115 Accounting AS Level (Theory and Practice)

DescriptionCurrent financial reporting practices have been under major review with the approach of a single market, moving towards harmonization. Consequently, all global syllabuses, from December 2007 onwards, use international terminology.The globalized frame work of Cambridge International Advanced Level, in practice over 125 countries, has led to the introduction of an international format and layout for all its syllabuses.This book Accounting A Level Theory and Practice Article Number 115 is intended to cover the accounting content of CIE Advanced Level syllabus 9706 comprehensively. With a thorough discussion of the basic double entry principles for the beginners, it is also useful for those who have some knowledge. (Accounting AS Level)The strengths and weaknesses of accounting practices are reinforced by a set of Review Questions at the end of each chapter, enabling the students to put, what is learnt, into practice. These Questions have been developed by the author and are not taken from past exam papers.(Accounting AS Level)The Review Questions have been set in increasing order of difficulty and each odd number Question is complimented by an even numbered question with the same difficulty level.Solutions to odd numbered questions are given in the appendix at the end of the book. In addition solutions to even numbered questions are available in a separate manual. Teachers using “AS Accounting Theory and Practice” as a text book, may get the manual by applying officially on a school letterhead. Providing the students with a solid foundation in the “Why” as well as the “How” of accounting concepts, the emphasis is put on understanding rather than mere cramming.A brief list of learning objectives at the beginning of each chapter will assist the readers to determine the things they should understand while going through the chapter. Hence, checking back may help them to identify weak areas which still need thorough review. I would like to thank numerous people for the contribution they made to the writing of this book. In particular,I gratefully acknowledge the input that Mr. Sajid Munir made in developing the Review Questions, text for various chapters and for his constructive criticism throughout the process of developing the book. In addition, my thanks owe to the Sheraz Siddiq, Waseem Zia, Zafar Hashmi, Rabia Malik for their continuous support, insightful comments and suggestions during several stages of the book development.Following are the topics covered in this bookTable of ContentsPreface (Accounting AS Level)Chapter 1 Bookkeeping and AccountingBranches of accountingAccounting equationAssets 17Liabilities 17Equity 17Drawings 17TransactionCash transactions 17Credit transactions 17Balance sheet (statement of financial position)Balance sheet (vertical style) 19Review questionsChapter 2 Accounting for Assets, Liabilities and Capital Evolution of book keepingRules of debit and creditLedgerAccount “T” account 26Double-entry relating to assets and liabilitiesExample 27Balancing of an accountWhen should accounts be balanced? 30Trial balanceUses of a trial balance 31Why is it necessary for a trial balance to ‘balance’? 31Trial balance – an aid to financial statements 32Review questionsChapter 3 Accounting for InventoriesInventory of goodsBookkeeping for inventory of goodsPurchasesCash purchases 35Credit purchases 36SalesCash sales 36Credit sales 36Purchases returns (return outwards)Sales returns (returns inwards)Trading section of income statementClosing of incomes and expensesClosing inventoryOpening inventoryCalculation of profits for service businessesReview questionsChapter 4 Accounting for Incomes and ExpensesIncomesExpensesDouble-entry for expenses and incomes (revenues)Bookkeeping for incomes and expensesCalculation of profit for the yearClosing of incomes and expensesReview questionsChapter 5 Financial Statements – An IntroductionNeed for income statementUses of income statementCarriage inwardsCarriage outwardsIncome statement and balance sheet-an important considerationAccounting periodDrawingsAssetsNon-current assets 52Current assets 52LiabilitiesCurrent liabilities 52Non-current liabilities 52Review questionsChapter 6 Books of Original Entry & Division of LedgerAdvantages of maintaining books of original entryComponents of books of original entrySales journalPosting from the sales journal to the ledger 63Trade discount 63Sales on credit card 64Purchases journalPosting from the purchases journal to the ledger 64Return inwards journalPosting from the returns inwards journal to the ledger 65Return outwards journalPosting from the returns outwards journal to the ledger 66General journalPosting from the general journal to the ledger 68Cash bookTwo column cash book 68Cash discounts 69Three column cash