accounting ch 9-10

Question 1

1 Define revenue

Answer 1

inflows of economic benefits (or savings in outflows), in the form of increases in assets or reductions in liabilities, that lead to an increase in owner’s equity

Question 2

define expense

Answer 2

outflows or consumptions of economic benefits (or reductions in inflows), in the form of decreases in assets or increases in liabilities, that lead to a decrease in owner’s equity

Question 3

define profit

Answer 3

– what is left over after expenses incurred are deducted from revenues earned.

Question 4

2 Explain how the Reporting Period principle assists in the calculation of profit.

Answer 4

The Reporting Period allows businesses to divide the life of the business into arbitrary periods in order to determine profit.

Question 5

3 Explain how the Reporting Period principle leads to Relevance in accounting reports.

Answer 5

Once the length of the Reporting Period is determined, it is important that the calculation of profit includes only revenues and expenses, and only those revenues and expenses that have occurred during the current Reporting Period. This ensures that the reports contain only information that is useful for decision-making and exclude information that is not useful for decision-making.

Question 6

1 Explain the process of closing the ledger.

Answer 6

Closing the ledger involves transferring balances from revenue and expense ledger accounts to the Profit and Loss Summary account so that profit can be calculated.

Question 7

2 Explain two reasons for closing the ledger.

Answer 7

• Transfer revenues and expenses to the Profit and Loss Summary account in order to calculate profit for the current Reporting Period.
• Reset revenue and expense accounts to zero in preparation for the next Reporting Period.

Question 8

3 Explain why asset and liability accounts are not closed.

Answer 8

Assets and liabilities will exist into the future. That is, the Balance Sheet items involve a future benefit or future sacrifice and so should not be reset to zero, but their balances should carry forward into the next Reporting Period.

Question 9

1 Identify the three entries that will be recorded in the Profit and Loss Summary account.

Answer 9

• total revenues
• total expenses
• net profit/loss figure

Question 10

2 Referring to revenues and expenses, explain why the cross-references in the Profit and Loss Summary account are not ledger account names.

Answer 10

Rather than list each and every one of these account names, the cross-reference is simply ‘revenues’ or ‘expenses’ to indicate that there are a number of revenue and expense accounts linked to these total figures.

Question 11

3 Explain how the Profit and Loss Summary account would be classified in the Balance Sheet. (Beware!)

Answer 11

The Profit and Loss Summary account is a temporary account that opens (when the revenues and expenses are transferred in) and closes (when the profit or loss is transferred out) on the same day. Its function is simply to facilitate the calculation of profit and therefore is not entered in the Balance Sheet.

Question 12

5 Show the General Journal entries necessary to close:

• revenue accounts to the Profit and Loss Summary account

Answer 12

Sales Revenue Debit
Stock Gain Debit
Discount Revenue Debit
Profit and Loss Summary Credit

Question 13

Show the General Journal entries necessary to close:

expense accounts to the Profit and Loss Summary account

Answer 13

Profit and Loss Summary 	Debit	
Cost of Sales		Credit
Wages		        Credit
Advertising		Credit
Discount Expense  Credit
Rent Expense		 Credit

Question 14

5 Show the General Journal entries necessary to close:

• The Profit and Loss Summary account to the Capital account

Answer 14

Profit and Loss Summary Debit
Capital – owner’s name Credit
Transfer of Net Profit from P&L Summary account to Capital account

Question 15

1 State one reason why transactions with the owner are recorded separately in the Drawings account (rather than directly in the Capital account).

Answer 15

It is recorded separately so that the owner’s transactions for a particular Reporting Period can be isolated. This is useful for decision-making so that the owner can assess the level of drawings

Question 16

2 State one reason why the Drawings account is closed to the Capital account

Answer 16

The Drawings account is closed to the Capital account so that the Capital account can reflect the net effect of all transactions with the owner.

Question 17

3 Referring to the definition of an expense, explain why the Drawings account is not closed to the Profit and Loss Summary account.

Answer 17

Although Drawings is an outflow of economic benefits in the form of a decrease in assets that reduces owner’s equity, it is expressly excluded from the definition of an expense, as it is a transaction with the owner.

Question 18

4 Referring to one qualitative characteristic, explain why Drawings are not included in the calculation of profit

Answer 18

Drawings is a transaction with the owner. Thus, to include drawings in the calculation of profit would be a direct breach of relevance. Relevance states that the accounting reports must contain all information that is useful for business decision-making; to include Drawings is to include information that is not useful for business decision-making.

Question 19

5 Show the General Journal entries necessary to close the Drawings account to the Capital account.

Answer 19

Capital – owner’s name Debit
Drawings Credit
Transfer of Drawings account to Capital account

Question 20

1 Explain why it is necessary to prepare an Income Statement even when the profit figure is known.

Answer 20

The Income Statement details the revenues earned and expenses incurred during the Reporting Period and, in the process, shows both Gross Profit and Net Profit. It shows the reasons why that profit/loss occurred, giving the owner far more information on which to base his or her decisions.

Question 21

2 Explain the relationship between the Profit and Loss Summary account and the Income Statement.

Answer 21

The Net Profit reported in the Income Statement should be the same figure determined in the Profit and Loss Summary account. This is because both will deduct expenses incurred from revenues earned for a particular Reporting Period.

Question 22

1 Explain why the Income Statement is titled for the period rather than as at a particular date.

Answer 22

The information it reports is not confined to a single day, but covers a period of time.

Question 23

4 Explain the difference between Cost of Sales and Cost of Goods Sold

Answer 23

Cost of Goods Sold is a heading referring to all costs incurred in getting goods into a condition and location ready for sale, with Cost of Sales simply one of the items that may be reported under this heading.

