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Accounting theory
1
...
Bookkeeping=detailed recording of all financial transactions of a business
2
...
Duality concept=states that every transaction has two equal aspects as
debit and credit
4
...
Non-current asset=an item held for more than 12 months, which is not for
resale
6
...
Liabilities=anything owed by the business to outside parties
8
...
Current liability=an amount to be paid within a year
10
...
Profit=difference between income and expenses for a particular period
12
...
Drawings=any value taken from the business by the owner for his / her
own use
14
...
Trial balance=a list of account balances at a specific date

16
...
Trade discount=allowance given to businesses in the same trade to
encourage bulk-buying or loyalty
...

Types of non-current assets
Intangible non-current assets
Goodwill= associated with the
purchase of one company by another
...

Patent= a legal document that gives
the holder exclusive rights to an
invention/ product for a set period of
time
...


Tangible current assets
Lands and buildings
Equipment

Machinery

Motor vehicles

Purposes of measuring business profit and loss
1
...

3
...


To assess past performance of the business
To identify areas where corrective action is required
Current year’s profit could be used as a basis for future planning
To control future activities of the business

How can the possibility of bad debts be reduced?
1
...

3
...


Sell on a cash basis
Allow cash discounts for prompt payment
Charge interest on overdue accounts
Refuse further supplies until outstanding balance is paid

Advantages of maintaining three ledgers

1
...

3
...


Work can be shared between several people
Easier for reference as same type of accounts are kept together
Easier to introduce checking procedures
Helps in the summarizing of accounting information
...
Purchases represents costs to the business
2
...
Purchases are amounts paid by the business

2
...
Book of prime entry=book where transactions (and other entries) are first
recorded
2
...
Dishonored cheque=cheque which has been returned unpaid by the bank
4
...
Bank statement=a copy of the customer’s account as it appears in the
books of the bank
6
...
Standing order=an instruction by a customer to the bank to pay fixed
amounts at fixed intervals to a named person or firm
8
...
Credit transfer=a direct payment into another person’s bank account
Advantages of preparing books of prime entry
1
...

3
...


To avoid multiple entries in the ledger
Different books of prime entry can be maintained by different people
Helps in the gathering and summarizing of accounting information
Helps in the auditing process

Purpose of a debit note
 Issued by the customer to request a reduction in the invoice received
Purpose of statement of account
1
...
To confirm settlement terms
3
...
Amount in figures doesn’t agree with amount in words
2
...
Stale cheques
Bank overdraft vs Bank loan
Bank overdraft
Varying amount
Can be paid back any time

Bank loan
Fixed amount
Fixed term

Variable rate of interest
May not be secured

Fixed rate of interest
Requires security

Advantages of maintaining a petty cash book
1
...

3
...


Removes small cash payments from the main cashbook
Provides training for junior staff members
Allows chief cashier to delegate some of the work
Reduces number of entries in the main cashbook (and ledger)

Advantages of petty cash imprest system
1
...
Can help reduce fraud
3
...

2
...

4
...

6
...

8
...

2
...

4
...

6
...
Verification of accounting records
Definitions
1
...
Error of commission=this occurs when a transaction has been posted to the
wrong account of correct class
3
...
Error of original entry=this occurs when a transaction has been incorrectly
recorded in the book of accounts
5
...
Error of compensation=this occurs when two or more errors cancel each
other out
7
...

2
...

4
...

2
...

4
...

Obtain bank loan from another source
...

Sell on cash basis
...
Accounting procedures
Definitions
1
...
Straight line method=the depreciation is calculated on the cost price and
the same amount is written off each year
...
Reducing balance method=the same percentage is written off each year,
but depreciation is calculated on the net book value of the non-current
asset
...

4
...
Bad debts recovery=when a customer pays some or all of a debt previously
written off as an irrecoverable debt
...
Provision for doubtful debts=an estimate of the amount which a business
may lose in a financial year because of irrecoverable debts
7
...
Net realizable value=the estimated receipts from the sale of the inventory
less any costs of completing the goods or costs of selling the goods
9
...
Other payable / Accrued expense / Prepaid income=an amount due and
payable; accrued expense is an amount which remains unpaid at the end of
the financial year
Causes of depreciation
1
...

3
...


