Chapter 13,14,15

Question 1

1 Distinguish between a cash transaction and a credit transaction.

Answer 1

When a cash transaction occurs, the goods and cash are exchanged at the same time; when a credit transaction occurs, the exchange of goods occurs first, with the exchanging of cash occurring at a later date.

Question 2

2 Referring to one Qualitative Characteristic, explain the importance of source documents in the accounting process.

Answer 2

Source documents provide the verifiable evidence that a transaction has occurred, thus ensuring that the reports are free from bias and subjectivity (Reliability).

Question 3

3 Explain why credit terms should be noted on an invoice.

Answer 3

Credit terms allow the business to stipulate to the debtor (on the invoice) exactly when the invoice has to be paid.

Question 4

4 Explain how a business can distinguish between a sales invoice and a purchase invoice.

Answer 4

The name of the seller is always identified at the top of the invoice, and the name of the customer is identified in the middle. Therefore, if the business for which we are accounting (‘our business’) is named at the top of the invoice, the document is a sales invoice. If, however, our business is named in the middle of the invoice, the document is a purchase invoice.

Question 5

5 Define the following terms:

• debtor
• creditor

Answer 5

• debtor – a customer who owes a debt to the business for goods or services sold to them on credit
• creditor – a supplier who is owed a debt by the business for goods or services purchased from them on credit

Question 6

6 Explain how debtors and creditors are reported in the Balance Sheet

Answer 6

Debtors are reported as a current asset as they are a resource controlled by a business from which future economic benefit is expected (when the debtor pays) in the next 12 months. Creditors are reported as a current liability as they are a present obligation, the settlement of which will result in an outflow of economic benefit (when the cash is paid to the creditor) in the next 12 months.

Question 7

7 Explain how the GST affects the amount owed to a creditor for the purchase of stock on credit.

Answer 7

When stock is purchased on credit, the business must pay not only for the stock, but also the GST. Therefore, the amount owed to a creditor includes the supplier’s price for the stock and 10% GST.

Question 8

1 Explain the role of the Purchases Journal.

Answer 8

A Purchases Journal is an accounting record that summarises all transactions involving the purchase of stock on credit.

Question 9

2 State which type of source document is used to verify all transactions recorded in the Purchases Journal.

Answer 9

A purchase invoice is used to verify all transactions recorded in the Purchases Journal.

Question 10

3 Explain the effect of ‘GST incurred on credit purchases’ on the valuation of stock.

Answer 10

GST incurred on credit purchases will not affect the valuation of stock, because it is in fact a reduction in the GST liability to the ATO (it does not affect the economic benefit to be derived from stock). Therefore, stock is valued at the supplier’s price, and the GST incurred on credit purchases reduces the GST payable.

Question 11

4 Referring to the Purchases Journal, state one reason why the amount recorded in the Total Creditors column is greater than the value of stock purchased.

Answer 11

It is greater due to the amount of GST incurred on the credit purchase.

Question 12

5 Explain the effect of ‘GST incurred on credit purchases’ on GST payable.

Answer 12

GST incurred on credit purchases reduces GST payable because the GST will be forwarded to the ATO by the supplier and it is as if the business paid the GST directly to the ATO.

Question 13

1 State the source document used to verify cash paid to a creditor.

Answer 13

A cheque butt is used to verify cash paid to a creditor.

Question 14

2 Explain why there is no GST to account for when cash is paid to a creditor.

Answer 14

There is no GST on a payment to a creditor because the GST is recognised and reported only at the time the original purchase is made.

Question 15

3 State one reason why ‘payments to creditors’ are recorded in their own classification column in the Cash Payments Journal.

Answer 15

Payments to creditors will be a frequent cash payment, and therefore will be recorded in their own classification column in the Cash Payments Journal.

Question 16

1 Explain the effect of recording a credit purchase in a stock card.

Answer 16

A credit purchase is recorded in the IN column of a stock card and increases the quantity of stock on hand.

Question 17

2 Referring to the stock card, state one way of distinguishing between a cash purchase and a credit purchase.

Answer 17

One way of distinguishing is to check the source document. A credit purchase is verified by reference to a purchase invoice whereas a cash purchase is verified by reference to a cheque butt.

