Accounting 1 Flashcards
Accounting is divided into two types, what are they
Financial and Managerial
What are the three types of business organisations
Proprietorship, Partnership, Company
What is the primary objective of accounting measurement?
To provide useful information for making investment and lending decisions
Entity Concept
The owner is separate to the business
Account Period Concept
Defines the unit of time for which accounting data is collected
Cost Principle Concept
States that accounting measures are based upon transaction costs
Matching Principle
Relates inputs and outputs of goods and services to one another
This unit assumes the cost principle, but it is slowly becoming outdated. What is it being replaced by
Fair Value principle.
Profit Recognition Principle
States that profit should be recognised when the sales and any other revenues or gains relating to the relevant activity are earned and can be reliably measured.
Conservatism Principle
Constrains management’s natural optimism
Going Concern Assumption
Assumes that the business as a whole will continue operating for the foreseeable future
Understandability Principle
Info should be presented in a form which is easily understood by the users
Relevance Principle
Info is relevant if it influences an economic decision made by a user.
Reliability (objectivity) principle
Reliability relates to the quality of information which assures the user that the information in financial reports represents faithfully, without bias or undue error, the transactions being reported.
Comparability principle
Reports for an entity, or group of related enitities, should allow results to be compared between entities and from one period to the next.
What are the four steps in the relationship of conceptual framework to financial statements
Conceptual Framework - Objective of Financial Reporting - Principles and Standards - Financial Statements
What is the accounting equation
Assets = Liabilities + Equity
Equity Definition
Is the residual interest in the assets of the entity after deducting all of its liabilities.
Assets
- A resource controlled by the entity
- A result of past events (transactions)
- From which future economic benefits are expected to flow through the entity
Liabilities
- Debts that are payable to outsiders called creditors
- Present obligation
- Arising from past events
- To settle this, we will have to hand over economic resources (cash, time, inventory etc)
Income
Refers to all increases in equity other than investments by owners
Revenue
Is that part of income arising from ordinary business activities
Expenses
Decrease equity by using up assets or increasing liabilities in order to deliver services to customers
What can increase/decrease owner’s equity
+ Contribution from owners
+ Income
- Expenses
- Payments to owners (Drawings or Dividends)
Five elements of the accounting equation
FINANCIAL POSITION
Assets, Liabilities, Equity
PERFORMANCE
Revenue, Expenses
Examples of Assets
- Cash
- Inventory
- Accounts Receivable
- Computer
- Prepaid Rent
- Motor Vehicles
- Equipment
- Stationary Stock
Examples of Liabilities
- Accounts Payable
- Loan from Bank
- Accrued Interest
- Wages Payable
Examples of Income
- Sales
- Interest Revenue
- Fees
- Service Income
Examples of Expenses
- Rent
- Insurance
- Wages
- Electricity
- Stationary used
- Interest Expense
Two things MUST happen with every transaction
- Affects at least two accounts
- Must balance
Accounting for business transactions (four points)
- Accounts record the impact of events that are considered to affect the value of entities’ assets and liabilities
- A transaction is an event that involves at least two parties exchanging resources
- Each transaction affects at least two accounts
- Some transactions affect only one side of the equation; some affect both sides
Complete set of financial statements comprise: (four points)
Statement of:
- Comprehensive Income
- Changes in Equity
- Financial Position
- Cash Flows
Each financials statement should have: (3 points)
- Name of the business
- Name of the financial statement
- Date or time period covered by the statement
If you are mostly interested in how best to manage a firm and how best to run its operations, what type of accounting would support that function
Management Accounting
What sort of work do financial accountants do?
Prepare financial statements for external decision makers, such as outside investors and lendors.
Choose the accounting concept for this statement: ‘Recognise that some accounting measurements take place in a context of significant uncertainty and that possible errors in measurement could occur. Financial statements should understate rather than overstate net assets and profit.’
Prudence or Conservatism
The basic objective of financial reporting is to:
Provide information that is useful in making investment and lending decisions
Define Accounting
Accounting is defined as the process of identifying, measuring, recording, and communicating economic information to permit informed judgments and decisions
by the users of the information.
Describe how accounting is regulated in Australia
Accounting standards in any country are the principles that guide and standardise accounting practices. Accounting standards in Australia are developed by the Australian Accounting Standards Board (AASB). The AASB is an Australian government agency which is overseen by the Financial Reporting Council (FRC).
