SAC 3

Question 1

What are the 2 types of ‘returns of stock’?

Answer 1

Purchase Return: A purchase return occurs when stock is returned by our firm to the supplier

Sales Return: A sales return occurs when stock is returned to our firm by a customer.

Question 2

What are the reasons for returns of stock?

Answer 2

The stock is damaged/faulty

The stock is the wrong size/colour/shape/model

Too many items of stock were purchased

The customers have simply changed their minds

Question 3

Explain one benefit that may be derived by accepting returns from customers who change their mind.

Answer 3

Businesses that accept returns from customers may actually generate greater sales, with customers more willing to buy if they know they can return the product if it turns out to be unsuitable.

Question 4

How should a Sales Return be priced?

Answer 4

Sales Returns should value stock at the cost price used in the most recent transaction in the OUT column. If the most recent sale involved two different cost prices, then a reversal of FIFO assumes that the last stock out is the first stock to be returned.

Question 5

Explain why sales returns are reported separately in the Profit and Loss Statements

Answer 5

The sales returns can indicate the satisfaction of customers. The higher the value of sales returns the lower the customer satisfaction levels. The lower the value of sales returns the higher the customer satisfaction levels.

Question 6

State changes that can reduce the amount of sales returns

Answer 6

Improve quality of products
Improve packaging
Improve delivery and ordering efficiency

Question 7

Define the term ‘cost’ as it is used in reference to stock.

Answer 7

The term cost in reference to stock is all the costs incurred in getting stock into either a condition or location ready for sale.

Question 8

Referring to one qualitative characteristic, explain why stock should be valued at its historical cost.

Answer 8

Reliability ensures that reports are free from bias and error, verifiable through source documents. By valuing stock at its Historical Cost, it ensures Reliability in the reports, because this valuation will be free from error and bias and based on verifiable evidence.

Question 9

Explain why valuing stock at its selling price would breach Conservatism

Answer 9

Conservatism ensures that gains are not recognised until they happen, whilst losses are recognised as soon as they’re seen likely to occur, in order not to overstate the new profit. Therefore, valuing stock at its selling price does not guarantee that the stock can be sold for this amount. This would recognise a gain (the profit on the sale of the stock) before it is certain, which would overstate the value of assets; namely, stock, thus, breaching the conservatism principle.

Question 10

Explain why GST is excluded from the calculation of the cost of stock.

Answer 10

GST is excluded from the calculation of stock because the GST will not provide any future economic benefit to the asset, stock. Rather, the GST incurred on stock, will reduce the liability GST clearing owing to the ATO, assuming GST clearing account has a credit balance. GST does not affect any future economic benefit gained when the stock is sold and thus, is excluded.

Question 11

State two reasons why it is important to have an accurate calculation of the cost price of stock.

Answer 11

In order to have an accurate value of stock on the Balance Sheet –> Therefore, the Conservatism principle is not breached, by recording the stock on the balance sheet at its Historical Cost.

In terms of earning a profit –> Therefore, when a business applies a mark-up, the cost price must be accurate so that the selling prices are not set too high or too low.

Question 12

Define the term ‘product cost’.

Answer 12

The product cost is the cost incurred in order to bring stock into a condition and location ready for sale, which can be allocated to individual units of stock on a logical basis.

Question 13

What is the ‘two way test’ when deciding if the cost is incurred as a product cost?

Answer 13

The cost must be incurred in order to bring the stock intro a condition or location ready for sale

The cost must be able to be allocated to individual units of stock on a logical basis. This means the cost must be directly traceable to a particular line of stock, and a per item cost can be calculated on some logical basis.

Question 14

Why is the product cost recorded as part of the cost of stock?

Answer 14

Because product costs are treated as part of the unit cost of each item of stock, they are not recorded separately, but rather as part of the value of stock in the stock card and the Stock Control Account. They are treated as part of the asset, stock.

Question 15

Define the term ‘period cost’.

Answer 15

The period cost is a cost incurred in order to bring stock into a condition or location ready for sale that is not allocated to individual units of stock because there is no logical basis to do so.

Question 16

Explain why delivery to customers is not considered to be part of the cost of stock.

Answer 16

Delivery to customers is an expense incurred after the sale, it is not an expense incurred in getting stock into a condition or location ready for sale, therefore, it is excluded from the cost of stock.

