W8 Flashcards
What are income and expense accounts in accounting?
Income accounts record sums received by the business, such as payments from customers for goods or services. Expense accounts record day-to-day spending, known as revenue or income expenditure. Expenses do not include spending on long-term assets, which are referred to as capital expenditure.
What does a balance sheet record?
A balance sheet records the value of the total assets held by a business at a specific date. It also shows the net worth or net asset value (NAV) of the business, which is the value of its assets minus its liabilities.
What is the purpose of making provisions for doubtful debts in accounting?
A business may choose to make provisions for doubtful debts to quantify its doubts about receiving payment from certain customers. This allows the business to express these doubts as an actual figure and create a cushioning effect.
What is the principle of double-entry bookkeeping?
The principle of double-entry bookkeeping is that every money transaction a business undertakes will have a dual effect in its accounts. For example, if a sole trader purchases an asset for £5,000, there will be a reduction of £5,000 in the record of its cash and an increase of £5,000 in the record of the assets of the business.
What are current liabilities and long-term liabilities?
Current liabilities are debts that are due to be paid within a year, such as a bank overdraft or trade creditors. Long-term liabilities, also known as non-current liabilities, are debts that are due after one year, such as a term loan.
What is the effect of debt finance on the balance sheet?
Debt finance can affect the balance sheet by increasing liabilities and potentially decreasing net assets. For example, if a company takes out a loan of £750 repayable over five years, it would increase the liabilities on the balance sheet.
What is the difference between a trade creditor and a trade debtor?
A trade creditor refers to a supplier of raw materials or goods that a business owes money to. On the other hand, a trade debtor refers to a customer who owes money to the business.
How is the provision for doubtful debts account treated in the balance sheet?
The provision for doubtful debts account is treated as a liability on the balance sheet. It is shown in a different way from other liabilities and is matched to the receivables asset account.
Why must the two halves of a balance sheet always balance?
The two halves of a balance sheet must always balance because they represent how the money invested by the owners of the business (recorded in the bottom half) has been used (recorded in the top half). If the two halves do not balance, it indicates that something has gone wrong in the financial records.
What is the purpose of a trial balance?
A trial balance is a list of all the balances on all of a business’s ledgers/accounts as at the end of an accounting period. It shows debit balances in one column and credit balances in another column. The total of each of the two columns should be the same, which helps ensure the accuracy of the financial statements.
How is the depreciation charge calculated using the reducing balance method?
The reducing balance method deducts the provision for depreciation from the cost figure to give the written down value. Then, the depreciation charge of 20% is applied to the written down value to calculate the charge for depreciation for the year.
Can a sole trader’s business and personal finances be treated separately?
For accounting purposes, a sole trader’s business and personal finances are treated as separate entities. The business has its own capital account and the owner pays themselves through drawings out of the profits of the business.
How are year-end adjustments used in the preparation of financial statements?
Year-end adjustments are transactions or modifications to the account entries on the trial balance. They are needed to apply the accruals concept to the preparation of financial statements. Year-end adjustments include items such as depreciation, accruals, prepayments, bad debts, and doubtful debts.
How are fixed assets and current assets classified in a balance sheet?
Fixed assets are tangible or intangible assets owned by a business that provide long-lasting benefits. Current assets include cash and items that can quickly be turned into cash within one year, such as stock, debtors, and cash in hand. These assets are classified based on their nature and liquidity.
How are doubtful debts accounted for in the profit and loss account?
Doubtful debts are accounted for in the same expense account as bad debts in the profit and loss account. However, only the increase (if any) in the provision for doubtful debts over the previous year’s provision is treated as an expense.
What are year-end adjustments?
Year-end adjustments are transactions or modifications to the account entries on the trial balance. They are needed to apply the accruals/matching concept to the preparation of financial statements.
What are year-end adjustments in accounting?
Year-end adjustments are made to some figures in the trial balance before preparing the financial statements. These adjustments ensure that all income and expenditure shown on the financial statements relate only to the relevant accounting period.
What is the purpose of a profit appropriation statement in a partnership?
A profit appropriation statement is used to divide the profits of a partnership among the partners. It determines the allocation of profits based on factors such as interest on capital, salaries, and the agreed profit share ratio.
How is the cost of sales calculated on a profit and loss account?
The cost of sales figure on a profit and loss account is calculated using figures for opening stock and closing stock. The formula used is: Opening stock + purchases - closing stock = cost of sales.
What is the purpose of depreciation in accounting?
Depreciation is a mechanism used in accounting to deal with the decline in value of a fixed asset over time. It spreads the cost of the asset over its useful life and ensures that the accounts give a true reflection of the position of the business. Depreciation can be calculated using methods such as straight-line or reducing balance.
How are drawings by partners treated in partnership accounts?
Drawings by partners are withdrawals of profits made by the partners during the year. They are usually based on an estimate of the partner’s share of expected profits. If partners draw too much, they may be liable to contribute a balancing payment back to the partnership.
What is the purpose of a profit and loss account?
The purpose of a profit and loss account is to record the income of a business throughout an accounting period and deduct the expenses incurred in that period. This calculation results in a profit or loss figure for the period.
What are accruals and when do they occur?
Accruals occur when a business has had the benefit of something in one accounting period but will not pay for it until the next. They are made to comply with the accruals/matching concept and ensure a true reflection of the business’s financial position.
How does the straight-line method of depreciation work?
The straight-line method of depreciation spreads the depreciation charge evenly over the life of the asset. It is the most common and straightforward method used when the service provided by the asset continues consistently over its useful economic life.
