Business Accounts Flashcards
List the two main financial statements prepared at the end of an accounting period.
The two main financial statements are the profit and loss account and the balance sheet.
What is the relationship between a business and its owner regarding capital contributions?
A business is treated as a separate entity from its owner, meaning that if an owner contributes capital, the business ‘owes’ that capital back to the owner.
Define ‘nominal ledger’ in the context of book-keeping.
A nominal ledger is a record where transactions of a similar type, such as payments for rent and electricity bills, are grouped together.
How does book-keeping contribute to financial management in a business?
Book-keeping contributes to financial management by providing a clear record of all transactions, which aids in budgeting, forecasting, and financial analysis.
How does a purchase of an asset affect the accounts in double entry book-keeping?
When a sole trader purchases an asset for £5,000, there is a £5,000 reduction in cash and a £5,000 increase in assets.
What must be true about the sum of debits and credits in double entry book-keeping?
The sum of all debits must equal the sum of all credits over the relevant accounting period.
Describe the business structure of Mr X.
Mr X operates as a sole trader running the business of XYZ Trading.
Define a trial balance.
A trial balance is a list of all the balances on a business’s ledgers/accounts at the end of an accounting period, showing debit balances in one column and credit balances in another.
Explain the relationship between a trial balance and financial statements.
A trial balance forms the basis of information from which financial statements, such as the profit and loss account and balance sheet, are compiled.
What are payables in a trial balance.
Payables represent the amounts owed by the company to creditors, indicating the company’s short-term liabilities.
What role do receivables play in a trial balance?
Receivables indicate the amounts owed to the company by customers, reflecting the company’s assets.
Identify the types of revenue included in a trial balance.
Revenue in a trial balance typically includes sales income, service income, and any other income generated by the business.
Explain the significance of the provision for doubtful debts in a trial balance.
The provision for doubtful debts accounts for potential losses from uncollectible receivables, impacting the net asset value.
Describe the relationship between purchases and inventory in a trial balance.
Purchases increase inventory levels, and the cost of goods sold is reflected in the expenses, impacting the overall profitability.
Identify the five types of accounts represented in a trial balance.
The five types of accounts are asset, liability, capital, income, and expense (ALCIE).
Describe the importance of the ALCIE classification in financial statements.
The ALCIE classification is important as it helps in categorizing different types of accounts, which is essential for preparing accurate financial statements like balance sheets.
What is a balance sheet.
A balance sheet is a financial statement that summarizes a business’s assets, liabilities, and equity at a specific point in time.
What is in a balance sheet extract.
A balance sheet extract typically includes fixed assets, current assets, current liabilities, long-term liabilities, and net assets.
Define net book value in the context of a balance sheet.
Net book value is the value of an asset after accounting for accumulated depreciation.
What are current assets in a balance sheet.
Current assets represent the assets that are expected to be converted into cash or used up within one year, indicating liquidity.
What are long-term liabilities in a balance sheet.
Long-term liabilities are obligations that are due beyond one year, impacting the company’s financial stability and leverage.
Discuss the importance of cash at bank in current assets.
Cash at bank is crucial as it represents liquid assets available for immediate use, impacting a company’s liquidity and operational flexibility.
How long must a company hold a fixed asset for it to be classified as such?
A company must hold a fixed asset for over a year for it to be classified as a fixed asset.
What are fixed assets also known as?
Fixed assets may also be called ‘non-current assets’.
Define current assets.
Current assets are cash and items owned by a business that can quickly be converted into cash, typically within one year.
Do current assets include items owed to the business?
Yes, current assets include items owed to the business, such as accounts receivable.
Describe the two main categories of liabilities.
Liabilities are categorized as current liabilities, which are due to be paid within a year, and long-term liabilities, which fall due after one year.
Give examples of current liabilities.
Examples of current liabilities include a bank overdraft (repayable on demand) and trade creditors (such as suppliers of raw materials).
Identify a common example of a long-term liability.
A common example of a long-term liability is a term loan, which falls due after more than one year.
What is another term for long-term liabilities?
Long-term liabilities are also known as non-current liabilities.
How does a sole trader pay themselves from the business profits?
A sole trader pays themselves through drawings taken from the profits of the business. They cannot employ themselves and pay a salary
How do year-end adjustments affect the trial balance?
Year-end adjustments correct imbalances in the trial balance, ensuring that expenses and income are accurately reflected for the current accounting period.
What happens if year-end adjustments are not made?
