dh

Question 1

Explain how the Accrual basis assumption helps to ensure Relevance in the Accounting reports

Answer 1

By including information that is capable of making a difference to decision-making (i.e. exclude drawings, loan repayments or last year’s wages)

Question 2

Explain the purpose of closing the ledger

Answer 2

1. To transfer the revenue and expense amounts (temporary) to the Profit & Loss Summary Account to calculate profit for the current Period
2. To reset revenue and expense accounts to zero in readiness for the next Period

Question 3

Explain why ledger accounts are closed with reference to an Accounting Assumption

Answer 3

Period / Accrual basis

• Revenues earned and expenses must be transferred to the P&L Summary account in order to determine profit for the current Period
• Revenue and expense accounts must be reset to zero in readiness for the next Period to avoid including revenues and expenses from other periods in Profit calculation for the next period

Question 4

Explain why asset and liability accounts are not closed

Answer 4

• Only revenues and expense are used to determine profit, and revenues and expenses exist only during a particular Period
• Assets (economic benefit carried forward) and liabilities (present obligation until it is paid for) will exist into the future so they are not closed but balanced so that they carry forward into the next period

Question 5

Explain why the Drawings account is closed to the Capital account

Answer 5

So that the Capital account can show the net effect of all transactions with the owner

Question 6

List 5 strategies to generate more revenues

Answer 6

1. Change selling prices
2. Market strategically and effectively
3. Implement strategies to manage inventory (inventory mix, sale of complementary goods, up-to-date inventory, rotate inventory)
4. Better location
5. Improve customer service

Question 7

List 3 strategies to control expenses

Answer 7

1. Change inventory management practices
2. Change staff management practices (have to be careful about industry awards, contracts and type of employee)
3. Change non-current asset management practices

Question 8

Explain the purpose of an Income Statement

Answer 8

Income Statement communicates information about a firm’s revenue, expenses and profit for a particular reporting period in a more informative manner.

Question 9

Explain the purpose of Net Profit Margin

Answer 9

A profitability indicator that indicates expense control by calculating the percentage of Net sales revenue that is retained as Net Profit

Question 10

Explain the purpose of Gross Profit Margin

Answer 10

A profitability indicator that measures the average mark-up by calculating the percentage of Net sales revenue that is retained as Gross Profit

Question 11

Explain the treament of Inventory Gain

Answer 11

• Inventory gain is treated as a revenue because it results in an increase of Assets (Inventory) and thereby an increase in Owner’s equity
• It is listed as an Other revenue because it is related to the managment of inventory. In doing so, Adjusted Gross Profit Margin can reflect more accurately the effectiveness of inventory management practices

Question 12

Explain the treatment of Discount revenue

Answer 12

• Discount revenue is a revenue because it decreases liability (Account Payable) and thereby causes an increase in Owner’s equity
• It is an Other revenue because it is not earned from the sale of inventory and therefore will not have a direct impact on Gross Profit and should not be included in the measure for mark-up

Question 13

Referring to financial and ethical considerations, discuss whether the owner’s Drawings should be reported as part of Wages

Answer 13

• Yes: Owner is also an employee and is entitled to a wage. If this amount is withdrawn on a regular basis, it should not distort the evaluation of business profitability. Moreover, both Wage and Drawings will decrease Assets and Owner’s equity
• No: Drawings are excluded from the definition of Expense as it does not relate to business operation. Doing so would overstate Expenses and understate Profit and leads to poor financial decisions

Question 14

• Explain the purpose of graphical representations with reference to a Qualitative Characteristic

Answer 14

Understandability as the user (the owner) is able to comprehend the information without relying on Accounting knowledge, leading to more informed and better decision-making

For instance, a pie chart can highlight problem areas (especially for the biggest piece of the pie) so decisions can be made to improve expense control within the business

Question 15

Explain the treatment of Sales Return

Answer 15

• Sales returns is treated as a negative revenue item in the Income Statement because it reduces the sales revenue for a period. Sales is a revenue item because it causes an inflow of economic benefits, thereby increasing Owner’s Equity. Sales returns brings about a reduction in these inflows and is therefore a negative revenue that will cause a decrease in Owner’s Equity because a lower profit will be reported for the period as a result of Sales returns made.
• NOT an expense because when a sale is made, revenue is deemed to be earned. If a return is attempted by an account receivable, it is at the discretion of the business whether or not the return will be accepted. If it is accepted, the revenue earned is then cancelled by issuing of a credit note

Question 16

Referring to Qualitative Characteristic, explain why business would prepare an Income Statement when the Profit and Loss Summary would provide the Net Profit amount

Answer 16

Income Statement is more easily read by individuals who may not have a thorough accounting background and is inline with the demands of Understandability.