Accounting Fundamentals Pre course Workbook

What are the two basic questions an investor in a business should ask

1. Is the business making a profit? 2. Has the business got enough funds to pay its debts?

What are the two principal statements in a set of accounts

The statement of financial position and the statement of profit or loss

Define the statement of financial position

A statement of the financial position of a business at a given date

Define the statement of profit or loss

A summary of the results of a business's transactions for a period ending on the date of the statement of financial position

What are accounts

The means by which we answer whether a business is making a profit and whether it has enough funds to pay its debts

Does the amount of detail in a set of accounts vary

Yes, it varies with the type of accounts and the people using them, but the same principles always apply

What are the three types of business

Sole trader, partnership and company

Do all three types of business produce financial statements

Yes, regardless of type all businesses produce a statement of profit or loss and a statement of financial position periodically, usually annually

Define a sole trader

A usually small business which is owned and managed by the same person

Who is liable for the losses of a sole trader business

The sole trader is legally responsible for all of the losses their business makes

How regulated are sole trader accounts

Not heavily regulated, and the sole trader will usually employ a firm of accountants to prepare the accounts

Define a partnership

A business owned and managed by two or more people, for example accountancy and law firms

How is each partner treated for accounting purposes

Each partner is a sole trader for accounting purposes, and a partnership is a collection of sole traders acting together in business

What is the liability position of partners

Partners are jointly and severally liable for any losses their business makes

What accounts do partnerships produce

Special partnership accounts

Define a company

A business often owned by shareholders who buy shares and elect directors to run it, so it is not always owned by its managers

What is limited liability

The owners of a company, the shareholders, are not responsible for the losses of the company because the company is a legal entity in its own right

How are company accounts regulated

Companies must produce company accounts, which are regulated by company law and accounting standards

Define bookkeeping

Bookkeeping is the recording of a business's commercial transactions

What is the purpose of bookkeeping

To enable transactions to be summarised at the end of a period so that accounts can be produced

Why must transactions be recorded as they happen

Because accounts are produced periodically, so purchases, sales, expenses and cash movements must be recorded as and when they occur

Where does the expression books of account come from

From the days before computers when everything was written up in leather-bound books, though records are now mostly computer print-outs

What does the word position mean in statement of financial position

What the business owns or controls, the assets, and what the business owes, the liabilities

Define assets

Things which the business owns or controls

What are the two types of asset

Non-current assets and current assets

Define non-current assets

Assets acquired for use within a business over more than one year, usually several years, with a view to earning profits but not for immediate resale

Give examples of non-current assets

Land, buildings, plant and machinery, patents, motor vehicles, tools, fixtures and fittings, office equipment, computers, long-term investments, ships, works of art and locomotives

Define current assets

Assets acquired for conversion into cash in the ordinary course of business, typically expected to be converted into cash within 12 months

What are the three most common examples of current assets

Inventories, cash and receivables

Define inventories

Goods held for resale

Define cash as a current asset

Positive bank balances and physical cash balances

Define receivables

Amounts owed to us because we sold goods to customers on credit, usually paid within 1 to 3 months

Contrast non-current and current assets

Non-current assets are kept and used in the long term, usually more than 12 months, while current assets pass through the business as part of the normal trading process

Define a liability

An amount owed by the business, meaning it has an obligation to pay money at some future date

What are the two types of liability

Non-current liabilities and current liabilities

Define non-current liabilities

Amounts owed by the business payable in more than one year after the date of the statement of financial position

Give the most common example of a non-current liability

A long-term bank loan

Define a current liability

A short-term liability, an amount owed by the business payable within 12 months

Name two types of current liability

Trade payables and a bank overdraft

Define trade payables

Amounts we owe our supplier because we bought goods on credit, usually paid within 1 to 3 months

Define a bank overdraft

A negative balance on a bank account, meaning we are in debt to the bank

What is the business entity concept

From an accounting perspective the owner and the business are treated as two separate entities, so if the owner puts money or assets into the business, the business owes this back to the owner

Define capital

The total amount which the business owes to its owner or proprietor

Define opening capital

The amount the proprietor has invested in the business at the start of the year

Define capital injections

Amounts the proprietor has invested in the business during the year

Define drawings

Any amounts taken out of the business by the business owner, for example a monthly amount taken as salary

How do we calculate closing capital

Opening capital plus capital injections plus profit or minus loss, less drawings

Which bank accounts of a sole trader appear in the business accounts

Only the account used for business receipts and business payments, personal and joint domestic accounts are excluded under the business entity concept