If year-end adjustments are not made, the financial statements may inaccurately reflect the business’s expenses and income, leading to potential financial misstatements.
Describe the purpose of a profit and loss account.
The profit and loss account records the income of a business throughout an accounting period minus the expenses incurred in that period, resulting in a profit or loss figure for the period.
What type of account is ‘cash at bank’ and where does it appear?
‘Cash at bank’ is an asset account and does not appear on the profit and loss account.
What is the significance of opening and closing stock in the Profit and Loss Account?
Opening stock is the value of inventory at the beginning of the period, while closing stock is the value at the end; they are used to calculate the cost of sales.
Explain the calculation of cost of sales in the Profit and Loss Account.
Cost of sales is calculated by adding opening stock to purchases and then subtracting closing stock.
How does closing stock affect the cost of sales calculation?
Closing stock reduces the cost of sales, as it is subtracted from the total of opening stock and purchases.
Describe the purpose of a balance sheet .
A balance sheet records the financial position of a business by detailing its assets, liabilities, and capital accounts, providing a complete view of its financial status at year-end.
Define the components of a balance sheet.
The components of a balance sheet include assets, liabilities, and capital accounts.
What role do liabilities play in a balance sheet?
Liabilities represent the obligations or debts that a business owes to external parties, indicating the financial responsibilities of the business.
Describe the main difference between a balance sheet and a profit and loss account.
A balance sheet is a snapshot of a business’s financial position on a specific date, while a profit and loss account relates to a period of time, typically a year.
What information does a balance sheet provide about a business’s assets?
A balance sheet records the value of the total assets held by the business as of the specified date.
Describe the two key pieces of information provided by a balance sheet.
The balance sheet reveals the net worth or net asset value (NAV) of a business, which is the value of its assets minus its liabilities, and the capital invested in the business to achieve that net worth.
How is net worth represented on a balance sheet?
Net worth is recorded in the top half of the balance sheet as the net asset value (NAV), which is the value of the assets less the liabilities.
What does the bottom half of a balance sheet represent?
The bottom half of the balance sheet represents the capital invested in the business to achieve its net worth.
Explain the relationship between the two halves of a balance sheet.
The two halves of the balance sheet must always balance, meaning the net worth in the top half equals the capital invested in the bottom half, unless there is an error.
Define net asset value (NAV) in the context of a balance sheet.
Net asset value (NAV) is the value of a business’s assets minus its liabilities, indicating the business’s net worth.
How does the top half of the balance sheet relate to the bottom half?
The top half of the balance sheet shows how the money invested by the owners (shown in the bottom half) has been used to create the net worth of the business.
What would the accumulated depreciation be in the context of Marleys Department Store.
Accumulated depreciation refers to the total depreciation expense that has been recorded against an asset over time. In Marleys’ example, after Year 3, the accumulated depreciation would be £3,600.
Explain the significance of Net Book Value for a business.
Net Book Value is an estimate of the current value of the asset to the business, reflecting its worth after accounting for depreciation.
What formula is used to determine the Net Book Value of an asset?
The formula used is COST – ACCUMULATED DEPRECIATION = NET BOOK VALUE.
How is the current value of a fixed asset calculated?
The current value of a fixed asset is calculated by subtracting accumulated depreciation from the original cost of the asset.
What financial statements reflect the depreciation charges for the van?
The depreciation charges for the van are reflected in the Profit and Loss Account as expenses for each year and on the Balance Sheet as accumulated depreciation liabilities.
What is the total accumulated depreciation at the end of Year 3?
At the end of Year 3, the total accumulated depreciation is £5,856, which is the sum of Year 1 (£2,400), Year 2 (£1,920), and Year 3 (£1,536) depreciation charges.
Calculate the depreciation charge for Year 3 based on the accumulated depreciation.
The depreciation charge for Year 3 is calculated as 20% of the reduced balance, which is £12,000 - £4,320 (total accumulated depreciation after Year 2). This results in a depreciation charge of £1,536 for Year 3.
How does accumulated depreciation appear on the Balance Sheet after Year 2?
After Year 2, the accumulated depreciation appears on the Balance Sheet as a liability, totaling £4,320, which is the sum of Year 1 (£2,400) and Year 2 (£1,920) depreciation charges.
What is the depreciation charge for Year 2 based on the reduced balance?
The depreciation charge for Year 2 is calculated by applying the 20% depreciation rate to the reduced balance of £9,600. This results in a depreciation charge of £1,920.
