Books of original entry and ledgers

What is the name of the document sent to a customer by a supplier at the end of the
month showing the amount payable for credit sales?

Statement (of account)

Tahir Ali is a trader who keeps a full set of accounting records. He divides his ledger
into three specialist areas nominal (general) ledger, purchases (creditors) ledger and
sales (debtors) ledger.

State one advantage of dividing the ledger into these three areas.

Work can be shared between several people

Easier for reference as same type of accounts are kept together
Easier to introduce checking procedures

Cash book,Petty cash book and bank reconciliation.

Explain what is meant by the imprest system in relation to petty cash books.

The petty cashier starts each period with the same amount of money (the
imprest).
At the end of the period the chief cashier will make up the cash remaining so
that it is equal to the imprest amount (1)

Give two examples of adjustments made in a bank reconciliation statement.

Outstanding lodgements
uncredited or unpresented cheques
Items found in updating cash book, e.g. direct debits, bank interest, charges,
dishonoured cheques, bank or cash book errors

State two reasons, other than finding errors, why Jane should reconcile her cash book
with the statement received from the bank.
Ascertain the true bank balance at a certain date
Assist in detecting fraud and embezzlement
Identify any stale cheques
Demonstrate that any differences between the cash book balance and that on
the statement are due to genuine reasons such as standing orders, bank charges,
credit transfers

1
Explain why items are recorded on the opposite side of the cash book to that on which
they appear on the bank statement.
The bank statement is a copy of the account of the business as it appears in the books of
the bank. This is from the viewpoint of the bank the business depositing money is a
creditor of the bank.
The bank account in the cash book is prepared from the viewpoint of the business the
bank is a debtor of the business which has deposited the money.

Explain the difference between capital expenditure and revenue expenditure.

Capital expenditure is money spent on acquiring, improving and installing fixed assets.
Revenue expenditure is money spend on running a business on a day-to-day basis.

Explain the difference between capital receipts and revenue receipts.

Capital receipts are amounts received from the sale of fixed assets
Revenue receipts are sales and other items of income which are recorded in the trading
and profit and loss account.

Control accounts

State advantages of preparing control accounts.

Assist in the location of errors

Provide instant totals of debtors/creditors
Proves the arithmetical accuracy of sales/purchases ledgers
Enable the Balance Sheet to be prepared quickly
Provide a summary of the transactions relating to debtors/creditors
Provide an internal check on sales/purchases ledgers may reduce fraud

State advantages of preparing a sales ledger control account other than the location of
errors.
Provides instant total of debtors
Proves the arithmetical accuracy of sales ledger
Enables the Balance Sheet to be prepared quickly
Provides a summary of the transactions relating to debtors for the period
Provides an internal check on the sales ledger may reduce fraud

Explain what is meant by a contra entry in connection with control accounts.

A contra entry is where a transfer is made from an account of a person/business in the

sales ledger to an account of the same person/business in the purchases ledger.
This may occur when a person/business is both a customer and a supplier.

2
State two reasons why it is possible to have a debit balance on a purchases ledger
control account.

Overpayment of amount due

Cash discount not deducted before payment made
Returned goods after payment of amount due
Payment made to creditor in advance
State one reason why it is possible to have a credit balance brought down on a sales
ledger control account.

Overpayment of amount due by debtor

Cash discount not deducted by debtor before payment made
Goods returned by debtor after payment of amount due
Payment made in advance by debtor

Explain why the information used to write up Susans purchases ledger control
account is obtained from books of prime (original) entry and not from the purchases
ledger.

A purchases ledger control account acts as a check on the purchases ledger. If there is
an error in the purchases ledger it will not be revealed by a control account prepared
from the individual accounts in that ledger.

Partnerships accounts

Ann and Fay are in partnership They invited Kim to join the partnership;
State one disadvantage to Ann and Fay of Kim joining the partnership.

Ann and Fay lose a degree of control

Ann and Fay will have to share any future profits with Kim
The risk of conflict of opinion is increased
May involve extra costs (accommodation/staff support etc.)

Explain to Kim two advantages of joining the partnership.

Will have a share in the profits
Can take part in decision-making
Prospects for the future
Explain to Kim two disadvantages of joining the partnership.

