital 3
Explain why, in addition to agreeing the profit-sharing ratio, Ann, Fay and Kim should draw up a partnership agreement. To avoid disagreements/misunderstandings later [2] Interest on capital [1] Partner s salary Explain why Ann and Fay should value the Goodwill of the business before admitting Kim to the partnership. A new partner joining an existing partnership will benefit from the Goodwill built up by the existing partners, who must be compensated for this. State and explain one advantage of maintaining both a capital and a current account for each partner. Easier to see profit retained by each partner Easier to calculate interest on capital (if allowed) Easier to see salary earned by partner(s) Easier to see drawings made by a partner Easier to calculate interest on drawing (if charged) Depreciation and application of matching and prudence concept. Name one accounting principle which is applied when fixed assets are depreciated. Matching or Prudence Explain why the accounting principle named above is applied when providing for depreciation of fixed assets. Matching To ensure that the loss in value of fixed assets is spread over the period in which they are earning revenue. OR Prudence To ensure that the profit is not overstated and the value of the fixed assets is not overstated. 4
Tahir Ali decided that depreciation should be calculated on motor vehicles owned at 31 December each year at the rate of 20 % per annum, using the reducing (diminishing) balance method. A full year s depreciation should be provided in the year of purchase, but no depreciation should be provided in the year of disposal. Explain how Tahir Ali is applying the matching principle when he depreciates his motor vehicles. Ensures that the loss in value of motor vehicles is spread over the period in which they are earning revenue. Explain the revaluation method of depreciation. Fixed assets are valued at the end of each financial year. This value is compared with the previous valuation (or the cost if it is the first year of ownership) and the amount by which the asset has fallen in value is the depreciation for the year. State one type of fixed asset which is suitable for depreciation using the revaluation method. Hand tools Packing cases/crates Bad debts,provision for doubtful debts and application of matching and prudence concept. Mohammed is a trader. His financial year ends on 31 January. Miriam employs a bookkeeper to maintain her financial records. The following account appears in Mohammed s ledger: Provision for doubtful debts account 2008 $ 2007 $ Jan 31 Profit & loss 50 Feb 1 Balance b/d 650 Balance c/d 600 650 650 2008 Feb 1 Balance b/d 600 5
State one reason why Mohammed should maintain a provision for doubtful debts. Ensures that profits are not overstated (prudence) Ensures that debtors are shown in balance sheet at more realistic amount (prudence) Application of matching principle as the amount of sales unlikely to be paid for are treated as an expense of that particular year Explain each entry in the provision for doubtful debts account as it appears in Mohammed s ledger. 2007 February 1 Balance The provision for doubtful debts in existence at that date brought down from the previous financial year. (2) 2008 January 31 Profit and loss The amount transferred to the profit and loss account representing the surplus provision no longer required. (2) Explain the significance of the $600 shown at the end of the account. The new provision for doubtful debts carried forward to the next financial year. (2) State four ways in which Mohammed could reduce the risk of bad debts. Obtain references from new credit customers Fix a credit limit for each customer Issue invoices and statements promptly Follow up overdue accounts promptly Supply goods on a cash basis only Refuse further supplies until outstanding account is paid State two possible advantages to Mohammed of paying his creditors before the due date. May be able to take advantage of cash discounts Improve the relationship with suppliers State one possible disadvantage to Mohammed of paying creditors before the due date. The business is deprived of the use of the money earlier than necessary 6
John Chan s financial year ends on 30 April. The following account appears in his nominal (general) ledger: Provision for Doubtful Debts account 2006 $ 2005 $ April 30 Profit & Loss 80 May 1 Balance b/d 500 Balance c/d 420 2006 May 1 Balance b/d 420 500 500 Explain why $80 is transferred from John Chan s provision for doubtful debts account into his Profit and Loss Account for the year ended 30 April 2006. The $80 transferred to the Profit and Loss Account is the difference between the provision for doubtful debts at the start of the year and the provision required to carry forward to next year. In this case it is the amount of surplus provision not required. (2) State whether the $80 will appear as a debit or a credit item in John Chan s Profit and Loss Account for the year ended 30 April 2006. This amount will be credited to the Profit and Loss Account. John Chan is rather disappointed with the collection period for debtors. Explain three ways in which the collection period for debtors may be improved. Offer cash discount for prompt payment Charge interest on overdue accounts Improve credit control Refuse further supplies on credit until any outstanding balance is paid Ahmed is a trader who sells goods on credit. He offers his credit customers a cash discount of 3 % provided the account is paid within 30 days. He has applied the accounting principle of prudence and maintains a provision for doubtful debts. This provision amounted to $150 on 1 February 2006. State two effects on his final accounts of applying the principle of prudence. So that the profits for the year are not over-stated [1] So that the debtors in the Balance Sheet are shown at a realistic amount [1] Name one other accounting principle which Ahmed is applying by maintaining a provision for doubtful debts. Matching principle 7