How is the depreciation charge of 20% for Year 1 calculated for the van purchased by First Response Plumbers for £12,000?
The depreciation charge for Year 1 is calculated as 20% of the initial cost of the van, which is £12,000. Therefore, the depreciation charge is £2,400. £2,400 (Year 1 depreciation) = £9,600.
Describe the process of calculating depreciation using the reducing balance method.
The reducing balance method calculates depreciation by applying a fixed percentage to the asset’s book value at the beginning of each period. For example, if a van is purchased for £12,000 and depreciated at 20%, the first year’s depreciation is £2,400 (20% of £12,000). In subsequent years, the depreciation is calculated on the reduced balance after deducting previous depreciation.
Explain how accumulated depreciation affects the Balance Sheet
Accumulated depreciation is shown in a liability account on the Balance Sheet, which reduces the net book value of the asset, indicating the total amount of depreciation that has been charged against the asset.
What impact does depreciation have on the Profit and Loss Account
Depreciation is recorded as an expense on the Profit and Loss Account, reflecting the loss in value of the shelving as a cost to the business.
Define the accruals/matching concept.
The accruals/matching concept requires that all income and expenditure be matched to the relevant accounting period and that current obligations be anticipated as liabilities.
Marleys Department Store purchases shelving for £6,000, expected to last 5 years. The cost is spread evenly, resulting in an annual depreciation charge of £1,200. This charge accumulates each year, impacting the Profit and Loss Account as an expense and reducing the net book value of the asset on the Balance Sheet.
How is the annual depreciation charge calculated in the example of Marleys Department Store?
The annual depreciation charge is calculated by dividing the total cost of the shelving (£6,000) by its expected lifespan in years (5), resulting in a charge of £1,200 per year.
Explain when the straight-line method is most appropriate to use.
The straight-line method is most appropriate when the service provided by the asset continues consistently throughout its useful economic life.
How does the depreciation graph appear for the reducing balance method?
If plotted on a graph, the depreciation of the asset using the reducing balance method would form a curved line.
In what scenario is the reducing balance method typically used?
The reducing balance method is used where an asset is likely to lose a large part of its value in the first few years of ownership, such as motor vehicles.
What is meant by ‘charge to depreciation’?
The ‘charge to depreciation’ or ‘depreciation charge’ refers to the amount of depreciation expense allocated for an asset during a specific period.
How does a van’s depreciation differ from shelving?
A van tends to produce more revenue in its earlier years and loses value more quickly, making the reducing balance method more relevant compared to shelving.
What is the reducing balance method of depreciation?
The reducing balance method of depreciation applies a higher depreciation charge in the earlier years of an asset’s life, reflecting its rapid loss of value.
Explain why shelving uses the straight-line method.
Shelving uses the straight-line method because it is used consistently over its lifespan and generates a consistent amount of income.
Define the straight-line method of depreciation.
The straight-line method of depreciation allocates an equal amount of depreciation expense for each year of the asset’s useful life.
How should depreciation be carried out according to accounting principles?
Depreciation must be carried out in a systematic and regular manner, using a method that closely reflects how the asset loses value over the relevant accounting periods.
Describe the purpose of depreciation in accounting.
Depreciation is used to account for the decline in value of fixed assets over time and to spread the cost of the asset over its useful life, ensuring that the financial statements reflect a true position of the business.
How do year-end adjustments affect financial statements?
Year-end adjustments ensure that income and expenses are recorded in the correct accounting period, providing a more accurate representation of a company’s financial position.
Describe the situation regarding Panache Beauty Salon’s legal fees at the year end.
Panache Beauty Salon has a balance of £27,000 in the Legal Fees account but has incurred an additional £5,000 in legal fees for which it has not yet received a bill, bringing the total legal fees used to £32,000.
Define the term ‘Accrual’
An Accrual refers to an accounting adjustment that recognizes expenses that have been incurred but not yet paid.
Describe a prepayment
A prepayment arises when an expense is paid for in the current year, but all or part of the cost should be charged as an expense for the next year.
How does a prepayment affect financial statements?
If an adjustment is not made for the prepayment, the accounts will not reflect the true position of the business, potentially showing artificially low profits.
How can prepayments impact a business’s profit reporting?
Prepayments can lead to an artificially low profit reporting if the expenses are not properly matched to the period in which the benefits are received.
What is an example of an accrual
An accrual arises when an expense has been incurred but not yet recorded in the accounts, typically because an invoice has not been received.
How does an accrual affect the profit of a business?
