- Explain the difference between capital receipts and revenue receipts.
Capital receipts: are amounts received from the sale of Non- current assets Revenue receipts: are sales and other items of income which are recorded in the trading and profit and loss account.
- State the effect on gross profit & profit for the year with opening inventory and Closing inventory.
If Opening inventory is overstated the net profit is understated vice versa If Closing inventory is overstated the net profit is overstated vice versa
- Give two reasons why it is important for a business to prepare final accounts or financial statements each year.
To calculate profit or loss
To know what assets and liabilities the business has
To compare with previous year
To compare with other businesses
To calculate accounting ratios
For use by other parties e.g. bank
- Explain what is meant by a service business
A service business provides services, not goods e.g. travel agent, professionals, insurance
- Explain the effect on income statement of recording capital expenditure as revenue expenditure.
Expenses are overstated
Profit for the year is understated
- Explain the effect on statement of financial position of recording capital expenditure as revenue expenditure. Non-current assets are understated
Owner’s capital (Profit )is understated
Concepts & Principle
| Concept | Definition | Applications | |
| 1- Business Entity | This rule states that only the transactions of the business should be recorded and NOT the owner’s private transactions. | The owner is treated as a T.P when he introduce more capital He treated as T.R when he making any withdrawals Any personal expenses are not included in the firm books. | |
| 2- Money Measurement | Only transactions that can be expressed in monetary terms are to be recorded. | Non- monetary items such as goodwill and management skills do not appear in the books. We record non- current assets in the SOF without mentioning whether they have high or low quality. | |
| 3- Historic Cost | All transactions are recorded at their cost to the business. | Recording non- current assets in the SOF at their historic cost , regardless of their current market value. | |
| 4- Realization | Profits are realized (actually earned) when cash or a debtor replaces the goods or services. A transaction is NOT realized when an order is received or when a debtor pays his debt. | Goods sent to customer are not recorded as sales until the customer accepts the invoice. We cannot assume achieving profit on the revaluation of non- current asset | |
| 5- Duality | Every transaction will affect two items in the business – this is represented by both a debit AND a credit entry in the ledger. | Any transaction will apply this concept. Ex. Dr ( cash book) cr ( sales account ) | |
| 6- Consistency | Transactions of a similar nature should always be recorded in the same way. This is to ensure that the Profit and Loss Accounts and Statement of financial positions can be meaningfully compared each year | Provision for depreciation. Inventory valuation | |
| Concept | Definition | Applications | |
| 7- Materiality | This concept implies that you should not waste time recording transactions that are trivial (involving very small amounts of money). | When using the straight line method of depreciation . it’s assumed that the asset will be equally consumed every year while tis is untrue. | |
| 8- Accruals (Matching) | The Trading and Profit and Loss Account should only include the income earned and expenses incurred for the current financial year. | Other payable at the end of the period should be subtracted from the profit by added to expenses Other receivables at the end of the period should be subtracted from expenses and added to profit Provision for depreciation & provision for doubtful debts & bad debts | |
| 9- Prudence | profits must not be overstated and the value of Assets must not be shown to be too high. The accountants’ duty is to ensure that the readers of the final accounts get a true and proper picture of the financial state of the business. | Provision for depreciation. Provision for doubtful debts. – Inventory valuation | |
| 10- Going Concern | It is assumed that a business will continue to exist for a long period of time. If business weren’t assumed to be going concerns , assets are shown in the SOF at their realizable value | Spreading the cost of the non- current assets over its estimated useful lifetime. Paying in advance and delaying some of the payments to the future. | |
| 11- Accounting Period | An accounting period is a period of time such as the 12 months of January 1 through December 31. It is the period for which financial statements are prepared. | ||
- State what is meant by the accounting concept of matching.
Matching concept states that costs incurred in an accounting period should be matched against the revenue / income of that period
- Explain what is meant by the going concern principle.
Accounts are prepared on the basis that the business will continue to operate for an indefinite period of time.
- List and Explain four objectives which must consider when selecting accounting policies.
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
Reliability : information must be capable of being:
Independently verified.
Free from bias
Free from significant errors.
Prepared with suitable caution applied to any judgments which are necessary. Comparability : information must be compared with other similar information about the same business for another period or at another point in time. Understandability: : Financial statement can be understood by users of these statements.
