Revision notes Accounting A

Introducing Accounting and the Financial Statement

Four accounting assumption when communicating accounting information
Economic entity: The business financial is separate from the business
owners financials.
Time period: Accounting information can be meaningfully communicated
over a short period of time
Monetary unit: The dollar is the most effective means to communicate
economic conditions.
Going concern: Accountants assumes that companies will continue to
operate in the future.
Generally Accepted Accounting Principles (GAAP) covers the standard and the
general rules of rules accountant observe and understand.
Income statements:
Expense: A decrease in resources from a sales of goods or revenue
Revenue: An increase in resources from a sales of goods or revenue
Matching principles: expenses should be recorded in the period resources are used
to generate revenue
Revenue recognition principle: a revenue should be recorded when a resource has
been earned
Contributed capital Resources that investors contributed to a business in
exchange for ownership interest
Retained earnings Earnings that have been retained and not paid out to owners
(dividends or drawings)
In a balance sheet, current assets are listed in order of liquidity
Horizontal analysis changes that occur between year.
Vertical analysis
Conducted on balance sheet and income sheet]
Method of comparing a companys account within a year
Basic structure of changes in equity
Retained earnings, beginning balance
+/- net income/ loss (profit or loss)
- Dividend (drawings)
= retained earnings, ending balance

Cash flows = operating activities, investing activities

Auditors report a report, prepared by a registered company auditor for the
shareholder, stating an opinion on the financial statement.
Qualitative characteristics of accounting information Understandability,
materiality, relevance, reliability, consistency, conservatism, comparability
Recording Transactions
Assets = liabilities + equities
Assets cash, accounts receivable, inventory, supplies, prepaid rent, delivery van
Liabilities Account payable, unearned revenue, interest payable, salaries payable,
and electricity payable, and notes payable.
Equity contributed capital, retained earnings
Normal Balance is the side of an account where an increase is recorded.
Accrual Accounting and Adjusting Entries
 Cash basis When cash is received (revenue). When cash is paid (expenses)
Accrual basis When they are earned (revenues), when they are incurred
(expenses)
Deferred revenue (unearned) Receive cash, later earn revenue
Accrued revenue (earned) Earned revenue, later receive cash.
Deferred expense (prepaid) Pay cash, later incur expense (use asset)
Accrued expense (paid) incur expense, later pay cash
Cash is never involved in the adjusting entry.
Post-closing trial balance
After journalizing the closing entries and posting them to the general ledger,
prepare a post-closing trial balance. Because revenues, expenses and dividends are
0, the post-closing trial balance only shows the balance sheet accounts.
Account Cycle summary Journalize and post accounting transaction,
prepare an unadjusted trial balance, journalise and post adjusting entries,
prepare an adjusted trial balance, prepare financial statements, journalise
and post closing entries, prepare a post-closing trial balance
Internal control and cash

Five components of internal control

1. Control environment
2. Risk assessment
3. Control activities
4. Information and communication
5. Monitoring
Limitation of internal control
The human element and cost benefit analysis
Two methods of internal control over cash bank reconciliations and petty cash
funds
Bank reconciliation Reconcile the bank balance to the actual cash balance, reconcile
the companys book balance to the actual cash balance, adjust the companys book
balance to the actual cash balance.
Credit memorandum: Addition to the cash balance on the bank statement for items
such as the collection of interest
Debit memorandum: A subtraction from the cash balance on the balance statement
for items such as service charges
Deposit in transit: A deposit has been made by the company but has not been cleared
by the bank
Outstanding cheque: A cheque that has been distributed by the company but has not
been cleared by the bank
Dishonored cheque: A cheque that has been banked but since there were insufficient
funds in the drawers account to pay (NFS)
Receivables
Bad debt expense is included in the calculation of profits but is usually combined
with other expenses
An uncollectible account is written-off and an expense is recognized
When the expense is recognized depends on the method of accounting for
uncollectible accounts
 There are two methods to account for bad debt expense direct write-off method
and allowance method
Direct write-off method bad debt is recorded when the business determines that a
receivable is uncollectible and removes it from its records
Advantage simple
Disadvantage Violates the GAAP
Estimating bad debts
Percentage of sales approach, aging of accounts receivable approach

