Flashcards · 9706 · AS Topic 1

Financial accounting (AS Level) flashcards

54 cards on AS Topic 1, subtopics 1.1 to 1.6. Pick a subtopic or study them all.

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1.1 Types of business entity

Sole trader: liability and the accounts it keeps: Unlimited liability. Keeps a capital account and records drawings.
Partnership: liability and the accounts it keeps: Unlimited liability (usually). Keeps capital and current accounts for each partner, and an appropriation account.
Limited company: liability and the accounts it keeps: Limited liability. Keeps share capital, reserves and records dividends.
What does unlimited liability mean?: The owner's personal assets can be taken to settle the business's debts.
One advantage and one disadvantage of a limited company compared with a sole trader: Advantage: limited liability and easier access to larger amounts of capital. Disadvantage: more regulation and disclosure, and (for a plc) some loss of control as ownership spreads across shareholders.
Name the sources of finance listed in 9706 topic 1.1: Loans (secured or unsecured), bank overdrafts, payment by instalments, rental or leasing, and trade credit.
Are debentures share capital?: No. Debentures are long-term loans. Debenture interest is an expense, not an appropriation of profit, and debenture holders have no vote.

1.2 The accounting system

The accounting equation: Assets = liabilities + capital. Every transaction changes it in a way that keeps both sides equal.
Put the stages of the accounting system in order: Source documents → books of prime entry → ledgers → trial balance → financial statements.
What goes in the sales journal, and what does not?: Credit sales of goods only. Cash sales go to the cash book; sales of non-current assets go to the general journal.
Name the six books of prime entry: Sales journal, sales returns journal, purchases journal, purchases returns journal, cash book and general journal.
Business entity concept: why does capital appear with liabilities, and why do drawings not reduce profit?: The business is separate from its owner, so capital is an amount the business owes back to the owner. Drawings reduce capital, not profit.
Prudence concept: Profits are not overstated; losses and liabilities are not understated.
Realisation concept: Revenue is recorded when it is earned, not necessarily when cash is received.
Matching (accruals) concept: Income and expenses are recorded in the period they relate to, not when cash moves.
Substance over form: Transactions are recorded by their real economic substance, not just their legal form.
Going concern concept: The accounts assume the business will continue operating for the foreseeable future.
Computerised accounting: two advantages, two disadvantages and the usual data safeguards: Advantages: speed, fewer arithmetic errors, easier reports. Disadvantages: set-up and training cost; reliance on system reliability and data security. Safeguards: passwords, access levels and regular backups.

1.3 Accounting for non-current assets

Capital expenditure vs revenue expenditure: Capital: acquiring or improving a non-current asset; benefits more than one period. Revenue: day-to-day running costs, including repairs; benefits the current period only.
Effect of recording capital expenditure as revenue expenditure: Profit is understated and the non-current asset is understated. (Recording revenue expenditure as capital overstates both.)
Four causes of depreciation: Physical wear and tear, economic obsolescence, the passing of time (a fixed useful life) and depletion (for example mineral reserves).
Straight-line depreciation: formula, and the charge on a $20,000 van with a $2,000 residual value and a 4-year life: (Cost − residual value) ÷ useful life. ($20,000 − $2,000) ÷ 4 = $4,500 every year.
Reducing balance at 40% on a $20,000 van: charges for years 1 and 2: Year 1: 40% × $20,000 = $8,000 (carrying value $12,000). Year 2: 40% × $12,000 = $4,800. The percentage is applied to carrying value, not cost.
Cost model vs revaluation model: Cost model: the asset stays at cost less accumulated depreciation. Revaluation model: the asset is revalued to current value; gains generally go to a revaluation reserve, not straight to profit.
A machine (cost $15,000, accumulated depreciation $9,000) is part-exchanged for an allowance of $4,500. Profit or loss on disposal?: Carrying value $15,000 − $9,000 = $6,000. $6,000 − $4,500 = $1,500 loss on disposal, taken to the statement of profit or loss.
Disposal account: the three main entries: Debit disposal, credit the asset account with cost. Debit accumulated depreciation, credit disposal. Credit disposal with the proceeds or part-exchange allowance. The balance is the profit or loss on disposal.

