Accounting Theory flashcards

Explain contra item

A contra item is an offset of a debtor against a creditor where the debtor and creditor are the same person.

How does an opening balance of x arise

Full payment of debt followed by a credit note. 
Over payment of a debt. 
Full payment followed by discount

Outline advantages of control accounts to a firm

Act as a check on the accuracy of ledgers by comparing control balance with the total of the schedule. 
Errors can be found more speedily using control a/c.

Give reasons why creditor control a/c may not agree with the schedule of creditors 

Errors in either the control a/c or the schedule but not in the other. 
Errors in ledgers. 

Which books of first entry are used in production of debtors control a/c

Sales, sales returns, general journal, receipts and payments.

Importance of control accounts 

Locate errors quickly and narrow searching for errors to confined areas. 
Allow amounts owed by or owed to debtors and creditors to be fixed quickly by balancing the control a/c.

Limitations of control a/c

They do not identify the ledger of where the problem occurred. 
Some errors are not revealed by it such as errors of commission and omission.

: What is meant by a debit/credit balance in the creditors/debtors control a/c

The debit balance means x is owed money by at least one of his debtors.

Can arise by a previous overcharge when the correction is made. Can arise where x overpaid the supplier. 

Can arise by a previous overcharge when the correction is made. 
Can arise where x overpaid the supplier.

What's restocking charge how might it arise

FIX ME

Identify three types of errors that affect the balancing of a trial balance 

Entering one amount on the debit side of one ledger account and entering a different amount on the credit side of another ledger account. 
Mathematical error: figures and addition. 
Posting only one side of the double ent

Errors not revealed by t.b

Errors of original entry: errors made in book of first entry. 
Errors of principle: entered the incorrect class of account. 
Errors of omission: where both credit and debit were omitted. 
Error of commission: posting to wrong account but on correct side of that account. 
Compensating errors: errors of equal value cancel each other. 
Reversal of entries: debit entry is credited while credit entry is debited. 

What is purpose of a trial balance

A trial balance is prepared to test the accuracy of double entry bookkeeping before preparing for final accounts. A trial balance should have the same number of debits as credits because of double entry bookkeeping.

Outline the purpose of a suspense account

A suspense account is used when there is a mistake in the accounts that prevents the trial balance from balancing. The difference between the debit and credit side is entered in the suspense account until the errors are resolved for the trial balance to balance. The relevant errors are corrected through the suspense account, and the balance is eliminated. 

Give an example of an error of commission. Will it be revealed by the trial balance

This is where an amount is posted to the correct side of the incorrect account. 

For example, 5000 of goods sold on credit to A. Jeffers were debited to H. Jeffers. 

Will not be revealed by trial balance because the debit and credit entry will agree with each other. 

Outline different types of errors that may affect balancing of a balance sheet 

Entering one figure on one side of the ledger account but entering an incorrect figure on the right side of another account. 
Entering figure on one side of the ledger account but entering on the same side of another account. 
Entering one figure on one side of the ledger account but entering nothing in the other account. 

What is depreciation

Depreciation is the measure of the wear and tear or loss in value of a fixed asset because of wear and tear or passage of time. 

Why make a charge for it dep 

Depreciation is an expense. Failure to record depreciation will result in profits being overstated and net assets in the balance sheet will not show its true value. 

Why choose one method over the other dep

A method of depreciation is chosen because of the company’s policy on depreciation and ensuring the consistency concept is applied when preparing accounts. 

Straight line method is where the same cost of the asset is written off each year. This is appropriate in the case the asset remains in the business for a long period of time and loses value slowly (buildings). 

Reducing balance method is where a fixed percentage of the assets value is writing off each year. The amount written off is high in the early years and reduces each year. This method applies to assets that lose most of its value in the years immediately after purchase. (vehicles)

Factors to be considered when calculating depreciation

Type of asset. 
Cost of asset. 
Method of depreciation. 
Estimated life of the asset. 

Explain useful economic life in relation to F.A

Useful economic life is the expected period in which an asset is beneficial to the business. It is how long the fixed asset can contribute to generating income before it becomes obsolete. When an asset depreciates to the point it is no longer useful it is said it is past its economic life. 

Identify a noncash expense and a noncash gain 

Noncash exp: Depreciation, increase in bad debts provision. 
Non-cash gain: profit on sale of asset or decrease in bad debts provision. 