In what order are items presented in the statement of financial position

Non-current assets, then current assets, giving total assets, then capital, then non-current liabilities and current liabilities, giving total capital and liabilities

State the accounting equation

Total assets equals capital plus total liabilities

State the accounting equation in its rearranged form

Assets equals liabilities plus capital

Does the accounting equation always hold

Yes, the assets of a business will always equal the liabilities plus what the business owes back to the owner as capital

What does the statement of profit or loss summarise

The sales a business has made and the expenses it has incurred over a period

When has a business made a profit

When it has more sales than expenses

When has a business made a loss

When it has more expenses than sales

What does revenue include

Sales made for cash and sales made on credit

If sales are 120,000 but only 100,000 has been paid by customers, what is revenue

120,000, because revenue includes sales where the customer has not yet paid

How is cost of sales calculated

Opening inventories plus purchases less closing inventories

Why do we deduct closing inventories in cost of sales

Because we are determining the cost of goods actually sold in the period, and closing inventories will be sold next year

What does cost of goods available for sale mean

Opening inventories plus purchases

Define cost of sales

The cost of the goods actually sold during the year or period

How do units in cost of sales compare with units in revenue

The number of units reflected in cost of sales must be identical to the number of units reflected in revenue

How is gross profit calculated

Revenue less cost of sales

Why is gross profit also called core profit

Because it shows the results of the actual buying and selling operations of the business, as opposed to incidental expenses

How is net profit calculated

Gross profit less all other expenses of the business

What kind of items are deducted after gross profit

Items of income and expenditure which are relevant to the business but incidental to it and not part of the buying, selling or manufacturing of goods

What is the final figure in the statement of profit or loss called

Net profit or net loss

Give examples of expenses shown after gross profit

Property taxes, lighting and heating, telephone, postage, stationery, office salaries, accountancy and audit fee, bank charges and interest, delivery costs and advertising

How does the statement of profit or loss link to the statement of financial position

The net profit or loss is included in the calculation of capital in the statement of financial position

What happens to capital if the business makes a net profit

Capital increases

What happens to capital if the business makes a net loss

Capital decreases

What is the dual effect

A consequence of the accounting equation, that every transaction will have two effects

How is inventory treated when applying the dual effect

We ignore movements in inventory until the year-end adjustment, so buying goods is recorded as a purchase expense and selling goods is recorded as sales or revenue

What type of asset is inventory

A current asset

What are the two effects of the owner paying money into the business

Cash increases so assets go up, and capital increases

What are the two effects of buying goods for cash

Purchases expense increases so profit and capital fall, and cash falls so assets fall

What are the two effects of buying goods on credit

Purchases expense increases so profit and capital fall, and payables increase so liabilities rise

What are the two effects of selling goods on credit

Receivables increase so assets rise, and sales income increases so profit and capital rise

What are the two effects of buying a non-current asset for cash

Non-current assets increase and cash decreases, both within assets

What are the two effects of paying a credit supplier

Cash falls so assets fall, and trade payables fall so liabilities fall

What are the two effects of borrowing money from a bank

Cash increases so assets rise, and non-current liabilities increase

What are the two effects of receiving cash from a credit customer

Cash increases and trade receivables decrease, both within assets

What are the two effects of paying rent

Rent expense increases so profit and capital fall, and cash falls

What are the two effects of paying wages

Wages expense increases so profit and capital fall, and cash falls

What are the two effects of the owner withdrawing money from the business

Cash falls so assets fall, and drawings increase which reduces capital

What are the six types of account we consider in double entry

Expenses, assets, drawings, liabilities, income and capital

Give examples of expense accounts

Purchases, gas bill, phone bill, electricity bill and salaries

Give examples of asset accounts

Cash, receivables, factory and cars

When do drawings arise

Whenever a sole trader takes something out of the business

Give examples of liability accounts

Payables and loans

Give examples of income accounts

Sales and interest income

What is capital in double entry terms

What the business owes back to the business owner

What does the acronym DEAD CLIC stand for

Debit Expenses Assets Drawings, Credit Liabilities Income Capital

Which accounts do we debit to increase

Expenses, assets and drawings

Which accounts do we credit to increase

Liabilities, income and capital

How do we record a decrease in an expense, asset or drawings

With a credit

How do we record a decrease in a liability, income or capital

With a debit

What are the conventional abbreviations for debit and credit

Dr and Cr

What are the four steps to record a transaction

1. Identify the two accounts affected 2. Consider whether they are increased or decreased 3. Decide whether each is debited or credited 4. Check that a debit and a credit for equal amounts have been made

What is the golden rule of double entry

You must always have an equal and opposite debit and credit for every transaction