Financial Accounting - theory

Question 1

Why is the regular preparation of bank reconciliations important?

Answer 1

The regular preparation of bank reconciliations is important for the following reasons:
i. Identification of errors, such errors may have been made either by the bank, the company or both;
ii. Items such as bank interest, charges, standing orders, direct debits and dishonoured cheques. These
will be known by the bank but not identified by a business until it receives the bank statement and
prepares the bank reconciliation.

Question 2

A brief explanation of the function of the following books of prime entry and how the books of
prime entry fit into the overall accounting process:
i Sales day book;

Answer 2

The sales day book records credit sales.

Question 3

A brief explanation of the function of the following books of prime entry and how the books of
prime entry fit into the overall accounting process:

ii The cheque payments book;

Answer 3

The cheque payments book is part of the cash book which records all transactions through the
bank. The cheque payments book as the name suggests records payments made by cheque.

Question 4

A brief explanation of the function of the following books of prime entry and how the books of
prime entry fit into the overall accounting process:
iii The journal.

Answer 4

The journal records all transactions that are not recorded in any other book of prime entry.
Examples included non-regular transactions for example the month end depreciation and accruals
journals.

Question 5

Outline the purpose of the books of prime entry

Answer 5

The primary purpose of financial accounting is to record, summarise and classify information that arises
from the transactions that a business enters into. However, if the ledgers were updated each time a
transaction occurred, the ledgers would quickly become cluttered and errors may be made. Therefore, when
a transaction occurs it is entered into the books of prime entry. Entry of a transaction into the books of
prime entry does not record the double entry required for that transaction. However, the books of prime
entry do form the source for double entries for the ledger accounts. From the ledgers the trial balance and
finally the financial statements are prepared.

Question 6

Define revenue expenditure

Answer 6

Revenue expenditure is expenditure that is incurred for the purpose of running the business. That is, this
expenditure is on items which are short term in nature, (will last for less than one year). Such items of
expenditure are recorded in the Income Statement and therefore impact on the profitability of a business.
Examples include: wages, purchases of inventory for resale and light and heat.

Question 7

Define capital expenditure

Answer 7

Capital expenditure is expenditure on items that tend not to be purchased for resale but are used within the
business to help generate profits. Such expenditure tends to be long term in nature, that is, the item
purchased tends to last for longer than one year. Such items are recorded on the statement of financial
position. Examples of such expenditure are the acquisition of non-current assets and the repayment of loans.

Question 8

Define carriage inwards and outline its accounting treatment in preparation of an Income Statement

Answer 8

Carriage inwards is the term commonly given to the transportation costs associated with the purchase of
goods. Such costs cover the cost to transport goods from the supplier’s premises to the business’s own
premises.
In some situations, the supplier will bear these costs and as such the cost is part of the purchase price
charged to the business. In order situations the transport cost will not be included in the purchase price but
will be quoted separately. In order to ensure that cost of sales and hence gross profit are consistently
calculated in both of the above scenarios carriage inwards when separately quoted is added to the cost of
purchases in the cost of sales section in the Income Statement.

Question 9

Outline the accruals concept

Answer 9

The accruals concept states that income should be recorded in the accounting records when it is earned
and expenses should be recorded when they are incurred even though payment occurs at a different
time. Application of the accruals concept is generally referred to as ‘accruals accounting

Question 10

Is it acceptable under FRS102 to apply “offsetting” of assets and liabilities when preparing financial statements?

Answer 10

Offsetting is prohibited under FRS 102. The prepayments must be shown as a current asset and the
accruals must be shown as a current liability.

Question 11

Give reasons why a business should prepare control accounts?

Answer 11

Control accounts are prepared by businesses for the following reasons:
1. The purpose of the control account is to keep the nominal ledger free of details, yet have the correct
balance for receivables and payables for the trial balance which in turn forms part of the financial
statements.
2. Control accounts are a means of proving the accuracy of the ledger accounts of receivables and
payables. As a result, this is a control mechanism to ensure accuracy of the receivables and
payables personal ledgers. This control assists in the location of errors.
3. Control accounts can also act as an internal check, i.e. the person posting entries to the control
account acts as a check on a different person who posts amounts from the daybooks to the personal
ledgers.

Question 12

Outline the three ways a business can be setup

Answer 12

A business can be organised as a sole trader, partnership or company.