Nangolo is a trader. His financial year ends on 31 December. State, giving a reason, what entries (if any) Nangolo should make in his accounting records in each of the following situations. On 31 December 2003 Zanetti, a debtor, owes $24 for goods purchased on credit in 2002. Nangolo has been unable to find Zanetti. Write Zanetti s account off as a bad debt (1) Explanation: Amount now outstanding for over 1 year with little hope of recovery (1) On 31 December 2003 Lim, a debtor, owes $390 for goods purchased on credit in November 2003. The period of credit allowed is 1 month. Lim has informed Nangolo that he is unlikely to pay the amount due before February 2004. No entries in accounting records are necessary (1) Explanation: Account is still likely to be paid, there is no evidence yet that it will not be paid by Lim (1) On 31 December 2003 Nangolo examines his sales ledger and decides that he is unlikely to receive $280 of the total amount owing to him. Create a provision for doubtful debts of $280 (1) Explanation: Must ensure that he does not overstate his net profit for the year (1) Stock valuation and application of prudence concept State the basis on which Mohammed should value his closing stocks. Stocks are valued at the lower of cost and net realisable value. Name one accounting principle Mohammed is applying by valuing his closing stocks on this basis. Prudence 8
Income and expenditure accounts (Non Profit making entities) Following terms are used in connection with non-trading organisations such as clubs. Explain each of the following terms. Income and Expenditure Account The Income and Expenditure Account is equivalent to a Profit and Loss Account of a trading organisation. (1) It is used to calculate the annual surplus or deficit. (1) Or other suitable points [2] Accumulated Fund The accumulated fund is equivalent to the capital of a trading organisation, the difference between the assets and the liabilities. (1) The annual surpluses (less any deficits) accumulate within a non-trading organisation to form the accumulated fund. (1) State one of the items appearing in the summary of the cash book which should not be included in the income and expenditure account and explain why it does not appear. Or Opening bank balance (1) This is neither income nor expenditure for the year as it represents the bank overdraft on1 October 2006/ it represents the amount of money in the bank on that particular date. (1) Opening balance or closing balance (1) Opening/closing bank balance is neither income nor expenditure for the year as (1 Purchase of new instruments/ equipment (1) This is not regarded as revenue expenditure as it is the purchase of a fixed asset. (1) [2] Or Transfer to bank deposit account (1) Transferring money from one bank account to another is neither income nor expenditure. (1) 9
Select one of the items appearing in the income and expenditure account which does not appear in the receipts and payments account and explain why it does not appear. Either Subscriptions prepaid (1) This item represents an amount received during the previous financial year which relates to the current financial year. Application of matching principle. (1) Or Subscriptions owed by member at the end (1) This item represents an amount relating to the current financial year which has not yet been received. Application of matching principle. (1) Or Rent accrued (1) this item represents an amount relating to the current financial year which has not yet been received. Application of matching principle. (1) Or Depreciation of equipment (1) this is a non-monetary expense but must be taken into account in calculating the surplus/deficit. Application of matching principle. (1) Or Deficit for the year (1) this is the difference between the income and expenditure and is the loss for the year and does not represent money paid/received. (1)Alternatively surplus with a suitable comment if a surplus is shown in the answer 10
