Benefits/Limitations Flashcards
Benefits of producing a trial balance
THINK- PUPAT
Addition error - There have been mathematical errors when calculating balances on accounts or when calculating totals in the books of prime entry.
Partial Omission error- an item has only been entered once (either as a debit or credit).
Transposition error- an amount has been posted with two numbers the wrong way around (e.g £456 instead of £465).
Unequal posting error- Different amounts have been debited and credited, usually because one side of the double entry has been wrongly posted.
It clearly lists all the figures that are needed to produce the financial statements
Limitations of the trial balance
OPCOR
Omission - A transaction has been completely omitted from the accounting records
Commission- A transaction that’s been entered in the wrong type of account but the right type of account (e.g the wrong expense, or the wrong account in the receivables ledger or payables ledger
Principle - A transaction has been entered in the wrong type of account (e.g Motor expenses instead of Motor vehicles or an expense in the income statement instead of Drawings)
Compensating errors- where two errors cancel out each other
Reversal - the debit and credit entries have been entered the wrong way around
Although it may reveal that an error has taken place, it will not reveal where that error has occured
Benefits of producing a bank rec
it enables errors on the bank statement to be investigated and notified to the bank for correction
it helps prevent fraud as the bank statement is an independent accounting record prepared by the bank
it enables out of date cheques to be identified and cancelled in the cash book
Limitation of bank rec
it will not immediately show if a payment or receipt has been left out of the cash book or, is incorrectly entered in the cash book, if the payment or receipt is also unpresented
Benefits of control accounts
Can show that an arithmetical error has occurred if the balance on the control account does not equal the total of the individual accounts in the receivables ledger. If they don’t agree, then an error has definitely taken place. This helps to avoid incorrect balances in the receivables ledger and in the payables ledger.
Control accounts immediately provide total figures for TR and TPs, instead of having to add up the individual accounts in the receivables ledger and payables ledger. This helps to produce the financial statements.
They help to prevent fraud - managers have access to CAs, which restricts the possibility of fraudulent entries by other employees
Limitations of Control Accounts
They don’t prove that each individual account balance is correct, they will not show :
If a transactions has been completely left out of the accounting system (omission error)
If the wrong amount was entered in the accounting system for a transaction (original entry error)
If a transaction was entered in the wrong account in the receivables/payables ledger (commission error)
Don’t show exactly where in the receivable/payables ledger the error has taken place
Limitations of financial statements and ratio analysis
both contain historical data from the past - they may not reflect what will happen in the future or what is currently happening.
the values of assets may be inaccurate- due to policies regarding depreciation, inventory valuation and doubtful debts.
financial statements don’t include items that can’t be measured financially- e.g. quality and staff morale or external factors that’ll affect the business in the future.
the income statement for a limited company is in summary format- it doesn’t show individual expenses which may limit its usefulness
Benefits of Payback
It’s easier to understand than NPV - this is because it doesn’t involve the time value of money.
It’s easier to calculate than NPV- this is because you don’t have to obtain discount factors.
It’s more likely to be accurate than NPV- it only includes earlier cash flows , which are more reliable than later cash flows
Benefits of net present value
NPV calculates the profitability of the investment - this is because it includes cash flows after the payback period.
It considers the timing of cash flows- predicted cash flows are discounted in order to calculate their present value.
Uses forecast cash flow and not forecast profit.
Takes into account the time value of money by discounting cash flows.
Limitations of net present value
Harder to understand for some users of information- the concept of present values and the time value of money are difficult to understand.
Predicted rate of interest may be incorrect- this means the discount factors and the present values may be incorrect.
Predicted cash flows may be inaccurate (although also true for payback)- this means the calculations of present values may be incorrect.
Benefits of SOCF
can help shareholders to assess the business’ liquidity
show shareholders where cash has come from and where it has been spent
they provide some info that isn’t available in the income statement or SOFP
Importance of liquidity
Cash is essential to the short term survival of the business. If a business can’t pay its running costs, it can be placed into administration.
Liquidity could affect the level of dividends.
Liquidity may indicate whether the company can afford future expansion.
Limitations of SOCF
Shareholders need to use income statements (to assess profitability) and SOFP (to assess liquidity and gearing).
Like other financial statements, SOCF are historical and don’t always indicate what’ll happen in the future.
Like other financial statements, many items are summarised and do not provide detailed information.
Benefits of Schedule of NCAs
They show the breakdown of NBV between cost and P4D.
The depreciation for the year shows the impact of NCAs on the profitability of the company. This wouldn’t be shown as a separated expense in the company’s income statement.
They are required by the regulatory framework, which helps to provide a true and fair view.
Limitations of Schedule of NCAs
The info + historical, and may not reflect the current position.
The info is summarised, as it doesn’t provide a detailed breakdown of the cost of each asset, addition or disposal.
The figures for depreciation may not be accurate, and therefore the NBV could be incorrect.
Disadvantages of keeping incomplete records
More danger of fraud and theft- the business owner is less likely to see cash or inventory that has been stolen.
Inaccurate info for tax purposes- this would cause incorrect amount of tax being paid to HMRC.
It’s harder to prep financial statements - this’ll increase the amount that needs to be paid to accountants to prepare the income statement and SOFP.
