AS LEVEL ACCOUNTING THEORY

Types of Expenditures & Reciepts

Expenditures
Money outflows or money spent on something
Reciepts
Money recieved or cash inflows

Capital Expenditures
Money spent on Acquiring improving or installing a non current Assest and has a benefit of more than a year
Any Capital Expenditure must be capitalised which means it must be added to the value of the non current asset
For example, delivery of the new non current asset must be capitalised. Any cost of Acquiring or upgrading it must be
considered as a capital expenditure

Revenue Expenditure
Money Spent on costs of day to day runnings of the business on resources that are used up with in a year
Whenever a cost has the prefix "re" such a repainting then this is a cost that is done to maintain the non current asset
Cost such as rent, repainting, repairment cost are revenue expenditures but cost of upgrading the non current asset such as
adding a new extension is a capital expenditure

Capital Reciepts
Money recieved not from normal day to day transaction but Capital Transactions
This is when you recieve huge amounts of money not normally from trading activites. Examples are sale of surplus non
current asset. Other common examples include introduction of new captial or obtaining a new long term loan

Revenue Reciepts
Money Recieved from day to day tradings of the business
These include commision, rent income etc

Difference between Capital & Revenue Expenditure

1. Firstly, We can talk about the definitions for each
2. Capital Expenditure is recorded in the Balance sheet where as Revenue expenditure is recorded in the income statement
3. Capital Expenditures aids profit and are not for resale and must be depreciated whereas, revenue expenditure is charged
fully for that year
4. Capital Expenditure has a benefit of more than a year, where as revenue expenditure has a benefit of less than a year

How can we identify them?

For some questions, it can get confusing...
For example, if the engine of the motor vehicle fails and the business plans to replace it with a newer efficient engine
This seems to contradict with the "re" prefix but the big giveway is the efficient word and so we can consider this as an
improvement thus a captial expenditure

Wrong Treatments of Capital & Revenue Expenditures

In some questions, the owner might have accidently recorded revenue expenditure as capital expenditure or vice versa
In each scenario, we need to explain the effect of the error:
1. If Revenue expenditure is overstated, the the expense will be overstated and profit will be understated in the income
statement whereas in the balance sheet the non current assets will be understated and the capital will be understated due to
profits
2. If Revenue expenditure is understated, the the expense will be understated and profit will be overstated in the income
statement whereas in the balance sheet the non current assets will be overstated and the capital will be overstated due to
profits
3. Also the accounting records will not show a true and fair view of accounting records and it will be inaccurate
Depreciation
The Cost of an asset that is consumed by that financial period by the business
OR
The Allocation of Cost of an Asset over its useful working life

Discuss the possible ways of funding for the purchase of an additional non current asset
1. Bank Loan
2. Partner's Loan
3. Sale of surplus non current asset
4. Hire purchase
5. Partner introduces more capital
6. Admit a new partner

Why a Company Calculates Depreciation?

1. To comply with the prudence concept by avoiding overstating non current assets and profit by recording the depreciation
charge as an expense
2. To comply with Matching Concept by matching the loss in value of the asset with the income generated from using it
3. Ensure the financial Statements show a true and fair view
4. To match the loss in value with wear and tear and obsolescence etc

State Causes of Depreciation

1. Time or Passage of Time
2. Obsolescence
3. Technology Advances
4. Economic Factors
5. Wear & Tear
6. Depletion

State an example for each cause of depreciation

Passage of time - Leasing a building
Obsolescence & Technology Advances - Machinery & Office Equipment
Wear & Tear - Fixtures & Fittings
Depletion - Quarry, oil wells and mines
Economic Factors - Such as inflation and deflation of market value

State four factors to consider when calculating depreciation charge

1. Type of Asset
2. Depreciation Method
3. Cost of the Asset
4. Length of Owneship
5. Usage
6. Residual Value

Why different Assets have different Rates of Depreciations

This is because different assets decrease in value at different values compared to other assets. For example, Machinery has a
heavier fall in value in the early stages and it decreases with time as the usage decreases. So reducing balance method is the
most suitable.
For Fixtures and fittings, the decrease in value will be even as the usage will be even so straight line method is the best
option
Why you shouldn't change the depreciation Method...
The business should not change the depreciation method as it violates the consistency concept and makes comparison
between years of very little benefit
There is only one reason for change. Only if the business is able to prove the change will improve the true and fair view of
the business. However, changes must be done to the previous years due to this

Why change from reducing balance to straight line method?