Explain each of the following entries in the subscriptions account as it appears in the ledger of El Nil Sailing Club. State where the double entry for each transaction would be made. 2005, Aug 1 Balance $750 Explanation this represents the amount of subscriptions still outstanding from members for the financial year ended 31 July 2005 Double entry Credit subscriptions account for the year ended 31 July 2005 (1) 2006, July 31 Bank $5850 Explanation: this is the total amount of subscriptions received from members during the financial year ended 31 July 2006 Double entry Debit bank account (1) 2006, July 31 Income and Expenditure Account Explanation this is the total subscriptions which relate to the financial year ended 31 July 2006(1) Double entry Credit Income and Expenditure Account (1) (ii) The significance of the $900 shown at the end of the account This represents the amount paid by members during the financial year ended 31 July 2006 but which relates to the following financial year. It will appear as a current liability in the Balance Sheet as at 31 July 2006. State what is meant by working capital. Current assets less current liabilities Working Capital Management. Explain why it is important for a business to have an adequate amount of working capital. To be able to meet debts when they fall due To be able to take advantage of cash discounts To be able to take advantage of business opportunities as they arise To ensure that there is no difficulty in obtaining further supplies 11
State and explain two disadvantages to a business of having insufficient working capital. May have problems paying debts as they fall due May not be able to take advantage of cash discounts Cannot make the most of opportunities as they occur Difficulties in obtaining further supplies Or other suitable points State two ways in which a business could increase its working capital. Injection of more capital Long-term loans Sale of surplus fixed assets Reduce drawings On 31 December 2008 Morag MacDonald had money in the bank but her working capital was lower than it was at the start of the year. State and explain the effect of each of the following transactions on Morag MacDonald s working capital. Office equipment, $10 000, was purchased by cheque. Effect working capital decreases by $10 000 Explanation The current assets decrease by $10 000 as the bank balance decreases. There is no change in the current liabilities. An increase in the provision for doubtful debts of $50. Effect Working capital decreases by $40 (1) Explanation Current assets decrease by $50 as net debtors decreases. There is no change in the current liabilities. (1) Payment of $200 by a debtor in cash. Effect Working capital does not change (1) Explanation The current assets do not change as the cash increases and the debtors decrease by $200. There is no change in the current liabilities. (1) Payment of $96 by cheque to a creditor in full settlement of $100 owing. Effect Working capital increases by $4 (1) Explanation Current assets decrease by $96 and the current liabilities decrease by $100. (1) 12
Financial Ratio analysis Explain why the quick ratio more reliable than the current ratio as an indicator of liquidity. Does not include stock in the calculation Either Stock is not regarded as a liquid asset a buyer has to be found and then the money collected. Some stock may prove to be unsaleable. Or The quick ratio shows whether the business would have any surplus liquid funds if all the current liabilities were paid immediately from the liquid assets. State two ways in which the rate of stock turnover of finished goods may be improved. Reduce stock levels Generate more sales activity Explain the difference between mark-up and margin. Mark-up is when the gross profit is measured as a percentage of the cost price of the goods (1) Margin is when the gross profit is measured as a percentage of the selling price of the goods State two ways in which the percentage of gross profit to sales could be improved. Look for cheaper supplies Increase selling prices Change proportions of different types of goods sold State two ways in which the percentage of net profit to sales could be improved. Increase gross profit e.g. increase profit margin, increase selling prices etc. Increase sales Reduce expenses e.g. reduce staffing levels, reduce advertising etc. Increase other income e.g. rent out part of premises, earn more discount State two possible advantages to Mohammed of paying his creditors before the due date. May be able to take advantage of cash discounts Improve the relationship with suppliers 13
State one possible disadvantage to Mohammed of paying creditors before the due date. The business is deprived of the use of the money earlier than necessary Users of accounting information List three business people (excluding the owner) who would be interested in a business final accounts. In each case state one reason why the person would be interested in the accounts. Bank manager Assessment of prospects of any requested loan/overdraft repaid when due Assessment of prospects of any interest on loan/overdraft being paid when due Assessment of the security available to cover any loan/overdraft Lenders Assessment of prospects of any requested loan when due Assessment of prospects of any interest on loan being paid when due Assessment of the security available to cover any loan Creditor for goods Assessment of the liquidity position Identifying how long the business takes to pay creditors Identifying future prospects of the business Identifying what credit limit is reasonable Managers (if any) Assessment of past performance Basis of future planning Control the activities of the business Identifying areas where corrective action is required Or other suitable interested persons e.g. trades unions/employees/ government bodies/take-over-bidders/competitors etc 14