1.4 Reconciliation and verification

What logic do the trial balance, bank reconciliation and control accounts share?: Take two independently produced figures that should agree, compare them, and investigate any difference.
Name the six errors that do not affect the balancing of the trial balance: Omission, commission, principle, original entry, complete reversal and compensating errors.
Error of commission vs error of principle: Commission: right type of account, wrong account (for example the wrong customer). Principle: wrong class of account altogether (for example an expense posted to an asset).
$600 of stationery is posted to Office Equipment. Type of error and correcting entry?: Error of principle (asset instead of expense). Debit Stationery expense $600, credit Office equipment $600. No suspense account: the trial balance still balanced.
When is a suspense account opened?: Only when an error makes the trial balance disagree. It holds the difference until correcting journal entries clear it.
Cash book $1,850; bank statement $2,100; unpresented cheque $400; bank charges $150 not in the cash book. Reconcile.: Updated cash book: $1,850 − $150 = $1,700. Bank statement $2,100 − unpresented cheque $400 = $1,700. Both agree.
Are unpresented cheques and outstanding lodgements errors?: No. They are timing differences. The cash book is not changed for them; the bank reconciliation statement explains them.
Control account: one benefit and one limitation: Benefit: an independent check that locates errors faster, since only that ledger needs checking. Limitation: the control account can itself contain errors, and agreement does not prove every transaction is right.

1.5 Preparation of financial statements

Year-end entries for an expense owing and an expense prepaid: Owing: debit the expense, credit other payables. Prepaid: debit prepayments, credit the expense.
Rent paid $7,200; $600 owing at the start and $900 owing at the end. Rent expense for the year?: Cash paid + closing accrual − opening accrual. $7,200 + $900 − $600 = $7,500.
Insurance of $3,600 is paid for 12 months from 1 October. Year end 31 December. Expense and prepayment?: Expense: 3 months = $900. Prepayment: 9 months = $2,700.
Receivables $20,000 before writing off $1,000. Allowance 4%; old allowance $650. Total charge?: Remaining receivables $19,000 × 4% = $760. Increase $760 − $650 = $110. Charge = $1,000 irrecoverable debt + $110 = $1,110.
Inventory cost $5,200, net realisable value $4,600. Value and write-down?: Lower of cost and NRV: $4,600. Write-down $600.
Incomplete records: opening capital $21,500, closing $26,300, drawings $11,000, capital introduced $2,000. Profit?: Profit = closing − opening + drawings − capital introduced. $26,300 − $21,500 + $11,000 − $2,000 = $13,800.
No partnership agreement: what does the Partnership Act 1890 provide?: Profits and losses shared equally; no partners' salaries; no interest on capital; no interest on drawings; 5% a year interest on partners' loans.
Where does interest on a partner's loan go?: It is an expense charged before profit for the year, not an appropriation. Interest on capital is an appropriation.
X (capital $50,000) and Y ($30,000): 6% interest on capital, Y salary $9,000, profit $40,000 shared equally. Each partner's total?: Interest: X $3,000, Y $1,800. Residual $40,000 − $3,000 − $1,800 − $9,000 = $26,200, so $13,100 each. X: $16,100. Y: $23,900.
A 2 for 5 rights issue on 90,000 $1 shares at $1.80. Entries?: 36,000 new shares. Debit bank $64,800; credit share capital $36,000; credit share premium $28,800.
Bonus issue: entry, and can the revaluation reserve fund it?: Debit a reserve, credit share capital. No cash is received. The revaluation reserve is not used for a bonus issue.
Capital reserves vs revenue reserves: examples: Capital reserves: share premium, revaluation reserve. Revenue reserves: retained earnings, general reserve.

1.6 Analysis and communication of accounting information

Revenue $480,000, cost of sales $288,000. Gross profit margin and mark-up?: Gross profit $192,000. Margin: 192,000 ÷ 480,000 × 100 = 40.0%. Mark-up: 192,000 ÷ 288,000 × 100 = 66.7%.
Return on capital employed: formula and what capital employed includes: Profit from operations ÷ capital employed × 100. Capital employed = issued shares + reserves + non-current liabilities.
Current assets $96,000 (inventory $40,000), current liabilities $56,000. Current ratio and acid test ratio?: Current ratio 96,000 : 56,000 = 1.7 : 1. Acid test (96,000 − 40,000) : 56,000 = 1.0 : 1.
Trade receivables turnover in days: formula, and the figure for receivables $45,000 and credit sales $438,000: Trade receivables ÷ credit sales × 365. 45,000 ÷ 438,000 × 365 = 37.5 days.
Opening inventory $30,000, closing $42,000, cost of sales $216,000. Inventory days and rate of inventory turnover?: Average inventory $36,000. Days: 36,000 ÷ 216,000 × 365 = 60.8 days. Rate: 216,000 ÷ 36,000 = 6.0 times.
Which ratios would a supplier check before granting credit?: The current ratio, the acid test ratio and trade payables turnover (days).
Possible causes of a fall in gross profit margin: Dearer materials, discounts given to customers, or a change in product mix.
Three limitations of accounting information when comparing businesses: Any three: historic cost and past data; estimates such as depreciation affect profit; non-financial factors left out; a year-end snapshot may be unrepresentative; different policies, size and year ends limit comparison.