Wear and tear
Obsolescence
Passage of time
Depletion

Purpose of accounting for depreciation
 To spread the cost of a non-current asset over its useful life
Reducing balance vs Straight line
Reducing balance
Has to be recalculated each year
Shows a more realistic book value
Unable to compare with previous
accounts

Straight line
Easier to calculate
Suitable when annual usage is the
same
Apply consistency

Accounting principles applied when charging depreciation
Matching
The cost of the non-current asset and
the revenues arising from its use are
matched in an accounting period

Prudence
-Ensures that non-current assets are
shown at more realistic value
-Ensures that profit for the year is not
overstated

Why shouldn’t depreciation be charged on land?
1
...
Land is not consumed by use
3
...
Land has an indefinite expected life

How can provision for doubtful debts be determined?
1
...
Considering the length of time debts have been outstanding
3
...
To apply the principle of prudence
2
...
To avoid overstating current assets
Accounting principles applied in closing inventory
Matching

Prudence

The loss arising from the damage is
recorded in the same year as the
damage occurred

It avoids current assets/ profit for the
year being overstated

5
...
Income statement=statement of all the revenues and costs of an
organization for a specific period
2
...
Capital expenditure=money spent on acquiring, improving, and installing
non-current assets
4
...
Revenue expenditure=money spent on the running of a business on a dayto-day basis
6
...
Capital employed=total of owner’s capital and long-term/non-current
liabilities
8
...
Owner has sole control over the business
2
...
Easy to set up – no legal requirements

Disadvantages of starting a sole trader business
1
...

3
...

5
...


Owner’s liability is unlimited towards the business organization activities
Continuity is uncertain
Owner bears all risk
Lack of skills and ideas
Owner bears all the workload

Disadvantages of raising funds by means of a bank loan
1
...
Loan interest to pay irrespective of profits
3
...

2
...

4
...

2
...

4
...


To calculate profit or loss
To compare with other businesses
To calculate accounting ratios
To know what assets and liabilities the business has
To compare with previous years

Capital expenditure vs Revenue expenditure
Capital expenditure
Provides benefit for more than one
year
Statement of financial position

Revenue expenditure
Provides benefit for less than a year
Income statement

Equations
Capital employed=Owner’s capital + non-current liabilities

Working capital=Current assets – Current liabilities
Advantages of working capital
1
...

3
...


To be able to meet debts when they fall due
To be able to take advantage of cash discounts
To be able to take advantage of business opportunities as they arise
To ensure that there is no difficulty in obtaining further supplies

How can you improve the working capital of a business organization?
1
...

3
...


Injection of capital
Reduction of drawings
Sale of surplus non-current assets
Obtaining long term loan

5
...
Partnership=business in which two or more people work together as
owners with a view to make profits
2
...

2
...

4
...

6
...
All partners are responsible for the debts of the business
2
...
Profit has to be shared between partners
4
...
Decisions must be recognized by all partners
What do partners include in a partnership agreement?
1
...

3
...

5
...
To allow easy comparison of drawings and total profit share
2
...
Easier to calculate interest on capital
Why are partners charged interest on drawings?
1
...
To ensure that cash is retained in the business
Why do partners receive interest on capital?
1
...
To encourage partner to introduce more capital
Balances in a current account
Debit
-Partner may have drawn more from
the business than the profits allocated
to the partner
-Business may have made a loss
-Partner owed the partnership
Negative balance

Credit
The Partnership owes the partner

Positive balance

Advantages of being a partner rather than a sole trader
1
...

3
...

5
...
Extra funds may be required for a limited period only
2
...
Loan is repaid before capital in a winding-up
The Act of Partnership 1985
1
...

3
...

5
...
3 Limited companies
Definitions
1
...
Authorized share capital/ Registered share capital=the maximum amount
of share capital the company is allowed to issue
3
...
Called-up share capital=the amount of share capital a company has
requested from its shareholders

5
...
Called-up share capital not paid=part of the called-up share capital for
which the company has not received cash from its shareholders
Types of limited companies
Private Limited company
Shares can be issued only to family
members and friends

Public limited company
Shares can be issued to the general
public and announcing issuing of
shares through the media is allowed

Advantages of limited companies
1
...

3
...

5
...
Company should comply with the Company Act of 1982
2
...
Control of the business is difficult as there are many shareholders
How does a limited liability company raise funds?
1
...
By issuing debentures
Ordinary shares vs Preference shares
Ordinary Shares
Carry variable rate of dividend
Carry voting rights at Annual General
meetings

Preference Shares
Carry fixed rate of dividend
Do not carry voting rights at Annual
General meetings

Ordinary share dividend is paid after
any dividend on Preference shares
Ordinary shareholders capital is repaid
last in the event of a winding-up

Preference share dividend is paid
before ordinary share dividend
Preference shareholders capital is
repaid before ordinary shareholders
capital in the event of a winding up

