Accounting Past Papers Flashcards
Identify three accounting concepts/principles that are applied when preparing financial statements.
Business Entity also known as Accounting Entity Concept.
Accruals Concept and the Matching Principle.
Dual Aspect Concept.
Explain what Business Entity )also known as Accounting Entity Concept) is.
The owner and the business are considered as two different persons, distinct from each other.
Transactions are recorded from the point of view of the business and not the owner. As such, any amount invested by the owner in the business is considered as a liability by the business.
Also, only those transactions that concern the business are recorded.
Explain what Accruals Concept and the Matching Principle is.
According to the Accruals concept, when calculating the profit of a given period, revenues earned in that period need to be matched against expenses incurred for that same period. This is done irrespective of amount received as revenue or amount paid for the expenses.
According to the matching principle, when calculating profit, revenues need to be matched against those expenses incurred to earn the revenues.
Explain what the Dual Aspect Concept is.
This concept takes into account the two aspects of a accounting represented on one side by the assets of the business and on the other by the claims against those assets.
This duality is also explained by the accounting equation as follows:
Assets = Capital + Liabilities
Explain the purpose of the bank reconciliation.
A bank reconciliation is a process performed by a company to ensure that the company’s records (check register, general ledger account, balance sheet, etc.) are correct and that the bank’s records are also correct.
Explain fully the findings of the bank reconciliation will have on the financial statements.
As mentioned above, performing a bank reconciliation is necessary for the accuracy of the accounting records and for the company’s financial statements.
Bank reconciliations are also associated with a company’s internal controls over cash.
If the bank reconciliation is performed by someone other than the authorized check signers and record keepers, the company has improved its internal control over cash.
Define the term ‘contribution’.
Contribution is the amount of earnings remaining after all direct costs have been subtracted from revenue.
This remainder is the amount available to pay for any fixed costs that a business incurs during a reporting period. Any excess of contribution over fixed costs equals the profit earned.
How do you calculate the contribution margin?
Contribution Margin = Sales - Variable Costs
How do you calculate the break-even point in UNITS?
Fixed Cost / (Sales Price - Variable Cost)
How do you calculate the break-even point for REVENUE?
Break-even point (units) X Sales Price
Explain the term ‘margin of safety’.
Margin of safety is a principle of investing in which an investor only purchases securities when the market price is significantly below its intrinsic value.
In other words, when market price is significantly below your estimation of the intrinsic value, the difference is the margin of safety. This difference allows an investment to be made with minimal downside risk.
How do you calculate the margin of safety in UNITS terms?
Margin of Safety = Total budgeted or actual sales − Break even sales.
How do you calculate the margin of safety in PERCENTAGE terms?
Margin of Safety / Actual Sales X 100
Outline and explain the assumptions of the break-even analysis.
(1) All costs can be categorized as fixed or variable costs.
(2) Total fixed costs remain unchanged for all output levels.
(3) Total variable costs fluctuate proportionately with output level resulting in no change in per unit variable cost.
(4) Sale price per unit remains the same for each output level.
(5) Costs and revenue behave in a linear fashion within a relevant range.
(6) No factor other than sales volume can affect costs and sales revenue.
(7) The analysis relates to businesses producing one product only or a constant product mix.
(8) The technology, production methods and efficiency remain unchanged.
(9) There are no inventories at start or at end of the accounting period or inventory levels are expected to remain constant.
What’s the definition of an asset?
“a resource controlled by the entity as a result of past
events and from which future economic benefits are
expected to flow to the entity”
What are liabilities?
“a present obligation of the entity arising from past
events, the settlement of which is expected to result in
an outflow from the entity of resources”
What is Capital/Equity/Ownership Interest?
“the residual interest in the assets of the entity after deducting all its liabilities”
the amount(s) invested by the owner(s) of the entity
(amounts owed to owners)
Define Expenses/Loss.
“decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants”
Define Income / Revenue / Gains?
“increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants”
Distinguish between variable costs and fixed costs.
A variable cost is one which varies directly with changes in the level of activity, over a defined period of time.
A fixed cost is one which is not affected by changes in the level of activity, over a defined period of time.
Semi-variable = fixed + variable.
Step cost = fixed cost increases by steps.
What are Sunk Costs?
Costs created by a decision made in the past and cannot be changed by any future decisions.
