AOS 4 Flashcards
Closing Ledger accounts
Assets, liabilities and owner’s equity accounts should be balanced in preparation for the balance sheet.
Revenue and expense accounts should be closed off to the P&L summary account.
Why close ledger accounts
The P&L summary account uses the revenue and expense accounts to determine the net profit or loss for the period.
Revenue and expense accounts are returned to zero balances, ready for the new reporting period. This ensures that this period’s revenues and expense are not counted again in the subsequent period.
Income statement
The basic function of the income statement is to report on the revenues earned and the expenses incurred for the current period. This is done to determine profit under the accrual accounting assumption.
Why do income statement and of P and L Summary?
A formal report should always be prepared, even if the P&L summary has been finalised. The data in the P&L summary account is very limited; in order to satisfy the requirements of understandability, a formal income statement should always be prepared.
Link between income statement and balance sheet
The income statement determines the net profit for the period. This result is then included in the balance sheet as part of owner’s equity.
4 measures of profit in income statement
- the trend over consecutive periods
- budgeted or expected profit
- industry averages
- financial indicators.
What is trend analysis and how can it assist in evaluating profit
Trend analysis allows management to measure performance over a number of periods to identify improvements or decline in profit outcomes.
Distinguish between cost of sales and cost of goods sold?
Cost of sales is the cost price of goods sold in a given period. Cost of goods sold is a classification used in an income statement, which includes cost of sales, plus any other costs incurred in getting inventory into the business, putting it on display and preparing it for sale.
Things included in cost of goods sold:
Cost of sales Cartage inwards Customs duty buying expenses DO NOT INCLUDE CARTAGE OUTWARDS
Is a decrease in net profit indicate poor expense control
Poor expense control may bring about a decrease in net profit. However, profit can also decrease if suppliers’ prices increase and management does not adjust selling prices. Of course, a cause of a decrease in profit may simply be that the business has had a significant decrease in the number of units sold during a period.
Purpose of cash flow statement
The purpose of the cash flow statement is to provide a summary of all cash flows for a given period. It does so by classifying cash flows into three categories: operating, investing and financing cash flows.
What cash means when it is used in relation to a cash flow statement
Cash means all short-term cash investments that can be turned into cash in a short period.
Describe the three classifications used within a cash flow statement
Operating activities: cash flows from the day-to-day operations of the business.
Investing activities: cash flows relating to the selling or buying of non-current assets.
Financing activities: cash flows relating to changes in the financial structure of the business. This includes loans and loan repayments, capital injections and drawings.
4 different types of cash flow in relation to GST
- GST collected on cash sales: Operating inflow
- GST paid on cash purchases or expenses: Operating outflow
- GST settlement: Operating outflow whereby the business is paying off their GST obligation to the ATO
- GST refund: Operating inflow whereby the business receives a refund because it has paid more GST than it has received.
why monitor businesses inventory
- items are not going past their use-by-date
- slow moving lines of inventory are identified and possible eliminated
- fast moving lines are identified and re-ordered promptly
- all items are presented well and are not damaged or shop-soiled.
security measures to protect inventory
- security cameras in the store
- security tags on all products
- security personnel patrolling the store and/or standing at exits
- two-way mirrors, allowing management to monitor the store from another room
- dye bombs being tagged on inventory items (for example, clothing).
What is inventory turnover
Inventory turnover is a measure of the number of days it takes a business to turn its average level of inventory into sales
Procedures management should follow before granting credit to consumers
Before granting credit to customers, management should complete a thorough credit check. This may involve checking with references, requesting a credit rating or reviewing financial statements provided by the customer.
What is the purpose of age analysis of accounts receivable
An age analysis of accounts receivable classifies the amounts owing according to the age of their debts. Categories such as 0-30 days and 31-60 days provides information to management to help evaluate their collection procedures.
What does account receivable evaluate
Accounts receivable turnover determines the average time taken by credit customers to settle their accounts.
tactics to speed up account receivable turnover
- offering discounts for prompt settlements
- sending regular statements to all accounts receivable
- sending reminders to all overdue accounts
- threatening legal action to overdue accounts.
What is cash cycle
The cash cycle is the total time taken to turn inventory into accounts receivable and then into cash. This time is determined by adding the inventory turnover (in days) to the accounts receivable turnover (in days).
Problems with slow cash cycle
If the cash cycle increases in days, this indicates that the cycle is getting slower over time. This may cause a range of problems, the first being a fall in liquidity. If a business is taking longer to receive its cash, liquidity problems may result as they may have difficulty meeting its debts on time. Other issues may also result, as the slower cash cycle may be the result of poor inventory turnover. This may indicate that goods are past their use-buy-date, have gone out of fashion or have become technologically obsolete.
Factors when evaluating accounts payable turnover
Accounts payable turnover will often be affected by both inventory turnover and accounts receivable turnover. If a business is having difficulty getting cash in from their customers, their own accounts payable turnover may become slower and slower.
Implications of fast accounts payable turnover
If accounts payable turnover is very fast, a business may simply run out of cash. Sometimes business owners are attracted to discounts for prompt payments and may save 2% or 3% on all accounts. However, if they pay all accounts quickly they may run out of cash and the result may well be a bank overdraft. This may result in interest on overdraft being incurred, which could be greater than the discounts received.
Implications of slow accounts payable turnover
A slow accounts payable turnover may result in credit being refused by a supplier. If a business defaults on a debt, this can also affect their credit rating, which may make credit more difficult to obtain in the future.
