Accounting

What are the characteristics of a trading business?

What are the characteristics of a trading business?

• Sell inventory after marking up

• Do not manafacture their inventory

List the accounting assumptions

• Accounting entity assumption

• Going concern assumption

• Period assumption

• Accrual basis assumption

What is the accounting entity assumption?

a business is assumed to be seperate from the owner ad other businesses, and records should be kept on this basis

What is the going concern assumption?

the life of a business is assumed to be continuous, and records should be kept on this basis

What is the period assumption?

the life of a business must be divided into periods of time (no more than yearly), to allow reports to be prepared and compared

What is the accrual basis assumption?

that transactions should be recorded when they meet their respective element defenitions

List the qualitative characteristics

• Relevance

• Faithful representation

• Understandibility

• Comparability

• Verifiability

• Timeliness

What is relevence?

reports should include all information which is useful to decision making

What is faithful representation

reports should contain infromation that is accurate, and free from bias or error

What is understandability

reports should be presented in a manner that makes it easy to be understood by the user

What is comparability

reports should be able to be compared over time between different reporting periods and businesses

What is verifiability

information contained in reports should be true, and any external observer should be able to reach the same conclusion

What is timeliness

reports should be available to stakeholders in a timely manner in order for them to make appropriate decisions

What is an asset?

a resource controlled by the entity as a result of past events, from which future economic benefits are expected to flow to the entity

What is a liability?

a present obligation of the entity as a result of a past event, the setllement of which is expected to result in an outflow from the entity

How can assets and liabilities further be classified?

• Current: within 12 months

• Non-current: after 12 months

What is owner’s equity?

the residual interest in assets of the entity after deducting liabilities

What is the accounting equation?

Assets = Liabilities + Owner’s Equity

What is a revenue?

inflow of economic benefit/saving in outflow, in form of an increase in assets/decrease in liability, which increases owner’s equity. (not including capital)

What is an expense?

outflow of economic benefit/reduction of outflows, in form of decrease in assets/increase in liabilites, which reduces owner’s equity. (not including drawings)

Which journal(s) do cheques go in?

to the cash payments journal

Which journal(s) do receipts go in?

to the cash receipts journal

Which journal(s) do invoice go in?

to the purchases and sales journals

How do you calculate accounts receivable using journals?

OB + SJ - CRJ - sales return (+GST)

How do you calculate inventory using journals?

OB + CPJ + PJ - SJ (cost of sales) - CRJ (cost of sales) + sales return - purchase returns + inventory gain - inventory loss - drawings of inventory

How do you calculate accounts payable using journals?

OB + PJ - CPJ - purchase return (+GST)

How do you calculate GST (liability) using journals?

OB + CRJ + SJ - PJ - CPJ - GST settlement - sales return (GST) + purchase return (GST)

What is the purpose of inventory cards?

to record each individual transaction involving the movement in and out off the business of a particular line of inventory

What are the rules of FIFO method (inv loss/gain, and sales/purchase return)

• inventory gain: latest cost price on ‘in’ coloumn

• inventory loss: cost price of oldest available inventory

• sales returns: latest cost price on ‘out’ coloumn

• purchase returns: identified cost

What is the purpose of a budgeted income statement?

the income stament is a report which details the revenue earned and expenses incurred during the given reporting period

What are ethical considerations related to inventory?

• get inventory from local suppliers: builds reputation as you support local economy; may be more costly

• sell quality of product advertised: doing so means less sales returns and more profit; is more costly

• ensure products meet safety standards: doing so means avoiding legal issues; takes more money and effort

What are ehtical considerations related to non-current assets?

• ensure machinery comes with safety features: builds reputation for caring for employees; more costly

• get NCA locally: build reputation for supporting local economy; more costly

• get assets with minimal effect on environment: reputation as being enviroment friendly; more costly

What are some strategies for effective management of accounts payable?

• develop strong relationship with each supplier for better prices and credit terms

• pay close to but within credit terms for extended liquidity

• check statement of account against account payable to ensure accuracy and to avoid overpayment

What are some strategies for effective management of accounts recievable?

• offer discounts for quick settlement

• reminder notices ensure customers do not forget to pay early

• threats of legal action

How is depreciation calculated (straight line)?

(historical cost - residual value) / useful life

AND

historical cost * depreciation rate %

How is depreciation reported in income statement?

ensure the value is relevant to the reporting period, then put into income statement as depreciation of __ in less other expenses

How is depreciation reported in balance sheet?

ensure the value is relevant to the reporting period, then add to less accumulated depreciation under the NCA

What is historical value, and how is it valued?

how much the asset originally cost, with modifications. It is valued by including expenses, no recurring payments.

What is the carrying value?

how much the asset is worth after depreciation

Why is carrying value prefered over historical value when it is not accurate?

because it is more relevant to decision makers, and so in this case relevance overrides verifiability

How is number of sales returns a non-financial indicator (what it show)?

it measures the unit of inventory returned to the business.

Higher sales return → lower net profit → lower profitability

Also, lower account recievable → lower liquidity

How is number of customer complaints a non-financial indicator (what it show)?

it measures number of customer complaints, which corresponds to quality of staff and product.

High complaints → high sales returns → both lower profitability and lower liquidity

also, less repeat customers → lower profitability

Define return on assets

(net profit/avg total assets), a percentage whcih indicated how effectively a business uses its assets to earn profit.

What does increase/decrease ROA show?

An increased ROA is good, it means higher net profit with less assets.

A decreased ROA is bad, it means less net profit with more assets.

Define asset turnover

(net sales/avg total assets), times per period which indicates how many times in a period the value of assets was earned.

What does faster/slower ATO show?

A faster ATO is good, it means higher sales with less assets.

A slower ATO is bad, it means less sales using more assets.

WHat is relationship between ROA and ATO?

They should move in the same direction, however if:

• ATO up and ROA down, it means worsened expense control

• ATO down and ROA up, it means better expense control

Define working capital ratio

(current assets/current liabilites), ratio which indicates firm’s ability to meet its short term debts. It measures liquidity.

What does increased/decreased WCR show?

An increased WCR is good, it means there are much more assets than liabilites. However, it can be too high, which means assets aren’t being used effectively.

A decreased WCR is bad, it means there are too many liabilties compared to assets. It should be more than 1:1

Define inventory turnover

(avg inventory*365/cost of goods sold), number of days which business takes to convert inventory to sales

What does faster/slower ITO show?

A faster ITO is good, it means increased cost of goods sold, with less average inventory. However, it can mean mark up is too low or holding too little inventory.

A slower ITO is bad, it means less cost of goods sold, with more average inventory. It can be fixed by mixing inventory and ordering slower.

Define accounts reveivable turnover

(avg acc receivable*365/net credit sales), number of days which shows number of days it takes to collect cash from accounts.

What does faster/slower ARTO show?

A faster ARTO is good, it means more credit sales with less accounts receivable.

A slower ARTO is bad, it means less credit sales with more accounts receivable.

Define accounts payable turnover

(avg acc payable*365/net credit purchases), number of days which shows how long it takes for business to pay back suppliers.

What does faster/slower APTO show?

A faster APTO is good, it means increased credit purchases but decreased acc payable.

A slower APTO is bad, it means less credit purchase but more acc payable.

What is relationship between ITO, ARTO and APTO?

the firm’s ability to pay (APTO) on time will depend on their ability to generate sales (ITO) and receive the cash for them (ARTO).