Unit 3 Acc Chapter 01 Review Questions (Role of Accounting)

Question 1

RQ 1.1 // The Purpose of Accounting.

Q1. List five factors that can influence the likelihood that a small business will be successful.

Answer 1

●	consumer tastes
●	the level of competition
●	the quality of its staff/employees
●	the economic climate
●	the management skills of the owners

Question 2

RQ 1.1 // The Purpose of Accounting.

Q2. List three important decisions that a business owner would need to make on a daily basis.

Answer 2

●	determine selling prices
●	check stock levels
●	pay a creditor
●	pay electricity bill/other bills
●	chase up outstanding debtors
●	set a target sales figure for the day
●	other suitable answers accepted, but must be on a daily basis

Question 3

RQ 1.1 // The Purpose of Accounting.

Q3. Define ‘accounting’.

Answer 3

Accounting is the collection and recording of financial data, and the reporting, analysis and interpretation of financial information.

Question 4

RQ 1.1 // The Purpose of Accounting.

Q4. Explain the purpose of accounting.

Answer 4

The purpose of accounting is to provide business owners with financial information that will assist them in making decisions about the activities of the firm.

Question 5

RQ 1.2 // Users of Accounting Information

Q1. List six likely users of accounting information.

Answer 5

●	debtors and other customers
●	creditors and other suppliers
●	banks and other financial institutions
●	employees
●	prospective owners
●	Australian Taxation Office

Question 6

RQ 1.2 // Users of Accounting Information
Q2. Explain why banks and other financial institutions will be interested in the financial information of a small business.

Answer 6

They will be interested in the firm’s current levels of debt before providing it with any additional finance.

Question 7

RQ 1.2 // Users of Accounting Information

Q3. Explain the difference between ‘financial data’ and ‘financial information’.

Answer 7

Financial data are the raw facts and figures upon which financial information is based; whereas financial information is financial data that has been sorted, classified and summarised into a more useable and understandable form.

Question 8

RQ 1.3 // The Accounting Process

Q1. List the four stages in the accounting process.

Answer 8

● source documents
● record
● report
● provide advice

Question 9

RQ 1.3 // The Accounting Process

Q2. Explain the role of source documents in the accounting process.

Answer 9

Source documents provide the data on which the accounting information will be based.

Question 10

RQ 1.3 // The Accounting Process
Q3. State the type of transaction evidenced by the following source documents:
●	receipt
●	cheque butt
●	invoice
●	memo

Answer 10

● receipt – provides evidence of cash received by the business

● cheque butt – provides evidence of cash paid by the business

● invoice – provides evidence of credit sales and purchases

● memo – provides evidence of transactions within the firm itself.

Question 11

RQ 1.3 // The Accounting Process

Q4. Explain the difference between the ‘recording’ and ‘reporting’ stages of the accounting process.

Answer 11

Recording involves sorting, classifying and summarising the data contained in the source documents.

Reporting involves the preparation of financial statements that communicate the financial information to the owner, so that decisions can be made.

The accounting process involves taking the information generated from the accounting records (stage 2) and reporting that financial information to the owner of the business (stage 3).

Question 12

RQ 1.3 // The Accounting Process
Q5. State the purpose of the following accounting reports:
●	Cash Flow Statement 
●	Income Statement
●	Balance Sheet

Answer 12

● Cash Flow Statement – reports on the firm’s cash inflows and outflows, and the change in its cash balance over a period

● Income Statement – reports on the firm’s ability to earn a profit from its trading activities

● Balance Sheet – reports on the firm’s assets and liabilities at a particular point in time.

Question 13

RQ 1.4 // Accounting Principles

Q1. Define the following accounting principles

Answer 13

● entity – the business is assumed to be separate from the owner and other businesses, and its records should be kept on this basis

● Going Concern – the life of the business is assumed to be continuous, and its records are kept on that basis

● Reporting Period – the life of the business must be divided into periods of time to allow reports to be prepared; these accounting reports should reflect the reporting period in which a transaction occurs

● Historical Cost – the recording of a transaction at its original cost or value, as this value is verifiable by reference to the source document

● Conservatism – losses should be recorded when probable but gains should only be recorded when certain, so that liabilities and expenses are not overstated and assets and revenues are not understated

● Consistency – accounting methods should be applied in a consistent manner to ensure that reports are comparable between periods

● Monetary Unit – all items must be recorded and reported in a common unit of measurement; that is, Australian dollars.

Question 14

RQ 1.4 // Accounting Principles

Q2. Explain one practical consequence of adopting the entity principle.

Answer 14

If the owner has a beach house or a four-wheel drive, but this item is not being used by the business, it must not be included as a business asset in the firm’s Balance Sheet.