Will be personally liable for the debts of the firm

Will have greater responsibility
Will probably have to invest capital

3
Explain why, in addition to agreeing the profit-sharing ratio, Ann, Fay and Kim should
draw up a partnership agreement.

To avoid disagreements/misunderstandings later [2]

Interest on capital [1]
Partners salary

Explain why Ann and Fay should value the Goodwill of the business before admitting
Kim to the partnership.
A new partner joining an existing partnership will benefit from the Goodwill built up by
the existing partners, who must be compensated for this.

State and explain one advantage of maintaining both a capital and a current account
for each partner.

Easier to see profit retained by each partner

Easier to calculate interest on capital (if allowed)
Easier to see salary earned by partner(s)
Easier to see drawings made by a partner
Easier to calculate interest on drawing (if charged)

Depreciation and application of matching and prudence concept.

Name one accounting principle which is applied when fixed assets are depreciated.
Matching or Prudence

Explain why the accounting principle named above is applied when providing for
depreciation of fixed assets.

Matching
To ensure that the loss in value of fixed assets is spread over the period in which they
are earning revenue.
OR
Prudence
To ensure that the profit is not overstated and the value of the fixed assets is not
overstated.

4
Tahir Ali decided that depreciation should be calculated on motor vehicles owned at
31 December each year at the rate of 20 % per annum, using the reducing
(diminishing) balance method. A full years depreciation should be provided in the
year of purchase, but no depreciation should be provided in the year of disposal.

Explain how Tahir Ali is applying the matching principle when he depreciates his
motor vehicles.

Ensures that the loss in value of motor vehicles is spread over the period in which they
are earning revenue.

Explain the revaluation method of depreciation.

Fixed assets are valued at the end of each financial year.

This value is compared with the previous valuation (or the cost if it is the first
year of ownership) and the amount by which the asset has fallen in value is the
depreciation for the year.

State one type of fixed asset which is suitable for depreciation using the revaluation
method.

Hand tools
Packing cases/crates

Bad debts ,Provision for doubtful debts and application of matching and
prudence concept.

Mohammed is a trader. His financial year ends on 31 January. Miriam employs a

bookkeeper to maintain her financial records.

The following account appears in Mohammeds ledger:

Provision for doubtful debts account

2008 $ 2007 $
Jan 31 Profit & loss 50 Feb 1 Balance b/d 650
Balance c/d 600
650 650
2008
Feb 1 Balance b/d 600

5
State one reason why Mohammed should maintain a provision for doubtful debts.

Ensures that profits are not overstated (prudence)

Ensures that debtors are shown in balance sheet at more realistic amount
(prudence)
Application of matching principle as the amount of sales unlikely to be paid for
are treated as an expense of that particular year

Explain each entry in the provision for doubtful debts account as it appears in
Mohammeds ledger.

2007 February 1 Balance

The provision for doubtful debts in existence at that date brought down from the
previous financial year. (2)

2008 January 31 Profit and loss

The amount transferred to the profit and loss account representing the surplus
provision no longer required. (2)

Explain the significance of the $600 shown at the end of the account.
The new provision for doubtful debts carried forward to the next financial year. (2)

State four ways in which Mohammed could reduce the risk of bad debts.

Obtain references from new credit customers

Fix a credit limit for each customer
Issue invoices and statements promptly
Follow up overdue accounts promptly
Supply goods on a cash basis only
Refuse further supplies until outstanding account is paid

State two possible advantages to Mohammed of paying his creditors before the due
date.
May be able to take advantage of cash discounts
Improve the relationship with suppliers

State one possible disadvantage to Mohammed of paying creditors before the due
date.

The business is deprived of the use of the money earlier than necessary

6
John Chans financial year ends on 30 April. The following account appears in his
nominal (general) ledger:

Provision for Doubtful Debts account

2006 $ 2005 $
April 30 Profit & Loss 80 May 1 Balance b/d 500
Balance c/d 420 ___
500 500
2006
May 1 Balance b/d 420

Explain why $80 is transferred from John Chans provision for doubtful debts account
into his Profit and Loss Account for the year ended 30 April 2006.

The $80 transferred to the Profit and Loss Account is the difference between the
provision for doubtful debts at the start of the year and the provision required to carry
forward to next year. In this case it is the amount of surplus provision not required. (2)

State whether the $80 will appear as a debit or a credit item in John Chans Profit and
Loss Account for the year ended 30 April 2006.