Question 18

3 Explain the role of a Creditors record.

Answer 18

A Creditors record is a subsidiary accounting record that records each individual transaction with each individual creditor, and shows the balance owing to that creditor at any point in time.

Question 19

4 Explain the role of a Creditors Schedule.

Answer 19

A Creditors Schedule is a listing of the name and balance of each creditor’s record and is used to check that the same information has been recorded in both the journals and creditors records.

Question 20

1 Explain why a credit sale is classified as revenue.

Answer 20

A credit sale is revenue because it creates an inflow of future economic benefits, in the form of an increase in assets (Debtors) that leads to an increase in owner’s equity.

Question 21

2 State which type of source document is used to verify all transactions recorded in the Sales Journal.

Answer 21

A sales invoice is used to verify all transactions recorded in the Sales Journal.

Question 22

3 Explain how the cost price of a credit sale is determined.

Answer 22

The cost price of a credit sale is determined in the OUT column of the stock card using the FIFO assumption.

Question 23

4 Explain the role of the Sales Journal.

Answer 23

The Sales Journal is an accounting record that summarises all transactions involving the sale of stock on credit during a reporting period.

Question 24

5 Explain why the source documents in the Sales Journal run in sequence.

Answer 24

The source documents run in sequence because they are all issued by the business keeping the journal.

Question 25

6 Explain the effect of ‘GST incurred on credit sales’ on sales revenue.

Answer 25

GST incurred on credit sales has no effect on sales revenue, but rather it increases the debt owed by the debtor.

Question 26

7 Explain the effect of ‘GST charged on credit sales’ on GST payable to the ATO

Answer 26

GST charged on credit sales will increase GST payable because it is levied and collected on behalf of the ATO, and so must be forwarded to the ATO.

Question 27

1 State the source document used to verify cash received from a debtor.

Answer 27

A cash receipt is used to verify cash received from a debtor.

Question 28

2 State one reason why ‘receipts from debtors’ are recorded in their own classification column in the Cash Receipts Journal.

Answer 28

Receipts from debtors are a frequent cash receipt for a business. Therefore, they are recorded in their own classification column.

Question 29

4 Explain why a receipt from a debtor is not recognised as revenue.

Answer 29

A receipt from a debtor is not revenue as it is simply swapping one asset (Bank) for another (Debtors). The fact that assets do not increase overall means that it cannot be recorded as revenue. The revenue was already recorded – as a credit sale – at the point of sale.

Question 30

1 Explain the effect of recording a credit sale in a stock card.

Answer 30

A credit sale is recorded in the OUT column of a stock card and will decrease the quantity of stock on hand.

Question 31

2 Referring to the stock card, explain how a cash sale and credit sale can be identified

Answer 31

One way of distinguishing is to check the source document. A credit sale is verified by reference to a sales invoice, whereas a cash sale is verified by reference to a cash receipt.

Question 32

3 State three differences between a Debtors record and a Creditors record.

Answer 32

• Different source documents – sales invoice instead of purchase invoice; cash receipt instead of cheque butt
• Sales heading instead of Purchases heading
• Receipts heading instead of Payments heading

Question 33

1 Explain how subsidiary records can improve the management of debtors.

Answer 33

The records of individual transactions with each individual debtor allow for better management by helping to ensure that invoices are sent, debts are collected from debtors, and late-paying debtors are followed up.

Question 34

2 Explain how subsidiary records improve the Reliability of the accounting reports.

Answer 34

By checking the balance calculated using the formula against the Debtors/Creditors schedule, errors can be detected, helping to ensure that the figures used in the Balance Sheet are Reliable, or free from bias.

Question 35

3 Referring to one Qualitative Characteristic, explain why individual debtors and creditors are not reported in the Balance Sheet.

Answer 35

By preparing a schedule, only one figure needs to be reported in the Balance Sheet, with insignificant details omitted. These details, such as the names and balances of individual debtors and creditors, would not affect decision-making, so in reporting just the total, Relevance is upheld.