1. Easier to calculate and faster
2. Less error prone
3. More appropriate for items that have an even charge

Why change from Straight line to Reducing Balance Method

1. Even though it is harder to calculate and more error prone it is very accurate and reliable
2. Used with assets that have a higher fall in value in the earlier stages such as machinery so it reflects prudence and
matching more accurately
3. Also as the charge decreases the maintainance cost increase thus resulting in an even charge whereas for straight line the
charge increases as maintainance cost increases

The Main Reason for using Reducing Balance for Machinery & Equipment
Plant and Machinery has a larger fall in value at the earlier years. Also the maintainance cost increases and thus maintains
an even charge

Accounting Treatment for Loose tools

1. If the cost is material / significant then we must use the revalution method... Matching Concept
2. If the cost is not significant then charge the full amount to that year... Materiality Concept

Accounting Concepts related to Depreciation

You will need to memorise these:
 Consistency
The same depreciation method must be used every year to allow meaningful comparisons
 Prudence
To avoid overstating the non current assets and profit by charging depreciation as an expense
 Accurals / Matching
To charge the cost of the asset against the revenue generated from using it for that financial period

What is a Trial Balance?

A list of the balances of the ledger accounts at a specific date
Advantages of a Trial Balance
1. Used as an error correcting procedure
2. Used as a basis for financial statements

What is a Suspense account?

A temporary account that is created to temporarily balance the trial balance and to help correct errors affecting the trial
balance

Uses of Suspense account

1. Allows draft financial statements to be prepared
2. To facilate the correction of errors
3. To temporarily balance the trial balance
4. A place for the bookkeeper to enter the transaction when correcting the errors
State 6 Errors not affecting the trial balance
1. Error of Omission
2. Error of Commission
3. Error of Principle
4. Error of Original Entry / Transposition Error
5. Error of Complete Reversal
6. Compensating Error

Errors affecting the trial balance

1. Single entries
2. Entries on the wrong single account
3. Incorrect additions in the Trial Balance
4. Incorrect additions in the ledger accounts
5. Double entries in a single account
Narrations gives a reason for the entries made in the general journal

Advantages of Control Accounts

1. Provides Quick Totals of the Trade recievable/payables for the Quick preparation of financial statements
2. Helps in Identifying Errors by comparing the Totals in the ledgers and the trade recieveables and payables
3. Helps avoid frauds due to segregation of duties and providing an internal check
4. Provides a summary of the transaction related with the trade recieveables and payables
5. Proves the accuracy of the financial records

Advantages of Sales Ledger Control account

Same for purchase ledger control accounts...

Factors to Consider when Charging interest on Overdue Accounts

1. May lose customers as customers are demotivated
2. May require strict credit control procedures which may increase cost
3. May improve cash flow / liquidity as money is gained faster
4. Improves trade recievables collection period

Why are provision for Doubtful Debts not recorded?

Provision for doubtful debts does not affect individual debtors account

What is a Contra Entry and the Reason?

A contra entry is an entry that appears in the debit side of the purchase ledger control account and the credit side of the sale
ledger.
It is made to set off the value in the purchase ledger with the sales ledger of the same person
So the account can be settled using a single check and reduces administrative cost

Reasons for Credit Balance in the Sale ledger Control Accounts

1. Overpayment by customer in error
2. Failed to deduct cash discounts at the time the payment was made
3. Failed to adjust contra entries
4. Customer paid in advance for goods
5. The customer returned goods after the account has been settled

Reasons for Debit Balance in the Purchase ledger Control Accounts

1. Overpayment by the business in error
2. Failed to deduct cash discounts at the time the payment is made
3. Failed to adjust contra entries
4. Business paid in advance for goods
5. The Business returned goods after the account has been settled

Sole Trader & Financial Statements

A Business run by a Single Owner

Advantages of a Sole Trader

1. Easy and cheap to set up // No legal set up
2. Does not require permission from law to carry out business activities
3. All profit is enjoyed by owner
4. The sole trader has sole control

Disadvantages of Sole Trader

1. Unlimited Liabilities - Must Sacrifice personal funds to meet debts
2. There is no seperate legal existence between owner and business ( in terms of public )
3. No continuity so business dies with owner
4. Losses must be borne by the owner
5. More work load and less skill

Inventory Valuation
Inventory must be valued lower at cost and net realisable value
Net Realisable Value
Estimated Sale of Reciepts less the cost of completing the goods and less the selling expense

Types of Inventory Valuation

1. Current Replacement Cost
2. FIFO
3. AVCO
4. LIFO
However, IAS only accepts FIFO & AVCO Valuation

FIFO // First in First out

Simply, the first items to be bought are the ones that are sold first. For example, if we consider a new business and the
business buys goods on the 1st day, then again buys inventory on the 10th day. When sold the inventory bought on the first
day must be sold first

Advantages of FIFO
1. Makes sure inventory is valued at the most recent prices
2. Accepted by standards such as IAS
3. Simpler and easier to calculate
4. The cost of inventory matches the cost that was initially used to buy the goods

Disadvantages of FIFO
1. Can overstate profit if the prices of goods are increasing as inventory is recorded at the most recent prices
2. Cost of goods sold are at the old selling prices which is unrealistic
Remember there are 2 types of FIFO methods, one is perpetual and the other one is periodic. Both gives the same answer
but how often they calculate the inventory is different

LIFO // Last in Last out

The inventory is valued by selling the goods that was last in or most recently bought. Like a stack
Advantages of LIFO
1. Simpler and easier to calculate
2. Makes sure selling prices are sold at the most recent prices
3. The cost of goods matches the cost that was initially used to buy the goods