Inventory

Inventory is a tangible resource that is held for resale in the normal course of
operations.
Perpetual system: cost of goods sold is updated each time inventory is sold
Periodic system: cost of goods sold is calculated and recorded only at the end of the
period.
First in First Out (FIFO) First goods purchased, is sold first. Thereby giving the
lowest COGS. It also assigns the costs of the last and more expensive units to ending
inventory.
Last in First Out (LIFO) assigns the costs of the last, more expensive units to COGS,
resulting in highest COGS.
Inventory Errors:
Estimating Ending Inventory:
- Gross profit method: estimates inventory using a companys gross profit
percentage to estimate cost of goods sold and then ending inventory.
Lower-of-cost and net-realisable-value
The cost principle requires that inventory be recorded at its cost. Accounting require
that inventory be reported at its net realizable value if the NVR is lower than the
inventory cost
Introduction to management
Financial information: assets, liabilities, revenues, and gross margin, operating expenses
Non-financial information:
Qualitative information: Customers and employee satisfaction, product and service quality,
reputation
Other quantitative information: percentage of defects, number of customer complaints,
warranty claims, and inventory units, budgeted hours
External users: people outside of the company (shareholders, potential investors,
creditors, suppliers, etc.), Internal users: people or groups within the company
(employees, teams, departments and top management)
Types of information needed by internal users: Internal users, particularly
management, need more flexible and detailed information that will allow them to
perform: planning, operating, controlling.
Long term planning activities (strategic planning): Market shares, new equipment
investment, sales growth, plant locations
Short term planning activities (operation planning): Current cash needs, customer
service needs, sales quotas, time budgets
Controlling activities involve motivation, monitoring and evaluation of employees
to attain company goals e.g. incentives, performance measures, product quality
 Decision making: an effective decision-making model is one that focuses on
relevant factors that differ between alternatives.
Relevant costs: differ between alternatives
Sunk costs: already incurred and cannot be changed
Business model: defines the organizations approach to conducting core activities
Mission: sets out the fundamental reason for the organization
Vision and core values: Companies identify with a vision statement and core values,
which guide the achievement of the company
Business strategy: The company identifies the primary ways in which the mission,
vision and core values are to be pursued.
Types of companies:
Manufacturing: Takes raw material and produces products from them.
Service: Provides a service such as airlines, hospitals, etc.
Retailers: Merchandising companies sell products that someone else has
manufactured
Inventories serve as a buffer incase of unexpected demand or problems in
production
Three inventories exist: Raw materials, work-in-process, finished goods

Manufacturing traditionally: raw material -> process 1 -> additional process ->
finished goods inventory -> fill customer orders
Manufcaturing costs: costs incurred in the factory or plant
Non-manufacturing costs: costs that are incurred outside the plant or factory and
typically categorized (distribution, selling, after sales service and admin costs)
expensed in the income statement.
Direct materials various materials that can be directly and conventiently traced to
a product
Direct labour labour costs of assembly-line workers
Manufacturing overhead indirect materials e.g. glue, screws, etc.
Indirect labour e.g. factory maintenance, workers and factory cleaners
Cost-Volume-Profit Analysis
Variable costs, fixed cost, mixed cost.
Fixed: e.g. housing after a certain volume, there has to be an increase in cost.
Variable cost per unit
Assumptions of CVP Analysis consistent and linear over a volume of activities
Expenses can be classified as either variable or fixed
CVP relationships are linear over a wide range of production and sales
Sales prices, unit variable cost and total fixed expenses will not vary within the
relevant range
Volume is the only cost driver
The relevant range of volume is specified
Inventory levels will be unchanged
The sales mix remains unchanged during the period
Calculate breakeven (zero profit, no loss or profit) conventional income statement,
contribution margin income statement, and contribution margin ratio.
Conventional income statement (statement of comprehensive income)
Sales COGS = Gross margin
Gross margin operating expenses = net profit
 Contribution Margin Income Statement (used more often to calculate breakeven)
Sales- variable expenses = contribution margin
Contribution margin fixed expenses = net profit
Equation approach (breakeven sales in units calculated as)
[Total revenue] Unit sales price x units sold variable unit cost x units sold fixed
expenses = net profit = 0
Fixed expenses / contribution margin per unit = units
Contribution Margin ratio Formula = the percentage or ratio which goes to margin
Target profit m (90+45) / 0.3 = 45
Difference between variable costing and absorption costing
Absorption costing:
Product costs attach to the product, expensed when the product is sold, used for
both external financial statements prepared under GAAP and for income tax
reporting
Variable costing:
Only variable costs are product costs, fixed manufacturing overhead is a period
cost, used for internal decision making

1. Reducing variable cost per unit

Less expensive supplier of raw material
Reduce the amount of labour
Use lower-wage employees
- Qualitative factors should be considered

Budgeting and activity based costing

Lack of adequate planning for cash needs is one of the main reason why small
businesses fail
Due to computers and technological improvements, small businesses can now
easily perform analysis.
If managers dont consider contingent factors, they wont be able to assess
performance.
Sales forecast help in the preparation of production budgets
Sales budget: The sales budget is the key component used in overall planning.

Relevant costing & long-term decision-making

Deciding whether to accept a special order in a short-run decision
Management must decide what sales price is appropriate for one-time customers,
does the company have excess capacity, can it produce additional units with its
existing resources.