– One condition which must be present for information to be regarded as reliable is shown below. State two other conditions.
1- The information must be capable of being depended on as being a true statement of the transactions and events which are being recorded. 2- Information must be –
- capable of being independently verified
- free from bias
- free from significant errors
- prepared with suitable caution being applied to any judgments and estimates which are necessary
- Explain why the accounting principle (matching/ prudence) is applied when maintaining a provision for doubtful debts
Matching : to ensure that the amount of sales for the year which are unlikely to be paid are treated as an expense of that particular year.
Prudence : to ensure that the profit is not overstated and that the asset of debtors in the Balance Sheet shows a more realistic amount
- Explain why it is important that the stocks are valued at the lower of cost and net realisable value
If stock is not valued at the lower figure then both the net profit and the current assets may be overstated. Or/ It is the application of the principle of prudence.
- State one reason why 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
- State the difference between cost and net realisable value.
- Cost is the actual purchase price plus any additional costs incurred in bringing the inventory (stock) to its present condition and position.
- Net realisable value is the estimated receipts from the sale of the inventory (stock), less any costs of completing or selling the goods.
- Explain why it is important for Owner to keep his personal expenses separate to those of the business.
Applying the business (accounting entity principle the business is treated as being completely separate from the owner. (1) Only the transactions of the business are recorded in the business’ books
BANK RECONCILIATION STATEMENT
The purpose of bank reconciliation statement is to explain any difference between the bank balance appearing on the bank statement provided by the bank..
Reasons For Difference:
Sometimes it so happen that some entries are made in cash book but they are not recorded in the bank. Like.
- Cheques deposited but not credited in the Bank.
- Cheques issued but are not presented in the bank.
Sometimes it so happens that some entries are made in bank statement but they are not recorded in cashbook. Like.
- Direct deposits in the bank by our customers
- Direct collections made by the bank on our behalf
- Direct payments made by bank
- Interest allowed by the bank and charged by the bank
- Dishonoured cheques.
Therefore a statement is prepared to reconcile this difference. This statement is called as “Bank Reconciliation statement”.
Methods Of Preparing Bank Reconciliation Statement:
Step I: Compare the bank column of the cashbook with the bank statement. Tick all those receipts and payments which can be found in both the cash book and the bank statement, when this has been done, there remains some unticked items in cash book and the bank statement.
Step II: Make Adjusted cash book by taking into account all the existing cash book entries plus the unticked bank statement items into the cash book and calculate the new balance. This balance is considered as the true bank balance of the business and this figure will be shown in the statement of financial position as bank balance.
Step III: Prepare Bank Reconciliation Statement.
Note: When we prepare B.R.S. we do not look at the entries of bank statement. We just take into account the entries which are in Cash Book but not in Bank Statement.
- Start with the balance shown in the Adjusted cash book.
- Add the entries that are credited in the cash book but not debited on the bank statement. (unpresented cheques)
- Deduct any items that are debited in the cash book but are not credited in the bank statement.
The resulting figure should be equal to Bank Statement balance.
Reasons For Preparing bank Reconciliation Statement:
- To ensure that the cash book entries are complete.
- To discover bank errors.
- To discover errors in cash book.
- To check Fraud and embezzlement.
- To discover dishonoured cheques.
– Bank Statement & bank Reconciliation Statement.
- Bank Statement : Is a copy of the business as it appears in the books of the bank.
- Bank Reconciliation Statement: shows the balance on the bank statement adjusted for amounts not yet credited , Cheques not yet presented and any Bank error . the final figure should agree with the balance in the bank account in the Cash book.
- Give two examples of adjustments made in a bank reconciliation statement.
- Uncredited or unpresented cheques
- Items found in updating cash book, e.g. direct debits, bank interest, charges,
- Dishonoured cheques
- bank or cash book errors
- Suggest two items which may appear on the bank statement but not in the cash book
Standing orders / Direct debits/ Credit transfers/ Dishonoured cheques/ Bank charges interest/ Bank errors
- Explain the difference between a dishonoured cheque and an unpresented cheque
Dishonoured cheque – a cheque which the bank refuses to pay (1) Cheque not presented – cheque paid by the business but which has not yet been presented to the bank for payment/not yet paid by the bank (1)
- Give two reasons why the balance shown in a cash book might not agree with the balance shown on a bank statement at the same date
- Items on bank statement not shown in cash book (accept individual items, bank charges, bank interest, etc.)