book 69Nature of discounts columns 69Folio columns 70Contra entries 70Balancing of cash and bank columns 70Cash book in recent times 70Personal ledgersCash bookGeneral ledgerPrivate ledgerReview questionsChapter 7 Bank Reconciliation StatementsReasons for difference between bank statement and cash book balanceItems in the bank statement but not in the cash book 76Items in the cash book but not in the bank statement 76Bank reconciliation statementSteps for preparing a bank reconciliation statementUses of bank reconciliation statementReview questionsChapter 8 Bad Debts and Provision for Doubtful Debts Bad debtsDoubtful debtsProvision for doubtful debtsGeneral provision for doubtful debts 86Specific provision for doubtful debts 87Calculation of provision for doubtful debts 87Treatment of provision in financial statements 87Ageing scheduleBad debts recoveryCash discounts allowed and provision for discounts allowedBenefits of offering cash discounts 89Recording of provision for discounts allowed in journal 90Why provisions are made for bad debts and discounts allowedSalient points to noteReview questionsChapter 9 Accounting for Non-current AssetDepreciationAmortization and depletionEffects on cash flowsRelationship with market valueCauses for depreciationFactors for calculating depreciationThe original cost of asset 95The estimated useful economic life 95The approximate residual value 95Characteristics of depreciationWhy depreciation is provided for?Methods for calculating depreciationRevaluation method 96Straight line method or original cost method 96Reducing balance method 97Annual depreciation under reducing balance & straight line methodsDistinctive features of straight line and reducing balance methodChoice of a methodDifference between depreciation and provision for depreciationDepreciation policiesDepreciation accountingDepreciation and accounting conceptsReview questionsChapter 10 Accounting Concepts and ConventionsConventions and concepts – an implicationDual aspect (duality) conceptBusiness entity conceptPrudence conceptConsistency conceptMateriality conceptRealisation conceptAccrual conceptMatching conceptSubstance over formObjectivityMoney measurement conceptHistorical cost conceptGoing concern conceptRevaluation of assetsA critical review of accounting conventionsReview questionsChapter 11 Capital and Revenue Treatment of capital and revenue items in financial statementDistinction between capital and revenue expendituresExpenditures for acquisition of a non-current asset 113Expenditures for improving efficiency /capacity of a non-current asset 113Expenditure at the initiation of business 114Expenditure on extension of business 114Expenditures to increase the useful life of an asset 114Expenditures of abnormal amounts 114Application of materiality conceptDifference between capital and revenue receiptsRevenue receipts 114Capital receipts 114Effects of wrong treatment of capital and revenue itemsReview questionsChapter 12 correction of errors and suspense accountTypes of errorsErrors not affecting agreement of trial balance 118Errors affecting agreement of trial balance 120Suspense accountEffect on profit of correcting errorsEffects on balance sheet of correcting errorsReview questionsChapter 13 Control AccountsControl accounts in cambridge a level syllabusThe format of sales ledger and purchase ledger control accountsHow control accounts are prepared?Contra entryTwo balances of control accountsReasons for having two balances of a control account 131Treatment of two balances in the balance sheet 131Correction of errors in control accountsAdvantages and uses of control accountsLimitations (disadvantages) of preparing control accountsReview questionsChapter 14 Financial Statements with AdjustmentsCash and accrual basis of accountingNeed for adjustmentsTypes of adjustmentsInventory at year endClosing inventory in trial balance 143Drawings of goods for owner’s personal useAccrued expensesAccrued incomesPrepaid expenses (other receivables)Pre-received /deferred incomesTreatment of opening accruals or prepaymentsDepreciationMethods of depreciation 146Depreciation policies 146Recording of depreciation 146Bad debtsBad debts written off (included in the trial balance) 147Bad debts to be written off (given as an adjustment) 147Provision for doubtful debtsAdjusting more than two accountsCalculation of profits for service businessesUsers of financial statementsLimitations of financial statementsReview questionsChapter 15 Accounts from Incomplete RecordsThe reasons for incomplete recordsNeed for preparing financial statement from incomplete recordsCalculating profits and losses from changes in capital/net assetsStatement of affairs 161Statement of profit or loss 161Preparation of financial statements from incomplete recordsCalculation of opening capital through