Question 17

Explain the treatment of GST charged in calculating product costing

Answer 17

GST is excluded from the cost when calculating product cost as it’s not an expense incurred in getting stock into a condition or location ready for sale. Rather, the GST charged reduces the liability owing to the ATO, assuming GST clearing account had a credit balance.

Question 18

Explain the effect on profit if period costing is used instead of product costing.

Answer 18

If period costing is used then the cost for the entire period is recognised as being incurred in the period in which the stock is purchased, regardless of whether or not the stock is sold, this will OVERSTATE Cost of Goods Sold and UNDERSTATE Net Profit.

Question 19

Explain the effect on profit if period costing is used instead of product costing for all costs associated with the stock.

Answer 19

Profit will be reduced or understated by using period costing instead of product costing in circumstances where not all items of stock are sold. Period costing will recognise the expense as incurred regardless of the number of items sold, thereby increasing/overstating Cost of Goods Sold and decreasing/understating Net Profit. Product costing only recognises the expense as incurred when the actual item is sold.

Question 20

Explain the effect on the Balance Sheet if period costing is used instead of product costing.

Answer 20

If using period costing, then the stock value on the Balance Sheet will not include any of the additional costs to get the stock ready for sale, only the supplier’s price, thus, will UNDERSTATE Stock Control, assets, on the balance sheet and will UNDERSTATE Owner’s equity as the Net Profit will also be understated.

Question 21

State two circumstance where it would be acceptable to use period costing.

Answer 21

When the cost cannot be allocated to each individual unit of stock on a logical basis

When the cost concerned can be allocated, but is too small to affect decision-making (immaterial/insignificant)

Question 22

Referring to one qualitative characteristic, explain why the correct stock valuation method should be applied.

Answer 22

Relevance ensures that reports are useful for decision making and relevant to the current Reporting Period. Therefore, product costing should be used where possible, in order to include all information that is useful for decision making for the current Period.

Question 23

What are the differences between period and product costs?

Answer 23

Product costs are recognised in the period when the stock is sold

Period costs are recognised in the period when the stock is purchased

Profit will be lower under Period cost because ALL of the cost is written off in the period.

Question 24

Define the term ‘Net Realisable Value’

Answer 24

Estimated selling price of stock less any costs incurred in its selling, marketing or distribution

Question 25

What are some reasons that the value of stock can fall below its historical cost?

Answer 25

Damaged

Use by date (old)

Out of fashion

Out of season

Deliberate marketing ploy

Question 26

Which accounting principle is relevant to taking a stock write down?

Answer 26

Conservatism – the principle ensures that losses are recognised as soon as they are seen likely to occur, and therefore assets will not be overstated. Thus, if there is likely to be a loss in the value of stock, then it must be recorded in order not to overstate assets.

Question 27

Which qualitative characteristic is relevant to taking a stock write down?

Answer 27

Relevance – the characteristic ensures that what is recorded is useful and relevant for decision making in the business. Therefore, a stock write down is relevant because if the NRV value has fallen below the historical cost price, the historical cost of the item is no longer relevant or useful for decision making. Thus, a stock write down is recorded in order to uphold relevance in decision making about the line of stock.

Question 28

With reference to one accounting principle, explain why stock is valued at the lower of cost and net realisable value

Answer 28

Conservatism: The principle ensures that losses are recognised as soon as they’re likely to occur in order not to overstate assets. Therefore if the business identifies that they will be unable to sell product for more than cost price it should be valued at the NRV value in order not to overstate assets and profit.

Question 29

Explain why a firm may choose to use credit to purchase a non-current asset.

Answer 29

Non-current assets may have a exorbitant/large cost, thus, a firm may choose to use credit to purchase a non-current asset because it allows them to repay the creditor in instalments, rather than in one large payment.

Question 30

Explain why a credit purchase of a non-current asset must be recorded in the General Journal.

Answer 30

It is recorded in the General Journal because it is an infrequent and non-cash transaction that does not involve the purchase of stock for resale.

Question 31

Explain the difference between Creditors Control and a sundry creditor

Answer 31

A creditors control is used only for amounts owed for the purchase of stock. However, where a firm purchases an asset other than stock, a separate sundry creditor account must be created in the General Ledger. The sundry creditor is still a current liability, but has its own account in the General Ledger, and would be reported separately in the Balance Sheet.

Question 32

Define ‘Depreciation’

Answer 32

the process of allocating the cost of a non-current asset over its useful life as an expense.