What is the difference between doubtful debts and bad debts in accounting?
Bad debts represent a cost to the business as they are debts that have been written off as uncollectible. Doubtful debts, on the other hand, represent potential costs that the business may or may not incur. They are accounted for in the same expense account as bad debts.
What does the balance sheet of a business show?
The balance sheet of a business shows the assets, liabilities, and capital accounts of the business. It provides a snapshot of the financial position of the business on a specific date.
What are prepayments and when do they occur?
Prepayments occur when a business has paid for something in advance during one accounting period but does not get the benefit of all or some of what it has paid for until the next. Prepayments are the opposite of accruals and are adjusted to match the expenditure incurred to the relevant accounting period.
How does the reducing balance method of depreciation work?
The reducing balance method of depreciation expresses the depreciation charge each year as a percentage of the reducing balance, which is the net book value of the asset at the start of the relevant accounting period. This method is used when an asset is likely to lose a large part of its value in the first few years of ownership.
How is the net asset value (NAV) calculated on a balance sheet?
The net asset value (NAV) of a business is calculated by adding the fixed assets (net book value) and net current assets, and then deducting long-term/non-current liabilities. The amount of capital invested in the business is recorded in the bottom part of the balance sheet.
What is the purpose of a trial balance in preparing financial statements?
A trial balance is used as a basis for preparing financial statements, primarily the profit and loss account and balance sheet. It provides a comprehensive list of all the balances on a business’s ledgers/accounts, categorized by their debit and credit balances.
What is the impact of not making adjustments for accruals and prepayments?
If adjustments are not made for accruals and prepayments, the accounts will not give a true reflection of the business’s financial position. The profit may be artificially high or low, distorting the financial position.
How is the provision for doubtful debts calculated?
The provision for doubtful debts can be calculated based on a specific percentage of the receivables or through a general provision. The specific or general provision is determined at each year-end and may increase, reduce, or stay the same compared to the previous year’s provision.
What is the net asset value figure for a business after specific transactions?
After specific transactions, such as the injection of capital and obtaining a long-term loan, the net asset value figure for the business can be calculated by subtracting the long-term liability from the total assets. The net asset value represents the current value of the business after taking into account its assets and liabilities.
What are bad debts and when are they written off?
Bad debts are debts that a business knows with certainty it will never receive. They can be written off during the financial year or at the end of the financial year.
What is the difference between a profit and loss account and a balance sheet?
A profit and loss account records the income and expenses of a business throughout an accounting period to calculate the profit or loss figure. On the other hand, a balance sheet provides a snapshot of the assets, liabilities, and capital accounts of the business on a specific date.
What is the treatment of doubtful debts in the profit and loss account?
Doubtful debts are not shown as a whole amount in the profit and loss account. Instead, only the increase (if any) in the provision for doubtful debts over the previous year’s provision is treated as an expense.
What is a provision for doubtful debts and when is it made?
A provision for doubtful debts occurs when a business provides for the possibility that a debt or debts may not be paid. It can be specific or general and is made to accurately reflect the fact that the business may not receive all of the money owed to it.
What is the significance of a trial balance in accounting?
A trial balance is a crucial tool in accounting as it ensures that the sum of all debits equals the sum of all credits. It helps identify any errors or imbalances in the accounts before preparing financial statements, ensuring the accuracy and reliability of the financial information.
How is the provision for doubtful debts shown on the balance sheet?
The provision for doubtful debts is shown as a liability on the balance sheet. It is matched to the receivables asset account to accurately represent the business’s affairs and demonstrate prudent provision for potential unpaid debts.
How are assets and liabilities classified in a balance sheet?
In a balance sheet, assets and liabilities are separated to provide a clear view of a business’s financial position. Assets are things owned by the business, such as fixed assets and current assets. Liabilities are amounts owed by the business to others.
How are income and expense entries transferred into a profit and loss account?
Income and expense entries from the trial balance are transferred into a profit and loss account. For example, sales (income account) is recorded at the top of the profit and loss account, while expenses such as telephone and postage (expense accounts) are recorded in the expenses section.
What is the purpose of year-end adjustments for bad and doubtful debts?
Year-end adjustments for bad and doubtful debts ensure that the accounts accurately reflect the possibility of not receiving all or part of the money owed to the business. Bad debts are written off, reducing the receivables account, while a provision for doubtful debts is made as a liability.
What is the net current assets figure on a balance sheet?
The net current assets figure on a balance sheet indicates how much cash the business could make available at short notice. It is calculated by subtracting current liabilities from current assets.
What are the five year-end adjustments?
The five year-end adjustments are depreciation, accruals, prepayments, bad debts, and doubtful debts.
What are the specific adjustments for accruals and prepayments?
Accruals occur when an expense has been incurred but not yet paid for, while prepayments occur when an expense is paid for in advance but not fully utilized. These adjustments ensure that the expenses are matched to the relevant accounting period.
How are asset, liability, and capital entries transferred into a balance sheet?
Asset, liability, and capital entries from the trial balance are transferred into a balance sheet. Fixed assets and net current assets are categorized as assets, while current liabilities and long-term/non-current liabilities are categorized as liabilities. The amount of capital invested in the business is recorded in the capital section of the balance sheet.
What is the impairment of receivables on a company balance sheet?
The impairment of receivables on a company balance sheet refers to the adjustment made to reflect the decrease in value of the company’s assets.
What causes the figure for Net Assets to rise in the Balance Sheet?
The increase in the value of the asset in the Balance Sheet causes the figure for Net Assets to rise correspondingly. This is achieved by creating or increasing an existing revaluation reserve by the same value.
