Flashcards · 9215 · Topic 3

Development of the accounting model flashcards

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Business entity and money measurement: Business entity: the business and owner are separate (an owner’s personal bill is drawings). Money measurement: record only what has a money value (staff morale is not recorded).
Duality and historic cost: Duality: each transaction has two equal effects, a debit and a credit. Historic cost: record at the price paid (land bought for $30,000 stays at $30,000).
Going concern and accruals: Going concern: the business will carry on trading, so items such as prepayments are carried forward. Accruals: match income and expenses to the period they relate to.
Consistency and prudence: Consistency: the same methods each period. Prudence: do not overstate profit or assets; recognise foreseeable losses (such as a provision for doubtful debts).
Materiality and realisation: Materiality: only significant items need full treatment (a $9 stapler is expensed). Realisation: revenue is earned when the goods are delivered or the service given and the customer becomes liable to pay.
Inventory has been valued at selling price. Which concept is broken, and what happens to profit?: Prudence: selling price includes profit not yet realised, so profit is overstated.
Rent of $7,200 is paid on 1 October for 12 months; the year ends 31 December. Expense and prepayment?: Expense 7,200 × 3/12 = $1,800; prepayment $5,400 (accruals, with going concern supporting the carry forward).

Capital expenditure and revenue expenditure: Capital: buys or improves a non-current asset or gets it ready for use; benefit lasts more than one period; statement of financial position. Revenue: running costs and keeping assets working; income statement.
Capital income and revenue income: Capital income: sale proceeds of a non-current asset, capital introduced by the owner. Revenue income: sales, fees, rent, commission and interest received.
A freezer costs $2,500 with $150 delivery; $90 is spent repairing an old freezer. Treatment?: New freezer: capital expenditure of $2,650 (debit Freezers, credit Bank). Repair: revenue expenditure of $90, in the income statement.
Effect of charging a capital item as an expense, and of adding a revenue item to an asset: Capital item expensed: profit and assets understated. Revenue item capitalised: profit and assets overstated.
Repairs of $2,000 are wrongly added to the cost of an asset. Effect on profit?: Profit is overstated by $2,000 (before any depreciation effect).

Why do non-current assets depreciate?: Wear and tear from use, obsolescence (replaced by newer, better equipment) and the passage of time. Depreciation spreads cost over the useful life; it is not a market valuation.
Why is depreciation a non-cash expense?: Cash leaves when the asset is bought, not when depreciation is charged. The charge only reduces profit and the asset’s value in the statement of financial position.
A machine costs $36,000. Straight line with residual value $4,000 over 8 years, and 20% reducing balance for 2 years?: Straight line: (36,000 − 4,000) ÷ 8 = $4,000 a year. Reducing balance: Y1 7,200 (NBV 28,800); Y2 5,760 (NBV 23,040).
Entries for the yearly depreciation charge: Debit Depreciation, credit Provision for depreciation; transfer the depreciation to the income statement. The asset account stays at cost; NBV = cost − provision for depreciation.
Entries in the disposal account: Debit: the asset at cost. Credit: the provision for depreciation on that asset, and the sale proceeds. The balance is the profit or loss, transferred to the income statement.
An asset cost $30,000, provision for depreciation $21,000, sold for $7,000. Result?: NBV 9,000; proceeds 7,000; loss on disposal $2,000.

Other payables, other receivables, income due and income received in advance: effect on profit and where shown: Other payables (expense owing): profit down; current liability. Other receivables (expense prepaid): profit up; current asset. Income due: profit up; current asset. Income in advance: profit down; current liability.
Gas: $180 owing at the start, $2,150 paid, $240 owing at the end. Transfer to the income statement?: 2,150 − 180 + 240 = $2,210. The $240 is an other payable in current liabilities.
Insurance paid $1,500; $200 prepaid at the start and $260 prepaid at the end. Charge?: 1,500 + 200 − 260 = $1,440.
Rent received $3,300; the tenant owed $100 at the start and $180 at the end. Rent income?: 3,300 − 100 + 180 = $3,380.
Draft profit $12,000 omits income due $250, other receivables $180 and other payables $90. Adjusted profit?: 12,000 + 250 + 180 − 90 = $12,340.
Other payables compared with trade payables: Other payables are expenses owing, such as electricity or wages. Trade payables are owed to suppliers of goods for resale.

Irrecoverable debt compared with provision for doubtful debts: Irrecoverable debt: a named customer’s balance that will not be collected, written off (Dr Irrecoverable debts, Cr customer). Provision: an estimate of the loss on the remaining receivables, a credit balance.
Receivables $12,500; provision 4%; existing provision $380. Charge, and receivables shown?: New provision 500, an increase of $120 (an expense). Trade receivables 12,500 less provision 500 = $12,000.
Receivables $13,000; provision 3%; existing provision $520. Effect?: New provision 390, a decrease of $130: Dr Provision, Cr Income statement, so profit rises by $130.
28 units cost $40 each; each can be sold for $36 with $6 of selling costs. Inventory value?: NRV 30 each = $840, lower than cost of $1,120, so value at $840. Profit falls by $280 this year.
Closing inventory is too high. Effect this year and next year?: This year: cost of sales too low, gross and net profit too high, and the current asset overstated. Next year: opening inventory too high, so profit too low.
Which items in this area are not examined in 9215?: The recovery of irrecoverable debts, and FIFO, AVCO and LIFO inventory valuation.