Write a note on the Accounting standards Board (Financial Reporting Council) refer to main activity of the board and how it influenced the preparation of cash flow statements 

The Financial Reporting Council issues new accounting standards called Financial Reporting Standards. It also amends and withdraws old accounting standards. FRS1 was issued by the ASB in 1991 which requires large companies to prepare a cash flow statement for each activity period. It requires that individual cash flows should be entered under standard headings according to the activity that gives rise to them. 

Benefits of preparing cashflow statements 

It shows cash inflows and outflows during the past year. It shows profit doesn't always equal cash. It aids financial planning. It provides information to assess current liquidity. 

Distinguish between cash and non-cash expense

Cash expense reduces both profit and cash i.e. wages. 
Non-cash expense reduces profit but not cash i.e. depreciation. 

List responsibilities of directors

To comply with companies acts. 
Prepare annual financial statements. 
Sign financial statements.

Explain solvency

Solvency is the ability of the company to pay all its debts as they fall due for payment. A firm is solvent if total assets are greater than total external liabilities. 

Three accounting obligations under the CO Act

Must have its accounts audited. 
Provide explanatory notes to these accounts. 
Provide a full set of accounts, balance sheet and a cash flow statement to shareholders at AGM.

What is an FRS

An FRS is a rule that must be applied to all financial statements to give a fair and true view of the company's financial position. It sets out best practice in accounting that allows accounts to be compared year to year and from company to company. 

Gearing reduced what are the implication 

Low interest repayments increase the amount of profits available for investment elsewhere in the business. Shareholders are likely to get a dividend when gearing is low. The business should find it easier to raise additional finance. 

Indicate as treasurer your opinion if subs rate was to be reduced by X% 

: Reduction in subscriptions by X% would reduce income by x amount. The club can bear this; however, all the surplus income comes from entrance fees of x and sponsorship of x. Treasurer should refer to proposed capital expenditure in near future. While bank X and investments x are healthy these are not recurring. Even sponsorship may not be guaranteed in the future. 

Explain with an example of what is meant by a special purpose profit and loss a/c 

Sometimes non-profit organisations such as a club prepare a profit and loss account for activities that are carried out to make a profit (bar, catering). All expenses and revenues relating to that activity are entered in a special profit and loss account and the profit is transferred to the special profit and loss account. 

As a member what points would be made about a further X year levy to fund a $XXXXXX extension

The proposed levy would raise X over X years. As a member I would/wouldn't make the case the club can/cannot generate income from within as it has a surplus income of x. the club is/isn't financially sound as it has cash of X , building society investment of x and x% investments totalling to x even after it has paid off a loan and interest of x . However, a sizeable amount of the surplus is provided by entrance fees and sponsorship which may not be guaranteed in future years. 

State and explain two limitations of a R and P a/c 

Does not show if the club is profitable. 
Does not take losses into account such as depreciation. 
Amounts due but unpaid at end of year are not included. 

Club is considering buying item X for $XXXXX, why

Yes, I would advise the club buy this item, the improved facilities would allow longer use of the club resulting in added income. This could enable the club to increase its membership and thereby increase its annual surplus. The club is in a strong financial position. Has a surplus income of X. At this rate it could take only x years to supply the funds for this item. 

Distinguish between levy and life membership

Levy is a payment made to the club by its members to fund a special project such as an extension. It must be used for the purpose for which it is collected. It is due to the members until it is used so it is treated as a long-term liability in the balance sheet. 

Life membership is where a member pays a fee that entitles them to use the facilities for the rest of their lives. Treated as a long-term liability in the balance sheet and can be written off to income over a stated number of years. 

Explain why levies are charged

This is a charge made by the club to its members to fund a special project such as an extension where the club wishes not to borrow. Must be used for the purpose that it is collected for. It is a capital item and is credited to the levy reserve fund. 

Why are levies treated differently to subs

This is a charge made by the club to its members to fund a special project such as an extension where the club wishes not to borrow. Must be used for the purpose that it is collected for. It is a capital item and is credited to the levy reserve fund.

Subscriptions is a revenue item charged annually to its members for the use of the facilities provided. 

Factors lenders should consider before granting a loan

Gearing – the firm has no long-term loans now which would encourage a lender to grant a loan. 
What is the purpose – to do x making the company more efficient in the future. 
What security can they offer – Security is adequate with fixed assets of x and investments of x to cover a loan of x. 

Three items that must be included in directors report

The amount transferred to reserves. 
The principal activities of the company and any changed therein. 
Details of own shares purposed. 