Question 13

Describe a sole trader form of business

Answer 13

A sole trader business is the simplest business type, it is a business that is owned and operated by one
person. However, a sole trader business may employ more than one person. In the eyes of the law the sole
trader personally and the sole trader’s business are one and the same and therefore a sole trader is fully
personally responsible for any losses that the business might incur.

Question 14

Describe a partnership form of business

Answer 14

A partnership business is one that is owned and controlled by at least two people. Most partnerships have
between two and twenty partners but there are examples of partnerships, for example partnerships of
accountants that have up to 50 partners. The operations of a partnership business tend to be more formalised
and most partnership businesses will operate under partnership agreements. These agreements set down
how important areas within the business are to be run and managed. For example, the duties of each partner
and the ratio in which they share profits. In the absence of such an agreement the provisions of the
Partnership Act 1890 apply.

Question 15

Describe a limited company form of business

Answer 15

A limited company is a business that is owned by its shareholders, run by its directors and enjoys limited
liability. Limited companies can either be private or public. A private limited company does not sell shares
to the public whereas a public limited company does. Due to the large membership of limited companies
they tend to be large and, in many cases, have a multinational aspect.

Question 16

What are the advantages of setting up a business as a sole trader?

Answer 16

Advantages
• The sole trader has total control over the business and enjoys all of the profits;
• A sole trader business is cheap and easy to set up. There are very few forms to fill out and the sole
trader generally will only need to open a bank account and inform the tax authorities.

Question 17

What are the disadvantages of setting up a business as a sole trader?

Answer 17

Disadvantages
• A sole trader has unlimited liability and therefore will be personally responsible for any debts that
the business generates;
• Sole traders can find it difficult to raise long term finance as banks tend not to want to lend them
large sums and there are no other investors in the business who can invest capital;
• Sole traders tend to be small in size and therefore the business will usually not grow to a sufficient
size where it will enjoy economies of scale.

Question 18

What are the advantages of setting up a business as a partnership?

Answer 18

Advantages
• Spreads the risk across more people than a sole trader business. Therefore, if the business was to
get into financial difficulty there are more people to spread the debt between;
• Additional partners can bring resources, customers and skills into the business, allowing
partnership businesses to grow larger than sole trader businesses.

Question 19

What are the disadvantages of setting up a business as a partnership?

Answer 19

Disadvantages
• Profits have to be shared among the various partners;
• There can be disagreement over the direction of the business. Any partner within a partnership has
less control over the running of the business than a sole trader.

Question 20

What are the advantages of setting up a business as a limited company

Answer 20

Advantages
• Limited companies due to their size tend to find it easier than sole traders and partnerships to raise
finance and as a result tend to be large. Many enjoy economies of scale as a result of this;
• The shareholders in a limited company enjoy limited liability. This means that they are not
personally responsible for any debts that the company may generate. If a limited company runs
into financial difficulty the shareholders may lose their original investment but no more.

Question 21

What are the disadvantages of setting up a business as limited company?

Answer 21

Disadvantages
• Limited companies can be costly and complicated to set up as there is significantly more
documentation to prepare than is the case for either a sole trader or partnership business;
• Certain financial information must be made available to all users of financial information. That is,
it must be public information. This could potentially affect the competitiveness of the company as
potential sensitive information has to be released to the public and is freely available to
competitors.

Question 22

What is an error of omission

Answer 22

Error of omission

A transaction that has been entirely omitted from the accounting records.

Question 23

What is an error of commission

Answer 23

Error of commission
A transaction is recorded by means of an accounting journal but the wrong ledger account is debited or
credited. (correct category but wrong account)

Question 24

what is an error of principle

Answer 24

Error of principle

The journal was recorded in completely the wrong category. (An asset recorded in an expense account)

Question 25

what is a compensating error

Answer 25

Compensating error

The total of the errors on the debit side match the total of the errors on the credit side.

Question 26

what is an error of original entry

Answer 26

Error of original entry

The wrong amount is originally debited or credited but to the correct accounts.

Question 27

state how inventory is valued in financial statements under FRS102

Answer 27

Inventory is valued at the lower of cost and net realisable value

Question 28

Define cost of conversion

Answer 28

Cost of conversion (for manufacturing businesses) – this includes direct costs, such as direct
material, direct labour, direct expense, and production overheads. Examples of relevant costs include
factory rent and rates, factory light and heat.