Disadvantages of LIFO
1. Not recommended by the IAS
2. Uses the oldest prices for inventory valuation

AVCO // Average Costing Method

Similar to how relative atomic masses are calculated
When AVCO, each time goods are bought, the total cost of the product is divided by the number of units

Advantages of AVCO
1. It is a standard recommended by the IAS
2. It makes sure each product has an equal weightage and importance
3. More accurate and reliable as there is no significant changes with cost price per unit when goods are bought

Disadvantages of AVCO
1. Difficult to calculate as it is time consuming

Adjustments of Prepayments & Accurals

 Prepayments
If expense, must be reducted from expense in the income statement and must be added to the other recievebles under current
assets in the balance sheet
If income, must be reducted from income in the income statement and must be added to the other payables under current
liabilities in the balance sheet
 Accurals
If Income, must be added to the income in the income statement and must be added to other recievables under current assets
in balance sheet
If expense, must be added to the expense in the income statement and must be added to other payable under current
liabilities in balance sheet

Treatment of Provision for Doubtful Debts

 Statement of Financial Position
The closing provision is reducted from the trade recievables in the current assets
 Income Statements
Increase in provision for doubtful debts is charged as an expense that reduces profit
Decrease in provision for doubtful debts is entered as an income after gross profit

Reasons for increase in rate of provision for doubtful debts

1. Increase in credit sales
2. Worsening of the economy
3. Past experience
4. Age of the debtors' balance
5. Poor Credit Control systems

Reasons why a business maintains a provision for doubtful debts

1. To make sure prudence concept is followed by avoiding overstating trade recievables and profit
2. To follow accurals concept by charging the sales that are unlikely to be made against the revenue made for that financial
year

Accounting Concepts related with provisions for doubtful debts

1. Prudence Concept
2. Accurals / Matching Concept

Partnerships
Business run be two or more people working together as owners

Advantages of Partnerships
1. Range of more knowledge and skills
2. More capital can be raised
3. Management of the business can be shared
4. Decision making and responsibilities can be shared so less stress
5. Liquidity is improved ( more capital )
6. The business has more ideas
7. Losses can be shared

Disadvantages
1. Disagreements can occur
2. Profits have to be shared
3. Decision must be recognised by all partners so may take longer time to implement // loss of control
4. One partners action may bind another partner
5. All partners are responsible for the debts of the business

Ways in which the liquidity position of a partnership can be improved

1. Partner introduces more capital
2. Admit a new partner
3. Sale of a surplus non current asset
4. Reduce Partners Drawing and Salaries
5. Obtain a loan from partner or bank

Partnership vs Limited Liabilities

1. Partnership has no seperate legal entity whereas limited liability has seperate legal entity so there is continuity
2. Liability of partnership is unlimited whereas for companies it is limited
3. Partnership has more Control than limited liability where there are many shareholder involved
4. There could be disgreement & disputes between partners
5. More capital is raised by limited companies
6. Limited liability can be publicly scrutinised or sued
7.More paper work and detailed financial statements are required for limited companies. Also very costly to set up
8. In partnership, one partners action may bind another parnter

Items in a partnership agreement

1. The capital to be contributed by each partner
2. The rate of interest on drawing charged
3. The rate of interest on capital paid
4. The profit / loss sharing ratio
5. Drawing limitations
6. Salaries to be paid to partners
7. Duties / responsibilities for each partner
8. Procedure to be followed when partner dies retires or is admited

Which partnership agreement is followed when there is no agreement?

partnership act of 1890
What is included in it?
1. No partners Salary
2. No interest on drawings
3. Profit / loss share is equal
4. No interest on Capital
5. Interest in loan is 5%

Reasons why the partners current balance can have a debit balance
1. Has drawn excessively than the allocated profit
2. The business has made a loss

Reasons why there is a seperate account for capital & Current account
 Capital Account
1. Used to show permanent investment
2. To record big capital changes / impacts such as goodwill
3. To calculate interest on capital
 Current Accounts
1. To show profits retained by each partner and any ongoing transactions between partner and partnership
2. Reveal excess drawings
3. Compares profit earned and the amounts withdrawn
4. To calculate interest on drawings
5. To seperate profit , drawings and capital

List items in an appropriation account

1. Interest on drawing
2. Interest on capital
3. Partner's Salary
4. Profit Share

Why is interest on drawings charged?

1. To encourage partners to draw less
2. To reward partners with less drawings
3. To retain cash in the business

Why is interest on capital paid?