Qualitative characteristics of accounting information List four objectives which Ahmed must consider when selecting accounting policies.(qualitative features of accounting information) Relevance Reliability Comparability Understandability Explain to Ahmed what is meant by the term relevance. Financial information is only relevant if it can be used To confirm or correct prior expectations about past events To assist in forming, revising or confirming expectations about the future As the basis for financial decisions Explain the meaning of the accounting term comparability It must be recognised that a financial report can only be compared with reports for other periods if similarities and differences can be identified. Explain the meaning of the accounting term reliability. Information provided in financial statements must be reliable (1) Either It must be capable of being depended upon as a faithful representation of the underlying transactions and events it represents (1) Or It must be capable of being independently verified (1) Or It must be free from bias (1) Or It must be free from significant errors (1) Or It must be prepared with suitable caution being applied to any judgments and estimates (1) 15
Limitation of accounting statements. Mohammed s accountant informed him that the accounting statements prepared at the end of the financial year provide only a limited amount of information about the business. State how each of the following may be regarded as a limitation of accounting statements. Historic cost All transactions are recorded at the actual cost price. It is difficult to compare transactions taking place at different times. Money measurement Accounts only record information which can be expressed in monetary terms. This means that many factors which affect the performance of a business will not appear in the accounting records. (1) Time factor Accounting statements are a record of what has happened in the past. Either They are not necessarily a guide to future performance (1) Or significant events can occur between the end of the financial period and the time when the accounting statements are available. Limitations in comparisons of financial information. Farouk s brother Ahmed has a business which has a higher return on capital employed than Farouk s business. Suggest two reasons for this difference. Different type of business Different products Capital/labour intensive business Business with higher net profit Business with lower capital Maria is interested in comparing her results with those of another business and has obtained the final accounts of some other businesses in the same city. Explain three factors which Maria should bear in mind when attempting to compare her results with the accounts she has obtained relating to other businesses. Should compare with a business in same trade Should compare with a business of approximately the same size Should compare with a business of the same type (sole trader/partnership etc) The accounts may be for 1 year only which will not show trends and may not be a typical year 16
The financial year may end on different dates and the period of time covered may be different The businesses may operate different accounting policies There may be differences which affect profitability and the items on the Balance Sheet The accounts do not show non-monetary items, but these are important in the success of a business It is not always possible to obtain all the information about a business in order to make a true comparison Ahmed would like to compare his results with those of other businesses. He is aware that even comparing with a business of a similar size dealing in similar goods can produce misleading results. List four things Ahmed should consider when comparing his results with those of a similar business. There may be differences that affect profitability e.g. one business may rent premises and the other business may own premises. The accounts may be for 1 year only and not show trends The accounts may not be for a typical year The financial year may end at a different point in the trading cycle The businesses may operate different accounting policies e.g. depreciation The accounts do not show non-monetary items but these are important in the success of a business It is not always possible to obtain all the information about a business in order to make a true comparison Karabo wishes to compare her results with those of a similar business. She is aware that there are problems in making such a comparison. Explain how each of the following affects inter-firm comparison. Use examples to illustrate your answers. Different type of expenses One business may own premises, another may rent premises. This affects the expenses and the profit and the profitability ratios making comparison difficult. Non-monetary factors One example goodwill, quality of management, or other suitable example such items will not appear on the accounting statements but can influence the profitability and prospects of a business. Accounting policies Accounting policies one example methods of depreciation, methods of stock valuation, or other suitable example (1) these will affect calculation of the profit and the profitability ratios and the value of the assets. 17
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