This amount will be credited to the Profit and Loss Account.

John Chan is rather disappointed with the collection period for debtors. Explain three
ways in which the collection period for debtors may be improved.

Offer cash discount for prompt payment

Charge interest on overdue accounts
Improve credit control
Refuse further supplies on credit until any outstanding balance is paid

Ahmed is a trader who sells goods on credit. He offers his credit customers a cash
discount of 3 % provided the account is paid within 30 days. He has applied the
accounting principle of prudence and maintains a provision for doubtful debts. This
provision amounted to $150 on 1 February 2006.

State two effects on his final accounts of applying the principle of prudence.
So that the profits for the year are not over-stated [1]
So that the debtors in the Balance Sheet are shown at a realistic amount [1]

Name one other accounting principle which Ahmed is applying by maintaining a

provision for doubtful debts.
Matching principle

7
Nangolo is a trader. His financial year ends on 31 December.
State, giving a reason, what entries (if any) Nangolo should make in his accounting
records in each of the following situations.

On 31 December 2003 Zanetti, a debtor, owes $24 for goods purchased on credit in
2002. Nangolo has been unable to find Zanetti.

Write Zanettis account off as a bad debt (1)

Explanation: Amount now outstanding for over 1 year with little hope of
recovery (1)

On 31 December 2003 Lim, a debtor, owes $390 for goods purchased on credit in
November 2003. The period of credit allowed is 1 month. Lim has informed
Nangolo that he is unlikely to pay the amount due before February 2004.
No entries in accounting records are necessary (1)
Explanation: Account is still likely to be paid, there is no evidence yet that it will
not be paid by Lim (1)

On 31 December 2003 Nangolo examines his sales ledger and decides that he is
unlikely to receive $280 of the total amount owing to him.
Create a provision for doubtful debts of $280 (1)
Explanation: Must ensure that he does not overstate his net profit for the year
(1)

Stock valuation and application of prudence concept

State the basis on which Mohammed should value his closing stocks.

Stocks are valued at the lower of cost and net realisable value.

Name one accounting principle Mohammed is applying by valuing his closing stocks on
this basis.
Prudence

8
Income and expenditure accounts (Non Profit making entities)

Following terms are used in connection with non-trading organisations such as clubs.
Explain each of the following terms.

Income and Expenditure Account

The Income and Expenditure Account is equivalent to a Profit and Loss Account of a
trading organisation. (1) It is used to calculate the annual surplus or deficit. (1)
Or other suitable points [2]
Accumulated Fund
The accumulated fund is equivalent to the capital of a trading organisation, the
difference between the assets and the liabilities. (1) The annual surpluses (less any
deficits) accumulate within a non-trading organisation to form the accumulated fund.
(1)

State one of the items appearing in the summary of the cash book which should not
be included in the income and expenditure account and explain why it does not
appear.

Opening bank balance (1)

This is neither income nor expenditure for the year as it represents the bank
overdraft on1 October 2006/ it represents the amount of money in the bank on that
particular date.
(1)
Or
Opening balance or closing balance (1) Opening/closing bank balance is neither
income nor expenditure for the year as (1
Purchase of new instruments/ equipment (1)
This is not regarded as revenue expenditure as it is the purchase of a fixed asset.
(1) [2]

Or
Transfer to bank deposit account (1) Transferring money from one bank
account to another is neither income nor expenditure. (1)

9
Select one of the items appearing in the income and expenditure account which does
not appear in the receipts and payments account and explain why it does not appear.

Either Subscriptions prepaid (1) This item represents an amount received

during the previous financial year which relates to the current financial year.
Application of matching principle. (1)

Or Subscriptions owed by member at the end (1) This item represents an

amount relating to the current financial year which has not yet been received.
Application of matching principle. (1)

Or Rent accrued (1) this item represents an amount relating to the current
financial year which has not yet been received. Application of matching
principle. (1)

Or Depreciation of equipment (1) this is a non-monetary expense but must be

taken into account in calculating the surplus/deficit. Application of matching
principle. (1)

Or Deficit for the year (1) this is the difference between the income and
expenditure and is the loss for the year and does not represent money
paid/received. (1)Alternatively surplus with a suitable comment if a surplus is
shown in the answer

10
Explain each of the following entries in the subscriptions account as it appears in the
ledger of El Nil Sailing Club. State where the double entry for each transaction would
be made.

