Chapter 9 Exercise Review Flashcards
Explain how closing the ledger accounts ensures Relevance in the financial reports
It ensures that only those revenues earned and expenses incurred in the current Reporting Period are used to calculate profit, as it is only this information that is useful for decision-making.
Explain why Drawings is not closed to the Profit & Loss Summary Account
Because drawings is not an expense. It is expressly excluded by the definition as it is not an action of the business, but of the owner.
Explain why the firm must still prepare an income statement even though it knows its net profit from the Profit & Loss Summary
To aid decision-making about the firm’s trading operations by showing the particular revenues and expenses that have caused the Net Profit. The owner can examine Gross Profit to assess the adequacy of the mark-up, or assess control of particular expenses.
The owner has stated that owners equity has increased, the firms assets must also have increased. State one reason why this may be incorrect.
Liabilities may have decreased.
Explain why the owner should be concerned about the firms ability to control Cost of Goods Sold
Cost of Goods Sold is more than 70% of Sales revenue and as a consequence Gross Profit is not high enough to cover Other Expense. The business cannot earn a Net Profit with this level of average mark-up/with Cost of Goods Sold consuming this much of Sales revenue.
Actions the owner might take to improve net profit
- Increase selling prices (to increase m/up)
- Increase advertising (to generate sales)
- Find a cheaper supplier
- Negotiate cheaper rent (or move!)
- Assess staff rostering
Referring to 1 accounting principle explain why the ledger must be closed
Reporting Period
Revenue and expense amounts must be transferred to the P&L Summary account in order to determine profit for the current Reporting Period.
OR
Revenue and expense accounts must be reset to zero in readiness for the next Reporting Period.
Actions the owner can take to improve adjusted gross profit profit without affecting gross profit
- Improve physical security measures (such as locking the storeroom/security cameras)
- Check purchase invoices against delivery dockets
- Change store layout to improve surveillance/protect stock from damage
- More regular stocktakes
Explain ho reducing discount offered to customers will lead to a decrease in net profit
It may mean customers are less willing to buy from the firm, leading to lower Sales revenue and thus lower Net Profit.
Explain reasons why the owner could be disappointed with net profit
- It is less than Drawings
- It is less than the Wages paid to the shop assistant
Explain how an increase in other expenses might lead to an increase in net profit
Expenses are incurred in order to earn revenue, so increased
- advertising
- discount rate
- rent (from a better location)
- wages (from more staff, better customer service)
could lead to increased Sales revenue and increased Net Profit.
Uses of the income statement
Can be used to assist decision-making by identifying problem areas (such as revenue earning or expenses control) so that remedial action can be taken.
Can be used to assist planning by providing a basis for the next budgeted Income Statement, e.g. pricing, staffing levels, stock purchases, advertising requirements
Narration for closing revenue accounts
“Closing revenue accounts to P&L Summary account”
Narration for closing expense accounts
“Closing expense accounts to P&L Summary account”
Narration for closing the profit and loss summary account
“Transfer of net profit from P&L Summary account to Capital account”
