Week 7 - Preparing the financial statements and internal controls Flashcards

1
Q

What is a method of preparing for financial statements?

A
  1. If required, balance off and close ledger accounts at the period end
  2. List all balances in the initial trial balance and check debit and credits are equal
  3. Make adjustments to the trial balance for:
    - Closing inventory and inventory write-offs, COGS (week6)
    - Accruals and prepayments (week4)
    - Depreciation and amortisation (week5)
    - Bad debt write-offs and changes in the provision for doubtful debts (week 6)
    - Interest expense, new borrowings or repayment, and other provisions (week9)
    - New share issuance, and dividend payment (week9)
    - Errors and omissions
  4. Prepare financial statements
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2
Q

What are the main adjustments for COGS and opening and closing inventory?

A

adjust inventory to its end of year value and calculate COGS (pay attention to any written-down in the closing inventory)

Journals
Debit: Cost of sales XXX
Credit: OB Inventory XXX
Debit: Cost of sale XXX
Credit: Purchases XXX
Debit: Closing Balance Inventory XXX
Credit: Cost of sales XXX

OR

COGS = Opening Inventory + Purchases - Closing Inventory

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3
Q

What are the main adjustments for accruals?

A
  • Expense with accruals:
    Calculate how much expense (I/S) has been incurred over the year, starting from the cash payment in the trial balance, decreases (credit) the expense by the amount of opening accrual, and increases (debit) the expense by the amount of closing accrual.
  • Create (credit) a (closing) accrual as a liability in the B/S

Journal
Debit: OB Accruals XXX
Credit: Expense (I/S) XXX
Debit: Expense (I/S) XXX
Credit: CB Accruals (B/S) XXX

Directly working out:
Expense (I/S) = CB Accruals (B/S) + Cash payment - OB Accruals

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4
Q

What are the main adjustments for prepayments?

A
  • Expense with prepayments: calculate how much expense has been incurred over the year, starting from the cash payment in a trial balance, increase (debit) the expense by the amount of opening prepayments, and decrease (credit) the expense by the amount of closing prepayments
  • Create (debit) a (closing) prepayment as an asset in the B/S

Journal
Debit: Expense (I/S) XXX
Credit: OB Prepayment (/S) XXX
Debit: CB Prepayment (B/S) XXX
Credit: Expense (I/S) XXX

Directly working out:
Expense (I/S) = OB Prepayments + Cash Payments - CB Prepayments

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5
Q

What are the main adjustments for depreciation (accumulated depreciation)?

A
  • Calculate this year’s depreciation expense and include it in the Income Statement
  • Add this year’s depreciation to accumulated depreciation brought forward and include the total in the Balance Sheet

Journal
Debit: Depreciation expense (I/S) XXX
Credit: Accumulated depreciation (B/S) XXX

Adjustments for disposal of non-current assets:
- Remove the disposed assets’ cost and accumulated depreciation

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6
Q

What are the main adjustments for credit loss, allowance/provision for doubtful debts?

A

Adjustment for trade receivables:
1. Credit loss/ bad debts expense
Debit: Credit loss/ Bad debts expense (I/S) XXX
Credit: Receivables (B/S) XXX

  1. Allowance for credit loss/ provision for doubtful debts in the year
    - Two provisions: Specific allowance and/ or general allowance
    - The change in allowance for credit loss is included to the I/S (debit for an increase in the provision, credit for a decrease)
    - Total allowance for credit loss is shown below the trade receivables in B/S to reduce the trade receivables

Journals:
If the allowance for credit loss has increased from last year
Debit: Change in allowance for credit loss (I/S) XXX
Credit: Allowance for credit loss (B/S) XXX
If the allowance for credit loss has decreased from last year
Debit: Allowance for credit loss (B/S) XXX
Credit: Change in allowance for credit loss (I/S) XXX

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7
Q

What is specific allowance?

A

an allowance operation we set for a specific customer or specific trade receivables or we have a general allowance

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8
Q

Where are adjustments to trial balance made?

A
  • You can use journals to record the adjustments and post these to a final trial balance
  • You can use T accounts
  • For simple adjustments, use direct calculations
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9
Q

Why are internal controls required?