2005, Aug 1
Balance $750
Explanation this represents the amount of subscriptions still outstanding from members
for the financial year ended 31 July 2005

Double entry Credit subscriptions account for the year ended 31 July 2005 (1)

2006, July 31
Bank $5850
Explanation: this is the total amount of subscriptions received from members during the
financial year ended 31 July 2006

Double entry Debit bank account (1)

2006, July 31
Income and Expenditure Account
Explanation this is the total subscriptions which relate to the financial year ended 31
July 2006(1)
Double entry Credit Income and Expenditure Account (1)
(ii) The significance of the $900 shown at the end of the account
This represents the amount paid by members during the financial year ended 31 July
2006 but which relates to the following financial year.
It will appear as a current liability in the Balance Sheet as at 31 July 2006.

Working Capital Management .

State what is meant by working capital.

Current assets less current liabilities

Explain why it is important for a business to have an adequate amount of working

capital.

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

11
State and explain two disadvantages to a business of having insufficient working
capital.
May have problems paying debts as they fall due
May not be able to take advantage of cash discounts
Cannot make the most of opportunities as they occur
Difficulties in obtaining further supplies
Or other suitable points

State two ways in which a business could increase its working capital.

Injection of more capital

Long-term loans
Sale of surplus fixed assets
Reduce drawings

On 31 December 2008 Morag MacDonald had money in the bank but her working
capital was lower than it was at the start of the year.

State and explain the effect of each of the following transactions on Morag
MacDonalds working capital.
Office equipment, $10 000, was purchased by cheque.
Effect working capital decreases by $10 000
Explanation The current assets decrease by $10 000 as the bank balance
decreases. There is no change in the current liabilities.

An increase in the provision for doubtful debts of $50.

Effect Working capital decreases by $40 (1)

Explanation Current assets decrease by $50 as net debtors decreases.
There is no change in the current liabilities. (1)

Payment of $200 by a debtor in cash.

Effect Working capital does not change (1)

Explanation The current assets do not change as the cash increases and the
debtors decrease by $200. There is no change in the current liabilities. (1)

Payment of $96 by cheque to a creditor in full settlement of $100 owing.

Effect Working capital increases by $4 (1)

Explanation Current assets decrease by $96 and the current liabilities decrease
by $100. (1)

12
 Financial Ratio analysis
Explain why the quick ratio more reliable than the current ratio as an indicator of
liquidity.

Does not include stock in the calculation

Either
Stock is not regarded as a liquid asset a buyer has to be found and then the
money collected. Some stock may prove to be unsaleable.
Or
The quick ratio shows whether the business would have any surplus liquid funds
if all the current liabilities were paid immediately from the liquid assets.

State two ways in which the rate of stock turnover of finished goods may be
improved.
Reduce stock levels
Generate more sales activity

Explain the difference between mark-up and margin.

Mark-up is when the gross profit is measured as a percentage of the cost price of
the goods (1)
Margin is when the gross profit is measured as a percentage of the selling price
of the goods

State two ways in which the percentage of gross profit to sales could be improved.

Look for cheaper supplies

Increase selling prices
Change proportions of different types of goods sold

State two ways in which the percentage of net profit to sales could be improved.

Increase gross profit e.g. increase profit margin, increase selling prices etc.
Increase sales
Reduce expenses e.g. reduce staffing levels, reduce advertising etc.
Increase other income e.g. rent out part of premises, earn more discount

State two possible advantages to Mohammed of paying his creditors before the due
date.
May be able to take advantage of cash discounts
Improve the relationship with suppliers

13
State one possible disadvantage to Mohammed of paying creditors before the due
date.

The business is deprived of the use of the money earlier than necessary

Users of accounting information

List three business people (excluding the owner) who would be interested in a
business final accounts.
In each case state one reason why the person would be interested in the accounts.
Bank manager
Assessment of prospects of any requested loan/overdraft repaid when due
Assessment of prospects of any interest on loan/overdraft being paid when due
Assessment of the security available to cover any loan/overdraft
Lenders
Assessment of prospects of any requested loan when due
Assessment of prospects of any interest on loan being paid when due
Assessment of the security available to cover any loan
Creditor for goods
Assessment of the liquidity position
Identifying how long the business takes to pay creditors
Identifying future prospects of the business
Identifying what credit limit is reasonable
Managers (if any)
Assessment of past performance
Basis of future planning
Control the activities of the business
Identifying areas where corrective action is required