1. To encourage partners to introduce more capital
2. To reward partners for their business investments
3. To compensate due to the unequal capital introduction
4. To reward partners for lost opportunity cost on capital invested

Finance methods in Partnerships

1. Bank loan
2. Partner introduces more capital
3. Partner introduces loan
4. Admit a new partner
5. Sale of surplus non current assets
6. Get loans from family or grants
Items in the Appropriation account & Partnership Agreement
 Not present in the Appropriation but present in Agreement
1. Drawing limitations
2. Capital to be introduced
3. Duties & responsibilities of partners
4. Loan interest
 Present in both
1. Interest on drawings and capital
2. Profit sharing ratio
3. Partners Salaries

Why would a partner provide a loan instead of capital

1. Funds are required for a limited period only
2. Greater Security than Capital
3. Repayment of Loan is Before Capital so more secure

Why would a partner be an employee instead

1. More Secure // Less Risky
2. Less Stress as less decision making & responsibilities
3. Entitled to holidays & Sick Pay

What is goodwill?
It is an intangible asset that arises from customer loyalty, reputation and location and it is the total cost of acquiring
the business less assets and liabilities that have been purchased

Factors that arises the creation of Goodwill

1. Customer loyalty or returning of customers
2. Location
3. Profitability
4. Brand or logo // Reputation
5. Skill of workforce
6. Quality of products

Situations Goodwill must be Adjusted (only)

1. Changes in profit ratio
2. Admission of a new partner
3. Retirement of a partner
No goodwill is created when the business is dissolved

Why is Goodwill adjusted when a new partner is admitted

To reward or benefit the original partners for their efforts in building up the business and goodwill

Advantages of Goodwill
1. Gives an accurate value of the business
2. Doesn't understate the business value and rewards partners

Disadvantages of Goodwill
1. It is subjective so it is difficult to determine in terms of money
2. It is changed due to sudden events such as unethical action by a partner
3. According to IAS, only purchased goodwill is allowed to be recorded
The Question usually ask why Goodwill was not recorded in the books of account. This is called inherent goodwill and
not purchased goodwill

What is a Revaluation Account?

An account that records profit or loss due to any changes of the assets & liabilities value in the partnership
Limited liabilities also follow the same principle but they are called revaluation reserves

What is Realisation account?

Records any profit or loss on settling/closing the books accounts of the business

Adjusting goodwill and Revaluating Assets when partner retires

1. Fair value of the assets may be greater than the book value
2. Original partners are rewarded for the efforts in building up the business so any increase in value of assets must be
credited to the capital accounts and must be paid in cash when they retire
A very important point, I forgot to mention is that Goodwill and Profit from Revaluation are called unrealised
profits...Also a simple way to remember why they revalue assets is to remember 2 points. Fair value of Asset & Benefiting
Original Partners

Reasons for Dissolution

1. Partner retires or dies
2. Mutual Agreement between partners
3. There is disagreement between partners
4. Court orders to cease trading
5. Bankruptcy

What if Partner has a DEBIT balance due to the dissolution of a partnership?

The partner owes money to the business so he has to sacrifice his own funds and pay to the business bank account. So the
business has enough funds to pay the rest of the partners

Request of Payment of Partners Loan

1. Look at the Agreed Rapayment due date
2. Will partner have to borrow money // increase cost
3. Check interest on loan
4. Borrowing a loan may require security

Limited Companies
Advantages of Limited Companies
1. Seperate Legal Existance so there is continuity
2. Limited Liabilities
3. More Capital can be raised
4. High Status in the community so easier to obtain loans

Disadvantages of Limited Companies

1. High Setting up Cost
2. Loss of control as there many Shareholders involved
3. Companies must comply with company act of 1985

What is an incoporation?
The legal formation of an entity seperate from its owners

Difference between Non-profit Organisation & Company Financial Statements

 Limited Company Non-profit Organisation

Has a Statement of Financial Position Has a Balance Sheet

Shows Share Capital & Reserves Shows Accumalated Funds

Has an Income & Expenditure account Has an Income Statement

Has Reciepts & Payments account Has a statement of Cash Flow

More will be under the Non profit Organisation Chapter

Advantages of Converting Partnership

1. More capital can be raised
2. Seperate legal existence so there is continuity
3. Limited Liabilities
4. Has a higher status and so easier to obtain loans and debentures

Difference between Ordinary Shares & Preference Shares

Ordinary Shares Preference Shares

Variable Optional Dividends Fixed Dividends and is Mandatory if sufficient profit

Have Voting Rights No Voting Rights

Dividends is paid after preference shareholders are paid Paid Dividends before Ordinary Shareholders a

Paid Capital Last at a event of liquidation Paid before Ordinary Shares

What is Liquidation?
1. When the business does not have sufficient funds to discharge or pay of the loans. The business may have to sell the
assets to pay off all the capital and loans

Types of Preference Shares

 Cumulative Preference Shares
When the business is unable to pay the dividends for the current year , the amount is carried or accumalated to the next year
For example, the rate of dividends paid will increase next year
 Non Cumulative Preference Shares
If the business is unable to pay dividends for a financial year then it is not accumalated but forgotten
However, this is only if the business does not have enough sufficient funds or else it is mandatory
 Reedeemable Preference Shares
Preference shares that can be paid back by the company on a specific date. This is similar to a loan so it is not recorded
under equity but liabilities
 Non Reedeemable Preference Shares
Preference that can not be bought by the company on a specified date. This is part of equity as it is permanent
If you noticed under reserves, there is a reserve called capital redemption reserve. This is used to buy the preference
shares back...