Debentures vs Ordinary shares
Debentures
Debenture holders receive interest
Debenture holders are creditors of the
company
Carry fixed rate of interest
Debentures are long-term loans
Debenture holders do not carry voting
rights at Annual General meetings
Debenture holders are repaid before
ordinary share capital in the event of a
winding-up

Ordinary shares
Ordinary shareholders receive
dividend
Ordinary shareholders are members of
the company
Carry variable rate of dividend
Ordinary shares are part of equity
Ordinary shareholders carry voting
right at Annual General meetings
Ordinary share capital is repaid after
debentures in the event of a windingup

Debentures vs Preference shares
Debentures
Carry fixed rate of interest
Debenture holders are creditors of the
company
Debentures are long-term loans
Debenture holders are repaid before
preference share capital in the event
of a winding-up

Preference shares
Carry fixed rate of dividend
Non-redeemable preference
shareholders are members of the
company
Non-redeemable preference shares
are part of equity
Preference share capital is repaid after
debentures in the event of a windingup

How can the issue of debentures affect ordinary shareholders?

1
...
Prior claim on the assets of the company in the event of a winding-up
Why might directors decide that the total dividend should be less than the profit
for the year?
1
...
To reward shareholders for their investment
What factors should a limited liability company take consideration of when
considering issuing more ordinary shares or taking out a long-term bank loan to
raise more funds?
1
...

3
...


It may not be easy to sell the shares
The bank may require security
The company would have to pay interest irrespective of profit made
There will be a loss of control by existing shareholders

Why might a limited company decide not to distribute all its profit for the year
in the form of dividend / What are the uses of retained earnings?
1
...
To retain cash within the business rather than using it for dividends
3
...
To set aside profit for reinvestment
2
...
To indicate that part of the profit is not available for distribution
Advantages of raising money by issuing debentures to ordinary shareholders
1
...
It will not dilute their voting power in the company
3
...
Funds have to be available when repayment is due
2
...
Debentures have prior claim on the asset of a company in the event of a
winding-up
Disadvantages to existing ordinary shareholders if funds are raised by the issue
of additional ordinary shares
1
...
New shares rank equally with existing ordinary shares with regard to
dividend
3
...


Debentures / loan capital
Debenture holder is a creditor to the
company
Debenture holder’s reward is interest
Debenture holders are given priority
when paying their annual interest
Debenture holders’ capital is paid at
first in liquidation

*Authorised share capital= maximum amount of share capital company is allowed
to issue
...

*Called-up capital=total amount of capital a company has requested from its
shareholders
...

6
...
Business entity principle
 The business is treated as being completely separate from the owner of the
business
...
Money measurement principle
 Only information which can be expressed in terms of money can be
recorded in the accounting records
...
Duality principle
 States that every transaction has two equal aspects as debit and credit
...
Historical principle
 Requires that all assets and expenses are initially recorded in the ledger
accounts at their actual cost
...
Consistency principle
 The same accounting treatment should be applied to similar items at all
times, to allow comparison of financial statement from year to year
...
Matching principle
 To ensure that the revenue of an accounting period is matched against
expenses of the same period
...
Prudence
 To ensure that profit and assets and not overstated, and losses and
liabilities are not understated
...
Realisation

 States that a business should not account for revenue / profit until it is
earned
...
Materiality
 Individual items which will not significantly affect either the profit or the
assets of a business should be charged to a single accounting period as an
expense
...
Going concern
 Assumes that the business will continue to operate for an indefinite period
of time- no intention to close down the business or reduce the size of the
business
...
Provides a framework for preparation of financial statements
...
Accounts of different businesses can be compared with other businesses
...
Profit calculations can be relied upon as the accounting principles provide
protection against fraud
...
Some concepts can conflict with each other
...
Require professional skills to implement
...
Easier to calculate than reducing balance method
...
May be more representative of the annual loss in value
...
The annual depreciation charge would be reduced
...
Method of charging depreciation should be charged consistently
...
Profit may be overstated in the year of change
...
Comparison with previous years not meaningful
...

1
...
Relevance
3
...
Understandability
7
...
Subscriptions=amounts paid by members of the club to use the facilities
provided by the club
2
...
Surplus for the year=the amount by which income exceeds expenditure for
a club or society
...
Deficit for the year=the amount by which expenditure exceeds income for a
club or society
5
...
This is equivalent to the capital of
the club
...
Adjustments made for accruals
and prepayments
2
...
Includes non-monetary items

Receipts and payment account
1
...
Includes all money received and
paid
3
...
Shows cash position at the end
of the period
...
Show surplus / deficit at the end
of the period
...