A
  1. to prevent managers/ employees from misappropriating cash and other assets from the organisation (fraud)
    2, to identify errors in recording transactions and amounts
  2. to provide evidence to external stakeholders that the company is well governed
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10
Q

What are 5 examples of fraud/ theft

A
  1. Supplier fraud
  2. Fake employee
  3. Theft
  4. Customer fraud
  5. Collusion
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11
Q

What is supplier fraud?

A

employee creates a fake supplier and arranges for the invoices to be paid

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12
Q

What is a fake employee?

A

when an employee leaves, another staff member tells payroll that the employee’s bank details have changed and arranges for salary to be paid into their own account

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13
Q

What is theft?

A

taking petty cash, stealing inventory or stationary etc

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14
Q

What is customer fraud?

A

customers fail to pay for goods or pay using stolen credit cards or cheques

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15
Q

What is collusion?

A

where employees act together to defraud employer

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16
Q

What is the internal control and the separation of responsibility?

A

a self-checking mechanism
an accounting system control

no one person is responsible for the whole transaction, eg:
1. Initiating transactions
2. Recording of transactions
3. Custody of assets
For example, a sales executive or an inventory custody person cannot record cash, authorise credit notes, or write-off bad debts

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17
Q

What is a major external control/ monitoring on companies?

A

use of external auditors

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18
Q

What does an auditor do?

A

scrutinise accounts, records, controls to report an opinion on whether the accounts show a true and fair view

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19
Q

What do auditors not guarantee?

A

that the accounts are correct or that no fraud has occured

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20
Q

What must auditors be?

A

an expert, a registered auditor, and external auditors must be independent of the company

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21
Q

What is the purpose bank reconciliations?

A

it is a method for internal control
the purpose is to check whether the cash book balance is correct by comparing it to the bank statement

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22
Q

Why are the cash book balances often different?

A

because of timing etc and need to be reconciled

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23
Q

What is a bank reconciliation a part of>

A

not part of the double enry system but must be prepared as part of preparing the financial statements

24
Q

Why should the bank reconciliation always be prepared by someone different to the person who pays cash/ payments into the bank and writes cheques?

A

so it can act as a control

25
Q

Which one is correct if the cash book balance doesnt equal the bank statement balance?

A
  1. There are timing differences of payments and receipts
    eg if there are items in the cash book but not the bank statement
  2. Bank charges/ items notified to the bank
    eg items in the bank statement but not in the cash book
  3. Timing differences vs correction of errors
    - Final differences between the cash book and bank statement should always reflect timing differences
26
Q

What are differences arising between the cash book and bank statements to do with payments?

A
  1. corrections and adjustments to the cash book (the bank statement is correct, the cash book isnt)
    - payments made into or from the bank directly, eg by direct debit but havent been entered into the cash book yet
    - dishonoured (bounced) cheques
    - bank interest and charges not yet entered in the cash book
  2. Payments out from the bank not yet in the cash book sometimes called unrecorded cheques
  3. Payments into bank not yet in cash book are sometimes called unrecorded lodgements
27
Q

What are the corrections and adjustments to the cash book (the bank statement is correct, the cash book isnt)?

A
  1. payments made into or from the bank directly, eg by direct debit but havent been entered into the cash book yet
  2. dishonoured (bounced) cheques
  3. bank interest and charges not yet entered in the cash book
28
Q

What are dishonoured (bounced) cheques?

A

receipts recorded in the cash book but returned unpaid by customers bank

29
Q

What are differences arising between the cash book and bank statements?

A
  1. Timing differences
  2. Errors
30
Q

What are timing differences between cash book and bank statements?

A

reconciling items between cash book and bank statements (cash book is correct, bank statement is not)

31
Q

What are within timing differences between cash book and bank statements?

A
  1. Unpresented cheques
  2. Outstanding receipts
32
Q

What are unpresented cheques?

A

cheques which have been paid by the business and entered in the cash book but have not uet been paid in/ presented to the bank (unpresented/ outstanding cheques)

33
Q

What are outstanding receipts?

A

cash/ cheque receipts shown in the cash book but not yet recorded by the bank (often called uncleared receipts/ unpresented receipts/ outstanding lodgements)

34
Q

What are errors between cash book and bank statements?

A
  1. Mis-recorded items/ transposition errors/ addition errors in the cash book or bank statement
35
Q

What is the bank reconciliation procedure?