Question 33

Define ‘Accumulated Depreciation’

Answer 33

the value of the asset that has been consumed/allocated as an expense over its life so far

Question 34

Define ‘Carrying Value’

Answer 34

It represents the unallocated cost of the asset; that is the value of the asset that is yet to be consumed/allocated as an expense, plus any residual value

Question 35

Define the term over-depreciation

Answer 35

Over-depreciation occurs when excess depreciation has been allocated over the life of the asset, so that the carrying value of the asset is understated.

Question 36

Define the term ‘under-depreciation’

Answer 36

Under-depreciation occurs when insufficient depreciation has been allocated over the life of the asset, so that the carrying value is overstated.

Question 37

Referring to one accounting principle, explain the purpose of depreciating a non-current asset.

Answer 37

The Reporting Period principle ensures that the life of the business is broken up into intervals. Therefore, a non-current asset is depreciated to ensure that an accurate profit is calculated, by comparing revenues earned against expenses incurred in the current Reporting Period. Depreciation does this by recognising as an expense only the part of the cost of a non-current asset that is consumed/incurred in the current Reporting period.

Question 38

Referring to one qualitative characteristic, explain why depreciation methods should not be changed for a particular non-current asset over its useful life.

Answer 38

Comparability: Changing accounting methods will mean that the reports will not be able to be compared from one Reporting Period to another: it will be unclear whether changes in depreciation expense are the result of changes in financial performance or simply changes in accounting methods.

Question 39

Explain the effect on the carrying value of an asset at the end of its useful life if the owner has used the other depreciation method.

Answer 39

No effect: both the straight-line and reducing balance methods will allocate the same total depreciation expense over the life of the asset.

Question 40

The owner of a business said “We can change to the reducing balance method of depreciation if we want to”
Discuss whether this would be advisable.

Answer 40

According to Consistency, reports should be consistent from one reporting period to another, and comparability ensures that reports are comparable from one Reporting period to the next. Thus, reports can be analysed to see how the company performed and new budgeting reports can be made. Accordingly, it would not be advisable as Reports would be inconsistent and incomparable meaning that all the analysis and budgeting for the next Reporting period cannot be done. However, relevance ensures that what is useful to decision making should be recorded. If therefore it is more relevant to change depreciation methods it can be done, however, the owner would need to disclose the impact the change has had on assets, and profit and income statement. Overall the change should really not be made because the change in profit would be very insignificant and not worth it, from using the one depreciation method to the next and this point in time. (Look at cost of NCA compared to the business)

Question 41

State the assumption that underlies the straight-line method of depreciation in relation to how assets contribute to revenue.

Answer 41

The assumption made is that the asset being depreciated will contribute evenly to revenue, doing the same job when it is old as when it is new.

Question 42

Explain why the straight-line method should be used when depreciating shelving.

Answer 42

The straight-line method best reflects the revenue earning pattern of shelving, which will contribute evenly to revenue over its useful life (as it has no moving parts), and this method allocates depreciation expense evenly over the asset’s life.

Question 43

State the assumption that underlies the reducing balance method of depreciation in relation to how assets contribute to revenue.

Answer 43

The assumption made is that the asset being depreciated has moving parts and is therefore likely to be more efficient and productive when it is new, and so contributes more to revenue at the start of its useful life than at its end.

Question 44

What are some examples of non-current assets which would use the reducing balance method for depreciation?

Answer 44

Vehicle
Equipment
Sewing Machine
Machinery
Photocopier

Question 45

Explain how the reducing balance method of depreciation allocates depreciation expense.

Answer 45

The reducing balance method of depreciation assumes that the asset will contribute more to revenue at the start of its life, when it is new, efficient and productive. As a consequence, this method allocates more depreciation expense at the start of the asset’s life. Under this method, as the asset ages, its contribution to revenue decreases and so too does the depreciation expense.

Question 46

Explain why the reducing-balance method should be used when depreciating a sewing machine.

Answer 46

The reducing balance method best reflects the revenue earning pattern of the sewing machine, which will contribute more to revenue when it is new and less as it ages (as it has moving parts). This method allocates more depreciation expense at the start of the asset’s life and less as it ages.

Question 47

Explain how the reducing-balance method will affect net profit at the beginning of the asset’s life.

Answer 47

Net Profit will be lower under the reducing balance method because depreciation expense will be higher at the starts of its life. This is because the reducing balance method allocates more depreciation expense at the start of the asset’s life when it is newer and can contribute more to revenue.