Question 29

Define the ATI Ethical principle of integrity

Answer 29

Integrity – must be straightforward and honest in all professional and business relationships.

Question 30

Define the ATI ethical principle of objectivity

Answer 30

Objectivity – should be fair and not allow bias, conflict of interest or undue pressure from others to
override professional or business judgements.

Question 31

Define the ATI Ethical principle of professional competence and due care

Answer 31

Professional Competence and Due Care – maintain professional knowledge and skill to ensure
that a competent professional service is provided.

Question 32

Define the ATI Ethical principle of confidentiality

Answer 32

Confidentiality – respect the confidentiality of information acquired as a result of business and
professional relationships.

Question 33

Define the ATI Ethical principle of professional behaviour

Answer 33

Professional behaviour – comply with relevant laws and regulations and avoid action that discredits
the profession.

Question 34

Explain the concept of true and fair view

Answer 34

The concept of ‘true and fair’ is a dynamic concept, which means that it is subject to change over
time. There is no static legal definition of the concept of ‘true and fair’. What may have been sufficient
in financial statements 30 years ago to present a true and fair view is unlikely to be sufficient in the
modern business environment. However, it would be reasonable to state that compliance with all
contemporaneous regulatory and professional requirements is likely to result in financial statements
that present a true and fair view.

Question 35

Outline an accountants roles in an organisation

Answer 35

An accountant’s role in an organisation could include the following:
1. Preparation and presentation of financial and management accounts.
2. Identification of areas of inefficiency and wastages of resources in the business.
3. Raising new finance, managing cash flows.
4. Setting up and implementing effective systems of internal and accounting controls.
5. Assessing the financial viability/profitability or otherwise of proposed capital expenditure such as
the opening of a new factory or branch.
6. Investigation of the performance/operations of competing business organisations to assist
management in policy formulation.
7. Investigation of potential financial fraud within the organisation.
8. The accountant assists the organisation to optimise its tax exposure

Question 36

What is the effect on financial statements of applying the accruals concept

Answer 36

The consequences of the accruals concept for income and expenses are that:
▪ income is recorded in the ledger when it is deemed to be earned by the business (as opposed to
received).
• an expense is recorded in the ledger when it is deemed to be incurred by the business (as opposed
to paid).

Question 37

Explain what is meant by prudence (qualities of useful information)

Answer 37

Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making
the estimates required under conditions of uncertainty, such that assets or income are not overstated
and liabilities or expenses are not understated. However, the exercise of prudence does not allow the
deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses. In
short, prudence does not permit bias.

Question 38

Explain what is meant by substance over form (qualities of useful information)

Answer 38

Transactions and other events and conditions should be accounted for and presented in accordance
with their substance and not merely their legal form. This enhances the reliability of financial statements.

Question 39

Define accounting

Answer 39

Accounting can be defined as the process of identifying, recording, and communicating economic information to permit informed judgements and decisions by users of that information

Question 40

Define financial accounting

Answer 40

Financial accounting is oriented to users of accounting information who are external to the organisation. External users include investors, suppliers, customers, employee representatives, lenders, analysts, competitors, local and central government and the public at large

Question 41

Define management accounting

Answer 41

Management accounting is oriented to users of accounting information who are internal to the organisation. Internal users include management (and includes executive level employees)

Question 42

List the users of financial accounting information

Answer 42

Investors, lenders, suppliers, customers, competitors, employees, government, analysts, public at large incl. interest groups

Question 43

Define the statement of financial position

Answer 43

A statement of financial position lists an organisations assets, liabilities and equity at each reporting date

Question 44

Define the income statement

Answer 44

An income statement presents the income earned and expenses incurred by an organisation during a reporting period. For profit-orientated organisations, the purpose of an income statement is to calculate whether an organisation has made a profit or loss for the reporting period. An income statement is a performance statement because it measures how an organisation has performed during the year

Question 45

What are the elements of financial statements

Answer 45

Assets
Liabilities 
Owner equity/capital
Income 
Expenses

Question 46

Define assets

Answer 46

Assets are economic resources controlled by an organisation that can be put to productive use for the future benefit of the organisation. Assets are listed on the organisations statement of financial position

