Accounting for Sole Traders and Partnerships

Question 1

What is an Accounting Period?

Answer 1

The timeframe for which Financial Statements are prepared.

Usually one Year.

Question 2

What is an Income Statement?

This is otherwise known as the Profit and Loss Account.

Answer 2

An outline of the Firm’s Revenue and Expenses, and thus its Profits and Losses, over an Accounting Period.

This is forms part of the Financial Statement.

Question 3

What are the Contents of an Income Statement?

Answer 3

• Income Entries: All items in the Income Account from the Trial Balance are included.
• Expense Entries: All items in the Expense Account from the Trial Balance are included.

Question 4

What is the Format of an Income Statement?

Answer 4

1 — Income:

• Lists all Revenue Streams.

2 — Cost of Sales:

• Calculates the direct Costs associated with the Goods or Services sold.

3 — Gross Profit:

• Derived by subtracting the Cost of Sales from Total Income.

4 — Expenses:

• Itemises all Operating Expenses.

5 — Net Profit:

• The Final Profit after deducting all Expenses from the Gross Profit.

Question 5

What is a Balance Sheet?

Answer 5

An outline of the Firm’s Assets, Liabilities, and Capital on a specific date.

This is forms part of the Financial Statement.

Question 6

What are the Contents of a Balance Sheet?

Answer 6

Assets:

• Fixed Assets.
• Current Assets.

Liabilities:

• Current Liabilities.
• Long-Term Liabilities.

Capital and Equity:

• Start-of-Year Capital.
• Year-End Profits.
• Drawings.
• Retained Profits.

Question 7

What is the Format of a Balance Sheet?

Answer 7

1 —Net Assets:

• Net Assets = Total Assets - Total Liabilities.

2 —Capital:

• Capital = Start-of-Year Capital ± (Year-End Profits - Drawings).
• Retained Profits = Year-End Profits - Drawings.

Net Assets must equal Capital.

Question 8

What are the Three Main Types of Ledgers?

Answer 8

• Sales Ledger.
• Purchase Ledger.
• General Ledger.

Question 9

What is the Trial Balance?

Answer 9

A list of all Ledger Balances at the end of an Accounting Period.

Question 10

What are the Five Main Types of Accounts?

Answer 10

• Asset Account: Resources owned.
• Liability Account: Obligations owed.
• Capital Account: Equity and Retained Profits.
• Income Account: Income from Commercial Activity.
• Expense Account: Expenses from Commercial Activity.

Question 11

What is a Fixed Asset?

Answer 11

Any Long-Term Asset held for at least one year.

Question 12

What is a Current Asset?

Answer 12

Cash, or any Asset that can be Liquidated within one year.

Question 13

What is a Current Liability?

Answer 13

Any Debt due within one year.

Question 14

What is a Long-Term Liability?

Answer 14

Any Debt due within more than one year.

Question 15

What is the Accrual Principle?

Answer 15

Revenues and Expenses must be recorded when they are earned or incurred.

Question 16

What is the Matching Principle?

Answer 16

Expenses should be matched with the Revenues they help generate in the same Accounting Period.

Question 17

What are Year-End Adjustments?

Answer 17

Modifications to Account Entries on the Trial Balance to ensure an accurate reflection of the Firm’s financial position.

Question 18

What are the Five Main Types of Year-End Adjustments?

Answer 18

• Accruals.
• Bad Debts.
• Depreciation.
• Prepayments.
• Doubtful Debts.

Question 19

What is an Accrual?

Answer 19

The recognition of an Expense as a Current Liability since:

• It was incurred during the Current Accounting Period; but
• Has not yet been paid or recorded in the Trial Balance.

This is usually because the Firm has yet to receive an Invoice for the Expense.

Question 20

What is a Bad Debt?

Answer 20

A Debt owed that is confirmed to be uncollectable.

Question 21

How are Bad Debts recorded?

Answer 21

• Removal from Receivables: The Bad Debt is removed from the Firm’s Receivables in its Asset Account.
• Recognition as an Expense: The Bad Debt is added to the Firm’s Expense Account, under ‘Bad Debts’.

Question 22

What is Depreciation?

Answer 22

A Technique to allocate the Cost of a Fixed Asset over its Useful Life, thus reflecting its decline in value over time.

Question 23

How is Depreciation Recorded?

Answer 23

• As an Liability on the Balance Sheet.
• As an Expense on the Income Statement.

Question 24

What is an Asset’s Net Book Value?

Answer 24

The Asset’s current estimated value after Depreciation.

• In other words, Cost − AccumulatedDepreciation.

Question 25

What are the Two Methods of Depreciation?

Answer 25

• The Straight-Line Method.
• The Reducing Balance Method.

Question 26

What is the Straight-Line Method of Depreciation?

Answer 26

An even allocation of the Depreciation Expense over the Asset’s Useful Life.

This is most suitable for Assets providing consistent utility.

Question 27

What is the Reducing Balance Method of Depreciation?

Answer 27

A per-annum, fixed-percentage allocation of the Depreciation Expense over the Asset’s Useful Life.

This is most suitable for Assets that rapidly lose value.

Question 28

What is a Prepayment?

Answer 28

The recognition of an Expense as a Current Asset since:

• It was paid in full during the Current Accounting Period; but
• It relates wholly or partly to the Next Accounting Period.

Question 29

What is a Doubtful Debt?

Answer 29

A Debt with some prospects of recovery, but that may become a Bad Debt.

Question 30

What are the Two Types of Doubtful Debts?

Answer 30

Specific Doubtful Debts:

• Concerns Debtors disputing the Debt or known to be in financial difficulty.
• Concerns Debts with dubious recoverability for reasons known to the Firm.

General Doubtful Debts:

• Concerns the Firm’s Accounts Receivable generally, to account for uncertainty in economic conditions.

Question 31

How are Doubtful Debts recorded?

Answer 31

1 — The Provision of Doubtful Debts Account:

• This Account estimates the Receivables the Firm may never collect.
• It is a Contra-Asset Account, and is treated akin to a Liability because it reduces Net Asset Value.

2 — Accounting Treatment:

• If the Account increases from one Accounting Period to the next, Expenses are increased by that amount, and vice versa.

In the Statements, this is a specific Item, not a distinct Account.

Question 32

How are Doubtful Debts included on an Income Statement and Balance Sheet?

Answer 32

Income Statment:

• Recorded as an Expense under the heading “Bad Debt Expense” or “Provision for Doubtful Debts”.

Balance Sheet:

• Recorded as a deduction from Accounts Receivable in the form of a “Provision for Doubtful Debts”.
• Presentation-wise, Doubtful Debts are matched to the Assets they most directly concern.

Question 33

For a Partnership, what is Different about the ‘Capital’ Section of the Balance Sheet?

Answer 33

Each Partner has two Accouts, namely:

• A Capital Account, recording its Capital Contributions to the Firm; and
• A Current Account, recording its Profit Share and its Drawings, both available and already made.

Each Partner’s Drawings are recorded in a separate Document —the Profit Apporpriation Statement.

Question 34

What is a Profit Appropriation Statement?

Answer 34

A Financial Statement that records how the Partnership’s Net Profit is divided among the Partners.

• First, Partners will be paid any Salaries or Interest on Capital due; then
• Profits will be distributed per the Profit Share Ratio.

This is drafted after the Income Statement, but before the Balance Sheet.