Advantages & Disadvantages of Issuing Ordinary Shares to:

 Shareholder
1. More profit & dividends as there is no interest due to loan
2. Ordinary Shareholders have the same priority of repayment of capital, so less risk
3. Ordinary Shares have the same priority of payment of dividends
4. However, loss of control as ownership is diluted
 The Company
1. Profit is greater as there is less interest also dividend may not have to be paid
2. Ordinary Shareholders have control over the company
This part is in the business' viewpoint. see Business Entity Concept

Advantages & Disadvantages of Issuing Preference Shares to:

 Shareholder
1. No dilution of ownership as preference shares have no voting rights
2. Profit is fixed, so if profit increases, cash is retained ( improved cash flow )
 The Company
1. No dilution or controlling as preference shares don't have voting rights
2. Preference shares have fixed dividends
This part is in the business' viewpoint. see Business Entity Concept

Difference between Ordinary Shares & cumulative Shares

1. Main Difference is that Cummalative dividends is fixed and is accumalated whereas, the ordinary shares are not
accumalated and is optional and variable
2. No voting rights for cumulative preference shares whereas ordinary shares have voting rights
3. Same points as preference shares

Bank Loan or Share Issue

 Bank Loan
1. The lenders must be convinced the business is able to meet the interest and repayment obligation
2. The lenders will be secured on the non current assets of the business // requires security and collateral
3. Issue of Debentures is much faster than share issue
4. Will increase gearing ratio and risk // may deter potential investor & Suppliers
5. Interest must be paid annually so profit & dividends will reduce
6. Loan must be repaid on a specific date
 Share Issue
1. Longer time to issue
2. Doesn't required to be repaid
3. No interest so no reduction in profit
4. There is dilution of ownership so loss of control
5. Does not increase gearing or risk
6. Share issue may dilute share price
7. Share issue is expensive
This Question comes in many forms use the above to explain and advise whether to issue debentures or shares

Advantages of Debentures over the Shares

1. Faster to issue
2. No dilution or loss in ownership
3. Fixed rate of interest so can not increase if profits increases
4. Repayments are fixed so allow planning
An important point I forgot to mention is that the reasons why a partnership would admit a partner instead of a loan is
similar to the points for share issue vs debentures

Difference between Ordinary Shares & Debentures

Ordinary Shares Debentures

Owners Creditors

Fixed rate of interest must be be paid annually irrespe

Variable Optional Dividends
profit

Have Voting Rights No Voting Rights

Part of Equity Part of long term loans and liabilities

Debentures have the highest priority for capital repaym

Capital Repayment is paid after Debentures are paid
event of winding up
The marksheme usually say the word "discretion", this means that dividends to ordinary shares is optional

Where does Issue of Debentures Appear?

Debentures are long term liabilities so it is recorded in the statement of financial position as a non current liability

How does each issue affect profit:

 Debenture issue
Interest is charged as expense that reduces profit in the income statement
 Share Issue
Does not affect profit but does reduce retaining earnings in the statement of equity changes but no affect in the income
statement

Difference between Capital & Revenue Reserves

 Capital Reserves
1. Is not created by the transfer of profit.
2. Usually represent gains of unrealised profit
3. Can be used to issue bonus shares
4. Can not be used to pay dividends
 Revenue Reserves
1. Is Created by the transfer of profit
2. Usually arises to strengthen the financial position of the business or for a specific purpose
3. Used to pay dividends

Examples of Revenue / Distributable Reserves

1. Retained Earnings
2. General Reserves
3. Non Current Replacement Reserves
Examples of Capital / Non distributable reserves
1. Share premium
2. Revaluation reserves
3. Capital Redemption Reserves

Reasons for creating a General Reserve

1. To allocate profit for the reinvestment of the business
2. To pay future dividends
3. To use in the future when profits are low

What is meant by keeping the Reserves at most flexible form

Using capital reserves before revenue reserves to maintain maximum revenue reserves, to pay maximum dividends

Uses of Share premium Reserve

1. Issue of Bonus Shares
2. Company formation expenses
3. Cost of issuing debentures and shares
4. To pay premium on redemption of preference shares

Why the balance of Retained earning is lower than profit

1. Forwarding of a negative opening balance
2. High dividends paid
3. Issue of bonus shares
4. Transfer to general reserve

Double entry for Revaluation Reserves

1. Debit Non Current Assets & Provision for Depreciation
2. Credit Revaluation Reserves

Treatment of Proposed Final Dividends

Propsed dividends is not paid and is not a liability in the statement of financial position but is disclosed as note in the
financial statement as it is a non adjusting event and adjusted in the next financial year
You will know more on what is an adjusting event later in A levels