Or other suitable interested persons e.g. trades unions/employees/ government

bodies/take-over-bidders/competitors etc

14
 Qualitative characteristics of accounting information

List four objectives which Ahmed must consider when selecting accounting
policies.(Qualitative features of accounting information)

Relevance
Reliability
Comparability
Understandability
Explain to Ahmed what is meant by the term relevance.
Financial information is only relevant if it can be used
To confirm or correct prior expectations about past events
To assist in forming, revising or confirming expectations about the future
As the basis for financial decisions

Explain the meaning of the accounting term comparability

It must be recognised that a financial report can only be compared with reports for
other periods if similarities and differences can be identified.

Explain the meaning of the accounting term reliability.

Information provided in financial statements must be reliable (1)

Either
It must be capable of being depended upon as a faithful representation of the
underlying transactions and events it represents (1)
Or
It must be capable of being independently verified (1)
Or
It must be free from bias (1)
Or
It must be free from significant errors (1)
Or
It must be prepared with suitable caution being applied to any judgments and
estimates (1)

15
 Limitation of accounting statements.

Mohammeds accountant informed him that the accounting statements prepared at

the end of the financial year provide only a limited amount of information about the
business.
State how each of the following may be regarded as a limitation of accounting
statements.

Historic cost
All transactions are recorded at the actual cost price. It is difficult to compare
transactions taking place at different times.

Money measurement
Accounts only record information which can be expressed in monetary terms.
This means that many factors which affect the performance of a business will not
appear in the accounting records. (1)
Time factor
Accounting statements are a record of what has happened in the past.
Either They are not necessarily a guide to future performance (1)
Or significant events can occur between the end of the financial period and the
time when the accounting statements are available.

Limitations in comparisons of financial information.

Farouks brother Ahmed has a business which has a higher return on capital employed
than Farouks business. Suggest two reasons for this difference.

Different type of business

Different products
Capital/labour intensive business
Business with higher net profit
Business with lower capital

Maria is interested in comparing her results with those of another business and has
obtained the final accounts of some other businesses in the same city.

Explain three factors which Maria should bear in mind when attempting to compare
her results with the accounts she has obtained relating to other businesses.
Should compare with a business in same trade
Should compare with a business of approximately the same size
Should compare with a business of the same type (sole trader/partnership etc)
The accounts may be for 1 year only which will not show trends and may not be
a typical year

16
 The financial year may end on different dates and the period of time covered
may be different
The businesses may operate different accounting policies
There may be differences which affect profitability and the items on the Balance
Sheet
The accounts do not show non-monetary items, but these are important in the
success of a business
It is not always possible to obtain all the information about a business in order to
make a true comparison

Ahmed would like to compare his results with those of other businesses.
He is aware that even comparing with a business of a similar size dealing in similar
goods can produce misleading results.
List four things Ahmed should consider when comparing his results with those of a
similar business.

There may be differences that affect profitability e.g. one business may rent
premises and the other business may own premises.
The accounts may be for 1 year only and not show trends
The accounts may not be for a typical year
The financial year may end at a different point in the trading cycle
The businesses may operate different accounting policies e.g. depreciation
The accounts do not show non-monetary items but these are important in the
success of a business
It is not always possible to obtain all the information about a business in order to
make a true comparison

Karabo wishes to compare her results with those of a similar business. She is aware
that there are problems in making such a comparison.
Explain how each of the following affects inter-firm comparison. Use examples to
illustrate your answers.
Different type of expenses
One business may own premises, another may rent premises. This affects the
expenses and the profit and the profitability ratios making comparison
difficult.
Non-monetary factors
One example goodwill, quality of management, or other suitable example such
items will not appear on the accounting statements but can influence the
profitability and prospects of a business.
Accounting policies
Accounting policies one example methods of depreciation, methods of stock
valuation, or other suitable example (1) these will affect calculation of the profit
and the profitability ratios and the value of the assets.

17
18