statement of affairs 162Preparation of cash/bank account 162Calculation of total sales 162Calculation of total purchases 163Calculation of incomes/expenses to be shown in income statement 164Calculation of non-cash expenses 166Mark-up and marginUse of mark up and margin to calculate missing items in trading section 167Conversion of mark-up into margin 169Conversion of margin into mark-up 170Calculation of goods lost by theft or firePreparing balance sheet from incomplete recordsInventory count and the balance sheet dateDisadvantages or defects of accounts prepared from incomplete recordsReview questionsChapter 16 Financial Statements of PartnershipsCharacteristics of partnershipAdvantages and disadvantages of the partnershipPartnership agreementContents of partnership deed 183Provisions of partnership act 1890 when no partnership agreement existsFinancial statements of a partnershipAppropriations of profit 184Balance sheet of partnerships 186Accounting records for partnersPartners’ capital accounts 186Drawings accounts 187Partners’ loan account 188Calculation of interest on capitalCalculation of interest on drawingsPartner’s guaranteed share in profitReview questionsChapter 17 Changes in PartnershipsAdmission of a new partnerRetirement or death of an existing partnerFinal settlement of retired or deceased partner’s capital 200Changes in profit-sharing arrangementsApportionment of profitsAdjustments for goodwillTypes of goodwill 202Factors affecting value of goodwill 202Valuation of inherent goodwill 203Why goodwill is accounted for in partnership? 204Accounting treatment of goodwill 204Case 1: A goodwill account is opened and retained 204Case 2: A goodwill account is opened and then written off 205Change in goodwill 206Revaluation on partnership changeOpening of a revaluation account 207Profit or loss on revaluation 207Revaluation of non-current assets with provision for depreciation 209Revaluation and the accounting conventions 211Values to remain unaltered in books 211Capital in profit and loss sharing ratiosReview questionsChapter 18 Dissolution of Partnerships Reasons of dissolving a businessRealisation accountAccounting treatment on dissolutionAssets on dissolution 225Goodwill on dissolution 225Liabilities on dissolution 225Expenses on dissolution 226Profit (loss) on realization account 226Partners’ loans accounts on dissolution 226Current account balances on dissolution 226Cash or bank balance on dissolution 226Partners’ capital accounts on dissolution 227Review questionsChapter 19 Financial Statements of CompaniesThe need for companiesChoice between a partnership and a limited companyAdvantages and disadvantages of forming a limited companyAdvantages of a limited company 233Disadvantages of forming a limited company 234Sources of finance for a companyTypes of sharesOrdinary shares 235Preference shares 235DebenturesTypes of preference sharesParticipating preference shares 236Non-participating preference shares 236Cumulative preference shares 236Non-cumulative preference shares 237Forms of capitalAuthorized share capital 237Issued share capital 237Called up share capital 238Paid up capital 238Financial statements of limited companiesStatement of changes in equityEquity dividends on ordinary shares19 ias rules for equity dividends 239Transfer to general reserve 239Shareholders’ equityReservesCapital reserves 239Revenue reserves 240Financial statements in cie examsA comparison of financial statements of business organisationsReview questionsChapter 20 Issue of Shares & DebenturesPrices of a sharePar value 248Issue price 248Book value 248Market value 248Selling shares to the general publicIssue of shares at par 249Issue of shares at premium (at a price more than face value) 249Rights issueAdvantages of rights issue 250Disadvantages of rights issue 250Bonus or scrip issueReasons for bonus issue 250Effect on earnings per share (eps) 251Advantages of bonus issue 251Disadvantages of bonus issue 252Difference between rights and bonus issueIssue of loans and debenturesIssue of debentures at par 253Issue of debentures at premium (at a price more than face value) 254Issue of debentures at discount (at a price below face value) 254Review questionsChapter 21 Ratio AnalysisFinancial ratiosAnalysis of ratiosComparing one year with another (trend or time series analysis) 259Comparing one business with another business (cross-sectional analysis) 260Rule of thumb 260Demonstration of ratiosProfitability ratiosGross profit ratio 260Profit for the year ratio 261Operating expenses ratio 261Return on assets 262Return on capital employed (roce) 262Return on equity 262Activity ratiosInventory turnover ratio 263Trade receivables’ collection period 263Trade payables’ payment period 264Non-current asset turnover 264Liquidity ratiosCurrent ratio 265Liquid ratio 265Uses of ratio