Name the bodies/institutions that regulate the production etc of financial statements

The Government. 
The European Union. 
Accounting Standards Board. 
The Stock Exchange.

What is an audit

An audit is an examination of the financial statements of an enterprise by an appointed independent auditor. The auditor expresses an opinion and certifies whether the accounts give a true and fair view of the financial position of the business. The companies act requires the auditor to certify that the accounts give a true and fair view of the financial position of the business. 

What's a qualified auditors report

A qualified auditors report is when an auditor in their opinion is not satisfied or is unable to conclude that all or any of the following apply: the financial statements give a true and fair view of the state of affairs of the company by the end of the year. The financial statements are in accordance with the companies acts. All information necessary for the audit was available.

Explain why financial statements need it be properly regulated

To ensure that financial statements: are consistent from year to year, can be easily compared to other businesses, comply with international law. Good regulation makes fraud less likely and builds up trust among the investing public. 

How does the EU regulate the presentation of accounts

The European Union influences regulation by issuing directives. Directives are instructions that are binding on member states. Member states are given a fixed period to implement the directive into international law. The purpose of directives is to harmonise accounting practice in the member states. 

: How does an auditor safeguard the interest of shareholders

Being independent of the directors, the auditor is appointed by the shareholders and is responsible to them. By being able to threaten a qualified audit report thereby discouraging fraud. By examining the financial statements and giving an assurance that they give true and fair view. 

3 reasons why a plc publishes its annual report and accounts

To comply with legal requirements, the companies act require publication of a profit and loss a/c and balance sheet. 
To report to shareholders, final accounts are prepared along with a director's report and an auditor's report. 
To attract investors who might be interested in the financial position of the business to determine whether to invest funds. 

Summary of advice you would give to X in relation to recordkeeping

File source documents (receipts and invoices). Enter daybooks (sales and s returns daybook, purchases and p returns daybook, cashbook, general journal). Enter a ledger system using double entry. Extract a trial balance. Prepare final accounts without using estimates. 

What additional information would be available if double entry system used

: Sales, Purchases, all expenses incurred, all liabilities, all assets and drawings

Name two fundamental accounting concepts 

Accruals, going concern, consistency and prudence.

Explain the term accounting concept

Accounting concepts are the accounting practices or rules applied in the preparation of financial statements.

Illustrate an accounting concept applying to the above accounts

The accruals concept: all expenses incurred in a particular period must be included in the accounts of that period regardless of whether they are paid or not. Similarly, all revenue income must be included in the accounts of the period whether received or not. Electricity due for the current year must be included in the accounts, although the bill may not be paid until the following year as the expense refers to the current year.

Explain the accruals concept and why it is fundamental in accounting

: The accruals concept: all expenses incurred in a particular period must be included in the accounts of that period regardless of whether they are paid or not. Similarly, all revenue income must be included in the accounts of the period whether received or not. Electricity due for the current year must be included in the accounts, although the bill may not be paid until the following year as the expense refers to the current year. 

Explain why X should record drawings

If drawings are not treated correctly, they may be entered in error as a business expense with the result that the profit figure would be reduced. It is also essential to control how much is taken from the business in the form of drawings.

Explain the importance of double entry bookkeeping

It provides a more accurate look at the financial position of the business than using entry bookkeeping due to the matching principle which uses accrual accounting rules to record revenue and expenses. It reduces fraud because it allows transactions to be retraced or audited. It can be used in preparation of financial statements. 

Explain two fundamental accounting concepts 

The consistency concept says items must be treated the same way from one accounting year to another. We cannot tell from just one set of accounts if this is the case. We would need to examine the depreciation policy of the next year and to examine consistency from one year to the next. 

The prudence concept says when preparing accounts caution should be exercised. Possible losses must be recorded immediately but income must not be recorded until it is reasonably certain or realised for example a bad debt provision being set up. 

Limitations of preparing accounts from incomplete records 

Accuracy cannot be guaranteed because figures are often based on assumptions.

A trial balance cannot be prepared, so arithmetical accuracy cannot be checked. 
Errors and fraud are difficult to detect due to lack of double entry. 
True profit or loss may not be calculated, only an approximate figure. 

Why earning a profit does not always increase a cash baslance

Credit sakes/purchases affect profit but not cash

Non cash losses and gains affect profit but not cash

Purchase and sale of fixed asset by cash affect cash but not profits.

Introduction or withdrawal of capital in cash affect cash but not profit.