Difference between Rights & Bonus Issues

1. Bonus shares are issued from reserves
2. Rights Issue raises cash and capital
Bonus shares are issued from reserves and there is an order in which you need to remember bonus shares are issued
from
1. Share premium
2. Revaluation Reserves
3. Capital Redemption Reserves
4. Non Current Replacement Reserves
5. General Reserves
6. Retained Earnings
This is the same order of how statement of changes of equity is arranged

Why does a company make Bonus Shares

1. To liquidate capital reserves that can not be used to pay dividends
2. When profit is low, to reward shareholders without paying dividends
3. Good sign to potential investor
4. Helps release reserves with no impact to cash flow
5. Help to capitalise capital reserves but no change to net assets
6. Helps to increase the perception of business size by increaseing issued share capital
7. To match the long term Assets with Long term captial

Advantages of Bonus Shares

1. Does not affect cash flows as no dividends is paid // cash is retained
2. Good sign to potential investors
3. Does not dilute ownership as the ownership remains with existing shareholders
4. Helps to release capital reserves

Disadvantages of Bonus Shares

Does not raise any cash or capital

Benefits of Rights Issues

1. Cheaper than issuing normal shares
2. Raises cash // results in a cash inflow
3. No dilution in ownership as it remains with the ownership
4. More likely to subscribed than a new share

Disadvantages of Right Shares

Can cause the share price to fall

Difference between Rights Share & Bonus Shares

1. Rights share raises cash as it must be paid, where as bonus shares are free and so does not raise cash
2. Rights issue causes an increase in net assets/capital whereas bonus shares do not affect net assets
3. Rights issues can be rejected if share holder does not want to exercise his right whereas bonus shares are automatically
added
Incomplete Records
Accounts that don't follow the double entry

Benefits of a Bookkeeper
1. Produces up to date financial records
2. Can be used to improve the credit control systems
3. Improves Decision making
4. Improves Cash Flow / reduces bad debts

Disadvantages of a Bookkeeper
1. Costly
What is a bank statement?
It is the copy of the customers account in the bank's books of account
This is confusing but the debit and credit is opposite

Advantages of Bank Statements

1. Helps Obtain the correct bank balance
2. Find errors in the bank statement
3. Find errors in the bank account
4. Identify errors and frauds
5. Identify stale and dishonoured checks
6. Identify unpresented cheques
7. Identify uncredited lodgements
Advantages of InComplete Records
1. Enables the trial balance to be prepared
2. Enables financial Statements to be prepared
3. Improves arithmetical accuracy of record. Also reduces error
4. Reduces frauds by introducing reconcillations to check the balances by using trial balance and control accounts
5. It shows the balances of the trade recievables and payables so avoid overpayments
6. Improves decision making and can be used to measure performance easily

Disadvantages of Control accounts

1. Increased Cost & more time consuming
2. Requires a specialist team to be employed

Advantages of Preparing financial Statements

This is a general question and it includes benefits to different parties
1. Can be presented to bank for additional finance
2. Can be used to measure performance of previous years
3. To make Decisions
4. To make plans and targets
5. To identify areas where correction action is required
6. To calculate tax

Should a business have complete records?

The answer is always yes... but make sure to advise with both disadvantages and advantages

Ratio Analysis & Communications

Difference between Gross Margin & Markup
1. Gross Margin is the Gross profit as a percentage in relation to revenue
2. Gross Markup is the Gross profit as a percentage in relation to cost of sales

What is ROCE / return on capital employed?

The profit earned or return for every $1 of Capital Employed
This measures profitability

What do you mean by liquidity?

The ability for current assest to meet current liabilities

How to improve gross profit margin?

1. Increase selling prices
2. Find cheaper suppliers / lower purchase price
3. Change sales mix
4. Take advantage of trade discounts / Bargain for more
5. Allow lower rates of trade discounts to customers
These are also the reasons for increased margin. Worsening of margin is the opposite of this

How to increase profit margin

1. Increase in gross profits
2. Greater control over expenses
3. Higher other incomes
If the gross profit is lower than last year then the first point is not applicable

How to Improve ROCE?

1. Increase profits or the business is profitable
2. Employ capital more efficiently

Importance of Current Ratio / Working Capital Ratio

1. Measure the funds available in the short term to meet current liabilities
2. Does not show liquid assets as it includes inventory
3. It measure liquidity as it measure excess current assets over current liabilities

Why is Quick Ratio a better indicator of liquidity?

