Lecture 5

Question 1

What is the capital working cycle?

Answer 1

The sequence of transactions and events, involving current assets and current liabilities through which the business makes profit

Question 2

What is the working cycle if you were to draw it?

Answer 2

Inventories (stocks) -> Receivables (debtors) -> Cash -> Payables (creditors) in a circle

Question 3

What is the definition of working cycle?

Answer 3

The amount of finance which a business might provide to finance the current assets of a business to the extent that these are not covered by current liabilities

Question 4

How do you calculate the working capital?

Answer 4

Current assets - current liabilities

Question 5

What does it mean if the working capital of a business is low?

Answer 5

The business has a close match between current assets and current liabilities
May risk not being able to pay its liabilities as they fall due
Not enough inventory to meet demand

Question 6

What does it mean if the working capital of a business is high?

Answer 6

Current assets are greater than current liabilities
Too much money being put into current assets
If assets are MUCH GREATER than liabilities, business has a lot of finance tied up in the current assets when the finance would maybe be put to better use by getting more fixed assets to expand the profit-making capacity of operations

Question 7

What is the future economic benefit of finished goods, WIP, raw materials?

Answer 7

The selling price which exceeds the cost of purchase or manufacture that makes a profit and increases OI but prudence dictates that profit should not be anticipated

Question 8

How are finished goods, WIP and raw materials measured?

Answer 8

The cost of purchase or manufacture

Question 9

If the cost of manufacture is less than the market value, which figure should be used?

Answer 9

The lower one - so in this case, cost of manufacture

Question 10

What are receivables (debtors)?

Answer 10

People who owe money to a business

Question 11

What are trade receivables?

Answer 11

Amount outstanding from customers buying goods on credit

Question 12

What are some examples of other receivables?

Answer 12

Loans made to another enterprise to help that enterprise in its activities
Loans made to employees to cover removal and relocation expenses or advance in salaries
Refund due to overpaid tax

Question 13

Why do trade receivables meet the recognition conditions?

Answer 13

There is an expectation of benefit when the customer pays

Question 14

How are trade receivables measured?

Answer 14

At the selling price of the goods

Question 15

In terms of trade receivables, when is profit recognised?

Answer 15

When the goods or services have been supplied to the customer

Question 16

What are doubtful debts?

Answer 16

When there is a risk that a customer will not pay

Question 17

How are doubtful debts/risk of non-payment dealt with?

Answer 17

By reducing the reported value of the reported value of the asset by and estimate for doubtful debts

Question 18

What are prepayments and what are some examples?

Answer 18

Amounts of expenses paid in advance
E.g. rent, insurance premiums

Question 19

Tell me about investments as current assets

Answer 19

Usually highly marketable and readily convertible int cash
Expectation of future economic benefit is therefore usually clear

Question 20

How are investments as current assets measured?

Answer 20

At fair value

Question 21

What is fair value equal to?

Answer 21

Selling price

Question 22

Is change in fair value reported in the income stamens?

Answer 22

Yes x

Question 23

What is the meaning of cost?

Answer 23

The cost of any item of inventory or WIP is specified as the expenditure
Has to be incurred in the normal course of business in bringing the product or service to its present location and condition

Question 24

How is expenditure calculated?

Answer 24

Purchase price + transport and handling + import duties - discounts - subsides

Question 25

Treatment of item of inventory whose market value has decrease due to obsolesce, damage or other changes in market conditions
Items have become “slow moving”
How do we treat these items?

Answer 25

Application of the prudence concept
Inventories are valued at the lower between the cost and the market value (net realisable value)

Question 26

How would you calculate the Net Realisable Value?

Answer 26

Estimated selling price - any further costs of completion and all costs to be incurred in marketing, selling and distributing the sale

Question 27

EXAMPLE:

Coffee beans purchased by coffee manufacturer for $1,000. Beans hold for 3 months up to the date of the financial statements.
During that time, there is a fall in the word price of coffee beans and the coffee beans would now only sell for $800 in the market.

What effect will this have on the accounting equation?

Answer 27

When asset is acquired:
Assets (inventory) will increase by $1000 and assets (cash) will decrease by $1000
After asset found to be worth $800:
Assets (inventory) decrease by $200 and OI (expense) decrease by $200

Question 28

What should be done if there is doubt about the value of an asset?

Answer 28

Directors should be invited to consider making provision (estimation of the amount of doubtful debt that will need to be written off) against the loss of the asset

Question 29

What should be done when it is KNOWN that the debt is bad (customer has declared themselves bankrupt)?

Answer 29

Debtor should be removed from the record s a bed debt (trade receivable value as €0)

Question 30

Where/how would you record doubtful debts in a spreadsheet?

Answer 30

Under assets (provisions) and OI (profit of the period)

Question 31

EXAMPLE:

During year 2, customer who was showing signs of financial distress could improve their financial position and there is no longer any doubt that they will not be able to make their payment.
At the end of year 2, provision for doubtful debts is no longer needed
At the end of year 2, the receivables amount to €2,500. A review of th list of debtor causes considerable doubt regarding an amount of €350/
A new provision of €350 is created

Question 32

How would you record in the spreadsheet if the provision is no longer needed (customer was able to improve financial situation and so can pay the complete amount)?

Answer 32

Remove it from the record under the provisions
For example if doubtful debt was already recorded as -€200, add €200 back to assets (provisions) and OI (profit of the period)

Question 33

How is tax recorded on the balance sheet?

Answer 33

Liability increase, OI decrease
When tax paid in following year:
Assets (cash) decrease, liability decrease

Question 34

What will an understatement of liabilities result in?

Answer 34

An overstatement of the OI

Question 35

What is the matching concept?

Answer 35

Match all expenses of the period against revenue, whether paid in cash or not

Question 36

What is the matching concept?

Answer 36

Match all expenses of the period against revenue, whether paid in cash or not

Question 37

What is the accruals concept?

Answer 37

Record all known liabilities at the date of the financial statements

Question 38

What does the accrual of a liability allow the reporting entity to do?

Answer 38

To match costs incurred with the revenue that have been generated in the accounting period

Question 39

What is this an example of?

When a company purchases supplies from a vendor but has not yet received an invoice for the purchase

Answer 39

Accrual

Question 40

What if payment is made in advance for the year ahead and the benefit is gradually used up as the year goes along e.g. insurance premium?
(on the balance sheet and income sheet)

Answer 40

Need to allow the balance sheet to recognise the unexpired portion of the insurance premium as an asset
The income statement will report the amount consumed during the period

Question 41

EXAMPLE:

On 1 Oct Year , a company paid $1,200 for one year’s vehicle insurance. At the balance sheet date of 31 Dec there have been three months benefit used up and there is a nine month benefit yet to come.
How would this be recorded on the spreadsheet?

Answer 41

Payment of premium:
Cash -1200
Expense -1200

Identification of asset remaining as prepayment:
Prepayment +$900
Expense +$900

Cash total: -1200
Prepayment total: +900
Expense total: -300