Describe the basic accounting principles and their applications in business
The goal of the financial accounting process is to communicate useful, relevant, and reliable economic information to assist people making decisions about the allocation of scarce resources.
What does GAAP stand for
Generally Accepted Accounting Principles
Understandability Principle
Information should be presented in a form which is easily understandable by the users
Relevance Principle
Information is relevant if it influences an economic decision made by a user
Materiality Principle
Information is material if its omission, misstatement or non-disclosure has the potential to influence the economic decisions of users
Comparability Principle
Reports for an entity, or group of related entities, should allow results to be compared between entities and from one period to the next
Timeliness Principle
Information should be reported without undue delay. There may be a trade-off between timeliness and reliability
Cost vs Benefit principle
The costs involved in preparing and providing the information should not be greater than the benefits derived from providing it
Closing the Accounts four steps
1 - Make the revenue accounts equal to zero via the Income Summary account
2 - Make expense accounts equal to zero via the Income Summary account
3 - Make the income summary account equal to zero via the Capital account
4 - Make the Drawings account equal to zero via the Capital account
The two main inventory accounting systems are the
Perpetual and Periodic
Formula for calculating inventory turnover
Cost of Sales/Average Inventory
Formulate Average Inventory
Beginning Inventory + Closing Inventory /2
Formula for calculating Gross Profit Percentage
Gross Profit / Net Sales Revenue
Formula for calculating Gross Profit
Net Sales - Cost of Sales
Formula for Days In Inventory Ratio
365 days / Inventory Turnover Ratio
How much revenue does a company need to have to charge GST
Over $75,000
3 points on Inventory
- Held for sale in ordinary course of business
- In the process of production for such sale
- In the form of materials or supplies to be consumed in the production or in the rendering of services.
Features of effective Information Systems
Control
Compatibility
Flexibility
Cost-Benefit Relationship
What does ERP system stand for
Enterprise Resource Planning
Three stages of data processing for AIS
Inputs
Processing
Outputs
What journal does Credit sales usually go on
Sales Journal
Four key elements of Internal Control
- Safeguard Assets
- Encourage employees to follow organisational policy
- Promote operational efficiency
- Ensure accurate, reliable accounting records
Five components of internal control
- Monitoring Controls
- Information Systems
- Control Procedures
- Control Environment
- Risk Assessment
Benefits of Special Journals
- Efficient accounting, can post multiple amounts to journal.
- Promotes division of labour for specialisation and division of labour.
- Therefore promotes good internal controls, to avoid conflicting responsibilities.
Advantages of subsidiary ledgers
- Allow transactions relating to an individual to all be shown in the one account
- Frees the general ledger of excessive entries, allowing just the special journal amounts to post in them, much more efficient.
- Permits the division of labour, one person managing sub account, another posting to general ledger.
Three points to a liability
- Based on past event
- Result in Outflow of economic resources
- Present Obligation
Three points to an asset
- A resource controlled by an entity
- Based on a past event
- Going to provide future economic benefit to business
What is an Account
An account is a detailed record of all the changes that have occurred in a particular asset, liability or owner’s equity item during a period.
What is a Ledger
A record holding all accounts. Summarises all the transactions in one spot so you get a total
Trial Balance
A list of all the ledger accounts, along with their balances.
Recognition Criteria
- The inflow of economic benefits to entity is probable.
- The cost/value can be measured reliably.
5 benefits of partnership
- Less expensive to organise
- More productive than individuals
- A partnership pays no income tax
- Combines the partners’ expertise
- Partnerships can raise more money than individuals
3 disadvantages of partnerships
- Mutual agency and unlimited liability create personal obligations for each partner
- Partnership agreement may be difficult to formulate
- Partnership agreement must be rewritten with change in the partnership
Entity Concept
A business entity is separate and distinct from its owners and from all other business
entities
Accounting Period Concept
The life of an entity can be divided into equal arbitrary time intervals for reporting
purposes
Cost Principle
The cost principle states that accounting measures are based upon transaction costs.
Resources and services acquired by a business are recorded initially at cost as a
reflection of their value. Their actual cost is sometimes called ‘historical cost’.