Question 36

1 Explain the role of accounting reports.

Answer 36

The role of accounting reports is to provide the owner of the business with financial information in order to aid decision-making

Question 37

2 Explain what is shown in each of the three general-purpose accounting reports.

• Statement of Receipts and Payments
• Income Statement
• Balance Sheet

Answer 37

• Statement of Receipts and Payments – shows cash receipts and payments and the change in a firm’s bank balance over a reporting period
• Income Statement – shows revenues earned and expenses incurred in a particular reporting period
• Balance Sheet – shows assets, liabilities and owner’s equity at a particular point in time

Question 38

3 Name the source documents we studied so far, and the accounting records in which they would be recorded.

Answer 38

• Cash receipt – Cash Receipts Journal, Debtors record (receipts from debtors) and stock card (cash sales)
• Cheque butt – Cash Payments Journal, Creditors record (payments to creditors) and stock card (cash purchases)
• Purchase invoice – Purchases Journal, Creditors record and stock card
• Sales invoice – Sales Journal, Debtors record and stock card.

Question 39

4 Explain the relationship between accounting records and accounting reports.

Answer 39

Once transactions (source documents) are recorded in the accounting records, the summarised data from these records becomes information presented in the accounting reports.

Question 40

1 Explain the role of the Statement of Receipts and Payments.

Answer 40

The Statement of Receipts and Payments shows total cash receipts and payments and the change in a firm’s bank balance over a reporting period.

Question 41

2 Explain the role of cash journals in the preparation of a Statement of Receipts and Payments.

Answer 41

The cash journals summarise the cash transactions for a particular reporting period allowing these totals to be reported in the Statement of Receipts and Payments.

Question 42

3 Explain how the following items are reported in the Statement of Receipts and Payments:

• capital contribution
• credit sales
• payments to creditors
• Cost of Sales .

Answer 42

• capital contribution – cash receipt
• credit sales – not reported in the Statement of Receipts and Payments, because they do not represent a movement of cash
• payments to creditors – cash payment
• Cost of Sales – not reported in the Statement of Receipts and Payments as it does not involve an outflow of cash, but rather the outflow of stock.

Question 43

1 Explain why credit sales is classified as revenue.

Answer 43

When a credit sale is made (and the goods are provided to the customer), an inflow of future economic benefit occurs, in the form of an increase in assets (Debtors), and this leads to an increase in owner’s equity.

Question 44

2 Referring to one Qualitative Characteristic, explain why credit sales must be included in the Income Statement.

Answer 44

As credit sales fits the definition of revenue, despite the fact that no cash is received on the day the sale is made, it must be reported in the Income Statement. Failing to include it would understate Net Profit and thus undermine the Relevance of the Income Statement, making it less useful for decision-making.

Question 45

3 Explain why receipts from debtors is not reported in the Income Statement.

Answer 45

When cash is received from a debtor, there is an inflow of economic benefits (in the form of cash), but it does not increase assets overall (Debtors decreases by the same amount). A receipt from a debtor is, in fact, just swapping one asset (Debtors) for another (Bank); there is no increase in owner’s equity, so it cannot be reported as revenue, and should be omitted from the Income Statement.

Question 46

4 Explain why credit purchases and payments to creditors are not classified as expenses.

Answer 46

Although credit purchases lead to an overall increase in liabilities (Creditors increase more than GST payable decreases), they also lead to an increase in assets (Stock), and so there is no effect on owner’s equity as is demanded by the definition of an expense. Similarly, payments to creditors does not affect owner’s equity, but will decrease assets (Bank) and also decrease liabilities (Creditors). Therefore, payments to creditors fails to meet the definition of an expense on two counts, and so must be omitted from the Income Statement.

Question 47

5 Define the term ‘accrual accounting’.

Answer 47

Accrual accounting is determining profit by recognising revenues as earned when the good/service is provided, and expenses as incurred when the benefit is consumed.

Question 48

6 Explain why GST charged on credit sales is not reported in the Income Statement.

Answer 48

GST charged on credit sales is excluded from the Income Statement as it does not increase owner’s equity but increases the GST payable to the ATO. This is because it is charged and eventually collected (from the debtor) on behalf of the government and will increase the GST liability to the ATO.

Question 49

4 Explain the circumstances in which the GST balance would be classified as a current liability

Answer 49

If GST received and charged on sales is greater than GST paid and incurred on purchases, then the business will report the GST balance in the Balance Sheet as a current liability called ‘GST payable’. This is because selling prices are usually higher than cost prices, and therefore GST on sales will usually be higher than GST on purchases.

