Week 4

Question 1

What does an income statement show?

Answer 1

How the company has performed over a period;.

Question 2

How is net income calculated?

Answer 2

Income - expense

Question 3

What is included in the income statement?

Answer 3

Revenue
Cost of sales
Gross profit
Administrative
expenses
Distribution expenses
Operating profit
Finance costs
Investment income
Profit before tax
Taxation
Net profit

Question 4

How is gross profit calculated?

Answer 4

Revenue - cost of goods sold

Question 5

How is operating profit calculated and what does it show?

Answer 5

Gross profit - operating expenses - shows profit from business operations before deduction of interest and taxes.

Question 6

How is profit before tax calculated and what does it show?

Answer 6

Operating profit - costs of finance – shows the profit made from the ordinary course of trading, less cost of finance.

Question 7

What is included in income?

Answer 7

Revenue + gains

Question 8

What is revenue?

Answer 8

Income arising in the course of an entity’s ordinary activities, e.g. sales, fees, interest, dividends, royalties and rent.
Principles for recognition
* Entity has transferred promised goods or services to the customer
* Entity has received or is entitled to receive payment in exchange for promised goods or services

Question 9

What is gains?

Answer 9

Represent other items that meet the definition of income that are not classed as revenue, e.g. gains from selling non current assets.

Question 10

At which point is revenue recognised?

Answer 10

• From sale of goods when goods are delivered and accepted by the customer
• Services when services are provided
• Long term contracts as each distinct stage is completed

Question 11

What is an expense?

Answer 11

Losses as well as those expenses that arise in the course of the ordinary activities of the entity. decreases in owners equity that arise when generating revenue.

Question 12

How to recognise expenses (which principles and what are they)?

Answer 12

• Matching principle. Expenses are matched to the revenue that they help generate
• Conservatism or prudence principle. Recognise anticipated losses immediately and recognise anticipated gains only when they arise.

Question 13

How to recognise interest expenses?

Answer 13

Must distinguish 1. Paying interest=the price that a lender charges for the use of the lender’s money and 2. Repaying the principal amount (i.e. the amount borrowed initially)

For Interest expense:
Dr Interest expense (expense account, goes to IS)
Cr Bank OR Cr Interest payable (for unpaid interest)

For Principle amount
Recording a loan:
Dr Bank (BS)
Cr Loan (BS)
Repaying the loan:
Dr Loan (BS)
Cr Bank (BS)

Question 14

What are adjusting entries and what do they do?

Answer 14

Accounting journal entries made at the end of the accounting period after a trial balance has been prepared. Adjusting entries update the financial records for events that
have occurred, but no document for a transaction exists.

Question 15

How to recognise tax expenses?

Answer 15

Tax expense is usually estimated at the end of the year but not paid until 4-6 months later after tax financial statements prepared. At the end of the year we will have an estimate for tax for the year but it is not paid thus creating a tax liability (tax payable).
Dr Tax expense (IS)
Cr Tax payable (SOFP)

Question 16

What are adjusting entries?

Answer 16

1. Accruals/prepayments
2. Depreciation
3. Provisions for bad and doubtful debts
4. Inventory:
   * Inventory write-downs
   * Cost of sales calculation

Question 17

What is cash basis accounting?

Answer 17

Records only transactions with cash: cash receipts and cash payments. When cash is paid, expenses are recorded. As a result, revenues are only recorded when cash is received and expenses are recorded only when cash is paid.

Question 18

What is accrual basis accounting?

Answer 18

Records effect of each transaction as it occurs - that is, revenues are recorded when earned and expenses are recorded when incurred. revenues are considered to be earned when the goods or services are provided to the customers. In accrual basis accounting, it is irrelevant when cash is received or paid.

Question 19

The figures in the trial balance will usually be the amounts paid
in cash in the period, and they need adjusting for?

Answer 19

Outstanding amounts (=accruals) and amounts paid which relate to other periods (=prepayments) to get the correct charge in the statement of profit and loss.

Question 20

What are accrued expenses and on which financial statement do they appear?

Answer 20

Expenses that have been incurred, but not yet recorded (not invoiced) as expenses. I.e. g+s received from suppliers, but payment has not yet been made.
Appear in the SOFP in current liabilities.

Question 21

What are prepaid expenses?

Answer 21

Future expenses that have been paid in advance. Cash has been paid, but g/s have not been received yet.

Question 22

How do we account for inventory and where do we find it?

Answer 22

It is found in current assets in SOFP. When goods are sold their cost becomes an expense, ‘cost of sales’, in the income statement. This expense is deducted from sales to determine gross profit.

Question 23

How to calculate cost of sales (COS)?

Answer 23

Opening inventory + purchases - closing inventory = Cost of goods sold

Question 24

What is a perpetual inventory system?

Answer 24

Where a company keeps a detailed record of the cost of each inventory purchase and sale. Under such system a company determines the cost of goods sold each time a sale occurs.

Question 25

How would you enter a double entry for goods sold?

Answer 25

1. Journal entry for sale transaction
   Dr trade recievables (SOFP)
   Cr sales (IS)
2. Journal entry for recognising COS (expense)
   Dr COS (IS)
   Cr Inventory (SOFP)

Question 26

What is a periodic inventory system?

Answer 26

Companies do not keep detailed inventory records of the goods on hand throughout the period. Instead, they determine the cost of goods sold only at the end of the accounting period.

Question 27

How is COS calculated in a periodic inventory system?

Answer 27

Under the periodic inventory system, all purchases made between physical inventory counts are recorded in a Purchases account: Dr Purchases (instead of Dr Inventory) and Cr Bank/TP.

Question 28

What is a receivable?

Answer 28

The right to receive cash in the future from a current transaction. It is something the business owns; therefore it is an asset.
Each receivable transaction involves two parties
* the creditor who recieves a receivable
* the debtor, the party to a credit transaction who takes on an obligation/payable. The debtor will pay cash later.

Question 29

What are the pros of selling on credit?

Answer 29

the potential for increased revenues and profits by making sales to a wider range of customers

Question 30

What are the cons of selling on credit?

Answer 30

Some customers do not pay, creating uncollectible receivables.

Question 31

How does a company measure the amount of bas debts expense associated with the cost of uncollectible amounts?

Answer 31

They use the provision/allowance method which is based on the matching principle. key idea being to record bad debts expense in the same period as the related sales revenue. The business doesn’t wait to see who pays. Instead, forms an estimate developed from past experiences.

Question 32

What if customers do not pay receivables?

Answer 32

Irrecoverable debt - write off
May not be paid - doubtful debt provision

Question 33

How would you record bad debt written off?

Answer 33

Dr Bad debt write-off (IS) £2,000
Cr Trade receivables (SOFP) £2,000

Question 34

How would you record provision for doubtful debt?

Answer 34

Times the provision (percentage) for doubtful debt by the trade receivable.