Thus, the firm is able to assess its performance based on assets under the control of the business.

Question 15

RQ 1.4 // Accounting Principles

Q3. State the length of a Reporting Period. (Beware: this is a trick question!)

Answer 15

A Reporting Period can be as short as the owner requires, but in most cases, to meet taxation requirements, is not longer than a year.

Question 16

RQ 1.4 // Accounting Principles
Q4. Explain why the implementation of the Going Concern principle requires the adoption of the Reporting Period principle.

Answer 16

The Going Concern principle assumes the life of the business is continuous.
As we cannot wait until the end of the firm’s life to calculate profit, it is necessary to divide that life into arbitrary periods so that profit can be calculated for the Reporting Period as determined by the owner.

Question 17

RQ 1.4 // Accounting Principles

Q5. State how profit is calculated under accrual accounting.

Answer 17

Under accrual accounting, profit is determined by comparing revenues earned against expenses incurred in a particular reporting period.

Question 18

RQ 1.5 // Qualitative Characteristics

Q1. Define the qualitative characteristics

Answer 18

● Relevance – accounting reports should include all information that is useful for decision-making, and exclude information that is not

● Reliability – accounting reports should contain information that is free from bias and error, and thus can be relied upon for its accuracy through proof/verifiable evidence

● Comparability – accounting reports should be able to be compared over time through the use of consistent accounting methods

● Understandability – accounting reports should be presented in a manner that makes it easy for them to be understood by the user.

Question 19

RQ 1.5 // Qualitative Characteristics

Q2. Explain how the Entity and Reporting Period principles ensure Relevance in the accounting reports.

Answer 19

When preparing a Balance Sheet it is not relevant to include the personal assets of the owner, as these are not being used by the business to earn revenue, and thus are not useful for decision-making.

Similarly, the Income Statement should include only revenues and expenses from the current reporting period and not from a previous or future reporting period, thus making decision-making more useful.

Question 20

RQ 1.5 // Qualitative Characteristics

Q3. Referring to one qualitative characteristic, explain why accountants must follow the Historical Cost principle.

Answer 20

Accountants must follow the historical cost principle because using the original purchase price of a transaction is the best way to ensure that the information in the Balance Sheet is free from bias and error.

This price is verifiable by reference to the source document and ensures Reliability in the accounting reports.

Question 21

RQ 1.5 // Qualitative Characteristics

Q4. Explain how the recording system can ensure Comparability of accounting reports.

Answer 21

If the recording system used by a business has been utilising consistent accounting methods, then the reports over time and between companies can be comparable.

Question 22

RQ 1.5// Qualitative Characteristics

Q5. Suggest two ways of improving the Understandability of accounting reports.

Answer 22

Accounting reports can be more effective if information is presented in the form of graphs, tables or charts, or simply in a language that is free from accounting jargon.

Question 23

RQ 1.6 // The Elements of Financial Statements
Q1. Define the following items:
●	asset 
●	liability
●	owner’s equity
●	revenue
●	expenses

Answer 23

● asset – a resource controlled by an entity, as a result of past events, from which future economic benefits are expected to flow to the entity

● liability – a present obligation of the entity, as a result of past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits

● owner’s equity – the residual interest in the assets of the entity after the deduction of its liabilities

● revenue – an inflow of economic benefits (or saving in outflows) in the form of an increase in assets (or decrease in liabilities) that increases owner’s equity, except for capital contributions by the owner

● expense – an outflow or consumption of economic benefits (or reduction in an inflow) in the form of a decrease in assets (or increase in liabilities) that reduces owner’s equity, except for drawings by the owner.

Question 24

RQ 1.6 // The Elements of Financial Statements

Q2. State one reason why wages is not considered to be an asset.

Answer 24

Cash paid to wages this month is not an asset as there is no future economic benefit. In order to gain a further benefit from employees, a further payment must be made.

Question 25

RQ 1.6 // The Elements of Financial Statements

Q3. State one reason why the advertising for next year is not considered to be a liability.

Answer 25

If advertising is expected to be paid next year, it cannot be considered a liability because at present there is no obligation to pay.
The obligation will only occur once the firm has signed the contract, or the advertising itself has been provided.

Question 26

RQ 1.6 // The Elements of Financial Statements

Q4. Explain why a capital contribution is not considered to be revenue.

Answer 26

Capital contributions are excluded from revenues because they occur not due to the activities of the business, but rather the actions of the owner.

Question 27

RQ 1.6 // The Elements of Financial Statements

Q5. Explain why drawings is not considered to be an expense.

Answer 27

Drawings are excluded from expenses because they do not contribute to the firm’s ability to carry out its trading activities, and so does not affect its ability to earn revenue or profit.