Chapter 13 - Long-term borrowings

Question 1

1. Explain the matching theory behind the accounting of interest.

Answer 1

According to the matching theory, the interest expense incurred must be matched against the income earned from using the loan to operate the business in the same financial year.

Question 2

1. Explain the accrual basis of accounting behind the accounting of interest.

Answer 2

According to the accrual basis of accounting theory, interest expenses must be recorded in the financial year it was incurred, regardless of whether money has been paid

Question 3

2. Name the accounting theory behind the accounting of bank interest

Answer 3

Matching theory
Accrual basis of accounting theory

Question 4

4. How is bank loan repaid?

Answer 4

The business makes regular cash payments in equal instalments over the loan period or a one-time lump-sum payment at the end of the loan period to reduce the principal sum.

Question 5

5. How is bank overdraft repaid?

Answer 5

The business deposits cash into the bank account within the year to reduce the overdraft.

Question 6

3. Explain the differences between bank loan and bank overdraft

Answer 6

=A bank loan is a fixed amount borrowed and cash is transferred to the business bank account
=A bank overdraft occurs when the business withdraws more than what it has deposited in the bank account, up to the limit which the business and the bank has agreed upon.
=A bank loan is presented as long-term borrowings, under non-current liabilities in the statement of financial position.
=A bank overdraft is presented as bank overdraft, under current liabilities in the statement of financial position.