Question 50

5 Explain the circumstances in which the GST balance would be classified as a current asset.

Answer 50

If GST paid and incurred on purchases is greater than the GST received and charged on sales, then the business will report the GST balance as a current asset called ‘GST receivable’. This can occur if large outlays are made to purchase non-current assets, or stock has been purchased but not yet sold.

Question 51

1 Explain how Debtors records can be used to aid debtor management.

Answer 51

By examining the Debtor records, the owner can identify slow-paying debtors, and then take steps to recover the cash. Some larger firms may even employ an accounts clerk whose sole role is to manage debtors by issuing invoices, collecting cash and making reminder calls to those who are overdue.

Question 52

2 State what is measured by Debtors Turnover (DTO).

Answer 52

Debtors Turnover is an efficiency indicator that measures the average number of days it takes for a business to collect cash from its debtors.

Question 53

3 Show the formula to calculate Debtors Turnover.

Answer 53

Debtors Turnover (DTO) = Average debtors/Credit Sales x 365

Question 54

4 Explain the importance of credit terms offered to customers in assessing Debtors Turnover.

Answer 54

Credit terms offered to customers should be used to determine whether Debtors Turnover is satisfactory and can indicate effective or poor debtor management. If the Debtors Turnover is well above the credit terms, the business is forced to wait longer to collect its cash, which may place a strain on its ability to meet its other debts.

Question 55

5 Explain why Debtors records and Debtors Turnover should both be used to assess the management of debtors.

Answer 55

A business should use both the Debtors records and Debtors Turnover to assess the management of debtors so that the owner can improve the collection of cash from debtors. Given that Debtors Turnover uses average Debtors in its calculation, the individual Debtors record can identify those particular debtors that are paying late, and action can be taken to encourage them to pay.
 

Question 56

6 Explain why debtor management is vital to ensuring adequate liquidity.

Answer 56

If a firm has a significant amount of sales on credit, then they will not only have to wait until the stock is sold (Stock Turnover), but also wait again until the cash is collected from its debtors (Debtors Turnover) in order to pay its creditors, wages and other expenses. This means the firm’s ability to manage its debtors effectively is crucial to its liquidity..

Question 57

7 List the strategies a business could use to improve its Debtors Turnover, in the order in which they should be implemented.

Answer 57

• Conducting extensive credit checks
• Issuing invoices promptly
• Offering discounts
• Sending reminder notices
• Threatening legal action
• Employing a debt collection agency
• Withdrawing credit facilities

Question 58

1 State what is measured by Creditors Turnover (CTO).

Answer 58

Creditors Turnover is an efficiency indicator that measures the average number of days it takes for a business to pay its creditors.

Question 59

2 Show the formula to calculate Creditors Turnover.

Answer 59

Creditors Turnover (CTO) = Average creditors/Credit purchases x 365

Question 60

3 State three negative consequences of exceeding the credit terms offered by suppliers.

Answer 60

• A loss of any possible discount for early repayment
• Interest charges on late accounts
• A refusal of credit facilities by the supplier
• A reduction in the firm’s credit rating (which may jeopardise future borrowing)

Question 61

4 Explain the relationship between Stock and Debtors Turnover, and Creditors Turnover.

Answer 61

The firm’s ability to pay its creditors will rely heavily on its ability to generate cash from its stock. This means Creditors Turnover is reliant on Stock Turnover and (if the business deals mainly on credit) Debtors Turnover. If stock is sold and cash is collected from customers quickly, then creditors can be paid on time. If not, debt may become overdue, and a whole variety of liquidity problems may result.

Question 62

1 Explain what is meant by ‘accrual accounting’

Answer 62

Accrual accounting is calculating profit by comparing revenues earned against expenses incurred in a particular reporting period.

Question 63

2 Explain the purpose of balance day adjustments

Answer 63

The purpose of balance day adjustments is to ensure that profit can be calculated accurately, by comparing revenues earned against expenses incurred in the current reporting period.