- Items in cash book not on bank statement (accept individual items, cheques not yet presented, etc.)
- Errors in cash book or made by bank (accept only one type of error) Dishonoured cheques
- Explain the meaning of each of the following terms.
Bank reconciliation statement : A statement prepared by the trader to explain why the balance on the bank column in the cash book differs from the balance on the bank statement
Cheques not yet credited : Cheques received by the trader and recorded in the cash book but which have not yet been recorded as being received by the bank Cheques not yet presented: Cheques paid by the trader and recorded in the cash book but which have not yet been recorded as being paid by the bank
- Explain the difference between a standing order and a direct debit Standing order – an instruction by a customer to the bank to pay fixed amounts at stated dates to a named person or firm (1)
Direct debit – authority given to the bank to make payments (at irregular dates and amounts) on request by a named person or firm (1)
- State two reasons, other than finding errors, why we should reconcile 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
- 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. (2)
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 (2)
- Explain why the company decided to make the set-off
Save on administration costs
The debt can be settled by using one cheque only
- State why the updated cash book balance rather than the balance on the bank statement would appear in the balance sheet.
The balance sheet would not balance if the bank statement balance was included because only balances on the books of the business can be included in the balance sheet of the business
END OF YEAR ADJUSTMENTS
Types of Adjusting Entries
Generally, there are 4 types of adjusting entries. Adjusting entries are prepared for the following:
- Accrued Income – income earned but not yet received
- Accrued Expense – expenses incurred but not yet paid
- Deferred Income – income received but not yet earned 4. Prepaid Expense – expenses paid but not yet incurred Also, adjusting entries are made for:
5. Depreciation
Doubtful Accounts or Bad Debts, and other allowances
| – | “Adjusting entries” refer to the 6 entries mentioned above. However, in some branches of accounting (especially auditing), the term adjusting entries could refer to any entry that aims to adjust incorrect account balances. |
| – | As a result, there is little distinction between “adjusting entries” and “correcting entries“, however, adjusting entries are those made at the end of the period to take up accruals, deferrals, prepayments, depreciation and allowances. |
| – | Expenses of the period ( Income Statement ) = Payment of the period – opening unpaid + Closing unpaid |
| – | Expenses of the period ( Income Statement ) = Payment of the period + opening prepaid – Closing prepaid |
| – | Revenue of the period ( Income Statement ) = Payment of the period – opening unpaid + Closing unpaid |
| – | Revenue of the period ( Income Statement ) = Payment of the period + opening prepaid – Closing prepaid |
– Explain the difference between a prepayment and an accrual.
A prepayment is an amount paid in advance for a service which has not yet been received
An accrual is an amount owed for a service which has been received but not yet paid for
- Explain how we will be able to decide in the future if the provision for doubtful debts is adequate
By comparing (1) the amount of actual bad debts (1) with the provision made.
CAPITAL AND REVENUE EXPENDITURE
| Capital Expenses: | All expenses for acquiring the fixed Assets like, Machinery, Building, Furniture etc; All expenses incidental to the acquisition of Fixed Assets. Examples: Transporting of Machinery and Fixing and Registration of Land and Building or Business. All expenses to improve the existing Assets to increase Profit earning capacity. Major repairs and renewals to increase the efficiency of the business. |
| Revenue Expenses: | All regular expenses which are incurred in the daily course of business. Example: Wages, Salaries, Repairs, Administration expenses. Purchase of Raw Material and goods. Losses through bad debts and depreciation. Interest paid on borrowed funds. Etc. |
| Capital Income/ Capital Receipt: | The receipt of money, which arise not from regular source of income Examples: i. Capital bought in to the business. ii. Income through bank loan. iii. Income through sale of fixed Assets. |
| Revenue Incomes/Revenue Receipts: | The receipt of money, which arises in regular course of business. 1. Sales proceeds of business 2. Commission or Interest received 3. Discount received. etc. |
- Explain the effect on income statement of recording capital expenditure as revenue expenditure.
Expenses are overstated
Profit for the year is understated
- Explain the effect on balance sheet of recording capital expenditure as revenue expenditure.
Non-current assets are understated Owner’s capital (Profit )is understated