2
...

4
...

Sponsorships
Grants

Explain why the accumulated fund cannot be distributed among the club
members
...

Advantages in reduction of annual subscription fees to members who pay in
advance
...
Cash received earlier
...
Reduced risk of irrecoverable subscriptions
3
...


Disadvantages in reduction of annual subscription fees to members who pay in
advance
...
Less cash received
...
Possible reduction in membership
3
...

Advantages:
1
...


2
...
Irrecoverable debts would be minimized if the direct debits were set up for
the start of the year
...
Members may prefer to choose their own method of payment
...
Some members may decide not to renew their membership
...
They may prefer to pay their subscription at a time of their choosing
...
Manufacturing accounts
*Manufacturing accounts show the cost of production of finished goods
Definition
1
...

2
...
Finished goods= goods which are completed which are awaiting sale
...
Prime costs= costs which can be traced to a product
...
Factory overheads / Indirect cost= costs that cannot be directly linked with
/ traced to a product
...
Royalty= for every item produced, the manufacturer has to pay a fee to the
person who originally invented the product
...

Direct wages
...

Royalties
...

 Depreciation on loose tools
...

1
...

2
...

How can the cost of production be reduced?
1
...

3
...


Lower quality materials
...

Reduce wages
...


9
...
Profitability ratios= measure the business’ ability to generate profit to
justify the risk of capital
...
Liquidity ratios= measure the business’ ability to meet short term debts
when they fall due
...
Rate of inventory turnover= the number of times a business sells and
replaces its inventory in a given period of time
...
Inventory turnover=Length of the period of time that the business takes to
sell off its inventory
...

Profit Margin= Profit for the year / Net revenue *100
 Indicates the proportion of profit that has been earned after overhead
expenses have been made
...

ROCE= Profit from operations / Capital employed * 100

 Shows the profit earned for every $100 used in the business
...

Quick ratio= Current Assets (excluding inventory) / Current Liabilities
Trade Receivables Turnover= Net Trade receivables / Credit Sales
Trade payables Turnover= Trade payables / Credit purchases
Inventory turnover= Average inventory / Cost of Sales
 The length of time the business takes to sell off its inventory
...


Reasons for deterioration of gross profit margin
1
...

3
...


Selling goods at lower prices
...

Not taking advantage of bulk buying
Allowed customers a higher trade discount
...

2
...

4
...


Reasons for deterioration of profit margin
1
...

3
...


Higher expenses
Less control over expenses
...

Lower income
...
Reduce expenses
...
Increase gross profit
...
Increase other income
...
The capital is not being employed as efficiently as in the previous year
...
The profit earned for every $100 used in the business decreases
...
Poor control over expenses- profit is lower, interest payable is higher
...

2
...

4
...

6
...

The profit earned for every $100 used in the business increases
...

Reduce expenses
...

Reduce capital employed
...

2
...

4
...


Increase in trade payables
...

Repayment of loans
...

Purchase of non-current assets

How can current ratio be improved?

 By improving working capital position
Disadvantages of a business having a poor current ratio
1
...

3
...


Shortage of liquid funds
...

Cannot meet immediate liabilities from immediate assets
...


Why is calculating quick ratio important to a business?
1
...

2
...

Reasons for deterioration of quick ratio
1
...
Reduction in bank balance because of:
Purchase of non-current assets
...

Repayment of long-term loan
...

1
...

3
...


May have difficulty in paying debts when due
...

Cannot take advantage of cash discounts
...


Disadvantages of poor trade receivables turnover
1
...

2
...


3
...

How can trade receivables turnover be improved?
1
...

3
...


Offer cash discount for prompt payment
...

Charge interest on overdue accounts
...


Disadvantages of poor trade payables turnover
1
...

3
...


Damage to relationship with supplier
...

Suppliers may insist on cash purchases in the future
...


Advantages of paying suppliers later to reduce bank overdraft
...
Would delay the outflow of cash
...
May reduce bank overdraft charges
...

1
...

2
...

3
...

Reasons for deterioration of inventory turnover
1
...

2
...

3
...

What are the advantages of calculating ratios?
1
...

2
...


3
...

What are the limitations of ratio calculations?
1
...

2
...

3
...

State two non-financial aspects which may affect a supplier’s trading results
...

2
...

4
...


Action of competitors
Location of business
...

Government decisions
...


What are the limitations of accounting statements?
1
...

2
...

3
...

State the name of the parties, other than the owner, who would be interested
in the owner’s financial statements
...

-To identify the future career development opportunities of their employments
...




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