Question 64

3 Explain how balance day adjustments ensure Relevance in the accounting reports.

Answer 64

Balance day adjustments apply the Reporting Period principle to ensure Relevance in the accounting reports. That is, by adjusting the figures so that they show revenue earned and expenses incurred in the current reporting period, we are ensuring that the Income Statement (and, for that matter, the Balance Sheet) includes all information that is useful for decision-making, while excluding information that is not (such as revenue or expenses that were earned or incurred outside the current period).

Question 65

4 List the four balance day adjustments that relate to expenses.

Answer 65

• Stock loss
• Prepaid expenses
• Accrued expenses
• Depreciation expense

Question 66

1 Define the term ‘prepaid expense’.

Answer 66

A prepaid expense is an expense that has been paid but is yet to be consumed.

Question 67

2 Explain why a prepaid expense is classified as a current asset.

Answer 67

At the time an expense is paid in advance, none of it has been consumed. In fact, it will not be consumed until some time in the future, so it is not a consumption of an economic benefit, but rather a future economic benefit. Therefore, it is a resource controlled by the business of which future economic benefit is expected in the next 12 months.

Question 68

4 Referring to one Accounting Principle, explain which part of a prepaid expense should be reported as:

• an expense
• a current asset

Answer 68

• an expense – the amount incurred (consumed or ‘used up’)

* a current asset – the amount that has not yet been consumed (‘unused’).

Question 69

1 Define the term ‘accrued expense’.

Answer 69

An accrued expense is an expense that has been incurred but not yet paid.

Question 70

2 Explain why an accrued expense is classified as a current liability.

Answer 70

An expense that has been incurred in the current reporting period, but is not yet paid is classified as a current liability because it represents a present obligation, the settlement of which will result in an outflow of economic benefit (when the accrued expense is settled) sometime in the next 12 months.

Question 71

4 Referring to one Accounting Principle, explain why accrued expenses must be added on to the amount paid to determine the total expense figure.

Answer 71

If an expense will be incurred before it is paid, the extra amount that has been incurred (consumed) in the current reporting period must be added to the amount paid to determine the total expense incurred. This ensures that the expense incurred is the most accurate amount used in the calculation of profit for the current reporting period.

Question 72

1 Explain why the entire cost of a non-current asset should not be reported as an expense in one reporting period.

Answer 72

The entire cost should not be reported as an expense as its future economic benefit is not entirely consumed in the one reporting period, but rather over a number of reporting periods.

Question 73

2 Define the following terms:

• finite life
• depreciable asset
• depreciation
• depreciation expense

Answer 73

• finite life – the limited period of time (usually measured in years) for which a non-current asset will exist
• depreciable asset – a non-current asset that has a finite life, and thus must be depreciated over that life
• depreciation – the allocation of the cost of a non-current asset over its useful life
• depreciation expense – that part of the cost of a non-current asset that has been consumed in the current reporting period.

Question 74

3 Referring to one Accounting Principle, explain the purpose of depreciating a non-current asset.

Answer 74

Because a non-current asset is not entirely consumed within one reporting period, depreciation attempts to calculate how much of the asset’s value has been consumed in the current reporting period. It therefore spreads out or allocates the cost of the asset over the years in which it is useful for earning revenue. In that way, only that part of the cost of the non-current asset that is consumed/incurred in the current reporting period is used in the Income Statement. This ensures that profit will be calculated accurately

Question 75

4 Explain the effect of depreciation on a firm’s bank balance.

Answer 75

Depreciation has no effect on the bank balance because it does not involve any payment of cash. The cash payment relating to each non-current asset will be recorded only at the time when the asset is purchased.

Question 76

1 Explain the assumption that underlies the straight-line method of depreciation in relation to how assets contribute to revenue.

Answer 76

The straight-line method of depreciation assumes that non-current assets contribute evenly to revenue and, as a result, it allocates the same depreciation expense every year.

Question 77

2 Show the formula for calculating depreciation expense using the straight-line method.

Answer 77

Depreciation expense ($ per annum) = Historical Cost less Residual Value/Life

Question 78

3 Define the following terms:

• Historical Cost
• Residual Value
• Useful Life

Answer 78

• Historical Cost – the original purchase price of the non-current asset
• Residual Value – the estimated value of the non-current asset at the end of its useful life
• Useful Life – the estimated period of time for which the non-current asset will be used (by the current entity) to earn revenue (this is usually measured in years).