Sunk Costs are irrelevant costs
(not all irrelevant costs are sunk costs)
Distinguish between relevant and irrelevant costs and revenues.
Relevant Costs / Revenues
future costs / revenues that will be changed by a decision
Irrelevant Costs / Revenues
will not be affected by a decision
Example: Going to Glasgow to watch the football and do some shopping.
Do I take my own car or go by train?
Relevant costs – fuel for car, car parking
Irrelevant costs – car tax, car insurance
What are examples of fixed costs?
Salary paid to a supervisor.
Advertising in the trade journals.
Business rates paid to the local authority.
Depreciation of machinery calculated on the straight-line basis.
What are Period and Product Costs?
for profit measurement and stock valuation
Product Cost
identified with goods purchased / produced for sale (include direct & indirect production costs)
Period Cost
not included in the inventory valuation and are treated as expenses in the period in which they are incurred
How do you calculate the gross profit?
Sales - Cost of Goods Sold
How do you calculate the selling price for a unit?
(Total fixed costs + Total variable costs) / Total units produced
How do you calculate the net profit?
Total Revenue -Total Expenses = Net Profit
Distinguish between marginal costing and fixed costing.
Marginal costing is a technique of costing in which allocation of expenditure to production is restricted to those expenses which arise as a result of production, e.g., materials, labor, direct expenses and variable overheads.
Fixed overheads are excluded in cases where production varies because it may give misleading results. The technique is useful in manufacturing industries with varying levels of output.
The practice of charging all costs both variable and fixed to operations, products or processes is termed as absorption costing. (Fixed Costing)
Distinguish between Financial Accounting and Managerial Accounting.
Aggregation. Financial accounting reports on the results of an entire business. Managerial accounting almost always reports at a more detailed level, such as profits by product, product line, customer, and geographic region.
Efficiency.
Financial accounting reports on the profitability (and therefore the efficiency) of a business, whereas managerial accounting reports on specifically what is causing problems and how to fix them.
Distinguish between Financial Accounting and Managerial Accounting. (2)
Efficiency. Financial accounting reports on the profitability (and therefore the efficiency) of a business,
whereas managerial accounting reports on specifically what is causing problems and how to fix them.
Distinguish between Financial Accounting and Managerial Accounting. (3)
Proven information. Financial accounting requires that records be kept with considerable precision, which is needed to prove that the financial statements are correct.
Managerial accounting frequently deals with estimates, rather than proven and verifiable facts.
Distinguish between Financial Accounting and Managerial Accounting. (4)
Reporting focus. Financial accounting is oriented toward the creation of financial statements, which are distributed both within and outside of a company.
Managerial accounting is more concerned with operational reports, which are only distributed within a company.
Distinguish between Financial Accounting and Managerial Accounting. (5)
Standards. Financial accounting must comply with various accounting standards,
whereas managerial accounting does not have to comply with any standards when it compiles information for internal consumption.
What is a budget?
“is a plan expressed in money. It is prepared and approved prior to the budget period and may show income, expenditure and the capital to be employed. May be drawn up showing incremental effects on former budgeted or actual figures, or be compiled by zero-based budgeting.”
What is the cash budget?
One of the most important budgets
Objective – to ensure sufficient cash to meet the organisations needs
Rolling Budget
Cash Flow Management
to manage cash to achieve maximum interest and cash availability
plan for deficits
plan for cash surplus
What is the cash budget? (2)
Receipts include: Cash sales, receipts from debtors, sale of assets, dividends received, interest received, new share issue etc.
Payments include: Payments to creditors for stock, and material purchases, wages, dividend payments, loan repayment
Some receipts/payments are not in Profit & Loss e.g. purchase of fixed assets, cash from new share issue
Some payments in P/L are not in cash budget – non-cash e.g. depreciation
Why do we produce budgets?
Planning
annual operations – long term plans
encourages managers to anticipate problems
Coordination
activities of various parts of organisation
managers to examine relationship between own operations and those of other departments
Communication
plans & policies & constraints
ensure appropriate individuals accountable
top management – lower management
during budget preparation
Motivation
can influence managerial behaviour
participation assists managing departments
provides a target
Control
compare actual with budgets
management by exception:
investigating significant deviations
identifying inefficiencies
take appropriate action
Performance Evaluation
assess managers performance against targets
How could a business improve their financial position?