Question 47

Give examples of assets

Answer 47

Examples of assets include buildings, equipment, machinery, furniture and fittings, motor vehicles, inventories of goods that are available for sale, amounts owed to the organisation by customers, money in bank and cash in hand

Question 48

Define liabilities

Answer 48

Liabilities are obligations to third parties (other than owners of the business) that must be settled at some point in the future. Liabilities are listed on the organisations statement of financial position

Question 49

Give examples of liabilities

Answer 49

Examples of liabilities include outstanding bank loans, bank overdrafts and amounts owed to suppliers

Question 50

Define owner equity

Answer 50

Owner equity/capital is the residual amount of assets attributable to the owner(s) of the business once the liabilities are settled

Question 51

Define income

Answer 51

Income most commonly arises from the provision of goods and services to customers. This form of income is more generally known as sales or revenue

Other forms of income include rental income (from letting a premises) and interest income (from financial investments)

Question 52

Define expenses

Answer 52

An expense is a cost of carrying on a business.

Accounting for expenses depends on the nature of the expense and whether the benefit of the expense will be consumed in its entirety in the current reporting period or will also be consumed in future reporting periods

Question 53

List the qualities of useful information

Answer 53

Understandability 
Relevance 
Materiality 
Reliability 
Substance over form 
Prudence 
Completeness 
Comparability 
Timeliness 
Balance between cost and benefit

Question 54

Define understandability

Answer 54

The information provided in financial statements should be presented in a way that makes it comprehensible by users who have a reasonable knowledge of business and economic activities and accounting and a willingness to study the information with reasonable diligence

Question 55

Define relevance

Answer 55

The information provided in financial statements must be relevant to the decision making needs of users.

information has the quality of relevance when it is capable of influencing the economic decisions of users by helping them evaluate past, present or future events or confirming, or correcting, their past evaluations

Question 56

Define materiality

Answer 56

Information is material - and therefore has relevance - if its omission or misstatement, individually or collectively, could influence the economic decisions of users taken on the basis of the financial statements

Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. The size or nature of the item, or a combination of both, could be the determining factor

Question 57

Define reliability

Answer 57

The information provided in financial statements must be reliable. Information is reliable when it is free form material error and bias and represents faithfully that which it either purports to represent or could reasonably be expected to represent

Financial statements are not free from bias (i.e. not neutral) if by the selection or presentation of information, they are intended to influence the making of a decision or judgement in order to achieve a predetermined result or outcome

Question 58

Define substance over form

Answer 58

Transactions and other events and conditions should be accounted for and presented in accordance with their substance and not merely their legal form

this enhances the reliability of financial statements

Question 59

Define prudence

Answer 59

Prudence is the inclusion of a degree of caution in the exercise of the judgements needed in making the estimates required under conditions of uncertainty, such that assets and income are not overstated and liabilities or expenses are not understated

However, the exercise of prudence does not allow the deliberate understatement of assets or income, or the deliberate overstatement of liabilities or expenses.

In short, prudence does not permit bias

Question 60

Define completeness

Answer 60

To be reliable, the information in financial statements must be complete within the bounds of materiality and cost

An omission can cause information to be false or misleading and thus unreliable and deficient in terms of its relevance

Question 61

Define comparability

Answer 61

Users must be able to compare the financial statements of an entity through time to identify trends in its financial position and performance

Users must also be able to compare the financial statements of different entities to evaluate their relative financial position, performance, and cash flows

Hence, the measurement and display of the financial effects of like transactions and other events and conditions must be carried out in a consistent way throughout an entity and over time for that entity, and in a consistent way across entities

Question 62

Define Timeliness

Answer 62

To be relevant, financial information must be able to influence the economic decisions of users

Timeliness involves providing the information within the decision time frame

If there is undue delay in the reporting of information it may lose its relevance

Management may need to balance the relative merits of timely reporting and the provision of reliable information

In achieving a balance between relevance and reliability, the overriding consideration is how to best satisfy the needs of users in making economic decisions

Question 63

Define balance between cost and benefit

Answer 63

The benefits derived from information should exceed the cost of providing it

The evaluation of benefits and costs is substantially a judgemental process

Furthermore, the costs are not necessarily borne by those users who enjoy the benefits, and often the benefits of the information are enjoyed by a broad range of external users

Question 64

Define a limited partnership

Answer 64

The limited Partnership Act 1907 facilitates the possibility of a partnership in which some members of the partnership have limited liability in respect of the debts of the partnership business