Question 79

4 Explain why each non-current asset must be depreciated individually (rather than as a total).

Answer 79

Each non-current asset must be depreciated individually because each non-current asset is different in terms of its useful life and residual value.

Question 80

5 Referring to one Accounting Principle, explain why Residual Value is deducted from Historical Cost when calculating depreciation using the straight-line method.

Answer 80

The residual value is the value of the non-current asset that will not be consumed by the current entity but rather by the next owner, thus keeping the business separate from other businesses.

Question 81

1 Explain how depreciation is reported in the Income Statement.

Answer 81

Depreciation is reported as an ‘Other Expense’ in the Income Statement (as it is not related to the purchase or sale of stock).

Question 82

2 Define the term ‘accumulated depreciation’.

Answer 82

Accumulated depreciation is the value of the non-current asset that been consumed over its life so far.

Question 83

3 Referring to one Accounting Principle, explain the difference between depreciation expense and accumulated depreciation.

Answer 83

Whereas depreciation expense refers to the amount consumed in the current reporting period (and is reported in the Income Statement), accumulated depreciation refers to depreciation that has accumulated (or built up) over the life of the asset so far (and is reported in the Balance Sheet).

Question 84

4 Referring to one Accounting Principle, explain why the original purchase price of a non-current asset must be disclosed in the Balance Sheet.

Answer 84

To ensure the reports remain as free from bias as possible, the asset must always be reported at its Historical Cost – its original price – as this amount is verifiable by reference to a source document.

Question 85

5 Define the term ‘carrying value’.

Answer 85

Carrying value is the value of a non-current asset that is yet to be consumed/allocated as an expense, plus any residual value.

Question 86

6 Referring to one Qualitative Characteristic, explain why non-current assets must be reported at their carrying value in the Balance Sheet.

Answer 86

For depreciable assets, reporting the non-current asset at its carrying value is more useful for decision-making (Relevance) than its Historical Cost because its carrying value can give the owner an indication when the asset might need replacing.

Question 87

8 Referring to one Qualitative Characteristic, explain why it may be useful to represent depreciation graphically.

Answer 87

In order to satisfy Understandability, reports must be prepared in a manner that is readily understandable by the user. Preparing a graph can make it easier for the owner to understand both the idea of depreciation, and its effect on the accounting reports.

Question 88

1 Show the formula for calculating the rate of depreciation.

Answer 88

Depreciation rate (% per annum) = Depreciation Expense/Historical Cost x 100

Question 89

2 Referring to one Accounting Principle, explain why it is not always accurate to report depreciation expense per annum.

Answer 89

If the reporting period for the business is less than 12 months, then the depreciation expense must be calculated according to the length of the reporting period. For example, if the length of the reporting period is six months, then the depreciation expense per annum (as calculated per the formula) must be divided by two to represent six months of depreciation expense for the Income Statement.

Question 90

3 Explain the process for calculating depreciation when the firm has had control of the asset for less than a year.

Answer 90

Because the life of the asset is usually measured in years, the formula will calculate depreciation expense per annum. However, if at the time the reports are prepared the firm has had control of the asset for less than a year, the depreciation expense figure will need to be applied on a pro-rata basis.

Question 91

4 Explain how depreciation can undermine the Reliability of accounting reports.

Answer 91

Because the residual value and life are estimates, using them in the calculation of depreciation means that the reports will not be free from bias, and to some extent this will undermine the Reliability of the accounting reports.

Question 92

5 Explain how depreciation ensures Relevance in the accounting reports.

Answer 92

Depreciation ensures that the Income Statement includes all information that is useful for decision-making (about profit) by showing the consumption of non-current assets in the current reporting period. Similarly, by showing accumulated depreciation in the Balance Sheet, it ensures that assets are shown at their carrying value, which is more useful for decision-making about their replacement.

Question 93

Invoice

Answer 93

A source document that verifies the details of a credit transaction

Question 94

Credit Purchase

Answer 94

A transaction that involves the acquisition of stock (or other goods) from a supplier who does not require payment until a later date

Question 95

Depreciable Value

Answer 95

The total value of the asset that will be consumed by the current entity, and so must be allocated over its useful life

Question 96

Depreciable Expense

Answer 96

The value of a non-current asset which has been consumed in the current reporting period