Revenue is recorded at the price at which goods and services are sold. Cost is
considered a reliable and objective measure
Matching Principle
The cost of inputs is matched against the revenue from outputs of goods and services.
The revenues earned in a period are matched against the expenses incurred in earning
that revenue during the period
Profit Recognition Principle
Revenues are recognised in the period in which they are earned, regardless of the
period in which cash is received (p. 15).
Expenses are recognised in the period in which they are incurred, or immediately a
loss is recognised as having occurred, regardless of when cash is paid (if there is any
cash involved).
Conservatism
‘Anticipate no profits; but anticipate all losses’
Going Concern
The going concern or continuity convention assumes an entity will continue in the
future, in the same line of business, and use its assets in operations rather than sell
them
Understandability Principle
Information should be presented in a form which is easily understandable by the users
Relevance Principle
Information is relevant if it influences an economic decision made by a user
Material Principle
Information is material if its omission, misstatement or non-disclosure has the
potential to influence the economic decisions of users
Reliability Principle
Reliability relates to the quality of information which assures the user that the
information in financial reports represents faithfully, without bias or undue error, the
transactions being reported
Comparability Principle
Reports for an entity, or group of related entities, should allow results to be compared
between entities and from one period to the next
Timeliness
Information should be reported without undue delay. There may be a trade-off
between timeliness and reliability
Cost vs Benefit Principle
The costs involved in preparing and providing the information should not be greater
than the benefits derived from providing it
Conceptual Framework
A broad definition for the Conceptual Framework is that it seeks to define the nature,
subject, purpose and broad content of general-purpose financial reporting
Assets are future economic benefits controlled by an entity as a result of past
transactions or other events. They will have:
- probable future benefit to the entity
- exclusive control by the entity
- arisen from previous transactions
- ability to be measured in monetary terms.
Owner’s equity is:
- increased by owner’s investments in the business
- decreased by owner’s withdrawals (Drawings) from the business
- increased by revenue earned by the business
- decreased by expenses incurred by the business
Account definition
An account is the basic summary device used to record all changes that occur within a
period of time to a particular asset, liability or owner’s equity item. All accounts are
grouped together in a record called a ledger, which may be a book or a computer file.
Journal
A chronological (date order) record of transactions is referred to as a journal. A transaction, (see Topic 1) is an event that involves two parties exchanging resources and can be reliably measured.
Ledger
The ledger is a record holding all the accounts.
Trial Balance
A list of all the ledger accounts, along with their balances is called a trial balance.
Under manual accounting systems, the trial balance is a crucial tool when preparing
financial reports.
Prepayments/deferrals and accruals
- prepaid expenses (prepayments)
- depreciation of non-current assets (prepayments)
- accrued expenses (accrual)
4 accrued revenues (accrual)
5 unearned revenues (prepayments).
Periodic Inventory
A periodic inventory system records inventory acquisitions as purchases in an
expense account rather than in an inventory account. The cost of inventory on hand
is calculated and recorded in an inventory account after the periodic physical
inventory count or stock-take at the end of the period.
Perpetual Inventory
A perpetual inventory system records inventory acquisitions and disposals in the
inventory account at the time the transactions occur. It provides a continuous
inventory record showing the physical quantity of trading stock and its equivalent
value, which is available as stock in hand. Inventory disposals and losses are
transferred to the cost of sales account from the inventory account.
Compare and contrast the purposes of adjusting entries and closing entries
Adjusting entries are made at the end of an accounting period, but are made before the preparation of financial statements (Trial Balance, Balance Sheet etc.), and are used to ensure that the correct expenses, revenues, assets and liability accounts are up to date in line with the accrual - balance method of accounting.
Closing entries are also at the end of an accounting period, however these are made after the preparation of financial statements, and are done to close the expense/revenue accounts to zero, and allocate profit/loss to the owner capital accounts. This resets the accounts, and provides easy and accurate to previous/future periods.
Define Inventory
Inventory is an asset account where goods are held for sale or in the process of being sold, to be consumed in the production process process, or in the rendering of services. Under the conservatism principle, inventory must be recorded at the lower or either cost, or net-realisable-value.