A limited partnership must have at least one general partner and one limited partner

The general partners have unlimited liability and the limited partners have limited liability (limited to the agreed amount of their capital contribution)

As with a normal partnership there is no legal distinction between the business and its partners

Question 65

State the business entities a not for profit may choose

Answer 65

A not for profit may be an incorporated entity (commonly as a company limited by guarantee)

It may also be a charitable trust

Or it may be an unincorporated association (unlimited liability on members) - may suit a small org with limited assets provided it takes out all necessary insurances to protect the individual members

Question 66

What are the primary sources of the financial accounting regulatory framework

Answer 66

The primary sources are:

1. European Law
2. Companies Acts legislation
3. Financial Reporting Standards issued by the Financial Reporting Council

Question 67

What is the purpose of EU Law on accountancy

Answer 67

The purpose of European directives and regulations as they pertain to accountancy is to standardise and harmonise the standards, principles and practices of financial reporting

Question 68

What are the requirements of companies acts

Answer 68

Requires that financial statements are prepared for each company and presented to shareholders at each Annual General Meeting (AGM)

Permitted formats and required content of financial statements is also set out

Sets out requirements for the filing of company financial statements with CH depending on the size of the company

Question 69

What is the purpose of Financial Reporting Standards

Answer 69

Set out how professionals should account for various transactions and events

Also adhere to legislative requirements as set out by Companies Acts and EU Law

FRS102 is intended to apply to all types of reporting entities where the intention is to produce high-quality financial statements

High quality means that the financial statements of the reporting entity provide a true and fair view view of the performance and position of the entity for the reporting period

Question 70

Explain the concept of true and fair

Answer 70

An overriding objective of the financial statements of a reporting entity is that they fairly communicate the economic reality (economic substance) of the transactions and events that have taken place during a reporting period

This objective applies both to the performance of the reporting entity (in terms of income and expenses) during the year and the position of the reporting entity (in terms of assets, liabilities and equity) at the end of the year.

If the objective is deemed to be achieved, the financial statements are commonly referred to as presenting a true and fair view of the performance and position of the reporting entity

Question 71

Explain auditing

Answer 71

Independent examination of financial statements with a view to an opinion being expressed as to whether those financial statements present a true and fair view

Question 72

What is the purpose of an audit

Answer 72

To provide a degree of assurance to interested parties that the information contained in the financial statements can be relied upon

Directors of companies are required by law to account for their stewardship and this is achieved by means of the statutory financial statements. An external audit adds an independent expression of opinion that the financial statements prepared by the directors do indeed present a true and fair view of the performance and position of the company for the reporting period

Question 73

What are the fundamental principles of ethical behaviour

Answer 73

Integrity 
Objectivity 
Professional Competence and Due Care 
Confidentiality 
Professional behaviour

Question 74

Define integrity

Answer 74

Integrity - must be straightforward and honest in all professional and business relationships

Question 75

Define objectivity

Answer 75

Objectivity - should be fair and not allow bias, conflict of interest or undue pressure from others to override professional or business judgements

Question 76

Define professional competence and due care

Answer 76

Professional competence and due care - maintain professional knowledge and skill to ensure to ensure that a competent professional service is provided

Question 77

Define confidentiality

Answer 77

Confidentiality - respect the confidentiality of information acquired as a result of business and professional relationships

Question 78

Define professional behaviour

Answer 78

Professional behaviour - comply with relevant laws and regulations and avoid action that discredits the profession

Question 79

State the accounting equation

Answer 79

Assets= Liabilities + Equity

The accounting equation must always be true

The accounting equation must return to equilibrium after each transaction has been recorded in the accounting records

Double-entry bookkeeping is the method which ensures that the accounting equation returns to equilibrium after each transaction

Question 80

Explain the business entity concept

Answer 80

The business entity concept is the separation of the business from its owners

This accounting concept applies to all types of businesses even though from a legal perspective sole traders and partnerships are regarded as one and the same entity

Question 81

Explain the concept of duality

Answer 81

The concept of duality refers to the two-fold effect that each transaction has on the accounting equation

Every transaction affects the accounting equation in two ways through some combinations of increases/decreases in assets, liabilities and equity

Question 82

Explain the accruals concept

Answer 82

the accruals concept states that income should be recorded in the accounting records when it is earned and expenses should be recorded when they are incurred even though payment occurs at a different time

Application of the accruals concept is generally referred to as “accruals accounting”

Question 83

Define trial balance

Answer 83

A Trial Balance is a list of ledger balances that are extracted from the ledger at a given point in time

Question 84

What is the purpose of extracting a TB

Answer 84

The primary purpose of extracting a TB is to confirm that the double-entry bookkeeping is carried out methodically and that all debit entries to the ledger accounts are matched by corresponding credit entries.