Question 24

5 Identify two revenues that would be classified as ‘Other Revenue’.

Answer 24

• Discount Revenue
• Interest Revenue
• Commission Revenue

Question 25

1 Explain the purpose of preparing an Income Statement.

Answer 25

The purpose is to detail individual revenue and expense items, and to identify Gross Profit and Net Profit, thus making the report more useful as a decision-making tool.

Question 26

2 Explain how the preparation of an Income Statement can assist decision-making.

Answer 26

It allows the owner to assess:
• the firm’s ability to earn revenue so decisions can be made about the types of stock that are held for sale, the level and/or type of advertising, or the level of selling prices
• the adequacy of the firm’s mark-up so decisions can be made about adjusting selling prices or controlling cost prices
• the firm’s ability to control its expenses so decisions can be made about managing staff wages, protecting stock from stock loss, or operating more efficiently to control operating costs.

Question 27

3 Explain how the preparation of an Income Statement can assist planning for the future.

Answer 27

By providing a basis for the next budget, the Income Statement will aid in the setting of targets for the future. This may include stock levels, staffing requirements or advertising expenditure.

Question 28

1 Explain why profit may be inaccurate if balance day adjustments are not recorded.

Answer 28

If at balance day there is revenue that has been earned but not yet received, or expenses incurred but not yet paid, then these items may not appear in the revenue and expense accounts. Thus, the calculation of profit would be inaccurate.

Question 29

2 Explain the purpose of a balance day adjustment.

Answer 29

The purpose of a balance day adjustment is to ensure that profit can be calculated accurately, by comparing revenues earned against expenses incurred in the current Reporting Period.

Question 30

3 Explain how balance day adjustments ensure Relevance in the accounting reports.

Answer 30

The application of the Reporting Period principle leads to relevance by ensuring that the Income Statement (and, for that matter, the Balance Sheet) includes all information that is useful for decision-making, while excluding information that is not. Information that would not be useful includes revenue or expenses that were earned or incurred outside the current Reporting Period.

Question 31

4 List the four balance day adjustments that relate to expenses.

Answer 31

• stock losses
• prepaid expenses
• accrued expenses
• depreciation.

Question 32

1 Explain why a prepaid expense is classified as a current asset.

Answer 32

An expense that has been paid in advance is a current asset because the economic benefit has not yet been consumed, but instead the future economic benefit will flow to the entity within the next 12 months.

Question 33

2 State the effect on the accounting equation of a payment for a prepaid expense.

Answer 33

Assets	Decrease (decrease Bank, increase Prepaid Expense)
Liabilities	Decrease (GST Clearing)
Owner’s Equity	No effect

Question 34

3 Show the General Journal entries necessary to record a balance day adjustment for the consumption of a prepaid expense.

Answer 34

Insurance Expense Debit
Prepaid Insurance Credit
Adjusting entry to record one month insurance incurred (Memo x)

Question 35

4 State the effect on the accounting equation of the balance day adjustment for the consumption of a prepaid expense.

Answer 35

Assets Decrease (Prepaid Insurance expense)
Liabilities No effect
Owner’s Equity Decrease (increase Insurance Expense decreases Net Profit)

Question 36

1 Explain why an accrued expense is classified as a current liability.

Answer 36

An expense incurred but not yet paid is considered to be a present obligation of the entity, as a result of past events, the settlement of which is expected to result in an outflow of economic benefits (when the accrued expense is paid) sometime in the next 12 months.

Question 37

2 Show the General Journal entries necessary to record an accrued expense.

Answer 37

Electricity Expense Debit
Accrued Electricity Credit
Adjusting entry to record electricity consumed but not yet paid (Memo x)

Question 38

3 State the effect on the accounting equation of the balance day adjustment for an accrued expense.

Answer 38

Assets No effect
Liabilities Increase (Accrued Electricity)
Owner’s Equity Decrease (increase Electricity Expense decreases Net Profit)

Question 39

4 Explain why the payment of an accrued expense in a subsequent period requires the payment to be split in the Cash Payments Journal.

Answer 39

When a payment of an accrued expense in made is a subsequent period, some of the payment is used to reduce the liability for accrued expenses (expense incurred in the last period), and some of the payment is used for the expense incurred and paid in the current period.

Question 40

5 State the effect on the accounting equation of the payment of an accrued expense in a subsequent period.

Answer 40

Assets	Decrease (Bank)
Liabilities	Decrease (Accrued Electricity, GST Clearing)
Owner’s Equity	Decrease (increase Electricity Expense decreases Net Profit)

Question 41

6 Distinguish between an accrued expense and a sundry creditor.

Answer 41

An accrued expense occurs when an expense has been incurred, but the payment has not yet been made (no invoice has been received). A sundry creditor occurs when items other than stock are purchased, but the payment has not been made (invoice has been received).

Question 42

1 Explain the difference between a Pre-adjustment Trial Balance and a Post-adjustment Trial Balance.

Answer 42

A Pre-adjustment Trial Balance is prepared before balance day adjustments have been made to check that total debits equal total credits; a Post-adjustment Trial Balance is prepared after balance day adjustments have been made.

Question 43

2 Explain how a Post-adjustment Trial Balance can assist in the calculation of an accurate profit figure.

Answer 43

Preparing the Post-adjustment Trial Balance assists in ensuring that the closing entries and the Income Statement use the correct amounts; that is, the adjusted figures for the amounts incurred and earned rather than the unadjusted figures, which do not account for any balance day adjustments.