Perpetual Inventory is Superior to Periodic. Discuss
Perpetual system is superior, especially for major and larger companies as it continuously updates stock or inventory with each transaction that occurs. Normally, if a sale or transaction is made, the item is scanned, and updated into a computer, which calculates how much stock is left, and also updates the cost of sales as they are made. The major advantage is that you get up-to-the-minute and (to a degree) accurate information regarding your inventory throughout the year. Periodic inventory, used in smaller business can only measure how much inventory they have, and their cost of sales at the end of the accounting period when they conduct their stocktake.
Why do businesses that use a perpetual inventory system conduct a stocktake?
Even though the perpetual inventory method records up-to-the-minute details regarding inventory, it doesn’t account for inventory items that may be lost, stolen, or damaged. A stocktake at the end of the period is imperative to accurately measure and compare what is actually on hand, with what is being recorded in the system. If there is a difference between what is on hand and what is recorded, you debit or credit the cost of sales account accordingly.
How do we measure the value of inventory
To measure the value, companies must choose a cost-flow-assumption to measure the cost. You can do so by the FIFO, LIFO or Average cost measure, which are the most common. Once a sale is made, you deduct the cost of the item from the inventory, and the remainder gives you the value.
Define NRV. How is it calculated?
Sometimes inventory can lose it’s value due to replacement costs etc. This is know and as the Net-Realisable-Value, where the inventory is reevaluated to determine it’s actual economic benefit. Physical deterioration or loss of interest in product could determine change in NRV. It is calculated by measuring the units on hand with the expected sales price, less all costs associated with disposal of items. If this amount falls below the cost amount of the inventory item, then this is what should be recorded in inventory. Inventory sales value, minus estimated cost of completion and disposal.
What items are included in the cost of inventory
The actual cost price of each item, plus everything involved in getting the inventory ready for production. This can include freight charges, holding charges, administrative costs etc.
Benefits of a good internal control system
Internal control can prevent fraud, theft, and unnecessary loss of economic benefit. It also protects the company and makes it much more efficient across the board.
What are the advantages of the use of special journals?
Reduces recording times and amounts, instead of recording 500 transactions, you can post the total amount into the special journal for more effecient accounting. Promotes good internal control. Promotes division of labour, and therefore promotes good internal controls, to avoid conflicting responsibilities.
Advantages of subsidiary ledgers
- We remove a mass of details from the general ledger
- More than one person can work on the system at one time
- The requirement for the total of accounts in the subsidiary ledger to agree with
the control account is an important measure of control - The individual debtor accounts are kept up-to-date daily.
Briefly explain the purpose of the conceptual framework
Provide a basis for developing accounting systems and practices, and to provide a framework to consistently develop and compare standards across separate entities.
Why might the Allowance for Doubtful Debts have a debit balance before the final year end adjustment?
This is where charges that are deemed uncollectible and need writing off have exceeded the allowance for doubtful debts. This would need to be accounted for and journalised as a further bad debt expense.
Difference between the direct write-off method and the allowance method
Once a company deems an amount uncollectable, the company writes it off as of that date under the direct write-off method. This expense is then recorded in that period, not in the period the income was earned.
The allowance method estimates a write-off amount under the assumption that some debt won’t be repaid, a percentage of what is earned during the account period the sale was made. It records the debt expense in that period, and once something is deemed uncollectable, it is debited from the allowance amount.
Revenue Recognition Criteria
- Collection probability
- Delivery/Supply is complete
- Persuasive evidence transaction has been made
- Price can be determined
Depreciation purpose
The purpose of depreciation is to match the cost of a productive asset (that has a useful life of more than a year) to the revenues earned from using the asset. Since it is hard to see a direct link to revenues, the asset’s cost is usually allocated to (assigned to, spread over) the years in which the asset is used.
Materiality Principle
Materiality principle states that a cost or similar amount on a financial statement can be ignored if it does not mislead the user of the information. To reverse, anything that is deemed material or important to a financial statement, and the data it provides must be present on the financial statements.
Which items are included in the cost of a non-current asset such as equipment?
Any costs that are associated with bringing the asset ready to start production, and therefore expect to begin providing economic benefit. This includes sale, construction of equipment, legal or sales fees, and (arguably) training. Once set up and functioning, maintenance of the asset is considered an expense.
There are a number of available methods to determine depreciation expense. Name the methods and state when each one should be used.