If an accrual is not recorded, the profit of the business may appear artificially high, as the expense that should be accounted for in the current period is omitted.
Explain the importance of making adjustments for accruals.
Making adjustments for accruals is crucial to ensure that the financial statements provide a true and fair view of the business’s financial performance and position.
Do accruals impact the trial balance?
Yes, accruals impact the trial balance as they represent expenses that have been incurred but not yet recorded, affecting the overall financial results.
What is the Receivables account in a business context.
The Receivables account shows the amount of money owed to the business by debtors, representing an asset that the business expects to collect.
Explain what constitutes a bad debt.
A bad debt is a receivable that a business knows it will not collect, often due to the debtor’s insolvency.
What happens to bad debts in accounting?
Bad debts are written off, meaning they are removed from the Receivables account as the business gives up any prospect of collecting the debt.
How do bad debts affect the trial balance
Writing off bad debts during the accounting year affects the trial balance by creating a bad debts expense account. If no debts are written off, this account will not exist.
Define a doubtful debt.
A doubtful debt occurs when a business recognizes the possibility that a debt or debts may not be paid, without completely writing off the debt.
Describe the difference between a doubtful debt and a bad debt.
A doubtful debt is not written off completely, as the business still hopes to receive payment, while a bad debt is fully written off as uncollectible.
What are general doubtful debts?
General doubtful debts refer to a situation where a business lacks specific information about debtors but anticipates that a certain percentage of its receivables may not be paid due to overall market conditions.
How might a business estimate general doubtful debts?
A business may estimate general doubtful debts by analyzing market conditions and determining a percentage of receivables that are likely to remain unpaid, such as estimating that 5% of receivables may not be collected.
What actions might a business take when it identifies a specific doubtful debt?
When a specific doubtful debt is identified, a business may choose to monitor the debtor’s situation closely and may set aside a provision for the potential loss while still hoping for payment.
Define the term ‘Provision for Doubtful Debts’.
It is an account that reflects the estimated amount of receivables that may not becollected, serving as a financial cushion for the business.
What is the effect of a doubtful debts account?
Its nature is similar to that of a liability account, as it reduces the net asset value of the business.
What types of provisions can a business choose to make?
A business may choose to make a specific provision, a general provision, or a combination of both.
How is the expense for doubtful debts calculated in the Profit and Loss Account?
Only the increase in the provision for doubtful debts over the previous year’s provision is treated as an expense, not the whole amount.
What financial benefit does Nightingales experience in Year 3 due to the change in Provision for Doubtful Debts?
In Year 3, Nightingales experiences a financial benefit of £1,000 due to the reduction in the Provision for Doubtful Debts, which lowers their expenses.
How does the Provision for Doubtful Debts relate to the concept of prudence in accounting?
It reflects the principle of prudence by ensuring that potential losses from uncollectible debts are recognized in financial statements.
What alternative term is used for ‘Provision for Doubtful Debts’ in a company’s Balance Sheet?
It is referred to as ‘Impairments’ in the Balance Sheet.
Define the main difference in the Balance Sheet of a partnership compared to a sole trader.
The main difference is in the bottom half of the Balance Sheet, which denotes capital, as a partnership is owned by at least two different people.
Explain the additional step required to show the capital of a partnership on the Balance Sheet.
To show the capital of a partnership correctly on the Balance Sheet, it is necessary to prepare a profit appropriation statement.
What is the purpose of a profit appropriation statement in a partnership?
A profit appropriation statement records how the profits of the business for the relevant accounting period are divided between the partners.
Describe the purpose of ‘drawings’ in a partnership.
Drawings are withdrawals of profits by the partners during the year, allowing them to pay themselves based on an estimate of their share of expected profits.
How can excessive drawings affect a partner in a partnership?
If a partner draws too much, they may be liable to contribute a balancing payment back to the partnership, depending on the terms of the partnership agreement.
What does the Capital account represent in a partnership?
The Capital account represents the partner’s original investment in the partnership along with any subsequent investments, and this capital cannot be withdrawn in normal circumstances.
Explain the function of the Current account in a partnership.
The Current account records the partner’s share of ongoing business profits and shows any drawings that the partner has taken out over the year.
What is the significance of having separate accounts for each partner in a partnership?
Having separate accounts for each partner allows for clear tracking of individual investments, profits, and withdrawals, ensuring transparency and accountability.
How are the Capital and Current accounts classified in a partnership?
Applying the A/L/C/I/E classification, both the Capital and Current accounts are considered capital accounts.