That the total of the debits equals the total of the credits is proof that the accounting equation returned to equilibrium

If a TB does not balance it indicates that the bookkeeping has not been sufficiently methodical and the accounting equation is not in equilibrium

Question 85

Define the cash receipts day book

Answer 85

The cash receipts day book records all the cash receipts of a business.

For many businesses, cash receipts would most commonly arise from cash sales and receipts from credit customers

Question 86

Explain the petty cash imprest system

Answer 86

The Petty cash imprest system manages and accounts for petty cash (minor amounts of) and expenditure.

Income comes from the bank account to create the required float

The petty cash account records minor items of expenditure and the total amount of expenditure is replenished at the end of the period so that the following period begins with the same opening petty cash balance

Under the imprest system the b/fwd total and c/fwd total are always the same unless the imprest amount is changed

Question 87

Explain the matching concept

Answer 87

The matching concept is related to the accruals concept in that income earned during a reporting period should be matched with the expenses incurred to earn that income

Question 88

Define “current asset”

Answer 88

Current assets are those that are likely to be converted into cash in the short term future (usually within a year) and are commonly related to the trade of the business

Question 89

Define “non-current asset”

Answer 89

Non-current assets are those that are used within the business (they are not bought with the intention of being sold) and are likely to generate economic benefits for the business for more than one year

Question 90

Explain the purpose of formatting financial statements

Answer 90

Formatted financial statements add value to the accounting process

Information is presented in ways that are more easily understood by non-accounting readers of the financial statements.

It is also possible to distinguish between gross profit and net profit, between non-current assets and current assets, and between non-current liabilities and current liabilities

Question 91

List the different types of inventories

Answer 91

Goods purchased for resale
Raw materials to be used in production (not yet processed)
Partly finished goods (otherwise known as work in progress/WIP)
Finished goods (and ready for sale)

Question 92

What is the purpose of doing a stocktake

Answer 92

At the end of each reporting period a business must establish the quantity of each item of inventory that is on hand , this is achieved by undertaking a physical inventory count

Question 93

What is book stock

Answer 93

Book stock is a report generated by computerised accounting records that lists the inventory quantities that should be on hand

Having book stock does not obviate the need for a stocktake

Question 94

List the two cost methods of inventory valuation

Answer 94

Cost of purchase

Cost of conversion (for manufacturing businesses)

Question 95

Define NRV

Answer 95

Net realisable value (NRV) is selling price less costs to complete and sell

Net realisable value is the revenue expected to be earned in the future when the goods are sold, less any further costs (incl. selling costs) that need to be incurred to complete the sale

Question 96

Define irrecoverable debt

Answer 96

an irrecoverable debt arises when the business is reasonably certain that the customer is not going to pay the amount owed and the debt is considered uncollectable

when an amount is uncollectable, the basis of the trade receivable as an asset no longer exists. hence, the appropriate accounting entry is to write off the trade receivable as an irrecoverable debt expense to the IS

Question 97

What expenditure should be capitalised

Answer 97

The capitalised amount of expenditure should include all expenditure necessarily incurred for the purpose of preparing the asset for its intended use (legal fees, delivery and installation costs)

Expenditure that improves the capabilities of an asset (in terms of its effectiveness or efficiency) should also be capitalised (such as increasing capacity, quality of output, extending economic life)

Question 98

What is the purpose of a Non-current asset register

Answer 98

A non-current asset register is an important internal control for management, particularly for large organisations that may operate in more than one location

Question 99

Define depreciation

Answer 99

Depreciation is an estimation of the economic benefits of a non-current asset that are consumed during a reporting period

It is commonly caused by:
Use 
Wear and tear 
Passing of time 
Obsolescence 
Depletion of natural resources