1. Does not include inventory as it is not a liquid asset
2. Inventory is regarded as two stages from liquidity

Consequences of Poor Liquidity

1. Not enough short term funds to meet short term debts
2. Loss is cash discounts
3. Loss in business opportunities
4. May increase borrowing and interest

Other Ratio that Measure Liquidity

Quick Ratio - The Best
Current Ratio - Good
Trade recievable / payable turnover - useful
Inventory turnover - last used

Advantages of Ratios
1. Allows comparison between businesses
2. Show trends / performances by comparing with past years
3. Can be used to compare with market leader
4. Allows managers to measure performance and set targets / benchmarks
5. Can be compared with industrial averages
6. Gives quick details such as risk and perfomance and efficiency to potential users

Disadvantages / Limitations of Accounting ratios

1. Based on past / historic information
2. Uses only financial information and non-financial items are excluded
3. Doesn't consider seasonality or year ends
4. Doesn't consider inflation
5. Uses subjective data
6. Doesn't give a reason for the cause
7. Doesnt consider state of the asset such as probability of debtor paying

Factors to consider when comparing businesses

1. Must be in the same industry or sell the same products
2. Same size / revenue or capital structures
3. Must be operating at the same accounting policies
4. Must be operating at the same year ends

Limitations of Comparing Businesses

1. Doesn not consider non-financial aspects
2. Not same year ends or seasons
3. Not operating at the same accounting policies
4. May not be in same industry
5. May not be the same size
6. One years of data is not enough to make valid conclusions

Cost & Management Accounting

The budgeting side of accounting

What are variable costs?

Cost that varies directly proportional with the level of output
Examples are cost per unit such as labour per unit

What are fixed costs?

Fixed costs are cost that remain constant for all levels of output for a specific range
Examples are rent and insurance and they are called period costs as they remain constant with in an agreed period
The reason why I say specific range is that it is not really realistic for fixed cost to be constant for all levels of output. If
you consider for all levels of output then it becomes a stepped cost

What are Stepped Costs?

These are cost that increase as the capacity of the business increases. It remain fixed with in a relevant range of capacity and
increases as it exceeds a particular capacity. Ex Salary of Quality Workers

What is fixed cost per unit and variable cost per unit
This is very self explainatory as it is the cost dividing over the number of units. It is really simple. Think about it! Fixed cost
remains constant with in a range so when we increase the number of units then the fixed cost per unit decreases. This is
called economic of scale
However, for variable cost per unit it must remain constant
In fact these are some of the limitations in break even analysis

What is sunk cost?

They are cost that have already occured in the past and is not relevant for future decision
Examples are last years rent

Uses of Marginal Costing

1. To determine the break even of a product
2. For make and buy decisions
3. Limiting factor decisions
4. To determine whether to discountinue or close a department or product if negative contribution
5. To accept or reject orders below normal price
6. To accept orders if spare capacity
7. For sensitivity analysis
6. To identify the turnover required to make a target profit

Advantages of Marginal Costing

1. Useful for short term decisions as fixed cost do not change and only considers variable cost
2. Good for special orders prices to be set accurately
3. Allows comparsions between make and buy
4. More easier to calculate, except dividing the cost to fixed and variable
5. Less time Consuming to Calculate as there is no adjustments for under or over absorption

Disadvantages of Marginal Costing

1. Not useful for long term decisions as fixed cost change
2. Not realistic for financial statements, as it understates the value of inventory
3. Harder to divide the cost to fixed and variable and more time consuming
This could be reasons for keeping or not using Marginal Costing

What is a Cost Centre?

A cost centre is a department with in the business in which cost can be apportioned or allocated to

What is a Cost unit?

A unit of production

What is allocation?
These are cost that can be clearly identified with a cost centre and the total amount is charged directly to it
Examples are direct materials and labour

What are Overheads?

Overheads are cost that can not be traced to a specific department or product so it is an indirect cost

What is apportionment?
The Cost that are not clearly identified with a specific cost centre and must be charged on an appropriate basis such
as floor area

What is Absorption?
The process of charging the total allocated or apportioned fixed costs to the production units
A point to remember is that cost must be either allocated or apportioned no matter what

Cause for Over Absorption & Under Absorption of Overheads:

 Over Absorption
1. When the Actual Activity ( be specific ) is greater than the budgeted activity
2. When the Actual overhead is less than the budgeted overheads
 Under Absorption
1. When the Actual Overheads is greater than the budgeted
2. When the Budgeted Activity is less than Actual
The easiest way to remember is to use the formula. When the result is positive then it is over absorption...Vice versa
Under or Over Absorption = ( Overhead Absorption rate * Actual Activity ) - Actual Overheads

What is Overhead absorption rate?

Overhead attributed per machine or labour hour

Why are budgeted figures used to calculate the overhead absorption rate?
The actual values are not available and so the cost must be known in advance to determine the selling price so the overheads
are fully recovered

How Under or Over Absorption of Overheads Affect Profit

 Over Absorption
1. Increases cost charged from the customer so profits increase
2. Due to increase selling price it could lead to lower in demand and less profits
 Under Absorption
1. Insufficient overheads charged by customers so reduction in profits
2. Decrease in selling price can cause an increase in demand and profits
Departmental vs Factory Wide Overhead absorption rates
Factory wide rate means the total cost of a business over the activity whereas the departmental rate is overhead per
activity for each department
 Factory wide Rate
1. Easier and cheaper to calculate
2. Less accurate
 Departmental Rate
1. More Accurate
2. Different products may spend different times in each department
3. Different products may require different amounts of labour or machine hours

How are direct cost charged to each department?