Less evidence to support applications to for bank loans- the lack of full accounting records may prevent the owner from demonstrating the liquidity of the business to potential lenders.
Reasons for keeping incomplete records
Lack of knowledge- the owner may not know how to maintain double-entry bookkeeping.
Cost- the business may not be able to afford the cost of employing a bookkeeper or training the owner to carry out double entry bookkeeping.
Time- consuming - if the owner of the business carries out the bookkeeping, it leaves less time to concentrate on other aspects of the business.
Limitations of Activity based costing
Not all expenses can be related to cost drivers e.g. rent, insurance, so there will still have to be some arbitrary apportionment of overheads.
It’s more time-consuming than absorption costing because of the need for detailed record keeping.
It’s doubtful whether a single cost driver can explain the cost or behaviour of an activity.
Benefits of ABC compared with absorption costing
It enables management to have a greater understanding of why costs are incurred and therefore how to control costs.
More accurate unit costs can lead to a more accurate establishment of selling prices.
It doesn’t require an arbitrary apportionment of overheads based on labour hours and machine hours.
Benefits of Absorption Costing
Ensures full cost recovery, as unlike marginal costing, it doesnt include overheads.
Mark up % for the selling price will be lower than using marginal costing.
Acceptable under international accounting standards for a valuation of inventory
Limitations of Absorption Costing
Improvement in technology may lead to the use of labour hours not being a relevant basis of apportionment.
OAR will be inaccurate if the estimated figures for overheads and the level of production are inaccurate.
Ways to apportion overheads between cost centres and/or from service departments may not be completely accurate.
Limitations of payback
It ignores the profitability of the investment- this is because it ignores cash flows after the payback period.
It ignores how long the asset is expected to last after the payback period- this is because it ignores the large outflow that will be needed to replace the asset.
The predicted cash flows may be inaccurate (although also true for NPV) - this means the calculation of the payback period may be incorrect.
It ignores life expectancy of the project ; it doesn’t consider cash flows that take place after the payback period.
Benefits of specific budgets
Improved decision making - the cash budget will help managers make decisions about managing cash flow and obtaining finance - the sales budget will inform market decisions- production , purchases and labour budgets will help decision making in those departments.
Control- assists with purchase costs, labour costs and any expenses in the cash budget.
Improved planning- assists with production levels, purchases and labour hours- also for planning how to deal with any negative balances in the cash budget.
Limitations of Dividend Yield
No guarantee that the dividend will be the same as last year.
Short term = ignores capital growth.
Limitations of Price Earnings
Market price will be changing every minute, meaning shares can be overvalued
Limitations of Interest Cover
Historic information.
No indications when loans are due therefore it doesn’t take account of having to pay it back.
Limitations of Earnings per share
Ignores the fact that companies have different amount of shares.
Needs to be used with dividend yield to compare with previous years.
Limitations of Dividend cover
Dividends paid out aren’t always the same each year
Benefits of specific/cash budgets
Target setting- well
Describe disadvantages of a standard costing system
Cost- it will take time to collect the data to set up the standard cost. These will need to be regularly reviewed so there will be an ongoing cost.
Doesn’t encourage continuous improvement- it may be seen that meeting the standard is acceptable so there would be no incentive to improve.
May not be suitable for all organisations- more suited. To a production company rather than service company, as it’s difficult to quantify eg customer satisfaction.
Advantages of being a sole trader
The owner keeps all the profits
The owner is their own boss making all the decisions
It’s quicker and easier to set up this type of business than a partnership or limited company
The sole traders financial statements remain private and don’t have to be made available to the public
Disadvantages of being a sole trader
The owner plus what they can borrow is the only source of capital
The owner experience long working hours on a heavy workload
The owner will lose money if sick or on holiday
The owner has unlimited liability - their personal assets are at risk if the business is unable to pay debts.
Advantages of a partnership
More than one source of capital though not necessarily equal amounts
Shared workload
Partners can specialise allowing each to concentrate on what they can do best
It’s quicker and cheaper to set up than a limited company
The partnership’s financial statements remain private and don’t have to be made available to the public
Disadvantages of a partnership
Profits have to be shared between the partners, not necessarily equally
There can be disagreements between the partners
The owners still have unlimited liability – the partners are responsible for paying any business debts, even if that means selling their own personal assets
Give the advantages of becoming a plc
Large amounts of capital raised by issuing shares through the stock market.
The capital raised through the sale of shares can be used to expand the business (instead of a bank loan).
Expansion leads to higher levels of profit.
Given the disadvantages of becoming a plc
Profits have to be shared with a large number of shareholders.
Original owners probably lose control as they own less than 50% of the shares.
Financial statements are freely available on the company’s website
Give the advantages of a limited company
More capital can be raised by selling shares.
The shareholders have limited liability which means less risk. The most they can use is what they paid for their shares ;they don’t have to provide any more money to pay the company’s debts
Give the disadvantages of a limited company
It takes longer and is more expensive to set up a limited company than a sole trader or partnership.
The profits have to be shared with shareholders.
The original owners lose controls of they own fewer than 50% of the shares.
FS are no longer confidential as anyone can obtain them from Companies House or for a plc from the company’s website .
Benefits of a production budget
Identify the production capacity available
Schedules resources - e.g cash, materials, labour effectively
Meet sales demand
Make best use of space capacity