Question 100

Explain the rationale for depreciation

Answer 100

Depreciation is the accounting mechanism whereby capital expenditure is allocated on a systematic basis over the useful economic life of the non-current asset to the income statement for inclusion in a calculation of profit or loss

the matching concept is also relevant here

Question 101

What factors are taken into account when estimating depreciation

Answer 101

The amount of depreciation that is allocated to each reporting period depends on:

• the useful economic life of the asset
• the depreciable cost of the asset
• the pattern of consumption of the non-current asset

Question 102

What is the useful economic life of a non-current asset

Answer 102

The useful economic life of a non-current asset is the number of reporting periods during which the business expects to benefit from the use of that non-current asset

Question 103

what is the depreciable cost of a non-current asset

Answer 103

Depreciable cost is the amount of the cost of the non-current asset that is depreciated over its useful life

Question 104

what is residual value

Answer 104

a residual value of a non-current asset is the estimated value of a non-current asset at the end of its useful economic life and is also commonly referred to as salvage value

Question 105

explain the straight line method of depreciation

Answer 105

the straight-line method of depreciation assumes that the benefits of using a non-current asset are realised evenly over its useful life

Thus, the depreciable cost of the non-current asset is likewise allocated evenly over its useful economic life (thereby reflecting the matching concept)

Question 106

define net book value

Answer 106

Net book value is the difference between the cost of the non-current asset and the accumulated depreciation at the end of the reporting period.

it is also known as carrying amount

Question 107

define the reducing balance method of depreciation

Answer 107

The reducing balance method of depreciation assumes that the business consumes a greater proportion of the economic benefits of the non-current asset in the earlier years of its useful economic life

Therefore, greater amounts of depreciation expenses are recorded in the earlier years of its useful economic life

Question 108

what is the correct ways to account for acquisition of a FA partway through a FY?

Answer 108

2 methods may be used:

1. Expense a full year of depreciation in the year of acquisition, and no depreciation expense charge in the year in which the asset is disposed of or scrapped

OR

2. Calculate the annual depreciation expense based on the number of months the asset is in use during the reporting period (on a pro-rata basis)

Question 109

explain why depreciation should be applied and calculated consistently?

Answer 109

the depreciation method must be applied consistently form year to year for comparability purposes and may only be changed if a new method represents a more accurate allocation of the cost of a non-current asset

the depreciation method, the estimated residual value and the estimated useful economic life should be reviewed periodically and if the pattern of consumption of benefits has changed, the depreciation method should also be changed

Question 110

what is the benefit of doing a bank rec

Answer 110

the bank rec process can be a useful part of the internal controls of an organisation because it is a check on the accuracy and completion of a bank ledger account by reference to an independent third party source (a statement of account that is produced by the bank)

Question 111

what are the common reasons for differences when completing a bank rec

Answer 111

Transactions such as bank charges, bank fees, DDs are included on a bank statement but do not come to the attention of a business until a bank statement is received. They are unrecorded items that need to be recorded by the business

There is a possibility of errors or omissions by either the business or the bank or both

Differences arising due to timing differences (eg. chqs) these will need explained on a bank rec statement

Question 112

what is a bank reconciliation statement

Answer 112

a bank reconciliation statement is a memorandum explanation of why the balance on the ledger account differs from the balance on the bank statement

Question 113

define a control account

Answer 113

a control account is a summary account in the general ledger.

the trade receivables and trade payables are two common control accounts

Question 114

what is the purpose of a control acc rec?

Answer 114

the purpose of a control account rec is to confirm the balances on the control accounts agree to the sum of the individual balances that are listed in the subledgers

Question 115

what is a contra entry

Answer 115

a contra entry can be performed when a credit customer is also a supplier on credit

in this case, the receivable is netted against the payable to calculate the net receivable/payable

Question 116

define subledger account

Answer 116

subledgers record the detail of sale and purchase transactions with individual customers and suppliers respectively

the information that is recorded in the subledgers is sourced from the books of prime entry

a subledger is not a part of the double-entry bookkeeping

Question 117

what is the purpose of control accounts?

Answer 117

• keeps the general ledger free of the details but still produces the correct balance for trade receivables/payables for presentation on a SOFP
• provides a control mechanism to ensure accuracy of the trade receivables/payables subledgers. this control can also assist in the identification of errors in the subledger and/or the control account
• control accounts also assist in the identification of omitted amounts if accounting records are incomplete
• act as an internal checking system within the business

Question 118

How can possible errors and omissions be identified?