Straight-line method - Easiest to use and calculate, it determines the carrying value, and measures it’s depreciation over equal increments.
Unit of production method - Useful for cars, or printers where cost can be determined on how many units used. You divide the cost with the expected units to be produced, and then measure depreciation dependant on how many units are produced.
Reducing method - Appropriate when asset expected to yield most results in early years. Also beneficial for tax purposes as you can claim tax benefits early with more depreciation expense incurred.
What is impairment? When should it be considered?
The term impairment is usually associated with a long-lived asset that has a market which has decreased significantly. For example, a meat packing plant may have recently spent large amounts for capital expenditures and then experienced a dramatic drop in the plant’s value due to business and community conditions.
If the undiscounted future cash flows from the asset (including the sale amount) are less than the asset’s carrying amount, an impairment loss must be reported.
If the impairment loss must be reported, the amount of the impairment loss is measured by subtracting the asset’s fair value from its carrying value.
A liability and a contingent liability are the same. Discuss
A contingent liability is a potential liability…it depends on a future event occurring or not occurring.
In accounting, a contingent liability and the related contingent loss are recorded with a journal entry only if the contingency is both probable and the amount can be estimated.
If a contingent liability is only possible (not probable), or if the amount cannot be estimated, a journal entry is not required. However, a disclosure is required.
When a contingent liability is remote (such as a nuisance suit), then neither a journal nor a disclosure is required.
With reference to the conceptual framework explain why future warranty costs should be recognised as a liability in the current financial period?
The matching principle requires that where firms offer a warranty on their products, that they record by an adjusting entry the warranty expense in the period in which the sale was made. Once a claim is made on the firm, and warranty is involved, then the cash refund or replacement item given to the customer will be made from the Estimated Warranty Payable which was created in the period in which the sale was made.
This is also good for the relevancy and reliability principle.
What is the difference between revenues and gains?
Revenues are all cash or income that is resulted from standard business operations. Gains however, are the profit made when you subtract all relevant expenses involved with earning the revenues. Revenues - Expenses = Gains
How should inventory losses be recorded in a perpetual system?
A stocktake at end of the period would give you an exact amount of physical goods on hand. Once compared to the perpetual computer inventory system, if it appears there are losses, then an adjusted journal entry is required to bring the computer or ledger amount up to date with what is physically on hand.
“The value of our buildings have increased during the year. Therefore we do need to record depreciation expense. Discuss this statement.
Depreciation is not a measure of the value of your asset, rather the cost of the expense in relevance to the revenues gained in an entity. Depreciation is necessary. If land has been revalued to cost more, this may be updated, as well as the useful life in order to calculate depreciation.
Going Concern Assumption
Going concern is a basic underlying assumption in accounting. The assumption is that a company or other entity will be able to continue operating for a period of time that is sufficient to carry out its commitments, obligations, objectives, and so on.
Implications of Going Concern Assumption
Entity could go into bankruptcy, and therefore not be able to cover it’s debts as assumed under going concern. This is the same regarding death of the owner/s.
Impairment examples
- Land is valued at less
- Demand on sales is now down, devaluing inventory
- Market value of car or other stuff is down.
3 elements of of a computerised accounting system
- Hardware
- Software
- Trained Personnel
Four special journals. Where do the rest of transactions go.
- Cash Receipts
- Cash Payments
- Credit Sales
- Credit Purchases
General Ledger
Define Internal Control
Internal control can be defined as “a system ensuring that all transactions of a business are properly recorded and documented, assets are protected and an independent internal verification of records is provided”
Internal Control Characteristics
- competent, reliable and ethical staff—staff will be carefully selected and trained appropriately for the tasks required. Adequate supervision must be provided
- assignment of responsibility, and subdivision of duties. See Exhibit 9–2 for the division of responsibilities and separation of duties
- good systems of authorisation and documentation, including electronic devices and computer controls
- separation of duties
- existence of internal and external audits
- documents and records
- electronic devices and computer controls
- other controls such as secure vaults, alarms, point-of-sale terminals, fidelity insurance, mandatory holidays and job rotation.
Internal Control limitations
- Collusion between employees may occur
- Cost may outweigh the benefit.
Documents used to control bank accounts
Signature cards, deposit slips, cheques, bank statements and bank reconciliations