analysisLimitations of ratio analysisUsers of financial ratiosPreparation of financial statements with the help of ratiosReview questionsChapter 22 Statement of Cash FlowsClassifications of cash flows – an exampleCash and cash equivalentsCash 277Cash equivalents 277Bank overdrafts 277Preparation of a statement of cash flowsCash flow from operating activitiesImportance of cash flow from operating activities 277Calculation of cash flow from operating activitiesCash from operating activities in direct method 277Cash from operating activities in indirect method 277Investing activitiesFinancing activitiesCash flow at a glanceUses of a statement of cash flowsReview questionsChapter 23 Cost Accounting – An IntroductionDifference between cost and expenseCost classification by changes in activityFixed cost 290Variable costs 290Mixed costs 290Step costs 291Cost classification by traceabilityDirect costs error! Bookmark not definedIndirect costs 291Sunk costs 291Direct labour costIndirect labour costLabour cost and timekeepingClock card (time card) 292Time sheets 292Wage sheet 292Calculation of labour costPiece work wage system 292Time wage system (pay on time basis) 293OvertimeIncentive schemes and bonus plansReview questionsChapter 24 Inventory Valuation – Further IssuesInventory valuation methodsFirst in first out (FIFO) 300Last in first out (LIFO) 301Weighted average cost (AVCO) 301Relationship of inventory valuation methods with physical flow of goodsBases of inventory valuationRole of accounting concepts in inventory valuationSeparate valuation of inventory itemsCalculation of cost of work in processEffects of errors in valuing inventoryGoods on sale or returnGoods sent to customers on sale or return (approval) basis 303Goods received on sale or return (approval) basis 303Systems of inventory accountingPeriodic inventory system 304Perpetual inventory system 304Review questionsChapter 25 Absorption CostingAbsorption costingCalculation of total production costFeatures of absorption costingAbsorption costing in price settingCost centerProduction cost centers 312Service cost centers 312Cost unitAllocation of production overheadsApportionment of production overheadsAllotment of service department costs to production departmentsProduction cost centers 313Service cost centers 314Allotment of non-reciprocal services 314Allotment of reciprocal services 315Calculation of overhead absorption ratesActual vs predetermined absorption rate 317Advantages of using predetermined overhead absorption rates 317Choosing the appropriate absorption base 320Single (factory wide) overhead absorption rate 320Departmental overhead absorption rate 320Absorption of overheadsOver/under absorbed overheadsOver-absorbed overheads 321Under-absorbed overheads 321Costing systems/methodsSpecific order costing 321Continuous costing 322Review questionsChapter 26 Marginal CostingMarginal costMarginal costingThe principles of marginal costingAdvantages and disadvantages of marginal costing techniqueAdvantages 330Disadvantages of marginal costing technique 330The uses of marginal costingContributionBreak even analysisBreak-even point 331Break-even point in sales ($) value 332Target profits 332Break even chart 333Assumptions and limitations of break even analysis 334Significance of break even analysis 335Margin of safetyProfit-volume chartHow to increase contribution ratio 337Income statements under marginal costing and absorption costingProfits of marginal costing and absorption costing 339Difference between marginal and absorption costing 339Short term decision makingMake or buy decisionQualitative factors for make or buy decision 341Special order to use up spare capacityAcceptance of order with negative contribution 343Conditions for accepting order below normal price 343Considerations for accepting order below normal price 344Consequences of acceptance of order below normal price 344Abandonment of a product line/departmentFactors to be considered before closure of a department 345Limiting factorExamples of limiting factors 345Reducing the effects of limiting factors 346Decision- making process to reduce effects of a limiting factor 346Review questionsChapter 27 Accounting & Business Planning 359Difference between budgets and budgetary controlPurposes of budgetAdvantages of budgetary control systemLimitations of budgetary control systemStages in the budgetary planning processEffects of principal budget factors on the preparation of budgetsBehavioural aspects of budgetary control systemSolutions to Odd Numbered QuestionsChapter 1Chapter 2Chapter 3Chapter 4Chapter 5Chapter 6Chapter 7Chapter 8Chapter 9Chapter 10Chapter 11Chapter 12Chapter 13Chapter 14Chapter 15Chapter 16Chapter 17Chapter 18Chapter 19Chapter 20Chapter 21Chapter 22Chapter 23Chapter 24Chapter 25Chapter 26Key to Even Numbered QuestionsIndex