Recover outstanding debt Reduce/rearrange expenses Sell assets Increase prices Look for government grants Use new marketing techniques
What impact do bad debts have on financial statements?
This results in an expense on the income statement (sooner than would occur under the direct write-off method) and a reduction of the current assets on the balance sheet.
What are examples of variable costs?
materials used to manufacture a unit of output or to provide a type of service.
labour costs of manufacturing a unit of output or providing a type of service.
commission paid to a salesperson.
fuel used by a haulage company.
Distinguish between variable costs and fixed costs.
A variable cost is one which varies directly with changes in the level of activity, over a defined period of time.
A fixed cost is one which is not affected by changes in the level of activity, over a defined period of time.
Semi-variable = fixed + variable.
Step cost = fixed cost increases by steps.
Identify groups of users who are known to examine published financial statements and why they have an interest in such statements.
Customers.
When a customer is considering which supplier to select for a major contract, it wants to review their financial statements first, in order to judge the financial ability of a supplier to remain in business long enough to provide the goods or services mandated in the contract.
Identify groups of users who are known to examine published financial statements and why they have an interest in such statements. (2)
Employees. A company may elect to provide its financial statements to employees, along with a detailed explanation of what the documents contain. This can be used to increase the level of employee involvement in and understanding of the business.
Identify groups of users who are known to examine published financial statements and why they have an interest in such statements. (3)
Governments. A government in whose jurisdiction a company is located will request financial statements in order to determine whether the business paid the appropriate amount of taxes.
Identify groups of users who are known to examine published financial statements and why they have an interest in such statements. (4)
Investment analysts. Outside analysts want to see financial statements in order to decide whether they should recommend the company’s securities to their clients.
Identify groups of users who are known to examine published financial statements and why they have an interest in such statements. (5)
Investors. Investors will likely require financial statements to be provided, since they are the owners of the business, and want to understand the performance of their investment.
Explain the term ‘Principal Budget Factor’.
The principal budget factor is the factor that limits the activities of functional budgets of the organisation.
The early identification of this factor is important in the budgetary planning process because it indicates which budget should be prepared first.
Define the Going Concern Concept.
It is assumed that the business will continue to operate in the foreseeable future (as far as one can predict). Therefore, there is no intention of closing down.
This concept may not be applied if there are evidences or conditions requiring the ceasing of business – for example persistent losses or liquidity problem.
How can accounting concepts be seen as helpful?
Accounting concepts are very helpful in applying commonly established procedures in preparing financial statements.
Distinguish between relevant and irrelevant costs and revenues.
Relevant Costs / Revenues
future costs / revenues that will be changed by a decision
Irrelevant Costs / Revenues
will not be affected by a decision
Example: Going to Glasgow to watch the football and do some shopping.
Do I take my own car or go by train?
Relevant costs – fuel for car, car parking
Irrelevant costs – car tax, car insurance
What are limitations of the break-even analysis?
Unrealistic assumptions – products are not sold at the same price at different levels of output; fixed costs do vary when output changes
Sales are unlikely to be the same as output – there may be some build up of stocks or wasted output too
Variable costs do not always stay the same. For example, as output rises, the business may benefit from being able to buy inputs at lower prices (buying power), which would reduce variable cost per unit.
Most businesses sell more than one product, so break-even for the business becomes harder to calculate
Discuss the criticisms of budgeting in modern organisations.
Demotivational budgets
Setting unrealistic targets
Budgetary Slack
Incremental approach – budget ratcheting
Use it or lose it – budget lapsing
Name, Blame & Shame
Time consuming
Unethical behaviour
A yearly rigid ritual
Cost
What are limitations of using financial ratios?
Many large firms operate different divisions in different industries. For these companies it is difficult to find a meaningful set of industry-average ratios.
Inflation may have badly distorted a company’s balance sheet. In this case, profits will also be affected. Thus a ratio analysis of one company over time or a comparative analysis of companies of different ages must be interpreted with judgment.
Seasonal factors can also distort ratio analysis. Understanding seasonal factors that affect a business can reduce the chance of misinterpretation. For example, a retailer’s inventory may be high in the summer in preparation for the back-to-school season. As a result, the company’s accounts payable will be high and its ROA low.
What are examples of current assets?
Cash, including foreign currency Investments, except for investments that cannot be easily liquidated Prepaid expenses Accounts receivable Inventory
