accounting - theory questions

what is the accounting period assumption?

The accounting period assumption states that the life of a business can be divided into artificial, arbitrary time periods (i.e. monthly, quarterly, annually) for the purpose of reporting financial performance and position. The purpose of this is to determine how the business is going, whether it is making a Profit and Loss and the position of the business (ie: what the business owns, what the business owes and the owner’s investment. This ensures consistency and comparability of financial information across periods, allowing stakeholders to evaluate trends, performance and financial health.

what are the benefits of the accounting period assumption for businesses?

determines how the business is progressing on a more regular & periodic basis and keep stakeholders informed (i.e. ATO, creditors, investors, owners etc). Allows owners to assess the company’s performance over specific intervals, identify areas for improvement and make timely decisions.

what is profit determination?

Prrofit determination refers to the process of calculating the net income or net loss of a business for a specific accounting period by comparing total revenues earned with total expenses incurred during that period. This discovers whether a business has earned profit or suffered loss during a specific period.

what are the benefits of profit determination for businesses?

Helps business measure performance and make informed decisions, including how to allocate resources effectively and whether to expand. Determines whether the company has the funds to cover operational and financial expenses. Allows them to pay taxes, attract investors, control costs and survive in the long-term.

what is a bank rec statement?

a statement prepared to bring into agreement the balances as shown by a bank statement and the balance shown in the bank account of the enterprise and explains any discrepancy between the two balances. The purpose of Bank Reconciliation is to check the cash records of the firm against those of the bank and to account for any differences. It is important for the film to compete one as they must be sure that their cash records are the same as the bank records. If a bank reconciliation is not completed, the business may overspend because the business believe he has money in the bank.

what are the benefits of the bank reconciliation statement?

It ensures that the business avoids overdrafts and penalties. Furthermore, it acts as a mechanism for internal control, helping to identify and report fraudulent activity and errors quickly. It ensures that the company’s cash records are accurate, up-to-date and correctly managed.

what is the cash-flow statement?

A cash flow statement is a period statement that shows the cash inflows of a business entity during a period, and the cash outflows of the business during that period (i.e. monthly, quarterly or annually). It tracks how much cash is coming in and going out, helping to assess the company’s liquidity – that is, its ability to meet short-term obligations. The main purpose of a Cash flow statement is to highlight (in detail) the operating, financing and investing activities of the entity during a period. It is important because it tracks the actual movement/flow of cash coming in and out of the business. It also tracks changes in financial position and capital contributions & loans.

what are the benefits of the cash-flow statement for the business?

It helps prevent cash shortages, as it can prepare the business to have enough cash to be able to pay bills when they are due. It helps the owner make more informed decisions regarding short-term operational planning and long-term financial planning, such as when to invest or cut costs. It provides details on where money is most spent and allows investors to analyze the movement of working capital

what are closing entries?

Closing Entries are journal entries made at the end of an accounting period (usually annually) to transfer the balances of temporary ledger accounts to permanent ledger accounts. Temporary accounts include transactions for a single accounting period (i.e. revenue, expenses, dividends). They are transferred into the Profit or Loss Summary account through a journal entry, where revenue is debited, the income summary is credited and vice versa for expenses. They are then ‘closed’ (reset) at the end of the period in the general ledger, resulting in a zero balance when opening the next accounting period. This ensures that they are reported in defined periods and not carried over into the future. Closing entries are made to reset the temporary accounts so that the business is prepared to record new transactions for the new financial year.

what are the benefits of the cash-flow statement for the business?

This helps clearly separate each year’s financial performance and keep the business’s accounting records organised and accurate. This also informs the business on whether there was net income (credit income summary balance) or net loss (debit income summary balance).

what are reversing entries?

Reversing entries are optionally made on the first day of an accounting period to remove accrual adjusting entries that were made at the end of the previous accounting period. This is typically done to correct errors or adjust for accruals/prepayments that were recorded in the previous accounting period.

This ensures that ‘correct’ amounts for revenue and expenses are recorded in the period in which actually occur. Additionally, they cancel the temporary asset and liability account created by balance day adjustments (i.e. prepayments and accruals).

what are the benefits of closing entries for the business?

This greatly reduces the chance of double-counting revenues and/or expenses (recording accounts twice in the same period), provides transparency through an audit trail, reduces errors and simplifies accounting. Ultimately, this ensures that financial statements accurately reflect the current financial position of a company. This allows stakeholders to make informed decisions based on the company’s financial health for the given period.

what are balance day adjustments?

Balance day adjustments are entries made at balance day (June 30) in order to match the revenue against the expenses accurately so that profit can be determined, and to bring into account assets and liabilities not previously recorded. At the end of the statutory financial year, the business needs to report the results of its operations to its external stakeholders – including owners and the ATO. Business transactions flow continuously through the life of the business and are interrupted by the end of the accounting period. Therefore, adjustments must be made to record figures at the end of the accounting period. The aim of these adjustments is to calculate a profit figure that is as accurate as possible for every accounting period.

explain how balance day adjustments work (i.e. what are accrued expenses etc?)

Adjustments are recorded for items such as Accrued expenses, accrued revenue, prepaid expenses and unearned revenue. Accrued expenses are expenses that have been used but not yet paid. Accrued Revenues is income earned that hasn’t yet been paid by debtors. Prepaid expenses are expenses that have been paid in advance but not yet used. Finally, unearned revenues are payments received in advance for work to be done in the new year.

what are the benefits of balance day adjustments?

Without adjustments, the business may overstate or understate their true earnings. By accurately representing the financial position of the business, this aids in making informed decisions involving expansion, investing and forecasting.