A
  1. Check all the items in the cash book against those on the bank statement to identify the reasons for the difference
  2. Check all the computations in the cash book
  3. Enter the omissions in the cash book and correct any errors
  4. Prepare a bank reconciliation statement
36
Q

Example Pt1: Internal to external reconciliations bank reconciliations

A

R Copeland
Cash book balance £2,894
Bank Statement £2,956
(now find out why we have two different cash figures, bank reconciliation)

Investigation reveals that, at 31st March:
1. Cheques for £62 and £138, dated 28th March, havent passed through the bank account (time differences)
2. Bank charges of £48 were not entered in the cash book (omission)
3. Bankings paid-in in cash book were recorded as £870, but on the bank statement as £780. The bank statement was correct (error in cash book)

37
Q

Example Pt2: Bank reconciliations Method 1: Two complementary statements

A

Corrected Balance in Cash book::
Original balance (cash book) £2,894
Less: Bank charges not recorded £48 (omission corrected)
Less: Paying - in bankings overstated £90
= £2,756

Corrected Cash book::
Bank reconciliation at XX.XX.XXXX
Reconciliation of timing differences:
Balance per bank statement £2,956
Less: Two unpresented cheques £62 and £138
CORRECETED = £2,756

38
Q

Example Pt3: Bank reconciliations Method 2: Showing in one statement

A

Alternatively, in one statement:
Reconciliation of bank statement and cash book at XX.XX.XXXX
Balance per bank statement £2,956
Less: unpresented cheques £62 and £138

CORRECTED CASH BOOK = £2,756

Add: Bank charges £48
Overstated banking £90

Original Cash Book £2,894

39
Q

What does the trial balance aim to check?

A

The accuracy of the ledgers. If both sides of the trial balance agree, each entry has been entered once on each side and there are no addition errors.

However, there may still be errors even if both sides of the trial balance agree

40
Q

What errors dont cause the trial balance to disagree (even if we have these errors may still have the same number from the debit totals and credit totals)?

A
  1. Errors of principle
  2. Errors of commission
  3. Errors of omission
  4. Errors of original/ prime entry
  5. Compensating errors
41
Q

What is errors of principle?

A

entries in the wrong type of account, eg the sale of an asset has been entered in a sales account (should have credit assets, but credit revenue)

42
Q

What is errors of commission?

A

entries are in the wrong account, eg a receipt from a credit customer is posted to the wrong customer’s account (should have credit trade receivable from customer A, but credit trade receivable from customer B)

43
Q

What is errors of omission?

A

the transaction hasnt been recorded anywhere, eg. bank charges (should have debit expense and credit cash; but didnt do anything)

44
Q

What are errors of original/ prime?

A

the incorrect amount has been entered in the day book (the source of number is wrong, then bring the wrong number to both sides of double entry)

45
Q

What are compensating errors?

A

two errors are posted which are different but are the same amounts and offset each other (should have debit expense by 10, but debit expense by 20; simultaneously should have credit sales by 10, but credit sales by 20

46
Q

What should we do when we have different numbers from total debit and credit?

A

correcting errors and suspense accounts

47
Q

Which errors cause the trial balance to disagree?

A
  1. Addition/ arithmetic errors
  2. Posting errors, such as single entries instead of double entries, two entries on the same side and where the two amounts entered arent equal
  3. Extraction errors
48
Q

What are extraction errors?

A

figures may have been incorrectly extracted from the ledgers or posted to the wrong side of the trial balance

49
Q

What are suspense accounts used for?

A

to collect together errors and any unidentified problems causing the trial balance to disagree

50
Q

What is used in the suspense account is used to fix errors when the source of the problem is identified?

A

double entry

51
Q

What are the two purposes of suspense accounts?

A
  1. Recording unidentified transactions, eg cash received with no name attached
  2. A quick way to make the trial balance agree. The difference is posted to a suspense account and solved without delaying the production of the accounts from the trial balance
52
Q

What is the approach of recording unidentified transactions?

A

is to debit the cash to the cash book and credit the same amount to a suspense account to await identification

when the source is identified, debit the suspense account with the customers name and credit the customer’s receivable account

53
Q

What errors are posted to the suspense account?

A

only errors which make the trial balance disagree

54
Q

What must the entry in the suspense account must be on the same side as?

A

must be on the same side of the ledger as the entry in the trial balance

55
Q
A