Direct costs are allocated to the department as they are directly attributed to the production units

Basis used for Apportionment

Cost Pool Basis

Insurance Floor Area

Rent Floor Area

Depreciation Cost of an asset

Power or Electricity Kilowatt

Heating & Lighting See below

Maintainance Cost Machine Hours

Supervisor's Salaries Number of Workers

Canteen Cost Number of Workers

For Heating & Lighting it changes, if they have only given kilowatt then use that. If they have given only floor area then
use that. If both are there use kilowatt

What is Job Costing?

A costing method used for single unique order that is made according to the customers preference
1. Single orders
2. Unique and made according to the customer's preference
3. Has a relative high Cost
4. Not available for stock
5. A quotation is charged for every customer on an hourly basis
Examples are tailoring, architecture or other single unique orders

What is Batch Costing?

A costing method applied to the production of identical items. The cost per unit is found by dividing the total cost of
the batch by the number of units in the batch
A batch order is actually a special type of job costing or it could be a mix of both. For example, a business might have
asked to make a large quotation on 100 products

Uses of Absorption Costing

1. Helps to set selling prices
2. Useful for long term decisions as fixed cost change
3. Realistic and acceptable in financial statements

Disadvantages of Absorption Cositing

1. Subjective as the basis used for apportionment are arbitary
2. Harder to calculate and managers may require training
3. Very time consuming especially when adjusting over and under absorption or overheads
4. If there is an increase in inventory, it can cause profits to be overstated
5. Not useful for short term decision as fixed cost do not change

Why profits calculated will be different for Absorption & Marginal Costing?
1. In Absorption costing, fixed cost are treated as production cost, where as in marginal costing they are treated as period
cost
2. In Absorption cost, both variable and fixed cost are included in the inventory valuation whereas, marginal only includes
variable
3. In Absorption Cost, only part of the fixed cost are charged against sale volume and the rest is carried to the next year
where as in marginal costing the complete fixed cost is charged for the year
The only conditions when the profit of both methods are the same are when the production is equal to the sold units
because there is no change in inventory

Should you accept orders below the normal selling price?

 In favour:
Yes, if the product has positive contribution as it will give additional profit if there is spare capacity
 Not in Favour
1. No, Because if the existing customers find out about the new selling prices they will not be satisfied and request for that
selling price
2. This will lead to a reduction in profit
3. It may result overheads not being completely absorbed

Factors to Consider when changing Suppliers

1. Will the new supplier maintain the same price?
2. Will the new supplier allow the same credit systems?
3. Will the quality of products be acceptable?
4. Will the new supplier give the same trade discounts?
5. Is the new supplier realiable

What is Break Even Point?

The level of activity which the business makes neither a profit nor a loss. The total cost is equal to the ttotal revenue
of the activity

What is Margin of Safety?

The difference between the predicted output and the break even point. It shows the activity the business can lose
before a loss is made. This measure risk
1. This measures risk
2. Measures tha activity that can fall before a loss is made
3. It Shows the ability to withstand harsh trading conditions

What is Contribution?
The amount which each unit makes towards covering up the fixed cost and earning a profit. it is difference between
the selling price and the total variable cost per unit

What is C/S Ratio?

The Contribution Earned for every 1$ for revenue earned

Advantages of Break Even Analysis & Graphs

1. Allows to determine the margin of safety and angle of incidence
2. Determines the number of units to be produced before a loss is made
3. Breaks cost in to variable and fixed
4. Forecasts profit and loss at different levels of output

Disadvantages of Break Even Analysis

1. Assumes fixed cost remains constant within a relevant range
2. Revenue and Cost are linear
3. Only applies for a single product or sale mix
4. Assumes variable cost per unit remains constant
5. Assumes total units produced are sold
6. Assumes cost can be easily broken down to variable and fixed cost
7. Only applies for a short and relevant period
8. Assumes selling price per unit remains constant for all levels of output
9. Can be time consuming to prepare charts and graphs

What is the purpose of cost-volume-profit analysis?

To forcast the changes in profit and revenue with the changes of cost and volume

Disadvantages of cost-volume-profit analysis?

Same as break even analysis

Advantages of Cost-volume-profit Analysis

1. Useful for planning
2. Provides Quick Estimates
3. Changes in cost can be easily coporated
4. Forecasts profit at various levels of output
5. Identifies break even point
6. Useful for making short term decisions. Example: spare capacity and special orders

What is budgetary control?

Controlling of the use of resources using budgets to achieve an overall objective
What are budgets?
A plan expressed in financial terms

Advantages of Budgetary Control

1. Aids Coordination and Communication between Employees
2. May motivate staff and managers by reaching the targets and the reward
3. Allow delegation to staff
4. Assist in decision making
5. Measures performance
6. Control and planning by comparing budgets with actual and finding variances

Disadvantages of Budgetary Control

1. Very time consuming and costly // may require a specialist staff to be employed
2. Budgets are estimates thus inaccurate
3. Can cause conflicts between departments
4. Can demotivate staff
5. Can restrict staff innovation
6. Budgets could be unrealistic and not look at the unforseeable circumstances..Ex: Recession