Answer 118

By:

• Trial Balance
• Bank account rec
• Receivables and payables control account recs
• Review of financial statements by management
• Independent audit

Question 119

Define error of omission

Answer 119

a trans has been entirely omitted from the accounting records

Question 120

define error of commission

Answer 120

a trans has been recorded by means of an accounting journal but the wrong ledger account is debited or credited

Question 121

define error of principle

Answer 121

an asset type ledger account should be debited (capital expenditure) instead of an expense type ledger account (revenue expenditure)

Question 122

define compensating errors

Answer 122

an error on the debit side of one transaction is compensated (by chance) by an error (for the same amount) to the credit side of another trans

Question 123

define error of original entry

Answer 123

the accounts that are debited and credited are correct but the wrong amount is debited and credited to those ledger accounts

Question 124

define reversal of entries error

Answer 124

the ledger account that is debited should have been credited and the account that is credited should have been debited

Question 125

what is the purpose of the suspense account

Answer 125

Inclusion of a suspense account balance is a temporary solution to get the TB totals to agree until the underlying errors are identified and corrected (at which point the suspense account should no longer be required in the TB)

Question 126

What is the accounting equation for a not for profit

Answer 126

Assets-Liabilities=Accumulated Fund

Question 127

What are the terms used in not for profit for
IS
SOFP
Profit/loss

Answer 127

IS=Income and expenditure account
SOFP=Accumulated fund statement
Profit/loss=Surplus of income over expenditure/deficit of income over expenditure

Question 128

what is a receipts and payments account

Answer 128

A receipts and payments account is a formatted presentation of the not-for-profits bank account

the receipts present an analysis of the lodgements to the bank and the payments present an analysis of the payments out of the bank account

the accruals basis does not apply and no distinction between capital and revenue expenditure

ideal for very small not-for-profits where bank account is only asset

Question 129

what are the main provisions of the partnership act of 1890?

Answer 129

all profits and losses must be shared equally

all partners have the right to take part in the business

no interest is paid on the capital advanced by each partner

no remuneration is paid to the partners for acting within the business

all partners have the right to prevent the entry of another partner

all partners have the right to examine the books of the partnership

difference of opinion shall be settled by the majority of the partners but the nature of the business cannot be changed without the consent of all partners

all partners have the right to receive interest at 5% p.a. on loans and advances made to the partnership in excess of their capital subscription

Question 130

define the partner capital account (partnership accounts)

Answer 130

the capital account records the initial capital introduced to the partnership business by each of the partners

the balance generally remains fixed unless additional capital is introduced by a partner or an amount of original capital is withdrawn subsequently by a partner

it is regarded as the long term permanent investment of each partner

Question 131

define the partner current account (partnership accounts)

Answer 131

the purpose of the current account is to record interactions with partners that are short-term in nature (relative to the long term nature of the capital accounts)

These interactions commonly include partners salary, drawings, and each partners share of periodic profits or losses

Question 132

what is the purpose of using capital and current accounts in partnership accounts

Answer 132

the purpose of using capital and current accounts in partnerships is to distinguish between the permanent capital base of the business (capital accounts) and the recurring transactions between the partners and the business (current accounts)

this distinction can help to provide stability in terms of knowing each partners long term commitment and clarity in terms of knowing the extent to which profit and salary are earned and withdrawn by each partner

Question 133

define ordinary share capital

Answer 133

each ordinary share represents a unit of ownership of the company

The ordinary shareholders are therefore the owners of a limited company

Question 134

define share premium

Answer 134

share premium is the excess of share issue price over the nominal value of that share

it is accounted for in a share premium account

Question 135

what is retained earnings

Answer 135

retained earnings are the accumulated profits or losses of a company since the company was established that have not been distributed in the form of a dividend

Question 136

what is a dividend

Answer 136

a dividend is a distribution of the accumulated profits of a limited company to its shareholders

a dividend distribution has the effect of reducing retained earnings

Question 137

how can a dividend distribution take place

Answer 137

a dividend distribution by a ltd company must be approved by the shareholders before the distribution takes place

typically the directors propose a dividend by means of a resolution to be passed or rejected at the company’s annual general meeting AGM

if approved it becomes a company liability, dividend payable